Lesson 12: Tax Advantaged Accounts
Employee Retirement Income Security Act (ERISA)
A law passed by congress that governs qualified corporate retirement plans. According to ERISA, for a plan to be qualified and eligible for tax-deductible contributions, it must be offered to all full-time employees with at least 21 years of age and one year of service with the employer. The plan must also have a vesting schedule.
457(b) plan
A qualified retirement plan offered by state or local government entities and certain nonprofit organizations. Other than the fact that these are offered by public entities rather than private corporations, they work similar to 401(k)s in that they allow eligible employees to make tax-deductible contributions
Roth 401(k)
A special type of employer-sponsored retirement plan that combines a traditional 401(k) with a Roth IRA. These plans allow the employee to contribute either pre-tax dollars to his 401(k) or after-tax dollars to a Roth account while the company makes all tax-deductible matching contributions to the employee's 401(k)
Variable annuity
An annuity contract between an individual and an insurance company that pays the owner a fluctuating payout over his lifetime based on the market performance of his investments. To generate this variable return, all premiums are invested into the insurance company's separate investment account and grow tax-deferred until the investor takes distributions from the account
Fixed annuity
An annuity contract that guarantees the owner a fixed rte of return over the life of the contract. To generate this fixed return, all premiums are invested in the insurance company's general account. Because investors are guaranteed a return, fixed annuities are not considered a security.
Gifts may be contributed to 529 plans, for the benefit of the child, by...
Anyone, provided the gifts do not exceed maximum contributions
The first required minimum distribution from a Traditional IRA must be taken no later than
April 1 of the year following the year in which the IRA owner turns 72
Surrender charges
A fee charged by an insurance company when money is withdrawn from an annuity with a certain period of time from a purchase payment. These charges are typically assessed as a percentage of the amount withdrawn and generally decline to zero over time. However, while these charges are in existence, they create a lack of liquidity for the investor.
A SIMPLE IRA can only be adopted for this kind of commodity
Small companies with 100 or fewer employees
Program disclosure document
a disclosure document provided by states, which describes in detail the 529 plan the state offers
The person upon whose lifetime the payouts from an annuity are based is called the...
Annuitant
A couple wishes to choose an annuity payout that will provide a predictable monthly income as long as either is alive. The payout they should choose is...
Joint and last survivor
401(k)
A type of qualified, defined contribution corporate retirement plan that allows each eligible employee the option of deferring a portion of his or her salary into the plan instead of receiving current pay in cash. Employers also have the option of matching all or part of each employee's contributions. Because these plans are qualified, they allow for tax-deductible contributions
Once required minimum distributions from Traditional IRAs begin, the account owner must continue them...
On an annual basis until the IRA is depleted or until death
A wife works and has earned income of $10,000. Her husband does not work. The maximum IRA contributions they can make are...
$10,000 for the wife and $6,000 for the husband. However, the combined contributions may not exceed $10,000 (100% of the earned income of the working spouse)
Annual IRA catch-up contribution amount allowed for individuals 50 and over
$1000
The maximum contribution that may be made to a Coverdell Education Savings Account is...
$2,000 per child
The maximum IRA contribution that may be made by an individual with $3,000 of earned income and $20,000 of investment income is...
$3,000. The maximum currently is the lesser of $6,000 or 100% of earned income. Investment income and income from retirement plans cannot be contributed.
The maximum IRA contribution that may be made by an individual with earned income of $50,000/year is...
$6,000. The maximum is currently the lesser of $6,000 or 100% of earned income
The total annual IRA contribution that can be made by a working person age 55 with $100,000 of earned income is...
$7,000. This consists of $6,000 regular contribution plus a $1,000 catch-up contribution available to those age 50 and up.
Amount of IRA early distribution penalty
10% of amount distributed (plus ordinary income tax)
The penalty that applies if funds are withdrawn from an annuity before age 59 1/2
10% penalty on earnings
Distributions from 403(b) plans are
100% taxable
Distributions from tax deferred annuities are
100% taxable
Defined benefit plan
A type of qualified corporate retirement plan, such as a pension plan, that is 100% funded by the company and promises to pay each employee a specified income benefit at retirement. Because these plans are qualified, they allow for tax-deductible contributions
ERISA-defined employee eligibility requirements for plan participation
21 years of age and one year of fully time service
Qualified plan available to employees of non-profit organizations
403(b)
A type of qualified retirement plan available only to employees of public schools, colleges, and non-profit organizations is...
403(b) Plan
A college professor participates in a retirement plan with many of the same features of a 401(k), except that it only invests in annuities. It is a...
403(b) also known as a tax-sheltered annuity
Pension plan
A type of qualified, defined benefit corporate retirement plan that is 100% funded by the company and promises to pay each employee a specified income benefit at retirement. The benefit is based on the employee's salary, age, and years of service. Because these plans are qualified, they allow for tax-deductible contributions.
Amount of IRA insufficient distribution penalty
50% of amount that should have been withdrawn
Age at which distributions from an IRA may begin without penalty
59 1/2
Penalty for excess contributions made to an IRA account
6%
How long does an individual have to complete an IRA rollover to avoid potential tax liabilities and early withdrawal penalties
60 days
In a traditional IRA account, age at which distributions must begin to avoid penalties
72
Profit-sharing plan
A type of qualified, defined contribution corporate retirement plan that allows companies to contribute to their employees' retirement based on the companies' profits. Because these plans are qualified, they allow for tax-deductible contributions.
The penalty for making an excess contribution to an IRA is...
A 6% tax penalty assessed by the IRS
A special type of IRA contribution that can only be made by individuals age 50+ is called...
A catch-up contribution. It is an additional $1,000 contribution above the normal limit of $6,000 per year.
Annuity
A contract between an individual and a life insurance company. They are used for retirement savings, as the insurance company will pay income to the contract holder that is guaranteed for life.
Non-qualified corporate plan
A corporate retirement plan, such as a deferred compensation or payroll deduction plan that is not required to meet strict ERISA guidelines. Instead, companies have the flexibility to choose which employees are offered to participate in the plan. Because these plans are discriminatory, they do not allow deductible contributions. Instead, after-tax contributions are made, which grow tax-deferred, and when distributions are taken, only the growth is taxed as ordinary income.
qualified corporate retirement plan
A corporate retirement plan, such as a defined benefit plan or defined contribution plan, that meets ERISA guidelines. These plans offer pre-tax or tax-deductible and tax-deferred growth, with all distributions being fully taxed as ordinary income
Qualified corporate retirement plan
A corporate retirement plan, such as a defined benefit plan or defined contribution plan, that meets ERISA guidelines. These plans offer pre-tax or tax-deductible contributions and tax-deferred growth, with all distributions being fully taxed as ordinary income.
Definition of a guaranteed investment contract (GIC)
A life insurance contract that functions like a time deposit, with all principal guaranteed by the insurance company
Underfunded pension plan
A pension plan that does not have sufficient assets to pay retirement obligations to employees. This becomes a risk if the investments inside the plan do not perform as expected.
An investor owns a variable annuity and is unhappy with its performance. He wishes to exchange it for a fixed annuity without paying current income tax on accumulated gains. He may purchase this goal through...
A tax-free section 1035 exchange
Roth IRA
A type of IRA that requires after-tax contributions, but allows the assets in the plan to grow tax-free. Distributions from the plan are also completely tax-free as long as the assets have been in the plan for at least five years and withdrawals do not begin prior to age 59 1/2. Only individuals who have income below a certain threshold are allowed to contribute to a Roth IRA.
Payroll deduction plan
A type of non-qualified corporate plan that allows employees, after-tax, to deduct a portion of their salary for retirement savings
Defined contribution plan
A type of qualified corporate retirement plan, such as a 401(k), in which retirement income depends on the amount contributed and the performance of those investments. Because these plans are qualified, they allow for tax-deductible contributions.
Federal tax status of contributions made to Section 529 plan
After-tax
The tax benefits of an ABLE account are
All contributions are made with after-tax dollars. Earnings grow tax-free and distributions made for qualified disability expenses are tax-free
The purpose of a 529 plan is to...
Accumulate money on a tax-advantaged basis for a child's college education
The two phases of a variable annuity contract
Accumulation phase and annuity phase
An accounting measure used to determine the owner's interest in the separate account when purchasing a variable annuity
Accumulation unit
Tax status of contributions made to Roth IRAs
After tax
Tax nature of contributions to Section 529 Plans
After tax contributions
Spousal IRA
Allows an individual with earned income to make a separate contribution to a traditional IRA on behalf of a non-working spouse with no compensation
Tax-deductible contribution
Also referred to as a pre-tax contribution, occurs when individuals make a contribution to a retirement plan before taxes on their income are paid, which allows investors a slight tax break, as they do not have to pay income taxes on those funds today.
403(b) plan
Also referred to as a tax-sheltered annuity, this plan is a qualified retirement plan offered by nonprofit organizations and education institutions. Other than the fact that these are offered by public entities rather than private corporations, they work similar to 401(k)s in that they allow eligible employees to make tax-deductible contributions
Vesting schedule
An ERISA requirement for a plan to be qualified and eligible for tax-deductible contributions. A vesting schedule specifies when plan participants have ownership rights to employer contributions made on their behalf; these contributions cannot be taken away from the employee.
Non-discriminatory
An ERISA requirement for a plan to be qualified and eligible for tax-deductible contributions. This means that the plan must be offered to all full-time employees with at least 21 years of age with one year of service.
Subaccount
An account, similar to a mutual fund, that is contained within the insurance company's separate investment account. It provides investors the opportunity to invest in different types of funds, each having its own risks and objectives.
The transition from the accumulation to the payout phase of a variable annuity
Annuitization
Life insurance company contract designed to provide a stream of guaranteed income payments for life
Annuity
A life insurance company's general account usually invests in
Conservative investment options such as Treasury securities and high-grade corporate bonds
Tax advantage available for 529 plan contributions in many states to state residents
Contributions to 529 plan sponsored by that state are tax deductible on state tax returns
The main difference between contributions made to Traditional IRAs vs. Roth IRAs is
Contributions to Roth IRAs are always with after-tax dollars, while contributions to a traditional IRA are typically pre-tax.
When income tax becomes due on contributions to Roth IRAs and earnings in Roth IRAs
Contributions: At the time the contribution is made. Earnings: Never, if the distribution is qualified.
A risk factor of non-qualified retirement plans that does not exist in ERISA-qualified plans is
Credit risk - i.e. the risk of the employer's insolvency
ABLE accounts are tax-advantaged savings vehicles that may be opened for the benefit of...
Individuals with diabilities
Who is eligible to make a catch-up contribution
Individuals with earned income age 50+
The conditions under which distributions from Roth IRAs are tax-free are...
Distributions must be made after reaching age 59 1/2 and the money must have been in the Roth IRA at least five years.
When a preliminary prospectus can be used to market an offering of securities to investors
During the cooling-off period. The preliminary prospectus is also called a red herring
The tax treatment of any investment earnings in a Roth IRA is...
Earnings accumulate tax-free
Federal regulation that specifies guidelines for private sector and certain union plans
Employee retirement income security act (ERISA)
Contributions to SEP-IRAs are made by
Employers only. The contributions go directly into Traditional IRAs owned by each employee
Unfunded pension liabilities
Exist when future pension payment obligations to retirees exceed the value of the funds available to pay them. This situation could result in a default on pension benefits or other debts, negatively impacting the issuer's credit
Type of annuity that guarantees the rate of return that will be earned on the investment
Fixed annuity
The insurance company account in which fixed annuity payments are invested
General account
A non-working spouse can have an IRA...
If they have a working spouse who contributes to a spousal IRA account in the non-working spouse's name
The value of accumulation units in a variable annuity will fluctuate based on...
Investment performance of separate account funds chosen by each contract holder
A risk assumed by the owner of a variable annuity
Investment risk
The type of company that stands behind a guaranteed investment contract (GIC)
Life insurance company. The principal is guaranteed by the insurance company, along with an interest rate for a stated period of time.
A single woman wants to receive a fixed annuity payment each month for a period of 20 years. If she dies before 20 years, she wishes payments to go to her child. The payout she should choose is...
Life annuity with 20-year period certain
Municipal issue disclosure document for prospective buyers
Official statement
Tax status of distributions from Roth IRAs
Non-taxable
Rights of accumulation
Offer investors an opportunity to receive breakpoints on new mutual fund purchases based on the current value of those customers' invested funds
Taxation that applies to a lump sum withdrawal from an IRA account at age 55
Ordinary income on earnings + 10% penalty
A 60-year-old man chooses a straight life annuity payout. If he dies two years later...
Payments will cease as a straight-life annuity makes payments only over the life of the annuitant
Contributions to traditional IRAs are usually made...
Pre-tax. Earning on those contributions are tax-deferred until withdrawn, at which time they are taxed as ordinary income
A risk associated with the loss of buying power from a fixed annuity's payment
Purchasing power risk
Category of retirement plans with tax deductible contributions
Qualified
Distributions from 529 plans can be tax-free if they are used for...
Qualified education purposes, such as tuition and books
Municipal fund security
Similar to a mutual fund, it is a collection of capital from many investors that is invested to achieve a stated investment objective. However, these are exempt from the investment company act because they are issued by state and local governments rather than by private entities. Examples include 529 plans, ABLE accounts, and local government investment pools.
Required minimum distribution (RMD)
Requires the owner of a traditional IRA to begin minimum withdrawals specified by IRS rules from the account by April 1st following the individual's 72nd birthday. Any shortfalls in this distribution are penalized with a 50% tax on the under-distribution amount
A guaranteed investment contract (GIC) can be an attractive retirement plan investment choice for a person with this investment objective
Safety or preservation of capital. The principal is guaranteed in fully by a life insurance company
In variable annuities, most of the assets are invested in this account of the insurance company
Separate account
The insurance company account in which variable annuity payments are invested
Separate account
The fee paid by the owner of an annuity contract for cancelling the contract in the early years is called a...
Surrender charge
The main reason to make contributions to a Roth IRA vs. a Traditional IRA is...
TO be able to receive tax-free earnings and growth
Tax treatment of withdrawals from Section 529 plans
Tax free withdrawals (after-tax contributions)
General account
The account of an insurance company in which customer premiums are invested into conservative options that deliver a guaranteed fixed rate of return. All premiums for a fixed annuity are invested into this account.
Annuitant
The contract owner of an annuity
Required beginning date (RBD)
The date on which an owner of a traditional IRA must begin taking distributions from the account. Specifically, these withdrawals must begin by April 1st following the individual's 72nd birthday. Any shortfalls in this distribution are penalized with a 50% tax on the under-distribution amount.
The investment risk in a fixed annuity is assumed by
The insurance company that issues the annuity
Tax-deferred
The manner in which investments grow within a retirement plan, an annuity, a 529 plan, and an ABLE account. Tax-deferred means that there is no tax paid annually on any investment earnings, such as dividends, capital gains, or interest income. Taxes are only paid when withdrawals are made.
Traditional IRA
The most common type of IRA, which can be established by any individual with earned income. Depending on the individual's income level and whether or not she is eligible for a corporate plan, contributions can be either pre-tax or after-tax
In a variable annuity, the investment return depends on
The performance of specific separate account portfolios chosen by the contract owner
The maximum age at which IRA contributions may be made
There is no maximum. Contributions to both a Roth and Traditional IRA can continue for as long as the owner has earned income
IRA owners are not subject to required minimum distributions during their lifetimes if...
They own Roth IRAs. These distributions must be taken annually from Traditional IRAs, but not from Roth IRAs.
What a 1035 exchange allows an annuity owner to do
Transfer from one annuity contract to another tax-free
Assets in a Coverdell Education Savings Account must be withdrawn or transferred no later than...
When the beneficiary reaches age 30
Retirement plan that can make non-deductible employee contributions on a discriminatory basis
non-qualified
The SEP-IRAs are designed mainly for this type of employer
small businesses
Separate account
the account of an insurance company into which customer premiums are invested for a variable annuity. Within this account, individuals can invest their contributions into various subaccounts, which are essentially just mutual funds with different risk and reward profiles. Because the returns of the separate account are market driven, investors benefit from the highs of the market, while simultaneously risking the lows of the market.