Retirement

Question 1

Advantages of Qualified Plans

Answer 1

To Employer:
- ER contributions are tax deductible
- ER contributions are NOT subject to payroll taxes
To Employee:
- Pre-tax contributions
- Tax deferral of earnings
- ERISA protection
- Lump sum distribution option (10-year averaging for ppl born before 1936, NUA, pre-1974 capital gain treatment)

Question 2

Disadvantages of Qualified Plans

Answer 2

• Limited contribution amt
• Contributions cannot be made after money is received
• Limited investment options
• No or limited access to money while employed
• Distributions are taxed at ordinary income (basis = $0)
• Early withdrawal penalty may apply
• Mandatory distributions at age 72
• Only ownership permitted is by account holder
• Cannot assign or pledge as collateral
• Cannot gift to charity before age 70 1/2 without income tax consequences
• Limited enrollment periods
• Considered to be an Income in Respect of a Decedent asset, subjecting distributions to both income and estate taxes with no step-up basis
• Costs of operating the plan

Question 3

Standard Eligibility of Qualified Plans

Answer 3

Standard Eligibility Requirements (the most stringent):
- Attainment of age 21, or
- Completed 1 year of service (12-month period with at least 1,000 hours)
Special Eligibility Rules
- 2 years of service and immediate vesting
- not available to 401Ks

Question 4

Coverage Tests for Qualified Plans

Answer 4

General Rule: MUST cover at 70% of nonhighly compensated employees
Must meet at least 1 of 3 tests:
- General Safe Harbor Test
- the ratio percentage test
- average benefit test
- 50/40 test + 1 of the above 3 (Defined benefit plans) - LESSER of 50 EEs or 40% of all nonexcludable EEs

Question 5

Highly Compensated Employees

Answer 5

• > 5% owner at any time during the plan year OR preceding year, or
• An EE with compensation > $130,000 (2020) for the prior year plan

Family attribution rule

Question 6

General Safe Harbor Test

Answer 6

% of NHC Covered >= 70%

Question 7

Ratio Percentage Test

Answer 7

% of NHC Covered / % of HC Covered >= 70%

Question 8

Average Benefits Test (both tests)

Answer 8

1. Average Benefit % of NHC / Average Benefit % of HC >= 70%

2. Nondiscriminatory test

Question 9

Vesting

• EE contributions are always IMMEDIATELY vested

Answer 9

Defined Contribution Plan Vesting Schedules

• 2 to 6 Year Graduated
• 3 Year Cliff
• 2 Year Eligibility with immediate vesting (not allowed for 401k)

Defined Benefit Plan Vesting Schedules
Non Top Heavy 
- 3 to 7 Year Graduated
- 5 Year Cliff 
- 2 Year Eligibility
Top Heavy Plans
- 2 to 6 Year Graduated
- 3 Year Cliff
Cash Balance Plan: ONLY 3 - Year Cliff

Question 10

Key Employees

Decision makers, either Owner or Officer

Answer 10

Definition:

• > 5% Owner, or
• > 1% Owner with compensation > $150,000 (not indexed), or
• An officer with compensation > $185,000 for 2020

Question 11

Top Heavy Plans

Definition: > 60% of the benefits or contribution are going to key employees

Answer 11

Once a Qualified Plan is considered top heavy, the plan MUST

1. Use top heavy vesting schedules, AND
   - 2 to 6 year graduated or 3-year cliff
2. Provide minimum funding to non key employees
   - For DC Plans: at least 3% of the EE’s compensation or same % contribution to key EEs
   - For DB Plans: at least 2% x Years of Service x Compensation

Question 12

Plan Limitations on Benefits and Contributions

Answer 12

ER’s Max TAX-DEDUCTIBLE Contributions: 25% of ER’s total covered compensation
415c Limit: ER’s contribution + EE’s contribution + Any Forfeitures, is the lesser of
- 100% of EE’s compensation for the plan year, or
- $57,000 for 2020 plus $6,500 catch-up

Question 13

Maximum Annual Benefits of Defined Benefit Pension Plans

Answer 13

LESSER of:

• $230,000 (2020)
• 100% of the Average EE’s 3 Highest Consecutive Years Compensation

Question 14

DB Pension Plans vs. DC Pension Plans

Answer 14

• Benefits** Accrued (DB) vs. Account Balance (DC)
• Actuary: Annual (DB) vs. Inception or predetermined (DC)
• Funds: Commingled (DB) vs. Separate Individual Investment Accounts (DC)
• Investment Risk: Plan sponsor (DB) vs. Plan Participant (DC)
• Forfeitures: Reduce Plan Cost ONLY (DB) vs. Plan Cost + Allocation to Participants (DC)
• PBCG: DB Plans ONLY, except plans of Professional Service Corps w/t less than 25 participants
• Credit for Prior Service: DB Plans ONLY (must be nondiscriminatory)
• Integration with SS: Offset or Excess Method (DB) vs. Excess (DC)

Question 15

DB Pension Plans (Formula for Benefits)

Answer 15

o Flat Amount Formula: provides an amount that each plan participant will receive at retirement, such as $xx/mo. Not based on years of service or salary. Each participant receives the same amount at retirement.
o Flat Percentage Formula: provides a benefit equal to a percentage of the participant’s salary, usually the final salary or an average of the participant’s highest salary. The % remains the same throughout participation in the plan.
o Unit Credit Formula: utilizes a fixed % of both a participant’s salary and years of service to determine the participant’s accrued benefit. (most frequently used)

Question 16

Cash Balance Pension Plans

Answer 16

o A DB pension plan that shares many characteristics of a DC plan but provides specific defined retirement benefits
o EE gets a statement of Hypothetical account + Hypothetical allocations + Hypothetical earnings
o Pay Credit (hypothetical contribution % of salary) + Interest Credit (Guaranteed return determined under plan document)
o Generally more favorable for younger participants coz more years of contributions and earnings
o Easy to understand for EEs
o Popular way to get rid of old expensive DB plans!
o ONLY use 3-YR Cliff Vesting

Question 17

Money Purchase Plan

Answer 17

o EGTRRA 2001 eliminated the usefulness of the plan
o Mandatory contribution: fixed % of EE’s compensation
o Separate account on behalf on each participant
o Benefits younger EEs with increased number of contributions and compounding years

Question 18

Target Benefit Pension Plan

Answer 18

o EGTRRA 2001 eliminated the usefulness of the plan
o Mandatory contributions that’s actuarily equivalent to the PV of benefit at retirement
o Benefits older EEs with greater contributions to older EEs
o Separate account and EE is responsible for choosing investments
o A special type of Money Purchase Plan

Question 19

Profit Sharing Plans (SS Integration)

Answer 19

o Base rate: applied on income earned up to the integration level (usually the SS wage base $137,700)
o Excess rate: applied to income earned above the integration level BUT only up to the max covered compensation limit ($285,000)
o Base Rate + Permitted Disparity = Excess Rate
o Permitted Disparity: LESSER of the base rate or 5.7%

Question 20

Cash or Deferred Agreements (CODA) [401k Plans]

Answer 20

o Generally referred to as a 401k plan
o A feature that attaches to certain types of qualified plans to create a contributory component
o Permitted with Profit Sharing Plans and Stock Bonus Plans

Question 21

Entities Allowed to Establish a 401K Plan

Answer 21

o      C Corp
o      Partnerships
o      LLCs
o      Proprietorships
o      Tax-exempt entities

Question 22

Nondiscrimination Tests for 401K Plans

Answer 22

1) Perform ADP and ACP tests and take corrective action if the plan fails the test
2) Institute a qualified automatic feature and comply with the new Safe Harbor
3) Comply with the old Safe Harbor

Question 23

Actual Deferral Percentage (ADP) Test

Answer 23

o Limit the HC EEs from deferring significantly more than the NHC EEs, OR
o Raise the amount being received by the NHC

Question 24

Corrective Remedies (If ADP or ACP failed)

Answer 24

o Corrective distributions: easiest & cheapest - just return the funds to HCs; must be completed within 2.5 months after the end of the plan year
o Recharacterization: recharacterize the excess deferrals from pre-tax to after tax; must be completed within 2.5 months after the end of the plan year
o Qualified non-elective contributions (QNEC), or - 100% vested when contributed !!
o Qualified matching contributions (QMC) - 100% vested when contributed!! But NHCs who didn’t defer will not receive the matching contributions

Question 25

Safe Harbor 401(K) Plans

Answer 25

o General Safe Harbor Test: >=70% of NHCs are covered o Non-elective 401K safe harbor status: MUST contribute at least 4% for all eligible EEs and 100% immediately vested o Standard Match Formula o 100% on the first 3% deferral o 50% on the next 2% of deferral o An election must be made to become a Safe Harbor 401K o Automatic Enrollment (also known as "negative election") Safe Harbor 401K Plans: Elective contributions by EEs are made at a specified % unless the EE elects otherwise

Question 26

Qualified Plan Loans: - QPs are permitted, but not required to provide loans from the plan to participants

Answer 26

o QPs may permit loans up to the LESSER of 50% of the vested plan accrued benefit and $50,000 o If vested accrued benefit <= $20,000, loan is limited to the LESSER of $10,000 or vested accrued benefit o Reduce the $50,000 maximum by the highest outstanding loan balance within the prior 12 months o Loans are usually associated with 401K and 403b plans o Usually MUST be paid back in 5 years o Exception: loans used for purchase of personal residence, which must be reasonable and could be as long as 30 years o Loans are usually repaid thru payroll deductions and MUST generally be repaid within 5 years from the date the loan commences

Question 27

Stock Bonus Plan | YES integration with SS

Answer 27

o Plan participants MUST have pass-through voting rights on ER stock held by the plan o Participants MUST have the right to demand ER securities on distributions o Participants MUST have the right to demand ER repurchase if they are not publicly trade (Put option) o Distributions MUST begin within 1 year of normal retirement age, death, or disability or within 5 years for other modes of employment termination o Distributions can be lump sum or installment; in the form of ER stock or cash equivalent o ER can deduct the FMV of stock contribution Tax treatment upon distribution o Cash: NUA treatment is lost o Stock： o At time of distribution: FMV of stock (At contribution) is treated as ordinary income o At time of sale: FMV of Stock (at sale) - FMV (at contribution) = Capital Gains

Question 28

Employee Stock Ownership Plan | NO integration with SS

Answer 28

o A special form of Stock Bonus Plan o An ESOP is controlled through a trust; the trust may borrow money from a bank or lender to purchase the ER stock; both interest and the principal payment are income tax deductible --> LESOP o Allows owners to diversify his/her interest in a closely held corporation: through selling his ownership to an ESOP --> to qualify for nonrecognition of gain, the following requirements MUST apply: o ESOP MUST hold at least 30% of the corporation's stock immediately after the sale o Seller(s) MUST reinvest proceeds from the sale to qualified replacement securities within 12 mo after the sale and hold such securities 3 years o Qualified replacement securities: domestic corporations: stocks, bonds, debentures or warrants with no more than 25% income from passive investments o The corporation of ESOP MUST have NO class of stock outstanding that is tradable on an established securities market o EE may also benefit from NUA at the time of stock distributions o EE might lack of diversification, but once reaches age 55 and 10 years of service, the ER must offer some diversification options o Annual appraisal to determine the value of tax deduction for ER o Voting rights of ESOP participants o ER Deduction: 25% of covered compensation + unlimited interest deduction for LESOP o Any distribution from an ESOP that is not lump-sum WILL NOT receive NUA treatment

Question 29

In-Service withdrawals from Qualified Plans

Answer 29

In-service withdrawals are allowed if 1 of the following 3 situations are met: 1. Attainment of specific age or years of service (NRA for a Money Purchase Plan and 59.5 for 401K deferrals) 2. Hardship 3. age 62 for DB Plans.