TOOLS & TECHNIQUES OF EMPLOYEE BENEFIT AND RETIREMENT PLANNING
11th Edition
College Course Materials
Deanna L. Sharpe, Ph.D., CFP®, CRPC®, CRPS®
Associate Professor
CFP® Program Director
Personal Financial Planning Department
University of Missouri-Columbia
Please Note: Correct answers for each question are indicated in bold type. After each question,
the number of the page containing information relevant to answering the question is given. When
a calculation is necessary or the reasoning behind a given answer may be unclear, a brief
rationale for the correct answer is also given.
Part A: Retirement Planning
Defined Contribution Plans
Chapter 21: Cross-Tested/Age-Weighted Plan
True/False
21.1
A target plan is a pension plan that uses an age-weighted contribution formula.
21.2
A cross-tested plan uses a fixed age-weighted formula. The plan is designed to maximize
benefits for a firm’s highly compensated employees while providing whatever is necessary
for remaining employees to satisfy nondiscrimination regulations
21.3
A self-employed person can adopt an age-weighted or cross-tested plan.
Answers:
21.1 true [p. 187]
21.2 false [p. 187]
21.3 true [p. 191]
Multiple Choice
21.4
Advantages of an age-weighted plan include each of the following except:
a. can maximize retirement benefits of employees who enter the plan at older ages
b. can replace a defined benefit plan and give approximately the same benefit to most
employees
c. due to their predetermined structure, an age weighted plan is exempt from
nondiscrimination rules
d. provides tax deferral while account investment grows
e. plan can favor owner and key employees
Answer: C [p. 188]
21.5
Annual additions to an age-weighted plan include
a.
b.
c.
d.
e.
employer contributions to participants’ accounts
employee contributions to own account
forfeitures from other accounts
all of the above
only a and b
Answer: D [p. 190]
21.6
Disadvantages of cross-tested plans include:
a.
b.
c.
d.
e.
hire of new employees can upset the age distribution in the plan
discourages hire of older employees
complex rules
all of the above
only a and b
Answer: D [p. 188]
Application
21.7
Sentenal Corp., a restaurant supply company, is a closely held business. Tom Brady,
founder and owner of the business is 59. Jeff Alcorn, age 53, is a key employee. The
business employs 10 other rank and file employees earning an average of $30,000 per
year. Both Tom and Jeff would like to contribute between $30,000 and $40,000 per year to
a qualified retirement account. The advantages of using a profit sharing, age-weighted plan
at Sentenal rather than a defined benefit plan include:
a.
b.
c.
d.
e.
the age-weighted plan is simpler to install
the age-weighted plan is less expensive to administer
the age-weighted plan allows more flexibility in plan contributions
all of the above
only a and b
Answer: D [pp. 187-88 – Age-weighted plans are simple to install and inexpensive to use. If an
age-weighted plan is a profit sharing plan, the employer is not committed to any funding formula
and may not fund the plan during some years, whereas a defined benefit plan must be funded
each year in an amount that will meet contractual obligations.]
21.8
The law firm of Willie, Cheatum, and Howe is structured as a professional corporation that
has three key employees between age 39 and 43, two law clerks in their late 20s, and two
secretaries, both age 31. The three key employees earn $500,000 per year. The law
clerks are paid $30,000 and the secretaries are paid $15,000 annually. Turnover for both
the law clerks and secretaries has been rather high, with at least one law clerk and one
secretary leaving about every 6 months for the past year. Characteristics of the firm that
would make a cross-tested plan a less than optimal solution for the firm include:
a. the plan would have to be reconsidered at each new hire
b. the plan would provide relatively few advantages given the age of the highly
compensated group
c. having more than one highly compensated employee makes coverage tests related to
the plan more difficult to apply
d. all of the above
e. only b and c
Answer: D [p. 189]
21.9
Tom Smyth owns a business that sponsors a cross-tested defined benefit plan, but he
wants to adopt an simpler alternative that would still allow a current tax deduction and be
easier to explain, design, and administer. Tom’s best alternative, given his concerns, would
be
a.
b.
c.
d.
e.
another defined benefit plan
a money purchase plan
a nonqualified deferred compensation plan
an individual retirement savings plan
a target benefit plan
Answer: B [p. 191 – a defined benefit plan is complex to design and administer; tax deductions are
deferred for nonqualified plans; an individual retirement plan does not provide a business
deduction; target plans are difficult to explain]
21.10 Ocatagon Industries has an age weighted profit sharing plan that uses a fixed ageweighted formula for allocating employer contributions. The plan covers 50 employees.
The owner and 2 key employees are highly compensated, each earning $500,000 per
year. Average pay for the rank and file employees is $35,000 per year. This year, the
company allocated $1,000 to each employee’s retirement account. The tax implications of
such an allocation include which of the following:
a. because the plan is top-heavy, Ocatagon cannot receive a tax deduction until an
employee withdraws funds from his or her retirement account
b. participant does not pay income tax on employer contributions and earnings until the
plan participant withdraws the funds
c. plan distributions for hardship withdrawals made to employees before age 59 1/2 are
tax free
e. a and c
Answer: B [p. 190]