Retirement Planning HW 1 Duplicates PDF

Retirement Planning Problem Set DUPLICATES (HOMEWORK) TEST 1 INFO: Chapters 1 and 2 1. What is the historical average annual rate of return for different types of assets? Small cap (less than 2 billion in market cap) à 12% Large cap (more than 10 Billion in market cap à 10% LT Govt B...

Retirement Planning Problem Set DUPLICATES (HOMEWORK) TEST 1 INFO: Chapters 1 and 2 1. What is the historical average annual rate of return for different types of assets? Small cap (less than 2 billion in market cap) à 12% Large cap (more than 10 Billion in market cap à 10% LT Govt Bond à 5.5% T-Bills à 3.5% CPI à 3% 2. What is the historical average annual real rate of return for different types of assets (before-tax inflation adjusted return)? Small cap (less than 2 billion in market cap) à 12% - 3%(CPI) = 9% Large cap (more than 10 Billion in market cap à 7% LT Govt Bond à 2.5% T-Bills à.5% *real return factors out inflation 3. What is the historical average standard deviation for each of these assets? Small cap (less than 2 billion in market cap) à 32% Large cap (more than 10 Billion in market cap à 20% LT Govt Bond à 10% T-Bills à 3% CPI à 3% *SD is a measure for risk à square root of variance 4. What is the 95% confidence interval for each of these assets? Small cap (less than 2 billion in market cap) à -52% - 76%  Large cap (more than 10 Billion in market cap à -30% - 50% LT Govt Bond à -14.5% - 25.5% T-Bills à % CPI à % 5. What is the VAR for each of these assets? Small cap (less than 2 billion in market cap) à 12% - 1.65 * 32% = -40.8% Large cap (more than 10 Billion in market cap à 10% - 1.65 * 20% = LT Govt Bond à % T-Bills à % CPI à % *VAR à value at risk, way to measure risk of an asset, take the mean of the asset and subtract 1.65*SD of the asset VAR = Average return - 1.65* SD of asset VAR is the WORST 5% outcome (work 1 out of 20 years) 6. Describe the Rule of 72 and its ramifications for retirement planning. Rule of 72 is how quickly until your money doubles - How many years until your money doubles? 72/ i (historical interest rate of the asset) *it takes 7.2 years for the stock market to double for large caps 7. What is the percentage of workers who have less than $25,000 in total savings and investments (excluding DB plans and home equity)? 34% 8. What does financially prepared mean? It means 3 things: - Must have sufficient assets accumulated - Need an appropriate investment plan - Need a distribution plan (4% ruleà when you reach retirement age, the first year you take out 4% of whatever you have saved and then you can grow it by inflation after that) 9. Describe the top-down approach to financial planning for retirement needs. You calculate the wage replacement ratio: EX: you make 100k a year and want a 60% replacement ratio… need to save 60k/year for retirement Usually around 60, 70, 80% 10.Describe the bottom-up approach to financial planning for retirement needs. You estimate a detailed line-by-line budget of your retirement needs - May not include a mortgage (when you are retired, probably won’t have a mortgage) - No savings (don’t save anymore in retirement bc/ you are using and spending your savings 11.What are the sources of retirement income? - Social security (usually about 1/3 of total income in retirement) - Company sponsored retirement plans (might be a 401k, 403b) - Personal retirement plans (might be a Roth IRA – tax exempt, IRA – tax deferred account) - Personal savings (taxable) - Continued employment 12.What is a Monte Carlo Analysis? This predicts the success of a financial plan - Want the success rate to be greater than 90% - 1,000 simulations with different assumptions 13.What are the 4 stages of retirement? - Vacation  - Lose your identity - Try new things - Give back to society 14.Utilizing the top-down approach, an individual who earns $98,000 per year as an employee for Golf Enterprises, LLC and saves $24,000 of their earnings per year towards retirement will have a wage replacement ratio of what (assume 7.65% payroll taxes)? Top down approach – wage replacement 98,000 – (98,000 *.0765) – 24,000 = $66,503 Wage replacement ratio = $66,503/98,000 = 67.86% 15.Will an individual’s work life savings rate impact their retirement plan funding requirements? Yes - It reduces your retirement plan funding 16.What costs and expenses can be eliminated in retirement? EX: mortgage payment, payroll taxes, savings expense, paying for parking at work, dry cleaning 17. Brian would like to retire in 20 years when he turns 63. He wants to have enough money to replace 70% of his current income less what he expects to receive from Social Security at the beginning of each year. He expects to receive $18,000 per year from Social Security in today’s dollars. Brian is conservative and wants to assume an 8% annual investment rate of return and that inflation will be 2% per year. Based on his family history, Brian expects that he will live to be 106 years old. If Brian currently earns $180,000 per year and he expects his salary increases to equal the inflation rate, how much will he need at retirement? 180k *.70 = 126,000 126 k – 18,000 = 108,000 PV = -108k N = 20 (years until retire) I/Y = 2 (inflation)  Compute FV = 160,482.32 PMT = 160,482.32 N = 106-63 = 43 I/Y = (1.08/1.02 – 1)*100 = 5.88 Click BEG Complete PV = 2,642,103 18. Jada, age 49, earns $85,000 per year from her employer. Jada saves $16,000 per year for retirement and pays $15,000 per year for her home mortgage. Given this information and considering that Jada will have eliminated her mortgage debt before retirement, what is Jada’s expected wage replacement ratio during retirement? 85k – (.0765*85k) – 16k – 15k = 47497.50 Wage replacement ratio: 47497.50 / 85k =.558 19.Which expense will most likely increase during retirement? Medical Expenses, travel, hobbies, 20. An individual has determined utilizing the annuity method of capital needs analysis that they need $1,445,656 at the beginning of their retirement to meet their retirement life expectancy goals. If this individual would like to be more conservative in their retirement planning forecast and maintain this capital balance throughout their retirement life expectancy of 34 years, given an expected earnings rate of 6%, and an inflation rate of 3% during the period, how much more would they need to have at the beginning of their retirement? FV = 1,445,656 N = 34 I/Y = 6 Compute PV = 199,373 21.Marcus has been employed by GCD Enterprises for 17 years, and currently earns $90,000 per year. Marcus saves $18,000 per year. He plans to pay off his home at retirement and live debt free. He currently spends $15,000 per year on his  mortgage. What do you expect Marcus’ wage replacement ratio to be based on the above information? 90k – (.0765 * 90k) – 15k – 18k Wage Replacement Ratio = 50,115/90,000 = 0.5568 22.What factors may affect a person’s individual retirement planning? - Work life expectancy - Retirement life expectancy - Savings rate o If its higher, you need less retirement funds - Inflation rates 23.Cedric wants to retire in 18 years when he turns 65. He wants to have enough money to replace 80% of his current income less what he expects to receive from Social Security at the beginning of each year. He expects to receive $21,000 per year from Social Security in today’s dollars. Cedric is conservative and wants to assume a 6% annual investment rate of return and assumes that inflation will be 3% per year. Based on his family history, Cedric expects that he will live to be 90 years old. If Cedric currently earns $130,000 per year and he expects his raises to equal the inflation rate, approximately how much does he need at retirement to fulfill his retirement goals? (130k *.8) – 21k = 82,000 PV = -82k N = 18 I/Y = 3 Compute FV = 141,301.94 PMT = 141,301.94 N = 90-65 = 25 I/Y = (1.06/1.03 -1)*100 Compute PV = 2,557,008.29 24.Rochelle, age 30, wants to retire as soon as possible. She is an engineer and makes $120,000 per year but can live off of $35,000 after paying her federal income tax (average of 20.35%) as well as paying her payroll tax. Rochelle is conservative and wants to assume a 6.0% annual investment rate of return and assumes that inflation will be 4% per year. Based on her family history, Rochelle expects that she will live to be 98 years old. She currently has $39,500 saved. Can Rochelle retire in 10 years assuming she saves as much as possible after covering her needs and taxes and thinking she can live off of $35,000 in today’s dollars? PV = -35k N = 10 I/Y = 4 Compute FV = 51,808.55 CHANGE TO BEG PMT = 51,808.55 N = 98 – 40 = 58 I/Y = (1.06/1.04 -1)*100 Compute PV = 1,836,210.54 FV = 1,836,210.54 Compute N = I/Y = 6 PMT = 120,000 – (.0765 *120,000) – (.2035*120,000) – 35,000 = 51400 PV = -39500 25.Lynda (age 35) is a data analyst and earns $150,000 per year. She is an avid adventurer and would like to retire as early as possible. She currently pays total taxes of 40% (including state, federal, and payroll). She spends about $52,000 on required expenses, such as rent, food, etc. Although she spends a lot of money on frivolous items, she has savings of $230,000. Lynda wants to assume an 8% annual investment rate of return and inflation of 4% per year. Based on her family history, Lynda expects that she will live to be 90 years old. Assuming she could live on $52,000 per year, how much would she have to save every year to retire at age 57? ON EXAM Step 1: find wage replacement  Step 2: grow the wage replacement with inflation until you retire Step 3: take that wage replacement at inflated level, take that as a annuity in retirement… take the PV of the annuity Step 4: How much do I need to save to reach that goal? Compute PMT PV = -52k (wage replacement) N = 20 I/Y = 4 Compute FV = 123236 BEG PMT = 123236 N = 90 – 57 = 43 I/Y = (1.06/1.04 -1)*100 = Compute PV = 2368587 FV = PV N = 55-35 = 20 I=8 PV = -230,000 Compute PMT = 20,163.15 26.Sophia, who is not married, has been employed by Phone Services, Inc. for 13 years, and currently earns $161,000 per year. She saves $29,000 per year and plans to pay off her home at retirement and live debt free. She currently spends $15,000 per year on her mortgage. What do you expect Sophia’s wage replacement ratio to be based on the above information? 161k – (.0765*161k) – 29k – 15k = 104,683.5 Ratio = 104,683.5/161,000 = 65.02% 27.Arlie is currently age 65 and about to retire. He has accumulated $1,639,800 in his 401(k) and would like to know what amount he could withdraw at the beginning of the first year of retirement if the purchasing power of the withdrawals will be  maintained during retirement. Arlie expects to continue to earn 8% on his investments, assumes inflation will be 3%, and expects to live to age 92. What is the amount of the first-year distribution? BEG – annuity DUE PV = 1639800 N = 92-65 = 27 I = (1.08/1.03)-1 * 100 FV = 0 Compute PMT = 105,114 28.Christian wants to retire in 20 years when he turns age 65. Christian wants to have enough money to replace 80% of his current income less what he expects to receive from Social Security at the beginning of each year. He expects to receive $18,000 per year from Social Security in today’s dollars. Christian is an aggressive risk tolerance investor and wants to assume an 9% annual investment rate of return and that inflation will be 3% per year. Based on his family history, Christian expects that he will live to be 90 years old. If Christian currently earns $93,000 per year and he expects his raises to equal the inflation rate, how much does he need at retirement to fulfill his retirement goals? (93k *.8) – 18,000 social security payments = 56,400 wage replacement PV = -56,400 I=3 N = 20 Compute FV = 101864.67 PMT AD BEG = 101864.67 N = 90-65 = 25 I = 1.09/1.03 -1 * 100 Compute PV = 1401209.87 29.Courtney wants to retire in 20 years when she turns age 62. She wants to have enough money to replace 85% of her current income less what she expects to  receive from Social Security at the beginning of each year. Courtney expects to receive $26,114 per year from Social Security in today’s dollars at full retirement age of 67. However, she will take Social Security early at age 62, when she retires (reduce full social security payment by 30%). Courtney is an aggressive risk tolerance investor and wants to assume an 8% annual investment rate of return and that inflation will be 3% per year. Based on her family history, Courtney expects that she will live 26 years in retirement (age 88). If Courtney currently earns $115,000 per year and she expects her raises to equal the inflation rate, how much does she need at retirement to fulfill her retirement goals? (115,000*.85) – (.70 * 26,114) = 79470.2 PV = 79470.2 I=3 N = 20 Compute FV = 143532.02 PMT AD BEG = 143532.02 N = 26 I = 1.08/1.03 -1 *100 Compute PV = 2196324.28 Chapter 3 1. Describe 2 types of defined benefit (DB) pension plans. - Defined Benefit Pension (much more rare now) - Cash Balance Pension Plan - Both of these define the benefit you will receive when you retire very clearly - Income for life from your employer (and maybe your spouses’ life) 2. Describe 2 types of defined contribution (DC) pension plans. - Money purchase pension plan - Target Benefit Pension plan - Both of these define the contribution you will receive from your employer very clearly (no guarantees what the total benefit will be when you retire) 3. Describe some DC Profit Sharing Plans.  - Profit sharing - Stock Bonus plan - ESOP - 401K - Age based profit sharing plan 4. Are Pension Plans subject to mandatory funding by the company? YES 5. How about Profit Sharing Plans? NO 6. Which plan provides survivor annuities? - Pensions - Still have to choose this pension option for your spouse - Can opt out 7. Who assumes the investment risk with pensions? - Defined Benefit Pension and Cash Balance plan it is the company. - Money purchase and Target benefit pension plan it is the employee 8. Who assumes the investment risk with profit sharing plans? The employee 9. Which plans are insured? - DB - Private pensions - Not government pensions 10. Which plans have co-mingled accounts? DB 11. Which plans have separate accounts? DC 12. What are the tax advantages to the employer from these plans? - Can write off their contributions to the plans on behalf of their employees - Lowers taxable income of the company 13. What are the tax advantages to the employee from these plans? - Can deduct their contributions to the plans (if employees can contribute to the plan) - Lowers AGI of the employee 14. Define a highly compensated employee (HC). - Makes more than 150K per year OR - Owns more than 5% of the company 15. What is a rank and file employee (NHC)? - Those employees that are not HC 16. Define a general safe harbor coverage test? - The plan benefits 70% or more of the non-excludable NHC 17. Describe the different types of non-discrimination tests DC and DB plans must pass each year for a company with 100 HC and 92 participate in the retirement plan and 400 NHC and 290 are participate in the retirement plan. Average Benefit is 13% for HC and is 6% for NHC. Must pass one of 3 tests each year: 1) 70% or more of eligible NHC must be covered. 2) Ralo Percentage test, 70% or higher. 3) Average Benefits test, 70% or higher For a company with 100 HC and 94 parlcipate in the relrement plan and 400 NHC and 295 are parlcipate in the relrement plan. Average Benefit is 12% for HC and is 7% for NHC. 1) 295/400 =.74 2) (295/400) / (94/100) =.79 3).07 /.12 =.58 The company passes the first 2 tests, only need to pass one 18. Do all 3 of these tests have to be passed each year? No, just 1 each year 19. Which additional test must a defined benefit (DB) plan pass each year? - DB also has to pass this: - 50 or more nonexcludable employees are part of the plan or - 40% of nonexcludable employees are part of the plan - whichever is LESS 20. What is a safe harbor test for a DC plan? - Allows company to bypass the 3 non-discrimination tests if: - Company can give 3% (of employee’s income) to all eligible employees - Or Match 3% of employee’s first 3% contribution, and 3.5% for employee’s 4% contribution, and 4% for employee’s 5% contrib. - Or match 4% of employee’s first 4% contribution 21. What is a safe harbor test for a DB plan? - For a DB plan 70% or more of eligible NHC must be covered - Very simple 22. What is vesting for a DC plan? - 2 to 6 year graded vesting or - 3 year cliff vesting for DC plans 23. What is vesting for a DB plan? - 3 to 7 year graded vesting or - 5 year cliff vesting for DB plans 24. What is a top-heavy retirement plan? - A plan is top-heavy when the owners and most highly paid employees ("key employees") own more than 60% of the value of the plan assets. - This ratio is tested every year based on the account balances on the last day of the prior plan year. 25. How is a key employee defined? - Greater than 5% owner or - Greater than 1% owner and makes more than 150K per year or  - An officer of the company making more than 215K per year 26. What must a company do if its retirement plan is top-heavy? - Give 3% of salary to all non-key, non-excludable employees if it is a DC plan. - If DB plan is top-heavy then must vest at the same requirements as a DC plan (2 to 6 year graded or 3-year cliff) - AND must give 2% * years of service (max is 10 here) * average annual salary to non-key and non-excludable employees (max of 20% of annual salary) 27. What is the maximum total benefit at retirement for a DB plan? - The lesser of: - 265K or - Average of 3 consecutive highest earning years - This is the maximum benefit received per year 28. What is the maximum annual contribution for a DC plan? Lesser of: - 100% of the annual compensation for employee OR - 66,000 plus 7,500 if over 50 (2023) - This includes employee and employer contributions combined - This goes up most every year 29. Describe the Secure 2.0 Act 2022. - An Act to help and encourage people save money 30. Describe 7 benefits from the Act. - Automatic enrollment for a 401K - RMD increased from 72 to 73 (more years to save) - Catch-up contributions are increased - 529 plans can roll into Roth IRAs after 15 years - Saver’s tax credit for low income (government will match) - Hardship withdrawals increased - Emergency savings plan (max up to 2500) similar to 401K but can withdraw early, portable 31.MH sponsors a qualified profit-sharing plan. Of their 205 employees, 200 are non- excludable. Of the 200 nonexcludable employees, 150 are NHC and 50 are HC. The plan covers 110 of the NHC and 15 of the HC. Does this plan meet the coverage requirements? MH’s plan meets the coverage requirements because the plan passes the ratio percentage test. The percentage of NHC covered, 68.75% (110/160), divided by the percentage of HC covered, 37.5% (15/40), is greater than 70%. MH’s plan meets the coverage requirements because the plan passes the ratio percentage test. The percentage of NHC covered, 73.33% (110/150), divided by the percentage of HC covered, 30% (15/50), is greater than 70%. 32.Is a 403(b) plan is a qualified plan? - NO - A 403(b) plan is a tax-advantaged plan, not a qualified plan. The 403(b) plan does share many of the characteristics of the qualified plans, but a 403(b) plan is not a qualified plan under the IRC. - Does not have to follow ERISA 33.Since turnover is usually highest for employees in their first few years of employment and for younger employees, does it make sense from an  administrative standpoint for a plan sponsor to delay these employees’ participation in a qualified plan? - Yes - By delaying participation in a qualified plan for those employees in their first few years of employment and for younger employees, the employer does not have to allocate any of the contributions to the plan to these individuals. 34.In addition to meeting one of the other coverage test requirements, must a defined benefit plan also cover the lesser of 50 employees or 40% of all eligible employees each day of the plan year? - True - The 50/40 test requires a defined benefit pension plan to cover the lesser of 50 people or 40% of all eligible employees each day of the plan year. 35.For purposes of meeting the coverage requirements of a qualified plan, a defined benefit plan must cover everyone who is 21 years old and has completed one year of service with the plan sponsor. - False - This statement describes the standard eligibility rule. - The coverage rules require a defined benefit plan to meet the 50/40 test plus one of either the (1) general safe harbor test, (2) the ratio percentage test, or (3) the average benefits test. 36.Describe the requirements of a qualified tax-advantaged retirement plan. - Plan documentation. - Employee vesting. - Broad employee participation. - Employee communications. 37.What are reasons employers may choose to delay eligibility of employees to participate in a retirement plan? - Employees do not start earning benefits until they become plan participants (except in defined benefit plans, which may count prior service). - Since turnover is generally highest for employees in their first few years of employment and for younger employees, it makes sense from an administrative standpoint to delay their eligibility. 38.What are the benefits of a vesting schedule for a qualified plan being restrictive? How about being generous? - 1. Two advantages of choosing a restrictive vesting schedule are (1) to reduce costs attributable to employee turnover and (2) to help retain employees. - 2. Three advantages of choosing a liberal vesting schedule in which there is immediate and full vesting are (1) to foster employee morale (2) to keep the plan competitive in attracting employees, and (3) to meet the designs of the small employer who desires few encumbrances to participation for the “employee family.” 39.Packlite Company has a defined benefit plan with 100 employees, of which 80 are nonexcludable employees (10 HC and 70 NHC). They are unsure if they are meeting all of their testing requirements. What is the minimum number of total employees that must be covered daily to conform with the requirements set forth in the IRC? - The 50/40 rule requires that defined benefit plans cover the lesser of 50 employees or 40% of all eligible employees. Here 40% would be 36 (90 x 0.40), so 36 is less than 50. This would be the absolute minimum number of covered employees. 40.What type of employee is considered highly compensated (HC)? - An individual is deemed highly compensated if they are either a greater than 5% owner, or if the individual has earnings in excess of $135,000 in 2022, the lookback year for the 2023 plan year ($150,000 in the 2023 lookback year for the 2024 plan year).  - The definition may also require that the employee be in the top 20%, as ranked by salary of all employees. 41.What is a noncontributory plan and give examples? - Employers generally contribute to Money Purchase Pension Plans, ESOPs (employee stock ownership plan), and Profit-Sharing Plans. These are noncontributory plans. - Employees contribute (thus contributory plans) to 401(k)s and Thrift Plans. 42.Generally, younger entrants favor which type of plans? Which type of plans are favored by older entrants? - Cash Balance and Money Purchase Pension Plans favor younger entrants. - Defined Benefit and Target Benefit Pension Plans favor older age entrants with less time to accumulate, and therefore, require higher funding levels 43.Describe a qualified retirement plan? - Through your company - Follows ERISA and IRS guidelines. - Examples are: 401(k) plan or profit sharing plan or stock bonus plan or money purchase plan or defined benefit plans 44.Which of the following vesting schedules may a top-heavy defined benefit plan use? Years of (A) (B) (C) (D) Service 1 0% 10% 0% 0% 2 10% 20% 0% 0% 3 15% 45% 0% 20% 4 20% 65% 100% 40% 5 60% 100% 100% 60% 6 100% 100% 100% 80% 7 100% 100% 100% 100% - The correct answer is b. - A top-heavy defined benefit plan must use a vesting schedule which provides the employees with a vested benefit at least as rapidly as a 2-to-6-year graduated vesting schedule or a 3-year cliff vesting schedule. Option b is the only schedule depicted which meets this requirement. Option a does not  meet the requirement as it does not provide a greater vested benefit in each year as compared to the required 2-to-6-year graduated vesting schedule. Option c is a 4-year cliff vesting schedule and option d is a 3--to-7-year graduated schedule; neither providing a vested benefit as rapid as a 2--to-6- year graduated vesting schedule or a 3-year cliff vesting schedule. 45.XYZ has a noncontributory qualified profit-sharing plan with 320 employees in total, 200 who are nonexcludable (50 HC and 150 NHC). The plan covers 70 NHC and 30 HC. The NHC receive an average of 4.0% benefit and the HC receive 7.0%. Does this plan have to meet the 50/40 test? Does this plan meet the ratio percentage test? Does this plan meet the average benefits test? - The plan does not have to meet the 50/40 test because it is a defined contribution profit-sharing plan. The plan meets the ratio percentage test (53.33%/64.00% = 82.8%) and fails the average benefits test (4.0%/7.0% = 57.14%). 70% is the cutoff 46.What is a key employee? A key employee is anyone who is any one or more of the following - (1) a greater than five percent owner, or - (2) a greater than one percent owner with compensation in excess of $150,000, or - (3) an officer with compensation in excess of $215,000 (2023). 47.Who can be excluded from a qualified profit sharing plan? How about from a 401k plan? - A company cannot exclude anyone who has attained age 21 and has completed one year of service with the company with 1,000 hours during that year. - Long-term part-time employees who attained age 21 and worked at least 500 hours per year for the employer for three consecutive years are also eligible in a 401(k) plan 48.Describe the general safe harbor test. - At least 70% of the NHC employees are covered by the plan. 49.Bank Corp has a defined benefit plan with 300 employees. What is the minimum number of employees the defined benefit plan must cover to conform to the requirements set forth by the IRC? - The plan must cover the lesser of 50 people or 40% of all employees. In this case, the lesser would be 50. 40% of 300 employees is 120 employees. - This only applies to DB plans 50.Who is eligible to participate in a 401k plan? - The most restrictive eligibility for a 401(k) plan is age 21 and one year of service for employees working at least 1,000 hours. The SECURE Act, passed in December 2019, amended the eligibility requirements to allow long-term part-time employees who are age 21 and worked at least 500 hours per year for the employer for three consecutive years to participate in the employer’s 401(k) plan by making employee contributions to the plan, effective for plan years beginning after December 31, 2020. 51.Do employers receive a tax credit when offering a retirement account to military spouses? - Yes, as an incentive to encourage small employers to offer more lenient eligibility and vesting for military spouses, the SECURE 2.0 Act of 2022 created a tax credit to help offset the increased cost to the employer. The credit is available during the first three years of participation by the military spouse. The credit available each year is $200 plus the amount of employer contributions (up to $300) for each military spouse who participates during the year. To qualify, the military spouse must be eligible to participate within  two months after their date of hire and must be immediately vested in all employer contributions to the plan. Chapter 4 1. Describe 2 types of Defined Benefit Pension Plans. Traditional pension - Receive a % of your income in retirement (based on an average of your 3 highest consecutive earning years) Cash balance pension plan - Fixed payment (% of a participant’s annual salary each year) and fixed interest rate 2. Describe 2 types of Defined Contribution Pension Plans. - Money purchase pension plan (Employer contributions are based on a fixed percentage of an employee's annual compensation, interest rate is market driven and is not guaranteed by employer) - Target benefit pension plan (need actuary in year 1 to establish a target and do not change assumptions for this type of pension) 3. Give an example of a traditional pension plan formula with a 60% wage replacement ratio. - 1.5% *40 years * 100K income = 60% * income - receive 60% wage replacement ratio (WRR) 4. Describe 4 pension plan requirements. - Mandatory annual funding by the company - Disallow in-service withdrawals by the employees - Limited investment in employer’s securities - Limited investment in life insurance 5. What is a plan’s funding target? - Present Value of all estimated future benefits accrued or earned under the plan as of the beginning of the plan year. This is a liability of the company on its balance sheet. - Compare this to fair market value (FMV) of assets currently in the company pension plan - Pension plan is underfunded if FMV of pension assets < PV of future pension benefits (liab)  - Present value of future pension benefits is lower if the actuary assumes a higher interest rate (discount rate). Less likely to underfund pension, but may not be realistic - Interest rates have dropped over the past 40 years, which lowers growth of pension assets and raises PV of future benefits. Both of these events lead to more underfunded pensions 6. When is a plan at risk? - If under 80% funded or - Worst case actuarial assumptions is under 70% funded - Company is penalized if drop below this - 7. What is the maximum a plan can invest in the company securities? - 10% of the fair market value of the pension plan assets - Pension plan administrators are considered fiduciaries and must act prudently to diversify investments and minimize risk for plan participants 8. How else is diversification met? - DC plan must offer at least 3 different investment options with different risk and return characteristics - Example: stock, bond, cash fund (money market) 9. Can pension plans hold life insurance? - YES 10. How much? - Term or universal life, premiums paid cannot exceed 25% of total contributions made by the employer on the employees’ behalf - Whole life, premiums paid cannot exceed 50% of total employer contributions - Death benefit cannot exceed 100 times the value of the monthly pension benefits for DB 11. Can a 401K plan hold life insurance? - Yes, same rules as previous slide 12. Can an IRA hold life insurance?  - NO 13. When is an actuary needed for a DB and cash balance plan? - Annually 14. How about for a target benefit plan? - At inception only 15. How about for a money purchase plan? - Never 16. Who assumes the investment risk for a DB and cash balance plan? - Employer 17. How about for a money purchase plan and target benefit plan? - Employee 18. What is a forfeiture? - When an employee terminates employment before being fully vested - Lose the contribution from the employer 19. How is this handled in a DB and cash balance plan? - Can be used to reduce plan administrative expenses or - Be used for future contributions to the pension assets 20. How is this handled in a DC plan? - Can be used to reduce plan administrative expenses or - Allocate these funds today to remaining participants 21. Describe what the Pension Benefit Guaranty Corporation is. - Insures DB plans (but not for government employee DB plans) - Created in 1974 - If company fails, employees still receive their retirement benefits 22. Are DC plans covered by PBGC? - NO 23. Can a participant in a DB plan receive credit for prior service at a different company? - YES 24. How about a participant in a DC plan? - NO 25. How is social security integrated with a DB retirement plan? - An integrated pension plan factors in the employee's Social Security benefits into the formula for determining their pension benefits. - As a result, an integrated pension plan is less costly and less financially burdensome for the employer. - Social Security is counted as part of the employees' total benefits. 26. How is social security integrated with a DC retirement plan? - DC plans can only use excess method. With the DC excess method, an individual can receive the lower of these for contributions on earnings ABOVE the Social Security wage base threshold: (1) the base rate x 2 OR (2) the base rate + 5.7% - No social security tax paid after income of 168,600. Therefore, can give more employer contributions to HC if HC has income greater than 168,600. - If base rate is 8% of compensation, company can give up to 8% +5.7% to HCE for their earnings above 168,600 27. Which retirement plan has commingled accounts? - DB 28. Which one has separate accounts? - DC 29. Describe 3 DB funding formulas. - Flat amount formula, $250 per month - Flat % formula, 10% of compensation per year at retirement - Unit credit formula, 2%* years of service* average 3 highest consecutive years of compensation 30. Describe a cash balance plan. - Fixed payment (% of a participant’s annual salary each year) and fixed interest rate 31. Describe a money purchase plan. - Fixed payment and an earning interest rate that varies with the market - Has a separate account - Benefits younger participants 32. Describe a target benefit pension plan. - Actuary creates a funding formula when a participant starts the plan - The formula is the target and does not change - Formula benefits older participants - Assumptions are fixed - The company’s contribution stays the same based on the original assumptions - Market rates change and thus the retirement benefit is not fixed or defined and will change - Participant chooses the investments - This is a DC plan 33.Will an individual who’s average three highest consecutive years of compensation is $180,000 have a maximum benefit payable at retirement from their defined benefit pension plan of $265,000? - The maximum benefit payable to a participant of a defined benefit pension plan at retirement is the lesser of $265,000 (2023) or the average of the participant’s three highest consecutive years of compensation. - Since this individual’s average three highest consecutive years of compensation is less than the maximum, the maximum payment to the individual at retirement from the defined benefit pension plan is $180,000. 34.Describe a defined benefit pension plan which uses a flat-amount formula. - Pays each participant the same dollar amount during their retirement. 35.Does a cash balance pension plan maintain separate accounts for each of its participants? - A cash balance pension plan does not have a separate account for each participant even though the plan participant receives a statement detailing a separate account in their name. - A cash balance pension plan consists of a commingled account that has a value equal to the actuarial equivalent of the present value of the expected  future benefits that will be paid from the cash balance pension plan to the participants. 36.Within a defined benefit pension plan, is the participant’s accrued benefit at any point the participant’s present account balance? - NO, A participant’s accrued benefit of a defined benefit pension plan is the actuarial equivalent of the benefit that will be provided to the participant if the participant waits until retirement to receive the pension benefit. - Recall that a defined benefit pension plan is a commingled account for the benefit of the pension plan participants. - Each participant does not have a separate account. 37.If a participant terminates service with a defined benefit pension plan sponsor before becoming 100% vested, is the participant’s forfeitures allocated to the other participants of the defined benefit pension plan? - NO - The plan forfeitures of a defined benefit pension plan may only be used to reduce future plan funding costs of the employer. 38.If a term life insurance policy is purchased in a defined contribution plan, the aggregate cost of the term life insurance policy cannot exceed 35% of the value of the account. - FALSE. - The aggregate cost of a term life insurance policy included in a defined contribution plan cannot exceed 25% of the value of the defined contribution plan assets. 39.Describe the characteristics of a defined benefit retirement plan. - Defined benefit plans assign the risk of pre-retirement inflation, investment performance, and adequacy of retirement income to the employer, not the employee. 40.Describe a cash balance pension plan. - Payments are a fixed percentage of annual salary and - Guaranteed minimum investment return. 41.A company’s defined benefit pension plan utilizes a funding formula that considers years of service and average compensation to determine the pension benefit payable to the plan participants. If Kim is a participant in this defined benefit pension plan, she has 30 years of service with the company, and she always had annual compensation of $105,000, what is the maximum pension benefit that can be payable to Kim at her retirement? - The maximum amount payable from a defined benefit pension plan is the lesser of $265,000 (2023) or 100% of the average of the employee’s three highest consecutive years compensation. Because the average of Kim’s compensation is $105,000, she would be limited to receiving a pension benefit at her retirement of $105,000. 42.Which of the following statements concerning the use of life insurance as an incidental benefit provided by a qualified retirement plan is (are) correct? a. The Table 2001 premium for the life insurance policy within the qualified plan is taxable to the participant at the time of payment. b. Under the 25 percent test, if whole life is involved, the aggregate premiums paid for the policy cannot exceed 25 percent of the employer’s aggregate contributions to the participant’s account. If term or universal life policies are used, however, the aggregate premiums paid for the whole life policy cannot exceed 50 percent of the employer’s aggregate contributions to the participant’s account. - Both are correct Statement 1 is correct. The Table 2001 premium for the life insurance policy is taxable to the participant at the time of payment (because the death benefit is tax free to the beneficiary). - Statement 2 is correct because the 25 percent test is a misnomer, for it is really two tests: a 25 percent test and a 50 percent test, depending on which type of life insurance protection is involved.  Chapter 5 1. List some profit sharing plans. - profit sharing plan - stock bonus plan - ESOP Employee Stock Option Plan - 401K - thrift plan - age-based profit-sharing plan 2. Are profit sharing plans DC or DB? - DC 3. Describe the main differences between a pension plan and a profit sharing plan. - Employer pays pension at retirement based on a formula versus employee deferred compensation and tax deferral for profit-sharing plan - No in-service withdrawals allowed in a pension plan (usually) versus in- service withdrawals are allowed in a profit-sharing plan after 59.5 years of age or for certain hardships - (in-service withdrawals are taking money out of retirement fund while still working) - Mandatory funding from the employer for a pension plan versus discretionary employer contributions for a profit-sharing plan - Maximum % allowed to invest in Company stock: 10% for a pension plan versus 100% for a profit-sharing plan 4. Describe different ways a profit sharing plan can be allocated to plan participants. Evenly or by age or by pro rated % of total company wages - Pro rated % is called comp to comp and is most popular method (example): - Employee 1 salary is $20K (20% share of total) - Employee 2 salary is $30K - Employee 3 salary is $50K - Total salaries are $100K - If the company decides to share $10K of profits, employee 1 will get $2K, employee 2 will get $3K, and employee 3 will get $5K 5. Can a profit sharing plan be integrated with social security? - Yes, profit sharing plans can only use excess method. With the excess method, an individual can receive the lower of these for contributions on  earnings ABOVE the Social Security wage base threshold: (1) the base rate x 2 OR (2) the base rate + 5.7% - No social security tax paid after income of 168,600. Therefore, can give more employer contributions to HCE if HCE has income greater than 168,600. - If base rate is 8% of compensation, company can give up to 8% +5.7% to HCE for their earnings above 168,600 6. Describe an age-based profit sharing plan. - Use both age and compensation as the basis for allocating contributions to an employee’s account 7. What is a forfeiture and how are they handled in a profit sharing plan. - Employee leaves the company before being fully vested and does not receive this part of the employer’s contribution to the plan. - Reduce future plan contributions or administrative costs - or - May be reallocated to the remaining plan participants - Cannot discriminate in favor of HC 8. How are profit sharing plans vested? - 2 to 6 year graduated or 3-year cliff (can be 1 to 5, that is more generous) 9. What is a CODA? - Attaches to certain qualified plans to create a contributary component to the plan for the employee - A cash or income deferral arrangement for the employee AKA 401K plan - On a pre-tax basis, contribute pre-tax dollars 10. Describe the advantages of a 401K plan to employees. - Shelter current income from taxation (lowers AGI and taxes owed) - Self-directed investments - Earnings grow tax deferred until distributed - Match from employer - May be able to borrow up to $50K from your 401K ($100K if in a disaster area) 11. Describe the advantages of a 401K plan to employers.  - Minimal expense compared to pension plan - No annual contribution commitment required - Owner/employees may participate (CODA) - No investment risk 12. Which type of entities can establish a 401K? - Corporations (S or C) - Partnerships - LLCs - Sole Proprietorships - Tax-exempt entities 13. Have 401Ks grown in popularity? - Yes, cheaper and less risk for company as compared to a traditional pension plan - Lower interest rates have made it difficult for companies offering traditional pensions, cannot grow their investments enough to fund the plan 14. Who is eligible to participate in a 401K? - 21 or older and worked for the company for 1,000 hours during the year Or - 21 and 500 hours for 3 consecutive years (only for 401K plans) 15. Describe the vesting requirements for a 401K. - Employee gets all of their own contribution immediately, then 2 to 6 years graduated or 3 year cliff for the employer matching contributions 16. Is a salary reduction employee contribution to a 401K a popular CODA? - Yes (not paid from employee’s bank account) 17. What is the maximum annual elective deferral limit for an employee in a 401K? - $22,500 and $7,500 catch up contribution if over 50 (2023 rules) - It increases often because of inflation 18. Must a company promote its 401K to employees? - Yes, ERISA (1974) requires it 19. What is a Thrift Plan? - Employees can make after-tax contributions to this plan but pay taxes on gains when take out - Get tax deferred-growth - Not as popular now because of Roth option (1998 was Roth inception) 20. Describe a Roth 401K? - Contribute after-tax dollars - No AGI limits - Does have Required Minimum Distribution (RMD) (73 years old) - Must hold for 5 years - Qualified withdrawals are tax free (withdraw of company match is not tax free though, treated as a regular 401K) - Nonqualified distribution of basis is not taxed but may have penalty (before age 59.5) - Earnings will be taxed if nonqualified withdrawal 21. Describe a Solo 401K. - covers only the owner of the business - the business cannot have employees - could have a separate Solo 401K for each owner of the business - easy to administer and low cost (better online technology now days) - must fill out more administrative forms when assets exceed $250K - annual funding is not required - $66K limit per year plus $7,500 if over 50 (in 2023) - also can be a Roth - has advantages when doing a Backdoor Roth Conversion (compared to a SEP IRA) 22. If the retirement plan has a CODA, what 2 nondiscrimination tests must be passed? - Actual deferral percentage ADP - Actual contribution percentage ACP 23. Describe ADP. - The ADP test compares the average salary deferral percentages of HC to NHC - If NHC defer 0 to 2% of their income, then HC can defer 2x NHC max - If NHC defer 2 to 8%, then HC get ADP for NHC plus 2% - If NHC defer over 8%, then HC get 1.25x 24. What happens if a company fails the ADP test? - Company must make more contributions to NHC or - Give back HC contributions (they must count this as taxable income) 25. Describe ACP. - Same scale applies as the ADP test, but ACP considers employee contributions and employer matching contributions 26. How can a company avoid the ADP, ACP, and the Top-heavy test? - Company can use the Safe Harbor Provision 27. How can the Safe Harbor Provision be satisfied? - An employer makes a nonelective contribution to all eligible employees (3%) - An employer makes a matching contribution (3% for 1st 3%, then.5% and.5% for 4% and 5% for a total match of 4%) to those already participating in the plan - A qualified automatic contribution arrangement (QACA) with a match, must notify all employees - 100% vested immediately for first 2 of these (but not QACA) 28. Describe QACA in more detail. - Qualified automatic contribution arrangements (QACAs) are a form of automatic-enrollment retirement plan offered by employers. - Employee can opt-out - A QACA must specify a schedule of uniform minimum default percentages starting at 3% that gradually increase with each year that an employee participates - Employee contributes 3% of income, and company matches 3% (increases each year)  - QACA increases participation and employee contributions - 2 year vesting for QACA 29. When can a CODA plan participant take a distribution? - Retirement - Death (Beneficiary receives the distribution) - Separation of service (leave job) - Termination of plan - Attain 59.5 - Certain hardships - Victim of domestic abuse - Residence in a disaster area - Certain emergency expenses - Payment of premiums for LT care 30. Describe a Thrift Savings Plan. - For federal employees and uniformed services - Automatic enrollment plan - Automatic employee 5% contribution and a 5% match 31. What is an appropriate percentage for an employee to contribute to their retirement fund? - 3% of your income to start, work your way to 10% (automatic millionaire) - Must get all the match available from your employee 32. What is IRS Rule 55? - Can take a penalty-free distribution if leave job for any reason and over 55 - Only for 401k 33. What is an in-service withdrawal? - Can withdraw money from qualified plan with penalty for certain life events 34. Can a company have a profit sharing plan and a 401k? - Yes, but annual limit is $66k (this includes CODA and employer contribution) - plus $7,500 if over 50 (if the plan has a CODA) - (2023) 35. What is the maximum income that can be considered for a profit sharing plan?  - $330K for 2023 36.If ICE Electronics, Inc. (ICE) established a profit-sharing plan for the current year, is ICE required to make contributions to the profit-sharing plan for the current plan year? - ICE is not required to make contributions to a profit-sharing plan each year - ICE can make contributions at its discretion. 37.Can the plan sponsor of a 401(k) plan require its employees to attain the age of 21 and complete 2 years of service to be eligible for participation in the 401(k) plan? - NO, The standard eligibility rules require the plan sponsor of a qualified plan (including a 401(k) plan) to consider all employees who have attained the age of 21 and who have completed one year of service (1,000 hours) for eligibility in the plan. - Could be 21 and part-time worker too (500 hours a year for 3 consecutive years) 38.Do all 401(k) plans need to pass the ADP test? - NO - A 401(k) plan that elects safe harbor status is not required to comply with the ADP test. 39.Toni, an executive vice-president, terminates her employment with Kerry Oil and Gas after three years of service. Her account balance in the company profit-sharing plan was $28,000 at the time of termination. The plan follows the least generous graduated vesting schedule permitted, so Toni’s vested benefit in the profit-sharing plan is $9,400. - NO, A profit-sharing plan which follows the least generous graduated vesting schedule permitted must follow a 2-6 year graduated vesting schedule. In such a case, after three years of service, Toni would be 40% vested in the $28,000 profit-sharing plan account balance - Her vested account balance would be $11,200 ($28,000 x 40%). 40.Robert, age 58, is a participant in a noncontributory qualified profit-sharing plan sponsored by his employer. Is the maximum that may be contributed to Robert’s account by the employer for the 2023 plan year $79,500?  - NO, The maximum contribution to a qualified profit-sharing plan for 2023 is $66,000. The catch-up contribution can only be contributed as a deferral contribution from employees who are age 50 and over. - Since Robert’s employer’s qualified profit-sharing plan is noncontributory (all contributions are made by the employer), Robert would not have the availability to make deferral contributions to the noncontributory profit- sharing plan to meet the catch-up availability. 41.What are advantages of profit-sharing plans to businesses and business owners? - Allows discretionary contributions. - Controls benefit costs. - May provide legal discrimination in favor of older owner-employees. 42. Which vesting schedules may a top-heavy qualified profit-sharing plan use? - Qualified profit-sharing plans must use a vesting schedule that provides participants with vested benefits at least as rapidly as either a 2- to 6-year graduated vesting schedule or a 3-year cliff vesting schedule. - This requirement applies without regard to whether the profit-sharing plan is a top-heavy plan. 43.Jared, age 52, earns $240,000 per year and is a participant in his employer’s 401(k) plan. Ignoring the ADP test requirements, what is the maximum amount that Jared can defer under the 401(k) plan in 2023? - The deferral limitation for 2023 is $22,500 and Jared can defer an additional $7,500 (2023) as a catch-up contribution because he is age 50 or older. 44.Tonya, age 53, is a highly compensated employee who earns $340,000 per year and is a participant in her employer’s 401(k). Her employer also made a 20% profit- sharing plan contribution during the year. Ignoring the ADP test requirements, what is the maximum amount that Tonya can defer under the 401(k) during 2023? - Tonya’s employer contributed $68,000 ($340,000 maximum compensation x 20%). This contribution “maxes” out Tonya’s ability for contributions to qualified plans - with one exception - the deferral catch-up for those individuals age 50 and older. - In this case, Tonya could make the catch-up deferral of $7,500 (2023) because the employer maxed out the contribution of $68,000. The fact that Tonya is highly compensated is irrelevant in this question. 45. Which of the following vesting schedules may a non-top-heavy profit-sharing plan use? 1. 2-to-6-year graduated. 2. 3-year cliff. 3. 1-to-4-year graduated. 4. 4-to-8-year cliff. - The correct answer is 1,2 and 3. - A profit-sharing plan must vest at least as rapidly as a 3-year cliff or 2- to-6- year graduated schedule without regard to the plan’s top-heavy status. The profit-sharing plan can follow any vesting schedule that provides a more generous vesting schedule. 46.Lamont, age 55, is employed by BB Trucking Company as a tire repair specialist. He earns $125,000 per year and received an allocation of $41,000 to his employer- provided profit-sharing plan for the year. If BB Trucking does not match employee deferrals, what is the maximum amount Lamont can defer to his 401(k) plan for the 2023 plan year? - The maximum deferral to a 401(k) plan for a participant who is 50 years old or over in 2023 is $30,000 ($22,500 plus catch-up of $7,500). - The deferral is also included in the maximum defined contribution limit of $66,000 ($73,500 if 50 and over with catch-up). - Since Lamont has received an allocation from the profit-sharing plan of $41,000, he is able to defer $25,000 ($66,000 - $41,000) plus the $7,500 catch-up deferral for participants who are 50 years and older to maximize his defined contribution plan limit for the year of $32,500. HOWEVER, the max CODA per year is $22,500, so the answer is $22,500 + $7,500 = $30,000 47.Sheila earned $105,000 during the year. She elected to defer $4,000 of her earnings into her employer’s 401(k) plan and her employer matched this deferral dollar-for- dollar. In this year, what amount of Sheila’s earnings was subject to payroll taxes? - Sheila’s earnings of $101,000 that were not deferred to the 401(k) plan would be subject to payroll taxes plus her deferrals of $4,000 to the 401(k) plan would be subject to payroll taxes. - The employer’s matching contributions are not subject to payroll taxes. - The amount subject to payroll taxes would be $105,000 ($101,000 + $4,000). 48.Describe an age-based profit-sharing plan?  - An age-based profit-sharing plan provides a greater benefit to older plan participants as the allocation of the plan contribution is based upon the age of the participants. 49. Going Higher Construction sponsors a 401(k)-profit-sharing plan. In the current year, Going Higher Construction contributed 25% of each employee’s compensation to the profit-sharing plan. The ADP of the 401(k) plan for the NHCs was 3.0%. If Kendra, age 57, earns $130,000 and is a 7% owner, what is the maximum amount that she may defer into the 401(k) plan for 2023? ON EXAM - Kendra is highly compensated because she is more than a 5% owner, so the maximum that she can defer to satisfy the ADP test requirements is 5.0% (3.0% + 2%) and because she is age 50 or older, she can defer the additional $7,500 (2023) as a catch-up contribution. Kendra can defer $6,500 (5.0% x $130,000) and $7,500 (the catch-up) for a total of $14,000. 50.Yoshi, age 45, works full time at Mario’s Plumbing where she earns $80,000. Yoshi contributes 10 percent of her salary to the company’s 401(k) plan and receives a dollar-for-dollar match on deferrals up to five percent of salary in 2023. Yoshi also works part time as a self-employed dog groomer, earning net self-employment income of $90,000 in 2023. When preparing her 2023 taxes in 2024, Yoshi’s accountant advises her to establish a solo 401(k) for her dog grooming business. What is the maximum employee contribution Yoshi may make to the solo 401(k) for the 2023 plan year? ON EXAM - The employee deferral limit of $22,500 (in 2023) applies per individual for all 401(k), 403(b), SARSEP, and SIMPLE plans combined. Since Yoshi contributed $8,000 to the 401(k) plan at Mario’s Plumbing, she is limited to $14,000 ($22,500 - $8,000 = $14,500) in the solo 401(k). - She is not over 50, so no catch-up contribution - The SECURE 2.0 Act expanded the ability of a sole proprietor to make contributions for the first plan year by permitting employee contributions for sole proprietors to be made until the due date of the proprietor’s tax return (without extensions).