Module 2 QBank Quiz

Target benefit pension plans do which of these? They best serve the middle-aged, rank-and-file workers. They guarantee that the targeted benefit will be paid. They disproportionately benefit the young executive employees in a large, publicly held corporation. They are appropriate for a corporation that cannot afford a traditional defined benefit pension plan and that has a substantial group of older (age 50+) key employees. A) IV only B) II and III C) II and IV D) I only

A) Explanation An employer hopes to pay, but does not guarantee, the targeted benefit. Such plans allow proportionately greater employer contributions for older employees, due to age-weighting. The target benefit is not guaranteed, and the plan benefits older participants by making higher allocations to the accounts of the older participants. LO 2.3.2

Cheryl is an executive with Chandler Corporation where she has been employed for the past 24 years. Her current salary is $400,000. Chandler's defined benefit plan provides participants with 25 years of service an 85% of salary annual retirement benefit. Assuming Cheryl's salary remains at $400,000, what will be the amount of her annual retirement benefit if she retires this year? A) $265,000 B) $330,000 C) $340,000 D) $280,500

A) Explanation On the basis of years of service and salary, Cheryl would be entitled to a retirement benefit of $280,500 using only the first $330,000 of employee compensation; however, the defined benefit pension plan benefit limit for 2023 is $265,000. LO 2.1.2

Which of the following statements regarding a target benefit pension plan is CORRECT? The services of an actuary are required in the first year of operation. The plan is funded using the percentage of compensation approach. Minimum funding standards apply. A target benefit pension plan is a type of defined benefit pension plan. A) I, II, and III B) I only C) I, II, III, and IV D) II only

A) Explanation Statement IV is incorrect. A target benefit pension plan is a type of defined contribution pension plan. LO 2.3.2

Which one of these describes a basic provision of qualified retirement plan contribution or benefit calculations? A) A career-pay provision generally results in a plan benefit that reflects the impact of inflation. ​ B) The plan must define its normal retirement age as the Social Security full retirement age. C) A final-pay provision generally results in a higher benefit for the employee. D) Compensation is limited to $265,000 in 2023.

C) Explanation A defined benefit plan can base the retirement benefit on the employee's average pay over the employee's career or over the final three or five years. The final-pay provision is generally a higher amount, reflecting the impact of inflation in recent years. The plan's normal retirement age does not necessarily have to be the Social Security full retirement age. The compensation limit is $330,000 in 2023. The defined benefit limit is the lesser of 100% of the plan participant's high three years or $265,000 in 2023. LO 2.1.2

All of the following are characteristics of traditional defined benefit pension plans except A) a limited benefit is guaranteed by the Pension Benefit Guaranty Corporation (PBGC). B) the employer is required to make annual contributions. C) employees assume the risk of poor investment results. D) the plans are complex to design and operate.

C) Explanation A traditional defined benefit pension plan guarantees a specific benefit level at retirement, so the employer assumes the risk of poor investment results in the plan. If investment results are poor, the employer may have to supply additional funding to ensure that the guaranteed benefits are available. LO 2.1.1

Which of these is a type of defined contribution pension plan? A) Employee stock ownership plan (ESOP) B) Cash balance pension plan C) Stock bonus plan D) Target benefit pension plan

D) Explanation A target benefit plan is a type of defined contribution pension plan. A stock bonus plan and an ESOP are types of defined contribution profit sharing plans. A cash balance plan is a type of defined benefit pension plan. LO 2.3.2

Richard participates in a traditional defined benefit plan at work. His projected monthly benefit under the plan is $1,000. If the plan provides life insurance for Richard, the death benefit payable under the policy is limited to A) $25,000. B) $50,000. C) $35,000. D) $100,000.

D) Explanation Defined benefit plans use the 100 times test for determining whether they comply with the incidental benefit rules. Under this test, the death benefit cannot exceed 100 times the participant's projected monthly benefit (in this instance, $100,000). LO 2.1.2

Your client, the chief financial officer of a new company, wishes to install a retirement plan in the company in which the pension benefits to employees are guaranteed by the Pension Benefit Guaranty Corporation (PBGC). Identify the plan(s) which must meet this requirement. Profit-sharing plan Money purchase plan Target benefit plan Defined benefit plan A) IV only B) II and III C) I and II D) III and IV

A) Explanation Only two defined benefit pension plans (defined benefit and cash balance) have PBGC insurance. LO 2.1.1

Which of the following are factors that would be expected to reduce the amount of the retirement benefit from a defined benefit pension plan? (Assume that the plan meets the minimum funding requirements each year.) Less than 10 years of plan participation Investment earnings that are lower than expected Use of a flat-benefit formula rather than a unit benefit formula Participant's retirement before age 62 A) I and IV B) I, II, and IV C) I and II D) II and III

A) Explanation Retiring before age 62 or with less than 10 years of plan participation generally will reduce a participant's retirement benefit from a defined benefit plan. The reduction is usually 10% for each year of service less than 10. While this seems like a very big reduction for these people (and it is), without this provision the cost of hiring someone within ten years of retirement age would be prohibitive and thus people in this situation would rarely be hired. However starting benefits at age 65 or later often means no reduction for having less than 10 years of service. The ​employer is obligated to provide the plan-specified benefit, regardless of whether investments perform as expected. The benefit formula—flat benefit or unit benefit—does not result in a generally lower or higher benefit, as it will depend on the individual participant's circumstances. LO 2.1.2

Joe, 46, has owned his company for 18 years and wishes to retire at age 70. All of Joe's employees are older than he is and have an average length of service with the company of eight years. Joe would like to adopt a qualified retirement plan that would favor him and reward employees who have rendered long service. Joe has selected a traditional defined benefit pension plan with a unit benefit formula. Which of these statements regarding Joe's traditional defined benefit pension plan is CORRECT? Increased profitability would increase both Joe's and his employees' pension contributions. A unit benefit plan formula allows for higher levels of integration than other defined benefit pension plans. A unit benefit plan formula rewards older employees who were hired in their 50s or 60s. A traditional defined benefit pension plan will maximize Joe's benefits and reward long-term employees based on length of service. A) IV only B) I, II, and IV C) II only D) III and IV

A) Explanation Statement I is incorrect. Contributions to traditional defined benefit pension plans are not dependent on the profitability of a company. Statement II is incorrect because a unit benefit plan formula will not allow higher integration levels. Statement III is incorrect because a flat percentage formula favors workers without much longevity. LO 2.1.2

For 2023, the maximum annual contribution under a money purchase pension plan on behalf of a participant is the lesser of 100% of the employee's covered compensation, or A) $66,000. B) $265,000. C) $22,500. D) $330,000.

A) Explanation The maximum annual contribution for a money purchase pension plan on behalf of a participant is subject to the annual additions limit, which is the lesser of 100% of the participant's covered compensation, or $66,000 (2023). LO 2.3.1

Which of the following is an advantage of fully insured (Section 412(e)(3)) plans? A) Employer funding is flexible. B) Benefits from the plan are guaranteed by the insurance company with the employer transferring all investment risk to the third party. C) There is a flexible investment return. D) Participant loans are available.

B) Explanation Benefits from the plan are guaranteed by the insurance company with the employer transferring all investment risk to the third party. The investment return is derived solely from the fixed, guaranteed cash value rates in the insurance or annuity policies. Participant loans are not available, and annual plan funding is mandatory, not discretionary. LO 2.2.2

Which of these are CORRECT statements about defined contribution pension plans? They use an indefinite allocation formula. They provide a benefit that is based on the value of a participant's account. They require employer contributions to be made from business earnings. They require fixed employer contributions according to the terms of the plan. A) I and II B) II and IV C) II and III D) I and IV

B) Explanation Employer contributions to a defined contribution pension plan (money purchase plan or target benefit plan) must be fixed according to the terms of the plan; e.g., a plan could stipulate that the employer shall contribute an amount equal to 10% of the compensation of each participant. The investment performance of a participant's account balance determines the value of his or her benefit upon termination or retirement. However, contributions must be made to fund a pension plan, even if an employer has no earnings or profits. Defined contribution plans must also have definitely determinable benefits; i.e., the annual employer contribution to an employee's account must be fixed or definitely determinable. LO 2.3.2

Marvin, age 52, is the owner of Ready-Pour Concrete, Inc., a company he started 17 years ago. The 12 rank-and-file employees of Ready-Pour range in age from 22 to 33, and they have from one to three years of service. Typically, employees remain at the company for an average of only one-and-a-half years. Marvin is considering installing a defined benefit plan to ensure his retirement security, and wants to take into account past service. Which one of the following would apply to the installation of a defined benefit plan with a unit benefit formula at Ready-Pour Concrete Inc.? A) The plan would allow Marvin to exclude employees who have not accrued sufficient units to participate in the plan. B) The plan would be more favorable to Marvin than it is to the younger employees. C) A unit credit defined benefit plan would provide a greater retirement benefit for rank-and-file employees than would a flat benefit formula plan. D) The plan would be more favorable to the younger employees than it is to Marvin.

B) Explanation Marvin is age 52 and, thus, would benefit from the more substantial funding allowed by a defined benefit plan. In addition, if employee tenure continues to be relatively short, a unit benefit formula allows Marvin to be credited with a significantly higher number of years of service compared to the total years for any of his employees. LO 2.1.1

Which of the following statements regarding money purchase pension plans is CORRECT? A) Annual employer funding is optional. B) These plans typically favor younger employees. C) They allow a maximum of 25% of employer stock. D) The plan requires actuarial services.

B) Explanation Money purchase plans favor younger employees. Money purchase pension plans have known funding costs, mandatory annual contributions, and limit the amount of company stock to a maximum of 10%. LO 2.3.1

Which of the following factors affect a target benefit plan participant's retirement benefits? The actuarial assumptions used to determine the contribution to the plan The participant's compensation for the plan year The investment performance of the plan's assets The age of the plan participant A) I and II B) I, II, III, and IV C) II, III, and IV D) I and III

B) Explanation Options I, II, III, and IV are all correct. Actuarial assumptions about longevity and interest rates affect the amount contributed to a participant's account. A participant's compensation directly affects the size of her plan benefit. The value of a participant's target benefit account balance (i.e., a separate account) depends, in part, on the investment performance (gains and losses) of the plan's assets. Target benefit plans favor older employees who are closer to retirement. LO 2.3.2

Which of the following is a retirement plan that is expensive to administer, the employer assumes the investment risk, favors older plan participants, and does NOT permit elective deferrals? A) Money purchase pension plan B) Traditional defined benefit pension plan C) Target benefit pension plan D) Traditional profit-sharing plan

B) Explanation The question is describing a traditional defined benefit plan. LO 2.1.1

The following information relates to Elizabeth Chen and her business, Chen Cards Ltd.: Elizabeth, 48, started her company 15 years ago and does not plan to retire until age 70. The other Chen Cards Ltd. employees range in age from 45 to 63 and have from one year to eight years of service. Elizabeth would like to install a qualified plan that would both favor her and reward long-term employees before they retire. Which one of these is an advantage to Elizabeth of installing a defined benefit plan with a unit benefit formula? A) It could maximize Elizabeth's benefits and give employees incentive to work harder as units of profit are allocated to their accounts. B) It could reward older employees hired in their 50s or 60s and who are nearer to retirement. C) It could use a higher integration level than other plan types to maximize the owner's benefits. D) It could both maximize Elizabeth's benefits and reward long-term employees because benefits are based in part on length of service.

D) Explanation A unit benefit formula in a defined benefit pension plan will favor employees who have accrued many years of service with the company—in this case, primarily Elizabeth and the long-term employees she would like to reward. Note that Elizabeth founded the company; thus, she has the maximum longevity possible for any employee. LO 2.1.2

Which of these qualified plans may require the use of the three highest consecutive years' earnings for purposes of determining the maximum benefit that is promised? Money purchase pension plan Stock bonus plan Profit sharing plan Traditional defined benefit pension plan A) I, II, and IV B) I and II C) I, III, and IV D) IV only

D) Explanation Only the traditional defined benefit plan requires the use of the three highest consecutive years of earnings to derive the maximum benefit. This plan provides a promised benefit to participants. Note the difference between the law limiting the maximum defined benefit amount allowed that uses the highest three consecutive years of compensation and the manner in which most defined benefit plans determine the actual benefits received by employees. Actual benefits can be determined in virtually any manner but usually use the highest 3-5 years without requiring that the years be consecutive. LO 2.1.2

James, a pilot, founded an airline, Margaritaville Airways, as a sole proprietorship 15 years ago. Six years ago, he hired six employees. Now the business has grown, and he decides to incorporate. The new successor entity, Margaritaville Airways, Inc., offers a defined benefit plan. If a unit benefit formula is used, James wants to know if employees will receive credit for past years of service. Which of the following is CORRECT? A) All employees will receive credit for 10 years of past service. B) The owner will receive credit for 10 years of service. The employees will receive no credit. C) Neither the owner nor the employees will receive any credit for past service. D) All employees will receive credit for 5 years of past service.

D) Explanation Under IRS safe harbor rules, a successor entity may recognize up to five years of service when establishing a defined benefit plan. The plan may not discriminate in favor of the highly compensated employee-owner(s). LO 2.1.2