Tools & Techniques of Life Insurance Planning

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 B: Employee Benefit Planning

Cash Compensation

Chapter 33: Severance Pay Plan

True/False

33.1 Severance agreements can be negotiated individually with executives.

33.2 Unfunded severance pay plans assets can be accessed by creditors

33.3 If a severance pay plan is structured as a parachute, the employer deduction is limited and the employee is subject to penalty.

Answers:

33.1 True [p. 281] 33.2 True [p. 281] 33.3 True [p. 282]

Multiple Choice

33.4 In absence of a written severance pay plan, which of the following might the IRS deem is a severance pay payment?

a. a large gift b. a dividend c. a “buy out” payment for the employee’s interest in the business d. all of the above e. only b and c

Answer: D [p. 281]

33.5 In general, the tax consequences of a severance pay plan are similar to a. a profit sharing plan b. an IRA c. a defined benefit plan d. a nonqualified deferred compensation plan e. a cash balance plan

Answer: D [p. 282]

33.6 Department of Labor regulations state that a severance pay plan will not be considered a ‘pension plan’ under ERISA if

a. payments do not depend on retirement b. total payments are less than two times the employee’s compensation for the year before terminating employment c. all payments are complete 24 months after employee reaches the latter of reaching normal retirement age or terminates employment d. all of the above e. only a and c

Answer: D [p. 282]

Application

33.7 Tanya Lawry is laid off on December 29, 2008. The severance pay plan at her employer, Bigg Industries, is unfunded. Tanya is entitled to an immediate severance benefit of $3,500. Tanya asks her employer to pay the severance benefit on January 2, 2009.

a. Tanya can defer taxation with no penalty b. Tanya cannot defer the entire amount to next tax year, but must report up to 50% of her severance benefit in 2008 c. Tanya can defer taxation to 2009, but must pay a 10% penalty to do so d. If Tanya takes the $3,500 in substantially equal payments over 2009, she can avoid any penalties for deferring taxation e. Tanya must report the severance benefit as income in 2008

Answer: E [p. 282]

33.8 Pierre Baste’s employer Bigg Corp. was bought out by Mega Corp. As a result of the merger, Pierre’s position was eliminated. When Pierre was hired by Bigg Corp, Bigg Corp had a severance pay plan fund set up for Pierre or others in similar positions that creditors could access. Severance payments were taxable to Pierre:

a. in the year constructively received b. in the year actually received c. when Pierre was hired d. only a or b e. only a or c

Answer: D [p. 281] 33.9 Mike Newton negotiated a severance pay plan with Biscotte, Inc., his employer, to delay payment of this year’s $5,000 holiday bonus pay until he retires 2 years from now. Biscotte has set aside the funds to pay Mike in a welfare benefit trust. Which of the following is (are) true for Mike?

a. Biscotte, Inc. is not subject to ERISA reporting requirements for Mikes severance pay plan b. Mike must pay the income tax on the $5,000 this year c. If Mike does not have a written agreement with Biscotte, the IRS could aruge that the $5,000 is for something other than compensation d. a and b e. a and c

Answer: E [p. 282]

33.10 Tom Harris, a 57 year old executive with Ace Broadcasting Company, has a severance pay plan that gives him a severance benefit of two year’s salary payable over a five year period. When Tom severs employment with Ace or anytime thereafter, he can choose to accelerate the payments. Which of the following is true?

a. tax on the severance pay plan is due the year that Tom and Ace sign the severance agreement b. Tom will include the payments in his taxable income as they are received c. Tom’s severance pay benefits are tax free d. Tom must report the entire amount as income when the first payment is received even though he may receive the payments over a longer period of time e. Ace Broadcasting must meet ERISA reporting requirements for Tom’s severance pay plan

Answer: D [p. 282]