Practice Exam 1 (CRPS)

Which one of the following describes a basic provision of a qualified retirement plan contribution or benefit calculations?

A) Compensation taken into account is limited to $290,000, indexed for inflation. B) The normal form of benefit under defined benefit plan is a lump sum distribution. C) The annual additions limit applies to both defined contribution and defined benefit plans. D) The plan must define its normal retirement age as the Social Security retirement age. Explanation The annual additions limit applies to defined contribution plans but not defined benefit plans. The normal form of benefit under a defined benefit plan is a single life annuity (or joint and survivor annuity if the plan participant is married). The plan's normal retirement age is not necessarily the Social Security retirement age. The maximum includible compensation limit is $290,000 (2021), indexed for inflation. LO 5-3

Which one of the following statements regarding IRA distributions is correct?

A) Distributions from an IRA following separation from service after attaining age 55 are exempt from the 10% early withdrawal penalty and taxation. B) Withdrawals from an IRA to pay for qualified education expenses are exempt from the 10% early withdrawal penalty and taxation. C) Distributions from an IRA following separation from service after attaining age 55 are exempt from the 10% early withdrawal penalty. =D) Withdrawals from an IRA to pay for qualified education expenses are exempt from the 10% early withdrawal penalty. Explanation Withdrawals from an IRA to pay for qualified education expenses are exempt from the 10% early withdrawal penalty, but would be subject to taxation if contributions had been deductible. The exemption for distributions following separation from service after attaining age 55 applies to qualified plans and 403(b) plans, but not IRAs. LO 7-2

The three types of standards that apply to investment advisers include

A) ERISA fiduciary standard, RIA suitability standard, and registered representatives fiduciary standard B) ERISA fiduciary standard, RIA fiduciary standard, and registered representatives fiduciary standard =C) ERISA fiduciary standard, RIA fiduciary standard, and registered representatives suitability standard D) ERISA suitability standard, RIA suitability standard, and registered representatives suitability standard Explanation Professionals who give advice on qualified retirement plans are held to the highest standard, which is a fiduciary standard. Registered investment advisers, who are paid for their financial advice on a non-commission basis, are also held to a fiduciary standard. Registered representatives are held to a lower standard, which is the suitability standard. LO 1-3

Worthy Tools Inc. is designing a defined contribution plan for eligible employees. Employee turnover at Worthy Tools Inc. is high; the rank-and-file employees' average tenure is 20 months. Although occasionally a non-key employee stays at the company for over two years, none has ever completed more than 2.5 years of service. Management would prefer to minimize the benefits available to rank-and-file employees. Based on the above information, which one of the following vesting schedules would be the most appropriate for the Worthy Tools retirement plan?

=A) 3-year cliff B) 3- to 7-year graded C) 5-year cliff D) 2- to 6-year graded Explanation The only vesting schedules available to a defined contribution plan are 3-year cliff and 2- to 6-year graded; 3-year cliff would be the best choice for minimizing benefits to rank-and-file employees, who have historically stayed a maximum of two years with the company. LO 6-2

Which one of the following is not a characteristic of a rollover?

=A) Amounts rolled over from a qualified plan to an IRA and subsequently distributed to the participant will be taxed according to the rules that apply to the original qualified plan. B) A rollover generally must be completed within 60 days of the distribution. C) An eligible qualified plan distribution may be rolled over to another qualified plan, TSA, SEP, IRA, or governmental 457 plan that accounts for such rollovers separately. D) If a qualified plan distribution is made due to the participant's death, the surviving spouse may roll the distribution into another qualified plan, TSA, SEP, IRA, or governmental 457 plan that accounts for such rollovers separately. Explanation Amounts distributed from an IRA are taxed according to the rules that apply to IRAs, regardless of the type of plan from which the funds may have been rolled over. LO 7-3

Why do employees seek retirement savings education from their employers?

=A) Because employees do not understand how their retirement benefit will be calculated or what their options are for withdrawal. B) Social Security requires workers to attend educational programming before applying for benefits. C) Third-party administrators require employees to attend retirement savings workshops in order to participate in the plan. D) Participating in a qualified plan requires employees to attend retirement savings workshops at their workplace. Explanation Employees usually need help understanding their retirement benefits and options. LO 7-1

Which of the following transactions between a qualified plan and a disqualified person are always "prohibited transactions" as defined by ERISA? I. The employer's purchase of a mortgage note in default from the plan for more than fair market value II. The sale of undeveloped land to a qualified plan for a bargain price III. The acquisition of a share of employer stock by a profit sharing plan for full and adequate consideration IV. A plan loan to a 100% shareholder-participant in an amount equal to the amount available to other plan participants, as specified in the plan documents

=A) I and II B) I, II, and IV C) II and III D) I, II, and III Explanation Options I and II are correct statements for the following reasons. The sale or exchange of property (i.e., a mortgage note in this situation) between a plan and a disqualified person results in a prohibited transaction. The sale of the undeveloped land is a prohibited transaction for the same reason. The federal courts have held that an in-kind contribution of employer-owned property to a plan in satisfaction of the employer's funding obligation is a prohibited transaction; i.e., a sale or exchange. Options III and IV are not prohibited transactions. ERISA specifically exempts the acquisition or sale of qualifying employer securities by an individual account plan (such as a profit sharing plan) from prohibited transaction treatment. A qualified plan loan to a 100% shareholder-participant-a disqualified person-in an amount equal to the amount available to other plan participants, as specified in the plan documents is permitted as long as it meets the statutory requirements for plan loans to plan participants. LO 1-2

Which of the following is a common error committed by plan administrators? I. Failure to adopt amendments in a timely manner when the law changes II. Failure to match employee contributions at a minimum level III. Failure to make hardship withdrawals upon request IV. Failure to make loans to participants upon request

=A) I and III B) II and IV C) I only D) II only Explanation Statements II and IV are incorrect. Only eligible employee contributions must be matched, and only when the plan has a matching program. Loans must be made on request, but only if plan rules as to minimum and maximum loan amounts, terms, and vesting apply. LO 6-3

Harry operates a consulting business as a sole proprietorship with a net income of $25,000. One-half of the self-employment tax equaled $1,766. He wants to maximize the contributions to the profit sharing Keogh plan that he has established for this business. Which one of the following statements best describes the limits that apply in Harry's situation?

A) He is not permitted to contribute any funds to his account in the Keogh plan this year. B) He may contribute $25,000 (100% of his earnings from the consulting business) to the Keogh plan. C) He may contribute 25% of his $25,000 net income (reduced by one-half of the self-employment tax) to his account in the Keogh plan. =D) He may contribute 20% of his $25,000 net income (reduced by one-half of the self-employment tax) to his account in the Keogh plan. Explanation Harry's contribution to his account in the Keogh plan cannot be the full 25% profit sharing contribution. Due to his owner status of an unincorporated business, the maximum contribution on his behalf is 20% of his sole proprietorship net income reduced by one-half self-employment tax, or 20% of $23,234. The Keogh contribution percentage is computed by dividing the maximum contribution percentage of 25% by 1 plus the percentage: .25 divided by 1.25 equals .20. LO 4-2

Which of the following describe allowable rollovers? I. From a qualified retirement plan to an individual retirement account (IRA) II. From a qualified retirement plan to another qualified retirement plan (assuming plan provisions allow) III. From a Section 403(b) plan to a qualified retirement plan IV. From a Section 403(b) plan to a Section 457 governmental plan

A) I and II =B) I, II, III, and IV C) I, II, and III D) II and III Explanation All of the rollovers mentioned are currently permitted. LO 7-3

As a general rule, which of the following legal requirements apply to a profit sharing 401(k) plan? I. Nonelective employer contributions must be made out of profits. II. Employer matching contributions must satisfy the ACP test. III. Salary reduction elections must be made before compensation is earned. IV. Special safe harbor provisions can be used to comply with the ADP tests.

A) I and II B) I, II, and III =C) II, III, and IV D) III and IV Explanation Options II, III, and IV correctly describe the restrictions on employer matching contributions, the timing of salary reduction elections, and the availability of special provisions ("safe harbors") to enable a 401(k) plan to comply with the ADP tests. Option I is incorrect because contributions can be made to a profit sharing plan even if the employer does not have current or accumulated profits. LO 3-1

A qualified plan must allow a 22-year-old employee who satisfies the plan's one-year service requirement to commence participation in the plan no later than which two of the following events? I. The first day of the plan year beginning after the date on which the employee satisfies such requirements II. The last day of the plan year during which the employee satisfies such requirements III. The date six months after the date on which the employee satisfies such requirements IV. The first day of the plan year in which the employee satisfies such requirements

A) I and II B) II and III C) I and IV =D) I and III Explanation A plan that contains an age 21 and one-year-of-service requirement must provide that an employee who meets the age and service requirements shall participate in the plan no later than the earlier of the first day of the first plan year beginning after the date on which the employee satisfies such requirements, or the date six months after the date by which the employee satisfies such requirements. LO 5-3

Mike Hendry has been contributing to his SEP-IRA for many years. To which of the following plans may the SEP-IRA be rolled? I. Another IRA II. His TSA III. A 401(k) IV. A governmental 457 plan (that separately accounts for rollovers)

A) I and II B) II and III C) I only =D) I, II, III, and IV Explanation A SEP-IRA may be rolled to another SEP-IRA, TSA, IRA, qualified plan, or a governmental 457 plan that accounts for such rollovers separately. LO 7-3

Harvey Winkler is age 52 and has been employed as an administrator for the MidWest Consortium of the Arts, a nonprofit organization that is dedicated to promoting the arts, for 27 years. His salary this year is $120,000. He is concerned about his ability to retire in 13 years and wants to begin participating in the tax-sheltered annuity (TSA) plan offered by his employer. Which of the following statements apply to Harvey's contributions to the TSA for 2021? I. Harvey can contribute up to $19,500 this year, plus any catch-ups for which he may be eligible. II. Harvey can contribute an additional $6,500 this year under the age 50 catch-up. III. Harvey can take advantage of the catch-up provision that allows the participant to increase the salary deferral limit by up to $3,000 per year. IV. Harvey cannot take advantage of the catch-up provision available to employees with 15 years of service.

A) I and III =B) I, II, and IV C) I and IV D) II and III Explanation The $19,500 salary reduction limit for 2021 will apply plus the $6,500 age 50 catch-up, making the total $2000. Harvey is employed by a nonprofit organization that promotes the arts. He is not an employee of a health care organization (hospital, home health, or health/welfare service agency), educational organization, or church organization, and therefore is not eligible for the long service catch-up. He therefore cannot use the catch-up that allows $3,000 increases to the salary deferral limit. Since Harvey is 52, the age 50 catch-up allows him to increase his total deferral to $26,000. LO 3-3

Harlan Johnson is the president of WireWeels Corporation, a company he started 35 years ago. He is pondering the meaning of a letter he just received from National Benefits and Compliance, his third-party administrator. In part, the letter reads, "To maintain qualified status, a qualified plan must meet certain tests that demonstrate nondiscriminatory coverage. We recently completed testing your plan for compliance with IRC coverage requirements and are pleased to inform you that your plan has passed coverage." Harlan hasn't a clue about the meaning of the letter, though he has received a similar letter every year for at least eight years, along with a bill for services rendered. Which of the following correctly describe the coverage test? I. The plan must benefit at least 70% of all employees. II. In a plan covering a nondiscriminatory class of employees, the average benefit percentage for non-highly compensated employees must be at least 70% of the average benefit percentage for highly compensated employees. III. The percentage of eligible non-highly compensated employees who benefit from the plan must be at least 70% of the percentage of eligible highly compensated employees who benefit from the plan. IV. In a plan covering a nondiscriminatory class of employees, the average benefit percentage for non-key employees must amount to at least 70% of the average benefit percentage for key employees.

=A) II and III B) I only C) II and IV D) I and III Explanation Statements II. and III. represent the average benefit test and the ratio percentage test, the two coverage tests that are used for qualified plans. Statement IV. refers to key employee status rather than highly compensated employee status; key employees are not the relevant group for nondiscrimination testing. LO 6-2

Which of the following are primary responsibilities of a qualified plan trustee? I. Determining the tax consequences of a participant's planned distributions II. Investing the plan's assets according to ERISA's fiduciary requirements III. Monitoring and reviewing the performance of qualified plan assets IV. Preparing and designing plan documents as required by ERISA

=A) II and III B) I, II, and III C) I, II, and IV D) I and II Explanation Options II and III are correct because they accurately describe two of the primary responsibilities of a qualified plan trustee. Both of these tasks are required by the ERISA "prudent man" rule. An ERISA trustee also must comply with the following requirements: act solely in the interests of and for the exclusive purpose of providing benefits to plan participants and their beneficiaries ("duty of loyalty"), diversify the qualified plan's investment portfolio or that portion for which he or she is responsible ("diversification rule"), and comply with the written requirements of the qualified plan document and the plan's investment policy statements ("operational compliance"). Preparing and designing plan documents as required by ERISA is the duty of the plan administrator. LO 1-2

Which of the following statements correctly describe characteristics of a Section 457 plan? I. Distributions from the plan are not permitted until age 72. II. To avoid adverse income tax effects, the deferral agreement must be executed during the same month as the participant's services are provided. III. Eligible participants include employees of agencies, instrumentalities, and subdivisions of a state as well as Section 501(c)(3) tax-exempt organizations. IV. The deferral limit is the lesser of $19,500 in 2021, or 100% of compensation.

=A) III and IV B) II and III C) I and II D) I and III Explanation All of the organizations described in option III may establish a Section 457 plan. Option IV is correct. Section 457 plan deferrals are limited to the lesser of $19,500 in 2021 or 100% of compensation. Option I is incorrect because one could receive a distribution prior to age 72 if it was due to separation from service or an unforeseen emergency, and option II is incorrect because the salary deferral agreement must be executed before the first day of the month in which the services will be performed. The result will be a loss of the tax deferral for that month if the agreement is made during the month. LO 3-4

Which one of the following statements describes a characteristic of a qualified retirement plan termination?

=A) The PBGC may terminate a qualified retirement plan that is not in compliance with minimum funding standards. B) In an involuntary distress termination, the PBGC will take over the payment of all benefits currently being paid to retirees. C) If there are assets remaining in the plan trust following termination of the plan, the employer is permitted to acquire these funds without penalty. D) Following the voluntary standard termination of a qualified plan, the employer is not permitted to establish another qualified retirement plan. Explanation One of the reasons that the PBGC may terminate an underfunded defined benefit plan is that the plan was not complying with the minimum funding standard. (Other reasons include the plan not paying benefits when due, the plan having unfunded liabilities following the distribution of $10,000 or more to the owner, or the PBGC cutting its own anticipated losses.) LO 6-4

Which one of the following applies to defined benefit pension plans?

=A) They provide a predetermined, fixed retirement benefit for participating employees. B) They are not subject to the annual additions limit for contributions made on behalf of participants. C) They allow for a specified contribution to be made by the company, the employee, or both. D) They are a type of nonqualified retirement plan available to certain employees. Explanation Defined benefit pension plans provide a specific, fixed retirement benefit for participating employees when they attain the normal retirement age specified by the plan. An employer's contribution to a defined benefit plan is actuarially determined; the amount is not specified by a formula found in the plan document. Defined contribution plans, not defined benefit plans, are subject to the annual additions limit made on behalf of participants. Defined benefit plans are subject to an annual benefit cap, but not a contribution cap. Defined benefit plans are qualified plans, not nonqualified plans. LO 4-4

Fred is an employee of Slate Inc. and participates in the corporation's profit sharing plan. Fred owns 5.25% of Slate's voting stock but is not an officer of the corporation. Barney Slate owns the rest of the corporation's voting stock. Fred's annual earnings from Slate Inc. for the current year will be $78,000. Is Fred a key employee of Slate Inc.? Why or why not?

=A) Yes, because Fred's 5.25% ownership of Slate Inc. is greater than 5%, so he is a 5% owner. B) No, because Fred's compensation is less than the dollar limitation in effect under Code Section 415(b)(1)(A). C) Yes, because Fred is considered to own one of the largest interests in Slate Inc. D) No, because Fred's compensation is less than 50% of the amount in effect under Code Section 415(b)(1)(A). Explanation Owning a more-than-5% interest in the employer results in key employee status, regardless of compensation level. One way to remember this is that there are three letters in the word "key" and three definitions for key employee status: (1) greater than 5% owner; OR (2) greater than 1% owner with compensation greater than $150,000; OR (3) officer with compensation greater than $185,000. Contrast this with highly compensated's two words and two definitions: (1) greater than 5% owner; OR (2) greater than $130,000 in salary in 2020 (2020 is the lookback year for 2021). LO 6-2

Mike Robertson is an employee of Tower Inc. and participates in the corporation's profit sharing plan. Mike owns 10% of Tower's voting stock but is not an officer of the corporation. John Tower owns the rest of the corporation's voting stock. The following schedule summarizes Mike's annual earnings from Tower Inc. YearAnnual Earnings Year before last $50,000 Last year $86,000 Current year $89,000 Is Mike a key employee of Tower Inc.? Why or why not?

=A) Yes, because Mike's 10% ownership of Tower Inc. makes him a greater-than-5% owner. B) Yes, because Mike owns one of the largest interests in Tower Inc. C) No, because Mike's compensation is less than the dollar limitation in effect ($185,000). D) No, because Mike's compensation is less than $150,000. Explanation An individual who owns more than 5% of the employer company is treated as a key employee. The other choices are incorrect because they do not satisfy one of the following definitions of a key employee: - an officer of the employer whose annual compensation from the employer exceeds $185,000 (indexed) in 2021, - a more than 5% owner, or - a more-than-1% owner of the employer whose annual compensation from the employer exceeds $150,000 (not indexed). LO 6-2

Options to correct ADP test failures include

=A) all of these B) recharacterizing employer matching contributions as elective contributions. C) recharacterizing excess contributions as employee elective contributions on an after-tax basis. D) recharacterizing contributions to eligible employees who do not contribute to the plan as elective contributions. Explanation Plan administrators can take all of these steps in order to correct failed ADP tests. LO 3-2

Which one of the following qualified plans is required to offer survivor annuity benefits to married participants?

=A) defined benefit pension plan B) stock bonus plan C) profit sharing plan D)ESOP Explanation Qualified pension plans such as a defined benefit pension plan are required to offer survivor annuity benefits to married participants. Qualified profit sharing plans (including stock bonus plans and ESOPs) generally are not subject to the survivor annuity requirements, but more typically offer lump sum payouts. LO 5-3

Howard Anderson, age 69, has contributed $100,000 in after-tax dollars to his qualified retirement plan at work. The balance in his account is $400,000. Howard's benefit is payable as a joint and survivor annuity with his 70-year-old wife, Joan. Howard wants to know how much of each monthly annuity payment he receives from the plan will be tax-free. Using the table below, how will you calculate the correct amount? Combined Ages of Annuitants at Annuity Start Date Number of Monthly Payments 110 or less 410 111-120 360 121-130 310 131-140 260 141 and over 210

=A) divide $100,000 by 260 B) divide $300,000 by 210 C) divide $300,000 by 260 D) divide $100,000 by 210 Explanation Howard and Joan's combined ages at their annuity starting date is 139. Based on their combined ages, they will receive 260 monthly payments over their lifetimes. By dividing $100,000 (after-tax contributions) by the estimated 260 monthly payments they will receive, they will know how much of each monthly annuity payment is a tax-free return of after-tax contributions. The remaining balance of each payment is therefore fully taxable. LO 7-3

Glen Urban retired five years ago from Continental Pipeline Inc. (CPI). At his retirement, he received 567 shares of CPI common stock, resulting from the full distribution of his ESOP account. The ESOP was the only qualified plan offered by CPI. The shares had a cost basis (the employer's basis in the stock) of $50,000 and were valued at $200,000 at Glen's retirement date. He held the shares until this year, when he sold the stock for $300,000. Which one of the following statements accurately describes the income tax treatment of the distribution and sale, assuming Glen took advantage of the net unrealized appreciation feature of the distribution?

=A) taxation of $50,000 at distribution and $250,000 at sale B) taxation of $50,000 at distribution and $300,000 at sale C) taxation of $200,000 at distribution and $250,000 at sale D) taxation of $200,000 at distribution and $100,000 at sale Explanation Because Glen took advantage of the net unrealized appreciation feature of this distribution, he paid tax on the employer's cost basis of $50,000 at distribution, deferring the tax on any capital appreciation until actual sale of the shares. At sale, therefore, given the selling price of $300,000, he had $250,000 of taxable gain. If he preferred, he could have made an election to recognize the gain at the time of distribution of the stock-$200,000-and paid tax on any subsequent gains at sale of the shares. Instead, he elected net unrealized appreciation treatment in connection with his distribution. LO 2-2

Jackson Inc. has adopted a SIMPLE-IRA plan. The plan has opted to use the matching option instead of the nonelective contribution. John Jackson's compensation for the current year is $380,000. He defers the maximum allowed in the current year. What is the allowable matching contribution for John?

A) $11,400 B) $8,550 C) $5,300 D) $7,500 Explanation Under the matching contribution requirement, employers are generally required to match the employee's elective contributions in an amount up to 3% of the employee's annual compensation. If the employer makes matching contributions to a SIMPLE IRA, the normal $290,000 (2021) maximum includible compensation limit does not apply. Thus, 3% of $380,000 equals $11,400. LO 4-1

Lois Langley is age 39 and a teacher in the Homedale County school system. She has taught in the Homedale County schools for 12 years and will earn $50,000 this year. She has contributed a total of $56,000 to the school's tax-sheltered annuity (TSA) over the years. Assuming that none of the catch-up elections are of any benefit to her this year, what is the maximum amount Lois can contribute to the plan as a salary deferral for 2021?

A) $13,000 B) $12,500 C) $19,500 D) $25,000 Explanation Lois's maximum salary deferral is the lesser of: $19,500 in 2021 plus any catch-up contributions, if applicable; or the Section 415(c) limit of $58,000. The definition of compensation for purposes of the TSA includes not only taxable wages but also elective deferral amounts. The Section 415(c) limit would be $50,000—100% of $50,000. Because of her age and service, no catch-ups are available. LO 3-3

Jerry Sigman, age 48, works for Parts Unlimited Inc. and earns $350,000. The company provides a 2% nonelective contribution under a SIMPLE IRA plan. Assume the Section 401(a)(17) annual limit on includible compensation is $290,000 in 2021. What would be the maximum that could be contributed to Jerry's account this year (total of employer and employee contribution)?

A) $13,500 =B) $19,300 C) $7,000 D) $19,500 Explanation Under a SIMPLE IRA plan, the employee could defer up to $13,500 in 2021. The employer's 2% nonelective contribution was limited by the Section 401(a)(17) annual limit on includible compensation, which is $290,000 in 2021. With the nonelective contribution, the maximum the employer would contribute for one employee would be $5,800 ($290,000 x 2%). If the employer were to make a 3% matching contribution, the 401(a)(17) limit would not apply and the entire salary of $350,000 would be included. LO 4-1

Mary Black is a sole proprietor with 2021 Schedule C net income of $100,000. Her self-employment tax is $14,130. She has five employees who are eligible for, and participated in, the SEP. She contributed 15% of salary for each of these employees. What is the maximum amount that Mary may contribute to her own SEP-IRA?

A) $13,940 =B) $12,122 C) $15,000 D) $13,044 Explanation The first step in the calculation is to reduce the net income by one-half of the self-employment tax. $100,000 reduced by $7,065 equals $92,935 earned income. In this situation, 15% of employee compensation was contributed. So, using the calculation shown below, we determine that he can contribute a maximum of 13.0435% of his own net earnings: %contribution for common law employees / 1+%contribution for common law employees= .15 / 1.15= 13.0435% $92,935 x 13.0435% = $12,122 LO 4-2

Harlan is vested in 80% of his $30,000 401(k) balance, or $24,000. What is his maximum available loan amount to pay off his credit card balances?

A) $15,000 B) $10,000 =C) $12,000 D) $24,000 Explanation The non-disaster amount of a loan from a qualified plan may not exceed the lesser of $50,000 or one-half of the present value (fair market value) of the participant's nonforfeitable accrued benefit (account balance). Harlan is vested in 80% of his $30,000 balance or $24,000. Plans can allow loan amounts of up to $10,000 without regard to the 50% restriction. Harlan's loan cannot exceed $12,000 (50% x $24,000 = $12,000). For a disaster loan, the percentage becomes 100% and the maximum amount goes from $50,000 to $100,000. LO 7-2

John Dorban, 100% owner of Dorban Products Inc., will be paid a salary of $200,000 this year for his services as president of the company. Dorban Products Inc. has an annual payroll of $900,000, including John's salary. John wants his company to make the maximum allowed employer contribution to its nonintegrated profit sharing plan this year. What is the amount?

A) $250,000 =B) $225,000 C) $90,000 D) $135,000 Explanation The maximum contribution is $225,000 [25% x $900,000 (covered payroll) = $225,000]. LO 2-1

Over a period of 10 years, Mark Smith's employer contributed a total of $20,000 to his SEP-IRA. Now the value of Mark's SEP-IRA is $40,000, and Mark, who is age 45, has decided to use his entire SEP-IRA assets for the down payment on a second home. Assuming Mark's marginal tax bracket is 35%, which one of the following amounts, including penalties, if any, does he owe to the IRS?

A) $7,000 B) $9,000 =C) $18,000 D) $2,000 Explanation Mark's effective tax rate is 45%; i.e., 35% plus the 10% early withdrawal penalty. 45% of $40,000 = $18,000. He has no basis in the account, so the entire amount is taxable. There is an exception to the premature distribution penalty for a first-time homebuyer; however, there is no exception for purchasing a second home. Note that the exception to the premature distribution penalty for a first-time homebuyer does not apply to distributions from a qualified plan-only an IRA-based plan. LO 7-2

Velvet Lawns Inc. employs 26 full-time workers and provides a qualified defined contribution plan for eligible employees. All 26 employees are plan participants this year. Jack Fields, the sole owner of the company, has an account balance of $134,000. The total of the account balances of all plan participant amounts to $215,000. Which of the following statements apply to this plan? I. The plan would not pass the required coverage test and is therefore discriminatory. II. The plan is top-heavy. III. The plan may use either a 5-year cliff or 3- to 7-year graded vesting schedule. IV. The plan must comply with requirements for minimum contributions to non-key employees.

A) II and III B) I and III C) I, II, and IV =D) II and IV Explanation If all 26 employees are participating in the plan, the coverage and nondiscrimination tests would be passed. The plan would, however, be top-heavy (Jack's $134,000 account balance is 62% of the $215,000 total of all account balances). Top-heavy plans must comply with minimum contribution requirements for non-key employees and defined contribution plans use a 3-year cliff or 2- to 6-year graded vesting schedule. LO 6-2

Wilmont Corporation's traditional 401(k) plan imposes a one-year service requirement before an employee becomes eligible to receive matching employer contributions. Wilmont's plan must provide that participants become vested in discretionary employer matching contributions over a schedule that does not exceed which of the following alternatives? I. 3-year cliff vesting II. 2- to 6-year graded vesting III. 5-year cliff vesting IV. 3- to 7-year graded vesting

A) II and III B) I and IV C) III and IV =D) I and II Explanation As a qualified defined contribution plan, a traditional (non-safe harbor) 401(k) arrangement must provide for participants to become vested in all employer contributions over a schedule that does not exceed one of the following two alternatives: 3-year cliff vesting. At the completion of three years of service, a participant becomes fully vested in his or her account. 2- to 6-year graded vesting. Vesting must occur at a rate of at least 20% per year, beginning at the completion of two years of service. The participant is fully vested at the completion of six years of service. Alternative vesting schedules can be used as long as they are at least as favorable in every year to employees as the two schedules described above. LO 5-3

Steve and Susan Rickle, ages 42 and 44, respectively, are going through a divorce. Steve is receiving $21,500, representing one-half of Susan's 401(k) plan balance, in accordance with the terms of a qualified domestic relations order (QDRO). Which of the statements below describe an option that is available to Steve or a requirement he must meet in receiving these funds? I. To avoid the 10% early withdrawal penalty, he must leave the funds in Susan's plan until he is age 59½. II. To avoid the 20% mandatory withholding on the distribution, he must elect direct rollover treatment. III. He may roll over the funds into an IRA in his name. IV. He may roll over the funds into a qualified plan sponsored by his employer. V. He may elect lump sum forward-averaging tax treatment on the distribution.

A) II and III B) I and V =C) II, III, and IV D) I, III, and V Explanation Steve may roll over the QDRO distribution into an IRA or another qualified plan. The mandatory 20% withholding requirement will apply to the distribution, so a rollover would need to be made via a "direct transfer" to avoid this withholding. The distribution is exempt from the 10% early withdrawal penalty, so he does not need to wait until he is age 59½ to avoid the penalty. Forward averaging will not be available to him, as he was not age 50 before January 1, 1986. LO 7-5

Mike has been contributing to his deductible IRA for 17 years because his former employer did not offer a retirement plan. His new employer, Larmer County School District, offers a TSA program but doesn't offer any other retirement plans. Mike may roll his IRA over to which of the following? I. another IRA II. his TSA III. a 401(k) IV. a governmental 457 plan

A) II and III B) I, II, III, and IV =C) I and II D) I only Explanation Mike may roll his IRA to another IRA or his TSA. An IRA may be rolled to another IRA, TSA, SEP, qualified plan, or a governmental 457 plan that accounts for such rollovers separately. Mike participates in a TSA only so the other options are not available. LO 7-3

Johnson Services Inc. has been in operation for eight years and has been profitable for the past three years. Due to competitive pressures, the company will undergo an expansion of its workforce over the next five years-from the current 17 employees to a projected 36 employees. Tim Johnson, the owner, is interested in installing a qualified retirement plan to attract employees and reduce the company's tax burden. Tim is 40 years old, and his financial advisor has recommended that he save 12% of his salary each year for a retirement fund. Which of the following statements describe a key factor that affects the selection of a qualified retirement plan-in this case, making a defined contribution plan more appropriate than a defined benefit plan? I. A defined benefit plan would offer contribution flexibility in case the company had a down year II. The uncertainty of future cash available for plan contributions, given the planned growth of the company III. Tim's age IV. Tim's retirement savings need

A) II and III B) I, III, and IV =C) II, III, and IV D) I and II Explanation Defined benefit plans require a mandatory annual contribution. Defined contribution plans would provide discretionary contributions. Tim's young age, and his retirement savings need of only 12%, point in the direction of defined contribution plans. LO 5-2

Which of the following are characteristics that simplified employee pensions (SEPs) share with qualified profit sharing plans? I. 25% limit on deductible employer contributions II. The $290,000 maximum includible compensation limit III. Top-heavy rules IV. Statutory eligibility requirements (age 21, one year of service)

A) II and IV B) I and II =C) I, II, and III D) I, III, and IV Explanation SEPs and profit sharing plans are both subject to the 25% limit on deductible employer contributions, the maximum includible compensation limit, and the top-heavy rules. Eligibility requirements are different for a SEP (attainment of age 21, performed services for the employer in at least three of the five immediately preceding calendar years, and earned at least $650 during 2021) than for a profit sharing plan (generally a standard 21 and 1). LO 4-2

Which of the following allocations would be permitted in a qualified profit sharing plan? I. Investment earnings allocated in proportion to relative account balances II. Investment earnings allocated in proportion to relative compensation III. Employer contributions to the profit sharing plan allocated in proportion to relative compensation IV. Employer contributions to the profit sharing plan allocated in proportion to relative account balances

A) II and IV B) I, II, and IV C) II and III =D) I and III Explanation As a defined contribution plan, a profit sharing plan is an individual account plan; individual account plans allocate investment earnings in proportion to each participant's account balance. Employer contributions, on the other hand, generally are allocated based on relative compensation. LO 2-2

Which of the following statements accurately describe limits that apply to defined contribution plans? I. The employer contribution to a profit sharing plan is limited to 25% of covered payroll. II. The employer's contributions to all defined contribution plans is a combined limit of 25% of covered payroll. III. "Annual additions" are limited to the lesser of 25% of the participant's compensation or $58,000 (for 2021). IV. "Annual additions" are aggregated and limited to the lesser of 100% of the participant's compensation or $58,000 (for 2021) for all defined contribution plans of the employer or related employers.

A) II and IV B) III and IV C) I and III =D) I, II, and IV Explanation The annual additions limit for 2021 (the lesser of 100%-not 25%-of pay or $58,000) applies to the additions to a participant's account in all types of defined contribution plans. The employer deduction limit is a separate limit: 25% for profit sharing plans, money purchase plans, target plans, and multiple defined contribution plans. The annual additions limit for a participant in multiple defined contribution plans of the employer or related employers must also be aggregated. LO 2-1

John Smith provides a qualified profit sharing plan for his employees at Smith Enterprises Inc., a C corporation. Seven years ago, John borrowed $20,000 from his account to help with college expenses for his children; this loan amounted to less than half of his accrued vested benefit and is still outstanding. Several employees have also received loans from the plan in amounts ranging from $10,000 to $30,000. All of these loans were arranged at market interest rates and were made for purposes such as home improvements, college costs, and vacations. Loan amounts did not exceed one-half of the present value of each participant's vested plan accumulation. Which of the following statements correctly describe the plan's status according to the Internal Revenue Code? I. The plan is in violation of the prohibited transaction rules because John is using plan assets in his own interest. II. John's loan will be considered a taxable distribution because it has exceeded the five-year repayment limit. III. The plan is not in violation of the prohibited transaction rules because loans have been made available to other employees in equal or greater proportions than John's loan. IV. The plan is in violation of the prohibited transaction rules because it is lending money.

A) II and IV B) IV only C) I only =D) II and III Explanation Since the profit sharing plan allows loans, John Smith is allowed to take loans from his qualified plan account just as any other participant can. Note also that owner/employees in an S corporation, a sole proprietorship, or a partnership are also allowed to borrow from their qualified plan accounts. The five-year repayment limit can be exceeded only for loans used to purchase a primary residence. LO 7-2

Which of the following are correct statements about survivor benefits from a qualified retirement plan? I. Profit sharing plans that accept direct transfers from pension plans are not required to provide a QJSA. II. The qualified joint and survivor annuity (QJSA) may be waived if the spouse gives written consent to the effect of the election and the naming of another beneficiary. III. Defined benefit plans must provide a QJSA. IV. A pension plan is not required to provide a survivor annuity if the plan participant and spouse have been married for less than one year. V. The QJSA payable to the spouse must be at least 50%, but not more than 100%, of the annuity amount payable during the joint lives and actuarially equivalent to a single life annuity over the life of the participant.

A) II and V =B) II, III, IV, and V C) II, III, and IV D) I, II, and III Explanation The spouse may waive the qualified joint and survivor annuity (QJSA) option via written consent, which includes acknowledging the effect of the waiver and the naming of another beneficiary. If the participant and spouse have been married for less than one year, the plan does not have to provide a survivor annuity. The QJSA must be actuarially equivalent to a single life annuity over the life of the participant and at least 50%, but not more than 100%, of the annuity payable during the joint lives of the participant and spouse. Profit sharing plans that accept direct transfers from pension plans are subject to the QJSA requirements. LO 5-3

If an IRA owner's death occurs after the date required minimum distributions have already begun, which of the following beneficiaries of the deceased owner's IRA may use their fixed life expectancy or the deceased IRA owner's remaining life expectancy for purposes of calculating their required minimum distribution? I. two local 501(c)(3)charities are the only beneficiaries II. severely disabled daughter who is the sole beneficiary III. surviving spouse who was named as sole beneficiary

A) II only =B) II and III C) I only D) I, II, and III Explanation The charities must take required minimum distributions as if there is no beneficiary, so the applicable distribution period is based on the remaining life expectancy of the deceased IRA owner and subtracting one for each subsequent year. The disabled daughter is a non-spouse eligible designated beneficiary; she and the spouse can use their own life expectancy or the deceased IRA owner's remaining life expectancy to calculate their required minimum distributions. The daughter would use her Table I life expectancy for the next year's RMD and then subtract one for each subsequent year. The spouse would recalculate their life expectancy each year. LO 7-5

You have a client, age 56, who has decided to take early retirement. She would like to maximize distributions from her IRA without having to pay the 10% penalty tax on premature distributions. Which, if any, of the following words of advice should you give her? I. At age 59½, she can stop taking substantially equal periodic payments until age 72, if she wishes. II. Use of the fixed annuitization method or the required distribution method will maximize the amount of substantially equal periodic payments she receives.

A) II only B) both I and II C) I only =D) neither I nor II Explanation The client must take a series of substantially equal payments for the longer of five years (until age 61) or until she reaches age 59½, after which she can stop taking substantially equal periodic payments until age 72, if she wishes. Of the three methods that may be used to calculate substantially equal periodic payments, use of the fixed amortization or fixed annuitization methods will maximize payments to your client. In contrast, use of the required distribution method will minimize payments to your client. LO 7-2

Which of the following are correct statements about qualified defined contribution plans? I. They are permitted to invest plan assets in qualifying employer securities. II. The retirement benefit is not guaranteed. III. They include SEPs and SIMPLEs. IV. They are subject to Pension Benefit Guaranty Corporation (PBGC) coverage.

A) II, III, and IV B) I, II, and III C) II and III =D) I and II Explanation Defined contribution plans are permitted to invest in qualifying employer securities, and the retirement benefit is not guaranteed. SEPs and SIMPLE IRAs consist of IRA accounts that are not defined contribution plans. Defined contribution plans are not subject to PBGC coverage. LO 2-1

Which of the following correctly state provisions of a tax-sheltered annuity (TSA)? I. Salary reduction contributions made to a TSA are subject to Social Security tax (FICA). II. The TSA elective deferral limit of $19,500 in 2021 may be increased by up to $3,000 for employees of certain organizations who have completed 15 years of service and meet certain other requirements and by an additional $6,500 for those employees who are age 50 or older. III. The nondiscrimination test related to salary-reduction-only plans requires that any employee who wants to defer more than $300, indexed, must be allowed to participate in the plan. IV. When calculating the annual additions to a TSA account, one must include elective deferrals, forfeitures, and employer contributions. Any participant in a 403(b) plan may increase the maximum deferral by $3,000 if they have at least 15 years of service with the employer.

A) III and IV B) I and II C) III, IV, and V =D) I, II, and IV Explanation Contributions made to a TSA on a salary reduction basis are subject to FICA tax. Employees who work for an educational organization, home health service agency, hospital, church, association of churches, or health and welfare service agency and who have completed 15 years of service may elect a special limit that applies to them. That is, the $19,500 in 2021 limit may be increased by up to $3,000. The lifetime limit on these additional amounts is $15,000. Those employees who have attained age 50 may increase their deferral by an additional $6,500 catch-up contribution. This $6,500 increase is not affected by the Section 415 annual additions dollar limit. The annual additions limit for contributions to a TSA participant's account is the lesser of $58,000 (2021) or 100% of the participant's compensation. "Annual additions" include forfeitures, employer contributions, elective deferrals, and after-tax employee contributions. Option III is incorrect because those employees who want to defer $200 or more must be able to participate, and this figure is not indexed. Option V is incorrect since only participants in a TSA sponsored by a health, education, or religious organization ("HER organization") are eligible for the long service catch-up. LO 3-3

Which of the following are correct statements about the top-heavy rules? I. The sponsor of a top-heavy plan cannot use 5-year cliff or 7-year graded vesting. II. An employer's contribution to a top-heavy money purchase pension plan must be at least 3% of compensation per year for each employee. III. For purposes of applying the top-heavy test, benefits include any distributions due to separation from service, death or disability made during the current plan year. IV. Any employee having annual earnings from the employer in excess of $200,000 is considered to be a key employee.

A) III and IV B) I, II, and IV =C) I and III D) I and II Explanation Options I and III are correct statements about top-heavy plan vesting and the years taken into consideration for purposes of determining the top-heavy status of a plan. Option II is incorrect because the required minimum top-heavy contribution must be made on behalf of each non-key employee. Option IV is incorrect because compensation alone is not a determining factor. A key employee must meet one of three conditions: (1) a greater than 5% owner, (2) a greater than 1% owner with compensation in excess of $150,000, or (3) an officer with compensation in excess of $185,000. Contrast this with highly compensated employees: (1) greater than 5% owner; OR (2) greater than $130,000 in salary in 2020 (2020 is the lookback year for 2021). LO 6-2

Which of the following parties may be an alternate payee pursuant to a qualified domestic relations order (QDRO)? I. An aunt or uncle of the plan participant II. A spouse or former spouse III. A child IV. Another dependent of the plan participant

A) III and IV B) II and III C) I only =D) II, III, and IV Explanation An alternate payee in a QDRO may be a spouse, a former spouse, a child, or another dependent who is recognized by the court order to have rights to a participant's qualified plan benefits. LO 7-5

Kim Devoe, age 44, has been a participant in her employer's profit sharing plan for seven years. This year, she withdraws $16,000 (20% of her account balance) from the plan to cover her son's first year in college. Which of the statements below correctly describe the consequences of this withdrawal? I. The amount withdrawn will be subject to a 10% early withdrawal penalty. II. The amount withdrawn will be subject to ordinary income taxation. III. The distribution is considered a hardship withdrawal and is exempt from income taxation. IV. The distribution is considered a hardship withdrawal and is exempt from any penalty.

A) III and IV B) II and IV C) I and III =D) I and II Explanation A withdrawal prior to age 59½ is considered an early withdrawal and is subject to the 10% penalty and income taxation. Hardship withdrawals are not exempt from income tax. For a qualified plan, there is no exception to the premature distribution penalty for education. There is an exception for education if the plan is IRA-based. LO 7-2

A qualified retirement plan may exclude certain employees before determining whether minimum participation and coverage tests have been met. If the plan is designed with a graded vesting schedule, an employee may be excluded if he or she meets which of the following conditions? I. is under age 21 II. is under age 25 III. has completed less than one year of service IV. has completed less than two years of service

A) III only B) II and III =C) I and III D) I only Explanation A plan with a graded vesting schedule cannot require more than one year of service for plan eligibility, and the minimum age requirement for such a plan cannot be greater than age 21. LO 6-2

Mike Harper recently terminated employment with ENCO Inc. Mike has a $70,000 account balance in ENCO Inc.'s simplified employee pension (SEP) plan. Which one of the following steps should be taken by Mike to roll over his SEP account into an IRA?

A) Roll over all of the distribution he receives, within 60 days of receipt, into an IRA. B) Transfer his SEP account, net of the mandatory 20% withholding, directly to an IRA. C) Elect payment in the form of a direct rollover to an IRA. D) Ask for payment from the qualified plan to be made in the form of a check payable to the custodian of his conduit IRA. Explanation The direct rollover rules do not apply to plans that use IRAs as funding vehicles, i.e., SEPs, SARSEPs, and SIMPLE IRAs. The 20% withholding rules don't apply to rollover distributions from a SEP. A SEP is not a qualified plan. LO 7-3

Which one of the following qualified plans is most likely to motivate younger, lower-paid employees and improve company performance?

A) SIMPLE IRA B) traditional defined benefit plan C) profit sharing D) a SIMPLE 401(k) plan with a matching contribution Explanation A profit sharing plan can be structured to reward employees for helping to increase company profits. LO 5-2

Which nondiscrimination test statement is correct?

A) The ADR test calculates the actual deferral ratio (ADR) of each employee by dividing the employee's elective deferrals (contributions) by their annual compensation. The ADR must not exceed 200%. =B) ADP tests must be performed for nonhighly compensated employees as well as on highly compensated employees. C) If a plan fails a nondiscrimination test, it cannot correct the deficiency without disqualifying the plan. D) Catch-up contributions must be included when testing for discrimination of highly compensated employees. Explanation ADP tests are performed for nonhighly compensated employees as well as on highly compensated employees, then compared. There is no ADR test. ADR is calculated in order to use the ADP test. If a plan fails a nondiscrimination test, it has until December 31 of the following year to correct the deficiency; the plan remains qualified during that time. Catch-up contributions are not included when testing for discrimination of highly compensated employees. LO 3-2

Which statement is NOT a part of the approach the DOL takes regarding fee disclosure to qualified plans and their participants?

A) The DOL requires investment providers to deliver fiduciary status disclosures to plan sponsors. B) The DOL requires plan sponsors to send fee disclosures to a participant if the employee is allowed to select investments for the account. =C) The DOL requires an annual written disclosure of administrative expenses the plan charged to each employee's account during the previous year. D) The DOL requires plan administrators to report their fees to the IRS as well as to the DOL. Explanation The DOL requires a written disclosure of administrative expenses the plan charged to each employee's account on a quarterly basis. LO 6-1

Your client, Frank Scott, received a notice from his employer advising him about his defined benefit plan, and he has forwarded to you the parts of the letter he doesn't understand. Which one of the following statements about the defined benefit plan is not correct?

A) The services of an actuary are needed to demonstrate that the minimum funding standards are satisfied. B) The maximum allowable benefit is reduced proportionately for each year of participation less than 10. =C) The plan utilizes individual accounts for each plan participant. D) A definitely determinable retirement benefit must be provided regardless of employer profits. Explanation A defined benefit plan pools its investments so utilizing individual accounts for each plan participant is incorrect. The other choices correctly state the rules concerning the 10-year participation requirement for the maximum benefit, the need for an actuary to demonstrate adequate funding, and the requirement that the plan's benefit be definite. A pension plan's benefit cannot be conditional upon the employer's earning profits. LO 4-4

On December 31 of last year, Samuel Herman had $360,000 in his IRA. He has named Tully Herman, his wife, as beneficiary. Samuel died when he was 74, and Tully is 70. Tully wants you to determine her distribution alternatives. Which one of the statements below correctly describes one of the choices available to her?

A) Tully must continue distributions, but they must be recalculated on her life expectancy. B) Because Samuel had selected a joint life expectancy calculation and had begun to receive minimum distribution payments on a recalculated basis (and since his life expectancy became zero), his spouse must receive distribution of the entire amount. =C) Tully may roll the entire amount into an IRA in her name and defer RMD until she reaches age 72. D) Tully must complete distribution by December 31 of the year containing the fifth anniversary of Samuel's death. Explanation Tully is not required to take a lump sum distribution or even continue distributions, although these options are available to her. She would have the option to roll over the remaining balance to an IRA in her name and defer RMD until she reaches age 72. Also, when she reached 72 and would be forced to start RMDs, the RMDs would be based on Table III. If she held the account as an inherited IRA, the RMDs would be based on Table I. Table III is better because it would be based on the life expectancy of Tully and a hypothetical person 10 years younger than her. Table I is the life expectancy of the individual only. LO 7-4

Edith Franklin, age 45, employs five workers in their 20s and 30s in the bookkeeping service she started two years ago. She and her employees all earn moderate incomes within the range paid for similar work in their city. Edith's business may show a small profit for the first time this year, depending upon how much must be spent for the computer equipment it badly needs to remain competitive. Edith would like to help her employees as much as possible because she remembers her own difficulties at their ages when trying to support herself and her family. Is a qualified retirement plan currently an appropriate option to help fulfill Edith's objective of helping her employees, why or why not?

A) Yes, because she could save more for her retirement since the money put into the qualified plan would be deductible B) Yes, because she would be required to contribute to the qualified plan on behalf of her employees C) No, because it is unrealistic for her to want to help such young employees who have not yet shown if they will be loyal =D) No, because the business has not matured sufficiently since excess cash is needed to pay for new equipment Explanation Edith's business is only two years old, has not yet shown a profit, and likely will apply all or most of this year's available cash to upgrading the computers. Even though Edith has good intentions, these factors indicate that it would not be prudent for her to install a qualified plan at this time. LO 5-1

Which one of the following is a factor that affects a participant's accrued benefit in a defined benefit plan?

A) a participant's age at retirement B) the plan's mortality assumption C) inflationary trends during the plan year D) a participant's years of participation in the plan Explanation A participant's years of participation in a defined benefit plan determine his or her accrued benefit and vested percentage. Mortality assumption affects the amounts contributed for funding purposes, not the amount of the participant's benefit. Inflation may affect investment performance but will not affect a participant's benefits. Benefits are calculated based on the number of years of participation in the plan, not the participant's age. LO 5-3

The impact of ERISA or Regulation Best Interest holding financial advisers to a higher ethical standard is

A) declining because Social Security provides the majority of people's incomes in retirement. B) limited because the most valuable asset people have is usually their home, not their retirement account. =C) growing because as retirement plan assets increase, so do their fees, which reduces returns. D) declining because as retirement plan assets increase, their fees are applied at a lower rate, which increases returns. Explanation Almost $30 trillion was held in U.S. retirement accounts, incurring billions of dollars in advisory fees to financial professionals and plan sponsors. High fees reduce investment returns, compounding over a worker's lifetime. LO 1-4

Which of the following are exempt from the 10% penalty on qualified plan distributions made before age 59½?

A) distributions made to an employee because of "immediate and heavy" financial need B) distributions up to $10,000 for first-time homebuyers C) in-service distributions made to an employee age 55 or older =D) substantially equal periodic payments made to a participant following separation from service, based on the participant's remaining life expectancy Explanation The 10% premature distribution penalty does not apply to distributions on account of death or annuitized payments based on an individual's remaining life expectancy. Heavy and immediate financial need by itself is not an exception to the penalty. The age 55 exception does not apply to in-service distributions; i.e., the employee must have separated from the service of the employer. The first-time homebuyer exception applies only to IRA distributions, not to distributions from qualified plans. LO 7-2

George Elliot, age 45, owns a successful company whose earnings fluctuate significantly from year to year. His salary is $125,000. George wants to begin saving for retirement using a qualified plan that will provide the maximum benefit for him with a low cost of providing benefits for the other participants. The annual payroll is $780,000, all employees earn less than $30,000 per year, and their average age is 27. Which plan should he install?

A) integrated profit sharing plan B) SEP =C) age-weighted profit sharing 401(k) D) defined benefit pension plan Explanation George's company should not install a plan (such as a defined benefit pension plan) with a minimum funding requirement. The integrated profit sharing plan would work, but the age-weighted profit sharing 401(k) plan would allocate more of the nonelective employer contributions to his account in the good years and allow him to defer up to $19,500 (2021). LO 2-3

All of the following would be considered a fiduciary function under ERISA except

A) investment advice for a fee. B) selecting a 3(38) investment manager. C) preparing employee communications. D) discretionary authority. Explanation Preparing employee communications, maintaining records, and providing plan participants orientation information are all considered administrative functions. Any discretionary authority regarding a plan, charging a fee for investment advice given to a plan, and selecting a 3(38) investment manager to manage plan assets would all be considered fiduciary functions. LO 1-2

One advantage to an employer who requests and receives a favorable determination letter from the IRS concerning the adoption of a pension plan is that it

A) is binding on the IRS even if an employer's application contains a misstatement of fact. =B) provides an employer with a high degree of protection in the event the IRS attempts to disqualify the plan in subsequent years. C) protects an employer from lawsuits brought by plan participants against the plan. D) protects a pension plan that has an error in operation from being disqualified. Explanation Obtaining a favorable determination letter from the IRS provides an employer with an opinion letter that the form of the plan meets the requirements of the Internal Revenue Code. This gives the employer assurances concerning the tax-favored status of its qualified plan. These assurances, however, are not absolute. A plan must not only conform in form, but also in operation. Hence, a determination letter does not protect a plan if it incurs an operational defect. A determination letter cannot be relied upon if the determination letter application contained a misstatement or omission of a material fact. A determination letter will not protect an employer from lawsuits brought by plan participants against the employer and plan administrator. LO 5-4

The word "fiduciary" is derived from the Latin word fiducia, which means

A) loyalty. B) duty. C) integrity. =D) trust. Explanation Fiducia means "trust," which is the foundation of a fiduciary relationship. LO 1-2

Which one of the following types of qualified plans is most appropriate for motivating younger, lower-paid employees and improving company performance?

A) salary deferral 401(k) B) profit sharing C) defined benefit D) stock bonus Explanation A profit sharing plan can be structured to reward employees for helping to increase company profits. Stock bonus plans are best suited for sharing ownership. A defined benefit plan is best suited for providing retirement benefits for older employees. Also, the retirement benefit paid from a defined benefit plan is predetermined; there is no upside potential regardless of company performance. Lower-paid employees may not be financially able to participate in a salary deferral 401(k) plan. LO 5-2

When an investment professional refers a client to a retirement specialist, this is a demonstration of

A) the duty to disclose. B) the fiduciary duty. C) the duty to diagnose. =D) the duty to consult. Explanation The duty to consult includes referring a client to another specialist who has greater knowledge than the investment professional, in this case to a retirement specialist. The duty to diagnose includes knowing the customer and making sure that investment recommendations are suitable for the customer. The fiduciary duty requires that the customer's best interests must come first. The duty to disclose includes keeping the client informed about all material facts and all conflicts of interest. LO 1-2

When the law changes, what is the latest date that plans can adopt an interim amendment?

A) the last day of the plan year that includes the date in which the law change first became effective =B) the due date (excluding extensions) for filing the employer's income tax return for the taxable year that includes the date in which the law change first became effective C) the last day of the year after the plan year that includes the date in which the law change first became effective D) the due date (including extensions) for filing the employer's income tax return for the taxable year after the date in which the law change first became effective Explanation The IRS deadline for adopting an interim amendment incorporating a new law change is no later than the latest of the following two dates: the due date (including extensions) for filing the employer's income tax return for the taxable year that includes the date in which the law change first became effective, or the last day of the plan year that includes the date in which the law change first became effective. LO 5-5

The following information relates to Kathleen Williams, president and 100% owner of Security Properties Inc. - Kathleen is 40 years old and hopes to retire at age 60. - Kathleen is paid $120,000 in salary plus bonuses by the corporation. - Security Properties Inc. employs five rank-and-file employees with annual salaries ranging from $20,000 to $50,000. - Rank-and-file employees range in age from 21 to 50; turnover among these employees is low. - Cash flow for Security Properties Inc. has been increasing for the past five years and is expected to increase in the future. - Kathleen would like to implement a qualified defined contribution plan that will help to provide her with a large retirement benefit and minimize corporate income taxes. Which of the following are advantages of installing a profit sharing plan? I. This plan will permit the corporation to take a relatively large deduction and offers contribution flexibility. II. Kathleen will benefit more than any of the other employees from continuous contributions, investment growth, and compounding of earnings. III. The plan can be integrated to give Kathleen an even greater share of contributions. IV. An employer contribution equal to 25% of the total compensation of all employee-participants may be made to the plan.

A) I and III =B) I, III, and IV C) II and IV D) I and IV Explanation A profit sharing plan will help provide Kathleen with a large retirement benefit; also, it will enable her corporation to take a tax deduction for contributions made to the plan. A defined benefit plan will not achieve the same results because of Kathleen's and the other employees' ages. Forfeitures can be used to subsidize the cost of making plan contributions. The plan's investment growth will benefit the younger employees more than Kathleen. LO 2-4

Which of the following are basic provisions of an IRC Section 401(k) plan? I. Employee elective deferrals are exempt from income tax withholding, FICA, and FUTA taxes. II. An employer's deduction is limited to 25% of covered payroll, and covered payroll includes elective deferrals while the 25% contribution limit does not include elective deferrals. III. A Section 401(k) plan cannot require as a condition of participation that an employee complete a period of service greater than one year. IV. Employee elective deferrals may be made from salary or bonuses.

A) I and III B) I and IV =C) II, III, and IV D) II and IV Explanation Options II, III, and IV correctly describe the 25% employer deduction limitation, eligibility requirement, and potential sources of employee elective deferrals for Section 401(k) plans. Option I is incorrect because employee elective deferrals (i.e., salary deferrals) are subject to FICA and FUTA taxes. LO 3-1

Which of the following are provisions of qualified stock bonus plans? I. Taxation of the capital gain on employer stock held in the plan may be deferred beyond the distribution date. II. Like profit sharing plans, stock bonus plans allow for flexible employer contributions. III. Social Security integration generally is not allowed in stock bonus plans. IV. If the employer's securities are not readily tradable on an established market, the employer must stand ready to buy the employees' shares at fair market value.

A) I and III B) I, II, and III =C) I, II, and IV D) II and IV Explanation The unrealized gain (NUA) in the value of the stock may not be taxed until the stock is sold. Stock bonus and profit sharing plans both have the flexible employer contribution characteristics. Participants have the option to take the employer's stock under either. When the employer's securities are not readily tradable on an established market, a participant who separates from service must be provided the right to have the employer-not the plan-repurchase the employer securities under a fair valuation formula (i.e., a put option). Social Security integration is allowed in stock bonus plans, although it is not permitted in ESOPs. LO 2-2

Identify the factor(s) that can affect retirement benefits in a defined contribution plan. I. The ratio of the participant's age to years of service multiplied by the annual contribution to the individual account II. The actual investment return experienced in the individual account III. The interest rate assumption used by the plan administrator IV. The value of the participant's individual account balance at the time of retirement

A) I and III B) II only =C) II and IV D) I, II, and IV Explanation The retirement benefit available from a defined contribution plan is largely determined by the amount contributed to the participant's account and the investment performance of the plan assets. A participant's benefit is not guaranteed by the plan sponsor; the retirement benefit amounts to whatever is in the employee's account at the retirement date. LO 2-1

Brad Elberly has been the sole owner and operator of Woodmasters Inc. for the past 15 years. Brad is age 45, and his salary from the business is $130,000. Brad and his wife, Laura, want to retire when Brad is age 65. Relevant information regarding the business is summarized below: - Financial performance fluctuated over the first 10 years. - Cash flow and profits have stabilized during the past five years and are expected to show modest but consistent growth in the future. Excess cash flow of approximately $150,000 is expected to be available this year. Future years should be about the same. Brad has expressed some concern about the company's outdated equipment and is considering renovating the plant and replacing the outdated equipment over the next five years. The total cost should be about $300,000. - Total compensation for all employees (including Brad) is $200,000. - The four full-time rank-and-file employees range from age 19 to age 33, and have been with Woodmasters for periods ranging from four months to six years. Age and service information is shown below: EmployeeAgeCompleted Years of Service Brad 45 15 years Beth 29 6 years Todd 27 6 months Carol 33 2 years Jim 19 4 months Assume that Brad installs a 10% money purchase plan at Woodmasters this year. The plan provides for a graded vesting schedule. Which of the following statements will be true regarding this money purchase plan? I. The plan will be top-heavy. II. The plan will not be top-heavy. III. The longest allowable vesting schedule for a money purchase pension plan is the same whether the plan is top-heavy or not. IV. The plan will be discriminatory due to the ratio of Brad's salary to the other employees' salaries.

A) I and IV B) II and IV C) II and III =D) I and III Explanation In the first year of a qualified plan that uses a compensation-based allocation formula (as a money purchase plan does), it is possible to determine whether the plan will be top-heavy based on the key employees' compensation as a percentage of covered payroll. Brad's salary of $130,000 is 65% of the $200,000 covered payroll; since this exceeds 60%, the plan is top-heavy. Therefore, a top-heavy vesting schedule must be used. However, all top-heavy defined contribution plans are already set at the top-heavy schedule by law. A top-heavy defined contribution plan has a minimum employer contribution of 3% for the non-key employees. Thus, the plan is fine because it is already giving the non-key employees 10%. LO 6-2

Gary Trapp is employed by the city of Great Rapids, and his sister, Julie, teaches first grade in the Great Rapids public school system. They each participate in deferred compensation retirement plans through their employers: Gary participates in a 457 plan and Julie participates in a TSA. Which of the following statements correctly indicate how their respective plans compare to each other? I. Both plans are based on contracts with the employer. II. Both plans are subject to an $19,500 limit on elective deferrals in 2021. III. Both plans are available to employees of public school systems and Section 501(c)(3) tax-exempt organizations only. IV. Both plans are subject to rollover rules that are similar to the requirements that apply to qualified plans.

A) I only =B) I, II, and IV C) I and III D) I and II Explanation Both the Section 403(b) plan (TSA) and the Section 457 plan are based on contracts with the employer (the salary deferral agreement). Deferrals are limited to $19,500 in 2021 plus catch-ups, if applicable. Both plans are also subject to rollover rules that are similar to the requirements that apply to qualified plans. However, 457 plans are available to employees of state and local governments (not just employees of public school systems) and Section 501(c)(3) tax-exempt organizations. LO 3-3

A distribution cannot be made from a TSA until the employee does which of the following? I. separates from service II. attains age 55 III. becomes disabled or dies IV. under hardship rules

A) I, II, III, and IV =B) I, III, and IV C) I and II D) II and III Explanation Distributions can be made when an employee separates from service, attains age 59½, becomes disabled or dies, or qualifies under hardship rules. LO 3-3

John Lopez, the owner of Western Printers Inc., is considering installing a retirement plan for his employees. John is 37 and his salary is $97,000. John's accountant recommends a 401(k) plan since it is more flexible and allows employee pretax contributions. Which of the following legal requirements apply to a profit sharing 401(k) plan? I. Nonelective employer contributions must be made out of profits. II. In-service withdrawals must satisfy the hardship restrictions. III. Salary reduction elections must be made before compensation is earned. IV. Special safe harbor provisions can be used to comply with the ADP tests.

A) I, II, and III =B) II, III, and IV C) III and IV D) I and II Explanation Options II, III, and IV correctly describe the restrictions on hardship withdrawals, the timing of salary reduction elections so as to avoid constructive receipt, and the availability of special provisions ("safe harbors") to enable a 401(k) plan to comply with the ADP tests. Option I is incorrect because contributions can be made to a profit sharing plan, even if the employer does not have current or accumulated profits. LO 3-1

Which of the following legal requirements apply to employee stock ownership plans (ESOPs)? I. ESOPs maintained by privately owned companies must permit participants, who have reached age 55 and have at least 10 years of service, the opportunity to diversify their accounts. II. ESOPs cannot use permitted disparity (cannot be integrated with Social Security). III. An employer's deduction for ESOP contributions and amounts made to repay interest on an ESOP's debt cannot exceed 25% of the participants' payroll. IV. The mandatory 20% income tax withholding requirement does not apply to distributions of employer stock from an ESOP.

A) I, II, and III B) II and III C) I and II =D) I, II, and IV Explanation Option I correctly states the ESOP diversification rule and option II is a correct statement about the rule that prohibits integrated ESOPs. There is no limit on amounts used to pay interest on ESOP (LESOP) debt. ESOP distributions of employer stock only are not subject to the 20% income tax withholding requirement. LO 2-2

Which of the following are correct statements about survivor benefits from a qualified retirement plan? I. Profit sharing plans that accept direct transfers from pension plans are not required to provide a QJSA. II. The qualified joint and survivor annuity (QJSA) may be waived if the spouse gives written consent to the effect of the election and the naming of another beneficiary. III. Defined benefit, money purchase, and target benefit plans must provide a QJSA. IV. A pension plan is not required to provide a survivor annuity if the plan participant and spouse have been married for less than one year. V. The QJSA payable to the spouse must be at least 50%, but not more than 100%, of the annuity amount payable during the joint lives and actuarially equivalent to a single life annuity over the life of the participant.

A) I, II, and III B) II, III, and IV =C) II, III, IV, and V D) II, IV, and V Explanation The spouse may waive the qualified joint and survivor annuity (QJSA) option via written consent, which includes acknowledging the effect of the waiver and the naming of another beneficiary. If the participant and spouse have been married for less than one year, the plan does not have to provide a survivor annuity. The QJSA must be actuarially equivalent to a single life annuity over the life of the participant and at least 50%, but not more than 100%, of the annuity payable during the joint lives of the participant and spouse. Profit sharing plans that accept direct transfers from pension plans are subject to the QJSA requirements. LO 5-3

Which of the statements below describe one or more characteristics of hardship withdrawals from Section 401(k) plans? I. Hardship withdrawals may be taken from elective deferrals for the current plan year and the investment income from such deferrals. II. The participant must demonstrate "immediate and heavy financial need" and not have any other resources that are "reasonably available." III. All hardship withdrawals are exempt from the 10% early withdrawal penalty if the participant is below age 59½. IV. Hardship conditions must be established for hardship withdrawals from 401(k) plans.

A) I, II, and IV B) I only C) I and II D) II and III Explanation Hardship withdrawals from profit sharing or stock bonus 401(k) plans require that hardship conditions ("immediate and heavy financial need" and other resources not "reasonably available") be demonstrated. Option I is correct. Employee contributions and their earnings, plus certain types of of employer contributions and their earnings are available for hardship withdrawal if the plan document allows them. Not every employer contribution is eligible for a hardship withdrawal; in fact, most are not. However, safe harbor contributions, QNECs, and QMACs are now eligible for hardship withdrawals. Option III is incorrect because many hardship withdrawals from 401(k) plans are subject to the 10% early withdrawal penalty. LO 7-2

Brad Elberly has been the sole owner and operator of Woodmasters Inc. for the past 15 years. Brad is age 45, and his salary from the business is $130,000. Brad and his wife, Laura, want to retire when Brad is age 65. Relevant information regarding the business is summarized below: - Financial performance fluctuated over the first 10 years. - Cash flow and profits have stabilized during the past five years and are expected to show modest but consistent growth in the future. Excess cash flow of approximately $150,000 is expected to be available this year. Future years should be about the same. Brad has expressed some concern about the company's outdated equipment and is considering renovating the plant and replacing the outdated equipment over the next five years. The total cost should be about $300,000. - Total compensation for all employees (including Brad) is $200,000. - The four full-time rank-and-file employees range from age 19 to age 33, and have been with Woodmasters for periods ranging from four months to six years. Age and service information is shown below: EmployeeAgeCompleted Years of Service Brad 45 15 years Beth 29 6 years Todd 27 6 months Carol 33 2 years Jim 19 4 months Which of the following statements can be made regarding any qualified plan that Brad installs at Woodmasters? (Assume that the plan admits any employee who is eligible under the ERISA age and one-year service requirements and that all eligible employees are participating.) I. The plan passes the ratio percentage test. II. Three employees (in addition to Brad) will be eligible to participate. III. A defined benefit plan will pass the participation (50/40) test; however, a defined contribution plan is not required to pass this test. IV. Information is insufficient to perform coverage and participation tests.

A) II and III =B) I and III C) II and IV D) I and IV Explanation Because the plan admits all ERISA-eligible employees, relevant percentages for the coverage and participation tests will be 100%; the plan will pass the ratio percentage test (70% is required). Since the lesser of 50 participants or 40% of the ERISA-eligible employees is two and because three (100%) actually participate, a defined benefit plan passes the 50/40 test. The 50/40 test does not apply to defined contribution plans. LO 6-2

Which of the following legal requirements apply to profit sharing plans? I. Forfeitures must be used to reduce employer contributions or be reallocated to the remaining participants' accounts. II. Employer contributions must be allocated according to a compensation ratio formula only. III. Employer deductions for plan contributions are limited to 25% of the participants' total compensation. IV. Allocations to a participant's account cannot exceed the lesser of 100% of compensation or $58,000 annually in 2021.

A) II and III =B) I, III, and IV C) II and IV D) I and II Explanation Options I, III, and IV correctly state the rules for forfeiture, limitations on employer deductions, and the limitations on contributions to a participant's account. The allocation of employer contributions to a plan may be handled in one of several ways, including an age-weighted allocation system. LO 3-1