sie chapter 12

although coverdell and 529 plans have identical tax treatment, 529 plans are much more popular, as coverdell has a low maximum contribution limit

a coverdell can be opened for any student under the age of 18, but the assets must be withdrawn by the time the student reaches the age of 30 or else taxes and a 10% penalty apply. in contrast, there is no age limit on the beneficiary of a 529 plan

erisa defines and covers two broad types of qualified corporate plans, defined benefit plans and defined contribution plans

a defined benefit plan is 100% funded by the employer and promises to pay each participant a specified income benefit at retirement age. the benefit may be set at a dollar amount or by a formula that takes into account salary, age, and years of work service. traditional pension plans are usually defined benefit plans

ex. howard has a life annuity with a 10 year period. if howard passes away after year 6, his beneficiary will continue to receive payments for the remaining four years of the period certain. if howard instead passes away after year 17, he will receive payments during the entire period, but once he dies, no payments will be made to his beneficiary

a joint with last survivor option ensures that income will continue through the death of a second annuitant, regardless of who dies first. a common option for married couples, this option results in the smallest monthly benefit because it has the strongest guarantee and longest expected duration

like section 529 plans, able accounts are available in all states and share similar contribution limits, tax treatment, and reporting requirements

able accounts have the same tax structure as 529 plans, allowing the donor to contribute after tax dollars on behalf of an individual with disabilities. the earnings in the plan grow tax free, and distributions for qualified disability expenses (e.g. education, housing, healthcare, and transportation) are completed tax-free at the federal level

iras are the largest component of the us retirement market. iras were created to extend retirement plan coverage to individuals not covered by a workplace plan and to allow those that are covered to receive additional retirement benefits. iras allow individuals with earned income to open their own personal retirement accounts, separate from their employer. these accounts are typically opened by the individual with a bank or BD

an individual can contribute both to a corporate plan and an IRA

all ira contributions must be made by the due date of the individual's next federal income tax return, which is usually april 15

an individual can contribute for 2018 until april 15, 2019

able accounts were created by the ABLE (achieve a better life experience) act of 2014. the act helps ease the financial strain of individuals with disabilities by permitting the opening of tax-free savings accounts that can cover qualified expenses, such as education, housing, transportation, employment support and training, and health and wellness services. these savings accounts can supplement benefits provided through private insurances, social programs, and other sources

an individual is only eligible for an ABLE account if they have a disability prior to age 26

contributions made to a roth ira are always made with after tax dollars. qualified distributions from a roth are tax free (including on the growth). to be qualified, distributions must be made after age 59 1/2 and the money must have been in the plan for at least 5 years

an individual under age 59 1/2 with a valid exception (e.g. disability, education, or major medical expense) can withdraw funds from a roth ira that they have had for less than five years without being subject to a 10% early withdrawal penalty. however, in this situation, the individual WILL BE TAXED on the earnings. note that if the plan has been open for give years, then the earnings will NOT be subject to taxes

any adult may set up and contribute to a 529 plan for a designated beneficiary. the designated beneficiary, typically a minor, does not have to be a relative of the contributor, but the beneficiary must be an existing child (i.e. not an unborn child). additionally, there is no requirement to have earned income in the year of the contribution. all plan contributions are made with post tax dollars, and maximum contributions vary by state

because 529 plans are offered by states, the maximum amount that can be contributed will vary from state to state

qualified corporate retirement plan= a corporate plan that meets the guidelines of ERISA and therefore allows for pre-tax contributions

defined benefit plan= a type of qualified plan, such as a pension plan, where the amount of income received at retirement is predetermined based on the employee's age, position, and tenure with the company

for roth iras, rmds are not required from a roth until the death of the account owner

distributions from a traditional ira must begin on april 1 of the following year following an individual turning 72. this is referred to as the required minimum distribution. for roth iras, the RMD is triggered by the death of the owner

401(k) plans have become the most popular and prevalent type of employer-sponsored retirement plan in the US. they are a type of defined contribution plan that allows each eligible employee the option of deferring a portion of her salary into the plan instead of receiving current pay in cash

employers have the option of matching all or part of each employee's deferrals in addition to, or instead of, making profit-sharing contributions to the plan. 401(k) participation and contribution rates are much higher in plans with generous employer matching. participants in 401(k) plans direct their own investment choices

in order for a corporate plan to be qualified and receive these tax benefits, it must meet ERISA requirements. the landmark employee retirement income security act (erisa) was passed by congress in 1974 to strengthen the retirement security of private-sector american workers

erisa does not apply to plans for public workers or government employees; it applies to private, employer-sponsored plans only

from a regulatory perspective, the separate account is considered an investment company and is subject to registration under the investment company act of 1940. provisions of the securities act of 1933 and securities exchange act of 1934 also apply to variable annuities. the separate account manager is subject to the investment advisers act of 1940

fixed annuities offer both guaranteed principal and a guaranteed fixed rate of interest for the term of the contract, which is managed through the insurance company's general account. they accumulate a stated amount of interest and guarantee that a certain amount of income will be paid. with a fixed annuity "what you see is what you get" there is no variability to the investment returns or payments

ex. jordan works for a technology startup making $200,000 per year. bc jordan's employer does not offer him a corporate plan, jordan can contribute pretax dollars to his IRA. however, if jordan's employer introduces a corporate plan to its employees, jordan will now only be allowed to make after tax contributions to his IRA (because he makes over the income threshold)

from a tax perspective, tax deductible, traditional IRAs work like qualified plans and non-deductible traditional iras work like non-qualified plans

premiums for variable annuities are invested into the insurance company's separate account, which is the foundation of variable products. within the separate account, investors will direct their contributions into various subaccounts. these accounts function like mutual funds, with various risk and reward profiles. a wide variety of subaccount investment obj. can be selected to align with an annuity owner's needs and risk tolerance

general account= fixed return, very little risk; assumed by insurance company, typical investments in high grade corporate bonds, few equities

roth ira contributions are always made with AFTER tax dollars (non deductible). distributions from roth iras are tax free. rmds are never required from roth iras during the account owner's lifetime

if an individual has multiple iras (traditional and roth), the contribution limits apply to all iras in the aggregate. contributions may be made to any account, as long as the total doesn't exceed the annual dollar limit

3. an individual can have a non-deductible (after tax) ira if they are eligible for a corporate plan and make over a certain amount of income (the exact numbers are not important for the exam)

if an individual makes pre-tax contributions to their IRA, it grows tax-deferred, and all distributions are fully taxed ordinary income (scenarios 1 and 2). if an individual makes after tax contributions to their IRA, it grows tax deferred, and only the earnings (i.e. the growth) in the plan are taxable as ordinary income (scenario 3)

ABLE account= a tax advantaged savings account for individuals with disabilities

in a qualified corporate retirement plan employers and employees make pre-tax (i.e. tax deductible) contributions. this means that money is invested into the plan before taxes are paid on those funds. this cash is then invested into any number of eligible securities and those investments will grow tax-deferred. this means there is no tax each year on any investment earnings, including dividends, capital gains, or interest income. when the investor eventually reaches retirement age and makes withdrawals from the plan, all distributions are fully taxable as ordinary income. these tax benefits allow for compounding, or faster growth in the account, as they allow 100% of the yearly earnings to be reinvested to gain additional income, rather than requiring any annual taxes to be paid out

529 college savings plans enable tax-favored savings and investment for payment of qualified educational expenses. these programs are established and maintained by states. all states currently offer 529 plans, which include a variety of investment options. an individual can open a plan in any state; the beneficiary does not need to go to school there. however, certain tax benefits may exist for investing in your home state. all states provide a program disclosure document, which includes a description of their plans

in addition to savings plans, some states and educational institutions have established pre-paid tuition plans which allow for the prepayment of future tuition at one or more designated colleges, often limited to the designated public colleges within the state. in some cases, the cost of future tuition is locked in at the time of purchase. these plans are much less popular and therefore this section will focus on the characteristics of savings plans

a variety of investment obj. are available within 529 plans. some state plans offer age-based investment options, in which the underlying investments become more conservative as the beneficiary gets closer to college age. they also offer risk-based investment options in which the underlying investments remain in the same fund, or combination of funds, regardless of the beneficiary's age. guaranteed or insured products are also offered to protect principal

in most states, muni securities firms are engaged to sell 529 plans. in that case, investors may open an account through one of those authorized firms. these plans are called adviser sold plans

exceptions to the 10% penalty for early withdrawals include: disability of the owner, payment of education expenses for the account owner, her spouse, children, and grandchildren, first time homebuyers (limited to $10,000), medical expenses, death of the account owner

individuals can move their IRA investments from one plan provider to another (e.g. fidelity to wells fargo). this is referred to as a rollover and must be completed within 60 days to avoid potential tax liabilities and early withdrawal penalties

because fixed annuities are not securities, they are lightly tested

investor premium-> insurance company's general account-> fixed return

profit sharing plans= are a type of defined contribution plan that gives employers the flexibility to vary the level of annual contributions each year based on the company's profits. the same percentage of compensation generally must be contributed for all eligible employees. typically these plans are combined with 401(k)s allowing for both an employee deferral contribution as well as a company contribution based on profits

keogh plans= generally established as defined contribution plans, but also referred to as HR-10 plans are qualified plans that allow self-employed individuals and owners of unincorporated businesses to contribute for retirement on behalf of themselves and their employees. because of certain legislative changes, new keogh plans are seldom set up, though many are still in existence

straight life= guarantees payments for life to the annuitant, regardless of how long that person lives. however, no payments are made to the beneficiary upon death. even if the annuitant dies after receiving only a single payment, the insurance company is not obligated to make any further payments. because of the high risk associated with this option, it has the highest monthly payout amount

life with period certain= guarantees payments for life with a minimum period of time during which payments must be made to the annuitant or their beneficiary. if the annuitant outlives this timeframe, they still continue to collect payments until death. however, the beneficiary is only protected during the period certain. a period of 10 or 15 years is common

a 403(b) plan, also known as a tax-sheltered annuity, allows eligible individuals to make tax-deductible contributions to the plan

over the years, the variable annuities have been the source of complaints ranging from abusive sales practices to unsuitable recommendations. finra rule 2330 helps regulate variable annuity sales practices to ensure that customers who purchase these products are protected and that BDs and RRs that sell these products are properly trained and consider the best interests of their customers

roth iras are like traditional iras in several ways: the dollar limits on annual contributions are the same $6000 plus a $1000 catch up for those 50 and over. the contribution is limited to 100% of earned income

owners have discretion to invest in assets in a variety of investment choices and the prohibited transactions are the same as in traditional iras

non-qualified corporate plans carry credit risk if the employer is insolvent

payroll deduction plans and deferred compensation plans are examples of non-qualified corporate plans. their characteristics are not important for the exam, other than knowing that contributions are after tax (non-deductible)

a simple ira is a retirement plan for companies with 100 employees or less

pop quiz 1 defined contribution plan defined contribution plan defined benefit plan defined contribution plan defined benefit defined benefit and defined contribution plan defined benefit defined contribution plan defined benefit plan and contribution plan

roth ira= not tax deductible, all distributions are tax free

pop quiz 3 T F THERE ARE INCOME LIMITS ON WHO CAN CONTRIBUTE. THERE ARE NO AGE LIMITS T T T T T CONTRIBUTIONS ARENT PROHIBITED BECAUSE THE ROTH IRA OWNER OR A SPOUSE IS COVERED BY A RETIREMENT PLAN AT WORK

each state has its own set of rules, but it is important to keep in mind that investors might receive certain tax advantages for opening in-state 529 plans

pop quiz 4 D CONTRIBUTIONS ARE MADE WITH AFTER TAX DOLLARS, FOR FEDERAL INCOME TAX PURPOSES. HOWEVER, SOME STATES ALLOW A STATE INCOME TAX DEDUCTION FOR ALL OR PART OF THE CONTRIBUTION. DISTRIBUTIONS ARE ONLY TAX FREE IF THEY ARE MADE FOR QUALIFIED EDUCATIONAL EXPENSES. WHEN DISTRIBUTIONS ARE NOT MADE FOR QUALIFIED EDUCATIONAL EXPENSES, THE EARNINGS PORTION IS TAXABLE, AND A 10% FEDERAL PENALTY ALSO APPLIES ON IT

these reporting requirements do not apply to local government investment pools (LGIPs)

pop quiz 5 D B A C

ex. ali's 529 plan consists of $175,000 of after-tax contributions. over time, the assets grow to $275,000. when ali takes distributions to pay for college, the growth in the plan of $100,000 is completely tax free

roth iras and 529 plans have the same tax consequences. both offer after tax contributions, which grow tax free, and distributions are completely tax free as long as certain requirements are met

earnings accumulate on a tax-deferred basis- i.e. without current tax consequence

roth iras have these significant differences from traditional iras= roth ira contributions are available only to taxpayers who have an income below a certain limit. once a person's income exceeds the limit, she can no longer contribute to the plan

only the employer, NOT THE EMPLOYEE can contribute to a sep ira

savings incentive match plan for employees (SIMPLE IRA) is another ira plan available to small businesses, usually with no more than 100 eligible employees. in these plans, employer contributions are REQUIRED, and employees also have the option of making their own salary-reduction contributions

keogh is available for self-employed persons only

sep ira= simplified employee pension ira is a type of employer-sponsored retirement plan that is typically offered by small businesses because it is inexpensive to set up and maintain. contributions are made in the name of each participant directly into her individual retirement account or ira. sep iras are at the option of the employer, never required. however, the same percentage contribution must be made for all eligible employees

the payouts received by an investor from her variable annuity will fluctuate each month based on the performance of her separate account

the monthly payment will also be influenced by the payout option selected by the investor before annuitization. once a choice has been made, it cannot be changed. insurance companies offer several payout options

the dollars invested into the contract purchase accumulation units. each unit represents an interest in an underlying subaccount. the value of a unit fluctuates according to the value of securities in the portfolio, just like a share in a mutual fund its value is recalculated daily

the number of accumulation units will vary (the number will increase as the individual invests more money) as will the value of each unit (the value will fluctuate with the market)

investors may also choose to deal directly with the 529 plan. these plans are called direct-sold plans. the investor can access the fund through a primary distributor or directly through state personnel. fees and charges may be lower in a direct-sold plan, though investors may not have access to the advice of an investment professional like they do with adviser-sold plans

the purpose of a 529 plan is to help with payment of qualified higher education expenses. a qualified education expense is one for college, university, a vocational school, or another post-secondary institution that is eligible to participate in a federal student financial aid program. virtually, all accredited colleges and universities in the US qualify

owners of traditional iras are required to begin taking required minimum distributions (RMDs) by april 1 of the year following their turning 72. note that this date was increased from 70.5 on january 1 2020 by the secure act. this date of the first required distribution is referred to as the required beginning date (RBD). after this date, rmds must be made annually by the end of each subsequent calendar year. rmds must continue each year for as long as the owner is alive or until all funds have been depleted. ira owners may take a larger distribution than required by the rmd calculation. the irs requires these distributions so that it can generate tax revenue on funds that may have previously been sheltered from taxation

the rmd depends on the account value and the owner's life expectancy as published in IRS tables

progress check

1. B 2. A 3. D 4. D ALTHOUGH MOST EMPLOYERS MAKE MATCHING OR PROFIT SHARING CONTRIBUTIONS TO 401(K)S, THERE IS NO REQUIREMENT TO DO SO 5. C 6. A 7. B 8. D

unit exam

1. D 2. C 3. C 4. B 457(B) PLANS ARE SPONSORED BY STATE AND LOCAL GOVERNMENTS AND TAX-EXEMPT 501(c) ORGANIZATIONS. THEY SHOULD NOT BE CONFUSED WITH 403(B) PLANS WHICH ARE SPONSORED BY NONPROFIT, RELIGIOUS, AND EDUCATIONAL INSTITUTIONS. A 457(B) PLAN WORKS MUCH LIKE A 401(K) IN THAT IT IS PARTICIPANT-DIRECTED AND FUNDED IN PART BY PARTICIPANT ELECTIVE DEFERRALS 5. D NON QUALIFIED PLANS ARE NOT COVERED BY ERISA. UNLIKE ERISA PLANS, THEY DO NOT HAVE AUTOMATIC ELIGIBILITY RULES. EMPLOYERS CAN INCLUDE OR EXCLUDE ANY EMPLOYEES THEY WANT. THIS MAKES THESE PLANS USEFUL FOR REWARDING HIGHLY PAID, SENIOR, OR LOYAL EMPLOYEES 6. D 7. A A MARRIED COUPLE CAN BOTH CONTRIBUTE UP TO THE DOLLAR LIMIT (PLUS ANY CATCH-UPS) AS LONG AS THEIR COMBINED INCOME EQUALS OR EXCEEDS THEIR COMBINED ANNUAL CONTRIBUTIONS. IN THIS CASE, THEY CAN DIVIDE 6500 IN CONTRIBUTIONS IN ANY WAY AMONG TWO IRAS, TRADITIONAL OR ROTH. SHE IS LIMITED TO CONTRIBUTE 500 SINCE HE CONTRIBUTED 6000 8. D THEIR INCOME IS TOO HIGH FOR EITHER TO QUALIFY FOR A ROTH IRA CONTRIBUTION. ONLY ROTH IRAS HAVE INCOME LIMITS ON CONTRIBUTIONS. HOWEVER, BOTH INDIVIDUALS CAN CONTRIBUTE TO A TRADITIONAL IRA AS CONTRIBUTIONS TO A TRADITIONAL IRA ARE PERMITTED AT ANY AGE, PROVIDED THE INDIVIDUAL HAS EARNED INCOME 9. B WITHDRAWALS FROM IRAS ARE FULLY TAXABLE AT ANY AGE UNLESS THEY ARE WITHDRAWALS OF AFTER TAX CONTRIBUTIONS. EARLY WITHDRAWALS ARE THOSE MADE BEFORE AGE 59 1/2 AND THEY ARE SUBJECT TO A 10% PENALTY, 10% OF THE WITHDRAWAL UNLESS AN EXCEPTION APPLIES. PAYMENT OF EDUCATION EXPENSES FOR THE ACCOUNT OWNER, SPOUSE, HER CHILDREN, OR HER GRANDCHILDREN IS ONE OF THE EXPENSES 10. C FAILURE TO TAKE ALL OF A REQUIRED RMD SUBJECTS THE TRADITIONAL ACCOUNT OWNER TO A FEDERAL EXCISE TAX OF 50% ON THE AMOUNT THAT SHOULD HAVE BEEN DISTRIBUTED. NO EXTENSIONS ALLOWED, THE FEDERAL EXCISE TAX MUST BE PAID 11. C 12. D 13. C 14. A 15. C 16. C

pop quiz 2

1. F 2. T 3. F 4. F 5. F 6. T 7. T ONCE THEY START, RMDS MUST CONTINUE EVERY YEAR UNTIL THE ACCOUNT IS EXHAUSTED

msrb rule g-45 requires underwriters of 529 plans and able programs to electronically submit certain information to the msrb about the investment. specifically, three categories of information need to be submitted semiannually

1. information describing the plan, such as which state is offering it, and the name of the plan and plan manager 2. aggregate plan information, such as total plan assets as well as contributions and distributions during the period 3. investment option information, such as available investment options and their obj., the name and allocation percentage of each underlying investment within each option, expense data, and performance data

traditional ira contributions can be pretax or post tax. three potential scenarios. 1. an individual can have a tax deductible (pretax) ira if they are not eligible to participate in a corporate plan. for ex. the individual's employer does not offer them

2. an individual can have a tax-deductible (pretax) ira if they are eligible for a corporate plan, but make below a certain amount of income (the exact numbers are not important for the exam)

because erisa plans are only available to private sector employees, those who work for nonprofits or in the public sector are not eligible to participate. however, in lieu of erisa plans discussed, they are able to participate in similar types of qualified plans

403(b) plans are erisa plans sponsored by nonprofit organizations and educational institutions. like 401(k)s they allow participants to make elective deferrals. they are also called tax sheltered annuities (TSAs) and may be created for the benefit of employees of public schools, employees of 501(c)(3) tax-exempt organizations - which are charities - and employees of certain types of religious institutions

separate account= the investment account of an insurance company where the owner of a variable annuity contract's premiums are invested in order to generate market based returns

529 plan= a tax advantaged savings account that allows individuals to save for education-related expenses

although not like a municipal fund security, a coverdell works much like a 529 plan, offering after tax contributions, tax free investment growth, and tax free withdrawals when the funds are spent on qualified education expenses (college or earlier). however, the contribution is limited to $2000 per beneficiary per year, and this account type is only available to families below a certain income level

additionally, coverdell funds must be spent or transferred to a family member by the time the beneficiary turns 30, or the funds will be subject to federal income tax as well as a 10% penalty

every erisa-covered retirement plan must have at least one fiduciary who is legally required to act in the best interest of the plan participants

additionally, the plan must be non-discriminatory, meaning it must be offered to every full-time employee who is at least 21 years old with one year of service with the employer. part time workers who work at least 500 hours in three consecutive years must also be eligible to participate in the plan

annuities are another investment vehicle that aims to help individuals save for retirement. these products, which are offered by insurance companies, pay a stream of income that is guaranteed for the life of the contract owner, known as the annuitant. while life insurance is designed to protect against dying too soon, annuities are said to protect against living too long, and subsequently running out of savings

annuities can be deferred or immediate. deferred annuities accumulate earnings until a future date when payments of income to the annuitant begin. a deferred annuity can be purchased with either a single premium or periodic payments. immediate annuities begin payments shortly after the contract is issued (usually within one month to one year). the payment amount varies by the age of the individual, the contribution amounts, and the earnings applied to the purchase payments. a longer deferral period allows the annuity to accumulate more earnings, which increases the amount of the potential payout

accumulation period: annuitant makes payments to the insurance company. annuitant "buys" accumulation units in a selected subaccount. annuity has "death benefits"

annuitization period= annuitant receives payments from the annuity

while historically, 529 plans could only be used for higher education expenses, the tax cuts and jobs act passed at the end of 2017 expanded the usage of these accounts to elementary or secondary school. now up to 10,000$ can be distributed annually from the plan to cover the costs associated with elementary school and high school

as mentioned, 529 plans offer a tax advantaged way to save for education. specifically, owners contribute after tax dollars into the plan. the investments within the plan grow tax free, meaning the investment earnings generated each year are not taxed. distributions used to pay for qualified educational expenses are also tax free. note that, although distributions are tax free at the federal level, certain state tax consequences may apply

recently, the trend in retirement plans has been toward defined contribution plans. these allow both employers and employees to make contributions to accounts. unlike with defined benefit plans, no minimum benefit is promised. instead, the participant's retirement income is based on the amount contributed to the plan and the performance of the chosen investments. once participants reach retirement age, they take distributions from the plan

because defined contribution plans meet erisa guidelines, they are all qualified plans, meaning they enjoy tax deductible contributions and tax deferred growth, and all distributions are taxed as ordinary income

variable annuities are similar in structure to retirement plans, albeit with some insurance like differences

because investors take on the investment risk in variable annuities, variable annuities are considered securities and must be registered with the SEC and sold with a prospectus. the prospectus contains important information about the annuity contract, including fees and charges, investment options, death benefits, and annuity payout options

in contrast, some states penalize their residents for opening out of state plans. for ex, if an investor opens a plan in another state, although that investor receives federally tax free distributions, she many be required by her state of residency to pay state taxes on the plan's growth

because these plans are sponsored by states, they are subject to msrb regulation, which requires RRs to disclose potential out of state tax consequences to investors at or prior to the sale of securities involved in an out of state 529 plan

investor premium->insurance company's separate account->variable return

because variable annuities are securities, they can only be sold by individuals with both insurance and securities licenses

finally, the plan requires a vesting schedule, which specifies when participants have ownership rights to employer contributions. once benefits are vested, they cannot be taken away because of an event, such as the company's bankruptcy or an employee's dismissal from work. for ex. the schedule might say that if the employee leaves the company after two years of employment, he only gets to keep 50% of employer contributions, but if he leaves after four years, he gets to keep 100% of employer contributions

erisa requires that all of the employee's own contributions to the plan must be immediately vested, while employer contributions must be 100% vested after five years of work service

a pension plan is a defined benefit plan

ex. a defined benefit plan promises to pay a participant a monthly benefit that equals 1% of that person's average monthly salary in the last three years of employment, multiplied by years of total service. a participant who has worked 30 years might receive a monthly retirement income check equal to 30% of average salary

withdrawals from traditional iras may begin without penalty at age 59 1/2. if a withdrawal is made by a traditional ira prior to age 59 1/2, a 10% penalty is due unless an exception applies

ex. frank is downsized by his employer and needs to tap his traditional ira for cash at age 55. he withdraws $20,000 all of which were tax deductible contributions. he will add $20,000 to his taxable income for the year of the withdrawal and pay a $2000 penalty

during the accumulation phase, investors also have an insurance-like feature called a guaranteed death benefit. if an investor dies during this period, the investor's beneficiary receives the greater of the current value of the contract or the amount contributed (in the case that the contract's market value has decreased). the death benefit usually ends upon the annuitizaiton of the account

ex. jillian funds a variable annuity by contributing $100,000. over the five years, the value of the annuity grows to $150,000. if jillian passes away during the accumulation phase, her beneficiary joe, receives $150,000 (the greater of the current value and the amount invested). however, if jillian's investment had decreased to $80,000, joe would receive $100,000 (the amount invested)

traditional iras are personal accounts, always held in ONE individual's name, NEVER JOINTLY. however, if a working spouse has a traditional ira, that person can make a contribution in a separate traditional ira on behalf of a non-working spouse with no compensation. this separate ira is referred to as a spousal ira

ex. john and helen, a married couple, have total compensation of $80,000, all earned by john. john is 52, and helen is 48. john can contribute $7000 (regular + catch up) to his traditional ira, and he can contribute $6000 to helen's plan

distributions from a roth ira are completely tax free, including the growth, if they meet two tests: 1. distributions are made after the five year period that began with the first ta year in which a roth was established 2. distributions are made after reaching age 59 1/2

ex. kenneth established a roth ira on november 14, 2012. he meets the first test by waiting until 2017 to take a distribution, since 2012 is year 1 and 2016 is year 5. if he takes a distribution on or after january 1, 2017, when he is aged 59 1/2, it is qualifying and tax free

failure to take an rmd subjects the account owner or beneficiary to pay 50% excise on tax on the under-distributed amount

ex. leonard forgot to take an ira distribution to meet his rmd requirement at age 74. the rmd for the year was $10,000. he must pay $5000 on the shortfall

unlike qualified retirement plans, non-qualified plans do not create an immediate tax deduction for the company, meaning they are non-deductible or after tax. instead, the company sets money aside for the future use of key employees, as long as employees have no current ownership or control of assets, they do not pay current income tax. typically, tax is owed by the employee and companies take tax deductions when plan benefits are distributed

ex. robin is the ceo of xyz company. as a benefit to her, the company provides her a non-qualified corporate plan and funds it by contributing a total of $500,000. when robin reaches retirement, the account value has grown to $700,000. because the company's contributions are after-tax, robin is only required to pay ordinary income taxes on the growth of $200,000

all employee deferrals to the roth account are made POST TAX. roth distributions will be received by the participant TAX FREE if they are taken at least FIVE years after the first roth deferral, and the participant is at least age 59 and a half when the first distribution is made

ex. roy defers $2000 into his regular 401(k) account and another $1000 into his roth 401(k) account. his employer matches 100% of his contributions. all $3000 of employer contributions will go into the regular 401(k) account

the account owner retains control over plan assets, including the ability to select investments. the owner retains control until the money is withdrawn and spent. additionally, the owner has the right to change the designated beneficiary at any time, without tax consequences, provided the beneficiary is a family member of the old beneficiary

ex. ted has two children, barbara 14, and henry 11. he sets up a 529 savings plan and names barbara the designated beneficiary. over several years, ted makes contributions and the account grows in value. however, barbara decides not to go to college. ted may change the beneficiary to henry and continue making contributions for henry's college education. later, ted could change the beneficiary from henry to a grandchild if he wanted

if an investor's investment obj. have changed, they can transfer from one annuity contract to another without incurring any tax liabilities via a 1035 exchange. although the exchange is tax free, surrender charges may still apply

muni fund securities are investment pools like mutual funds, but they are instead issued by a state or local government entity. two types of muni fund securities - ABLE accounts and 529 plans - have a tax advantaged structure similar to those of the accounts and products discussed in this chapter. as with retirement investments and annuities, no annual taxation applies to the growth in these plans, meaning any capital gains, dividends, and interest income can be fully reinvested back into the funds without taxation. instead, they provide certain tax benefits to help those saving for education as well as with expenses for those with disabilities

corporate retirement plans: erisa qualified= 401(k), keogh plan (hr-10), pension plan

non qualified= payroll deduction, deferred compensation

457(b) plans are participant directed, erisa, deferred compensation plans sponsored by state or local government entities, as well as tax exempt 501(c) organizations. in virtually all respects, they work the same as 401(k) and 403(b) plans, with the same tax treatment and contribution limits

non-qualified corporate plans offer employers the opportunity to avoid the strict requirements of qualified plans. a non-qualified plan's main advantages include: flexibility to choose which employees participate, flexibility to structure the plan so that it offers greater reward to the most valuable executives, avoidance of nondiscrimination tests (because they are not ERISA covered), no limits on the amount of income that can be contributed

defined contribution plan= a type of qualified plan, such as a 401(k), where retirement income is based on the amount of money contributed to the plan and the performance of those investments

non-qualified corporate retirement plan= a corporate plan that does not meet the guidelines of ERISA and therefore only allows for after-tax contributions

most annuity contributions are made with after tax dollars. therefore, if a withdrawal is made by an annuity owner, income taxes are due on the difference between the amount paid into the annuity (i.e. basis) and its total value

note that, if the annuity was part of a qualified retirement plan for ex. a 403(b) plan, and all contributions were made with pretax dollars, all distributions would be subject to ordinary income taxation. in addition, as previously mentioned, any withdrawals prior to age 59 1/2 are subject to a 10% penalty

when free of annual taxation on gains and distributions, funds within variable annuities can accumulate at a much more rapid pace than when taxed

once withdrawals are made from annuity contracts, tax consequences will apply

in a non-qualified plan, after tax or non deductible contributions are made. the earnings in the plan grow tax deferred, and when the distributions are taken, the only GROWTH is taxed as ordinary income

one major risk of a non-qualified plan is the potential loss of benefits if the company changes its mind about paying them or is acquired by another company that does not wish to pay them. additionally, the assets in the plan are not protected if the company goes bankrupt, which means there is a risk of default, as the assets can be claimed by creditors

contracts typically have a minimum payment amount, called the premium. a contract may be funded with a single premium, a lump sum payment, or periodic payments that can be paid on a predetermined schedule or flexible schedule, depending on the purchaser's preference

one of the main benefits of annuities is that, like retirement plans, the investments grow tax deferred. this means that an investor will not pay taxes each year on the earnings or growth in the plan. the investor only pays taxes when he takes distributions

in this ex, the account owner is incentivized to hold the account for at least 10 years to avoid surrender charges, creating a lack of liquidity during the first 10 years

one of the most attractive benefits of variable annuities is tax-deferred growth. this benefit applies to annuities while in the accumulation phase. similar to retirement plans, the dividends, interest, and capital gains earned on investments are reinvested without incurring tax

an insurance company that offers both fixed and variable products manages its investments through two types of accounts. the general account of the insurance company invests customer premiums into conservative investment options, such as treasury securities and high grade corporate bonds, that deliver guaranteed returns to investors who own fixed insurance products. the general account usually has little equity exposure because of the need to continually deliver these guarantees to the owner

one product that an insurance company might offer investors through the general account is a guaranteed investment contract (GIC). a gic is an insurance contract that functions like a time deposit. an investor agrees to deposit cash with the insurance company for a fixed period and in return the insurance company provides the investor with a guaranteed rate of interest as well as return of principal

ex. harry is a college student who has a part time job. he earns $4000 in a year. he can contribute up to $4000 to his IRA in that year - 100% of his compensation. if harry earned more than $6000 in a year, the most he could contribute is $6000

only earned income can be contributed to an IRA. investment income, such as capital gains, dividends, interest, and pension income, cannot be contributed. if an individual's sole income is investment income, that person cannot contribute to an IRA

ex. over the course of her career, leigh contributes $80,000 into her qualified corporate retirement plan, which she invests into various mutual funds. at the time of retirement, the value of leigh's funds has grown to $150,000. leigh is required to pay ordinary income taxes on the distribution of $150,000

qualified plans allow for pre-tax contributions and tax-deferred growth. all distributions are taxable as ordinary income. taxable distributions from ANY retirement plan are always taxed as ordinary income, NEVER as capital gains

to be qualified, expenses must be required by the institution. qualified expenses include tuition, books, supplies, equipment, technology fees, internet service fees, and expenses for special needs students

room and board is a qualified educational expense only if the student is enrolled at least half time. in this case, expenses may not exceed the allowance for room and board, as determined by the institution

ex. abc company agrees to match 50% of each worker's elective deferral up to 5% of salary. jim, an employee, earns $100,000 and defers 10% of his pay - 10,000 per year. the company matches 50% of the first 5% of his elective deferral, for a matching contribution of $2500. each year, jim's 401(k) grows by total contributions of 12,500% plus investment earnings

roth 401(k) accounts. since 2006, 401(k) plans have been allowed to add a roth account feature. technically, a roth 401(k) is an optional roth account, which may be offered by the employer, to which each participant may choose to contribute in addition to their regular 401(k) contributions. the roth account works like a roth ira inside the plan. only employee contributions go in the roth account, employer match contributions are made to the regular 401(k) account

individual retirement account (IRA)= a retirement account that can be opened by an individual with earned income separate from the retirement plans offered by their company

roth IRA= a special type of retirement account available to individuals with lower income that allows for completely tax-free distributions of the growth and earnings in the account

because a straight life plan has the most risk and shortest expected duration, it pays the highest monthly income. in contrast, because a joint with last survivor plan has the least risk and longest expected duration, it pays the lowest monthly income

several charges apply to variable annuities, which can negatively impact the owner's return on investment. one important fee is surrender charges, which applies when money is withdrawn from the annuity within a certain period of a purchase payment. they are a type of back end sales charge that ensures the insurance company recoups the cost of sales commissions that are paid to RRs when the product is sold. surrender charges commonly apply for six to 10 years from the time of purchase. they are assessed as a percentage of the amount withdrawn and generally decline over the surrender charge period

investors typically make cash contributions to their iras and from there have broad discretion to invest in many types of assets, including stocks, bonds, mutual funds, and etfs

several types of investments are prohibited in iras: fixed life insurance, antiques and collectibles (other than certain us issued gold and silver coins), option positions, other than covered call writing programs on listed options, and real estate

separate account= variable return, risk varies. investors can select investments that range from aggressive (equities) to conservatives (treasuries or money market funds); risk assumed by account owner. typical investments= varies based on subaccount investments; do have market risk

sometimes insurers manage separate accounts with their own investment managers. alternatively, management responsibilities can be delegated to mutual fund subaccount managers

also note that any distributions from the plan are that are not used for qualified education expenses are subject to ordinary income tax as well as a 10% federal penalty

states offer 529 plans to help individuals save for higher education. in order to incentivize state residents to open in-state plans, certain tax benefits might be offered. for ex, some states allow a certain portion of the money contributed into the plan to be tax deductible and allow for tax free contributions at the state level

many different avenues allow for investors to save for retirement, including employer-sponsored plans, individual retirement accounts, and annuities. a main advantage of these plans is that the investor's earnings accumulate on a tax-deferred basis, meaning that there is no tax paid on the growth in the plan until the money is withdrawn. this allows for compounding growth, as the investor an reinvest 100% of the account earnings each year without having to pay any taxes

tax-deferred= the manner in which retirement accounts and other tax advantaged accounts grow meaning no taxation on the capital gains, dividends, or interest income that is generated each year until the funds are distributed from the plan

in a fixed annuity, the investor earns a guaranteed fixed return and any risk of negative performance of the investments is assumed by the insurance company. in a variable annuity, the investor earns a variable return based on the market performance of the investments they select within the insurance company's separate account; the investor bears the risk of any reduced payout

the accumulation phase is the time during which an annuity owner is putting money into the contract. the purchaser can choose to invest with a lump sum purchase or on a periodic-payment basis

defined benefit plans do not have individual employee accounts. rather, all company contributions are deposited into a trust and professionally managed to produce investment returns that are designed to meet the required retirement benefits. the employer bears 100% of investment responsibility and must make additional contributions if investment performance is poor or fails to attain the plan's goals. the employer must higher a professional known as an actuary to calculate the amount of annual contributions required to fund promised future benefits for all employed and retired participants. if the investments do not perform as expected, there is a risk of an underfunded pension plan, meaning there are not sufficient assets to pay retirement obligations

the complexity and administrative costs of defined benefit plans have caused many employers to discontinue offering them, and to offer defined contribution plans instead

importantly, the insurance company, not the investor, bears the investment risk, meaning that no matter how the market is performing, the insurance company must always pay the investor the guaranteed fixed rate. because investors do not bear the risk, fixed annuities are not securities, and individuals selling these products only require an insurance license, not a securities registration

the convenience and predictability of a constant, fixed payout make a fixed annuity popular with individuals who want a known income stream to supplement their other retirement income, and are wary of the stock market's ups and downs. however, these fixed payments may not keep pace with the rate of inflation

variable annuity sale recommendations= a sale is not to be recommended unless a rep has reason to believe that the product and any subaccounts chosen are suitable for the customer and that the customer would benefit from the features of the variable annuity. the customer must be informed of: the potential surrender period and surrender charges, potential tax penalty if customers take distributions before reaching age 59 1/2, fees paid for management of the subaccounts, sales charges paid to the rep, the insurance and investment component (e.g. death benefits and separate account), and market risk associated with investing in the product

the various fees and expenses imposed by annuities can make them costly to own, and reinforce that they are designed for long term investors

traditional IRAs are the most popular type of IRA. persons who work and earn compensation along with their spouses, can set up a traditional ira and make annual contributions

there is no minimum age, so even a child with a compensation is allowed to contribute to a traditional IRA. the maximum contribution as of 2020 is the lesser of $6000 or 100% of the individual's annual earned income, which includes wages, salary, and commissions. described differently, an individual can contribute up to $6000 of earned income to an IRA. in addition, individuals age 50 or over may add an annual catch up contribution of $1000, bringing the total to $7000. if the limit is exceeded, a 6% penalty is assessed on the excess amount

traditional ira (pre tax)= tax deductible, all distributions are taxable as ordinary income

traditional ira (post tax)= not tax deductible. distributions in excess of basis (i.e. contributions) are taxable as ordinary income

the greatest risk of a fixed annuity is purchasing power risk, as the fixed payments may not keep up with inflation

unlike their fixed counterparts, variable annuities are designed to boost retirement savings by offering returns based on market performance. because of this, they are resistant to inflation and provide the possibility of greater returns. variable annuities do this by allowing the contract owner to invest in the insurance company's separate account in a broad range of professionally managed investment options, typically mutual funds. contract owners may choose investments that offer different levels of risk and potential growth. the value of a variable annuity will vary, depending on the performance of the investment options that were chosen

fixed annuity= a contract between an individual and an insurance company that is used to supplement retirement savings and guarantees the owner a fixed rate of return for life

variable annuity= a contract between an individual and an insurance company that is used to supplement retirement savings and provides the owner with variable returns over their lifetime based on the market performance of the portfolio

the second phase of the annuity is annuitization, where the investor can begin taking income from the plan. as with iras, distributions can begin at age 59 1/2 with early withdrawals subject to a 10% penalty on the earnings

when the contract is annuitized, the accumulation units are converted into a fixed number of annuity units. the value of the annuity units determines the amount of payment the annuitant will receive each month. the payout amount under these circumstances is variable, which means it will fluctuate in value, and each payment may be worth a different amount. while the amount of the payment may change from month to month, the annuitant is guaranteed that payments will be made for life