CFP Retirement Planning - Lesson #3 - Administration of Qualified Plans

approaches to divide QDRO benefits

(1) *shared payment approach* - splits the actual benefit payments made between the participant and the alternate payee (2) *separate interest approach* - divides the participant's retirement benefits into 2 separate portions

death after beginning RMDs (death prior to 12/31/2019)

-if participant dies after beginning to take distributions, the calculation uses the designated beneficiary's life expectancy factor as determined on the last day of the year following the participant's death -if there is more than one beneficiary, the participant with the shortest life expectancy (usually oldest) is used as measuring life - however, the plan can also be divided into a separate account for each beneficiary to calculate RMD

owner's business and personal objectives

-if the company is a small or closely held private company, these are critical -small business owners usually want to decrease their current taxes and save for their own financial future

plan freeze

-in some cases, an employer may no longer want to contribute to the plan but doesn't want to fully terminate the plan -can be accomplished by freezing the plan -for DC plans, a freeze simply means the employer will no longer make any contributions -for DB plans, participants will no longer accrue additional benefits but the plan sponsor must maintain the previously accrued benefits

timing for RMDs

first distribution must be taken by April 1 of year after participant turns 72 -for each year thereafter, must be taken by Dec 31 (2 required in first year after)

excess annual addition

happens when more money is contributed to a defined contribution plan than is allowed -a plan can correct if the excess was caused by a reasonable error in estimating a participant's compensation, determining elective deferrals permitted, or because of forfeitures allocated to participant's accounts 3 methods

death before RMD no beneficiary

if no beneficiary is named by Dec 31 of year following owner's death (or if beneficiary is estate or charity), the account must be fully distributed before the end of the 5th year following year of death

making appropriate contributions minimum funding requirement

in general, sponsors of money purchase pension plans, cash balance pension plans, and defined benefit pension plans must contribute enough money into the plan to satisfy the minimum funding requirements as determined by an actuary for the year

qualified plans distribution options

lump sum, rollover, single life annuity, joint life annuity

involuntary termination

may be initiated by the PBGC for a plan that is unable to pay benefits from the plan in order to limit the amount of exposure to the PBGC

indirect rollover

occurs through a distribution to the participant in the amount of the full account balance reduced by the 20% mandatory withholding -in order to complete the rollover, the participant must reinvest the full original account balance of the qualified plan (including 20% withholding) within 60 days of distribution - you will then receive the tax withholding back on your tax return

early termination distribution

participant has 3 options if termination before retirement: (1) lump sum distribution (2) rollover to IRA/qualified plan (3) leave funds in pension plan if vested balance is <$5k may have forced payout -DOL requires that forced payouts between $1-$5k be directly rolled to an IRA if participant has not made a timely election

payment requirement for 72(t) distribution

payment calculated under one of the methods must continue exactly as calculated for the later of 5 years from the date of first payment or the participant attaining 59 1/2 -if payments change in any way, participant is considered to have made distribution equal to full account balance of qualified plan in the first year

qualified plan admin

qualified plans require ongoing administration and maintenance

minimum distribution rules

require that individuals begin taking RMDs at age 72 -if funds are not distributed by required date, 50% excise tax is levied on the participant -penalty is on an amount equal to the RMD less any distribution that was taken, but the result cannot be 0 -apply to qualified plans, IRAs, SEP, SIMPLE, or 457 plans -do not apply to Roth IRAs but apply to roth accounts in a 401k, 403b, 457 and inherited roth iras

section 72(t) distributions

substantially equal periodic payments that must be made at least annually or for the life/life expectancy of the participant or joint lives of participant and beneficiary -payments must be begin after separation of service and be made in one of 3 ways: (1) *RMD Method* payments are calculated in the same manner as RMD rules. Payments are recalculated annually (2) *Fixed Amortization Method* Payment is calculated over the participant's life expectancy if single or joint life if married and the interest rate is reasonable. This method creates a series of installment payments that remain the same in subsequent years (3) *Fixed Annuitization Method*participant takes distributions of the account over their life expectancy as determined by dividing account balance by an annuity factor using a reasonable interest rate and mortality table - payment doesn't change in future years

Master or Prototype Plans

the *majority* of qualified plans follow standard forms called mater or prototype plans -these plans have been pre-approved by the IRS and are available for employers to simply adopt

qualified trust

the assets of a qualified plan must be placed in a qualified trust or custodial account -custodial accounts are generally maintained by a bank or other financial institution

if trust is named as beneficiary

the beneficiaries of the trust will be treated as the designated beneficiaries, provided: -the trust is valid under state law -the trust is irrevocable or will become so upon the participant's death (inter vivos trust) -the trust beneficiaries are identifiable from the trust instrument -appropriate documentation has been provided to the plan administrator

to be considered a lump sum distribution, must meet these 4 requirements:

(1) distribution must represent that employee's entire accrued benefit in the case of a pension plan or the full account balance in the case of a defined contribution plan (2) the distribution must be on account of death, age 59 1/2, separation from service (except SE), or disability (3) the employee must have participated in the plan for at least 5 taxable years prior to the tax year of distribution (waived if death) (4) the taxpayer must elect lump-sum distribution treatment by attaching Form 4972 to tax return which must be filed within one year of distribution

steps in selecting a qualified plan

(1) establish the objectives for the plan (2) prepare an employee census to identify the beneficiaries of various plans and the financial impact of alternative plans on the employer sponsor (3) identify the types of plans that can meet both the quantitative and qualitative objectives (4) assess each plan's financial characteristics (5) select plan

death before RMD date spouse beneficiary

(1) spouse cab receive distributions over the participant's single remaining life expectancy - distributions must begin the year the participant would have turned 72 (2) can roll over balance to their own IRA and wait until 72 to begin taking distributions (3) can elect to distribute entire account balance within 5 years of owner's death

4 additional ways to avoid the 10% penalty (ETMQ)

(1) the government provides an exception (E) to the 10% penalty if the distributions are dividends paid within 90 days of the plan year end from an ESOP (2) if the distribution is made to pay uncertain income (T)axes because of a tax levy on the plan, the distribution will not be subject to 10% penalty (3) no penalty if the distribution is made to the participant for certain (M)edical expenses paid during the year over 7.5% AGI (4) QDRO

10-year forward averaging

(unlikely to be tested) -a participant born before 1936 may be eligible -for this, the income tax due on a lump-sum distribution is calculated by dividing the taxable portion of the lump-sum distribution by 10 and then applying the 1986 individual income tax rate (1/10 of total taxable distribution) then multiplying by 10 to determine total tax due -benefit is that the taxpayer avoids the distribution being taxed in higher current income tax brackets -tax must be paid in year of distribution

effect on participant death for RMDs of Eligible Designated Beneficiary

*surviving spouse* -can roll assets to own IRA, if deceased spouse was under 72, can delay distribution until participant would have been 72 *child participant who has not reached age of majority* -once child reaches age of majority, they become ineligible beneficiary and must follow rules for Designated Beneficiary *disabled or chronically ill individual* *any other individual who is not more than 10 years younger than the participant* upon death of the designated eligible beneficiary, their beneficiary, their beneficiary must distribute assets within 10 years

characteristics of a disqualified person

- a fiduciary of the plan -a person providing services to the plan -an employer, any of whose employees are covered by the plan -an employee organization, any of whose members are covered by the plan -any direct or indirect owner of 50% or more of the following: --combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corp --the capital interest or profits interest of partnership --the beneficial interest of a trust or unincorporated enterprise -a member of the family of these individuals

Periodic Pension Benefit Statement

-PPA '06 made it so the administrator of a defined contribution plan is required to provide a benefit statement: --to a participant or beneficiary who has the right to direct the investment of the assets in his/her account at least quarterly --to any other participant or other beneficiary, who has his/her own account under the plan at least annually --to other participants, upon written request, but limited to one request during any 12-month period

methods to correct excess annual contributions

-allocate the excess annual additions to other plan participants -hold excess annual additions in a separate account in future years -make corrective distributions

basis for annuity payments

-amounts distributed as an annuity are taxable to the participant of a qualified plan in the year in which payments are received -each annuity pmt is considered partially return of adjusted basis and partially ordinary income -distributions that are not lump-sum and not annuity are taxed pro rata based on account balance and basis

Qualified Domestic Relations Order (QDRO)

-an exception to ERISA anti-alienation rules -an order, judgement, or decree pursuant to a state domestic relations law that creates or recognizes the right of a third party payee to receive benefits from a qualified plan -a QDRO distribution will not be considered a taxable distribution to the third party alternate payee as long as the assets are deposited into the recipient's IRA or qualified plan

Normal retirement distribution

-at participant's normal retirement age, pension plan will typically distribute benefits through an annuity payable for remainder of life -single life annuity is generally automatic form for single participant but married individuals must be offered J & S annuity -taxable as ordinary income

distributions from profit sharing plans

-at termination, the participant may be able to take distributions from a profit sharing plan as ordinary taxable income, annuitize the value of the account or rollover assets -not required to offer survivor benefits if the plan doesn't pay the participant in the form of a life annuity benefit and the participant's nonforfeitable accrued benefit is payable to spouse upon death

tax on subsequent sale of NUA securities

-at the date of the subsequent sale of the employer securities, the participant will be required to recognize the LTCG deferred since the date of distribution -any subsequent gain after the distribution date will be treated as either STCG or LTCG based on the holding period beginning at the date of distribution

examples of plans' financial characteristics

-contribution costs -cost of administration -flexibility of contributions -burden of investment risks -necessity of mandatory funding

exceptions to 10% early withdrawal penalty

-death -age 59 1/2 -disability -72(t) substantially equal periodic payments -medical expenses that exceed 7.5% of AGI -$5k per taxpayer for birth or legal adoption -QDRO -qualified public safety employee who separates from service after age 50 -attainment of age 55 and separation from service

pension plan rollover distribution

-distribution may be rolled over into a new qualified plan or IRA, provided the participant is not required to take RMDs -in certain situations, when a distribution is lump sum, the participant may receive favorable tax treatment on the distribution (NUA for employer stock), 10-year forward averaging (born before 1936), and or pre-74 capital gain treatment -these favorable tax treatments will be lost with rollover

taking deductions employer deduction

-employers can usually deduct (up to certain limits), contributions made to a qualified plan -cannot exceed 25% of eligible employee compensation -deduction for contributions to defined benefit plan must be determined by actuary -only counts employer contributions

Individually Designed Plans

-if company has specific needs that are not addressed in a master or prototype plan, or if they just choose to, they can draft their own individual plan -in order to be considered a qualified plan, the plan must be permanent and for the exclusive benefit of the employees and their beneficiaries

carryover of excess contributions

-if employer contributes more to qualified plan than the permitted deductions excess contributions can be carried over to future years -amount carried over may be subject to excise tax (in general 10% excise tax applies to nondeductible excess contributions made to qualified pensions and profit sharing plans) -10% excise tax does not apply to any contribution made for a self-employed individual to meet the minimum funding requirements in a defined benefit plan

notifying eligible employees

-info regarding the qualified plan must be distributed to employees who might be eligible and ineligible employees too -before IRS can issue determination letter, employer must provide satisfactory evidence persons have been notified -proper advance notice can be made in person, mail/email or posting a notice -employer is required to provide (free of charge) a summary of the details of the qualified plan (Summary Plan Description) -employer also required to provide notice of any plan amendments or changes -employer also must provide copy of Summary Annual Report

Determination Letters

-may be used when a plan is adopted, amended or terminated -they may be filed in advance of the plan being adopted or immediately thereafter, usually by filing form 5300 -requested by plan sponsor but not required -even if letter is requested and approved, IRS may still disqualify plan

QJSA (Qualified Joint & Survivor Annuity)

-must be provided to married participants of pension plans and profit sharing plans, unless the benefit is payable to the surviving spouse upon the participant's death -pays a benefit as long as either spouse lives - joint life benefit can be anywhere from 50-100% -the nonparticipant spouse beneficiary can choose to waive right by executing a notarized or otherwise official waiver of benefits (can be made during 90 days before annuity start date)

QPSA (Qualified Pre-Retirement Survivor Annuity)

-must generally also be provided to married participants unless the benefit is payable to the surviving spouse upon death -provides a benefit to the surviving spouse if the participant dies before attaining normal retirement age -nonparticipant spouse can choose to accept or waive this option -full value of QPSA distribution is subject to ordinary income tax

effects of RMDs on multiple qualified plans or IRAs

-must take RMDs from each qualified plan -can combine RMDs to take from IRAs

several issues with NUA transactions

-participant must qualify for lump sum distribution treatment -the NUA portion must be relatively high in comparison to the cost basis portion - otherwise, the participant may be paying too much immediate ordinary income tax for the benefit of future LTCG treatment -investment risk of holding a large concentration of a single security -cash flow considerations of holding vs selling

pre-1974 capital gain treatment

-participants born before 1936 may be eligible to receive CG tax treatment on the portion of a lump sum distribution that is attributable to pre-1974 participation in a qualified plan -CG rate is 20% for this -to calculate portion that is considered LTCG, the total lump sum distribution is multiplied by the ratio of the participant's number of pre-1974 months/total months -the portion remaining of the lump-sum distribution is eligible for 10-year forward averaginf

investing plan assets

-plan assets will either be managed by plan sponsor or individually by participants -plan sponsors are generally considered fiduciaries of plans -plan must provide at least 3 investment alternatives which must meet these criteria --be diversified --have materially different risk/return characteristics --each alternative, when combined with other alternatives, tends to minimize (through diversification) the overall risk of the participant's portfolio

amending a qualified plan

-plan changes are very common due to tax law changes, business changes, or to solve a defect in a plan -changes are often easily implemented by amending the plan document -when the plan document is amended, the administrator must also amend the Summary Plan Description

qualified plans taxation of distributions

-plan custodian is generally required to withhold 20% from most distributions made to the participant other than hardship distributions or loans (only pertains to qualified plans)

direct rollover

-plan trustee distributes the account balance directly to the trustee of the recipient account -original plan custodian is not required to withhold 20%

reasons to amend or terminate a qualified plan

-qualified plans are often changed to maximize the provision of benefits to key employees -a law change may make an entire plan obsolete -plan may be terminated when the employer finds that it can no longer financially support the plan it has in place (decision may be made by the employer or PBGC) -plan may be terminated if employer simply finds it is not meeting the needs of the employees or company

permanency requirement

-qualified plans are required to be permanent but permanency doesn't necessarily require that the plan never terminate *mainly means that the plan must nor be established in a temporary program* -goal is to dissuade owners from creating plans that will only benefit the owners and key employees and then having the plan vanish before providing benefits for the other employees -abandonment of the plan for any reason other than business necessity within the first few years after it is established will be evidence that the plan was not a bona fide program for the exclusive benefit of employees

covering eligible employees

-qualified plans require annual coverage testing to ensure that the rank and file employees (non highly compensated/nonkey) are sufficiently covered

defined contribution plan termination

-terminating is relatively easy -already funded and not subject to PBGC -all the employer must do to terminate plan is pass a corporate resolution - at that point, any final promised contributions must be completed and the assets must be distributed from the plan

possible objectives for employer plans

-to benefit owners of a small business -to benefit all employees -to benefit select employees -to attract, retain, or reward employees -to encourage early retirement -to provide a tax-advantaged benefit

examples prohibited transactions

-transfer of plan income or assets to, use of by or for the benefit of a disqualified person -self-dealing by a fiduciary -receipt of consideration by a fiduciary for his own account when working with a party dealing with the plan (ex. accountant) -selling, exchanging, leasing, buying as well as lending or borrowing between a disqualified person and the plan

Non-designated beneficiary (ex. estate, charity, some trusts)

-use owner's age as of birthday in year of death -reduce beginning life expectancy by 1 for each subsequent year -can take owner's RMD for year of death before RMD -take entire balance by 5th year following year of death

terminating a qualified plan

-when a qualified plan is terminated (assuming that sufficient funds are available) all of the participants in the plan become fully vested in their benefits

employee census

-will identify each employee, their age, compensation # of years of employment and any ownership interest -helps identify which employees will benefit (and to what extent) from using various possible types of plans -a review of employee turnover is also essential because it can help determine vesting schedules and how to deal with forfeitures from employee termination

employer must apply contribution to previous year if these conditions are met:

1- contributions are made by the due date of the tax return of the previous year (plus extensions) 2- the plan was established by the due date of the tax return (plus extensions) 3- the plan treats the contributions as though it had received them on the last day of the previous year 4- the company specifies in writing to the plan administrator or trustee that the contribution apply to the previous year or the company take a deduction for the amount of the contribution on the tax return for the previous year

special tax treatments for lump sum distributions

10 year forward averaging pre-1974 capital gains treatment NUA treatment

initial penalty on prohibited transactions

15% excise tax on the amount involved each year -no excise tax will be assessed if the transaction is corrected within 14 days of discovery -if the transaction is not corrected within taxable period, an additional tax of 100% of the amount involved is imposed

for IRAs to avoid they 10% penalty, they say HIDE ME

1st time Home purchase health Insurance Death and disability higher Education Medical expenses Equal periodic payments age

death before RMD date non spouse beneficiary

2 options (1) first distribution period option is remaining single, nonrecalculated life expectancy of the designated beneficiary (2) beneficiary can elect to distribute entire account balance within 5 years after owner's death

DOL

Department of Labor -charged with enforcing the rules governing the conduct of plan managers, investment of plan assets, reporting and disclosure of plan info, enforcement of the fiduciary provisions of the law, and worker's benefits rights as regulated by ERISA

NUA calculation

FMV at date of distribution - value of securities used at the date of the employer contribution

pre-1974 CG calculation

LTCG portion = months of pre-1974 participation/total months of participation * taxable distribution

for qualified plans to over 10% penalty, they must make a MESS AT DQ

Medical expenses Equal periodic payments Separation from Service Age Tax levies Death and disability QDRO

a company's deductible contributions

a company may make deducible contributions for a tax year up to the due date of their tax return (plus extensions) for the year of contribution - no promissory notes allowed

Designated Beneficiary

a listed beneficiary that does EDB criteria -must distribute account balance by Dec 31 of year containing 10th anniversary of participant's death

exception to RMD for qualified plans

a participant that is still employed by the plan sponsor of the qualified plan does not have to begin taking RMDs until April 1 of the year after they terminate employment -this exception is not offered for any participant that owns more than 5% of the ownership of the plan sponsor in the year they turn 72

qualified plan distribution adjusted basis

a participant will have an adjusted basis in distributions received from a qualified plan if either has occurred: -the participant made after-tax contributions to a contributory qualified plan -the participant was taxed on the premiums for life insurance held in the qualified plan

Keogh Plan self employed individuals

a qualified plan for a self-employed person - reduced contribution may be made -earned income for SE individuals is defined as net earnings from SE - 1/2 SE tax - the deduction for contributions to the qualified plan

adopting a written plan

a qualified plan must be detailed in a written plan that is adopted by the company -to take an income tax deductions for contributions for a particular tax year, the plan must be adopted by the due date of the return plus extensions

Pension Benefit Guaranty Corporation (PBGC)

acts to guarantee pension benefits -does not cover defined contribution plans nor defined benefit pension plans of professional services corps with 25 or fewer participants -covers all other DB plans for $80 per participant charged to the sponsor each year and $38 per $1000 of plan underfunding for the year

defined benefit plan termination

because the PBGC is responsible for underfunded DB pension plans, there are more requirements for terminating these kinds of plans -ERISA requires that a DB plan terminate under a standard, distress, or involuntary termination

when can self-employed individuals contribute

can only contribute if they have positive net earnings

calculation self-employed individual's contribution rate

contribution rate / (1 + contribution rate) = self employed contribution rate

exclusion ratio

cost basis in annuity/total expected benefit once participant has recovered full basis, all future payments are ordinary income

Net Unrealized Appreciation (NUA)

defined as the excess of the FMV of the employer securities at the date of the lump-sum distribution over the cost of the employer securities at the time they were contributed to the plan

calculating RMDs

determined each year by dividing the account balance as of the close of business Dec 31 of preceding year by the distribution period determined by the Uniform Life Table

RMDs with deceased participant and no beneficiary

distributions must still continue over the remaining distribution period of the owner which is reduced by one each year

pension plan distributions

distributions normally made because of termination, early retirement, normal retirement, disability or death

cash flow considerations

the decision maker should always consider the company's financial stability and the predictability of its cash flows

prohibited transactions

transactions between the plan and a disqualified person that are prohibited by law -generally include actions by a disqualified person that potentially could have adverse consequences to the plan or participants

standard termination

voluntary and may occur when the employer has sufficient assets to pall all benefits (liabilities) at the time of final distribution

distress termination

voluntary and occurs when the employer is in financial difficulty and is unable to continue with the plan financially

administration costs

when a company implements a qualified plan, there are many costs with adopting and administering

RMD table for much younger spouse

when a participant's sole designated beneficiary is their spouse who is more than 10 years younger, instead of ULT, use the Joint Life Expectancy Table which will result in a longer life expectancy and reduce the RMD