Quiz 1
If a defined benefit pension plan is determined to be top heavy, what is one practical significance of this determination? A) Different eligibility requirements come into effect. B) One of two accelerated vesting schedules must be used. C) Different coverage requirements and nondiscrimination tests apply. D) One of two maximum contribution and benefit formulas must be used.
B) If a defined benefit pension plan is top heavy, one of two accelerated vesting schedules must be used: either 100% vesting after three years of service or graded two- to six-year vesting. The same eligibility and nondiscrimination tests apply as for qualified plans that are not top heavy.
Which statement regarding qualified retirement plans is FALSE? A) They have special tax advantages over non-qualified plans. B) They require an annual profit to allow funding for the plan. C) They must provide definitely determinable benefits. D) They must meet specific vesting requirements.
B) Qualified retirement plans do not require an annual profit to allow funding for the plan. Qualified plans must meet specific vesting schedules. Qualified plans are preferred to non-qualified plans because of the special tax advantages enjoyed by qualified plans. Qualified retirement plans must offer definitely determinable benefits.
Susan makes $400,000 working for Great Grapes, Inc. She defers 4% into the 401(k) and receives the 4% match. How much will go into her account in 2023? A) $22,500 B) $39,600 C) $26,400 D) $32,000
C) Only the first $330,000 of compensation may be used to determine contributions to qualified retirement plans in 2023. Thus, she contributes 4% of $330,000 in 2023. This amount is matched, so $330,000 × 0.08 = $26,400.
ERISA requirements for qualified plans include A) coverage and vesting. B) participation and fiduciary requirements. C) reporting and disclosure. D) all of these.
D) All of these are ERISA requirements for qualified plans.
Which of these describe differences between a tax-advantaged retirement plan and a qualified plan? Tax-advantaged plans are not required to meet all the ERISA requirements that a qualified plan must meet. Employer stock distributions from a tax-advantaged plan do not benefit from NUA tax treatment. A) Both I and II B) I only C) II only D) Neither I nor II
A) Both statements are correct. IRA-funded employer-sponsored tax-advantaged plans are SEPs, SARSEPs, and SIMPLE IRAs.
ERISA requires reporting and disclosure of plan information to all of the following except A) plan sponsors. B) the Department of Labor (DOL). C) plan participants. D) the Internal Revenue Service (IRS).
A) ERISA requires reporting and disclosure of plan information by plan sponsors to the IRS, DOL, Pension Benefit Guaranty Corporation (PBGC), and plan participants.
Able Company is considering various types of qualified plans and seeks your advice. You are asked how a plan participant's benefits at retirement are determined in a defined benefit plan with a flat benefit formula that uses the offset method of integration. Which of these statements would best answer the company's question? A) The percentage of pay benefit specified by the plan is reduced by a specific percentage of the retired employee's Social Security benefit. B) The benefit paid from the employer plan is based only on employee compensation above the Social Security wage base. C) The employee's Social Security benefit is reduced by a specific percentage of the retired employee's retirement plan benefit. D) The benefit paid from the employer plan is reduced by the amount the employer pays into Social Security on behalf of the employee.
A) The percentage of pay benefit specified by the plan is reduced by a specific percentage of the retired employee's Social Security benefit. Offset integration reduces the defined benefit received due to the retiree also getting Social Security benefits.
Which of the following is an example of a qualified retirement plan? A) SEP plan B) Deferred compensation plan C) Section 401(k) plan D) Section 403(b) plan
C) A Section 401(k) plan is a qualified plan. 403(b) plans and SEP plans are tax-advantaged plans, but are not ERISA-qualified retirement plans. A deferred compensation plan is a nonqualified plan. While tax-advantaged plans are very similar to qualified plans, there are some minor differences.
Max is the finance director for Bland Foods, Inc. He is trying to implement a new qualified retirement plan for the company. There are numerous federal guidelines with which the company must comply. Which of the following federal agencies is tasked with supervising the creation of new, qualified retirement plans? A) PBGC B) DOL C) ERISA D) IRS
D) The Internal Revenue Service (IRS) carries out the task of supervising the creation of new, qualified retirement plans.
Which of these statements regarding a top-heavy plan is false? A) A top-heavy plan is one that provides more than 50% of its aggregate accrued benefits or account balances to key employees. B) For a top-heavy defined contribution plan, the employer must make a minimal contribution of 3% of annual covered compensation for each eligible non-key employee. If the contribution percentage for key employees is less than 3%, the contribution percentage to non-key employees can be equal to the key employees' percentage. C) A top-heavy defined benefit pension plan must provide accelerated vesting. D) A top-heavy defined pension benefit plan must provide a minimum benefit accrual of 2% multiplied by the number of years of service (up to 20%).
A) A top-heavy plan is one that provides more than 50% of its aggregate accrued benefits or account balances to key employees is incorrect. The correct percentage is 60%.
Mac, age 39, started 2023 working for the SLH Company. He was paid $128,000 there before he changed jobs and started working for the AKH, Inc. He deferred $10,500 into his SLH 401(k). How much can he defer into his AKH 401(k) this year? SLH and AKH are not related. A) $12,000 B) $22,500 C) $49,500 D) $66,000
A) Mac can defer $12,000 into his 401(k) at AKH, Inc. The total he can contribute to employer retirement plans in 2023 is $22,500. Since he is already doing $10,500 at one employer, he is limited to $12,000 at the other. The fact that the two employers are unrelated does not matter for how much a worker can defer into the two plans. However, when it comes to unrelated organizations, each would have an independent annual additions limit. In other words, the law expects workers to know how much they are contributing to various employer retirement plans and to stay below the limit. The same would be true for related employers. However, unrelated employers are not held responsible for the employee or employer contributions to another employer's plan.
Jim, the president of East Dover Construction Company, has requested your advice in setting up a defined benefit pension plan for eligible employees in the company. Jim founded the company 17 years ago and now has 200 employees, most of whom are under 35 years of age. Due to the nature of the work and ongoing management difficulties, tenure among the employees has averaged under two years. Jim has just fired the managers who were creating problems, but turnover is likely to remain high due to ongoing morale problems. Jim's current salary is $300,000, and he wants the plan to provide him with annual retirement income of $100,000 per year. He expects to retire in 13 years, at age 64. Which of the following statements describes information you need to convey to Jim about factors that could affect the amount of his retirement benefit? A) The excess integration method could be used to increase the amount of his plan benefit in retirement. B) The contribution for Jim to a defined benefit plan would be limited to no more than 5.7% of the contribution percentage for below the integration level. C) One method of increasing the retirement benefit paid to him is by integrating the plan using the of
A) The excess integration method increases the retirement benefit for compensation above the integration level. The offset integration method reduces the retirement benefit due to the receipt of Social Security benefits. With a defined benefit plan, excess investment performance reduces the subsequent employer contributions. The maximum disparity for a defined contribution plan (not a defined benefit plan) for earnings above the integration level is limited to an additional 5.7%.
Which of these are minimum coverage tests for all qualified retirement plans? Minimum benefit test Average benefits percentage test Ratio test 50/40 test A) II and III B) I and III C) I and II D) II, III, and IV
A) The two minimum coverage tests for qualified retirement plans are the average benefits percentage test and the ratio test. To be qualified, a retirement plan must meet at least one of these tests if the plan does not meet the percentage (safe harbor) test. The 50/40 test is only required for defined benefit plans. There is no such thing as a minimum benefit test.
Which of these statements regarding prohibited transactions is FALSE? A) One category of prohibited transactions involves the sale, lease, or exchange of any property between the plan and a party in interest. B) The lending of money or other extension of credit between the plan and a party in interest is never a prohibited transaction exemption. C) One category of prohibited transactions involves the investment in the sponsoring employer's stock or real property. D) One category of prohibited transactions bars a fiduciary from causing the plan to engage in a transaction if the fiduciary knows or should know that such a transaction constitutes a direct or indirect involvement between the plan and the parties in interest.
B) Loans between the plan and a party in interest are prohibited transactions unless the loan is a normal retirement plan loan under the rules for retirement plan loans for participants. The point is that a plan cannot make any other type of loan to a party in interest.
Brad 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 $160,000. Brad and his spouse, Laura, want to retire when Brad is age 65. Relevant information regarding the business is summarized as follows: 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 $275,000. The four full-time rank-and-file employees range from age 19 to age 38, and have been with Woodmasters for periods ranging from four months to six years. Age and service information is as follows: Employee, Age, Completed Years of Service, Compensation Brad, 45, 15 years, $160,000 Beth, 38, 6 years, $40,000 Todd, 27, 6 months
B) Since 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. Two employees are not eligible to participate. Jim is under 21. Todd has less than a year of service. Also, Brad is highly compensated under both tests. He makes more than $150,000 in 2023 and he owns more than 5%. Since the lesser of 50 participants or 40% of the ERISA-eligible employees is two and because three (100%) actually participate, the plan passes the 50/40 test. The 50/40 test only applies to defined benefit plans.
In a Section 401(k) plan, which of these must be considered in complying with the maximum annual additions limit? Employee contributions Catch-up contributions for an employee age 50 or older Dividends paid on employer stock held in the Section 401(k) plan Employer contributions A) II and IV B) I and IV C) I and II D) I, II, and IV
B) Statement I is correct. Employee contributions are counted against the annual additions limit. Statement II is incorrect. Catch-up contributions for an employee age 50 or older are not counted against the annual additions limit. Statement III is incorrect. Earnings on plan investments are not taken into account when computing the maximum annual additions limit. Statement IV is correct. For 2023, the annual additions limit is the lesser of 100% of the employee's compensation, or $66,000.
Scott is the fiduciary of the BSB retirement plan. The entity responsible for monitoring his actions as a fiduciary is A) the PBGC. B) the DOL. C) the SPD. D) the ERISA.
B) The Department of Labor (DOL) governs the actions of plan fiduciaries and ensures compliance with the ERISA plan reporting and disclosure requirements.
Which statement regarding qualified retirement plans is CORRECT? A) They offer after tax earnings to employees each year. B) They are subject to ERISA requirements. C) They provide a deferred tax deduction for employer funding. D) They can discriminate in favor of highly compensated employees.
B) The answer is qualified retirement plans are subject to ERISA requirements. Qualified plans provide tax deferral on investment earnings for employees. While qualified plans in general can provide different levels of benefits to different classes of employees, qualified plans cannot "discriminate in favor of highly compensated employees" in the sense that there is a legal limit to the amount of the difference. As long as the difference is inside the legal limits, the plan is not discriminatory (by definition). Qualified retirement plans provide an immediate tax deduction on employer contributions—not a deferred tax deduction, like a nonqualified deferred compensation plan.
Window Washers, Inc., is establishing a profit-sharing plan using Social Security integration. The base contribution percentage for the profit-sharing plan will be 5%, and the owners have come to you with some questions about Social Security integration. Which one of the following statements is CORRECT? A) The permitted disparity for the plan is 3%. B) The excess contribution percentage for the plan could be as high as 10%. C) The permitted disparity for the plan is 5.7%. D) The excess contribution percentage for the plan could be as high as 26.25%.
B) The excess contribution percentage for the plan could be as high as 10%. The excess contribution percentage is the base contribution percentage plus the permitted disparity. The permitted disparity for the defined contribution plan is the lesser of the base benefit percentage and 5.7%. Thus, in this case, the permitted disparity is 5% and the maximum the excess benefit percentage could be would be 10%.
Which penalty applies to prohibited transactions? A) The transaction must be corrected and the plan placed in a financial position no worse than if the transaction had never occurred. B) A tax equal to 15% of the amount involved applies unless it can be demonstrated that the transaction satisfies ERISA's fiduciary standards. C) Plan participants who engage in prohibited transactions are subject to income tax on a judicially determined amount. D) Transactions that continue uncorrected into subsequent years are not subject to additional penalties.
B) The law requires correction (i.e., undoing) of a prohibited transaction and restoring a plan to the position it would have been in, had the transaction never occurred. Ongoing transactions (e.g., loans, leases) create additional prohibited transactions in subsequent years (and additional penalties) until corrected and are subject to additional penalties. Once the prohibited transaction has taken place, the 15% penalty cannot be waived for extenuating circumstances. Income tax consequences may or may not apply depending on the nature of the underlying prohibited transaction. Usually, the IRS (not the courts) determines the amount of tax involved.
The Jones Corporation has a profit-sharing plan with a 401(k) provision. The company matches dollar-for-dollar up to 5%. Pedro makes $150,000 and defers 5% into the 401(k) for 2023. The Jones Corporation has had a banner year and is considering a large contribution to the profit-sharing plan. What is the most that could be contributed to Pedro's profit-sharing account this year? A) $58,500 B) $51,000 C) $66,000 D) $22,500
B) The maximum allowed employer profit sharing contribution in this case for 2023 is $51,000. The Section 415 annual additions limit for 2023 is $66,000. However, Pedro has already contributed $7,500, and this amount has been matched. Thus, $15,000 has already gone toward the $66,000 annual additions limit for 2023.
With an integrated defined contribution plan, what is the maximum permitted disparity? A) The maximum permitted disparity is 25%, so if the base benefit percentage is greater than 25% then the permitted disparity would be capped at 25%. B) For an integrated defined contribution plan, the permitted disparity is the lower of the base amount, or 5.7%. C) In an integrated defined contribution plan, if the base contribution percentage is 5% then the permitted disparity is 5.7%. D) The permitted disparity is 0.75% per year for up to 35 years.
B) The permitted disparity is the lower of the base amount, or 5.7%. Thus, the maximum permitted disparity is 5.7% for integrated defined contribution plans. The number 5.7% is the percentage of an employee's compensation that goes toward his Social Security retirement benefit for compensation below the taxable wage base ($160,000 in 2023).
Which of the following is NOT an example of a qualified retirement plan? A) New comparability plan B) Employee stock ownership plan (ESOP) C) Section 403(b) plan D) Section 401(k) plan
C) A Section 403(b) plan is a tax-advantaged plan but not an ERISA-qualified retirement plan. While tax-advantaged plans are very similar to qualified plans, there are some minor differences. For example, a tax-advantaged plan is not allowed to have NUA treatment. NUA is covered later in the course. They are also not allowed to offer 10-year forward averaging or special pre-1974 capital gains treatment. Tax-advantaged plans also have less restrictive nondiscrimination rules. Otherwise, they are very similar to qualified plans.
In the administration of a qualified retirement plan, which of the following individuals is considered to be a fiduciary? A) The marketing director of the plan sponsor B) A highly compensated employee who participates in the plan C) A financial planner handling the investment of plan assets D) A CPA who prepares the plan's Form 5500
C) A person or corporation is considered a fiduciary under ERISA if that person or entity renders investment advice or services to the plan for direct or indirect compensation. Clearly, the financial planner-investment manager is within this definition.
Prohibited transactions are those that are not in the best interest of plan participants and include which of these? A loan between the plan and any party in interest The acquisition of employer securities or real property in excess of legal limits A transfer of plan assets to or use of plan assets for the benefit of a party in interest The sale, exchange, or lease of any property between the plan and a party in interest A) I and II B) I, II, and III C) I, II, III, and IV D) III and IV
C) All of the statements are prohibited transactions. Self-dealing is also a prohibited transaction.
Jerry wants to establish a qualified plan for his business to provide employees of the company with the ability to save for retirement. Which of the following plans is a qualified plan? Profit-sharing plan Simplified employee pension (SEP) plan SIMPLE IRA Section 457 plan A) Simplified employee pension (SEP) plan B) SIMPLE IRA C) Profit-sharing plan D) Section 457 plan
C) Of the plans listed, only the profit-sharing plan is a qualified plan. The SIMPLE IRA and the SEP plan are tax-advantaged plans, and the Section 457 plan is a nonqualified plan.
Nigel's employer, Alpha, Inc., maintains a qualified defined benefit pension plan. There are 100 eligible employees working for Alpha, Inc. What is the minimum number of employees the retirement plan must cover to satisfy the 50/40 test? A) 50 B) 100 C) 40 D) 80
C) Under the 50/40 test, a defined benefit plan must cover the lesser of 50 employees or 40% of all eligible employees. In this case, the lesser of 50 employees or 40% of all eligible employees (100) is 40 employees. One way to remember the 50/40 test is the phrase people before percentages (50 people or 40%). Also, note that there are no qualifiers to the types of people. It is not 50 non-highly compensated people. It is just 50 individuals who work for the employer.
Which statement regarding top-heavy plans is CORRECT? A) A qualified plan is considered top heavy if it provides more than 50% of its aggregate accrued benefits or account balances to key employees. B) Top-heavy defined benefit plans must provide a minimum benefit of 2.0% per year for eligible non-highly compensated employees for every year the plan is top-heavy (for up to 10 years). C) For a top-heavy plan, a key employee is an employee who owns more than 3% of the employer with compensation greater than $150,000 (2023). D) An accelerated vesting schedule is used when a defined benefit pension plan is top heavy.
D) An accelerated vesting schedule is used when a defined pension benefit plan is top heavy. A defined contribution plan always requires an accelerated vesting schedule. It sounds strange to say all defined contribution plans have "accelerated vesting," but this is the industry term for the vesting rules for defined contribution plans. Before the Pension Protection Act of 2006, top-heavy plans had accelerated vesting of 3-year cliff and 2-to-6 year graded vesting. Non-top-heavy plans had 5-year cliff and 3-to-7 graded vesting. The PPA changed the maximum vesting rules for defined contribution plans to the "accelerated" vesting schedule. Now only non-top heavy defined benefit plans can have 5 -year cliff and 3-to-7 year graded vesting. A qualified plan is considered top heavy if it provides more than 60% of its aggregate accrued benefits or account balances to key employees. Top-heavy defined benefit plans must provide a minimum benefit accrual of 2% per year of service for up to 10 years (20%) for all non-key employees. A key employee is an employee who, at any time during the plan year, is the following: greater than a 5% owner; a greater than 1% owner with compensation greater than $150,000 (not indexed); or an officer of the employer with compensation greater than $215,000 in 2023. Notice that one of the incorrect answers had "non-highly compensated employees" in place of "non-key employees." It is important to focus on the type of employee being addressed.
Which of the following is the easiest type of retirement plan for an employer to adopt? A) A Pension Benefit Guaranty Corporation (PBGC) plan B) An individually designed plan C) A custom plan D) A prototype plan
D) Master plans and prototype plans are easier to use than individually designed plans or custom plans because they are standardized plans approved as qualified in concept by the IRS. The PBGC is the governmental body that insures pension benefits; it is not a type of plan.
What is the permitted disparity for a defined contribution plan with a current base contribution percentage of 6%? A) 12.0% B) 6.0% C) 11.7% D) 5.7%
D) The permitted disparity is the extra amount reached above the integration level. For an integrated defined contribution plan, the permitted disparity is the lesser of 5.7% and the base contribution percentage. Since the base benefit percentage is 6%, the permitted disparity is limited to 5.7%. That would mean the excess benefit percentage is 11.7% (6% + 5.7%).
