Question

To prevent a qualified plan from being used primarily as a tax shelter for highly compensated employees and executives, the Tax Code imposes a limitation on which of the following?

I. Plan benefits
II. Plan contributions

A) I only
B) II only
C) Neither I nor II
D) Both I and II

Answer 1

The Tax Code places restrictions on both plan benefits and plan contributions to ensure that qualified plans serve the wider workforce rather than primarily benefiting highly compensated individuals.

Step-by-step explanation:

The Tax Code imposes limitations on both plan benefits and plan contributions to prevent qualified plans from being used predominantly as tax shelters by highly compensated employees and executives.

Step-by-step explanation:

Qualified retirement plans, such as 401(k)s and defined benefit plans, offer tax advantages to encourage saving for retirement. However, to ensure these plans do not disproportionately benefit highly compensated employees (HCEs) at the expense of other workers, the Internal Revenue Code (IRC) sets forth non-discrimination rules. These requirements include annual testing to compare contributions and benefits of HCEs to those of non-highly compensated employees (NHCEs).

Regarding plan contributions, the IRC requires adherence to specific contribution limits, which are periodically adjusted for inflation. Similarly, plan benefits must also conform to certain caps. If a qualified plan is deemed to be top-heavy or fails non-discrimination tests, it must take corrective action to maintain its qualified status, which may include refunding contributions to HCEs or increasing contributions to NHCEs.