Retirement Planning Exam 1

Top-heavy rules applied to small business plans

- DB Deemed top-heavy if 60% of PV of expected future benefits are allocated to key employees - DC plan top-heavy if 60% of current account balances are allocated to key employees

Defined Benefit

- Pension plan - investment risk lies with plan sponsor - require sponsoring employer to have stable cash flow

Features/benefits of MPPP

- only type with required contributions - require employer to have very stable cash flow

Features of 401(k) plan

- requires employee to contribute money out of gross compensation - typically matched by employer - employee always fully vested in their own salary deferrals - contribution limit of $19k for tax-deductible contributions

Characteristics of tax-advantaged, employer-sponsored plans

- sponsors receive tax deduction for tax year in which contribution is made - participant's taxes are deferred until money is withdrawn from account (typically in retirement) - ^ offers significant benefit as marginal tax rate will be lower in retirement - municipal bonds and other tax-free investments should not be held within an already tax-deferred plan - tax-free (or sheltered) investments usually have lower return because tax benefit attracts investors, but IRA or 401(k) would already receive favorable tax treatment - free to look for higher-yielding investments since there is no benefit from double tax-deferral

Features of Profit-Sharing Plan

- treated like DC, all investment risk with employee - employee receives contribution from their employer - based on level % of compensation, subject to 415(c) - employer has complete flexibility - company cannot provide targeted replacement ratio - no adjustment for past service

Employer advantages to employer-sponsored plans

1. Attract and retain skilled employees 2. Golden handshake - smoothing transition for older employees into retirement, making jobs for younger workers

Requirements of employer-sponsored plans

1. Broad Participation - rank and file must be included 2. Vesting 3. Employer must communicate the plan that is being offered - explained in plan document

Types of Pension Plans

1. DB Plans 2. CB Plans 3. MPPP Plans 4. Target-Benefit Plans

Agencies involved in regulating tax-advantaged retirement plans and their roles

1. IRS - audits tax-advantaged plans and regulates tax implications 2. DOL - Enforcement of Title I of ERISA (disclosure), exclusive benefit rule, fiduciaries held to prudence standard 3. PBGC - backstop for DB plans only, all DB plans required to buy this coverage

Fact-Finding Process

1. Identify goals and objectives that are quantifiable, realistic, and legal 2. Perform due diligence review

Types of DC Plans

1. MPPP - retirement savings accounts where employers make contributions that are not tied to corporate profitability. used to purchase annuity 2. 401(k) 3. PSRP - way for employers to contribute portion of profits to each employee's retirement savings accounts. 4. Stock bonus plan - for is ESOP

Safe Harbor Events

1. Medical care for employee, spouse, or dependents 2. Costs related to purchase of principal residence, college tuition and related educational expense 3. payments to prevent eviction or foreclosure of primary residence, funeral expenses, home repair expenses, and disability

Key Employees

1. Must be 5% owner (same for HCE) 2. Only own 1% of business but earn at least $150,000 in salary 3. Reserved for officers of the company who earn at least $180,000 *somebody earning $121,000 peryear could be considered an HCE but not a key employee!*

ADP Shortcut

1. NHCEs contribute 0-2% - double that to find what HCE can contribute 2. NHCE contribute 2-8% - add 2% 3. Anything above 8, use 1.25

Distinctions between Pension and Profit-Sharing Plans

1. Obligation level - pension obligated to make certain annual contribution, profit not required to make specified contributions. 2. Allowable distribution timing - pension have specific limitations on withdrawals, generally employee must be retirement age; profit permits in-service withdrawals 3. Use of company stock - pension limited to no more than 10% of company stock in investment pool. Profit have no restrictions

What was accomplished with the PPA of 2006?

1. Participants in DB plan should periodically be made aware of their plan's level of assets vs liabilities 2. Plan sponsors are required to offer alternatives to employer stock 3. higher contribution limits were made permanent 4. Excess plan assets can be used to purchase medical benefits for the sponsor's retirees

Types of Profit-Sharing Plans

1. Profit-Sharing Plans 2. 401(k) 3. Stock Bonus Plan 4. ESOPs

Why might an employer choose to offer a DB plan?

1. Provide Adequate retirement for long-service employees 2. Ability to account for past service 3. Maximize tax sheltering potential for older business owners

Post-Erisa Trends

1. Reduction in taxation benefits 2. Boundaries of IRAs have been expanded to encourage more private saving 3. Increasing use of non-qualified deferred compensation plans. Changed in 2001 and ongoing trend has been to give all business types equal access to employer-sponsored retirement savings plans. 4. Limits placed on tax deferral - Since 1986, requires distributions to begin by attained age 70.5 5. Top-heavy rules instituted to prevent the exclusion of rank-and-file employees

DB Characteristics

1. Specifies benefit 2. Assets not allocated 3. investment risk with employer 4. unpredictable cost 5. costly to administer 6. past service 6. not portable

Types of DB plans

1. Straight DB - employer pays certain benefit to employees during retirement 2. Cash Balance - rare, each employee has separate account where their benefits accrue

DC Characteristics

1. contribution/allocation 2. Individual accounts 3. Investment risk with employees 4. predictable cost 5. Less costly 6. No past service 7. Portable

Early Withdrawal Penalty

10% early withdrawal for before 59.5

Features/usefulness of cash balance plan

3-year cliff vesting schedule - all benefits accrued in CB must be fully owned by participant after 3 years

ADP Compliance Test

401(k) plan must pass this ADP 1.25 - average ADP of HCE cannot exceed 125% of ADP for NHCE. ADP 2.0 - HCEs must contribute no more than 200% of what NHCEs contribute, difference cannot exceed 2%

Excluded from Qualified Plans

403(b)s and any plan funded with an IRA (SEPs and SIMPLEs)

403(b)

A retirement account similar to a 401(k) plan, but offered by non-profit organizations, like universities or charitable organizations.

The average NHCE participant at Barkley Industries defers 4% of their salary into their 401(k). What is the maximum percentage than an HCE can contribute? A. 6% B. 4% C. 8% D. 5%

A. 6% Following the ADP 2.0 rule, the HCE's at Barkley Industries can defer up to 6%.

Which of the following is not a reason why an employer would choose a SEP plan? A. Account for past service B. Flexible contributions C. Low-cost administration

A. Account for past service

Which of the following is not a reason why a business owner might want to offer a plan? A. Exclude rank-and-file employees B. attraction of key talent C. shelter from bankruptcy.

A. Exclude rank-and-file employees

Which of the following is a character trait unique to the Defined Contribution plan type? A. The participant bears all investment risk. B. Total contributions are limited to $220,000 C. The employer bears all investment risk. D. DC plans have backstop coverage from the PBGC

A. The participant bears all investment risk.

What is the status quo tendency? A. This is a psychological bias that makes us think that our current experience will never end. B. This is a psychological bias that actually spurs people to plan for their futures...harness the power! C. This is a psychological bias that makes you wish that time stopped in the 1980s.

A. This is a psychological bias that makes us think that our current experience will never end.

Using a flat-percentage-of-earnings formula, the benefit relates solely to ___________________ and benefits are required to be reduced if less than ___________ years of service have been provided. A. a percentage of FAC; 25 B. a percentage of the 30-year average earnings; 20 C. a percentage of FAC; 30

A. a percentage of FAC; 25

A unit benefit formula is designed to ____________________. A. provide a set percentage of FAC for each year of service. B. limit benefit accruals for all DB funds past 35 years of service. C. favor those earning bonuses rather than overtime.

A. provide a set percentage of FAC for each year of service.

Which of the following is not a common feature of a 401(k)? A. Participants can defer a percentage of their salary. B. Employees have now way to access their savings until their official retirement age arrives C. Employers can also contribute to the participant's account.

B. Employees have now way to access their savings until their official retirement age arrives A 401(k) involves both the participant and the sponsor being able to make contributions. Employees have access to in-service withdrawals (hardship or safe harbor provisions apply) and plan loans as needed (not recommended).

Which of the following items in a non-employer sponsored plan? A. 401(k) B. IRA C. 403(b)

B. IRA

Which person below is considered to be a "key employee"? A. Stacey had a salary of $145,000 last year and owns 4.5% of her employer's stock. B. Jen had a salary of $115,000 last year and owns 7.5% of her employer's stock. C. Tim had salary of $147,500 last year and owns 3% of his employer's stock

B. Jen had a salary of $115,000 last year and owns 7.5% of her employer's stock.

Which of the following is not related to the structure and/or operation of an ESOP program? A. ESOP loans B. Tax-free withdrawals for all participants C. Potential for non-recognition of gains D. Cash-out opportunity for a departing owner

B. Tax-free withdrawals for all participants

Which of the following is not a factor in considering when to start planning for retirement? A. Starting earlier means that a smaller amount needs to be saved each month to reach the same goal (all else equal) B. Waiting until student loans are pterm-57aid off at age 40 is better than making too many financial sacrifices early in your career. C. Starting later means that the ratio of accumulation years to liquidation years is smaller (and this is a bad thing).

B. Waiting until student loans are paid off at age 40 is better than making too many financial sacrifices early in your career.

One reason to select a defined benefit plan is to _____________________. A. have a predictable cost structure B. provide for past service C. give all contributions to the owners

B. provide for past service

A plan sponsor for a Money Purchase Pension Plan should have _____________________. A. a good system for deducting contributions from employee payroll. B. stable cash flow to handle the required contribution. C. a pizza party every Friday.

B. stable cash flow to handle the required contribution.

Hardship withdrawals are ___________________________. A. a subset of the broader safe harbor withdrawal category. B. the umbrella that covers safe harbor withdrawals as well. C. the umbrella that covers safe harbor withdrawals as well.

B. the umbrella that covers safe harbor withdrawals as well. Hardship withdrawals are the umbrella that covers safe harbor withdrawals. Put another way, safe harbor withdrawals are a subset of hardship withdrawals. They are permitted in 401(k)s and PSRPs (and a few other plan types).

A Target Benefit Plan is which type of plan (select all that apply)? A. Defined Contribution B. Defined Benefit

Both A. Defined Contribution B. Defined Benefit

The average NHCE participant at Barkley Industries defers 8.25% of their salary into their 401(k). What is the maximum percentage that an HCE can contribute? A. 8.25% B. 10.25% C. 10.31%

C. 10.31% Following the ADP 1.25 test, the HCEs at Barkley Industries can defer up to 10.31% (8.25% x 1.25 = 10.3125%)

The Pension Protection Act of 2006 offers a list of benefits to plan participants. Which of the following items is not among the list? A. Age discrimination is not permitted B. DB plan participants need a periodic notice of the plans asset-level relative to their liability-level C. Automatic enrollment is not encourage because it violates freedom of choice. D. DC plan participants need to receive quarterly statements is they direct their own investment decisions.

C. Automatic enrollment is not encourage because it violates freedom of choice.

Which of the following is not a way in which a SEP similar to a Profit Sharing Plan? A. Both offer flexible contributions. B. Both can hold mutual funds. C. Both cover part-time employees.

C. Both cover part-time employees.

Which type of non-employer sponsored plan is not recommended? A. IRAs B. CDs C. Hiding money under the mattress D. Savings Accounts

C. Hiding Money Under the mattress

Which of the following people is most likely to very quickly develop an acute case of Ohnoitis? A. Scott, age 40, has been contributing to his 401(k) for 12 years. He has only been contributing 5% personally, but he figures "slow and steady wins the race." B. Tim, age 63, just receive notice of a $1 million dollar inheritance. C. Janice, age 61, just received her 401(k) statement in the mail. After a recent stock market correction, it shows a balance of $127,000.

C. Janice, age 61, just received her 401(k) statement in the mail. After a recent stock market correction, it shows a balance of $127,000.

Which statement below is most accurate for non-recognition of gains? A. Non-recognition of gains is only available for NHCEs. B. Non-recognition of gains works best when paired with a Profit Sharing Plan. C. Non-recognition of gains occurs when a departing owner in an ESOP uses the cash out proceeds to purchase another publicly-traded stock (or a series of publicly-traded stocks).

C. Non-recognition of gains occurs when a departing owner in an ESOP uses the cash out proceeds to purchase another publicly-traded stock (or a series of publicly-traded stocks).

Which of these options is not one of the R's of retirement planning? A. recruit B. Retain C. Refund D. Reward

C. Refund

Which plan type does not allow for employer matching contributions? A. SIMPLE B. 401(k) C. SEP D. Simple 401(k)

C. SEP

Which of the following is a character trait unique to a Defined Benefit Plan? A. Each employee has an individual account which is highly portable to another employee should the participant change jobs. B. Costs are known, in advance. C. They can account for past service.

C. They can account for past service.

In a cash-balance plan, participants are credited with _______________. A. the actual rate of return. B. the return on a 10-year Treasury plus 4%. C. a promised rate of return, not the actual rate of return.

C. a promised rate of return, not the actual rate of return. Cash-balance plans provide participants with a certain promised rate of return and not the actual investment return earned. The benchmark for the promised rate is determined by an actuary and not a set formula.

A distinguishing feature of a pension-type plan is that it ________________. A. has no limitations on investing in employer stock. B. permits in-service withdrawals. C. has required annual contributions.

C. has required annual contributions.

Which type of plan has a promised return that is paid in place of the actual market return experienced?

Cash Balance Plan

Flat Percentage of Earnings Method

Chosen percentage of FAC

Plan Sponsor

Company that hosts a retirement for their employees

S-Corporation and Partnership

Corporate entities pass through all business earnings to the owner's tax returns. - S-Corp permitted to use ESOP - Partnerships not permitted to use ESOP

Defined Benefit Rules: 1. 415(b) benefit limit - cannot exceed whatever balance to purchase life annuity at age 65 equal to the lesser of 100% of highest consecutive 3-year average compensation (280k limit) 2. Subject to PBGC 3. Longer Vesting Period 4. Employer bears investment Risk

Defined Contribution Rules: 1. 415(c) Contribution Limit - annual limit lesser of 100% compensation or $56,000. Allowed catch-up of 6k for 50 and older 2. No PBGC 3. Shorter Vesting Period 4. Employee Bears investment risk

Unit Benefit Formula

FAC[(Replacement Ratio)*(years of service/cap for service)

A self-employed person can open their own solo-401(k) and contribute the full limit for any given tax year even if they also work for an employer who offers a 401(k) to which they also max out the salary deferral limit.

False

For a Defined Contribution Plan, any catch-up contributions are still limited by the 415(c) threshold for any given tax year.

False

Once someone has reached 30 years of service, there is no pension-linked reason to continue working if the unit benefit formula in place has a 30-year service cap.

False

The eligibility rule for 403(b)s is that a full-time employees willing to defer at least $2,000 annually must be eligible to make salary deferrals.

False

A 403(b) plan shares the same catchup contribution rules as a 401(k)

False 403(b) catchup is less than a 401(k) and it is available after 15 years of service not the attainment of age 50

A 403(b) plan cannot be designed to permit participant loans.

False A 403(b) can be designed to permit plan loans.

An employer can sponsor both a SIMPLE and a money-purchase pension plan.

False A SIMPLE plan is the only plan type whereby the employer cannot offer any other plan type in conjunction with their SIMPLE plan.

A candidate that has a large number of part-time employees should choose a SEP because it can be designed to exclude part-time employees.

False Both SEPs and SIMPLEs include most part-time employees. This is a quasi non-discrimination feature since small businesses will sometimes use part-time employees in stead of simply rank-and-file.

A ESOP is a great tool for the departing owner in a partnership because it enables non-recognition of gains.

False ESOPs cannot be used by departing owners in a partnership.

Plan sponsors must have current or accumulated profits in order to make contributions to a profit-sharing plan.

False Profits are great, but they are not required to make a contribution to a profit sharing plan.

Everyone who receives any form of compensation from a qualified non-profit organization are considered eligible employees for purposes of making contributions to the organization's 403(b) plan.

False Sub-contractors are not eligible to be included in a 403(b) plan.

Target benefit plans have increased in popularity for the last several years because they involve employee payroll deductions and all investment risk is borne by the employer.

False A target-benefit plan is not very mainstream because there are so many other plan types that are a more natural fit for most situations. They do not involve employee payroll deductions an all investment risk is borne by the participants.

An Advanced Determination Letter (ADL) is required for all plans installed since August 17, 2006.

False - August 17th, 2006 was when PPA of 2006 was enacted. IRS was given overwatch with ERISA from 1974. Either way, ADL is a strictly voluntary process, but is HIGHLY recommended to avoid potential pitfalls.

Candidates for a defined-benefit plan typically have the objective of instituting a plan that has predictable costs.

False - a defined benefit plan has extremely unpredictable costs.

Profit sharing plans are the only DC type of investment that does not permit in-service withdrawals.

False - profit-sharing plans do offer in-service withdrawals

A strength of tax-advantaged retirement plans is that the plan can include only the business owners and exclude the rank-and-file employees. True

False - this statement is backwards. Plans can exclude highly compensated people, but they cannot discriminate against the rank-and-file employees.

Four titles of ERISA

I. Focuses on reporting and plan disclosure requirements II. Establishes minimum standards to protect participants III. Creates regulatory overwatch with the IRS and DOL IV. Creates PBGC (Pension Benefit Guarantee Corporation) as a backstop for DB plans

Difference between DB and DC plan

In a DC plan, employer agrees to make certain up-front contribution. Participant bears the full investment risk and ultimate outcome is uncertain.

Which type of plan has a required contribution with a flat percentage of compensation only?

MPPP

Features of ESOP

Provides non-recognition of gains, owner selling shares to ESOP can defer paying gains on taxes if ESOP owns 30% or more of the company

Business Owners need for Qualified Plans

Recruit, Retain, Reward, Retire

Profit Sharing vs SEP Plans - complex administration - employer contribution allocation method is flexible - 3-year cliff vesting - covers full-time workers with 1 year of service - plan loans permitted

SEP Plan - simple administration - employer contribution allocation is limited - covers part-time workers assuming 3 out of 5 years with earnings of $600 per year - plan loans NOT ALLOWED *available to employer with fewer than 100 employees*

401(k) vs Simple - Complex administration - higher salary deferral limit - flexible employer contribution options - covers FULL-time workers with 1 year of service - plan loans permitted

SIMPLE - simple administration - lower salary deferral limit - rigid employer contribution options - covers part time workers assuming 2 years of service with earnings of $5k in any year - plan loans NOT ALLOWED

Which type of plan has a required contribution that can account for past service?

Straight DB

Which type of plan has a goal in mind with no guarantee of arriving at the goal?

Target-Benefit Plan

What makes a plan tax-advantaged?

They allow the owner to defer taxes until retirement

Simple 401(k)

Traditional 401k adopts simple provisions. Exempt from ADP & ACP tests. Exempt from top heavy requirements. Rigid plan design. Still subject to 270k compensation cap. Exempt from creditors. The deferral is $12,500 but the match is limited to $8,100.

Non-Employer Options

Traditional IRA, Roth IRA CD - smallest amount of investment gain, but most security of principle - Stash Cash (not smart)

A 403(b) plan shares the same aggregate contribution limit as a 401(k).

True

A 403(b) plan shares the same plan loan access rules a 401(k)

True

An employer must notify the PBGC before terminating a defined-benefit plan that is covered by the PBGC insurance program.

True

Candidates for a defined-benefit plan indicate that the desire to provide an adequate standard of living in retirement outweighs the need to have an easily communicated and administratively simple plan.

True

Every plan has at least one named fiduciary who is responsible and accountable for operating the plan.

True

Profit-sharing plans can be designed to allow employees to withdraw funds from participant accounts as early as 2 years after they were contributed by the employer assuming that the employee has worked for the employer for at least 5 years.

True

The higher the employee's tax bracket, the greater the tax savings by using a tax-advantaged retirement plan.

True

Under the safe harbor rules, a withdrawal to pay a child's college tuition is considered a safe-harbor event.

True

Retirement plans play a key role in making a company competitive in the marketplace because they help the employer attract and retain employees.

True Attraction and retention are two of the major benefits of offering a tax-advantaged retirement plan for employees.

A SEP cannot contain a loan provision.

True Because a SEP is funded with an IRA, it cannot offer a loan provision.

A plan sponsor who makes a safe-harbor contributions to a 401(k) plan is exempt from ADP testing as long as they maintain the safe harbor program.

True Tremendous potential benefit to the plan's administrative cost structure

One of the major objectives of ERISA was to improve benefit security by requiring plans to disclose more information to participants about their benefits and their rights under ERISA. Correct! True

True - basically title I of ERISA

The DOL can sue fiduciaries and require restitution to the plan for any losses resulting from negligence.

True - fiduciaries are personally liable for breaches of their duty

Vesting is _______ A. What you do before you get in a kayak B. the process of covering all employees C. The timing of when you own your employer's contributions

c. The timing of when you own your employer's contributions

Examples of Qualified Plans

defined benefit plans, cash-balance plans, money purchase plans, target benefit plans, profit-sharing plans, 401(k)s, stock bonus plans, and ESOPs

Scope of Engagement

document that clearly outlines what the client expects you to do and what you are willing and able to do

Participants

employees involved in retirement plan

Features/benefits of Target-Benefit Plan

hybrid, actuarial contributions - if company has high % at time target-benefit is established - accounts for interest when calculated

Qualified plan

meets certain government requirements in order to be tax-deferred

Tax-Advantaged Plan

offers pre-tax contributions and tax-deferral on capital gains over the investment time horizon

Retirement planning is a ______ that requires an active tradeoff between _____ and _____.

process; saving; spending

Flat amount per year of service method

provides given dollar amount for every qualifying year of service given to the company

flat benefit method

sends same dollar amount to every qualifying employee

Profit-sharing plans permit plan loans.

true - two other types that allow plan loans are 401(k)s and 403(b)s

Being subject to ERISA

vesting schedules apply, increased admin costs, potential exemption from creditors in bankruptcy, ability to add an increased employer contribution that is tied to Social Security