RETIREMENT PLANNING: Ch. 3 - Qualified Retirement Plans

What are the plan limits for defined contribution plans?

$260,000 (2014)

What is the covered compensation limit for qualified plans?

$260,000 (2014)

Nondiscriminatory Classification Test specifications are

1) Classification must be based on the facts and circumstances of the business 2) Classification must be nondiscriminatory by meeting the SAFE HARBOR TEST & FACTS/CIRCUMSTANCES TEST.

What vesting schedules are available for qualified plans?

Cliff vs. graduated vesting. 3 year Cliff vesting schedule = provides employee full rights to plan's assets immediately after a certain # of working years 2-6 year Graduated vesting schedule = provides employees with full rights to a certain percentage benefit after completing a certain # of working years, and an additional percentage after more years

Average Benefits Test

Consists of two tests: 1) The average benefits percentage test 2) The nondiscriminatory classification test Equation: Average NHC% / Average HC% > 70% Step 1: Calculate the benefit % of each nonexcludable employee. benefit/annual compensation = % Step 2: Calculate the benefit % for each nonexcl. employee who doesn't benefit from the plan Step 3: Sum up the calculated %'s Step 4: Use the Av Benefits Test Equation

An employee meets the requirements of attaining one year of service if they work 1,000 hours in the first six months. T/F

False

Describe nondiscriminatory classification

If nonexcludable employees who will not benefit under a qualified retirement plan are excluded by job-related merits, as opposed to sex, age, race, etc.. So, hourly and contract employees are often exempt.

Describe CONTROLLED GROUP rules?

If two or more corporations, trades or businesses are part of a controlled group of businesses, the controlled group members are treated as a single employer when applying for qualified plan benefits.

Describe the taxation of contributions to plans

Income tax: - contributions by employers to qualified plans don't have to comply with the "matching" of taxable income. An employer can deduct up to 25% of total covered compensation to its employees. Employees aren't responsible for taxes until distribution. Payroll tax: - Employer's contribution is NOT subject to payroll tax, except with employee elective deferrals to 401(k), 403(b), SIMPLE, SARSEPs and 457 plans.

How is the vesting schedule of a qualified plan affected by the plan's top heavy status?

It ensures that the lower paid employees receive a minimum guaranteed benefit. A plan is considered top-heavy if, from the previous year, the total value of the account from key employees totals at least 60% of the total value in the plan.

When/how is a retirement plan deemed to be a QUALIFIED PLAN?

It must follow a set of rules and requirements set forth by the IRC 401(a). Qualified pension plans consist of pension and profit sharing plans, which can be categorized as either defined benefit or defined contribution plans.

What are the plan limits for defined benefit plans?

Lesser of: $210,000 or 100% of the average of the employee's three highest consecutive years compensation during the time of plan participation

Does ERISA protect qualified plan assets from all creditors?

No.

What are some key characteristics of a PENSION PLAN?

Pension plans are employer-established + maintained. Benefits are based on an employees longevity + gross pay, and generally paid over all of an employee's retirement years until death.

What are some key characteristics of a PROFIT SHARING PLAN?

Profit sharing plans are employer-established + maintained for the participation in his/her profits by employees. The plan must provide a definite predetermined formula for allocating contributions among participants & distributing the funds after a fixed number of years -- this formula must provide for an allocation that's proportionate to each participant's compensation level.

What are some key characteristics of a DEFINED BENEFIT PLAN?

Simply, a plan that is not a contribution plan. Aka a pension plan.

Ratio Percentage Test

This test compares the % of covered nonhighly compensated employees to the % of covered highly compensated employees - so long as the % of covered nonhighly compensated employees is 70% of highly compensated. NHC = 100 excluded, 60 covered (60%) HC = 50 excluded, 40 covered (40%) Ratio % test = %NHC covered/%HC covered 60/80 = 75% 75% > 70% PASS!!

Employee contributions to a qualified plan are always 100% vested? T/F

True

Employees who attain the normal retirement age as defined by their qualified retirement plan must be fully vested in that retirement period. T/F

True

What is top-heavy funding for benefit + contribution plans?

Used to provide non-key employees with a minimum level of funding. Defined Benefit plan: Must be at least 2% x years of service x compensation factor (up to 20%) Defined Contribution Plan: 3% minimum to all eligible non-key employees or less if less provided to the key employees

What are the plan limits for combined qualified plans?

lesser of: 100% of compensation or $52,000 employer contributions + employee contributions + plan forfeiture = lesser of $52K or 100% compenstn

What is the 50/40 test?

Defined Benefit plans must satisfy this test in addition to the other 3 coverage tests, which basically means they need to have benefited the lesser of 50 nonexcludable employees or 40% of all nonexcludable employees each day of the year. 1 employee = 1 must be covered 2-4 employees = 2 must be covered <125 employees = 40% must be covered >125 employees = 50 employees *This doesn't take into acct NHC or HC*

What are some key characteristics of a DEFINED CONTRIBUTION PLAN?

Each participant in the pool of active participants are guaranteed paid-out benefits based solely on their contribution level, and any income/expenses/gains/losses therein. - can be a pension or profit sharing plan

What protection does ERISA provide to participants in qualified plans?

Employee Retirement Income and Security Act (ERISA) 1) anti-alienation protection that prohibits any action that may cause the plan assets to be assigned/garnished/levied or subject to bankruptcy proceedings so long as the funds are in the plan 2) Protection from creditors and plan sponsors - your right as an employee is enforced by DOL.

Advantages of qualified plans to an Employer:

1) Employer contributions currently tax deductible 2) Employer contributions are not subject to payroll tax

To be qualified, a retirement plan must meet one of the following three coverage tests.

1) general safe harbor test 2) ratio percentage test 3) average benefits test

Define: years of service

A determination in plan contribution and vested levels, defined by a 12-month consecutive period with at least 1000 hours worked for the employer. Starts the day the employee is hired and not necessarily the day they are eligible to participate in the plan.

Safe Harbor Coverage Test

A qualified retirement plan satisfies the general safe harbor coverage test if the plan benefits 70% or more of the nonexcludable, nonhighly compensated (rank and file) employes. It doesn't care about the % of covered highly compensated employees.

At what point must the employer be 100% vested?

After 3 years for defined benefit accounts and/or in any accrued benefit/acct balance when the employee attains normal retirement age OR when the plan is terminated.

What is an OFFICER?

An administrative executive who is in regular and continued service. For plans, no more than 50 employes must be treated as officers, otherwise only the top 50 ranked by compensation will be considered officers.

What is Top-Heavy vesting for benefit + contribution plans?

To be considered top-vesting, a plan must meet one of the two criteria. 3 year cliff vesting - 100% vesting after 3 years of service with no minimum vesting before then. 2-6 year graded vesting - 20% vesting after year 2 of service, and an additional 20% each subsequent year until 100% vesting is reached after 6 years of service.

What does Vesting mean?

Where employees are given rights to the employer contributions made towards their retirement acct, after a certain period of working there.

Can a lump-sum distribution from a qualified retirement plan be eligible for special income tax treatment?

Yes.

Do qualified plans protect employees from the employer's wrong doings?

Yes.

Describe the eligibility requirements for qualified plans

You either have worked for the employer for a year minimum and are above 21 years old. This ensures employers don't require excessive service by employees nor that they only provide benefits to older employees. There's a defined plan entrance date (usually once, twice or 4 times a year). 2 year, 100% rule is usually when you have a young working force with high turnover in the first two years. Employers can delay entrance into the plan for up to 2 years & at age 21, but at that point the employee is guaranteed 100% fully vested.

A retirement plan must annually satisfy at least one of the following tests to be considered a qualified retirement plan, except a defined benefit plan must also pass the 50/40 test.

1) General Safe Harbor 2) Ratio Percentage Test 3) Average Benefits Test

Name 3 disadvantages of qualified plans

1) Limited contribution amounts 2) Considered to be income in respect to a decedent asset, subject to distributions to both income and estate taxes with no step-up in cost basis 3)

What are the key differences between a defined benefit vs. contribution plan?

1) The assumption of investment risk (employer vs. employee) 2) The allocation of plan forfeitures 3) Coverage under the Pension Benefit Guaranty Corporation (yes vs. no) 4) The calculation of accrued benefit or acct balance 5) The availability to grant credit to employees for prior service (yes vs. no)

Advantages of qualified plans to an Employee:

1) pre-tax contributions 2) tax deferral of earnings 3) ERISA protection 4) Lump-sum distribution option (10 year averaging, pre-1974 capital gain treatment)

Which employees are considered KEY EMPLOYEES?

A KEY EMPLOYEE is anyone who is any one or more of the following: a) A greater than 5% owner b) A greater than 1% owner with compensation in excess of $150,000 (not indexed) c) An officer (an administration exec) with compensation in excess of $170,000 for 2014, as determined by the previous year-end

What is a highly compensated employee?

An employee who is either: 1) more than 5% owner at anytime during the plan year or proceeding plan year 2) with compensation in excess of $115,000 for the prior plan year