CFP - Retirement Savings and Income Planning (18% of the exam) - Section F.48

Qualified plan rules and options

Eligibility, coverage and nondiscrimination testing, vesting schedules, contribution and benefit limits, top-heavy rules, catch-up contributions, loans and hardship withdrawals, and ERISA fiduciary duties. Items apply the current-year limits from the provided tax tables to an employer's plan design.

ERISAInternal Revenue Code Section 415Internal Revenue Code Section 401(a)

Practice question for this objective

Free sampleRetirement Savings and Income Planninghard

Owen owns a 22-employee engineering firm that sponsors a 401(k) profit-sharing plan. The plan is not a safe harbor plan and is not top-heavy. Its document provides that employee elective deferrals are fully vested at all times, that employer matching contributions vest on a five-year cliff schedule, and that discretionary profit-sharing contributions vest on a two-to-six-year graded schedule. A compliance review flags the plan as failing to satisfy the minimum vesting standards for a qualified plan. Which correction does the plan need?

ANo change is needed, because a five-year cliff schedule remains permissible for employer matching contributions in a defined contribution plan
BChange the matching schedule to seven-year graded vesting, which is the slowest schedule permitted for employer contributions to a defined contribution plan
CMake matching contributions fully vested at the moment they are credited, since employer money in a 401(k) plan cannot be subject to a vesting schedule at all
DShorten the matching schedule so that those contributions vest no more slowly than a three-year cliff or a two-to-six-year graded schedule Correct

Employer contributions to a defined contribution plan must vest at least as fast as a three-year cliff or a two-to-six-year graded schedule. The minimum vesting standards set a ceiling on how slowly a participant may earn a non-forfeitable right to employer money. For a defined contribution plan the sponsor chooses between full vesting after three years of service with nothing before that, which is the three-year cliff, or graded vesting that reaches 20 per cent after two years and rises by 20 percentage points a year to 100 per cent after six years. A five-year cliff leaves a participant with four years of service holding nothing, which is slower than either permitted schedule, so the matching contributions fail. The profit-sharing schedule described is exactly the permitted graded schedule and needs no amendment, and elective deferrals are always immediately non-forfeitable because they are the employee's own money.

Why A is wrong: Five-year cliff vesting was once a permitted schedule for employer contributions and is still seen in defined benefit plans, but a defined contribution plan may not use it for any employer contribution, matching money included.

Why B is wrong: Seven-year graded vesting is a superseded standard for defined contribution employer money and is slower than the five-year cliff it would replace, so it would make the compliance position worse rather than better.

Why C is wrong: Immediate vesting is required of a safe harbor matching contribution and of the deferrals themselves, and this option generalises that requirement; an ordinary discretionary match may be vested over the permitted schedules.

Why D is correct: Employer contributions to a defined contribution plan must satisfy one of these two schedules, so the five-year cliff on the match is the single defect, while the graded profit-sharing schedule already complies.

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.

A SEP individual retirement account, contributing 25 percent of her 180,000 dollars of net earnings from self-employment
Why it is wrong: This is tempting because a SEP is flexible and simple, but a SEP takes no elective deferral and no catch-up, and for a sole proprietor the employer rate is 20 percent of net earnings rather than the 25 percent stated for common law employees.
A SEP arrangement, because the employer may contribute up to 25 percent of each eligible person's pay
Why it is wrong: A SEP is easy to run and generous relative to a SIMPLE, but the contribution percentage must be uniform across eligible participants and is capped by the annual additions limit, so it cannot single out an older owner.
A traditional 401(k) plan, relying on an employee education campaign to lift staff deferral rates enough to pass the annual tests
Why it is wrong: A traditional 401(k) is subject to actual deferral percentage testing, and if staff participation stays low the owners' deferrals are cut back or refunded, which is precisely the outcome Marcus has ruled out.

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