©2015, College for Financial Planning, all rights reserved.

Session 5Fundamentals of Defined Contribution Plans

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMRetirement Planning & Employee Benefits

Session DetailsModule 3Chapter(s)

1

LOs 3-1 Describe the basic characteristics of defined contribution plans.

3-2 Describe the basic characteristics of money purchase plans.

3-3 Describe the basic characteristics of target benefit plans.

3-4 Describe the basic characteristics of profit sharing plans

5-2

Qualified & Nonqualified Plans

Qualified Plans Nonqualified Plans

Pension Plans

Profit Sharing Plans (DC)

Tax-Advantaged Plans

Other Nonqualified Plans

Defined Benefit (DB)

Profit Sharing Traditional IRA Section 457 Plans

Cash Balance (DB) Thrift Plan Roth IRA Stock Bonus SIMPLE IRA ISO

Money Purchase (DC)

ESOP (LESOP) SEP ESPP

Target Benefit (DC) Age-Weighted (SARSEP) NQSOCross-Tested (Comparability)401(k) Plan 403(b) (TSA) Deferred

Compensation Plans

SIMPLE 401(k) 5-3

Profit Sharing & Pension Plans

Qualified Plans

Profit Sharing Plans Pension Plans

Defined Benefit

Plans

Cash Balance Plans

Money Purchase

Plans

Age-weighted MP Plans or Target

Plans

5-4

Annual Addition Limits• Annual additions are comprised of

o employer contributionso employee contributionso forfeitures

• IRC Section 415(c) limit on “annual additions” is the lesser of o 100% of compensation, or o $53,000 (2015)

5-5

Contribution Limits• Employer deduction

limit: 25% of payroll (does not include employee deferral amounts)

• Combined employee and employer contribution limit: $53,000 (2015) or 100% of compensation

• Maximum includible compensation: $265,000 (2015)

5-6

Pension Plans & Profit Sharing Plans

Pension Plans Profit Sharing

Mandatory funding?

Yes No

Employer stock limitation?

Yes, no more than 10%

No, up to 100% can be in employer stock

Survivor annuities?

Yes No

In-service withdrawals allowed?

No, unless age 62 or older if plan allows

Yes, after two years if the plan allows

5-7

Participant

Employer

Advantages

No fixed annual contribution required may motivate employees if based on profits

Younger participants benefit from many years of tax-deferred contributions, compounding earnings, and forfeiture reallocations

Disadvantages

Plan may benefit younger participants when the goal is to benefit older owner

Employer is not required to contribute annually

Profit Sharing PlansBasic Provisions• 25% employer deduction limit• Employer contributions usually are discretionary, but

must be “substantial and recurring”• Forfeitures usually are reallocated to remaining

participants’ accounts

5-8

Defined Contribution Retirement Benefits

Type of Plan

Limits on Employer Contribution

Limits on EmployeeDeferrals

Allocation of Employer’sContributions

AdministrativeCosts/Burden

Target Benefit

25% deduction limit—subject to minimum funding standard

Not available

Age weighted Actuary first year

MoneyPurchase

25% deduction limit—subject to minimum funding standard

Not available

Fixed contributions,can be integratedwith Social Security

Relatively low

Profit Sharing

25% deduction limit

401(k)—(indexed)$18,000 plus catch-up if eligible

Plan formula may use salary or service; canbe age weighted or include integrationwith Social Security

Relatively low —employercontributions must be “substantial and recurring,” but employer has flexibility with annualcontributions 5-9

Practice Problem 1Match each item in the left-hand column

with the appropriate item in the right-hand columnCharacteristics of Employer

Contributions Retirement PlansA.Mandatory, uniform percentage of

pay _____Profit sharing plan

B.Mandatory, age-weighted allocation _____Cross-testedC.Cashless _____Money purchase

planD.Requires a gateway contribution _____Stock bonus planE. “Substantial and recurring” _____Target benefit plan

5-10

Question 2Which one of the following is not a characteristic of a target benefit plan?a. The retirement benefit is not certain;

investment risk is borne by the participant.

b. Annual additions are limited to the lesser of 100% of compensation or $53,000 in 2015.

c. Forfeitures may be applied to reduce the employer’s contribution, or they may be reallocated to remaining participants.

d. The plan requires annual actuarial determination.

5-11

Question 3Which of the following plans are subject to a 25% limit on deductible employer contributions? I. money purchase plans II. profit sharing plans III.target benefit plans IV.tandem (paired) plans

a. I and IV only b. II and III only c. I, III, and IV only d. I, II, III, and IV

5-12

Question 4Which of the following statements are correct descriptions of qualified plans?I. A target benefit plan is basically an age-

weighted money purchase plan.II. A target benefit plan is a defined benefit

plan.III. A money purchase plan is a pension plan.IV. A profit sharing plan is a flexible

contribution plan.a. I and IV onlyb. II and IV onlyc. I, III, and IV onlyd. II, III, and IV only

5-13

Question 5Which of the following are characteristics of an age-weighted profit sharing plan?I. An age-weighted allocation formula permits contributions

to favor older employees rather than younger employees because the younger employees have more time to accumulate contributions and earnings in their accounts.

II. An age-weighted allocation formula permits contributions to individual accounts to exceed the Section 415 limitations.

III. If an age-weighted plan becomes top heavy, the vesting schedule would be limited to either a three-year cliff or six-year graded schedule; the plan also must provide a minimum contribution of 3% of pay to non-key employees.

IV. An employer that uses an age-weighted allocation formula becomes subject to the minimum funding standards.a. I and III onlyb. II and III onlyc. I, II, and III onlyd. I, III, and IV only 5-14

Question 6Which one of the following objectives for establishing a profit sharing plan would be best met through use of an age-weighted profit sharing plan?a. using the plan to motivate all

employeesb. believing that it is more important to

motivate employees than it is to retain them

c. maximizing contributions for older employees

d. seeking to provide rank-and-file employees with a solid basis for retirement income

5-15

©2015, College for Financial Planning, all rights reserved.

Session 5End of Slides

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMRetirement Planning & Employee Benefits