MGT 409 Quiz 2

What is ERISA and who does it protect?

Employee Retirement Income Security Act. Protects employees (benefits).

Who imposes fiduciary responsibility?

ERISA

What is the IRS and what does it do?

Internal Revenue Service, the agency in charge of collection taxes and enforcing the legislative code.

What is the DOL and what does it do?

Department of Labor, helps job seekers, wage earners and retirees. Also governs the actions of fiduciaries.

What is the PBGC and what does it do?

Pension Benefit Guaranty Corporation, they are an insurance program for defined-benefit plans.
Oversees fund solvency (Voluntary or Involuntary)

Is defined benefit a qualified tax-advantage plan?

Yes

Is SEP a qualified tax-advantage retirement plan?

No, it is not a qualified but it is tax-advantaged

Is SIMPLE a qualified tax-advantage retirement plan?

No, it is not a qualified but it is tax-advantaged

Is 403(b) a qualified tax-advantage retirement plan?

No, it is not a qualified but it is tax-advantaged

Is cash balance a qualified tax-advantage retirement plan?

Yes

Is money purchase a qualified tax-advantage retirement plan?

Yes

Is target benefit cash balance a qualified tax-advantage retirement plan?

Yes

Is profit-sharing a qualified tax-advantage retirement plan?

Yes

Is 401(k) a qualified tax-advantage retirement plan?

Yes

Is stock bonus a qualified tax-advantage retirement plan?

Yes

Is ESOP a qualified tax-advantage retirement plan?

Yes

What are the attributes of a Qualified Plan?

1. Employer deduction at contribution

2. Tax deferral on earnings and income

3. Employees pay tax on distributions

4. Distributions can be rolled into other tax-deferred vehicles

5. ERISA protection

General Requirements of All Tax Advantaged Plans

1. Plan document

2. Eligibility and coverage

3. Vesting

4. Employee communications

5. Nondiscrimination

6. Prefunded

Is Defined-benefit PP a Defined-Benefit or Defined-Contribution?

Defined-Benefit

Is cash-balance PP a Defined-Benefit or Defined-Contribution?

Defined-Benefit

Is money-purchase PP a Defined-Benefit or Defined-Contribution?

Defined-Contribution

Is target-benefit PP a Defined-Benefit or Defined-Contribution?

Defined-Contribution

Is profit sharing a Defined-Benefit or Defined-Contribution?

Defined-Contribution

Is 401(k) a Defined-Benefit or Defined-Contribution?

Defined-Contribution

Is stock bonus a Defined-Benefit or Defined-Contribution?

Defined-Contribution

Is ESOP a Defined-Benefit or Defined-Contribution?

Defined-Contribution

What are some characteristics of a defined-benefit plan?

1. Specifies benefit

2. Assets not allocated

3. Investment risk with employer

4. Pre-retirement inflation

5. Unpredictable and expensive costs

6. Not Portable but takes in past service

What are some characteristics of a defined-contribution plan?

1. Contribution/allocation

2. Individual accounts

3. Investment risk with employees

4. No inflation protection

5. Predictable costs

6. Less costly to administer

7. Portable but doesn’t take in past service

Is defined benefit Pension or Profit Sharing?

Pension

Is cash balance Pension or Profit Sharing?

Pension

Is money purchase Pension or Profit Sharing?

Pension

Is target benefit Pension or Profit Sharing?

Pension

Is Profit Sharing Pension or Profit Sharing?

Profit Sharing

Is 401(k) Pension or Profit Sharing?

Profit Sharing

Is stock bonus Pension or Profit Sharing?

Profit Sharing

Is ESOP Pension or Profit Sharing?

Profit Sharing

What are some characteristics of a Pension?

1. Required funding

2. 10% of assets in sponsors stock

3. Distribution requires termination of employment

What are some characteristics of Profit-Sharing?

1. Discretionary funding

2. 100% invested in sponsor’s stock

3. In-service withdrawals

What are the three section 410(b) coverage rules?

1. General Safe Harbor

2. Ratio Percentage

3. Average Benefits

What is the General Safe Harbor test?

The plan covers > 70% of all NHCEs

What is an HCE?

Highly Compensated Employee.

What is the Ratio Percentage test?

NHCE must be at least 70% of the HCE percentage

Is Full Vesting required in Employee Contributions?

Yes

Is Full Vesting required in a Normal Retirement Age?

Yes

Is Full Vesting required in a Plan Termination?

Yes

Is Full Vesting required in the 2-Year Eligibility Requirement?

Yes

Is Full Vesting required in 401(k) Safe Harbor Contributions?

Yes

Is Full Vesting required in case of Death?

It is common but not required

Is Full Vesting required in the case of Disability?

Common but not required

Is Full Vesting required in the case of Early Retirement?

Common but not required

Is Full Vesting required in SEPs and SIMPLEs?

Always

Is Full Vesting required in 403(b) Plans?

Extremely common but not required

What is Vesting?

Where an employee earns full ownership of employer-provided assets (such as 401(k) matches or stock options) over a set period time or after milestones are reached.

What are some Vesting requirements?

1. 1,000 hours of service

2. Measuring period can be plan year

3. Disregard

   1. Pre-age 18

   2. Pre-establishment of plan

   3. In some cases after termination and reemployment

What are some characteristics of a Defined-Benefit Pension Plan?

1. Employer assumes responsibilities

2. Better tax shelter for older owners

3. Costly

4. Difficult to communicate

5. Employer’s future costs uncertain

6. Annual employer contribution

7. No in-service withdrawals

What is the Unit-Benefit Defined-Benefit Formula?

Final Average Monthly Compensation (FAC) x Years of Service x 1.5%

Ex: 30 years x $10,000 x .015 = $4,500

What is the Flat Percentage of Earnings Defined-Benefit Formula?

40% of FAC

Ex: $10,000 x .4 = $4,000

What is the Flat Amount Per Year of Service Defined-Benefit Formula?

$50 a month x years of service

Ex: $50 × 25 years = $1,250

What is the Flat Amount Defined-Benefit Formula?

$1,500 a month

What is some characteristics of Cash Balance Pension Plan?

1. Defined-benefit

2. Mandatory funding

3. Hybrid

4. Pension benefit based on an annual guaranteed contribution rate and guaranteed earnings on the contributions

5. Quasi-seperate accounts

What are some advantages to a Cash Balance Pension Plan?

1. Larger contributions like defined-benefit

2. Benefit structure similar to defined-contribution

3. PBGC coverage for employees

What are some disadvantages to a Cash Balance Pension Plan?

1. PBGC coverage costs

2. Admin costs

3. Required contributions

What are some characteristics of a Money Purchase Pension Plan?

1. Defined-contribution

2. Mandatory annual funding of a fixed percentage of pay

3. Participant holds risk

4. Separate accounts

5. Favors younger plan entrants

What are some advantages to a Money Purchase Pension Plan?

1. Predictable benefits costs

2. More security than with discretionary profit-sharing contributions

What are some disadvantages of a Money Purchase Pension Plan?

1. Rigid annual contribution requirements

2. Prefer flexibility of profit-sharing plans

What are some characteristics of a Target-Benefit Plan?

1. Special type of money purchase pension plan

2. Determines the contribution based age

3. Participant holds risk

4. Favors old plan entrants

If actual investment experience is higher than assumptions, total benefit will ____ (exceed, fall below) the target.

Exceed

What is a profit-sharing plan?

A defined-contribution plan where employer contributions are discretionary and allocated to employees based on a chosen formula.

What is standard allocation in profit-sharing?

Contributions are allocated proportionally to employees compensation
(if company has $500,000 in payroll and you make $250,000 you’re allocation is 50%)

What is an Age-Based Profit-Sharing Plan?

A plan that weights contributions by age x compensation

Giving larger contributions to older employees because they are closer to retirement

What is a New Comparability Plan?

A profit sharing plan that allocates by employee groups (owners vs. staff).

It must pass a nondiscrimination gateway

What is a 401(k) plan?

A retirement plan where employees can make salary deferrals

Employers may add matching or profit-sharing contributions.

What contributions can employees and employers make to a 401(k)

1. Employee: Salary deferrals (pre-tax or Roth).

2. Employer: Matching contributions and optional profit-sharing.

What is employer matching in a 401(k)

The employer contributes a percentage of the employee’s salary deferral (e.g., 50% match on the first 6%).

What is the ADP test?

Actual Deferral Percentage
A nondiscrimination test ensuring HCEs don’t defer too much more than non-HCEs.

What is a participant loan in a 401(k)?

A loan that lets employees borrow from their vested 401(k) balance if the plan allows loans. Plans are not required to offer them.

How much can you borrow in a participant loan, and how do you repay it?

You can borrow the lesser of $50,000 or 50% of vested balance. Loans must be repaid within 5 years, with payments at least quarterly.

What if a participant fails to repay a loan?

The unpaid amount becomes a taxable distribution and may face penalties.

If you leave your job, the employer can require immediate repayment or treat the balance as a distribution.

What is a stock bonus plan?

A defined contribution profit-sharing plan where the employer contributes company stock.

Contributions are discretionary

Allocations must be nondiscriminatory.

What special participant rights exist in a stock bonus plan?

1. Pass-through voting rights

2. The right to demand employer stock at distribution

3. A put option to sell shares back to the employer.

4. Distributions must start within 1 year of retirement/death/disability or within 5 years after other termination.

What is an ESOP

Employee Stock Ownership Plan

A defined contribution stock bonus plan where participants receive employer stock allocations

Employers get a tax deduction for the value of stock contributed

What are core ESOP characteristics?

1. Common in small companies

2. Follow the same voting/put-option rules as stock bonus plans

3. Cannot integrate with Social Security

4. Often use like a bank loan.

If actual investment experience is lower than assumptions, total benefit will ____ (exceed, fall below) the target.

Fall Below

What are the requirements for a HCE?

1. 5% owners during the current or previous year

2. Anyone who earned $160,000 in the previous year

What are the two rules to the ADP test?

1. 125% rule

   1. : HCE average ADP ≤ 125% of NHCE ADP.

2. 200% / 2% rule

   1. HCE ADP ≤ 200% of NHCE ADP and cannot exceed NHCE ADP by more than 2%.

What is the vesting schedule for employer matching?

1. Graded (2-6 years)

2. 3-year cliff schedules.