(CRPS) Practice Exam 1: Questions with In-Depth
Solutions
Which one of the following applies to defined benefit pension plans? Right
Ans - =A) They provide a predetermined, fixed retirement benefit for
participating employees.
B) They are not subject to the annual additions limit for contributions made
on behalf of participants.
C) They allow for a specified contribution to be made by the company, the
employee, or both.
D) They are a type of nonqualified retirement plan available to certain
employees.
Explanation
Defined benefit pension plans provide a specific, fixed retirement benefit for
participating employees when they attain the normal retirement age specified
by the plan. An employer's contribution to a defined benefit plan is actuarially
determined; the amount is not specified by a formula found in the plan
document. Defined contribution plans, not defined benefit plans, are subject to
the annual additions limit made on behalf of participants. Defined benefit
plans are subject to an annual benefit cap, but not a contribution cap. Defined
benefit plans are qualified plans, not nonqualified plans.
LO 4-4
Identify the factor(s) that can affect retirement benefits in a defined
contribution plan.
I. The ratio of the participant's age to years of service multiplied by the annual
contribution to the individual account
II. The actual investment return experienced in the individual account
III. The interest rate assumption used by the plan administrator
IV. The value of the participant's individual account balance at the time of
retirement Right Ans - A) I and III
B) II only
=C) II and IV
D) I, II, and IV
Explanation
The retirement benefit available from a defined contribution plan is largely
determined by the amount contributed to the participant's account and the
investment performance of the plan assets. A participant's benefit is not
,guaranteed by the plan sponsor; the retirement benefit amounts to whatever
is in the employee's account at the retirement date.
LO 2-1
Which of the following allocations would be permitted in a qualified profit
sharing plan?
I. Investment earnings allocated in proportion to relative account balances
II. Investment earnings allocated in proportion to relative compensation
III. Employer contributions to the profit sharing plan allocated in proportion
to relative compensation
IV. Employer contributions to the profit sharing plan allocated in proportion
to relative account balances Right Ans - A) II and IV
B) I, II, and IV
C) II and III
=D) I and III
Explanation
As a defined contribution plan, a profit sharing plan is an individual account
plan; individual account plans allocate investment earnings in proportion to
each participant's account balance. Employer contributions, on the other
hand, generally are allocated based on relative compensation.
LO 2-2
Which of the following statements accurately describe limits that apply to
defined contribution plans?
I. The employer contribution to a profit sharing plan is limited to 25% of
covered payroll.
II. The employer's contributions to all defined contribution plans is a
combined limit of 25% of covered payroll.
III. "Annual additions" are limited to the lesser of 25% of the participant's
compensation or $58,000 (for 2021).
IV. "Annual additions" are aggregated and limited to the lesser of 100% of the
participant's compensation or $58,000 (for 2021) for all defined contribution
plans of the employer or related employers. Right Ans - A) II and IV
B) III and IV
C) I and III
=D) I, II, and IV
Explanation
The annual additions limit for 2021 (the lesser of 100%-not 25%-of pay or
$58,000) applies to the additions to a participant's account in all types of
,defined contribution plans. The employer deduction limit is a separate limit:
25% for profit sharing plans, money purchase plans, target plans, and multiple
defined contribution plans. The annual additions limit for a participant in
multiple defined contribution plans of the employer or related employers
must also be aggregated.
LO 2-1
Worthy Tools Inc. is designing a defined contribution plan for eligible
employees. Employee turnover at Worthy Tools Inc. is high; the rank-and-file
employees' average tenure is 20 months. Although occasionally a non-key
employee stays at the company for over two years, none has ever completed
more than 2.5 years of service. Management would prefer to minimize the
benefits available to rank-and-file employees.
Based on the above information, which one of the following vesting schedules
would be the most appropriate for the Worthy Tools retirement plan?
Right Ans - =A) 3-year cliff
B) 3- to 7-year graded
C) 5-year cliff
D) 2- to 6-year graded
Explanation
The only vesting schedules available to a defined contribution plan are 3-year
cliff and 2- to 6-year graded; 3-year cliff would be the best choice for
minimizing benefits to rank-and-file employees, who have historically stayed
a maximum of two years with the company.
LO 6-2
Brad Elberly has been the sole owner and operator of Woodmasters Inc. for
the past 15 years. Brad is age 45, and his salary from the business is $130,000.
Brad and his wife, Laura, want to retire when Brad is age 65. Relevant
information regarding the business is summarized below:
- Financial performance fluctuated over the first 10 years.
- Cash flow and profits have stabilized during the past five years and are
expected to show modest but consistent growth in the future. Excess cash
flow of approximately $150,000 is expected to be available this year. Future
years should be about the same. Brad has expressed some concern about the
company's outdated equipment and is considering renovating the plant and
replacing the outdated equipment over the next five years. The total cost
should be about $300,000.
, - Total compensation for all employees (including Brad) is $200,000.
- The four full-time rank-and-file employees r Right Ans - A) II and III
=B) I and III
C) II and IV
D) I and IV
Explanation
Because the plan admits all ERISA-eligible employees, relevant percentages
for the coverage and participation tests will be 100%; the plan will pass the
ratio percentage test (70% is required). Since the lesser of 50 participants or
40% of the ERISA-eligible employees is two and because three (100%)
actually participate, a defined benefit plan passes the 50/40 test. The 50/40
test does not apply to defined contribution plans.
LO 6-2
Brad Elberly has been the sole owner and operator of Woodmasters Inc. for
the past 15 years. Brad is age 45, and his salary from the business is $130,000.
Brad and his wife, Laura, want to retire when Brad is age 65. Relevant
information regarding the business is summarized below:
- Financial performance fluctuated over the first 10 years.
- Cash flow and profits have stabilized during the past five years and are
expected to show modest but consistent growth in the future. Excess cash
flow of approximately $150,000 is expected to be available this year. Future
years should be about the same. Brad has expressed some concern about the
company's outdated equipment and is considering renovating the plant and
replacing the outdated equipment over the next five years. The total cost
should be about $300,000.
- Total compensation for all employees (including Brad) is $200,000.
- The four full-time rank-and-file employees ra Right Ans - A) I and IV
B) II and IV
C) II and III
=D) I and III
Explanation
In the first year of a qualified plan that uses a compensation-based allocation
formula (as a money purchase plan does), it is possible to determine whether
the plan will be top-heavy based on the key employees' compensation as a
percentage of covered payroll. Brad's salary of $130,000 is 65% of the
$200,000 covered payroll; since this exceeds 60%, the plan is top-heavy.
Therefore, a top-heavy vesting schedule must be used. However, all top-heavy
defined contribution plans are already set at the top-heavy schedule by law. A
Solutions
Which one of the following applies to defined benefit pension plans? Right
Ans - =A) They provide a predetermined, fixed retirement benefit for
participating employees.
B) They are not subject to the annual additions limit for contributions made
on behalf of participants.
C) They allow for a specified contribution to be made by the company, the
employee, or both.
D) They are a type of nonqualified retirement plan available to certain
employees.
Explanation
Defined benefit pension plans provide a specific, fixed retirement benefit for
participating employees when they attain the normal retirement age specified
by the plan. An employer's contribution to a defined benefit plan is actuarially
determined; the amount is not specified by a formula found in the plan
document. Defined contribution plans, not defined benefit plans, are subject to
the annual additions limit made on behalf of participants. Defined benefit
plans are subject to an annual benefit cap, but not a contribution cap. Defined
benefit plans are qualified plans, not nonqualified plans.
LO 4-4
Identify the factor(s) that can affect retirement benefits in a defined
contribution plan.
I. The ratio of the participant's age to years of service multiplied by the annual
contribution to the individual account
II. The actual investment return experienced in the individual account
III. The interest rate assumption used by the plan administrator
IV. The value of the participant's individual account balance at the time of
retirement Right Ans - A) I and III
B) II only
=C) II and IV
D) I, II, and IV
Explanation
The retirement benefit available from a defined contribution plan is largely
determined by the amount contributed to the participant's account and the
investment performance of the plan assets. A participant's benefit is not
,guaranteed by the plan sponsor; the retirement benefit amounts to whatever
is in the employee's account at the retirement date.
LO 2-1
Which of the following allocations would be permitted in a qualified profit
sharing plan?
I. Investment earnings allocated in proportion to relative account balances
II. Investment earnings allocated in proportion to relative compensation
III. Employer contributions to the profit sharing plan allocated in proportion
to relative compensation
IV. Employer contributions to the profit sharing plan allocated in proportion
to relative account balances Right Ans - A) II and IV
B) I, II, and IV
C) II and III
=D) I and III
Explanation
As a defined contribution plan, a profit sharing plan is an individual account
plan; individual account plans allocate investment earnings in proportion to
each participant's account balance. Employer contributions, on the other
hand, generally are allocated based on relative compensation.
LO 2-2
Which of the following statements accurately describe limits that apply to
defined contribution plans?
I. The employer contribution to a profit sharing plan is limited to 25% of
covered payroll.
II. The employer's contributions to all defined contribution plans is a
combined limit of 25% of covered payroll.
III. "Annual additions" are limited to the lesser of 25% of the participant's
compensation or $58,000 (for 2021).
IV. "Annual additions" are aggregated and limited to the lesser of 100% of the
participant's compensation or $58,000 (for 2021) for all defined contribution
plans of the employer or related employers. Right Ans - A) II and IV
B) III and IV
C) I and III
=D) I, II, and IV
Explanation
The annual additions limit for 2021 (the lesser of 100%-not 25%-of pay or
$58,000) applies to the additions to a participant's account in all types of
,defined contribution plans. The employer deduction limit is a separate limit:
25% for profit sharing plans, money purchase plans, target plans, and multiple
defined contribution plans. The annual additions limit for a participant in
multiple defined contribution plans of the employer or related employers
must also be aggregated.
LO 2-1
Worthy Tools Inc. is designing a defined contribution plan for eligible
employees. Employee turnover at Worthy Tools Inc. is high; the rank-and-file
employees' average tenure is 20 months. Although occasionally a non-key
employee stays at the company for over two years, none has ever completed
more than 2.5 years of service. Management would prefer to minimize the
benefits available to rank-and-file employees.
Based on the above information, which one of the following vesting schedules
would be the most appropriate for the Worthy Tools retirement plan?
Right Ans - =A) 3-year cliff
B) 3- to 7-year graded
C) 5-year cliff
D) 2- to 6-year graded
Explanation
The only vesting schedules available to a defined contribution plan are 3-year
cliff and 2- to 6-year graded; 3-year cliff would be the best choice for
minimizing benefits to rank-and-file employees, who have historically stayed
a maximum of two years with the company.
LO 6-2
Brad Elberly has been the sole owner and operator of Woodmasters Inc. for
the past 15 years. Brad is age 45, and his salary from the business is $130,000.
Brad and his wife, Laura, want to retire when Brad is age 65. Relevant
information regarding the business is summarized below:
- Financial performance fluctuated over the first 10 years.
- Cash flow and profits have stabilized during the past five years and are
expected to show modest but consistent growth in the future. Excess cash
flow of approximately $150,000 is expected to be available this year. Future
years should be about the same. Brad has expressed some concern about the
company's outdated equipment and is considering renovating the plant and
replacing the outdated equipment over the next five years. The total cost
should be about $300,000.
, - Total compensation for all employees (including Brad) is $200,000.
- The four full-time rank-and-file employees r Right Ans - A) II and III
=B) I and III
C) II and IV
D) I and IV
Explanation
Because the plan admits all ERISA-eligible employees, relevant percentages
for the coverage and participation tests will be 100%; the plan will pass the
ratio percentage test (70% is required). Since the lesser of 50 participants or
40% of the ERISA-eligible employees is two and because three (100%)
actually participate, a defined benefit plan passes the 50/40 test. The 50/40
test does not apply to defined contribution plans.
LO 6-2
Brad Elberly has been the sole owner and operator of Woodmasters Inc. for
the past 15 years. Brad is age 45, and his salary from the business is $130,000.
Brad and his wife, Laura, want to retire when Brad is age 65. Relevant
information regarding the business is summarized below:
- Financial performance fluctuated over the first 10 years.
- Cash flow and profits have stabilized during the past five years and are
expected to show modest but consistent growth in the future. Excess cash
flow of approximately $150,000 is expected to be available this year. Future
years should be about the same. Brad has expressed some concern about the
company's outdated equipment and is considering renovating the plant and
replacing the outdated equipment over the next five years. The total cost
should be about $300,000.
- Total compensation for all employees (including Brad) is $200,000.
- The four full-time rank-and-file employees ra Right Ans - A) I and IV
B) II and IV
C) II and III
=D) I and III
Explanation
In the first year of a qualified plan that uses a compensation-based allocation
formula (as a money purchase plan does), it is possible to determine whether
the plan will be top-heavy based on the key employees' compensation as a
percentage of covered payroll. Brad's salary of $130,000 is 65% of the
$200,000 covered payroll; since this exceeds 60%, the plan is top-heavy.
Therefore, a top-heavy vesting schedule must be used. However, all top-heavy
defined contribution plans are already set at the top-heavy schedule by law. A
