Mod 7
Identify six exceptions stated in the Internal Revenue Code (IRC) to the tax penalty assessed against distributions taken before age 59½.
the plan participant dies and the distribution goes to a beneficiary or the participant's estate the distribution is attributable to permanent disability distributions are part of a series of substantially equal periodic payments made over the plan participant's life expectancy or the joint life expectancy of the participant and spouse (or beneficiary of an IRA) distributions are made at separation from service at age 55 or older (not applicable to an IRA) the distribution is made to a former spouse or dependent under a QDRO (not applicable to an IRA; IRA assets can be transferred without penalty to the IRA of a former spouse when it is so ordered in a divorce decree) distributions do not exceed the amount of the participant's deductible medical expenses for the tax year Also, qualified education expense distributions from an IRA are not subject to the penalty. Distributions from an IRA or Roth IRA would also be exempt from the 10% penalty if used by first-time home-buyers for expenses, up to the $10,000 lifetime cap.
Periodic distributions from a qualified plan that take place over _____ years may not be rolled over into an IRA.(LO 7-2)
10 Periodic distributions from a qualified plan that take place over nine years or less may be rolled over into an IRA. However, periodic distributions from a qualified plan that take place over a period of 10 years or more cannot be rolled over into an IRA.
How long must contributions be stopped after a hardship withdrawal
6 months
Discuss the use of a "bucket strategy" to mitigate sequence of return risk.
A "bucket strategy" can mitigate the sequence of returns risk by creating a bucket of cash or money market instruments for immediate cash flow needs, while also maintaining a diversified portfolio of more volatile assets with higher potential returns for future needs. Having a "bucket" of low-risk products to rely on is essential, should equities experience negative returns during the first several years of retirement when sequence of return risk is at its greatest.
401k qualifications for Hardship Withdrawals
A 401(k) plan participant who demonstrates (1) "an immediate and heavy financial need" and (2) lack of other "reasonably available" resources
SERP
A SERP (supplemental executive retirement plan) is an employer paid nonqualified deferred compensation plan.
What interest rate are loans made at
A commercially reasonable interest rate Typically the prime rate
ACP test
A discrimination test that involves a percentage comparison of the matching contributions and nonelective employer contributions made on behalf of nonhighly compensated employees with the matching contributions and nondeductible employee contributions made on behalf of highly compensated employees.
ADP test
A nondiscrimination test that compares the deferral rates of nonhighly compensated participants with the deferral rates of highly compensated participants in the same 401(k) plan.
Simplified employee pension (SEP)
A pension plan established by a business on behalf of its employees; contributions are deposited into the individual retirement accounts (IRAs) of the employees.
Employee stock ownership plan (ESOP)
A profit sharing or stock bonus plan in which the funds must be invested primarily in the employer's securities. An ESOP may borrow in order to purchase the company stock.
Catch-up provision
A provision found in both 403(b) and 457 plans that allows an eligible employee to make higher annual contributions in the years just prior to retirement.
Money purchase pension plan
A qualified defined contribution plan in which the employer is required to contribute a percentage of covered payroll (up to 25%) to the plan each year.
Profit sharing plan
A qualified defined contribution plan that features a provision for flexible contributions from the employer to the accounts of eligible employees according to some percentage or formula. In most cases, the contributions bear some relationship to the employer's annual profits. However, some profit sharing plans such as 401(k) plans and other arrangements provide that contributions will be made, even if there are no employer profits
Keogh (HR 10) plan.
A qualified retirement plan for self-employed individuals established through a sole proprietorship or partnership (it is not designed for individual partners). Keoghs can be established either as defined contribution or defined benefit plans.
Section 457 plan
A retirement plan that enables employees of state and local governments and nonprofit organizations to defer taxation on salary-reduction contributions. Similar to a 401(k) plan but not to a qualified plan.
Discuss what is meant by a "rising equity glidepath."
A rising equity glidepath is defined as "the asset allocation path that results from spending down fixed income assets in the early years and letting equity exposure rise over time." Research has shown that the biggest threat to a retirement portfolio is poor market returns throughout the first half of retirement. Reducing exposure to equities in the early years can help ease the transition to retirement when sequence of return risk is the greatest.
SARSEP
A salary reduction plan that is available only to companies with 25 or fewer employees. What distinguishes a SARSEP from other SEPs is the opportunity for employees to elect to contribute a portion of their pay on a pretax basis. New SARSEPs cannot be established. Those established prior to 1997, however, can continue to be funded.
Which of the following statements is correct about qualified joint survivor annuities? (QJSAs) (LO 7-4)
All pension plans, which include defined benefit, cash balance, money purchase, and target benefit plans, must offer QJSAs.
RMD Plan Aggregation
Allowed with IRA's and 403b's Not allowed with 401k's and Roth 401k's
Savings incentive match plan for employees (SIMPLE).
An employersponsored retirement plan that can be either an IRA for each employee or part of a 401(k) plan. Available to employers with 100 or fewer employees who earn at least $5,000 a year and who do not participate in any other qualified plans.
Explain who is responsible for taxes on distributions made after the death of the plan participant.
Benefits distributed from a qualified plan or IRA are taxable to whatever individual or entity is designated as the distributee. Thus, the beneficiary or estate that receives the distribution is responsible for whatever tax is due. The payments are taxed as "income in respect of a decedent." If the deceased qualified for forward averaging, the beneficiary or estate has the right to use forward averaging in figuring the tax.
Describe the purpose of a qualified optional survivor annuity (QOSA) and how it differs from a qualified joint survivor annuity (QJSA).
Defined benefit and money purchase plans must provide a QOSA to the spouse of a plan participant who dies prior to retirement. The payment to the surviving spouse is equal to at least one-half of the participant's actuarially reduced pension benefit as of the date of death or the earliest retirement date from the plan. A QJSA is mandated in defined benefit plans and continues payments to the surviving spouse of the plan participant who has died after leaving service. The surviving spouse does have the option to waive the benefit.
Which plans typically include provisions for withdrawals by plan participants who elect to continue working past the plan's normal retirement age?
Defined contribution plans typically allow withdrawals by participants who continue to work past the plan's normal retirement age. Theoretically, defined benefit plans can do the same, but the record-keeping complexity resulting from these withdrawals discourages most from doing so.
Which plans typically provide for hardship withdrawals? Describe circumstances that may justify such withdrawals.
Hardship withdrawals are generally available from TSA, profit sharing, and 401(k) plans only. The participant must demonstrate an "immediate and heavy financial need" and a "lack of reasonably available resources." Medical expenses, the purchase of a primary residence, tuition payments, and payments to prevent eviction from one's home are all occasions when the hardship withdrawals may be allowed.
Conduit IRA
Holding place to roll qualified plan money between employment Must be set up new with no other co-mingled funds Cannot accept regular IRA contributions
What are the distribution options of the beneficiary when an IRA owner dies during retirement after their required beginning date?
If a surviving spouse is the sole IRA beneficiary, their required distribution period is the greater of their recalculated life expectancy factor (using the Single Life Table) or the deceased IRA owner's remaining fixed or unrecalculated actuarial life expectancy (using the Single Life Table). For example, let's assume that the surviving spouse: chooses not to roll the account into their own IRA is the sole beneficiary elects to take required minimum distribution over their life expectancy A spousal beneficiary is uniquely able to roll a lump sum distribution from the deceased's plan into an IRA in the surviving spouse's name. If an individual other than a spouse is the sole IRA designated beneficiary, the required distribution period is the greater of their fixed or unrecalculated life expectancy (using the Single Life Table) or the deceased IRA owner's remaining unrecalculated actuarial life expectancy (using the Single Life Table). In the case of one individual beneficiary (not the spouse) who takes the benefits over their life expectancy, the required distribution period begins the year following the year of death and is based on the beneficiary's life expectancy determined by their age on the birthday in the year following the year of the participant's death. For each subsequent year, the life expectancy is that of the previous year reduced by one. (In other words, the nonspouse beneficiary's RMD is calculated using the unrecalculated or fixed-term method.)
Which type of qualified plans may permit withdrawals before the participant has reached age 62?
Only profit sharing/stock bonus and thrift/savings plans may include provisions for in-service withdrawals by plan participants who are younger than age 62.
Options for spousal beneficiaries when Participant dies before RMD's begin
Option #1: Roll inherited assets into their own IRA (treat as your own) Option #2: Transfer assets to decedent or inherited IRA Option #3: Distribution according to 5-year rule Option #4: Lump sum distribution
Options for non-spousal beneficiaries when Participant dies before RMD's begin
Option #1: Rollover to decedent or inherited IRA following the death of the original participant Option #2: Distribution according to 5-year rule Option #3 Lump sum distribution
Options for spousal beneficiaries when Participant dies after RMD's begin
Option #1: Transfer assets to own IRA Option #2: Open a decedent or inherited IRA Option #3: Lump sum distribution
period-certain option
Provides regular monthly payments over a specified period, even if the recipient (and spouse) happens to die during the specified period. This ensures payments to a named beneficiary.
Qualified Joint and Survivor Annuity (QJSA)
Required for defined benefit, money purchase, and target benefit plans Employee must have been married for at least one year Continues to pay benefits as long as either the retiree or spouse continues to live The QJSA must be actuarially equivalent to a single life annuity over the life of the participant and at least 50%, but not more than 100%, of the annuity payable during the joint lives of the participant and spouse. In other words, if the QJSA payout is $1,000 per month while both spouses are alive, the survivor's lifetime annuity cannot be less than $500, or more than $1,000 per month.
Discuss sequence of returns risk and its implications for retirement planning.
Sequence of returns risk involves the order in which investment returns occur. Employing distribution strategies to reduce/eliminate the need to draw from a portfolio during a period of negative returns is essential. This is especially true during the first few years of retirement when large losses, coupled with withdrawals, could cripple an investment portfolio and cause it to fall short of its original goals.
Jeffrey died after beginning his required minimum distribution payments. He has named his daughter as the sole beneficiary of his IRA. Which one of the following statements is correct regarding her options for this IRA? (LO 7-4)
She must calculate her annual minimum distribution requirement using the fixed-term, or unrecalculated, method. The Uniform Table is only available to the original participant and spouse beneficiaries who choose to roll inherited IRAs to their own name. Non-spouse beneficiaries do not have the option of rolling inherited IRAs to their own name. The requirement that an IRA's balance be distributed within five years of the participant's death does not apply when there is a named beneficiary.
Rollovers are generally used to defer taxation of lump sum distributions and to retain tax-deferred accumulations. Describe an important negative aspect of this indirect approach to handling a lump sum distribution.
The indirect IRA fulfills the purpose of the rollover; however, the IRC requires the plan administrator to withhold 20% of the initial qualified plan or TSA distribution for tax purposes.
Qualified Plan RMD Requirement
The later of attainment of age 70.5 or retirement
What happens if payments are not made on a timely basis towards a loan
The loan will default and the entire balance outstanding will become a deemed distribution
What is the default distribution option for the married participant of a defined benefit plan? Explain what is required to change it.
The married participant in a defined benefit plan will automatically be given a joint and survivor annuity as a distribution option. This provides a fixed life benefit for the retiring participant, and a reduced benefit for their survivor. The plan participant cannot unilaterally cut the spouse out of this benefit. If another distribution option seems more appropriate, the spouse must give their written consent to the change.
Rollovers are generally used to defer taxation of lump sum distributions and to retain tax-deferred accumulations. How can the negative aspect of the indirect rollover be avoided?
The negative withholding aspect of the indirect rollover can be avoided by using a direct rollover. In this type of rollover, no funds are withheld for taxes.
Some IRAs and qualified plans contain contributions of after-tax dollars. When distributions from these plans are made through a series of equal installments, how does one identify which part of each payment is the aftertax dollars and which is not?
The nontaxable portion of each payment is determined by dividing the total contribution of after-tax dollars—i.e., the cost basis—by the number of anticipated monthly payments, according to the following table:
Qualified plans and TSAs may permit participants to borrow from their accrued benefits. What is the maximum repayment period for such loans?
The plan participant may borrow for a period of no more than five years, except in the case of loans used to acquire a principal residence.
Discuss the role that a single premium immediate annuity (SPIA) can play in a client's retirement income portfolio.
The purchase of a lifetime annuity eliminates the need to manage the investment of those funds, determining which assets should be used to fund distributions, and the fear of outliving one's assets. Knowing that one's fixed expenses are covered frees up their remaining savings, which can then be used to fund discretionary expenses. Research points to the partial annuitization of a portfolio improving its sustainability.
Define the objective of Monte Carlo analysis in retirement planning and identify its pros and cons.
The purpose of Monte Carlo analysis is to calculate the probability of specific scenarios that are based upon a given set of assumptions and standard deviations. When used in retirement planning it is designed to determine the probability of a particular income stream lasting through life expectancy. Pro: You can manipulate inputs related to inflation, longevity expectations, and annual withdrawal rate to see the impact on the likelihood of success, with success being defined as a given level of income lasting until death. Con: Results are based on historical data (i.e., historical returns, inflation rates), which are not always an accurate predictor of the future.
Explain the tax benefit of rolling over a lump sum distribution. What is the negative tax aspect of this option?
The tax benefit of a rollover is that, if properly executed, it defers taxation of the lump sum until such time as it is distributed from the IRA or other retirement plan into which it was rolled. The negative aspect of the rollover (except in the case of a conduit IRA) is that it may eliminate the opportunity for forward averaging.
What does the tax code require in terms of minimum distributions (RMDs) once the plan participant has attained age 70½?
The tax code has specific rules about how much must be distributed, or the RMD. They are: the amounts in the plan must be taken over a period of time that does not exceed the participant's life expectancy under the Uniform Table the amounts in the plan must be taken over a period of time that does not exceed the joint life expectancy of the plan participant and the spouse using the Joint and Last Survivor Table if the spouse is 11 or more years younger than the participant Life expectancy is based on an IRS table. The formula for determining the RMD is: Account balance on 12/31 of the prior year divided by the life expectancy based on Uniform Table
What are the two alternative payment options generally available to retired and terminated participants in qualified retirement plans?
The two forms of benefit payment generally offered to plan participants are: a lump sum distribution of the entire benefit, or a series of periodic payments (an annuity or series of installments).
Describe the objective of the "4% rule" as it relates to systematic withdrawals from retirement savings.
William Bengen developed the so-called "4% rule" in the early 1990s. Using historical data and a 50/50 stock/bond allocation, he argued that if the initial withdrawal rate were set at 4% of savings, and the dollar amount of subsequent withdrawals increased with inflation, just about all well-constructed portfolios would be able to last throughout retirement (at least for 30 years). Other researchers set the sustainable withdrawal rate higher, but in today's environment of sustained low interest rates, most agree that the rate needs to be lower in order to be sustainable throughout retirement.
The nontaxable portion of each annuity distribution payment
determined by dividing the cost basis by the number of anticipated monthly payments, according to the following schedule for single annuitants. Example. Hilda knows that she has contributed $80,000 in after-tax dollars to her plan, which was annuitized when she retired and began taking distributions at age 66. By dividing $80,000 by the estimated 210 monthly payments she will receive over her life, she knows that $380.95 of every monthly annuity payment is a taxfree return of her own after-tax contributions. The balance of each payment is therefore fully taxable.
Net unrealized appreciation (NUA).
the increase in the value of employer securities distributed from a stock bonus plan since the time they were contributed by the employer to the participant's plan.
The 10% penalty does not apply to qualified plan distributions that are:
due to the death of the plan participant due to permanent disability. due to separation from service after age 55 part of a series of substantially equal periodic payments made over the participant's life expectancy or the joint life expectancy of the participant and their beneficiary. related to certain medical expenses not reimbursed by insurance. These must be specified in the plan documents. In any case, the exception applies only to expenses that exceed 10% of the participant's adjusted gross income related to a qualified domestic relations order (QDRO). employer stock option plan (ESOP) dividends. When these shares pay dividends, participants can take the dividends out without incurring an early distribution penalty. taken to correct previous excess contributions or deferrals certain distributions to qualified military reservists called to active duty distributions due to an IRA levy
Identify the main sources of variability in retirement planning assumptions.
inflation investment return longevity
Roth IRA distributions that avoid 10% penalty
made to a beneficiary on account of account owner's death made on account of disability made as part of a series of substantially equal periodic payments to cover unreimbursed medical expenses that exceed 10% of AGI (for 2019) to pay medical insurance premiums after a job loss not exceeding the individual's qualified higher education expenses due to an IRS levy of the qualified plan a qualified reservist distribution a qualified recovery assistance distribution
IRS regulations provide the following examples of need that would be considered immediate and heavy:
medical expenses for a parent, spouse, child, dependent, or any primary beneficiary (defined below) purchase of a primary residence tuition payments for a parent, spouse, child, dependent, or any primary beneficiary payments to prevent eviction from one's primary residence funeral expenses for a parent, spouse, child, dependent, or any primary beneficiary repairs to principal residence that would qualify for a casualty loss income tax deduction
Profit sharing plans, including stock bonus plans and ESOPs, are not required to provide a QJSA if the following three conditions are met:
1. The plan does not allow for any life annuity options. 2. The plan does not accept direct transfers from other plans that are subject to QJSA. 3. The plan provides that the participant's vested benefits are payable in full, minus any outstanding loans, to the participant's spouse in the event the participant dies prior to retirement, although the spouse can waive the benefit.
Ordering Rules for Distribution of Roth IRA Funds
1. annual contributions 2. the "included as income" portion of the first or earliest conversion, then the "included as income" portion of the next conversion, etc. 3. earnings
Qualified Optional Survivor Annuity (QOSA)
An annuity for the life of the participant with a survivor annuity for the life of the spouse, which is equal to 75%, if the survivor portion of the annuity provided under the QJSA is less than 75%; or 50%, if the survivor portion of the annuity provided under the QJSA is 75% or more
Five-year cliff vesting
An approved vesting schedule in which the participant is fully vested in their benefits at the completion of five years of service. Under this schedule, the participant who is terminated or leaves the company prior to five years of service has no right to any benefits in the plan.
Direct Rollover
An eligible rollover distribution paid directly to an eligible retirement plan for the benefit of the distributee
Rollovers are generally used to defer taxation of lump sum distributions and to retain tax-deferred accumulations. Explain what the text described as an indirect rollover.
An indirect IRA rollover is one in which the plan participant takes receipt of a retirement plan distribution and, within a period of 60 days, places it into an IRA or other retirement plan.
What is a "QDRO"? Explain its common use with respect to retirement plans.
QDRO is shorthand for qualified domestic relations order. It is a legal judgment mandating the distribution or attachment of one person's property on behalf of another. In cases of divorce, a part of one exspouse's retirement plan is often attached for the benefit of the other ex-spouse by means of a QDRO. QDROs do not apply to IRAs or retirement plans that utilize IRAs.
How often must loan repayments be made
Quarterly
What is the required deadline for the commencement of distributions from qualified plans, IRAs, SEPs, TSAs, and other retirement accounts?
The deadline for taking minimum distributions is April 1 of the year following the year in which a plan participant or owner attains age 70½. For a common-law participant (a participant who does not own more than 5% of the company) in a qualified plan, the required beginning date is April 1 of the year following the later of attaining age 70½ or retiring from the company.
When must the designated beneficiary be determined in order to avoid having to distribute the full IRA balance under the five-year rule? (LO 7-4)
The designated beneficiary must be determined by September 30 of the year following the participant's death in order to avoid having to distribute the full IRA balance under the five-year rule.
When using the floor-and-upside strategy, all of the following are ideal for establishing the floor except
a municipal bond portfolio. Municipal bonds are not ideal for creating an income floor because they have default risk. All of the other options would be suitable.
The 10% penalty on early distributions from a qualified plan can be avoided if (LO 7-2)
a plan loan is repaid on a timely basis. A loan is not considered a distribution subject to taxation and possibly a 10% early withdrawal penalty if it is repaid on a timely basis and does not go into default. To avoid the 10% early withdrawal penalty, payments would need to be taken as substantially equal periodic payments over one's life expectancy. The exemption applies to certain medical expenses that are not reimbursed by insurance and exceed 10% (7.5% if over age 65) of the participant's AGI. The first-time home purchase exclusion applies only to IRAs.
Qualified plans and TSAs may permit participants to borrow from their accrued benefits. What happens if loans are not repaid within the allowed period?
Loans that are not repaid within the specified period are treated as taxable distributions.
Floor and upside strategy
Lock in a secure stream of income before investing any remaining retirement assets Could be annuity or guaranteed income such as zero coupon bonds
Define longevity risk and discuss its implications for retirement planning.
Longevity risk is the risk that life expectancy will exceed expectations, resulting in greater-than-anticipated retirement income needs. Because longevity is an unknown, retirees are faced with the competing risks of taking money out too quickly, and taking it out too slowly.
Tax implication when check is written to participant from a qualified plan or TSA
Mandatory 20% withholding
Tax implications for distribution from a qualified plan or TSA
Mandatory 20% withholding
Single Premium Immediate Annuity
create an immediate income stream from a single lump sum investment. The amount of the payment is determined by the interest rate in effect at the time the contract is issued and by the payment option selected (e.g., life only, joint life, period certain, etc.) Clients who have retirement savings, but not enough to last a lifetime —middle-income retirees- are the people most likely to need to annuitize some or a lot of their retirement assets to provide adequate income.
Qualified Longevity Annuity Contracts
deferred annuities where the lifetime annuity payments do not begin until a later date, usually age 85. QLACs provide a cost-effective way for retirees to trade a portion of their savings for protection against the risk of outliving their assets
GIGO
garbage in, garbage out. Any method of analysis, including Monte Carlo, is only as good as the assumptions and data used
Five-year clock for Roth IRA contributions.
it begins with the individual's initial contribution to a Roth IRA.
Exceptions to the 10% penalty that apply only to IRA's
First time home purchase Qualifying education expenses TABLE 1
Mandatory 20% withholding
Imposed on a qualified plan or TSA distribution (if the distribution is eligible for rollover treatment) if the plan issues a distribution check to the participant. The withheld 20% will be considered a taxable distribution, as it was not part of the rollover. The tax liability on this 20% distribution can be avoided if the participant deposits an equal amount into the rollover account.
Indirect rollover
In this case, the client takes a distribution from a qualified plan, SEP, TSA, IRA, or governmental 457 plan and within 60 days rolls it over to an IRA, the qualified plan, SEP, TSA, or governmental 457 plan of a new employer. Any amount that is not rolled over by the 60th day after receipt of the distribution will be subject to income tax (and the 10% penalty, if applicable). Only one indirect rollover is allowed in a 12 month period.
Maximum Amount for loans
Must not exceed the lesser of $50K or one-half of the present value of the participant's nonforfeitable accrued benefit Any amount above this will be deemed a distribution
Is interest paid on a loan tax deductible
No
Maximum term limit for Loans
No more than 5 years except if for the purchase of a primary residence, which may be for a longer period
Are loans subject to a premature distribution penalty
No unless not repaid by termination of employment
Automatic Rollover Rule
Requires past employers to roll over qualified plans in excess of $1K to an IRA unless the participant elects to have distribution rolled over to another plan or to receive the distribution directly
Hardship withdrawals are available from
TSA Profit Sharing 401k Plans
Rollover
Tax-free transfer of cash or other property from one retirement plan to another
What is the order in which retirement savings should be withdrawn to maximize the lifetime after-tax benefit?
Taxable accounts (taxable savings accounts) first, then partially taxdeferred assets (such as stocks and mutual funds), and then taxdeferred accounts (IRAs, annuities, qualified retirement plans). Tapping the least tax-favored assets first retains the benefits of tax deferral for as long as possible.
What is the negative tax aspect of taking a lump sum distribution?
The tax implication of taking a lump sum distribution is that the entire sum must be recognized as taxable income in the year in which it is received. The magnitude of the tax liability can be mitigated to some degree through the use of forward averaging.
The increase in value in the shares of stock distributed from a qualified stock bonus plan is known as (LO 7-2)
net unrealized appreciation.
Rising Equity Glidepath
the asset allocation path that results from spending down fixed income assets in the early years and letting equity exposure rise over time
