Chapter 4 Questions
T - F 1. Employers typically provide an income-replacement ratio equal to 100 percent
of an employee’s final-average salary. [4-1]
T - F 2. If the employer desires a more rapid turnover of older employees, the plan’s
benefit formula should contain a years-of-service cap. [4-1]
T - F 3. Under a flat-percentage-of-earnings formula, the benefit relates solely to
service. [4-1]
T - F 4. To satisfy nondiscrimination rules, a plan with a flat-percentage-of-earnings
formula generally has to reduce benefits for participants with less than 25 years of
service. [4-1]
T - F 5. A plan that defines compensation as base compensation will generally satisfy
the nondiscrimination requirements even if rank-and-file employees receive overtime pay
that is not included in the definition. [4-2]
T - F 6. An important reason to account for past service is to maximize the tax-shelter
potential of the plan for long-service owner-employees and key employees. [4-2]
T - F 7. A participant who receives a life annuity benefit of $2,000 a month beginning at
age 65 has received a more valuable benefit than the participant who receives a life
annuity of $2,000 a month beginning at age 62. [4-2]
T - F 8. Candidates for a defined-benefit plan typically have the objective of instituting a
plan that has predictable costs. [4-2]
T - F 9. Candidates for a defined-benefit plan indicate that the desire to provide an
adequate standard of living in retirement outweighs the need to have an easily
communicated and administratively convenient plan. [4-2]
T - F 10. A cash-balance plan is a form of defined-contribution plan. [4-3]
T - F 11. The first generation of cash-balance plans started as traditional defined-benefit
plans that were converted into cash-balance plans. [4-3]
T - F 12. In a cash-balance plan, participants are credited with a promised rate of return,
not the plan’s actual investment experience. [4-3]
T - F 13. Assuming that a cash-balance plan and a money-purchase plan each have a
contribution credit of 5 percent of compensation, participants are likely to accumulate a
larger benefit in a cash-balance plan over a long period of time than in the money-
purchase pension plan. [4-3]
T - F 14. The Pension Protection Act of 2006 prohibited employers from adopting new
cash-balance plans. [4-3]
T - F 15. In a money-purchase plan, annual contributions are required and are based on
the plan’s stated contribution formula. [4-4]
T - F 16. One major drawback to a money-purchase plan is that participants are not
protected if inflation spirals just before retirement age. [4-4]
T - F 17. Money-purchase plan candidates typically focus on the objectives of instituting
a plan that has predictable costs and that is easily communicated to employees. [4-4]
T - F 18. A target-benefit plan is a form of defined-contribution plan. [4-5]
T - F 19. Under a target-benefit plan, the employer bears the investment risk and
receives the benefit of the investment return. [4-5]
T - F 20. Under a target-benefit plan, the employer guarantees that the employee’s
benefit will be the target amount or greater. [4-5]
T - F 21. Target-benefit plans were first designed to best serve young, highly paid
professionals who were trying to maximize benefits. [4-5]
T - F 22. Interest in target-benefit plans has waned because today’s employers can meet
the same objectives with an age-weighted or cross-tested profit-sharing plan that has the
advantage of allowing discretionary contributions. [4-5]
Chapter 5 Questions
T - F 1. A profit-sharing plan can be set up to provide for discretionary employer
contributions. [5-1]
T - F 2. Employers can set a cap on the amount of profits that will be contributed to a
profit-sharing plan. [5-1]
T - F 3. Profit-sharing plans can be designed to allow employees to withdraw funds
from participant accounts as early as 2 years after they were contributed by the employer.
[5-1]
T - F 4. If a profit-sharing plan is used, the organization’s deduction for contributions to
the plan is limited to 25 percent of aggregate participant payroll. [5-1]
T - F 5. In most profit-sharing plans, the board of directors is given the discretion
whether or not to make contributions each year. [5-1]
T - F 6. The employer must have current or accumulated profits in order to make
contributions to a profit-sharing plan. [5-1]
T - F 7. Integration with Social Security, age-weighting, and cross-testing are all
allocation approaches that can be used to skew the employer’s contribution to the older,
more highly compensated employees. [5-1]
T - F 8. A 401(k) plan with an employer matching contribution creates a retirement
planning partnership between the employer and employee. [5-2]
T - F 9. Under a 401(k) plan, an employee may make salary reduction contributions of
up to $49,000. [5-2]
T - F 10. An IRA is a better tax-advantaged savings option than a 401(k) plan for most
employees. [5-2]
T - F 11. In addition to salary deferrals, an employer can make both matching
contributions and profit-sharing contributions to a 401(k) plan or neither contribution to
the plan. [5-2]
T - F 12. Employer-matching contributions can be fixed or can be made on a
discretionary basis. [5-2]
T - F 13. Employee salary deferral contributions to a 401(k) plan are always 100 percent
vested. [5-2]
T - F 14. Withdrawals can be made from a 401(k) salary deferral account after
participants have been in the plan for 2 years. [5-2]
T - F 15. Under the safe harbor rules, a financial hardship is said to occur if the
employee has to pay college tuition. [5-2]
T - F 16. In 2008 and 2009, Sally owns 6 percent of the employer’s stock and earns
$65,000. Sally will be considered a highly compensated employee for purposes of the
actual deferral percentage test for 2009. [5-2]
T - F 17. A popular use of the 401(k) plan is to include it as one of the benefits available
under a cafeteria plan. [5-2]
T - F 18. Salary reductions made under a 401(k) plan will reduce the amount of Social
Security taxes that are owed. [5-2]
T - F 19. If a 401(k) plan has a Roth feature, participants may request that company
matching contributions be made on an after-tax basis. [5-2]
T - F 20. Stock bonus plans and ESOPs are defined-contribution-type plans. [5-3]
T - F 21. One of the advantages of receiving a distribution in stock from a stock bonus
plan or an ESOP is that the unrealized appreciation is not taxed until the stock is sold. [5-
3]
T - F 22. Under the technique known as leveraging, the employer borrows funds from
the participants’ ESOP account to pay future contributions to the plan. [5-3]
T - F 23. It is prudent for a corporation with an ESOP to buy life insurance on the lives
of its key employees so the ESOP can buy back stock from the key employees’ estates.
[5-3]
T - F 24. A candidate for an ESOP is similar to a candidate for a profit-sharing plan
except that a candidate for an ESOP would like to create a market for employer stock
and/or leverage the purchase of employer stock. [5-3]
Chapter 6 Questions
T - F 1. A simplified employee pension (SEP) plan is a retirement plan that uses an
individual retirement account or an individual retirement annuity as the receptacle for
contributions. [6-1]
T - F 2. Employers are allowed to discriminate in a SEP with regard to contributions
that can be made to highly compensated employees. [6-1]
T - F 3. A SEP is a popular plan design choice for large corporations. [6-1]
T - F 4. All amounts contributed to a SEP are immediately 100 percent vested in the
participant. [6-1]
T - F 5. Today, employers can establish a salary reduction SEP. [6-1]
T - F 6. A SEP cannot contain a loan provision. [6-1]
T - F 7. A candidate that has a large number of part-time employees should choose a
SEP because it can be designed to exclude part-time employees. [6-1]
T - F 8. A SIMPLE can allow participants to borrow from the plan. [6-2]
T - F 9. An employer can sponsor both a SIMPLE and a money-purchase pension plan.
[6-2]
T - F 10. The employer can make both the 3 percent matching contribution and the 2
percent non-elective contribution to the SIMPLE. [6-2]
T - F 11. The employer who has few rank-and-file employees interested in participating
in the plan and a modest contribution budget should consider the SIMPLE over the
401(k) plan. [6-2]
T - F 12. All those who receive payment for services from a qualified tax-exempt
organization or public school are considered eligible employees for purposes of making
contributions to the organization’s 403(b) plan. [6-3]
T - F 13. A 403(b) plan can only be funded with an annuity contract or a mutual fund.
[6-3]
T - F 14. Salary deferral contributions to a 403(b) plan must be fully vested at all times.
[6-3]
T - F 15. Full-time employees willing to defer $200 or more generally have to be
eligible to make salary deferrals under a 403(b). [6-3]
T - F 16. A 403(b) plan that contains employer contributions must satisfy ERISA
requirements and meet coverage and nondiscrimination requirements that apply to
qualified plans. [6-3]
T - F 17. A 403(b) plan cannot be designed to permit participant loans. [6-3]
T - F 18. The same salary deferral dollar limit that applies to 401(k) plans applies to
403(b) plans as well. [6-3]
T - F 19. If an employee participates in a 401(k) plan or a SEP, the salary reduction
contributions under those plans are aggregated with 403(b) deferrals when applying the
salary deferral limit to the 403(b) plan. [6-3]
T - F 20. Similar to 401(k) plan, a 403(b) plan can allow for a Roth election and provide
for automatic enrollment. [6-3]
T - F 21. Regardless of whether a 403(b) plan is subject to ERISA, it must be
maintained pursuant to a written document. [6-3]
Chapter 4 Answers
1. False. Employers generally do not believe there is any need to replace 100 percent
of final-average salary because Social Security benefits, private savings, and
lower postretirement costs indicate that the same standard of living can be
maintained on less income.
2. True.
3. False.A flat-percentage-of-earnings formula relates the benefit solely to salary and
does not reflect an employee’s service. A formula that relates the benefit solely to
service is a flat-amount-per-year-of-service formula.
4. True.
5. False. This is exactly the type of situation where this definition of compensation
would be discriminatory. In this company, benefits for highly compensated
employees are based on total compensation, while some earnings are excluded for
the other employees.
6. True.
7. False. The situation is exactly the opposite. Receiving a $2,000 life annuity
beginning at age 62 is more valuable than having the $2,000 benefit begin at age
65 because the benefit payments will be made for a longer period.
8. False. Defined-benefit plan candidates typically do not have predictable costs
because funding is subject to an annual actuarial determination.
9. True.
10. False. Cash-balance plans are a form of defined-benefit plan. This concept is
important because even though the plan looks like a defined-contribution plan, it
is subject to the rules that affect defined-benefit plans, including coverage under
the PBGC insurance program.
11. True.
12. True.
13. False. The accumulation in a money-purchase plan over a long-period of time is
likely to be greater since the participants share in the plan’s actual investment
experience. Cash-balance plans typically promise a conservative bond oriented
type return, while money purchase assets are more likely to be invested in a long-
term stock-oriented portfolio. The accumulation in the cash-balance plan is,
however, more predictable.
14. False. The Pension Protection Act eliminated much of the uncertainty that
surrounded cash-balance plans.
15. True.
16. True.
17. True.
18. True.
19. False.Under a target-benefit plan, the employee bears the investment risk and gets
the benefit of the investment return, just like any other defined-contribution plan.
20. False. An employer hopes to provide the targeted benefit at retirement, but there
are no guarantees that the targeted benefit will be paid.
21. False. Target-benefit plans were designed for older owner-employees looking to
direct a large percentage of the total contribution toward the business owner(s).
22. True.
Chapter 5 Answers
1. True.
2. True.
3. True.
4. True.
5. True.
6. False. The employer does not need to have profits in order to make contributions
to a profit-sharing plan.
7. True.
8. True.
9. False. The maximum salary reduction that can be taken under a 401(k) plan is
$16,500 (as indexed for 2009). The limit described in the question applies in total
to all types of contributions to the 401(k) plan, including salary deferrals,
employer-matching contributions, profit-sharing-type contributions, and after-tax
contributions.
10. False. The maximum amount that can be saved on a pretax basis in a 401(k) plan
is$16,500 (for 2009 while the maximum deductible contribution to an IRA is only
$5,000). As we will see in chapter 17, many individuals are not allowed to make
deductible IRA contributions at all. Because of this, the 401(k) plan is almost
always a better pretax savings vehicle.
11. True.
12. True.
13. True.
14. False. Withdrawals from a 401(k) plan are restricted to retirement, death,
disability, separation from service, attainment of age 59½, or financial hardship.
The general 2-year distribution rule for plans that fall into the profit-sharing
category does not apply to 401(k) plans.
15. True.
16. True.
17. True.
18. False. Social Security FICA taxes are based on the employee’s unreduced salary
regardless of whether a salary reduction is taken.
19. False. A participant may not make a Roth (after-tax) election on employer
matching (or profit-sharing) contributions.
20. True.
21. True.
22. False. Under the technique known as leveraging, the plan trustee acquires a loan
from the bank and uses the borrowed funds to purchase employer stock. Shares of
this purchased stock are allocated to participant accounts when contributions are
made to the plan. The employer is entitled to a deduction when contributions are
made, as is the case for contributions to any qualified plan. Concurrently, the
money that would normally be used to make contributions is used to pay off the
bank loan. The result is that the employer receives the full proceeds of the bank
loan immediately and pays the loan off through tax-deductible contributions to the
ESOP.
23. True.
24. True.
Chapter 6 Answers
1. True.
2. False. Even though a simplified employee pension plan is not a qualified plan,
some of the rules that apply to qualified plans apply to SEPs, including the rule
regarding nondiscriminatory contributions.
3. False. Large corporations usually do not choose SEPs because of the rigid
coverage requirements.
4. True.
5. False. New salary reduction SEPs cannot be established after December 31, 1996.
However, old plans can continue under the old rules.
6. True.
7. False. A part-time employee with $550 (as indexed in 2009) or more in earnings
with 3 years of service must be covered under a simplified employee pension
plan.
8. False. SIMPLEs are funded with IRAs. Like SEPs, such plans cannot provide for
participant loans. Other IRA rules apply as well, such as immediate vesting and
no investments in life insurance or collectibles.
9. False. What makes the SIMPLE different from all other types of retirement plans
is that a sponsor cannot maintain any other type of tax-advantaged plan at the
same time that it sponsors the SIMPLE.
10. False. The contribution requirements for the SIMPLE are quite rigid. The
employer can make either the 3 percent matching contribution or the 2 percent
nonelective contribution, but not both.
11. True.
12. False. Full-time and part-time employees of a qualified employer will be eligible
employees if they are so-called common-law employees. However, if they are
independent contractors instead of common-law employees, they cannot be
covered by the organization’s 403(b) plan.
13. True.
14. True.
15. True.
16. True.
17. False. A 403(b) plan can be designed to permit participant loans.
18. True.
19. True.
20. True.
21. True.
