Competency 13 Section 1

Question 1

1. In most defined-benefit plans, the amount paid in the form of a qualified joint and survivor annuity is actuarially equivalent to the standard form of payment, which is a life annuity

Answer 1

True. (LO 13-1-1) 13.2 1c c. The joint-and-survivor form of payment is the actuarial equivalent of the standard form of payment

Question 2

2. Very few defined-benefit plans offer a lump sum option, and if they do most participants elect an annuity form of payment

Answer 2

False. Most defined-benefit plans today offer lump sum options,

and when a lump sum is available

most participants elect this form of payment. (LO 13-1-1) 13.2 1e

Question 3

3. As long as the participant’s accrued benefit does not change, the value of the lump sum equivalent will not change over time.

Answer 3

False.

To satisfy Code Sec. 417 when market interest rates change, the lump sum value will generally change as well. (LO 13-1-1) 13.2 1g (1) (2) f. The lump sum is based on the actuarial factors stated in the plan but note that Code Sec. 417 provides overriding interest rates for determining the minimum lump-sum value. g. Lump-sum amounts change as interest rates change over time. (1) Lower interest rates result in higher lump-sum values. (2) Higher interest rates result in lower lump-sum values

Question 4

4. A defined-benefit plan sponsored by a large employer is more likely to offer a subsidized early retirement provision than a small employer.

Answer 4

True. (LO 13-1-1) 13.2 j (1)(2)(3) j. Early retirement provisions (1) Typically, with smaller plans there is an actuarial reduction for a longer payment period. (2) Larger employers will often subsidize early retirement benefits. (3) Eligibility for early retirement may require both an age and service provision

Question 5

5. Even though a cash balance plan is technically a defined-benefit plan, the benefit structure looks more like a defined-contribution plan.

Answer 5

True. (LO 13-1-1) 13.3 2 a. b. 2. Cash balance arrangements a. These operate under law as defined-benefit plans—subject to all the same rules. b.

From the participant’s perspective it looks like a defined-contribution plan as the benefit is stated as an account balance

Question 6

6. A participant in a defined-contribution plan may choose to elect an annuity form of payment directly from the plan because of institutional pricing that may be available.

Answer 6

True. (LO 13-1-1) 13.3 b. b. May see better annuity pricing inside the plan because of institutional pricing

Question 7

7. Benefits accrue more evenly over time in a defined-benefit plan than in a defined-contribution plan.

Answer 7

False. Because the defined-benefit formula multiplies years of service by final average salary, increases in both salary and service supercharge the participant’s benefit at the end of his or her career. A defined-contribution has a more even accrual as contributions each year are tied to that year’s salary only.(LO 13-1-1) 13.4 b.(1)(2)

Question 8

8. A defined-benefit participant who changes jobs at age 60 going to a company with a defined-contribution plan is likely to have lower total benefits than if he or she stayed with the original employer.

Answer 8

True. (LO 13-1-1) 13.4 b.(1)(2) b. What benefits can be lost with a late career change? (1) Since fewer employers today have defined-benefit plans, changing jobs a few years from retirement could really have a negative effect on an individual’s benefits if the individual goes from an employer with a defined-benefit plan to one with a defined-contribution plan. (2) The employee loses those last few supercharged years in the defined-benefit plan and moves to a plan that has contributions that are more ratable

Question 9

A plan that bases average compensation as the three highest years of compensation in the final five years of employment may cause concern for the older worker looking to reduce hours in exchange for lower pay.

Answer 9

True. (LO 13-1-1) 13.4 e. (3) (a)(b) (3) Sometimes average compensation is limited to the final years of employment. (a) For example, the average of the final 5 years of compensation or the highest 3 out of the final 5 years of average compensation. (b) This can be a problem for the older worker who wants to cut back on hours or take on a job with less stress or fewer responsibilities

Question 10

10.A married participant in a defined-benefit plan that elects a lump sum distribution instead of a joint and survivor annuity will need a plan to ensure that a surviving spouse has sufficient income

Answer 10

True. (LO 13-1-1) 13.5 i (1) thru (5)i. Should a participant’s spouse waive his/her rights to the qualified joint-and-survivor annuity? (1) Qualified retirement plans are required to pay out benefits to married participants in the form of a qualified joint-and-survivor annuity unless both the participant and the spouse waive this form of benefit. (2) The plan must give the participant and spouse a required notice explaining this rule. (3) Part of the distribution option decision making involves this issue 4) Since most elect a lump sum, these rights are routinely waived—but it’s not clear that couples understand the implications of this decision. (5) Planning Point: Explaining the rules to clients is an opportunity to discuss two critical retirement income issues—the role of guaranteed income and the importance of planning for income for a joint lifetime.

Question 11

11.The best way to increase benefits in a defined-contribution plan is to increase wages in the final year of participation.

Answer 11

False. Since this only affects the current year’s contribution it will not have that much impact on the final benefit. In an account plan, investment experience is the most important factor in the value of a late-career participant. (LO 13-1-1) 13.7 e. (1) e. What factors have the most impact on increasing benefits near retirement? (1) With account plans, investment experience has the single most important impact on benefits late in one’s career, when account balances are at their highest

Defined Contribution = Year by Year Contribution

Question 12

13.Because of perceived abuses, the IRS and Department of Labor are looking for ways to eliminate annuity options in defined-contribution plans.

Answer 12

False. Both the IRS and the DOL have been studying lifetime income options and a recent regulatory package makes it easier to offer lifetime income options in defined-contribution plans. (LO 13-1-2)

Question 13

12.Cash balance benefits are more predictable than a defined-contribution plan.

Answer 13

True. (LO 13-1-1)

Question 14

14.Recent proposed regulations give defined-benefit plans guidance on how to allow participants to partially annuitize their benefit.

Answer 14

True. (LO 13-1-2) 13.8 6.b.(5)

Question 15

15.IRS guidance clarifies that employees can use 401(k) savings to purchase deferred annuities and still satisfy the spousal protection rules that apply to qualified plans with minimal administrative burdens.

Answer 15

True. (LO 13-1-2) 13.9 2.c.(2)

Question 16

16.IRS proposed regulations make it simpler for defined-benefit pension plans to offer partial annuitization—that is a combination of a lifetime annuity and a single-sum cash payment.

Answer 16

True. (LO 13-1-2) 13.10 9 2. d

Question 17

17.The problem with offering longevity insurance in a tax-advantaged retirement plan has been the limits of the required minimum distribution (RMD) rules.

Answer 17

True. (LO 13-1-2) 13.10 3. a.

Question 18

18.To qualify as a qualified longevity annuity contract (QLAC), the benefit must begin by age 85 and benefits can only be paid as a single life annuity with no refund feature.

Answer 18

False. The age restriction is correct, but a QLAC can pay out benefits as a joint and survivor benefit as well. The other allowable death benefit is a return-of-premium benefit payable to heirs as a lump sum. (LO 13-1-2) 13.11 e. f.(2)

Question 19

1. Cyrus is a participant in his company’s defined-benefit plan. The benefit formula provides for a life annuity beginning at age 65 in the amount of 1 percent of final average compensation multiplied by years of service. Cyrus is married and attains age 65 with 35 years of service and $5,000 of final average compensation. What is Cyrus’s monthly benefit under the formula? (LO 13-1-1)

A. $1,000

B. $1,750

C. $3,500

D. $5,000

Answer 19

1. The answer is B. The calculation is 1% x $5,000 x 35.

Question 20

2. Sally, age 64, is planning to retire in one year. Her company has a cash balance plan that has a contribution credit of 7 percent of total compensation plus a 4 percent interest credit and the participant’s benefit is the accumulated hypothetical account balance. Which of the following statements concerning her benefit is correct? (LO 13-1-1)

A. Sally will have to take the distribution in a form of lump sum.

B. If the S&P 500 index increases by 25 percent this year, her benefit is likely to increase by 25 percent.

C. If Sally cuts back her hours and lowers her compensation this year, it could affect the contribution credits for previous years of service.

D. If Sally elects a life annuity, it will be the actuarial equivalent of the lump sum using the actuarial factors stated in the plan document.

Answer 20

2. The answer is D. A is incorrect as cash balance plans must offer annuity forms of payment. B is incorrect as market performance does not affect Sally’s benefit. C is incorrect as a change in the current year’s compensation only affects this year’s.

Question 21

3. Which of the following statements concerning recent IRS and DOL guidance on lifetime income options in tax-advantaged retirement plans is correct? (LO 13-1-2)

A. Because of perceived abuses, the IRS and Department of Labor are looking for ways to eliminate annuity options in defined contribution plans.

B. Proposed regulations give defined-benefit plans guidance on how to allow participants to partially annuitize their benefit.

C. A revenue ruling allows a defined-benefit plan participant to transfer a lump sum value of their benefit into the same company’s 401(k) plan.

D. Regulations outlaw the use of longevity insurance in 401(k) plans and IRAs.

Answer 21

3. The answer is B.

A is incorrect since both the IRS and the DOL have issued guidance that encourages lifetime income options in defined contribution plans.

C is incorrect since the guidance allows the FROM 401(k) participant to transfer a lump sum TO the defined-benefit plan and receive an additional annuity from that plan. From the 401k To the DB plan & get a annuity

D is incorrect as regulations have made it easier to purchase longevity insurance in an IRA or qualified plan.

Question 22

•How does additional work affect benefits?

–Example: 1% x 30 years x $10,000 average monthly compensation = $3,000 a month

–1% x 31 years x $10,500 =$3,255

• Early retirement?
• Effect of a late career change?
• Impact of a service cap?
• Definition of compensation, average comp?
• Working past full retirement age?

Answer 22

TRUE

Question 23

Which of the following statements concerning distributions from qualified retirement plans is correct?

A. The methodology for determining the amount that will be paid if a participant elects a life annuity is the same in a 401(k) plan as with a cash balance plan.

B. If the market goes up in both a profit-sharing plan and a cash balance plan the account balance increases proportionately.

C. Similar to a traditional defined benefit plan, if George has a big increase in salary this year his benefit is likely to increase significantly in a cash balance plan.

D. Both traditional defined benefit plans and cash balance plans are subject to the PBGC insurance program and the minimum funding requirements.

Answer 23

D

Question 24

All the following statements concerning regulatory guidance on lifetime income options in tax-advantaged retirement plans are correct EXCEPT?

A. Regulations allow the participant in an IRA to disregard a QLAC when determining required minimum distributions from the account.

B. Proposed regulations make it easier for a defined benefit plan to offer a distribution option that is a combination of an annuity and a lump sum.

C. Regulations allow IRA participants to purchase a QLAC which can be either a deferred income annuity or a deferred annuity with a GLWB.

D. An IRS Notice simplified compliance with spousal protection rules when a participant elects to invest in a deferred annuity in a 401(k) plan.

Question 25

* 2014 Final Regs allow purchase of qualifying longevity annuity contracts**(QLAC)** in **qualified defined contribution** plans and **IRAs** * Example: If a client purchases a longevity annuity with $40,000 of her $250,000 IRA balance –RMD would be computed using an account value of $210,000 **–Once payouts begin under the annuity, the payouts cannot be used to satisfy the RMD rules**

Answer 25

TRUE

Question 26

QLACs ## Footnote * Premiums cannot exceed the lesser of **$125,000 or 25%** of the account balance aggregating all accounts * Only use DIAs with **latest** start date of 85 * The annuity can only be **a single or** **joint life annuity** with a chosen beneficiary •Only other death benefit is a **return-of-premium benefit**

Answer 26

True