FP 515 Retirement Savings and Income Planning Exam | Q & A (Complete Solutions)

FP 515 Retirement Savings and Income Planning Exam | Q & A (Complete Solutions) Juan has worked for the ABC Company for 23 years. The defined benefit plan pays 2% of an employee's average of his or her high five highest years of income. Juan's average is $60,000. How much will he receive each month if he retires this year? A) $3,000/month B) $1,200/month C) $2,300/month D) $800/month Juan will receive $2,300 per month. $60,000 × 0.02 × 23 ÷ 12 = $2,300/month Which of these statements regarding Social Security plan integration is false? I. Because there is a disparity in the Social Security system, all retirement plans are allowed to integrate with Social Security. II. Only the excess method can be used by a defined benefit pension plan. III. Under the offset method of integration, a fixed or formula amount reduces the plan formula. IV. The maximum increase in benefits for earnings above covered compensation level is 5.7% for a defined benefit pension plan. A) II and III B) II and IV C) I and III D) I, II, and IV Statement I is incorrect because not all retirement plans are allowed to integrate with Social Security. For example, ESOPs and SARSEPs are not permitted to use integration. Statement II is incorrect because the defined benefit pension plan can use either the excess or offset method in integrating with Social Security. Only the excess method can be used with defined contribution plans. Statement IV is incorrect because the permitted disparity limit for a defined benefit pension plan is 26.25% above the covered compensation level (0.75% per year for up to 35 years). Which of the following would NOT be a permitted disparity for a defined benefit plan that uses Social Security integration? A) An excess benefit percentage of 60%, if the base percentage is 30% B) An excess benefit percentage of 20%, if the base percentage is 15% C) An excess benefit percentage of 10% if the base percentage is 5% D) An excess benefit percentage of 40%, if the base percentage is 20% Base percentage + permitted disparity = excess benefit percentage. The permitted disparity is the base percentage, up to a maximum of 26.25% (0.75% per year for up to 35 years). Which of the following does NOT meet the definition of active participation in a retirement plan for the purposes of determining the deductibility of IRA contributions? A) Matt makes contributions to his employer's qualified plan. B) An employee is eligible to defer salary to his employer's Section 401(k) plan. C) Betty has employee forfeitures reallocated to her account by her employer but makes no elective deferrals in the same plan year. D) Kerry has benefits accrued for him under his employer's defined benefit pension plan. For the Section 401(k) retirement plan, an employee is considered covered as long as he or she is eligible to defer part of his compensation; he or she does not have to actually make contributions. Note, however, that active participation for purposes of determining deductibility of IRA contributions differs from being covered under a qualified plan for nondiscrimination testing. Specifically, an employee must be contributing to the plan, having employer contributions to the plan, forfeitures reallocated on his or her behalf, or accruing a defined benefit before he or she is considered an active participant in a qualified plan for IRA purposes. Plan earnings alone do not make someone an active participant. Also, receiving retirement plan benefits do not make someone an active participant. Which of the following statements regarding qualified retirement plans is CORRECT? I. Money purchase pension plans, employee stock ownership plans (ESOP), target benefit pension plans, and stock bonus plans are all examples of qualified retirement plans. II. Top-hat plans and cash balance pension plans are examples of qualified retirement plans. A) I only B) Both I and II C) Neither I nor II D) II only Statement II is incorrect because top-hat plans are nonqualified retirement plans. A cash balance pension plan, however, is an example of a qualified plan. The qualified retirement plan maintained by the ABC Corporation imposes a two-year waiting period before new employees may enter the plan. Which of the following statements is CORRECT? A) The plan is a Section 401(k) plan. B) The plan must provide 100% vesting to all employees immediately upon entry. C) The plan is in violation of ERISA. D) The plan may use the normal qualified plan vesting schedules. Most types of qualified plans are allowed to increase the waiting period to two years of service, but plans adopting this rule must provide 100% vesting to all employees immediately upon entry. Section 401(k) plans cannot require a two-year waiting period. Which of the following describe differences between a tax-advantaged retirement plan and a qualified plan? I. IRA-funded employer-sponsored tax-advantaged plans may not incorporate loan provisions. II. Employer stock distributions from a tax-advantaged plan do not benefit from NUA tax treatment. A) Neither I nor II B) I only C) II only D) Both I and II Both I and II are correct. IRA-funded employer-sponsored tax-advantaged plans are SEPs, SARSEPs, and SIMPLE IRAs. Which of these are minimum coverage tests for all qualified retirement plans? I. Minimum benefit test II. Average benefits percentage test III. Ratio test IV. 50/40 test A) I and II B) I and III C) II and III D) II, III, and IV 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. The 50/40 test is only required for defined benefit plans. There is no such thing as a minimum benefit test. The Jones Corporation has a profit-sharing plan with a 401(k) provision. The company matches dollar-for-dollar up to 5%. Pedro makes $150,000 and defers 5% into the 401(k) for 2023. The Jones Corporation has had a banner year and is considering a large contribution to the profit-sharing plan. What is the most that could be contributed to Pedro's profit-sharing account this year? A) $22,500 B) $58,500 C) $51,000 D) $66,000 The maximum allowed employer profit sharing contribution in this case for 2023 is $51,000. The Section 415 annual additions limit for 2023 is $66,000. However, Pedro has already contributed $7,500, and this amount has been matched. Thus, $15,000 has already gone toward the $66,000 annual additions limit for 2023. In a Section 401(k) plan, which of these must be considered in complying with the maximum annual additions limit? I. Employee contributions II. Catch-up contributions for an employee age 50 or older III. Dividends paid on employer stock held in the Section 401(k) plan IV. Employer contributions A) I and IV B) I, II, and IV C) II and IV D) I and II Statement I is correct. Employee contributions are counted against the annual additions limit. Statement II is incorrect. Catch-up contributions for an employee age 50 or older are not counted against the annual additions limit. Statement III is incorrect. Earnings on plan investments are not taken into account when computing the maximum annual additions limit. Statement IV is correct. For 2023, the annual additions limit is the lesser of 100% of the employee's compensation, or $66,000. Which of these is a type of defined contribution profit-sharing plan? A) Target benefit pension plan B) Employee stock ownership plan (ESOP) C) Cash balance pension plan D) Money purchase pension plan A cash balance pension plan is a type of defined benefit pension plan. An ESOP is a defined contribution profit-sharing plan. Which of the following does NOT meet the definition of active participation in a retirement plan for the purposes of determining the deductibility of IRA contributions? A) An employee is eligible to defer salary to his employer's Section 401(k) plan. B) Kerry has benefits accrued for him under his employer's defined benefit pension plan. C) Betty has employee forfeitures reallocated to her account by her employer but makes no elective deferrals in the same plan year. D) Matt makes contributions to his employer's qualified plan. For the Section 401(k) retirement plan, an employee is considered covered as long as he or she is eligible to defer part of his compensation; he or she does not have to actually make contributions. Note, however, that active participation for purposes of determining deductibility of IRA contributions differs from being covered under a qualified plan for nondiscrimination testing. Specifically, an employee must be contributing to the plan, having employer contributions to the plan, forfeitures reallocated on his or her behalf, or accruing a defined benefit before he or she is considered an active participant in a qualified plan for IRA purposes. Plan earnings alone do not make someone an active participant. Also, receiving retirement plan benefits do not make someone an active participant. An employer-sponsored money purchase pension plan, integrated with Social Security, uses a base contribution formula of 10% for all participants and the Social Security taxable wage base as the integration level. Given this information, what is the maximum permitted excess contribution percentage? A) 20.0% B) 5.7% C) 10.0% D) 15.7% The permitted disparity rules for defined contribution plans specify that the maximum excess percentage cannot exceed the lesser of (1) two times the base contribution percentage or (2) the base contribution percentage plus 5.7%. Therefore, the excess contribution percentage is 15.7% (10% + 5.7%). In a money purchase pension plan that utilizes plan forfeitures to reduce future employer plan contributions, which of the following components must be factored into the calculation of the maximum annual addition limit? (CFP® Certification Examination, released 11/94) I. Forfeitures that otherwise would have been reallocated II. Annual earnings on all employer and employee contributions III. Rollover contributions for the year IV. Employer and employee contributions to all defined contribution plans A) I and III B) IV only C) I, II, III, and IV D) I, II, and III Because the forfeitures will be used to reduce future employer contributions, they will not count against the annual additions limit. Defined contribution plans do not consider earnings on investments when calculating contributions. Which of the following types of qualified retirement plans are subject to the minimum funding requirements? I. Defined benefit pension plans II. Money purchase pension plans III. Profit sharing plans IV. Target benefit plans A) I and II B) I, II, and IV C) I, III, and IV D) II, III, and IV The only qualified plans exempt from the minimum funding standard are profit sharing plans and stock bonus plans. Section 401(k) provisions are only permitted with profit sharing plans and stock bonus plans. Which of the following is true regarding the interest rate credit used in cash balance pension plans? I. The interest rate credited to a participant's hypothetical account is determined upon the establishment of the plan and cannot fluctuate. II. If the underlying investments of the plan outperform the interest rate credit guarantee in a given year, the participant will receive a greater credit for that given year. III. If the underlying investments of the plan outperform the interest rate credit guarantee in a given year, the employer may reduce plan contributions for that given year. IV. Because of the hypothetical individual accounts, plan participants may choose among various fixed interest rate investments for their accounts. A) I, II, and IV B) III only C) I and III D) IV only Only Statement III is correct. Statement I is incorrect because the interest rate credit may be linked to a market rate, such as a Treasury security; the rate credited may fluctuate in a given year, but will never be less than the stated formula. Statement II is incorrect because the employee does not receive additional interest credit if the underlying assets outperform the guaranteed credit. This also makes it possible for the employer to reduce plan contributions in years in which the underlying assets outperform the guaranteed interest credit. The employer bears the investment risk in a cash balance pension plan; participants do not select their own investments. Joe, 46, has owned his company for 18 years and wishes to retire at age 70. All of Joe's employees are older than he is and have an average length of service with the company of eight years. Joe would like to adopt a qualified retirement plan that would favor him and reward employees who have rendered long service. Joe has selected a traditional defined benefit pension plan with a unit benefit formula. Which of these statements regarding Joe's traditional defined benefit pension plan is CORRECT? I. Increased profitability would increase both Joe's and his employees' pension contributions. II. A unit benefit plan formula allows for higher levels of integration than other defined benefit pension plans. III. A unit benefit plan formula rewards older employees who were hired in their 50s or 60s. IV. A traditional defined benefit pension plan will maximize Joe's benefits and reward long-term employees based on length of Statement I is incorrect. Contributions to traditional defined benefit pension plans are not dependent on the profitability of a company. Statement II is incorrect because a unit benefit plan formula will not allow higher integration levels. Statement III is incorrect because a flat percentage formula favors workers without much longevity. Baxter and Smith is a law firm with a defined benefit pension plan. When would the plan be required to be covered by the Pension Benefit Guaranty Corporation (PBGC)? A) If the firm employs 26 or more employees B) If the firm employs 25 or fewer employees C) If the firm employs 10 or more employees D) A professional service employer is not required to be covered by PBGC Defined benefit plans maintained by certain professional service employers with 26 or more employees must be covered by the PBGC. James, a pilot, founded an airline, Margaritaville Airways, as a sole proprietorship 15 years ago. Six years ago, he hired six employees. Now the business has grown, and he decides to incorporate. The new successor entity, Margaritaville Airways, Inc., offers a defined benefit plan. If a unit benefit formula is used, James wants to know if employees will receive credit for past years of service. Which of the following is CORRECT? A) The owner will receive credit for 10 years of service. The employees will receive no credit. B) All employees will receive credit for 10 years of past service. C) All employees will receive credit for 5 years of past service. D) Neither the owner nor the employees will receive any credit for past service. Under IRS safe harbor rules, a successor entity may recognize up to five years of service when establishing a defined benefit plan. The plan may not discriminate in favor of the highly compensated employee-owner(s). Which of these are CORRECT statements about defined contribution pension plans? I. They use an indefinite allocation formula. II. They provide a benefit that is based on the value of a participant's account. III. They require employer contributions to be made from business earnings. IV. They require fixed employer contributions according to the terms of the plan. A) II and IV B) I and II C) II and III D) I and IV Employer contributions to a defined contribution pension plan (money purchase plan or target benefit plan) must be fixed according to the terms of the plan; e.g., a plan could stipulate that the employer shall contribute an amount equal to 10% of the compensation of each participant. The investment performance of a participant's account balance determines the value of his or her benefit upon termination or retirement. However, contributions must be made to fund a pension plan, even if an employer has no earnings or profits. Defined contribution plans must also have definitely determinable benefits; i.e., the annual employer contribution to an employee's account must be fixed or definitely determinable. All of the following statements regarding target benefit pension plans are correct except A) the plans are covered by Pension Benefit Guaranty Corporation (PBGC) insurance. B) minimum funding standards apply. C) older participants are favored in a target benefit pension plan. D) each employee has an individual account. Target benefit pension plans are defined contribution plans, so they are not covered by PBGC insurance, and employees have their own individual accounts. Because they are pension plans, minimum funding standards apply. Similar to defined benefit plans, target benefit pension plans favor older participants with a larger contribution at plan entry than a younger person joining the firm with the same compensation. Assume a company's goal is to maximize retirement benefits to the highly compensated employees, who also happen to be the oldest employees (LO 2.3.1). Which of the following best accomplishes this goal if the company is installing a new plan? A) A target benefit pension plan B) An age-weighted profit-sharing plan C) A money purchase pension plan D) A defined benefit pension plan The defined benefit pension plan favors older participants and generally allows larger contributions than other plans. Age-based profit-sharing plans and target benefit pension plans also favor older participants. However, age-based profit-sharing plans and target benefit pension plans are both defined contribution plans that are subject to the annual additions limit (for 2023 a maximum contribution of no more than the lesser of 100% of an employee's compensation or $66,000). Which of these statements is CORRECT in describing the effects of actuarial methods or assumptions on contributions to a defined benefit pension plan? A) The higher the interest rate assumed by the actuary, the higher the required employer contribution for the year. B) The higher the turnover rate assumed by the actuary, the lower the required employer contribution for the year. C) Using salary scales tends to reduce the cost for funding younger employees' benefits. D) The lower the projected investment earnings on plan assets over the life of the plan, the lower the required employer contribution for the year. Because defined benefit plans must apply forfeitures to reduce the employer contribution, an actuarial assumption of high turnover in a plan year will result in a lower required employer contribution. An increase in which of these factors will increase plan costs for a defined benefit pension plan? A) Investment returns B) Mortality C) Life expectancies D) Employee turnover An increase in employee life expectancies will increase the potential costs of the plan, so life expectancies have a direct impact on plan costs. Fernando, age 45, participates in his employer's defined benefit pension plan. This plan provides for a retirement benefit of 2% of earnings for each year of service with the company and, given Fernando's projected service of 20 years, will provide him with a benefit of 40% of final average pay at age 65. What type of benefit formula is this plan using? A) A flat benefit formula B) A unit benefit formula C) A discretionary formula D) A flat percentage of earnings formula Because this formula considers both compensation and years of service, the defined benefit plan is using a unit benefit formula. This type of formula is frequently used to reward continued service with the same employer. Which of these is CORRECT about how the performance of a given variable will impact the employer costs and thus the contribution to a defined benefit plan? A) Life expectancy and plan costs have an inverse relationship. B) If the average age of new employees increases, plan contributions will decrease. C) If worker turnover is greater than the plan assumes, contributions will increase. D) If mortality is greater than expected, the employer contribution will decrease. Mortality is the rate at which people pass away. If the actual mortality rate is higher than expected, plan contributions will decrease. Life expectancy and defined benefit plan contributions move in the same directions. If people live longer, the plan costs more. If new workers are older than the plan assumptions, then contributions must increase because there is less time to fund the plan. Higher turnover would mean higher reallocated forfeitures and thus lower costs. Also, people leaving an employer means their future benefits do not need to be funded. Ross, age 75, works for Financial Strategies, Inc. The company has a long-established retirement plan. The plan does not require an actuary or Pension Benefit Guaranty Corporation (PBGC) insurance, but the employer is required to make annual mandatory contributions to each employee's account. What type of retirement plan was established by Financial Strategies? A) Nonqualified deferred compensation plan B) Cash balance pension plan C) Traditional defined benefit pension plan D) Money purchase pension plan A money purchase pension plan requires annual mandatory employer contributions to each employee's account, does not require an actuary, and does not require PBGC insurance. The other choices are incorrect: - A cash balance pension plan requires an actuary and PBGC insurance (LO 2.2.1). - Nonqualified deferred compensation plans are not required to be established for each employee's account. They are for selected, highly paid executives. - A traditional defined benefit pension plan requires the services of an actuary annually as well as PBGC insurance (LO 2.1.1). Under which of the following circumstances is a target benefit plan the most appropriate choice for small-business owners? I. To simplify and reduce the cost of eliminating a defined benefit plan (without termination) by amending it into a target plan II. Where the employer wants to provide larger retirement benefits for key employees who are significantly older than the other employees III. To meet the employer's goal of maximizing deductible contributions to provide benefits for older, highly compensated employees IV. Where the employer is opposed to assuming the investment risk and prefers the simplicity of a separate account plan A) II, III, and IV B) I, II, and IV C) II and IV D) I and III Statements II and IV are correct for the following reasons. Target benefit plans have benefit formulas similar to those of defined benefit plans, which favor employees who are significantly older and higher paid than the average employee of the employee group. Because target benefit plans use separate accounts, the participants bear the risk of the plan's investment performance. Statement I is incorrect because amending a defined benefit plan into a target plan will result in termination of the defined benefit plan. Statement III is not true since a DC plan is limited to 25%, and a DB plan is not limited by a set percentage. Therefore, the DB plan will usually provide a greater tax deduction if an age-weighted plan works best. The key word to Statement III is "maximizing." The Acme Corporation has six owners, ranging in age from 30 to 60 years old, and 25 rank-and-file employees. The owners want to adopt a qualified retirement plan that will allow them to maximize the contributions to the owners' accounts and to minimize the contributions to the accounts of the rank-and- file employees. Which of the following plans would best meet the owners' needs? A) New comparability plan B) Section 401(k) plan C) Age-based profit-sharing plan D) Keogh plan A new comparability plan would allow the owners to divide the participants into two classes based on their compensation levels, and to allocate different contribution levels to the classes. An age-based profit-sharing plan wouldn't meet their objectives because the owners' ages are significantly different. Section 401(k) plans are subject to discrimination testing, and a Keogh plan is inappropriate because the owners are not self-employed. A Section 401(k) plan allows plan participants the opportunity to defer taxation on a portion of regular salary or bonuses simply by electing to have such amounts contributed to the plan instead of receiving them in cash. Which of these statements are rules that apply to Section 401(k) plans? I. Section 401(k) elective deferrals are immediately 100% vested and cannot be forfeited. II. A Section 401(k) plan may allow in-service distributions. III. Eligible catch-up contributions are not considered in the application of the maximum annual additions limit. IV. The maximum elective deferral contribution for 2023 is $22,500, with an additional $7,500 catch-up for individuals age 50 or older. A) II, III, and IV B) I, III, and IV C) I, II, III, and IV D) I, II, and III Which one of the following would NOT be an acceptable course of action for a 401(k) plan that has failed the actual deferral percentage (ADP) test? A) A corrective distribution of a portion of the eligible nonhighly compensated employees' deferrals B) A qualified nonelective contribution for all eligible nonhighly compensated employees C) A qualified matching contribution for all eligible nonhighly compensation employees D) A corrective distribution to the eligible highly compensated employees The ADP test fails when too much is being saved or contributed on behalf of highly compensated employees. In order to bring the plan into compliance it would be necessary to make a corrective distribution to a portion of the highly compensated employee deferrals, not the nonhighly compensated employee deferrals. The other three options are stated correctly. Tina is a participant in her company's employee stock ownership plan (ESOP). The company transfers 1,000 shares of employer stock at $5 per share to her account. Several years later, when the stock is $11 per share, Tina retires at age 61. If she elects to receive the stock in a lump sum at retirement and later sells the stock for $12,000, what are the tax consequences to Tina? A) Tina will have a capital gain of $1,000. B) Tina will have ordinary income of $12,000 when she sells the stock. C) Tina will be taxed on $11,000 of ordinary income when she receives the stock at retirement. D) Tina will have a capital gain of $7,000. Because of the net unrealized appreciation rule, at distribution, Tina will be taxed only on $5,000, the original cost of the stock when it was contributed to the plan. Tina was taxed on the $5,000 basis in the stock when she received her distribution. Therefore, her capital gain will be $7,000 if she sells the stock for $12,000.