Insurance License - Chapter 11

Q: What are the two main categories of retirement plans?

A: Qualified plans and non-qualified plans.

Q: What is a Qualified Retirement Plan?

A: A plan that meets federal requirements and receives favorable tax treatment.

Q: How are employer contributions to a qualified plan treated for taxes?

A: They’re a deductible business expense and not taxable to the employee when contributed.

Q: When do employer contributions to a qualified plan become taxable to the employee?

A: When they’re paid out as benefits, typically at retirement.

Q: How are contributions to an individual qualified retirement plan treated under certain conditions?

A: They may be deductible from income.

Q: How are earnings within a qualified retirement plan taxed?

A: Earnings are tax-deferred until withdrawn.

Q: What is an employer retirement plan?

A: A plan a business makes available to its employees for retirement savings.

Q: Are employees taxed on contributions made by their employer to a qualified retirement plan?

A: No — they are not taxed on employer contributions when made.

Q: When are employees taxed on the earnings and contributions from a qualified retirement plan?

A: When the funds are actually paid out.

Q: Are an individual employee’s contributions to a qualified employer plan included in their ordinary income?

A: No — these contributions are not included in ordinary income and are not taxable at the time of contribution.

Q: What does ERISA stand for?

A: Employee Retirement Income Security Act of 1974.

Q: What is the primary purpose of ERISA?

A: To protect the rights of workers covered under employer-sponsored retirement plans.

Q: What standards does ERISA set for employer retirement plans?

A: Standards for participation, coverage, vesting, and fiduciary responsibilities.

Q: At what age and after how long must employees generally be allowed to enroll in a qualified retirement plan under ERISA?

A: At age 21 and after one year of service.

Q: What is the exception to the one-year service rule for plan enrollment?

A: If a plan provides 100% vesting upon participation, it may require two years of service.

Q: Which plans are exempt from ERISA regulations?

A: Church, governmental, and collectively bargained plans.

Q: What is a “top-heavy” plan under ERISA?

A: A plan where more than 60% of accrued benefits or account balances belong to key employees.

Q: What is Form 5500 used for?

A: It’s a disclosure document for employee benefit plans to satisfy annual ERISA reporting requirements.

Q: What are ERISA’s minimum vesting requirements?

A: Full vesting after five years or 20% vesting after three years with full vesting by seven years.

Q: Are employees always 100% vested in their own contributions to a retirement plan?

A: Yes — employees are always fully vested in their personal contributions.

Q: Who primarily funds a qualified defined contribution plan?

A: The employee, with optional employer matching contributions.

Q: How can employees contribute to a defined contribution plan?

A: By deferring a portion of their gross salary through pre-tax payroll deductions.

Q: Does an employer have an ongoing obligation for the performance of a defined contribution plan after funds are deposited?

A: No — the employee is responsible for investment decisions and outcomes.

Q: What are common investment options within a defined contribution plan?

A: Mutual funds, money market funds, annuities, and individual stocks.

Q: How is the money in a defined contribution plan taxed?

A: It grows tax-deferred and is taxed as ordinary income when withdrawn in retirement.

Q: What determines the final benefit amount available to a participant in a defined contribution plan?

A: Total contributions, plus accumulated interest, dividends, and investment performance.

Q: What is the IRS rule regarding contributions to defined contribution plans?

A: There’s an annual, inflation-adjusted contribution limit for employees.

Q: What are the three primary types of qualified defined contribution plans?

A: Profit-sharing plans, stock bonus plans, and money purchase plans.

Q: What is a profit-sharing plan?

A: An employer-established plan that allows employees to share in the company’s profits through contributions based on a portion of the firm’s net income.

Q: Are employers required to contribute to profit-sharing plans every year?

A: No — but to qualify for favorable tax treatment, contributions must be “recurring and substantial.”

Q: What tax penalty applies to early withdrawals from a profit-sharing plan?

A: A 10% tax penalty, plus ordinary income taxes, if withdrawn before age 59½.

Q: How is a stock bonus plan different from a profit-sharing plan?

A: Contributions in a stock bonus plan are not tied to profits, and benefits are paid in company stock.

Q: What is a money purchase plan?

A: A plan providing fixed contributions with future benefits determined by contributions and investment performance, allocated according to a specific formula.

Q: Which type of retirement plan most closely resembles a defined contribution plan?

A: A money purchase plan.

Q: What is an Employee Stock Ownership Plan (ESOP)?

A: An employee-owner program giving employees an ownership interest in the company through allocated company shares, typically held in trust until retirement or departure.

Q: What is a Qualified Defined Benefit Plan?

A: A retirement plan that guarantees eligible employees a specific future benefit, typically based on salary and years of service, determined by a formula.

Q: How does a defined benefit plan differ from a defined contribution plan?

A: A defined benefit plan promises a specific retirement benefit, while a defined contribution plan specifies contribution amounts with benefits dependent on investment performance.

Q: Who bears the investment risk in a defined benefit plan?

A: The employer.

Q: What does the term “pension” typically refer to?

A: A defined benefit plan.

Q: Give an example of a defined benefit formula.

A: 2% of the employee’s highest consecutive five-year earnings, multiplied by years of service.

Q: What must a defined benefit plan provide to qualify for federal tax purposes?

A:

1. Definitely determinable benefits by a formula or actuarial computation.

2. Systematic payment of benefits to employees over a period of years (usually for life) after retirement, detailing conditions and payment options.

Q: What is another name for a 401(k) plan?

A: A cash or deferred arrangement (salary reduction plan).

Q: How does a 401(k) plan work?

A: Employees can elect to reduce their current salary and defer amounts into a retirement plan, with the option of taking the money as current income or deferring it for tax advantages.

Q: Are employees required to participate in a 401(k) plan?

A: No, participation is voluntary.

Q: How are contributions to a 401(k) plan treated for tax purposes?

A: Contributions are made pre-tax (deductible), and earnings grow tax-deferred until distributed.

Q: Do 401(k) plans typically include employer contributions?

A: Yes, they often include matching employer contributions.

Q: Is there a limit to how much an employee can contribute to a 401(k) annually?

A: Yes, there’s an inflation-adjusted annual limit set by the IRS, with additional catch-up contributions allowed for employees age 50 or older.

Q: What is another name for a tax-sheltered annuity plan?

A: A 403(b) plan.

Q: Who is eligible to participate in a 403(b) tax-sheltered annuity plan?

A: Employees of specified non-profit charitable, educational, religious, and other 501(c)(3) organizations, including public school teachers.

Q: Are tax-sheltered annuity plans (403(b)) available to all employees?

A: No, they are only available to specific groups such as nonprofit and public education employees.

Q: How are contributions to a 403(b) plan typically made?

A: By the employer or through employee payroll deductions.

Q: How are contributions to a 403(b) plan treated for tax purposes?

A: Contributions are excluded from the employee’s current taxable income and grow tax-deferred.

Q: What type of employees are eligible for Section 457 deferred compensation plans?

A: Employees of state and local governments and non-profit organizations.

Q: Why did Congress enact Internal Revenue Code Section 457?

A: To allow participants to defer compensation without current taxation if certain conditions are met.

Q: When is deferred compensation under a Section 457 plan included in gross income?

A: When it’s actually received or made available.

Q: What are authorized investments for Section 457 deferred compensation plans?

A: Life insurance and annuities.

Q: How do the annual deferral limits for Section 457 plans compare to 401(k) plans?

A: They are similar.

Q: Why were small business owners historically excluded from participating in qualified retirement plans?

A: Because qualified plans were required to benefit employees, and business owners were considered employers.

Q: What law allowed small business owners and self-employed individuals to participate in qualified retirement plans?

A: The Self-Employed Individuals Retirement Act of 1962.

Q: How did the Self-Employed Individuals Retirement Act of 1962 change retirement plan eligibility?

A: It treated small business owners and self-employed individuals as employees, allowing them to participate in qualified plans.

Q: What retirement plan was created as a result of the Self-Employed Individuals Retirement Act?

A: The Keogh (or HR-10) retirement plan.

Q: What plan was later introduced to provide a simpler option for small employers' retirement savings?

A: The Simplified Employee Pension (SEP) plan.

Q: What type of businesses are Keogh plans designed for?

A: Unincorporated businesses and self-employed individuals.

Q: Who can participate in a Keogh plan?

A: The business owner or partner, as long as the business’s employees are included.

Q: What types of plans can a Keogh plan be established as?

A: Defined contribution plans or defined benefit plans.

Q: How have the rules for Keogh plans changed since their enactment?

A: Most unique rules have been eliminated, creating parity with qualified corporate employer retirement plans.

Q: What limits apply to Keogh plans?

A: They are subject to the same maximum contribution and benefit limits as qualified corporate plans.

Q: What compliance requirements do Keogh plans share with corporate plans?

A: They must comply with the same participation, coverage, and non-discrimination rules as qualified corporate plans.

Q: What is a Simplified Employee Pension (SEP) plan?

A: A qualified retirement plan suited for small employers that reduces administrative burdens and costs.

Q: Why were SEPs introduced in 1978?

A: To help small businesses overcome the costs, compliance, and administrative issues of traditional qualified plans.

Q: How do SEPs work for employees?

A: Employees establish and maintain an individual retirement account (IRA) to which the employer contributes.

Q: Are employer contributions to a SEP included in the employee’s gross income?

A: No, employer contributions are excluded from the employee’s gross income.

Q: How do SEPs differ from traditional IRAs in terms of contributions?

A: SEPs allow considerably higher annual contributions than traditional IRAs.

Q: What anti-discrimination rule applies to SEPs?

A: SEPs must not discriminate in favor of highly compensated employees in contributions or participation.

Q: What is a SIMPLE plan?

A: A Savings Incentive Match Plan for Employees of Small Employers that offers a simpler, lower-cost employer-sponsored retirement plan similar to 401(k) and 403(b) plans.

Q: Who is eligible to establish a SIMPLE plan?

A: Small businesses (including tax-exempt and government entities) with no more than 100 employees who earned at least $5,000 the previous year.

Q: Can an employer have a qualified plan and still establish a SIMPLE plan?

A: No, the employer must not have a qualified plan in place to establish a SIMPLE plan.

Q: How can SIMPLE plans be structured?

A: As either a SIMPLE IRA or a SIMPLE 401(k) cash or deferral arrangement.

Q: What is the vesting schedule for contributions to SIMPLE plans?

A: All contributions are non-forfeitable; employees are immediately and fully vested.

Q: How are contributions and earnings in SIMPLE plans taxed?

A: Tax-deferred until funds are withdrawn or distributed.

Q: What are catch-up contributions in SIMPLE plans?

A: Additional contributions allowed for participants aged 50 or older by the end of the plan year.

Q: What is a Roth IRA?

A: A retirement account with after-tax contributions whose earnings and future withdrawals are tax-free, created by the Taxpayer Relief Act of 1997.

Q: What is a Traditional IRA?

A: An individual retirement account allowing individuals to save for retirement with current tax deductions, where funds grow tax-deferred until withdrawn.

Q: Who can open and contribute to a Traditional IRA?

A: Anyone under age 72 with earned income, and also for a non-wage-earning spouse.

Q: What is the maximum annual contribution to a Traditional IRA?

A: $6,000 or 100% of earned income, whichever is less.

Q: What is the catch-up contribution for Traditional IRAs?

A: Individuals age 50 or older can contribute an additional $1,000, raising the limit to $7,000.

Q: When are IRA contributions tax-deductible?

A: When the individual is not covered by an employer-sponsored retirement plan, contributions are fully deductible regardless of income.

Q: How does participation in an employer-sponsored retirement plan affect IRA contribution deductibility?

A: Deductibility phases out based on income level; higher income means less deductible.

Q: Can someone contribute to a Traditional IRA even if their contributions aren’t deductible?

A: Yes, anyone under age 72 with earned income (or a non-wage-earning spouse) can contribute regardless of deductibility.

Q: What does tax-deferred growth mean in a Traditional IRA?

A: Earnings grow without tax until funds are withdrawn, usually at retirement.

Q: What is an ideal funding vehicle for an IRA?

A: A flexible premium, fixed, deferred annuity.

Q: Name some other acceptable IRA funding vehicles.

A: Bank time deposits, bank certificates of deposit, insured credit union accounts, mutual fund shares, face amount certificates, REIT units, U.S. gold and silver minted coins.

Q: When must Traditional IRA owners start taking withdrawals?

A: By April 1 following the year they reach age 72 (per the SECURE Act of 2019).

Q: What happens if a Traditional IRA owner fails to withdraw the required minimum distribution?

A: They may be subject to a 50% excise tax on the amount that should have been withdrawn.

Q: What is the penalty for withdrawing funds from a Traditional IRA before age 59 ½?

A: A 10% penalty in addition to income tax on the taxable amount withdrawn.

Q: List exceptions to the 10% early withdrawal penalty on Traditional IRAs.

A: Death or disability of owner, qualifying medical expenses, higher education expenses, first-time home purchase (up to $10,000), health insurance premiums while unemployed, correcting/reducing excess contributions.

Q: After age 59 ½, what options do IRA owners have for withdrawing funds?

A: Receive a lump-sum payment or periodic installment payments.

Q: How are Traditional IRA distributions taxed?

A: Non-deductible contributions are tax-free; interest earnings and deductible contributions are taxed.

Q: What happens to the remaining funds in an IRA if the owner dies before fully withdrawing?

A: The remaining funds are paid to the named beneficiary.

Q: What is unique about Roth IRAs compared to traditional IRAs?

A: Contributions are non-deductible (after-tax), but earnings and withdrawals are tax-free.