Retirement Flashcards
(152 cards)
1
Q
Defined Benefit Pension Plans
A
- Defined Benefit
- Cash Balance
2
Q
Defined Contribution Pension Plans
A
- Money Purchase Pension Plan
- Target Benefit Pension Plans
3
Q
Defined Contribution - Profit Sharing Plans
A
- Profit Sharing Plans
- Stock bonus plans
- EE Stock ownership plan
- 401k plan
- thrift plan
- new comparability plan
- aged-based profit sharing plans
4
Q
Pension Plans
A
- a qualified retirement plan that pays a benefit, to a plan participant for the participants entire life during retirement
5
Q
Profit Sharing Plans
A
- plan participants usually become responsible for the management of the plan’s assets (investment decisions) and sometimes even responsible for personal contributions to the plan
6
Q
Pension Plan vs. Profit Sharing Plan
A
7
Q
Defined Benefit Plan
A
- all DB plans are pension plans
- Pension plans can be either DB or DC
8
Q
Defined Contribution Plan
A
- DC plans can be either pension plans or profit sharing plans
- all profit sharing plans are DC plans
9
Q
Defined Benefit vs Defined Contribution
A
10
Q
Advantages of Qualified plans
A
- ER contributions are currently tax deductible
- ER contributions to the plan are not subject to payroll taxes
- availability of pretax contributions for employees
- tax deferral of earnings on contributions
- ERISA protection
- Lump-sum distribution options (10-year averaging only for those born prior to 1936)
11
Q
Disadvantages of Qualified plans
A
- limited contribution amounts
- contributions cannot be made after $ is received
- plans usually have limited investment options
- no/limited access to money while an active EE
- distributions usually taxed as OI (basis =0)
- early w/d penalties may apply
- mandatory distributions at age 72
- only ownership permitted is by the account holder
- cannot assign or pledge as collateral
- cannot gift to charity before 70.5 without income tax consequences
- any year a deductible contribution is made to an IRA and a charitable distribution is made from an IRA, the allowable charitable deduction will be reduced by deductible contributions made after 70.5
- limited enrollment periods
- considered to be an IRD asset, subjecting distributions to both income and estate taxes with no step-up in basis
- costs of operating the plan (charitable gifts from IRA post age 70.5 and pre-age 72 will not count towards RMDs for those turning 70.5 after 2019
12
Q
ERISA Protection
A
- anti-alienation protection
- qualified retirement plan assets are not protected from alienation due to a QDR, fed tax levy, or from a judgement/settlement rendered upon an individ for a criminal act involving the same qualified plan
- IRAs do not have ERISA protection
13
Q
Qualified plans
A
- provide ERS with current income tax deductions and payroll tax savings
- provide plan participants with income tax deferrals, payroll tax savings, and federally provided creditor asset protection
14
Q
Trade-offs for the tax advantages of qualified plans
A
- cost of the plan and compliance (vesting, funding, eligibility, nondiscrim testing, IRS reporting, and EE disclosure)
15
Q
Taxation of Qualified Plan Contributions
A
- ERs receive a current income tax deduction for contributions made to plans - ordinary and necessary cost of biz
- ERs are limited to a max of 25% of the total covered comp paid to its EEs as a contrib to a qualified plan
- EEs are not currently taxed on the related plan contribution - EEs will be taxed when the funds are distributed from the plan
- an EEs wages are subject to payroll taxes = 6.2% for OASDI on their com up to $147kand 1.45% for Medicare tax on 100% of the EEs comp
- the ER is required to match any payroll taxes paid by the EE, creating a combined total payroll tax of 12.4% for OASDI up to $147k and 2.9% for Medicare (100% of comp)
- ERs and EEs are exempt from payroll taxes on ER contributions to a qualified retirement plan, providing up to 15.3% savings on taxes for ER contributions into a qualified plan
- an individual is liable for additional Medicare Tax of 0.9% if the individuals wages, comp, or self-employment income exceeds the threshold amount for the individuals filing status:
- MFJ $250k
- MFS $125
- S $200k
- HOH $200k
- W w/ dep child $200k
16
Q
Key Employee
A
- > 5% owner
- > 1% owner with compensation >$150k OR
- an officer with compensation > $200k
- must be an officer OR an owner. Compensation itself will not make an EE a key EE
17
Q
Top Heavy Plan
A
- designed to ensure that qualified plans that significantly benefit owners and execs of the company (key EEs) must provide some min level of benes for the rank and file EEs
18
Q
Part time EE
A
- will change for plan years AFTER 1/1/2021
- consecutive 3 years of services (500+ hours)
- must be met before prior to being eligible
19
Q
Cash balance plans
A
- use 3 year cliff vesting schedule
20
Q
officer
A
- an administrative executive who is in regular and continued service
- no more than 50 EEs must be treated as officers
- if >50 officers, then only the 1st 50 ranked by compensation will be considered under Key EE definition
21
Q
Top Heavy Plan Determination
A
- DB Plan: considered when the PV of the total accrued benes of key EEs in the DB plan > 60% of the PV of total accrued benes of the DB plan for all EEs
- DC plan: considered when the aggregate of the account balances of key EEs in the plan > 60% of the aggregate accounts of all EEs
- if >60% of the benefits or contribution are going to Key EEs
22
Q
Top Heavy Vesting
A
- qualified DB retirement plan must accelerate the vesting from the standard vesting schedule to a 2-6 year graduated or 3-year cliff to maintain qualified status
23
Q
Top Heavy Funding
A
- must have a minimum level of funding for its non-key EEs
24
Q
Minimum Funding for contribution plans
A
- DC plan must provide each of its non-excludable, non-key EEs a contribution = at least 3% of the EEs compensation
- an exception to the 3% min funding req occurs when the largest funding made on behalf of all Key EEs is < 3%. the ER must provide non-key EEs with a contribution = to that of the Key EEs
25
Defined Benefit Plan
- a top-heavy DB plan must provide a benefit to its non-key EEs = to 2% per the EEs years of service * EEs average annual compensation over the testing period
26
Defined Benefit Plan
= 2% * YOS *compensation factor
27
Defined Contribution Plan
= 3% of EEs compensation
28
Covered Comp
$305,000
29
Section 72 annuity rules
- govern an IRA distribution that includes non-deductible and deductible contributions
30
Unearned portfolio income
- interest
| - dividends
31
Active Participants
- use thresholds of:
S: $68k - $78k
MFJ: $129k-$144k
32
Time Weighted Return
- activity IRR of just 1 stock
33
Dollar Weighted Return
Activity IRR of ALL stocks
34
Payout Ratio
- % of NI paid out as dividends
| - measure of a company's earnings retention philosophy
35
Defined Contribution Plan max contribution
100% of EEs compensation OR $61,000
36
max contribution limit entails:
EE contributions + ER contributions + forfeitures allocated from nonvested EEs terminated during the year
37
ER contribution to a Defined Contribution plan
- include any mandatory contributions, elective deferral contributions, AT contributions
- limited to $61,000
- if over 50, max of $67,500
38
forfeitures from nonvested EEs
-included as a contribution to the plan when determining the max annual limit
39
ER contribution limit
- ERs cannot deduct contributions to DC plans in excess of 25% of the ERs total covered comp ($305k)
- 25% does not apply to DB pension plans bc ER is required to fund the DB plan to the min funding standard determined by the actuary
40
DB Covered Comp Limit
$305k
41
DB MAX BENEFIT
lesser of:
- $245k
- average of 3 highest consecutive years of compensation
42
DC Covered Comp Limit
- $305k
43
DC max benefit
100% of compensation or $61k
44
Max defined contribution limit
= ER contribs + EE contribs + plan forfeitures = lesser of $61k or 100% compensation
45
controlled group
- combo of 2+ trades or bizs that are under common control
| - parent-subsidiary, brother-sister, combined group
46
Parent-subsidiary Relationship
- exists when 1+ corps are connected through stock ownership with a common parent corp AND
- 80% of the stock of each corp is owned by 1+ corp in the group
- the parent corp owns 80% of at least 1 other corp
47
Brother-sister relationship
- group of 2+ corps, where 5 or less common owners own directly or indirectly a controlling interst of each group and have "effective control"
- controlling interest means 80% or more of the stock of each corp
- effective control means > 50% of the stock of each corp, but only to the extent such stock ownership is identitcal w/ respect to such corp
48
Combined Group
consists of 3+ orgs that are organized as follows:
- each org is a member of either a parent-subsidiary or bro-sis group AND
- at least 1 corp is the common parent of a parent-subsidiary AND
- is also a member of a brother-sister group
49
Affiliated Service groups
- treat all EEs of the members of an affiliated service group as if a single ER employed them
- means a group consisting of a service org and 1+ A or B orgs
- may also involve a Management Organization
50
legal promise of a pension plan
- to pay a pension
51
PBGC monthly benefit at age 65
$6,204.55
52
PBGC yearly benefit at age 65
$74,454.60
53
Annual pension benefit amount
= 1.5% per year * # of years of service * average of 3 highest consecutive years salary
54
Pension Plan Chacteristics
- gov reqs annual and mandatory funding
- disallows in-service w/ds
- limits the investment of the plan assets in the ERs securities
- limits the investment of the plan assets in life insurance
- PBGC was established to provide add'l protection to lower-wage participants of DB plans
55
DB pension plan in-service distributions
- for 62 yrs or older
| - takes the form of a phased retirement benefit
56
Qualified Plan that includes life insurance must pass either the:
- 25% test OR
| - the 100% to 1 ratio test
57
25% Test for Life Insurance
- consists of 2 tests:
25% test and a 50% test
If term /UL insurance policy is purchased within the qualified plan, the aggregate premiums paid for LI policy cannot exceed 25% of the ERs agg contributions to the participants account
if whole life insurance policy is purchased within a qualified plan, the agg premiums paid for the whole life insurance policy cannot exceed 50% of the ERs agg contribution to the participants account
58
100 to 1 Ratio Test for Life Insurance in a qualified plan
- limits the amount of the DB of LI coverage purchased to 100x the monthly accrued retirement bene provided under the same qualified plans DB formula
59
Differences between a DB pension plans vs DC pension plan
- use of an actuary (annually or at inception)
- assumption of the investment risk (to ER or EE)
- disposition of plan forfeitures (reduce plan costs or allocate to remaining EEs)
- coverage under PBGC
- use of SSI
- the calc of accrued benes or account balance
- ability to grant credit for prior service for funding
- use of commingled funds vs separate, individual investment accounts
60
actuary
- used by a DB plan
- allows for some limited discrimination in benefit
- can increase costs of a plan
- DBs use only at inception and does not req actuarial work
- Money purchase pension plan has no need for actuarial services bc the annual contribution is predefined in the plan docs
61
PBGC
- pay premiums for insurance coverage designed to pay the "promised pension" in the event the plan is underfunded or unfunded
- only pays a limited retirement benefit $6,204 per month or $74,454.60 per year in the event a plan completely or partially terminating with an unfunded or underfunded liability
- does not insure DC pension or profit sharing plans and it does not insure DB pension plans or professional service corps with 25 or fewer participants
- does insure that all other DB plans and covered plans are req'd to pay a flat rate per participant premium
62
Participant in a DB Plan
- has an accrued benefit roughly equal to the PV of the expected future payments at retirement
63
permitted disparity
- social security integration
- allows a higher contribution or allocation of benefits to EEs whose compensation exceeds the SS wage base for the plan year
all qualified pension plans may use this as a method of allocating benefits to plan participants
- allows the qualified plan to consider the SS benefits that will be provided to plan participants in the calc of the participants accrual of benefit or contribution amount
- 2 methods: offset method and excess method
64
Excess Method (method of permitted disparity)
- provides an increasing % benefit to those plan participants whose earnings are in excess of an average of the SS wage bases over the 35 year period to the individuals SS retirement age
- the increased % benefit only applies to income that exceeds the covered comp limit and is limited to the lesser of:
- 0.75% per year of service
- the benefit % for earnings below the covered comp limit per year of service
- the max increase in benefits for compensation over the covered comp limit is 26.25%, which is 35 years * 0.75%
65
Retirement Benefit under a DB plan has 3 most common funding options:
- flat amount formula
- flat % formula
- Unit credit formula
66
Flat Amount Formula
- provides an amount that each plan participant will receive $250/mo at retirement
- each participant will receive the same exact amount at retirement
67
Flat % Formula
- all plan participants with a benefit = to a specific % of the participants salary (final or average of highest), the % remains the same throughout the participation in the plan and does not increase based on add'l YOS or age
68
Unit Credit Formula
- uses both a participants YOS and salary to determine the participants accrued benefit
- provide a fixed % of a participants salary * # YOS employed by the ER
- salary may be an average of the final 3 years, highest average 3 years or some iteration of that the ER chooses
- multiplier is chosen by the plan sponsor and is between 1-2%
69
Cash Balance Pension Plans
- require a guaranteed min investment return
- a DB pension plan that shares many of the characteristics of DC plans but provides specific defined retirement benes
- a qualified plan that consists of an individual account with guaranteed earnings attributable to the account balance
- the account the EE sees is a hypothetical account showing hypo allocations and earnings
- consists of the Pay Credit and Interest Credit Formula
- Pay Credit: integrated with SS to produce a higher benefit % to those participants who earn a salary above the SS wage base or may be based on a combo of age and YOS
- beneficial for younger participants bc the formula is based on # of years employed with a guaranteed rate of return. Younger participants have more years of contributions and earnings than older
- 3 YEAR CLIFF VESTING
70
Cash Balance Conversion
- when an ER changes from a traditional DB pension plan to a cash balance plan
- a popular choice to get rid of old expensive DB plans
- 3 requirements:
- a participant's accrued benefit would be equal to or greater than that of any similarly situated younger participant
- the interest rate used to determine the interest credit on the account balance in the hybrid plan must not be greater than a market rate of return, to be determined under regulations to be issued
- for plan years beginning after 2007, the hybrid plan must provide 100% vesting after 3 years of service
- addresses the "whipsaw" effect
71
whipsaw effect
- providing that the distribution of a participants hypo cash balance account is sufficient to satisfy their bene entitlement from distributions after the date of enactment
- ERs are no longer penalized for using a higher interest credit
72
Money Purchase Pension plan
- a DC pension plan that provides for a contribution to the plan each year of a fixed % of the EEs compensation
- the ER promises to make a specified contribution to the plan for each plan year, but the ER is not required to guarantee a specific retirement bene
- max contributions of either 25% of ERs total covered comp
- limited to contribution the lesser of 100% of the participants compensation or $61,000
- benefits younger participants because of the increased # of contributions and compounding periods
- 2-6 year graduated or 3-year cliff
73
EE contribute to
401ks
| thrift plans
74
ERs contribute to
money purchase pension plans
ESOPs
Profit sharing plan
75
target benefit pension plan
- special type of money purchase plan
- determines the contribution to the participants account based on the benefit that will be paid from the plan at the participant retirement
- plan formula may be written to provide a contribution to each participant during the plan year that is actuarially equivalent to the PV of the benefit at the participants retirement which provides a greater contribution for older participants
- actuary is required at the establishment of the plan but not required on an annual basis
- participant is responsible for choosing investments and is entitled to the plan balance at retirement
- favors older EEs
76
Profit Sharing Plan Categories
```
profit sharing plans
stock bonus plans
EE stock ownership plans
401k AKA CODA
age-based profit sharing plans
new comparability plans
```
77
profit sharing plan funding
- no mandatory funding
- contributions are discretionary but funding must be substantial and recurring
- generally have an ER plan contribution limit of 25% of covered comp
- can be funded as late as extensions on Oct 15
78
Permitted Disparity
- a technique of allocating plan contributions to EEs accounts so that a higher contribution will be made for those EEs whose comp is in excess of the SS wage base
- profit sharing plans only use the excess method
- Base rate: applied on income earned up to the integration level while the excess rate is applied to income earned above the integration level but only up to the max covered comp limit for the year $305k, excess rate is limited to the LESSER of twice the base rate or a difference of 5.7%
79
excess rate
generally 5.7% higher than the base rate
80
Base rate + Permitted disparity =
excess rate
| BP = exxon
81
permitted disparity for Profit Sharing Plans
= lesser of the Base Rate or 5.7%
82
Age-based profit sharing plans for Profit Sharing Plans
- use both age and compensation as the basis for allocating contributions to an EEs account
- chosen when the EE census is such that the owner or key EE is older than most or all other EEs and the company wants to tilt the contribution toward those older EEs
- use o fan actuary would allow for this 'tilting' of contributions
83
New comparability plans for Profit Sharing Plans
- generally a profit sharing plan where contributions are made to an EEs account based on their respective classification in the company as defined by the ER
- must comply with cross-testing rules to meet nondiscrimination rules
- cross testing rules dictate testing of DC plans on the expected benefits to be received by EEs at retirement
- more expensive to administer
84
Other Allocation Methods for Profit Sharing Plans
- a HC owner can fund his plan with the annual additions limit, $61k, using profit sharing plans with/w/o a cash or deferred arrangement
- the use of a CODA may enable an owner to reach the max contribution limit of $61k with a lower total ER contribution
85
Forfeitures for Profit Sharing Plans
- may be used either to reduce plan contributions or reallocated to the remaining participants accounts
- any such reallocations must not be discriminatory in favor of highly compensated EEs, owners, or officers
- can be allocated based on current year com - the same as normal contributions to the plan
- CANNOT BE REALLOCATED TO PARTICIPANTS ACCOUNTS THAT HAVE ALREADY REACHED THEIR ANNUAL ADDITIONS LIMIT FOR THE YEAR
- a policy of reallocation can be combined with integration or an age-based approach to assist the owner in receiving the max contribution allowed
86
profit sharing plan eligiblity
- subject to standard eligibility rules of other qualified plans
87
profit sharing vesting
- the same as for DC plans
- 3 year cliff or 2-6 year graduated vesting apply unless the plan reqs a 2year waiting period, in which all contributions must be 100% vested
88
profit sharing plan distributions
- do not allow EEs to receive distributions from the plan except upon termination, hardship disability, or retirement
- may allow in-service w/ds after the participant has fulfilled 2 years of service in the plan
89
CODAs (cash or deferred arrangements) AKA 401k plans
- a feature that attaches to a certain type of qualified plan to create a contributory component
- allowed with profit sharing plans and stock bonus plans
- allows EEs to defer a portion of their salary on a pretax basis to the qualified plan reducing current income liability
- EE elective deferral contributions are tax-deferred (earnings are not subject to income tax until EE takes distribution)
90
Entities Allowed to Establish a 401k plan
- corporations
- partnerships
- LLCs
- Proprietorships
- tax-exempt securities
91
most popular form of election under a CODA
- salary reduction agreement where EE agrees to reduce compensation in exchange for the elective deferral contribution in tot he plan
92
Annual Deferral limit of $20,500 + $6,500 catch up apply to:
- 401ks, SARSEPs, 403bs, 457s
93
thrift plans
- allow EEs to make AT contributions
- these plans are used by individuals who want to save more than the elective deferral limit or more than the amount allowed under ADP/ACP testing
-
94
Non Qualified Distributions from a Roth
1) contributions
2) conversions
3) earnings
95
profit sharing (stock bonus) contributions
- ERs may also make a contribution to the stock bonus plan
- EE elective deferral contributions do not count against the plan contribution limit of 25% so the ER does have the flex to make profit sharing plan contributions
- annual limit still limits contributions to $61k per person ($67.5k if 50+)
96
Profit sharing non-discrimination testing
- all qualified plans are required to meet these tests but CODAs must add 2 add'l tests (ADP and ACP)
97
ERs have 3 options in respect to 401k nondiscrimination testing
- 1. perform ADP and ACP tests and take correcting action if the plan fails the test
- 2. institute a qualified auto enrollment feature and comply with the new safe harbor
- 3. comply with the old safe harbor
98
ADP Test
- designed to test the elective deferrals of the EEs to ensure that the non HC EEs are not being financially discriminated against
- goal is to either limit the HC EEs from deferring significantly more than the Non HC EEs or to raise the amount being received by the Non HC EEs
Test 1: the ADP for the group of eligible HC EEs is not more than the ADP of all other eligible EEs * 1.25
Test 2: the excess of the ADP for the group of eligible HC EEs over that of all other eligible EEs is not more than 2% points and the ADP for the group of eligible HC EEs is not more than the ADP of all other eligible EEs * 2
99
ADP Schedule
100
Prior Year Method ADP
- calcs the max permissible deferral for HC EEs by using the Non HC EEs ADP from previous year
101
Current Year Method ADP
- provides a greater deferral % to the HC
| - also provides more flex to the plan sponsor in the event of ADP failures
102
ADP Calculation
- 1. Separate the eligible EEs into HC and NHC groups
- 2. calc the Actual elective Deferral Ratio (ADR) for each of the eligible EEs by dividing the elective deferral contribution by the EEs comp
- 3. once the ADR is determined for each eligible EE, the amount of the ADP is calculated by averaging the ADRs for the EEs within each group (HC or NHC)
- 4. Plug the ADP for the NHC into the chart and calc the max ADP allowed for the HC
- 5. compare the desired/required ADP to your actual ADP. If the HC are higher, ER failed the ADP test
103
Failing the ADP or ACP Test
- puts the plan at risk for disqualification
- corrective action must be taken and the plan sponspr has several options to choose from or to use in conjunction with the other
- 4 alternative remedies to bring into compliance are:
- corrective distributions
- recharacterization
- qualified non-elective contributions (QNEC)
- qualified matching contributions (QMC)
104
easiest and cheapest solution if the plan fails the ADP test
- reduce elective deferrals by distributing or returning funds to the HCs (corrective distribution)
- can be completed within 2.5 months after the end of the plan year
- a 10% excise tax is imposed on the amount that should have been distributed
- any earnings on those contributions must also be returned/distributed to the HC EEs
105
option if the plan fails the ADP test
- recharacterization
- change the excess deferrals (pretax) as AT EE contributions
- recharacterization of pretax contributions to AT contributions may cause a problem for the plans ACP test
106
option if the plan fails the ADP test
- QNEC
- an ER may choose to make a qualified non-elective contribution QNEC to all eligible NHC EEs CODA accounts to increase the ADP of the NHC EEs for the purpose of passing the ADP testing
- is made by the ER to all eligible NHC EE covered by the plan
- considered to be elective deferrals for the purpose of discrimination testing
107
option if the plan fails the ADP test
- Qualified matching contributions
- a contribution made by the plan sponsor that increases the ADP of the NHC EEs
- only made to those eligible NHC EEs who participated in the plan during the year
- treated as an additional deferral by the EEs to increase the deferral % of the NHCs and is immediately vested
108
Actual Contribution Percentage ACP
- calculates a contribution % for both HC and NHC for the express purpose of determining if the NHC are subject to financial discrimination
- tests the sum of the EEs AT contributions and ER matching contributions
- calculated the same was as ADP test
- if the ER fails the test, the same corrective measure are used to bring the plan back into compliance
109
Safe Harbor 401k plan
- a provision where the ER is not required to comply with the ADP, ACP and top heavy testing
- to comply, the plan must provide a min contribution that must be immediately 100% vested
- allowable contributions can be either a 3% min non-elective contribution or a matching contribution
- under the non-elective contribution, all eligible EEs would receive a 100% vested contribution = to 3% of their compensation from the ER each year
- if ER matches rather than non-elective contribution, the standard safe harbor match formula reqs the ER to match 100% of the 1st 3% of the EE deferrals and 50% of the EE elective deferrals > 3% and <5%/
110
Safe Harbor Match
111
Automatic Enrollment Safe Harbor 401k plans
- considered auto enrollment or negative election
- provide that elective contributions by the EE are made at a specific rate unless the EE elects otherwise
- the EE must have an effective opportunity to elect to receive taxable wages in lieu of contributions
112
Negative election clause
- a clause in a 401k plan that can assist the plan in meeting the reqs of the ADP test
113
Qualified Plan Loans
- are allowed up to the lesser of 1/2 of the vested plan accrued benefit up to $50k
- if the vested accrued benefit is < or = $20k then a loan is allowed up to the greater of $10k or the vested accrued value
- reduce $50k max by the highest outstanding loan balance within the prior 12 months
- loans must be repaid within 5 years w/ exception for loans associated with the purchase of personal residences, which must be reasonable and could be as long as 30 years
114
failure to repay a loan
- treated as a distribution as of the date of the original loan
115
CODA plan Distributions
- retirement, death*, or separation of service of the participant and attainment of age 55*
- termination of the plan w/o the establishment of another plan
- certain acquisitions of the company or company assets
- attainment of age 59.5 by the participant*
- certain hardships
* not subject to 10% penalty
116
stock bonus plan
- a plan established and maintained by an ER to provide benefits similar to those of a profit sharing plan except that contributions to and distributions from a stock bonus plan are generally in the form of ER stock
- DC profit sharing plan that allows ERs to contribute stock to a qualified plan on behalf of their EEs
- must have pass thru voting rights on ER stock held by the plan
- participants must have the right to demand ER securities on plan distributions and that the ER repurchase the ERs securities if they are not publicly traded
- distributions must begin within 1 year of normal retirement age, death, disability or within 5 years for other modes of employment termination
117
ESOP
- a qualified plan that invests in qualifying ER securities, typically shares of stock in the corp creating the plan
118
Stock Bonus Plan Advantages to the EEs
- ERs reduced cash outlay may encourage regular contributions
- EEs efforts may be rewarded at retirement by increased stock val
- EEs are eligible for preferred NUA tax treatment on lump-sum distributions of ER stock
119
Stock Bonus Plan Advantages to the ERs
- the FMV of contributions of ER stock are tax deductible to the ER, which can result in decreased income tax costs for the corp with no cash outlay since the contribution is made with ER stock
- EEs now share a vested interest in the success of the company which binds their financial well-being to ERs
120
Stock Bonus Plan Disadvantages to the EEs
- there is a risk associated with the non-diversified investment portfolio of ER stock
121
Stock Bonus Plan Disadvantages to the ERs
- the ownership and control of the corp is diminished (diluted) as shares are granted to the EEs
- the repurchase option could deplete the cash of the corp
122
Stock Bonus Plans vs Profit Sharing Plans
123
Stock Bonus Plan Portfolio Diversification
- usually funded with 100% ER stock
- must allow EEs to diversify their pretax deferrals, AT contributions, and ER contributions that have been invested in ER securities
124
Stock Bonus Plan Voting Rights
- participants must have pass-through voting rights on ER stock that is held by the plan on their behalf, meaning the participant can vote the shares of stock allocated to his stock bonus plan account
125
Stock Bonus Plan Distribution
- made in the form of ER stock but plan may provide EE with the choice of receiving the cash equivalent
- if a cash equivalent is received, the deferral of income tax on stocks appreciated value until the stock is sold is lost (NUA benefit)
- distributions of ER stock or securities from stock bonus plans are taxed depending on whether the distribution is a lump-sum distribution or an installment distribution
- if lump sum distribution: the EE is subject to OI tax in the year of distribution based on securities FMV at time of contribution
- the NUA of the stock is not taxed at the time of the distribution but rather follows the stock as deferred LTCG until the stock is ultimately sold
- if the distribution of the ER stock or securities is made in installments, the EE may only defer recognition of the appreciation on the stock purchased with AT EE contributions, everything else is subject to OI tax rates
126
Employee Stock Ownership Plan ESOP
- reward EEs w both ownership in the corp and provide owners w substantial tax advantages
- controlled through a trust
- sponsor company receives tax deductions for contributions of stock from the corp and the ESOP allocates the stock to separate accounts for the benefit of individual EE participants
- the trust may borrow money from a bank or other lender to purchase the ER stock
- both interest and principal repayments for the loan are income tax deductible and the ESOP can be leveraged
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Practical Uses of ESOPs and Nonrecognition of Gain Treatment
- ESOP must own at least 30% of the corps stock immediately after the sale
- seller(s) must reinvest proceeds from the sale into qualified replacement securities within 12 mo after the sale and hold such securities 3 years
- qualified replacement are securities in a domestic corp including stocks, bonds, debentures, warrants, which receive no more than 25% of their income from passive investments
- the corp that establishes the ESOP must have no class of stock outstanding that is tradeable on an established securities market
- seller(s), relatives of seller(s) and 25% shareholders in the corp are precluded from receiving allocations of stock acquired by the ESOP through the rollover
- ESOP may not sell the stock acquired through the rollover transaction for 3 years
- stock sold to the ESOP must be common or convertible preferred stock and must have been owned by the seller for at least 3 yrs prior to the sale
- if the seller purchases and retains qualified replacement securities, there will be no taxable event
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advantages to the ER of ESOPs
- shareholder is often the owner who is looking to retire
- the ability to sell shares to the plan, which is a ready and available buyer with deferred income tax consequence is a HUGE benefit
- without the ESOP, there may not be a market for the privately held corp stock
- the corp or trust is allowed to borrow money in order to provide contributions resulting in funds being provided immediately to the ESOP, while the ER repays the loan tot he ESOP with tax-deductible contributions
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advantages to the EE of ESOPs
- ESOP provides them with a type of retirement vehicle as well as ownership in their ER
- provides a vehicle to acquire a biz when EEs may have little to no chsh available to do so - job preservation
- the EE participant may also benefit from the NUA at the time of stock distributions bc of favorable cap gains rates and deferred recognition
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Disadvantages to the EE of ESOPs
- lack of diversification of the individual investment portfolio bc ESOPs must invest primarily in the stock corp
- there is some limited relief on this, once EE reaches age 55 and 10 years of services, the ER must offer some diversification options
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Disadvantages to the ER of ESOPs
- ESOPS dilute ownership in the corp by reducing the concentration of shares from the sellers to broaden the EEs holdings
- the repurchase option for stock that is not readily tradeable can create CF problems and admin concerns
- plan admin is costly, annual appraisals are recurring expenses which are necessary to determine the value of the tax deduction for the ER and determine the price that an ER or trust would pay for the repurchase of ESOP distributed shares
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advantages and disadvantages of ESOPs
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ESOP Voting rights
- same voting rights with allocated shares as other shareholders, including the right to vote the shares and the right to earn the divs
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Contributions to ESOPS
- ER contribs are deductible by the ER and are subject to the 25% limit of covered comp
- if ERs stock is obtained by a loan (leveraged ESOP), then the ER is allwoed to deduct all interest paid on the loan over and above the 25% deduction of total eligible payroll of the plan participants
- interest deduction is unlimited
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ESOP distributions
- subject to RMDs
- plan participants can elect to receive substantial equal periodic payments of their account balance NOT less than once per year after the participant separates from service
- the substantially equal periodic payments must be fore a period for no longer than 5 years, unless the participants account balance is valued at more than $1,230,000 in which case the distribution period may be extended 1 yr for each add'l $245,000 of account value up to a total of 10 years
- any distribution from an ESOP that is not a lump-sum distribution of the ER securities will not be eligible to receive NUA treatment and will be taxed as OI
- these distributions may also be subjected to the 10% early w/d penalty
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Valuation of ER stock in ESOPs
- when contributions are made to an EEs account, the ER must know the value of the contribution for the corps tax deduction purposes
- when contributions are made to an EEs account, the EE must know the value of the contribution for future NUA calculation
- if a lender lends $ to leverage the ESOP the lender must know the value of the stock to determine if and how much $ to lend to the corp
- if an EE exercises the put or repurchase option, the value of the stock must be determined
- valuations are needed for financial statements and reports
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ESOP diversification issues
- ESOPS are allowed to hold 100% of the corp stock in the trust
- qualified participants may force diversification of their holding s if they are at least 55 y/o and have completed at least 10 years of participation in the ESOP
- the qualified participant must be offered a diversification election within 90 days after the close of each plan year beginning with the year after the EE becomes qualified
- participant may elect to diversify up to 25% of the account balance into one of the plans alternative investment options
- in the final year of the 6 year election period, the cumulative diversifiable % is increased to 50%
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ESOP Put Options
- if the ER securities are not tradabel on an established market the participant has the right to require that the ER repurchase the ER securities under a FNV formula
- this is a put option or repurchase option
- the rank and file EEs are protected with the put option because the EE may force the corp to buy back the stock at FMV
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Stock bonus plans vs ESOPs
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Capital Preservation Model
- capital needs analysis method that mitigates the risk of outliving retirement funds
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401k
allows for voluntary EE elective deferral contributions
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Best retirement plan for a self-employed over 50+ y/o to shelter as much of her self-employed earnings as possible
- 401K
| - allows for catch-up contributions
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low cost retirement plan that allows EE pre-tax contributions
- Simple IRA
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Max IRA Deduction
If $110k is MAGI
Reduction is (($110,000 - $109,000) / $20,000) × $6,000 = $300 (2022). Therefore, the maximum deduction is $6,000 - $300 = $5,700 each. Larry's contribution of $2,000 and Terry's contribution of $900 are both fully deductible.
Formula: Contribution × [(your AGI – the bottom of the phase out range) divided by the amount of the range (129,000-109,000 is where the 20k comes from)]
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three methods to pay for stays after the 100th day
1. Long-term care insurance
2. Individual savings
3. Medicaid
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Profit-sharing plans contributions
should be "substantial and recurring."
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plan trustee duties
Investing the plan assets in a "prudent" manner.
| Monitoring and reviewing the performance of plan assets.
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plan administrator duties
Determining which employees are eligible for participation in the plan, vesting schedule, and plan benefits.
Preparing, distributing, and filing reports and records as required by ERISA.
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COBRA eligible coverages do include:
dental plans, vision plans, Medical FSAs, prescription drug plans and mental health plans
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ADP is irrelevant when
- a 401k is electing the mandatory 3% non-elective contribution
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Unrelated Business Taxable Income (UBTI)
A direct business activity carried on for the production of income is considered a trade or business for UBTI purposes.
Securities of the employer purchased with loan proceeds by an Employee Stock Ownership Plan (ESOP) are not subject to UBTI.
Dividends, interest, and other types of income derived from investments in a business are not subject to UBTI.
income from any type of leverage or borrowing within a plan is subject to UBTI
any business enterprise run by a qualified plan is subject to UBTI
If the plan actually participated in the development of the oil & gas reserves, there would be UBTI
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requirements for the owner of corporate stock who sells to an ESOP to qualify for the nonrecognition of gain treatment
The ESOP must own at least 30% of the corporation’s stock immediately after the sale.
The owner must reinvest the proceeds from the sale into qualified replacement securities within 12 months after the sale.
The ESOP may not sell the stock within three years of the transaction unless the corporation is sold.
The owner must not receive any allocation of the stock through the ESOP.
