RPA - Assignment 6

Explain (a) how employee forfeitures occur in profit-sharing plans, (b) what alternatives plan sponsors have to dispense forfeitures and (c) what alternative do plan sponsors typically choose.

(a) Employee forfeitures occur in a profit-sharing plan when employees terminate with less than full vesting. (b) Plan sponsors may use employee forfeitures either to reduce employer contributions or may reallocate the forfeitures among remaining plan participants. (c) Profit-sharing plan sponsors typically reallocate forfeitures among remaining participants. Generally, these reallocations are determined on the basis of pay of each remaining participant in proportion to the total pay of all remaining participants.

Explain how the tax law treats money purchase pension plans as (a) defined benefit plans (b) defined contribution plans

(a) because they technically are pension plans, money purchase plans are treated for many purposes as defined benefit plans. They are subject to the minimum funding and joint-and-survivor requirements that apply to defined benefit plans. (b) Individual accounts must be maintained for employees; the plans are subject to the annual addition limits of Section 415 of the IRC; and they are not subject to the plan termination provisions of Title IV of ERISA.

Explain the restrictions on the amount profit-sharing participants may invest from their plan in life and health insurance.

(c) if both ordinary life and accident and health contracts are purchased, the amount spent for the accident and health premiums plus one-half of the amount spent for the ordinary life insurance premiums may not, together, exceed 25% of the funds allocated to the employee's account. Additionally, an ordinary life insurance contract will be considered as incidental only if the plan requires the trustee to convert the entire value of the life insurance contract at or before retirement into cash, or to provide periodic income so that no portion of such value may be used to continue life insurance protection beyond retirement, or to distribute the contract to the participant.

Although money purchase plans are treated differently for different tax law purposes, they are fundamentally defined contribution arrangements. Explain.

(d) individual accounts are established for participating employees. (e) employees frequently are given a choice of several investment funds in which to invest their account balances. (f) an employee's benefit, at any given time, is whatever can be provided by his or her vested account balance at that time. (g) the employee's account balance usually is payable in full in the event of the employee's death.

Describe the three basic profit sharing plan approaches.

1. Current (cash) - Here, profits are paid directly to employees in cash, check or stock as soon as profits are determined. 2. Deferred - Profits are credited to employee accounts to be paid at retirement or other stated dates or circumstances. 3. Combination - Part of the profit is paid out currently in cash and part is deferred.

Is a definite predetermined contribution formula required in a profit-sharing plan in order for the plan to be qualified under the IRC? Explain.

A profit-sharing plan need not include a definite predetermined contribution formula as a condition for qualification under the IRC. It is not even necessary that contributions be based on profits. However, in the absence of a predetermined contribution formula, "substantial and recurring" contributions must be made to fulfill the requirement of plan permanency.

Describe how profit-sharing plans integrated with SS may meet these same requirements.

A profit-sharing plan that has an integrated allocation formula that meets the permitted disparity requirements of Section 401(I) will be considered to have a uniform percentage allocation formula.

Explain how vesting percentages are determined when a profit-sharing plan is terminated.

All assets in the fund vest immediately for the plan participants. Since all plan assets are already allocated to specific participants, no problem exists determining an order of priorities for the distribution of the fund. Each participant is entitled to the balance in his or her account.

Although money purchase plans are treated differently for different tax law purposes, they are fundamentally defined contribution arrangements. Explain.

Basic characteristics that are found in all defined contribution plans: (a) in establishing the plan, the employer agrees to make a fixed contribution each year for each eligible employee. (b) the plan may require employees to make contributions to participate. If so, these contributions can be made only from after-tax income. (c) both employer and employee contributions are transferred to a trustee, where they are invested on behalf of the employees.

Summarize the typical coverage requirements in a profit-sharing plan.

Because a profit-sharing plan must be for the exclusive benefit of employees and their beneficiaries in order to qualify under the IRC, coverage requirements must not discriminate in favor of highly compensated employees. Relatively few profit-sharing plans impose a minimum age requirement, whereas almost all specify a service requirement for participation. The IRC permits a minimum age requirement of up to age 21 and service requirement of up to one year or two years if the plan provides for full and immediate vesting and is not a cash or deferred arrangement.

Describe the DOL requirements that permit a plan sponsor to receive statutory relief from liability for poor investment choices by participants in a qualified profit-sharing plan.

By complying with these regulations, a plan sponsor may receive statutory relief: (a) At least 3 diversified categories of investment with materially different risk and return characteristics (b) Participants have the right to change investments at least quarterly - more often if needed because of the volatility of a particular fund (c) Regulatory liability protection can be afforded to employer stock if the shares are publicly traded in a recognized market and if the plan also offers the 3 required options; however, all purchases, sales, voting and related share activities must be implemented confidentially through a fiduciary.

Describe the limitation on the amount of loan that can be taken from a profit-sharing plan without triggering a taxable event.

Certain requirements must be met. These requirements involve the amount of the loan, the agreement concerning loan terms and the time period for repayment. The maximum amounts that can be borrowed without being considered a distribution depend on the amount of the employee's vested interest in his or her account balance.

Are there restrictions on the amount of employer securities that may be held by a money purchase pension plan? Explain.

Defined benefit plans generally are prohibited from having more than 10% of their assets invested in qualifying employer securities. Profit-sharing and stock bonus plans, on the other hand, are permitted to invest up to 100% of their assets in qualifying employer securities if the plan documents explicitly provide for this larger investment in employer securities. Money purchase plans, even though they are defined contribution plans, are subject to the same 10% limitation that applies to defined benefit plans.

If a money purchase pension plan involves after-tax employee and matching employer contributions, an actual contribution percentage test must be satisfied each year in accordance with the terms of IRC Section 401(m). The ACP test also applies to voluntary after-tax employee contributions even when there is no employer match. The test limits the participation of HCEs so that their average contribution percentages cannot exceed the average contribution percentages of the NHCEs by more than a stipulated amount.

If a money purchase pension plan involves after-tax employee and matching employer contributions, an actual contribution percentage test must be satisfied each year in accordance with the terms of IRC Section 401(m). The ACP test also applies to voluntary after-tax employee contributions even when there is no employer match. The test limits the participation of HCEs so that their average contribution percentages cannot exceed the average contribution percentages of the NHCEs by more than a stipulated amount.

Explain the restrictions on the amount profit-sharing participants may invest from their plan in life and health insurance.

If a profit-sharing participant invests in life and health insurance with funds that have accumulated for less than two years, additional IRS requirements must be met. IRS requires that amounts used to purchase life or health insurance be "incidental". IRS had defined incidental as being one of the following: (a) if only ordinary life insurance contracts are purchased, the aggregate premiums in the case of each participant must be less than one-half the total contributions and forfeitures allocated to his/her account. (b) if only accident and health insurance contracts are purchased, the payments for premiums may not exceed 25% of the funds allocated to the employee's account.

Explain the favorable taxation provisions that may be available to profit-sharing distributions that include employer securities.

If a total distribution of the employee's account is made under conditions qualifying for favorable tax treatment, a value for the distributed employer securities must be established to determine the employee's gain. The employee may opt to use either current market value of the securities or the original cost basis to the plan trust in determining his or her gain when the securities are distributed. In other words, the employee is not taxed at the time of distribution on the unrealized appreciation unless he/she so elects.

Describe what the requirements are if a profit-sharing plan's allocation formula is weighted for age and/or service.

If the allocation formula is weighted for age and/or service and for units of pay that do not exceed $200, the plan will meet the nondiscrimination requirements if the average of the allocation rates for HCEs does not exceed the average of the allocation rates for the non highly compensated employees. Otherwise the plan will have to meet the testing requirements of Section 401(a)(4).

If the vesting schedule in a qualified profit-sharing plan is changed, any participant with at least 3 years of service must be given the election to remain under the pre amendment vesting schedule.

If the vesting schedule in a qualified profit-sharing plan is changed, any participant with at least 3 years of service must be given the election to remain under the pre amendment vesting schedule.

If there are no mandatory employee contributions to the plan, the ACP test is not applicable to employer contributions, and this portion of the plan must satisfy the nondiscrimination requirements of Section 401(a)(4) of the IRC. The regulations prescribe two safe harbors that can be met in order to satisfy these requirements.

If there are no mandatory employee contributions to the plan, the ACP test is not applicable to employer contributions, and this portion of the plan must satisfy the nondiscrimination requirements of Section 401(a)(4) of the IRC. The regulations prescribe two safe harbors that can be met in order to satisfy these requirements.

Are employees permitted to take loans or to receive distributions from their money purchase pension plan accounts while still working for the plan sponsor?

It is possible but the practice is unusual. Also, because a money purchase pension plan generally cannot make distributions until the employee has severed employment, in-service withdrawals are not permitted.

Is there a maximum repayment period for loans from a qualified profit-sharing plan? Explain.

Loans must be repaid within 5 years, have substantially level amortization and have payments that are made at least quarterly. If the loan is used to acquire a principal residence of the participant and meets the amount limitation, the 5 year time limit does not apply.

Describe whether profit-sharing plans usually have difficulties passing the non discrimination-in-contributions requirements.

Most profit-sharing plans do not have difficulties passing the nondiscrimination-in-contributions requirements because profit-sharing plans usually allocate contributions on the basis of a uniform percentage of pay with the same vesting schedule and years-of-service definition applying to all participants.

Are employees permitted to make before-tax contributions to a money purchase pension plan? Explain.

No. The cash or deferred arrangement feature of Section 401(k) of the IRC, which permits employees to make elective deferrals and thus make before-tax contributions, is not available to money purchase pension plans. These elective deferral contributions can be made only in conjunction with profit-sharing and stock bonus plans and savings plans that are qualified as profit-sharing plans.

In addition to the limitation of amounts for purposes of taxation, what other requirements apply to loans from qualified profit-sharing plans? Explain.

Plan loans must be available to all participants on a reasonably equivalent basis, and loans may not be made available to HCEs in a percentage greater than that made available to other employees. The law also stipulates that the loan bear a reasonable rate of interest, be adequately secured and be made only by the plan. Note that a loan by a third party, such as a bank, using the employee's account balance as security is prohibited.

May profit-sharing plan participants withdraw any portion of their vested benefits in the plan prior to separation from service with their employer? Explain.

Profit-sharing plan participants may withdraw a portion of their vested benefit while still actively employed. The regulations permit distributions from a qualified profit-sharing plan "after a fixed number of years." The IRS has interpreted this to mean that accumulations cannot be distributed in less than two years. Therefore, if contributions have been credited to an employee's account for three years, he/she can withdraw an amount equal to the first year's contribution and the investment income credited in that year provided the plan allows in-service withdrawals. Tax law also permits the withdrawal of funds upon the happening of an event such as hardship or as interpreted by the IRS, upon the completion of five years of plan participation.

Qualification of profit-sharing plans for tax exemption under Section 401 of the IRC is restricted to deferred or combination type plans.

Qualification of profit-sharing plans for tax exemption under Section 401 of the IRC is restricted to deferred or combination type plans.

Explain the advantages of using a definite predetermined formula in making contributions to a profit-sharing plan.

Such a formula raises employee morale and feelings of security since they can readily calculate anticipated plan contributions based on measured operating results. Employees may feel that, without a definite formula, they cannot count on a share of the firm's profit.

Contributions under a profit-sharing plan may be made on a discretionary basis or in accordance with a definite predetermined formula. Explain the advantages offered by the discretionary approach.

The discretionary approach to making contributions to a profit-sharing plan is advantageous in that it provides contribution flexibility. Contributions can be adjusted to reflect a firm's current financial position and capital needs. Additionally, the discretionary approach assures that contributions will not exceed the maximum amount allowed as a deductible expense for federal income tax purposes.

Describe the maximum deductible employer contribution limitations for profit-sharing plans.

The maximum deductible employer contribution limitations for profit-sharing plans is 25% of the compensation paid or otherwise accrued during the employer's taxable year for years beginning after 2001 as a result of the EGTRRA. When the contribution in one taxable year is greater than the deductible limit for such taxable year, carryover provisions apply. This type of carryover is called a "contribution carryover." If a contribution is made in a given year in excess of the allowable deduction for that year, the employer is allowed to deduct such excess payment from the amount of contribution in a succeeding taxable year if it does not bring the deduction for the succeeding year to over 25% of the participating payroll for such succeeding year.

How does the answer to the previous question change if both a pension and a profit-sharing plan exist? Explain.

The total amount deductible in any taxable year for both plans together cannot exceed 25% of the compensation paid or accrued to covered employees for that year. The carryover provision applies in this case as well; and, when excess payments are made in any taxable year, the excess may be carried forward to succeeding taxable years, subject to the limitation that the total amount deducted for such a succeeding taxable year cannot exceed 25% of the compensation paid or accrued for subsequent year.

While the IRS does not require a profit-sharing plan to include a definite contribution formula for qualification, it is necessary that a profit-sharing plan include a definite allocation formula to become qualified.

While the IRS does not require a profit-sharing plan to include a definite contribution formula for qualification, it is necessary that a profit-sharing plan include a definite allocation formula to become qualified.

Are money purchase pension plans required to provide the joint-and-survivor options? Explain.

Yes. The joint-and-survivor requirements that apply to defined benefit plans apply equally as well to money purchase plans. Other forms of defined contribution plans are exempt from these requirements if: (1) the employee's spouse is the beneficiary for 100% of the employee's account balance unless the spouse consents in writing to the designation of another beneficiary (2) the employee does not elect an annuity distribution (3) the plan has not received a transfer from a pension plan. This exemption is also available to money purchase pension plans that are part of an employee stock ownership plan.