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Retirement Planning for Financial Planners

Chapter 3: Qualified Plan Overview

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Defined Benefit vs. Defined ContributionCharacteristics Defined Benefit Defined Contribution

What is the Annual Contribution Limit?

Not less than the unfunded current liability

25% of Covered Compensation

Who assumes the investment risk?

Employer Employee

How are forfeitures allocated? Reduce Plan CostsReduce plan costs or allocate

to other participants

Is the plan subject to Pension Benefit Guaranty Corporation

(PBGC) coverage?

Yes (except professional firms with less than 25

employees)No

Does the plan have separate investment

accounts?

No, they are commingled

Yes, they are usually separate

Can credit be given for prior service?

Yes No

3Pension Plans vs. Profit Sharing Plans

Characteristic Pension Plan Profit Sharing Plan

Legal Promise of the Plan

Paying a pension at retirement

Deferral of Compensation

In-Service Withdrawals?

No* Yes (after two years)

Mandatory Funding?

Yes** No

Investment in Employer Securities

10% 100%

QJSA & QPSA? Yes No

4Qualified Plans

Pension PlansProfit Sharing

Plans

Defined Benefit Pension PlansCash Balance Pension Plans

Profit Sharing PlansStock Bonus PlansESOPs401(k) Plans

Money Purchase Pension PlansTarget Benefit Pension Plans

Thrift PlansNew Comparability PlansAge-Based Profit Sharing Plans

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Advantages of Qualified Plans Taxation of Contributions to Plans

Income Tax Deferred Payroll Taxes Avoided on Employer Contributions

No avoidance for employee elective deferrals. Tax Deferral on Earnings and Income ERISA Protection

Anti-Alienation Prohibits any action that may cause the plan assets to

be assigned, garnished, levied, or subject to bankruptcy proceedings.

Protection from Employers.

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Qualification Requirements Plan Document Eligibility Coverage Vesting Special Qualification Requirements apply to:

Top-Heavy Plans Cash or Deferred Arrangements (CODAs)

Limitation on Benefits and Contributions

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Eligibility

Age 21 and one year of service (1,000 hours worked during one plan year). Special election to require two years of

service – 100% vesting requirement. Plan Entrance Date

Generally plans have two entrance dates during the year such as 1/1 and 7/1 Can’t make eligible employees wait more than

six months to enter plan Could also have quarterly or monthly entrance

dates

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Coverage (1 of 5)

Can exclude: Ineligible employees. Employees covered under a collective

bargaining agreement. Nonresident alien employees that do

not perform services in the U.S.

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Coverage (2 of 5)

Plan must be nondiscriminatory All qualified plans must pass at least ONE of the following tests:

Exhibit 3.8 on page 104

Coverage Test Required to Pass

Safe Harbor Test 70% of NHC (peons) Covered

Ratio % Test % of NHC (peons) Covered% of HC (top dogs) Covered

Average Benefits Test AB % of NHC (peons) CoveredAB % of HC (top dogs) CoveredAnd Nondiscriminatory Test

70%

70%

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Coverage (3 of 5)

Owner Employees Non-owner Employees

EitherAn owner of >5%*

Compensation in excess of $115,000 for 2014**

OrCompensation in excess of

$115,000 for 2014 **

*Anyone who owns more than 5% of a company’s stock or capital

** If elected, add “and in top 20% of employees ranked by salary”

Who is a Highly Compensated Employee (top dog)?

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Coverage (4 of 5)

5% Owner Defined Individually owned shares, plus Attribution of shares owned by:

Spouse Children Grandchildren Parents

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Coverage (5 of 5)

50/40 Test Plan must cover the lesser of: 50 employees 40% of employees

Defined Benefit Plans must additionally pass the 50/40 Test

See Exhibit 3.9 on page 105

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Vesting See Vesting Schedules, page 109. May always be more beneficial towards

employees In general for defined contribution plans:

100% for employee contributions Employer contributions:

3 year cliff or 20% in years 2 to 6

14Special Plan RequirementsTop-Heavy Plans

Top heavy: >60% account balances or accrued benefits for key employees instead of peons

Key Employee A greater than five percent owner, or A greater than one percent owner with

compensation in excess of $150,000 (not indexed), or

An officer with compensation in excess of $170,000 for 2014. Officer determined based on all facts

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Special Plan RequirementsTop-Heavy Plans Required Vesting

For plan years beginning after 2006, all qualified defined contribution plans will vest on a 3 year cliff or 2 to 6 year graduated schedule, without regard to the plan’s top-heavy status.

Funding Defined Contribution Plans

Employer must provide non-key employees with a contribution equal to at least 3% of employees compensation Except if key employee’s contribution is less

than 3%

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Special Plan RequirementsTop-Heavy Plans (3 of 3)

Defined Benefit Plans Employer must provide non-key

employees with a benefit equal to 2% per years of service (limit 20%) times employees average annual compensation.

17Plan Limitations on Benefits and Contributions

Covered Compensation $260,000 for 2014

Defined Benefit Plan Annual Benefits Lesser of

$210,000 for 2014 100% of the average of the employee’s

three highest consecutive years salary

18Plan Limitations on Benefits and Contributions (2 of 3)

Defined Contribution Plans Maximum contribution for the year

Lesser of: 100% of an employee’s compensation, or $52,000 for 2014

Limit consists of Employer Contributions, and Employee Contributions, and Any forfeitures allocated to participant’s

account

19Plan Limitations on Benefits and Contributions

Multiple Plan Limitation An employer maintains both a defined

benefit plan and a defined contribution plan If contribute less than 25% of compensation

to defined benefit plan, can contribute to defined contribution plan until combined balance is 25%