Retirement Planning: Lesson 2

What is the limit for employee salary deferrals?

$19,500 for 2020.

Provide an example of the 50/40 test?

1 employee: 1 employee. 2 to 4 employees: 2 employees. Less than 125 employees : 40% 125 employees or more : 50 employees

What are the two tests for determine a controlled group?

1. 50% test. 2. 80% test. If the same five or fewer persons who are individuals, estates, or trusts own stock possessing: A. At least 80% of the total combined voting power of all classes of stock entitled to vote or at least 80% of the total value of shares for all classes of the stock of each corporation. B. 50% of the same...taking into account the stock ownership of each such person only to the extend that such stock ownership is identical with respect to each such corporation.

What is the definition of a highly compensated employee?

1. A more than 5% owner at any time during the plan year or preceding year. 2. An employee with compensation in excess of $130,000 for the prior plan year.

Explain the difference between a defined benefit and defined contribution plan in regards to account?

1. Benefit: accounts are commingled. 2. Contribution: separate.

What are the two categories of qualified pension or profit sharing plans?

1. Defined benefit. 2. Defined contribution.

Who is exempt from qualified plan eligibly requirements?

1. Employees under collective bargaining agreement. 2. Nonresident Elian employer's who do not perform services in the US.

Who is a key employee?

1. Greater than 5% owner. 2. Greater than 1% owner with compensation in excess of $150,000 3. Officer with compensation in excess of $185,000.

What are some exclusions to the multiple plan limitations?

1. If there are no employees with benefits under both, does not apply. 2. If the plan is subject to PBGC insurance, the limit does not apply. 3. If one or more of the plans is a multi employer plan, then that plan is not considered. 4. Salary deferrals are not considered for purposes of determining the combined limits. 5. If contributions do not exceed 6% of the compensation otherwise paid or accrued during the taxable year to the bene under the plan.

Explain the difference in compensation between a Pension Plan and a Profit-Sharing Plan?

1. Pension plan: pays a pension at retirement. 2. Profit-Sharing Plan: deferred compensation and taxation.

When is someone considered a leased employee?

1. The services provided are pursuant to an agreement between the employer and a leasing organization. 2. Such person has performed services for the employer on a substantially full-time basis for period of at least one-year. 3. Such services are performed under the primary control of the employer.

When does an employer not have to count for purposes of vesting?

1. years of service the employee acquired with the employer before reaching the age of 18 if the employee was not participating in the plan at that time. 2. years of service the employee attained before the employer sponsored a qualified plan. 3. Years of services the employee attained during the years when he did not contribute to an employer-contributory plan.

What percentage of plan assets are available to be invested in employer securities with a pension plan?

10%.

What is the annual contribution limit for a defined contribution plan?

25% of covered compensation.

What is the vesting requirement for defined benefit plans?

3 to 7 year graded, or a 5 year cliff, except when a defined benefit plan is classified as top-heavy, in which case the minimum vesting will be the same as for defined contribution plans.

What are Payroll taxes?

6.2% for OASDI on compensation up to $137,700 for 2020 and 1.45% for Medicare tax on 100% of the employee's compensation. The employer is obligated to match, for a total of 12.4% of OASDI up to $137,700 and 2.9% for Medicare on 100% of employee compensation.

What is a cash or deferred arrangement (CODA)?

A 401(k).

What is a parent-subsidiary controlled group?

A group of businesses consisting of entities with common controlling ownership interest. However, for purposes of IRC, the 80% limit is reduced to 50%.

What is a Pension Plan?

A pension plan within the meaning of 401(a) is a plan established by the employer primarily to provide systematically for the payment of definitely determinable benefits to his employees over a period of years.

What is a profit-sharing plan?

A plan established and maintained by an employer to provide for the participation in his profits by his employees or their beneficiaries. The plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants. Will lose 401(a) status if the contributions to the plan are made at such times or in such amounts that the plan in operation discriminates in favor of officers, etc.

Explain vesting in terms of retirement.

A plan must also vest an employee 100% in any accrued benefit or account balance when the employee attains normal retirement age.

What is the 2 year 100% rule?

A qualified plan could require an employee to complete two years of service to be eligible for participation into the qualified retirement plan. Plan must provide 100% immediate vesting of their accrued benefit or account balance upon completion of two years to be considered 401(a). May be beneficial to employee turnover during the first two years of employment.

What are the three types of service groups?

A. A-organization. B. B-organization. C. Management groups.

What is a top heavy plan?

A. a defined benefit plan when the present value of the total accrued benefits of key employees exceeds 60% of the present value of the accrued benefits for all employees. B. a defined contribution plan when the aggregate account balance of key employees in the plan exceeds 60% of the aggregate of the accounts of all employees.

What are the three coverage tests?

A. the general safe harbor test. B. the ratio percentage test. C. the average benefits test. DEFINED BENEFIT PLANS MUST ALSO SATISFY THE 50/40 TEST.

What happens if the defined benefit plan is not covered by PBGC and if contributions do exceed 6%?

Any excess beyond the 6% will be subject to the limitation. When the employer contribution to a defined contribution plan exceed 6% of compensation, then the combined limit would apply.

What is a defined benefit plan?

Any plan which is not defined contribution plan. All defined benefit plans are pension plans, but defined contribution plans can be either pension or profit-sharing plans.

Explain how assets are contributed to a qualified retirement plan?

Assets are held in a tax exempt trust by a fiduciary, the plan sponsor, or an appointee of the plan sponsor.

What is the calculation for the Average Benefits Percentage Test?

Average Benefit % of NHC/Average Benefit of HC.

Explain a cash balance in terms of a vesting schedule.

Cash balance plans are a type of defined benefit plan. Required to provide a 3 year cliff vesting schedule. After 3 years, a participant has a nonforfeitable right to 100% of the benefit.

What is the General Safe Harbor Coverage Test?

Considers the number of non highly compensated employees covered by the qualified retirement plan. PASS, if 70% of NHC employees benefit from plan. EX: 125 employees. 75 NHC. Profit sharing plan benefits 55 of NHC. Meets test because profit sharing plan benefits 73.33% (55/75).

What is a controlled group?

Consists of two or more commonly owned corporations.

Explain an exclusion to the matching principle?

Contributions by employers to qualified plans do not have to comply with the matching principle. An employer may deduct an amount up to 25% of the total covered compensation paid to its employees as contributions to the qualified plan. Employer has deductible, but employee has no taxable income until the funds are taken out in retirement.

Explain the implication of the Pension Protection Act of 2006.

Defined contribution plans that hold publicly traded securities of the employer must allow plan participants to diversify their pre-tax deferrals, after-tax contributions, and employer contributions that have been invested in those employer securities. Must offer at least three investment options. Must have different risk characteristics.

What is the average benefits test?

Determines whether the plan adequately benefits the non highly compensated employees compared with the benefits received by the highly compensated employees and determines whether the employee classification is nondiscriminatory. A. Average benefits. B. Nondiscriminatory classification test.

What DOES and DOES NOT qualify for a NUA treatment?

Distributions from an IRA, SEP IRA, or SIMPLE IRA do not qualify as lump-sum distributions for the purposes of NUA, and are taxed at ordinary income tax rates.

How do you determine the benefit provided to each employee?

Divide that employees annual compensation ($100,000 salary with a $10,000 benefit has a 10% benefit). A benefit % is also determined for each non excludable employee who does not benefit from plan (0%). Then, summed and an average is calculated to determine the average benefit %. That average is then divided by the average benefit % of highly compensated employees to arrive at a ratio that must be equal or greater than 70%.

Which plans does the Payroll Tax Exclusion pertain towards?

Does not pertain to employee elective deferrals to 401(k)s, 403(b)s, SIMPLEs, SARSEPS, and 457 plans. If an employee defers income by making a pre-tax elective deferral contribution into one of these plans, then amounts deferred by the employee are subject to payroll taxes.

What is the social security wage base?

Earnings in excess of the social security wage base, are taken into consideration for the calculation of social security, but nothing beyond that point.

What is considered a qualified plan?

Either a pension plan or profit sharing plan.

Explain highly compensated in terms of owner-employees?

Either an owner of more than 5% for current or prior plan year OR compensation in excess of $130,000 for 2020 for prior plan year.

What is an affiliated service group?

Entities that constitute an affiliated service group who are treated as one organization for purposes of the qualified plan rules.

Explain 5-percent owner rule.

Family attribution rules direct that an individual is considered as owning the shares of stock of certain relatives, including stock owned by the individuals: A. spouse. B. Children. C. Grandchilren. D. Parents.

Explain forfeitures from non-vested employees.

If an employee terminates employment prior to being fully vested, the employee's benefits or a % of the employee's benefits will be forfeited and may then either be used to reduce future plan costs or increase the other plan participant's account balances.

What is net unrealized appreciation treatment?

If someone takes a lump sum from their IRA. A lump sum distribution is a complete distribution from a retirees account balance within one year of death, disability, attainment of 59 1/2, or separation from service. Requires the participant to pay tax in the year of distribution on the full cost of the employer securities purchased in the plan, rather than just the yearly annuity amount needed during retirement.

What is the Ratio Percentage Test?

If the plan does not meet the safe harbor coverage test, the plan must meet one of two other tests. Compares % of covered NHC employees to the percentage of covered HC employees. Satisfies test if plan covers at least 70% of the covered NHC employees. EXAMPLE: Profit sharing plan covers 60 of the 100 (60%) NHC employees and 40 of the 50 (80%) of HC employees. 60%/80%. That is 75% and thus, satisfies the ratio percentage.

What is the impact of a top-heavy plan on non-key employees...Defined Benefit Plans. Provide an example.

If three different companies are providing benefits of 1%, 1.5%, and 2% each year to non key employers, and the plan is top-heavy, they must provide a benefit of 2%, instead) up to 20%.

Who are leased employees?

Independent contractors and temporary or leased employees are usually not covered by a company's retirement plan. However, there are specific rules that determine when a leased employee must be treated as an employee for the purposes of this plan. If these rules were not in place, a company could simply hire temporary employees to fill positions within the company and avoid having to provide them with retirement benefits.

What was the purpose of ERISA?

It was designed to provide greatly enhanced protection for pension and retirement benefits.

What are the statutory requirements for defined benefit plans and their benefits?

Limits the employer to provide an employee with the following maximum annual expected benefit at retirement: 1. $230,000 for 2020. 2. 100% average of the employee's three highest consecutive years during the time of plan participation.

Explain the SECURE Acts impact on long-term part-time employees?

Long-term part-time employees (age 21 and worked at least 500 hours per year for 3 consecutive years) may participate in the employer's 401(k).

What is the age 26 rule for tax-exempt educational institutions?

May delay eligibility in its qualified retirement plan until later of the employee attaining age 26 or the completion of one year of service. Provides incentives for tax-exempt institutions to establish and fund qualified retirement plans, otherwise, the institution is unlikely to establish a qualified plan because the tax-exempt company, by nature, does not benefit from tax deductions created by contributions into qualified retirement plans.

In regards to defined contribution plans, what must a plan participant of three or more years be allowed to do?

Must be allowed to diversify the investment of employer contributions made on their behalf. Does not, however, apply to an ESOP if there are no contributions to the ESOP that are subject to the 401(k) nondiscrimination tests and the ESOP is a separate plan from any other qualified retirement plan.

What is the impact of a top-heavy plan on non-key employees? Defined Benefit Plans.

Must provide a benefit to non-key employees equal to 2% per the employee's years of service multiplied by the employees average annual compensation over the testing period. Consecutive years. Maximum top-heavy requirement, is a minimum benefit of 20% (10 years of service at 2%) of the employee's average annual compensation for the period of consecutive years not exceeding five.

What is the impact of a top-heavy plan on non-key employees? Defined Contribution Plans.

Must provide each employee a contribution equal to at least 3 of the employee's compensation. Exception: when the largest funding made on behalf of all key employees is less than 3%. In this case, all of the non-key employees must receive a minimum benefit % equal to the funding for the key employee with the highest % for the year.

What is the limitation on defined benefit plans for individual in the plan less than 10 years?

Must reduce the calculated maximum benefit by 10% for every year of participation less than 10.

What are the requirements for a plan that is considered a CODA?

Must satisfy two tests: 1. The Actual Contribution % (ACP) test for employee matching contributions. 2. Actual Deferral % Test for employee elective deferrals.

What is the vesting requirement for defined contribution plans?

Must vest employer contributions under a 2 to 6 year graded, or a 3 year cliff schedule.

What is the rule or limitation involving officers?

No more than 50 employees must be treated as officers. If the number of officers exceeds 50, then only the first 50 ranked by compensation will be considered officers under the key employee definition.

Is the two-year eligibility election available for 401(k) plans?

No, because most contributions to 401(k) plans are employee-elective deferral contributions.

Are defined contribution plans subject to Pension Benefit Guaranty Corporation coverage?

No.

Are employer contributions to qualified plans subject to payroll taxes?

No.

Are in-service withdrawals permitted for a pension plan?

No.

Can credit be given for prior service for the purpose of benefits, in relation to a defined contribution plan?

No.

Does the 25% deductibility rule apply to defined benefit pension plans?

No.

Is a profit-sharing plan subject to a mandatory funding standard?

No.

With a profit-sharing plan, must the plan provide qualified joint and survivor annuity and qualified pre-survivor annuity features?

No.

Who are rank and file employees?

Not executives.

What is ERISA's anti-alienation protection?

Prohibits any action that may cause the plan assets to be assigned, garnished, levied, or subject to bankruptcy proceedings while the assets remain in the qualified retirement plan. CAN ONLY be seized to pay federal tax liens.

What is a defined contribution plan?

Provides individual account for each participant. Benefits are based solely on the amount contributed to the participant's account.

What are Qualified Domestic Relations Order?

QDRO-a court order related to divorce, property settlement, or child support. Plan assets are not protected from alienation due to this order.

What is the Defined Benefit 50/40 test for defined benefit plans?

Requires the plan to benefit the lesser of 50 employees or 40% of all employees on each day of the plan year.

Explain BAPCPA 2005 in relation to bankruptcy and creditors?

Retirement accounts that are exempt from tax under the IRC are also exempt from the debtor's estate up to $1 million dollars.

What is vesting?

Some employers require employees to have many years of service for the employee to vest or receive ownership of employer benefits.

What is the plan document?

Terms of the qualified plan are identified and described in the plan document. Must be consistent with the IRC qualification requirements.

Explain safe harbor rules in terms of leased employees.

The IRC provides that if certain requirements are met by the leased organization, someone meeting the definition of a leased employee will not have to be treated as an employee.

Who assumes the investment risk in a defined contribution plan?

The employee.

What option does the employer have in regards to accelerating the vesting schedule?

The employer may always elect to provide the employee with a vested benefit faster than the standard schedules. When this happens, however, the vested benefit must always be at least as great as the standard schedule.

Who assumes the investment risk in a defined benefit plan?

The employer.

What is the limitation on defined contribution plan contributions?

The lesser of 100% of employee compensation for the plan year. OR... $57,000 for 2020. Catch up contributions increase this limit to $63,500 for 2020. The maximum contribution is a collective of: A. employer contributions. B. employee contributions. C. Forfeitures.

What is the covered compensation limit?

The maximum amount of compensation that can be considered for the plan year is $285,000. Example: an employee whose compensation is $350,000 for the year may only consider compensation up to the limit of $285,000 for 2020.

What is the nondiscriminatory classification test?

The method in which an employer chooses employees to cover under a qualified plan must meet both of the following requirements: A. must be reasonable and established on the facts and circumstances of the business. B. The classification must be nondiscriminatory. In order for the classification to see that, must meet two tests: i. safe harbor test. ii. facts and circumstances test.

What happens when a plan is top heavy?

The plan must: A. use top heavy vesting schedules. B. provide a minimum level of funding to non-key employees.

What is the annual contribution limit for a defined benefit plan?

The sum of the plan's funding target, target normal cost, and a cushion amount over the value of the plan asset OR the minimum required contribution for the plan year.

What is the Highly Compensated Election?

This election is available to reduce the number of employees considered highly compensated. This election allows an employer to only count those employees whose compensation is in excess of the dollar limit as highly compensated if that employee is also in the top 20% of all paid employees as ranked by compensation. Exception does not exclude employees who are more than 5% owners because such employees will be considered highly compensated based on ownership.

How does a company pass the average benefits test?

Three requirements: A. Average benefits % test. B. Reasonable classification requirement. C. Classification is nondiscriminatory. It will not be required to satisfy the general safe harbor coverage test or the ratio % test. Otherwise, it must pass either: A. General safe harbor test. B. Ratio % test.

What is the Employee Plans Compliance Resolution System?

To avoid the total loss of taxa vantages, a plan sponsor may voluntarily correct any problems with its qualified plan by following this before two years from the end of the plan year in which the problem occurred.

How are forfeitures allocated in a defined contribution plan?

To reduce plan costs or allocate to other participants.

How are forfeitures allocated in a defined benefit plan?

To reduce plan costs.

Provide an example of an affiliated service group?

Two person law firm that is structured as a partnership with two corporations as the partners. Each corporation is solely owned by an individual attorney, who is also the only employee of such corporation. The three organization constitute the affiliated service group.

What percentage of plan assets are available to be invested in employer securities with a profit-sharing plan?

Up to 100%

Explain how multiple plan limitations are handled.

When both a defined benefit and defined contribution plan are offered, the total amount deductible in a taxable year under such plans shall not: A. Exceed the greater of 25% of the compensation pair or accrued during the taxable year to the bene.

What is the matching principle?

When one individual or entity has a tax deductible expense, another entity or individual will have taxable income.

When is an employee considered covered?

When the employee receives a benefit from the plan. Example: for a profit sharing plan, the employee is considered covered if he receives a contribution to his profit sharing account for the year.

What classifications that are non discriminatory are considered reasonable?

Whether the employe is hourly or salaried, the geographic location of the employee, or the employee's job description.

Are defined benefit plans subject to Pension Benefit Guaranty Corporation coverage?

Yes, except professional firms with less than 25 employees.

Can credit be given for prior service for the purpose of benefits, in relation to a defined benefit plan?

Yes.

Is a pension plan subject to a mandatory funding standard?

Yes.

With a pension plan, must the plan provide qualified joint and survivor annuity and qualified pre-survivor annuity features?

Yes.

Are in-service withdrawals permitted for a profit-sharing plan?

Yes. After two years if the plan documents permit.