Key factors affecting plan selection for businesses

Matching a plan to an owner's goals: cash flow stability, employee demographics, desired owner contribution, administrative cost, integration with Social Security, and whether the owner wants to maximise their own deferral or reward employees. Items recommend a plan for a described business.

Retirement plan selection

Practice question for this objective

Free sampleRetirement Savings and Income Planninghard

Marisol is 56 and the sole owner of a consultancy with three employees aged between 26 and 31. Her net earnings from the business run at about 600,000 dollars a year and have been stable for a decade, and she intends to retire at 65. She tells her planner she wants to shelter at least 150,000 dollars a year of her own money on a deductible basis, that she accepts the cost of contributing meaningfully for her staff, and that she can commit to a required annual funding obligation. Assume the defined contribution annual additions limit is 72,000 dollars and that a participant aged 50 or over may add a further 8,000 dollar catch-up deferral. Which plan design meets her stated objective?

AAdopt a defined benefit or cash balance plan alongside a profit-sharing 401(k), because the required contribution is set actuarially from the promised benefit, her age and the nine years left to fund it Correct
BAdopt a one-participant 401(k), because it accepts an elective deferral, a catch-up deferral and an employer contribution without any separate coverage obligation to the three employees
CAdopt a simplified employee pension funded at 25 per cent of compensation, because that percentage applied to her earnings lifts her own allocation above the 150,000 dollar figure she wants
DAdopt a SIMPLE plan with a three per cent matching contribution, because the match keeps the cost of the three employees low while her own deferral shelters the amount she has asked for

A defined benefit or cash balance plan sets contributions actuarially, so an older owner can deduct far more than the defined contribution annual additions limit allows. Every defined contribution design, whether a profit-sharing plan, a 401(k) or a simplified employee pension, is bounded by the annual additions limit, which is 72,000 dollars here and 80,000 dollars once her catch-up deferral is added. That is short of the 150,000 dollars she has asked for, so no contribution formula inside a defined contribution plan can reach her target. A defined benefit or cash balance plan works from the other end: the plan promises a benefit at retirement, and an actuary calculates the contribution needed to fund that promise. Because Marisol is 56 with only nine years of funding left, the annual contribution required is large, and it rises rather than falls with her age. The price of that capacity is the required annual funding obligation and the actuarial cost, both of which the stem says she accepts, together with contributions for the three younger employees.

Why A is correct: A pension promise funded over only nine years for a participant of her age produces an actuarially determined contribution that can run well above 150,000 dollars, which no defined contribution design can reach.

Why B is wrong: A one-participant plan is only available to a business with no eligible common law employees, and she has three, so the plan would immediately fail coverage as well as capping her at 80,000 dollars.

Why C is wrong: A simplified employee pension is a defined contribution arrangement, so her allocation is capped at the 72,000 dollar annual additions limit however large the percentage looks, and it accepts no catch-up deferral.

Why D is wrong: The staff cost reasoning is sound but the deferral limit in a SIMPLE plan is a fraction of 150,000 dollars, and a sponsor of a SIMPLE plan may not maintain another qualified plan for the same year.

See more CFP practice questions, answers explained.

Exam traps in Retirement Savings and Income Planning

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

Add a discretionary matching contribution on a two-to-six-year graded vesting schedule, in the expectation that the match will lift deferral rates among the non-highly compensated group
Why it is wrong: Encouraging deferrals may raise the tested percentage over time but it is a behavioural hope rather than a rule, the plan stays subject to the test every year, and a discretionary graded match earns no exemption.
Terminate the 401(k) and adopt a SEP individual retirement account funded at a uniform percentage of pay for all 40 employees
Why it is wrong: A SEP avoids deferral testing by having no deferrals at all, so Owen loses the elective contribution he wants to preserve, and funding a uniform percentage across a 40 person payroll is far more expensive than a 3 percent commitment.
A one-participant 401(k), which she can fund generously in a strong year and skip entirely in a weak one
Why it is wrong: The flexibility described is real, but a one-participant plan is available only to a business with no eligible common law employees, and Nadia has six labourers, at least two of whom already meet a normal service condition.

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