Ch 13

DC Plan Example Before Dave retires at the end of 2022 he continues to contribute to his CBA-sponsored 101 (k) account. CBA matches employee contributions on a two-for-one basis up to 4 percent of the employee's salary. Dave is age 72 at the end of the year and he earned a salary of $600,000 during the year. Dave contributed $27,000 to his 401(k) account. How much will CBA contribute to Dave's 101(k) account?

Answer: $10,500 [$67,500 (Dave is 50+ years old) minus $27,000 (Dave's contribution)]. Without the limitation, C B A would have contributed $18,000 ($600,000 × 4% × 2) to Dave's account.

Minimum Distributions Example Assume that Dave retires from CBA in 2022 at age 74 (age at year-end). Also assume that his 401(k) account balance on December 31, 2021, was $3,500,000. What is the amount of minimum distribution he must receive for 2022 and when must he receive it?

Answer: $137,200 by April 1, 2023 ($3,500,000 × 3.92% from the Uniform Lifetime Table)

Saver's Credit LO#6

Credit for taxpayers contributing to qualified plans • Credit is in addition to deduction for contribution • Available to lower income taxpayers • Depends on filing status and AGI • Taxpayer must • be Z age 18, • not a dependent of another taxpayer, and • not a full-time student Credit based on contributions up to $2,000 • Maximum credit: $1,000 • Unavailable for MFJ with AGI over $68,000, HH with AGI above $51,000, and all others with AGI above $34,000.

Taxpayers receiving retirement distributions receive a

Form 1099-R • Two types of employer provided plans: • Defined Benefit Plan & • Defined Contribution Plan • Must not discriminate between employees

SEP IRA LO#5

Simplified Employee Pension (SEP) IRA • Contribution limit • Lesser of (1) $61,000 or (2) 20% × (net Schedule C income minus deduction for employer's portion of self-employment taxes paid • Employer's portion is 50% of SE Tax. • Must provide plan to employees if taxpayer has employees • After-tax contributions are not allowed (no Roth option).

Defined Benefit Plan LO#1

Standard benefits based on fixed formula • Years of service • Percentage of average compensation • The amount of compensation that can be taken into account for a particular year in determining the employee's benefit is capped by the annual compensation limitation. • The annual compensation limitation is $275,000 for 2018, $280,000 for 2019, $285,000 for 2020, $290,000 for 2021, and 305,000 for 2022.. • Maximum benefit in 2022 is the lesser of 100% of the employee's three highest consecutive calendar years of compensation, limited to the annual compensation limitation for each of the three years, or $245,000.

Deferred Compensation LO#3

• "Nonqualified plans" (similar to DCPs) • May discriminate • Generally provided to executives or highly compensated rather than rank and file • Employee contribute portion of salary, reduces income • Investment choices (employees) • Employee contributes portion of salary (limit set by employer) • Reduces taxable income • Risks to employees (potential to be unsecured creditor) • No employer deduction 'til paid (expensed Fin. Acg.) • Distributions taxable as ordinary to employee • Note: No age restrictions for distributions, and no RMD.

Example: Roth IRA Distribution Sherry, age 52, opened a Roth IRA three years ago. She has contributed a total of $12,000 to the Roth IRA. The current value of the Roth IRA is $18,000. In the current year, Sherry withdraws $15,000 of the account balance to purchase a car. Assuming Sherry's marginal tax rate is 24%, how much of the $15,000 withdrawal will she retain after taxes to fund her car purchase?

• 15,000 - 12,000 contribution = $3,000 earnings * 24 + .10 = $1,020 • 15,000 - $1,020 = $13,980

Required minimum distributions

• Based on applicable percentage of balance at end of prior year (% from IRS Uniform Life Table) • 50% penalty on undistributed portion of minimum distribution requirement.

Individual 401 (k)

• Contribution limit for 2021 • Lesser of (1) $61,000 or (2) 20% X (net Schedule C income minus ½ SE Tax deduction) + $20,500 • Additional $6,500 if age 50 by year-end • Maximum contribution is $67,500 ($61,000 + $6,500) • Contribution cannot exceed Sch C net income minus ⅓ SE Tax. • Dave's SEP example: $7,435 + 27,000 = $34,435 •27,000 = 20,500 + 6,500 catch-up • Does not exceed Sch C net income - ½ SE Tax: $37,174

Roth 401 (k) Plans

• Contributions: • Not deductible; employer portion go into traditional 401(k) • Qualified distributions • After account open for five taxable years and employee has reached age 59½ •Nonqualified distributions • Distributions of earnings are taxable. • Distributions of earnings are subject to 10 percent penalty unless the taxpayer is at least age 55 and retired or at least age 59½ if not retired. • Distributions from contributions are not taxable. • Contributions divided by account balance multiplied by amount of distribution equals distribution from contributions (ROC - not taxed).

Defined Benefit Plan (a.k.a Pension Plan)

• Contributions: Employer (No limit - Jeb Bush) • Deductible as contributions are made (employer) 1 Investment Risk: Employer • Vesting schedules • 5-vear cliff or • 7-year graded • Distributions are fully taxable at ordinary rates when received (employee) • Subject to penalty for early withdrawal (10%); or for not receiving a minimum distribution (50%) Most companies are only offering DCP, but there a several Companies that still offer DBPs: Exxon Mobil, UPS, Some Gov't entities, Coca Cola, JP Morgan Chase...

Defined Contribution Plan LO#2

• Defines: The maximum contribution (2021) • Employee: $20,500 (27,000 age ≥ 50) • Total employee & employer: lesser of 61,000 (67,500 age ≥ 50) or 100% of employee's compensation • Vesting Period (employer portion & earnings only) • 3-year vesting cliff or 6-year graded schedule (20% and yr) • Employee contributions & earnings vest immediately • Contributions: Employee (employer may match) • Contributions not taxable (deductible) • Distributions - employee & employer portions + earnings are fully taxable to the employee - ordinary rates • Investment Risk: Employee • 401(k) (for profit) , 103(b) (non-profit), or 457 (gov't) • Subject to penalty for early withdrawal; or for not receiving a minimum distribution.

Distributions

• Distributions are ordinary income Early distributions subject to a 10% penalty if • Before 59 ½ years of age if still working or • Before 55 years old and separated from service (retired) • Required minimum distributions (50% Penalty) • The year of age 72 or when the employee retires, if later (and each subsequent year)

Example: Roth 401 (K) Distribution Kristi, age 56, retired, contributed to a Roth 401(k) and employer contributed to a traditional 401 (k) on her behalf. Kristi has contributed $30,000 to her Roth 401(k) over the past six years. The current balance in her Roth 401(k) account is $50,000. Kristi needs cash because she is taking a vacation to travel the world. Kristi's marginal tax rate for ordinary income is 24%. • If Kristi receives a $15,000 distribution from her Roth 401(k) account, how much will she be able to keep after paying taxes and penalties, if any, on the distribution?

• Kristi is not 59 ½, so it's a non-qualified distribution; earnings are taxable. Because she is 56 and retired, she is NOT subject to a 10% penalty on the earnings. • Contributions/account balance = nontaxable portion * 30,000 / 50,000 = 60% is ROC, thus 40% is taxable • 15,000 * 10 = 6,000 * 21 = $1,440 • 15,000 - $1,140 = $13,560 she gets to keep

Individual Retirement Accounts

• Nonqualified Distributions (Roth IRA) earnings only are taxed as ordinary income • 10% penalty if before age 59½ & account open < 5 years • Certain exceptions • Distribution is attributable to the taxpayer being disabled. • Distribution is used to pay qualified acquisition costs for first-time homebuyers (limited to $10,000) • Nonqualified distributions are deemed to come: •First from the taxpayer's contributions (nontaxable), • Then from account earnings after the total contributions have been distributed (not prorated like 401(k)) • Emergency savings to extent of contributions

Individual Retirement Accounts

• Nonqualified Distributions (Traditional IRA) taxed as ordinary income • 10% penalty if before age 59½ • Certain exceptions • Medical expenses, insurance premiums, first home, childbirth or adoption • Same required minimum distributions apply as to qualified contribution plans • Qualified Charitable Distributions (QCDs) are excludable • Nontaxable percentage = nondeductible contributions divided by balance of account

Individual Retirement Accounts LO#4

• The maximum contribution to a Traditional or Roth IRA is ° Lesser of $6,000 or earned income • If age 50+ at year-end, limit is lesser of $7,000 or earned income. • Additional $1,000 "catch-up" contribution • A For AGI deduction for contributions ( Traditional IRA only) • Generally, not allowed if participant in an employer-sponsored plan (e.g., 401(k) plan) • Participating single taxpayers may deduct contributions if MAGI is below $68,000 and then phases-out up to $78,000. • MFJ Phases-out between $109,000 - $129,000. • Spouse participate, taxpayer doesn't: MAGI: $204,000 - $214,000 • Taxpayers may make non-deductible contributions (< max.) Qualified Distributions - Taxpayer must 59½

Individual Retirement Accounts

•Roth IRA contributions are NOT deductible • Regardless of participation in employer plan, contributions phases out for MAGI between • $129,000 and $144,000 for unmarried taxpayers ° $201,000 and $214,000 for married filing jointly. ° $0 and $10,000 for married filing separately. • No contributions allowed if MAGI exceeds the threshold. • Subject to 6% excise tax if excess contributions are not withdrawn by the filing due date of tax return. Limits do NOT apply to conversions or rollovers . • "Backdoor" Roth IRA contributions • Qualified distributions - Account open 5 years, age 59½ • Distributions are not taxable