F.47.2 Defined Contribution Plans

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1 A. Professional Conduct and Regulation

A.1 Code of Ethics and Standards of Conduct A.1.1 The Six Ethical Principles A.2 Procedural Rules and Discipline A.2.1 Fitness Standards for Candidates A.3 Financial Institutions Overview A.3.1 Broker-Dealers vs. RIAs A.4 SEC and Securities Regulation A.4.1 FINRA and Broker-Dealer Regulation A.4.2 State Securities Regulation A.5 Consumer Protection Laws A.5.1 Privacy and Confidentiality Requirements A.6 Fiduciary Duty and Application

2 B. General Principles of Financial Planning

B.7 The Financial Planning Process B.7.1 Establishing the Client Relationship B.7.2 Gathering Client Data and Goals B.8 Personal Financial Statements B.8.1 Key Financial Ratios B.9 Cash Flow Management B.9.1 Emergency Fund Planning B.10 Debt Management Strategies B.10.1 Mortgage and Home Financing B.11 Economic Concepts B.11.1 Planning for Inflation B.12 Time Value of Money Concepts B.12.1 TVM Calculations and Applications B.12.2 Loan Amortization B.13 Education Needs Analysis B.14 Education Savings Vehicles B.14.1 529 Plans In-Depth B.15 Education Funding Strategies B.16 Gift/Income Tax Strategies

3 C. Risk Management and Insurance Planning

C.17 Principles of Risk and Insurance C.17.1 Risk Management Process C.18 Analysis of Risk Exposures C.19 Health Insurance Fundamentals C.19.1 Types of Health Insurance Plans C.20 Disability Income Insurance C.20.1 Disability Policy Features C.21 Long-Term Care Insurance C.22 Annuities Overview C.22.1 Fixed vs. Variable Annuities C.23 Life Insurance Fundamentals C.23.1 Types of Life Insurance C.24 Business Owner Insurance Solutions C.25 Insurance Needs Analysis C.26 Insurance Policy and Company Selection

4 D. Investment Planning

D.27 Equity Securities D.27.1 Fixed Income Securities D.27.2 Mutual Funds and ETFs D.27.3 Taxation of Investment Vehicles D.28 Systematic Risk D.28.1 Unsystematic Risk D.29 Economic and Market Cycles D.30 Measures of Risk and Return D.30.1 Investment Performance Measures D.31 Asset Allocation Strategies D.31.1 Portfolio Diversification D.32 Bond and Stock Valuation D.32.1 Stock Valuation Models D.33 Investment Policy Statement D.33.1 Modern Portfolio Theory D.34 Active vs. Passive Investing D.34.1 Common Investment Strategies D.35 Alternative Investments D.35.1 Options and Derivatives

5 E. Tax Planning

E.36 Income Tax Fundamentals E.36.1 Filing Status and Tax Brackets E.37 Types of Income E.37.1 Deductions and Credits E.37.2 Capital Gains and Losses E.38 Business Entity Taxation E.38.1 Self-Employment Tax E.39 Taxation of Trusts and Estates E.40 Tax Reduction Strategies E.40.1 Retirement Account Tax Strategies E.41 Property Transactions E.41.1 Basis Rules for Acquired Property E.42 AMT and NIIT E.42.1 Special Tax Situations E.43 Charitable Giving Strategies

6 F. Retirement Savings and Income Planning

F.44 Retirement Needs Analysis F.44.1 Sources of Retirement Income F.45 Social Security Benefits F.45.1 Social Security Claiming Strategies F.45.2 Medicare Planning F.46 Eldercare and Special Needs Planning F.47 Qualified Plan Overview F.47.1 Defined Benefit Pension Plans F.47.2 Defined Contribution Plans F.48 Eligibility and Vesting F.48.1 Coverage and Discrimination Testing F.48.2 Contribution and Benefit Limits F.48.3 401(k) Plan Features F.49 Non-Qualified Deferred Compensation F.49.1 Executive Compensation Plans F.50 Retirement Plan Selection for Businesses F.50.1 Individual Retirement Accounts F.51 Distribution Rules F.51.1 Required Minimum Distributions F.52 Retirement Income Strategies F.52.1 Tax-Efficient Withdrawal Strategies F.53 Business Succession Planning

7 G. Estate Planning

G.54 Property Titling and Beneficiary Designations G.54.1 Beneficiary Designations G.55 Strategies to Transfer Property G.55.1 Lifetime Gifting Strategies G.56 Wills and Estate Documents G.56.1 Powers of Attorney G.56.2 Advance Directives and Healthcare Documents G.57 Federal Gift Tax G.57.1 Federal Estate Tax G.57.2 Generation-Skipping Transfer Tax G.58 Sources for Estate Liquidity G.58.1 Life Insurance for Estate Liquidity G.59 Trust Fundamentals G.59.1 Revocable Living Trusts G.59.2 Irrevocable Trusts G.59.3 Trust Income Taxation G.60 Marital Deduction Planning G.60.1 QTIP Trusts G.60.2 Portability of Estate Tax Exemption G.61 Intra-family and Business Transfer Techniques G.61.1 Family Limited Partnerships G.61.2 GRATs and IDGTs G.62 Postmortem Estate Planning Techniques G.62.1 Disclaimer Planning G.62.2 Estate Tax Elections G.63 Planning for Divorce and Unmarried Couples G.63.1 Estate Planning for Unmarried Couples G.63.2 Planning for Blended Families G.64 Planning for Special Needs and Circumstances G.64.1 Special Needs Trusts G.64.2 ABLE Accounts

8 H. Psychology of Financial Planning

H.65 Client and Planner Attitudes, Values, Biases H.65.1 Money Scripts and Money Attitudes H.65.2 Planner Self-Awareness H.66 Behavioral Finance H.66.1 Cognitive Biases H.66.2 Emotional Biases H.66.3 Heuristics and Mental Accounting H.67 Sources of Money Conflict H.67.1 Couples and Money Conflict H.67.2 Family and Intergenerational Money Conflict H.68 Principles of Counseling H.68.1 Therapeutic Techniques in Financial Planning H.68.2 Professional Boundaries and Referrals H.69 General Principles of Effective Communication H.69.1 Listening and Questioning Skills H.69.2 Managing Difficult Conversations H.69.3 Non-Verbal Communication H.70 Crisis Events with Severe Consequences H.70.1 Death and Divorce H.70.2 Job Loss and Health Crisis H.70.3 Sudden Wealth and Sudden Loss H.70.4 Natural Disasters and Traumatic Events

F.47.2 Defined Contribution Plans

Key Takeaways Explain This Topic AI

DC plans define contributions, not benefits; employee bears all investment risk

2026 annual additions limit is $72,000 (or 100% of compensation if less) under IRC 415(c)

DC plan types include profit sharing, 401(k), money purchase pension, stock bonus, and ESOP

Profit sharing contributions are discretionary but must be substantial and recurring

DC plans favor younger employees who have more time for compound growth

Net Unrealized Appreciation (NUA) treatment available for lump-sum distributions of employer stock
Last updated: October 2026

Defined Contribution Plans

Defined contribution (DC) plans specify the contribution amount rather than the retirement benefit. Unlike defined benefit plans where the employer promises a specific benefit, DC plan participants receive whatever their account balance grows to be based on contributions and investment performance. The employee bears all investment risk .

Key Characteristics of DC Plans

Characteristic Defined Contribution Plan
What is Defined Contribution amount/formula
Investment Risk Employee
Account Type Separate individual accounts
Mandatory Funding Generally no (except money purchase)
Favors Younger employees
PBGC Coverage No
2026 Annual Additions Limit Lesser of $72,000 or 100% compensation
Types of Defined Contribution Plans

DC plans fall into two main categories: pension plans and profit sharing plans .

DC Pension Plans

Plan Type Funding Actuary Who Favors
Money Purchase Pension Mandatory (fixed %) No Younger employees
Target Benefit Pension Mandatory (varies) At inception only Older employees

Money Purchase Pension Plans:

Mandatory annual funding of a fixed percentage (up to 25% of covered compensation)
Rarely established after EGTRRA 2001 due to profit sharing plans achieving same limits

Target Benefit Pension Plans:

Special type of money purchase plan
Contribution determined by participant's age to achieve a target benefit
Requires actuary at inception only (not annually)
Favors older employees (unlike other DC plans)
Profit Sharing Plans

The more common type of DC plan, profit sharing plans include several variations:

Plan Type Key Feature Contributions
Profit Sharing Discretionary employer contributions Employer only
401(k) / CODA Employee salary deferrals Employee + Employer
Stock Bonus Distributions in employer stock Employer stock
ESOP Invested primarily in employer stock Employer (often leveraged)
Thrift Plan After-tax employee contributions Employee + Employer match
Profit Sharing Plans
Core Characteristics
Established and maintained by an employer
Provides for employee participation in company profits
Uses a definite predetermined formula for allocating contributions
Must be nondiscriminatory
Contribution Rules

Discretionary but Substantial and Recurring:

Employer contributions are discretionary (can vary year to year)
However, contributions must be "substantial and recurring" to maintain qualified status
No requirement for actual company profits to make contributions

Contribution Limits:

Limited to 25% of total covered compensation for employer deduction
Per-employee limit: Lesser of 100% of compensation or $72,000 (2026)
Allocation Methods

Method Description Effect
Pro-rata Equal percentage to all participants Standard allocation
Social Security Integration (Excess) Higher allocation above SS wage base Favors higher-paid
Age-Based Combines age and compensation Favors older employees
New Comparability Based on employee classification Allows discrimination by class

Key Point: Profit sharing plans can only use the excess method for Social Security integration (not the offset method).

401(k) Plans / Cash or Deferred Arrangements (CODA)

A 401(k) is a Cash or Deferred Arrangement (CODA) attached to a profit sharing or stock bonus plan.

Key Features
Most prevalent type of qualified plan established today
Predominantly funded by employee salary deferral contributions
Permits employees to defer pre-tax (or Roth) compensation to a qualified plan
Employers may match employee deferrals (not required)
2026 Contribution Limits

Contribution Type 2026 Limit
Employee Deferral $24,500
Age 50+ Catch-up $8,000
Ages 60-63 Super Catch-up $11,250
Total Annual Additions (415(c)) $72,000
Eligibility and Vesting
Cannot use 2-year eligibility rule (unlike other qualified plans)
Must use standard age 21 and 1 year of service
Employee deferrals are 100% vested immediately

Employer contributions vest under standard schedules:

2-6 year graded, or
3-year cliff
ADP/ACP Testing

401(k) plans must pass discrimination testing:

ADP Test (Actual Deferral Percentage): Limits HC elective deferrals based on NHC deferrals
ACP Test (Actual Contribution Percentage): Tests employer matching and after-tax contributions

Safe Harbor 401(k) Plans avoid ADP/ACP testing by providing either:

3% non-elective contribution to all eligible employees, OR
Matching: 100% on first 3% + 50% on next 2% of deferrals

CFP Exam Tip: Safe harbor employer contributions must be 100% vested immediately .

2026 Annual Additions Limit (IRC 415(c))

The maximum annual additions to a participant's DC account for 2026:

Lesser of:

$72,000 , or
100% of the participant's compensation

Annual additions include:

Employer contributions
Employee deferrals (pre-tax and Roth)
Forfeitures allocated to the participant's account

NOT included:

Catch-up contributions (age 50+)
Rollover contributions

Component Included in 415(c)?

Employer contributions Yes
Employee deferrals Yes
Forfeitures Yes
Age 50+ catch-up No
Rollovers No
Stock Bonus Plans

Stock bonus plans are profit sharing plans where employer stock is the primary investment:

Key Features
Contributions can be made in cash or employer stock
Distributions typically made in employer stock
Employer receives tax deduction for FMV of stock contributed (cashless tax deduction)
Contributions are discretionary but must be substantial and recurring
Can invest 100% in employer securities (unlike pension plans limited to 10%)
Net Unrealized Appreciation (NUA)

A significant tax benefit available for lump-sum distributions of employer securities:

How NUA Works:

Employee takes a lump-sum, in-kind distribution of employer stock

At distribution:

Ordinary income = Value at date employer contributed the stock (cost basis)
10% early withdrawal penalty applies only to the cost basis (if applicable)
NUA is NOT taxed at distribution

When stock is sold:

NUA = Long-term capital gain (regardless of holding period)
Additional appreciation after distribution = capital gain (ST or LT based on holding period)

NUA Calculation:

Component Tax Treatment
FMV at Distribution Not fully taxed at distribution
Less: Employer's Cost Basis Ordinary income at distribution
= Net Unrealized Appreciation LTCG when stock is sold
Post-distribution appreciation Capital gain based on holding period

Example: Stock with $30,000 cost basis distributed when worth $100,000, later sold for $120,000:

Ordinary income at distribution: $30,000
LTCG (NUA) at sale: $70,000
Additional gain (ST or LT): $20,000

CFP Exam Note: NUA treatment is lost if stock is rolled to an IRA instead of taking the lump-sum distribution.

Employee Stock Ownership Plans (ESOP)

An ESOP is a special type of stock bonus plan with unique features:

Key Characteristics
Established as a trust that holds employer stock
Can be leveraged (ESOP borrows to buy employer stock)
Employer can deduct principal and interest on ESOP loans
Dividends paid on ESOP stock are tax-deductible to employer
Cannot use Social Security integration for allocations
ESOP Voting Rights

Company Type Voting Rights
Publicly Traded Full voting rights on all matters
Privately Held Vote only on major corporate decisions (mergers, acquisitions, liquidation, etc.)
ESOP Distributions
Participant can demand distribution in employer securities
Put option: Employee can require employer to repurchase stock at FMV
Substantially equal periodic payments allowed (5-10 year period for large accounts)
Lump-sum distribution qualifies for NUA treatment
ESOP Diversification

Qualified participants (age 55+ with 10 years participation) during their 6-year qualified election period may diversify:

Years 1-5: Up to 25% of post-1986 employer stock
Year 6: Up to 50% of post-1986 employer stock
DC Plans: Who They Favor

Defined contribution plans generally favor younger employees because:

Younger employees have more years for compound growth
Same dollar contribution grows much larger over 30+ years vs. 10 years
No credit for prior service (unlike DB plans)
Investment gains benefit the individual account holder

Exception: Target benefit pension plans favor older employees because contributions are calculated to achieve a specific benefit at retirement, requiring larger contributions for older participants.

Plan Type Favors
Profit Sharing Younger employees
401(k) Younger employees
Stock Bonus Younger employees
ESOP Younger employees
Money Purchase Younger employees
Target Benefit Older employees
Forfeitures in DC Plans

When employees leave before fully vesting, their non-vested employer contributions are forfeited:

Forfeiture Uses:

Reduce employer contributions , OR
Reallocate to remaining participants

Contrast with DB Plans: In defined benefit plans, forfeitures can ONLY reduce plan costs, not be allocated to other participants.

Comparison: DB vs. DC Plans

Feature Defined Benefit Defined Contribution
What's Defined Benefit Contribution
Investment Risk Employer Employee
2026 Limit $290,000 benefit $72,000 additions
Account Type Commingled (accrued benefits) Separate individual accounts
Favors Older employees (except cash balance) Younger employees (except target benefit)
PBGC Yes (with exceptions) No
Mandatory Funding Yes No (except pension plans)
Actuary Required Yes No (except target benefit at inception)
Prior Service Credit Yes No
QJSA/QPSA Yes No (unless plan distributes annuities)
Investment in ER Securities Limited to 10% Up to 100%