Module 1 Exam

Top-heavy plans:

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. A qualified plan is considered top heavy if it provides more than 60% of its aggregate accrued benefits or account balances to 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 $185,000 in 2021. LO 1.3.1

Which federal agency is tasked with supervising the creation of new, qualified retirement plans?

The Internal Revenue Service (IRS) carries out the task of supervising the creation of new, qualified retirement plans.

What is the permitted disparity for a defined contribution plan with a current base contribution percentage of 6%?

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%). LO 1.3.3

Minimum coverage tests for qualified retirement plans:

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. LO 1.3.1

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?

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. LO 1.3.1

The DOL governs the actions of:

plan fiduciaries and ensures compliance with the ERISA plan reporting and disclosure requirements.

ERISA requires reporting and disclosure of plan information by:

plan sponsors to the IRS, DOL, Pension Benefit Guaranty Corporation (PBGC), and plan participants.

Mac, age 39, works for the SLH Company. He has a salary of $28,000 and a 401(k) there. Mac also has another job with AKH, Inc., making $65,000. SLH and AKH are not related. Mac is deferring $9,500 into the 401(k) at SLH. How much can he defer into the 401(k) at AKH?

Mac can defer $10,000 into his 401(k) at AKH, Inc. The total he can contribute to employer retirement plans in 2021 is $19,500. Since he is already doing $9,500 at one employer, he is limited to $10,000 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 the other employers. LO 1.3.2

Which of the following is the easiest type of retirement plan for an employer to adopt?

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. LO 1.4.1

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 2021?

Only the first $290,000 of compensation may be used to determine contributions to qualified retirement plans in 2021. Thus, she contributes 4% of $290,000 in 2021. This amount is matched, so $290,000 × 0.08 = $23,200. LO 1.3.2

Qualified Plans:

Qualified plans must meet specific vesting schedules. Qualified plans are preferred to nonqualified plans because of the special tax advantages enjoyed by qualified plans. Qualified retirement plans must offer definitely determinable benefits. An annual profit is not required for a qualified plan to be funded. Qualified retirement plans are subject to ERISA requirements and 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.

ERISA requirements for qualified plans include:

Reporting and disclosure, coverage and vesting, and participation and fiduciary requirements.

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?

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%. LO 1.3.3

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?

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. LO 1.3.3

With an integrated defined contribution plan, what is the maximum permitted disparity?

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 ($142,800 in 2021). LO 1.3.3