CLU3 Lesson 4 chapters 5/6 quiz and def

Qualified Nonelective Contribution (QNEC)

- A contribution made by the employer to satisfy the ADP or ACP test that increases the ADP or ACP of the NHC employees by making additional contributions to all NHC eligible employees without regard to any elective deferral election made by the employees.

Actual Deferral Percentage Test (ADP)

- A nondiscrimination test that limits employee elective deferrals for the highly compensated employees (HC) based on the elective deferrals of non-highly compensated employees (NHC).

Stock Bonus Plan

- A qualified profit sharing plan funded solely with employer stock. Substantial and Recurring - IRC standard defining the frequency requirement of contributions by employers to profit sharing plans.

Employee Stock Ownership Plan (ESOP)

- A qualified profit sharing plan that utilizes employer contributions to the plan to purchase the stock of the employer's company and allocates the ownership to the plan participants.

Qualified Matching Contribution (QMC)

- Additional matching contributions made by the employer to satisfy the ADP or ACP test that increases the ACP or ADP of the NHC employees who had deferred compensation during the plan year.

Individual 401(k) Plan

- An easy-to-administer, low-cost retirement plan designed for self-employed individuals and owner-only businesses.- For plan years beginning in 2010 and later, a DB(k) retirement plan incorporates, under one single plan with a single trust, a defined benefit plan combined with a 401(k) arrangement.

Repurchase Option (Put Option)

- An option that allows a terminating employee to receive in cash the fair market value of the employer's stock within a stock bonus plan or ESOP if the employer stock is not readily tradeable on an established market. An option to sell to the employer.

Nonallocation Year

- Any plan year of an employee stock ownership plan that holds employer securities consisting of stock in an S corporation, and disqualified persons own at least 50 percent of the number of shares of stock in the S corporation.

DB(k) Retirement Plan

- For plan years beginning in 2010 and later, a DB(k) retirement plan incorporates, under one single plan with a single trust, a defined benefit plan combined with a 401(k) arrangement.

Rank-and-File Employees

- The non-key, non-highly compensated employees.

One Year of Service -

1,000 hours of service with an employer within a 12 month period.

Safe Harbor 401(k) Plans -

A 401(k) plan that satisfies a minimum contribution or matching test and allows the plan sponsor to bypass the ADP test, the ACP test, and the top-heavy tests.

Catch-Up Contribution -

A contribution that allows those nearing retirement to increase their deferral contributions to improve their financial situation for retirement. An elective contribution for employees age 50 and over that allows them to increase their elective deferral limit by up to $6,500 for 2020.

Nonrecognition of Gain Treatment -

A delay in the recognition of gain available to owners of a company that sell company stock to an ESOP. The transaction must meet the stated requirements of the IRC and the owner must reinvest the proceeds from the sale within 12 months of the sale into qualified domestic replacement securities.

Hardship Distributions -

A distribution from a 401(k) plan because the employee has an immediate and heavy financial need and the withdrawal is necessary to satisfy the need. The distribution is taxable and subject to penalties unless a penalty exception applies.

Corrective Distribution -

A distribution to satisfy the ADP or ACP test that reduces the elective deferrals or contributions of the HC employees by distributing or returning the funds to the HC employees.

Actual Contribution Percentage Test (ACP) -

A nondiscrimination test that limits the sum of employee after-tax contributions and employer matching contributions for the HC based on the sum of employee after-tax contributions and employer matching contributions for the NHC.

Qualified Automatic Contribution Arrangement (QACA) -

A plan that contains a "qualified automatic enrollment feature" and is eligible for a new nondiscrimination safe harbor under PPA 2006.

New Comparability Plan -

A qualified profit sharing plan in which contributions are made to employees' accounts based on their respective classification in the company as defined by the plan sponsor.

Age-Based Profit Sharing Plan -

A qualified profit sharing plan that uses a combination of age and compensation as the basis for allocating the contribution to a participant's account.

Profit Sharing Plan -

A qualified retirement plan established and maintained by an employer where the employer makes deductible contributions on behalf of the employees, the assets grow tax-deferred, and if there is a CODA feature, the employee also makes pre-tax or Roth contributions.

Thrift Plan -

A qualified retirement plan that permits employees to make after-tax contributions to the plan. Although the contributions are taxable before being contributed to the plan, the account still benefits from tax-deferred growth on earnings.

Nondiscriminatory -

A requirement of all qualified plans. The eligibility rules, coverage requirements, and contributions allocations of a qualified plan cannot discriminate against the rank-and-file employees for the benefit of shareholder, officers, and highly compensated employees.

Thrift Savings Plan (TSP) -

A retirement savings and investment plan for Federal employees and members of the uniformed services, including the Ready Reserve

Net Unrealized Appreciation (NUA) -

A special taxation treatment for a lump-sum distribution from a qualified plan that treats the appreciation in the value of employer stock after the date of contribution to the plan until the date of distribution as capital gain.

Permitted Disparity (Social Security Integration) -

A technique or method of allocating qualified plan contributions to an employee account that provides a higher contribution to those employees whose compensation is in excess of the Social Security wage base ($137,700 for 2020) or selected integration level for the plan year.

Social Security Integration (Permitted Disparity) -

A technique or method of allocating qualified plan contributions to an employee account that provides a higher contribution to those employees whose compensation is in excess of the Social Security wage base ($137,700 for 2020) or selected integration level for the plan year.

Leveraged ESOP -

An ESOP that borrows the funds necessary to purchase the employer's stock. The interest and principal repayments on the loan are tax deductible for the employer.

Explain the similarities and differences between a stock bonus plan and an employee stock ownership plan (ESOP).

An employee stock ownership plan, or ESOP, is a special form of stock bonus plan designed to invest primarily in employer stock.' CHART

Diversified Investment Portfolios -

An investment portfolio invested in a broad range of investment classes to reduce investment risk.

Understand the primary differences between pension plans and profitsharing plans.

CHART The BIG Difference from Pension Plans • Pension Plan: Annual plan contributions are mandatory. • Profit-Sharing Plan: Annual plan contributions are discretionary

Compare and contrast stock bonus plans and profit-sharing plans.

CHART Special rights for participants: • They have pass-through voting rights of stock held in their account. • The participants have the right to demand employer securities when taking distributions, even if the stock isn't publicly traded. • If the employee doesn't want to own distributed stock that isn't publicly traded, the plan must offer a "put option" to the employee. The employer must repurchase the stock at fair market value. A special valuation will be required to ascertain that value. • Other diversification and distribution rules are covered on subsequent slides. T Advantages Value of the employer stock contributed is taxdeductible for the employer Gives participants vested interest in performance of company Funding flexibility (discretionary contributions) Disadvantages Employee has the risk of a nondiversified portfolio Put "repurchase" option could create cash-flow problems for employer Employer incurs valuation costs at each contribution of stock Ownership and control of company is diminished or diluted as stock shares are granted to employees

Discuss the various methods of allocating profit-sharing contributions to employee accounts, and discuss the advantages and disadvantages of each

Cannot exceed 25% of total employee comp Discretionary- can be zero. Advantages: Easy for employees to understand Likely to be accepted as fair by all employees even though more highly compensated employees receive more dollars Easy to implement because math is straightforward Disadvantages: At retirement total income replacement (plan assets plus Social Security) will be lower for the owner(s) and executives than for rank-and-file employees If plan is established when the owner is older, owner will struggle to accumulate enough plan assets to replace preretirement income

What are the 7 types of profit sharing plans?

Contributatory: 401k Thrift Noncontributory Profit sharing stock bonus ESOP Age based profit sharing New comparability plans

Determine whether the advantages of an ESOP are appropriate given a client's situation and desired outcome.

ESOP Candidates Closely held corporation that... • is profitable, growing, and stable. • has good second-level management to replace currently departing owner Owners that ... • are willing to share future company success with employees. • want to maintain company culture (avoid sale to outside group). • are looking for income tax benefits (see subsequent slides). • are willing to deal with the complexity of a leveraged ESOP. • are willing to give up some control of voting rights. Major shareholders that... • are close to retirement. • want to diversify their investment

Employer Matching Contributions -

Employer provided contributions to a qualified retirement plan, usually a 401(k) plan that are based on the employee contributions.

Adequate Consideration Standard -

Fair market value determined in good faith.

Cash or Deferred Arrangement (CODA) -

Permits an employee to defer a portion of his salary on a pre-tax or Roth basis to a qualified plan or receive the salary as current taxable income.

Employee Elective Deferral Contributions -

Pre-tax employee contributions to a qualified retirement plan with a CODA. The employee must choose to defer the compensation before earning the compensation.

To change the nature

Recharacterization of Deferrals -of any excess employee deferrals from pre-tax employee contributions to after-tax employee contributions.

Qualified Replacement Securities -

Securities in a domestic corporation, including stocks, bonds, debentures, or warrants, which receive no more than 25% of their income from passive investments.

S Corporations -

Small corporations taxed as pass-through entities that cannot have more than 100 individual shareholders and have only one class of stock.

Discretionary -

The choice for a plan sponsor of a profit sharing plan as to the amount and frequency of a contribution.

Janet works for IBM, a publicly traded company that sponsors a stock bonus plan. All of the following statements regarding the plan are correct EXCEPT: If Janet has less than 3 years of service, she is permitted to diversify one-half of company match contributions that consist of IBM stock. Janet is permitted to vote the shares of IBM within her account. Upon termination, Janet must be given the right to receive IBM stock held in the plan as part of a distribution. If the distribution of IBM stock is made to Janet in installments over a 2-year period, the fair market value of all employer securities distributed in the installment distribution will be taxable as ordinary income.

The correct answer is (A).After 3 years of service, employer contributions of company stock can be fully diversified. Before 3 years, employees do not have the right to diversify company stock in a stock bonus plan of a publicly traded company. The other statements are correct.

Employee Age Covered Comp. Employee Deferral Years in Plan Bob 57 $160,000 10% 15 Lucy 23 $100,000 Not yet participating N/A Georgina 37 $80,000 20% 15 David 31 $76,000 4% 2 Bob has employed his son, David, and his new wife, Lucy. Bob feels the newlyweds are spendthrifts, and he wants the 401(k) plan to encourage them to save money and stick with their employment. He asks for your help in maximizing plan contributions, even if that entails making alterations in the plan. Which of the following would NOT be one of your recommendations? To maximize their deferrals, Bob and David should contribute more. Lucy should enter the plan and contribute 22% of her salary. Bob could add a profit-sharing contribution as a means of increasing contributions to the plan. In order to fully vest in the plan, David should be encouraged to stay employed with the Bagelry.

The correct answer is (B).Lucy should enter the plan, but she would not be able to contribute 22 percent because the limit for a 401(k) contribution is $19,500 for 2020. David and Bob should both increase their contributions - Bob because he is below the maximum of $19,500 and because of the $6,500 catch-up contribution allowed for his age. The graduated vesting schedule means David is not 100 percent vested and should be encouraged to stay with the shop. Since the annual limit for Profit Sharing plans in 2020 is $57,000, Bob can further increase the contribution for all in the family by adding a profit-sharing contribution to the plan.

Profit-sharing and stock-bonus plans have similarities and differences. Which of the following statements regarding these plans are correct? I. Both plans allow participants to vote their shares that are held by the plan .II. Stock-bonus and profit-sharing plans can make lump-sum distributions of employer securities at the termination of an employee. I only II only Both I and II Neither I nor II

The correct answer is (B).Only participants in a stock bonus plan can vote their shares. Both plans can distribute employer stock.

All of the following statements regarding stock bonus plans are correct EXCEPT: Stock bonus plans allow for the current deductibility of non-cash contributions. The required repurchase option for a stock bonus plan can create potential cash-flow issues in the future. Stock bonus plans are generally as cost efficient to operate as profit-sharing plans or money-purchase pension plans. The eligibility for a stock bonus plan could be that the person must be aged 20 and have given 6 months of service.

The correct answer is (C).Statements (A), (B), and (D) are true. Statement (C) is incorrect as the cost to value stock for a private stock bonus plan increases the administrative costs in comparison to profit-sharing or money-purchase plans.

There are additional tax advantages, beyond the mismatch of income and deduction, for the establishment of an employee stock ownership plan (ESOP). One of these is nonrecognition of gain treatment. To obtain nonrecognition of gain treatment, what percent of company stock must the ESOP own after the transaction? 85% Over 50% 30% 25%

The correct answer is (C).The ESOP must own at least 30 percent of the stock immediately after the sale.

All of the following statements regarding age-based profit-sharing plans are correct EXCEPT: An age-based profit-sharing plan provides greater benefits to the older plan participants. Younger plan participants in an age-based profit-sharing plan usually receive the minority of the profit-sharing plan allocation. Non-discrimination testing in age-based profit-sharing plans is based on benefits and not contributions. An age-based profit-sharing plan provides a greater benefit to those participants whose earnings exceed the Social Security wage base and who are older than 50 years old.

The correct answer is (D).Age-based profit-sharing plans provide increased benefits to older participants regardless of whether their wages are above the Social Security wage base. All the other statements are true.

Jack and Jill own a successful engineering company that sponsors a 401(k) plan that requires standard eligibility. Sam, Tom, and Pat are the only other employees. These employees are between the ages of 25 and 29 and have been with the company for a couple of years. Jack and Jill each have salaries of $200,000, while their employees have salaries ranging between $28,000 and $30,000. Jack and Jill both defer $10,000 each. Sam, who is Jack and Jill's son, earns $30,000 and defers $6,000 into the 401(k) plan. Tom, who makes $28,000, defers $2,800, while Pat does not defer anything into the 401(k) plan. Which of the following statements is correct? The ADP for the non-highly compensated employees (NHCEs) is 6.67 percent. Jack and Jill are the only highly compensated employees (HCEs) If the plan failed the ADP test, the issue could be solved by providing a qualified matching contribution (QMC) to all five employees. If the company hired a new employee, it would not increase the amount that Jack and Jill can defer during the first year of the employee's employment

The correct answer is (D).Sam is highly compensated through family attribution. The ADP of the NHCEs is 5 percent, not 6.67 percent. Statement (C) is not correct as a QMC would only go to NHCEs.

The Actual Deferral Percentage (ADP) test is one of the tests with which some qualified plans must comply. Which of the following plans must generally comply with the ADP test? I. Profit-sharing plans without a CODA II. Safe harbor 401(k) plans I only II only Both I and II Neither I nor II

The correct answer is (D).The ADP test generally only applies to non-safe harbor 401(k) plans. It does not apply to profit-sharing plans without a CODA.

Robin, who is 55 years old, runs a local restaurant in New Orleans. Several high school kids work for her part-time. Robin's mom, Deirdre, works there full-time. Which of the following plans makes the most sense for Robin if she earns about $120,000 and does not want to spend too much on a retirement plan? A money-purchase plan A tandem plan A cash-balance plan A 401(k) profit-sharing plan

The correct answer is (D).The first three options require annual funding, which generally is not the best choice for a small business. Option (D) permits Robin to save over $50,000 per year, or almost half of her income, between the salary deferral, the catch-up, and the profit-sharing contribution. In addition, she has no requirement to fund it all, as the plan is discretionary.

Colleen receives a lump-sum distribution of employer securities (1,000 shares) from her stock bonus plan in Year 1 worth $140,000. The net unrealized appreciation (NUA) for the stock equals $110,000 at the time of the distribution. Colleen sells half of the shares 4 years after she received them as a distribution from the qualified plan. She receives proceeds of $100,000 from the sale. How much is Colleen's capital gain? $55,000 $65,000 $75,000 $85,000

The correct answer is (D).The tax basis for the 1,000 shares is $30,000, the difference between the NUA and the proceeds. If she sells half the shares for $100,000, then the basis for that half equals $15,000. The long-term capital gain equals $85,000.

Standard Eligibility -

The general eligibility requirement that requires an employer to consider an employee eligible when the employee attains 21 years of age and has completed one-year of service (defined as 1,000 hours of service with an employer within a 12-month period). .

Covered Compensation Limit -

The maximum employee compensation that may be considered for contributions to qualified plans or the accrual of benefits to a qualified plan. For 2020, the covered compensation limit is $285,000.

Forfeitures -

The percentage or amount of a participant's accrued benefit that was not vested to the employee at the employee's termination from the plan sponsor. The forfeited amount stays in the plan and may be allocated to the other plan participants (defined contribution plan) or reduce future plan costs (defined contribution plan or defined benefit plan).

Fair Market Value -

The price that a willing buyer would pay a willing seller, both having reasonable knowledge of the pertinent facts and neither under duress.

Dilution -

The reduction in the monetary value or voting power of an owner's stock as a result of contributions to stock bonus plans and ESOPs.

Qualified Election Period -

The term "qualified election period" means the 6-plan-year period beginning with the first plan year in which the individual first became a qualified participant.

Qualified Participant -

The term "qualified participant" means any employee who has completed at least 10 years of participation under the plan and has attained age 55.

Pass Through Voting Rights -

The voting rights of the stock pass through from the ESOP or the stock bonus plan to the participant.

Evaluate the desired outcomes of a client's plan, and recommend an appropriate allocation method for a profit-sharing plan.

Understand the client's goals Does the client need significantly more than $57,000 of contributions into one or more employee accounts each year? Does the client wish to make modest levels of company contributions with the minimum amount of paperwork? Does the client wish to use company contributions primarily to motivate employees to save their own wages toward retirement? Would the client be satisfied with a simple and proportional sharing of company profits with all employees? Does the client wish to add an additional amount of contribution skewing towards all highly compensated employees? Does the client wish to significantly skew profit-sharing contributions toward owners regardless of their age? new comparability Does the client wish to significantly skew profit-sharing contributions toward all older employees?- age based

Disqualified Persons -

any person who owns with other family members 20 percent or more of the stock of the company, or in the case of someone without other family ownership, owns 10 percent or more of the stock of the company.

Explain the 401(k) deferral limits and how they impact the limits under IRC 415(c), and explain when it would be appropriate for a business to adopt this type of retirement plan.

chart The sum of all contributions (ignoring catch-ups) must not exceed the 415(c) limit, which is $57,000 in 2020. • The sum of all contributions including catch-ups must not exceed 100 percent of an employee's compensation. Employee contributions annual limits: • 401(k) deferrals: $19,500 for 2020 • Catch-up: $6,500 for 2020 • After-tax: none (other than compensation and 415(c) constraint) • Example: Jim, aged 49, has $53,000 of compensation in 2020. If he has made $19,500 of salary deferrals, what is his maximum after-tax contribution? • Compensation limited: $53,000 − $19,500 = $33,500