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CFP Items To Learn > Retirement And Employee Benefits > Flashcards

Retirement And Employee Benefits Flashcards

1
Q

What are the two types of pension plans (Are they defined benefit or contribution) and 6 types of profit sharing plans

A
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2
Q

What is the difference between a defined benefit and defined contribution plan

A

Defined benefit is a guaranteed payout, employer assumes investment risk, covered by teh pension benefit guaranty corp and are comingled with investment accounts.

Defined contribution is when you select what you contribute and your payout is based on that (annual contribution limit of 25% of total employee covered comp or 20% if for self-employed), employee assumes risk,

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3
Q

What are advantages of a qualified plan

A

Advantages of Qualified Plans
• “Qualified plans” under Section 401(a), provide employers with: (1) current income tax deductions and (2 payroll tax savings. They provide plan participants with (1) income tax deferrals, (2) payroll tax savings al federally provided creditor asset protection.
• The trade-offs for the tax advantages of qualified plans are the cost of the plan (both the operational expense contributions) and compliance, including vesting, funding, eligibility, nondiscrimination testing, IRS report and employee disclosure.
• Taxation of Plan Contributions
- Income Tax
• Employers receive a current income tax deduction for contributions made to plans; they are an ordinary and necessary cost of business.
• Employers are limited to a maximum of 25 percent (or as actuarially determined for defined ben plans) of the total of covered compensation paid to its employees as a contribution to a qualifie plan.

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4
Q

What are the advantages of a qualified plan for employee? for employer?

A

Employer contirbutions are tax deductible and not subject to payroll tax

Employee
Availability of pretax contributions for employees
Tax deferral of earnings and contributions, ERISA protection, lump sum distribution options

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5
Q

Qualified plan eligibility

A

later of 1 year of service or turning 21

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6
Q
A
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7
Q

What are the coverage tests for qualified plans

A

An employee is covered under a qualified retirement plan when he receives a benefit from the plan. The word benefit means an employer contribution, an accrued benefit, or simply the right to participate in the case of a 401(k) plan.
Nondiscriminatory Classification
While all “eligible” employees must be considered, not all must be covered by the plan for it to maintain its qualified status.
• However, the selection of nonexcludable employees who will benefit under a qualified retirement plan must be reasonable and established based on the facts and circumstances of the business under objective business criteria.
Coverage Tests
• The general rule for coverage is that the plan must cover at least 70% of nonhighly compensated employees (defined below). However, there are exceptions (ratio percentage test an average benefits percentage test).
Therefore, to be qualified, the retirement plan must meet at least one of the three following tests:
(1) the general safe harbor test, (2) the ratio percentage test, or (3) the average benefits test.
• In addition, Defined Benefit plans must ALSO pass an additional coverage test, know as the 50/40 test (discussed below).
Highly Compensated Employees (Very Important Definition)
• For purposes of several retirement plan test calculations, all of the “eligible” employees are further segregated into two classifications: Highly Compensated (HC) and Non-Highly Compensated (NHC). The definition of a highly compensated employee provided by the IRC is an employee who is either: a 5%+ owner or makes 155k+ (or those above this AND in the top 20%—useful for high comp firms )

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8
Q

What are the three tests a qualified retirement plan must just pass one of.

A

General safe Barbour: %of NHX covered is >= 70% (NHC is non-highly compensated )

Ratio % test: % of of NHC covered / % of HC covered >= 70%

Average benefit test
Non discriminatory and AB% of NHC / AB% of HC >= 70%

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9
Q

In addition to the 3 passing one of the 3 tests, what must a defined benefit plan also pass

A

50/40 coverage… it’s 50 non-excludible employees or 40% of all employees each day of the year must be covered

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10
Q

3 ways to be a key employee

A

: (1) a greater than five percent owner, or (2) a greater than one percent owner with compensation in excess of $150,000, or (3) an officer with compensation in excess of $220,000 (2024).

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11
Q

What is the minimum contribution of an employees salary must a defined contribution top heavy plan provide for NHC? For a DB?

A

3%

for a DB plan, it’s 2.5% x years of service

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12
Q

Maximum employee + employer + forfiture contribution per participant for qualified plans

A

For each, it is the lesser of any choices:
DC: 100% of salary or 69k (incl. 7.5k catchup for 50 years or older)

DB: 275k or 100% of average of the employees 3 highest years of service

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13
Q

How to be a HC employee

A

Salary >155k (this year or 150K last year), own 5%+

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14
Q

What is a profit sharing plan

A

A profit-sharing plan allows employers to contribute to the plan through cash or employer stock on a year-to-year basis. This plan is one of the most flexible defined contribution plans that allow the company to make annual changes to contributions based on company profits or cash flow.

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15
Q

What is a pension plan (describe the differences between the two types)

A

A defined benefit Pension plans: promises a specific monthly benefit amount upon retirement, traditionally based on factors including salary and years with the company.

A defined contribution pension plan: is funded by a specified amount contributed to the plan, with benefits based on how the investments of the amounts contributed have performed.

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16
Q

What is the maximum benefit a defined benefit pension plan that can be paid to an employee

A

the lessor of the max from the tax table or 100% of the average of highest 3 years of salary

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17
Q

What are the names of the formulas to calculate the employee benefit for a defined benefit plan

A

1) Unit benefit formula
2) Flat-percentage formula
3) Flat-amount formula

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18
Q

What is a cash balance pension plan? what is its vesting schedule? When is this strategically useful?

A

A DB pension plan that shows employees a calculated indicative cash balance of their qualified plan account balance.

better for younger people because they have more time to spend in the plan

vesting: 3 year cliff

Can convert a defined benefit plan to this. A good way to get rid of expensive DB plans (that benefit older people)

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19
Q

What is a money purchase pension plan? What type of employee is this plan better for and why?

A

A DC plan where the contribution to the plan is based on a fixed % of the employee’s compensation

All DC plans benefit younger participants (they have more time in the plan for more contributions and compounding to occur)

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20
Q

Excess rate with respect to social security is generally how much higher than the base rate

A

5.7%

Base rate + permitted disparity = excess rate

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21
Q

Who can make a 401k plan

A

Corporations
partnerships
LLC
proprietorships
tax-exempt entitites

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22
Q

What does ADP mean

A

Actual deferral percentage (how much each employee defers for retirment. Typically used in teh ADP test where you compare the total average employee actual deferral rate of HC vs NHC

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23
Q

How much higher is the average ADP of HC than NHC be

A

2%

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24
Q

What is the limit on loans from qualified plan

A

The lessor of
1) Greater of $10k or 50% of vested plan balance.
2) $50k

At any point in time.

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25
Q

what are the names of the two DB plans

A

Defined benefit and Cash balance pension plan

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26
Q

What is the least generous vesting schedule

A

3 year cliff or 2 to 6 year vesting (year 2 is 20%, year 6 is 100%)

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27
Q

Salary above what amount are considered excess comp when looking at pension plans when integrating social security

A

$168,600

28
Q

How is appreciation of distributed stock treated

A

As long or short term capital gain depending on how long it is held after distribution. Note Net Unrealized appreciation at distribution can be considered long term

29
Q

What is the tax penalty on a distribution and when

A

10% of the gain (not the adjusted basis portion) (TBD when, I think before 59.5) and

30
Q

How to avoid the 10% qualified retirement plan distribution penalty

A

Other exceptions to the 10 percent early withdrawal penalty are plan rollovers and p
Exam Tip
For Qualified Plans to avoid the 10% penalty, they make a “MESS AT D°O” (medical expenses, equal periodic payments, separation from service, age, tax levies (and terminal illness), death, disability, disaster, and QDRO).
Exam Tip
For IRAs to avoid the 10% penalty, they say “HIDE ME” (first time home purchase, health insurance, death and disability, domestic abuse, higher education, medical expenses, equal periodic payments, and of course, age.

31
Q

When do you have to take a RMD

A

When you get to age 73 after 12/31/22 and before 1/1/33. Will get hit with a 25% excise tax on underdistribtued amount (reduced to 10% if take within correction window). Unless the participant is still in service (employed by the company the plan is with–RMD starts after April 1st of the year after being terminated–this does not apply if you own 5% of the company)

32
Q

What retirement plans do RMDs not apply to

A

Roth

33
Q

When must the RMD be taken by

A

For the first time, by April 1st of the following year the participant turns 73; for subsequent years by Dec 31st.

If you have multiple qualfied accounts, can calc a combined number and take from 1 account

34
Q

How is RMD calculated?

A

Account balance as of Dec 31st prior year divided by number in the uniform lifetime table (unless the spouse is more than 10 years younger, than use a joint table). Use the age of the person by the year end (dec 31st) of the year the distribution must by taken in

35
Q

What happens to RMDs for the spouse

A

The younger spouse (say pre-73) can take a taxable lump sum distribution, can carry on with the same RMDs (pretending they didn’t die) or roll it into their IRA

36
Q

Eligible beneficiary

A

Can distribute the assets over their life;

An eligible bene is a
surviving spouse
child bene
disabled or chronically ill individual
anyone not 10 years younger than the plan owner

upon death the eligible beneficary, the new bene must take all the assets in the plan within 10 years

37
Q

What is a designated bene and when must they take all the assts

A

anyone that is not an eligible bene and must take the assets within 10 years

38
Q

What happens when quail plan owner dies prior to entire distribution

A
39
Q

What is a target benefit pension plan?

A

A DB plan that provide a base monthly pension at retirement that may change based on the plan’s performance (thus not distributions are not guaranteed)

Benefits older entrants. Employee has investment risk

40
Q

What is a money purchase pension plan?

A

A contribution percentage from employer is required (and an excise tax has to be paid if not done). For example, let’s say that your money purchase plan has a contribution of 5% of each eligible employee’s pay

The investment risk is with the employee

41
Q

What is a thrift plan?

A

A defined DC profit sharing retirement plan that offers Federal employees the same type of savings and tax benefits that many private corporations offer their employees under 401(k) plans.

Benefits savers and younger persons

42
Q

What is an age based profit sharing plan?

A

A Profit sharing plan (DC) that ts allows employers to allocate a greater percentage of profit-sharing contributions to older employees, under the logic that they have less time to save.

benefits older, highly compensated

43
Q

What is a new comparability plan?

A

A Profit sharing plan (DC) that puts employees into two or more groups on the basis of objective standards. An IRS- approved formula allows a greater percentage of profit-sharing contributions to be allocated to one group (e.g., “the owner”) versus the other group(s).

benefits owners

44
Q

What makes a 401k plan unique among all retirement plans DB or DC

A

Only one that does not permit social security integration (can be done with additional profit, but not with base match or employee contirbutions)

45
Q

What are the 4 pension plan types

A

Defined benefit
Cash balance
Money purchase
Target benefit

46
Q

What does non-contributory mean?

A

Employees do not contribute to the plan

47
Q

Write out the qualified retirement plan tree

A
48
Q

What is the maximum % of contributions to a retirement plan made by an employer

A

25% of employee compensation

49
Q

What is a Keogh plan?

A

All the retirement plans are renamed this if they are for a self-employed person?

50
Q
A
51
Q

What is the calculation for the contribution a self employed individual can make?

A

Contribution Rate ÷ (1 + Contribution Rate = Self-employed contribution rate

52
Q

What is the difference between earned and unearned income

A

Earned income is W2, schedule C net income, K1, alimony (pre-2019)

Unearned income: Rental, interest, dividend, capital gains, pension, alimony after 2019; unemployment, SS benefits, workers comp, deferred income

53
Q

IRA maximum contribution and penalties

A

7k +1k catchup if older than 50 by tax filing due date for that year (eg 2015 contribution can be made by april 15th 2016)

6% excess contribution tax on excess portion

10% early withdrawal

54
Q

Who can make an IRA contribution, who can deduct it? (individual, their spouse?)

A

Anyone with earned income can contribute to an IRA, but

Deductions of 8k or 7k
Single; starts to phase out at 77k
MFJ: starts to phase out at 123k

Non-active participant spouse can deduct if the joint income is below 230k

55
Q

When is a Roth distribution taxable

A

When it is taken within 5 years of a conversion and/or before someone is 59.5

56
Q

What is NQDC

A

non-qualified deferred compensation. Must have a substantial risk of forfeiture and not have constructive receipt

Can use a secular trust (with a condition of employment or vesting to get funds) or rabbi trust (where creditors can access) or a “unfunded promise to pay”

Benefits for employer:
cash outflow deferred, saves on payroll tax, income tax deferred and may discriminate among employees

benefits for employee
no current taxable income
employee saves on payroll tax (due at time deferred, not distributed)
may provide future tax savings if distributed when at a lower tax rate

57
Q

What is the tax treatment of ISO’s when they are excercised and when they are sold?

A

At exercise, no w2 tax implications, but need an AMT adjustment of the “gain,” at sale take that same AMT adjustment but make it negative and capital gains tax of full gain (ST or LT)

No ordinary income on the basis of the grant. And employer has not expense deductions from this

If you sell within 2 years of date of grant and 1 year of exercise, it is a qualifying disposition, the employee has ordinary income and the employer can take a tax deduction

58
Q

What are the holding period requirements of an ISO

A

If you sell within 2 years of date of grant and 1 year of exercise, it is a qualifying disposition, the employee has ordinary income and the employer can take a tax deduction (for the same amount of the ordinary income)

59
Q

NQSO (non-qualified stock options)

A

Basically an option to buy a stock at a pre-set price. No holding requirements.

Tax: When you exercise an option (you buy the stock at that price). So you pay ordinary income on the gain from the price on the day you buy it to the option price.

If the employee has ordinary income, the employer can take a tax deduction (for the same amount of the ordinary income)

Anything after that is like any normal stock you have: capital gains based on holiding for when you sell it.

60
Q

Restricted stock plan

A

Employer pays exec with stock but restricted to hold for X years (with right for company to take back) when substantial risk ends, the Exec has w2 income and employer has deduction

61
Q

ESPP (employee stock purchase plan)

A

Can purchase stock at least 85% value up to $25k worth.

Same qualifying rules (1 years since grant to exercise and 2 years total till sale) to be treated as ordinary income for the “company discount” and LT capital gains after that

62
Q

Vesting schedule if a qualified plan requires 2 years of service

A

full and immediate (after the 2 years)

63
Q

What are the vesting options for a top heavy plan

A

1) Immediate, 2) 3 year cliff, 3) 2-6 year graded

64
Q

What is the standard eligibility requirement for a qualified plan

A

1 year employment & minimum 21 years of age & 1000 hrs per 12 month period

65
Q

Describe situations when NUA applies, and what is its tax treatment

A

Net unrealized appreciation (NUA) occurs when there is a difference between the average cost basis and the current market value of the shares owned by the employee.

but requires a lump sum distribution

gets long term capital gains treatment

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