CFP Exam Prep Cards - Section 3 - Employee Benefits Planning
Terms
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EMPLOYEE BENEFITS PLANS
Group term insurance must satisfy four requirements: -
1) provide general death benefit excudable from income
2) provided as compensation for services performed
3) policy is carried by employer
4) amount of insurance computed by formula -
EMPLOYEE BENEFITS PLANS
Group term: Expensive? Easy to administer? -
- most inexpensive form of group insurance
- easiest and least expensive to administer -
EMPLOYEE BENEFITS PLANS
Group term - insurability - evidence of insurability is not required
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EMPLOYEE BENEFITS PLANS
Group term - what if employee leaves? - terminated employee may convert the group term policy to an individual cash value policy without evidence of insurability
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EMPLOYEE BENEFITS PLANS
Group Permanent - Three different types of group permanent insurance -
1) group paid up
2) group ordinary
3) group universal life (UL) -
EMPLOYEE BENEFITS PLANS
Plans can be established as one of two types (2): -
1) Contributory Plan - employee pays some of the cost
2) Noncontributory plan - employer pays entire cost -
EMPLOYEE BENEFITS PLANS
Group Term Tax Implications (on premiums)Less than $50k coverage -
- Premiums deductible by employer
- Premiums NOT taxable to employee -
EMPLOYEE BENEFITS PLANS
Group Term Tax Implications (on premiums)More than $50k coverage -
-Premiums deductible by employer
-Premiums taxable to employer -
EMPLOYEE BENEFITS PLANS
Group Permanent Tax Implications (on premiums)
-Any face amount -
-Premiums deductible by employer (if employee has vested rights to insurance)
-Premiums taxable to employee -
EMPLOYEE BENEFITS PLANS
Group disability insurance - Income Tax IMplications (premiums and benefits) -
-Premiums deductible to employer
-Premiums paid by employer are NOT taxable to employee
-Benefits recieved by employee ARE TAXABLE if paid by employer - Cafeteria Plan
- Written plan under which employees can choose between two or more benefits consisting of two mandatory components
- What are the two mandatory components of a Cafeteria Plan?
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1) Cash - taxable as compensation
2) One or more qualified benefits - What are the qualified benefits employees can choose from in a Cafeteria Plan? (2)
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1) Medical expense benefit via individual or group (NONTAXABLE)
2) Cost of group term in excess of $50k (TAXABLE) - What is a Flexible Spending Account (FSA)?
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Type of cafeteria plan funded through salary reduction which allows them to fund certain benefits with PRE TAX dollars
-KEY PHRASE: Use it or Loose it! Employer gets the forfeiture - Taxability of Fringe Benefits:
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Taxed on Fair Market Value of certain noncash fringe benefits
Treated as compensation
Included in gross income
(Country Club Dues, Season Tickets) - What is a VEBA (Voluntary Employee Beneficiary Association)?
- Multiple-employer trust that can be used to prefund employee benefits - deposits to trust are immediatly tax deductible
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Incentive Stock Options (ISO)
Transferability? - Only the employee can exercise during his life. Can be transferred at death
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Nonqualified Stock Options (NSO)
Transferability? - Option is transferrable to family members
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EMPLOYEE STOCK OPTIONS
Vesting Schedule
Staright Vesting: - Same percentage of option become exercisable each year
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EMPLOYEE STOCK OPTIONS
Vesting Schedule
Cliff Vesting: - all at once
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EMPLOYEE STOCK OPTIONS
Vesting Schedule
Step Vesting: - varies year to year
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EMPLOYEE STOCK OPTIONS
Vesting Schedule
Performance vesting: - vested in the year the company acheives a particular goal
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EMPLOYEE STOCK OPTIONS
Vesting Schedule
Early vesting (accelerated exercise): - allowed to immedeatly exercise options when granted. For each option exercise they recieve a share of "restricted" stock subject to a holding period
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EMPLOYEE STOCK OPTIONS
Expiration on options -
-Generally employees have 10 years (or less) to exercise
-Terminated employees may have 30 to 90 days -
EMPLOYEE STOCK OPTIONS
Incentive Stock Options (ISO)
Tax Implications - Upon Grant - no income tax due
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EMPLOYEE STOCK OPTIONS
Incentive Stock Options (ISO)
Tax Implications - Upon Exercise - No income for calculating regular tax
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EMPLOYEE STOCK OPTIONS
Incentive Stock Options (ISO)
Tax Implications - Upon QUALIFYING Sale - Regular tax - LTCG difference between FMV at time of sale and exercise price
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EMPLOYEE STOCK OPTIONS
Incentive Stock Options (ISO)
What are holding period requirements for a QUALIFYING SALE? -
Shares must be held at least 1 year after the option is exercised
At least 2 years after the option grant -
EMPLOYEE STOCK OPTIONS
Incentive Stock Options (ISO)
Tax Implications
What is penalty if holding requirements are not satisfied? - Then a portion of the employee's profit is taxed as compensation and the employer is allowed a deduction for that compensation
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EMPLOYEE STOCK OPTIONS
Non-Qualified Stock Opt (NSO)
Tax Implications - Upon Grant - no income tax is due
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EMPLOYEE STOCK OPTIONS
Non-Qualified Stock Opt (NSO)
Tax Implications - Upon exercise -
employee realizes income equal to difference between grant (exercise) price and FMV at time of exercise
THIS DIFFERENCE IS CALLED THE BARGAIN ELEMENT -
EMPLOYEE STOCK OPTIONS
Non-Qualified Stock Opt (NSO)
At time of exercise what is company required to do? -
Company must withhold federal and state tax
FMV at time of exercise becomes the new cost basis -
EMPLOYEE STOCK OPTIONS
Non-Qualified Stock Opt (NSO)
Tax Implications - Upon Sale - only additional tax if selling price exceeds the share basis
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EMPLOYEE STOCK OPTIONS
Non-Qualified Stock Opt (NSO)
Tax Implications - What is an 83(b) election? - employee makes an election to include in income the FMV of the stock, less any amount paid for the stock at the time the stock is issued
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Employee Stock purchase plan (ESPPs)
What are they? -
-stock option plan under IRC section 423
-allows a company to sell stock to employees at a discount from market price -
EMPLOYEE STOCK PURCHASE PLANS
Basic provisions (4) -
1) cannot be given on discrimanatory basis
2) ONLY employee can purchase
3) Purchase can be as low as 85% of FMV
4) Max FMV of stock cannot exceed $25,000 -
EMPLOYEE STOCK PURCHASE PLANS
Tax implications for GRANT, PURCHASE and SALE: -
Grant - no inc tax
Purchase - no inc tax
Sale - Can be income or LTCG depending on holding period requirements (as for ISOs) -
STOCK OPTIONS:
Which plans can discriminate and which cannot discriminate?
ESPP, ISO, NSO? -
ESPP - nondiscriminatory
ISO / NSO - discriminatory - Phantom stock - Basic provisions
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-Employee is awarded units analogous to shares using a formula (based on comp)
- Not real stock but method of tracking (no dilution of shares)
-no recognized income to employee
-cannot specify date on which to exercise stock
-upon exercise (usually given cash not stock) taxed as ordinary income -
EMPLOYEE STOCK PLANS
Stock appreciation right (SAR) - Basic provision -
Like Phantom stock except:
-offered together with stock option
-gives employee right to appreciation in the stock after the grant date
-employee has right to decide when to exercise SAR
-taxed as ordinary income at exercise -
EMPLOYEE STOCK PLANS
Restricted Stock - Basic Provision -
-granted to employee at not cost or at a bargain price with restrictions
-can be given on discriminatory basis
-form of incentive compensation to key employees -
EMPLOYEE STOCK PLANS
Junior stock - Basic Provisions - Restricted stock that can be converted into common stock of the company but only if performance goals are reached
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NONQUALIFIED DEFERRED COMPENSATION
Rabbi Trust -
-Irrevocable trust set up by employer to set funds aside prior to retirement to pay retirement benefits in an irrevocable trust
-Trust and benefits cannot be changed even in hostile takeover
-Not protected from bankruptcy -
NONQUALIFIED DEFERRED COMPENSATION
Pure deffered compensation plan: -
-Pure deferred compensation plan
-employee agrees to defer a specified portion of compensation in exchange the employer pledges to pay a benefit in the future equal to the amount deferred and a predetermined rate of interest
-rabbi trust often used to fund pure def comp plan -
NONQUALIFIED DEFERRED COMPENSATION
Supplemental Executive Retirement Plan (SERP) -
-employee (executive) does NOT give up current dollars for later benefits
-instead company pledges to provide the benefit often above and beyond companies qualified retirement plan calculations -
NONQUALIFIED DEFERRED COMPENSATION
Secular Trust -
-irrevocable trust set up to provide nonq benefits to an employee
-employer contribs are protected from creditors, bankruptcy, insolvency, takeover, merger, etc.
-contributions are taxable to employee -
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS
Buy-Sell Agreements -
-make sure an estate can sell a business interest for a reasonable price
-contains wording that binds the owner of a business to sell their share of it at a specified price to a pre-set buyer (usually partners in the business) -
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS
Cross-Purchase agreement -
-Each owner purchases an insurance policy on the other owners
-Policy owner is also bene
-upon death of an owner his estate will sell and other owners will buy the business interest
-insurance proceeds are used to fund the agreement -
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS
Entity Agreement (also called Stock-Redemption Agreement) - -The business (not owners like Cross-Purchase) buys the insurance on the owners
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EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS
Business overhead disability plan -
-used to cover ongoing operating costs of a business while owner is disabled
-premiums are deductible and benefits are taxable -
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS
Executive/owner benefits (Executive-Bonus Life Ins) - Allows an employer to provide life insurance protection for a selected employee on a tax-deductible basis
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EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS
Split-dollar -
-allows an employer to provide life insurance for a selected employee
-The death benefit is split as follows:
(a) corporation recieves return of premium (cash surr value)
(b) beneficiary receives the net amount of risk
-employer and employee share premium -
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS
Key employee insurance -
-Insurance on a key employee (business owns and is bene of)
-Premiums NOT deductible to business
-Death bene are tax free
-Primary purpose is to:
1) protect business against loss of income
2) provide funds for locating and traning replacement