Unit 24 - Retirement Plans including ERISA Issues and Educational Funding Programs

Note

IRA's are not to be confused with qualified plans or nonqualified plans used by business. Qualified plans are employer-sponsored and meet the IRS requirements for the contributions to the plan to be tax-deductible and the earnings to grow tax deferred.

Comparison of IRAs and Keogh Plans

IRAs does not involve employer contributions and thus is not a qualified plan by ERISA.

Real Estate in an IRA (or Qualified Plan)

If done hands-off , its unlikely there will be an issue. Any personal benefit or allowing prohibited persons, then a problem.

Summary Dusteibution Rules from both Qualified Plans and IRAs

In applying distribution rules, all traditional IRAs and SEPs are treated as a single account and must be liquidated at least to the extent of percentages specified on IRS tables. Qualified plans, however, are not aggregated; distributions from one qualified plan are not affected by distributions from another. What that means is an individual with multiple IRAs computes the RMD from each, but can elect to distribute the amounts from each IRA or select the IRA(s) from which to make the distribution. In the case of multiple qualified plans, (the individual worked for more than one employer and did not rollover the earlier employer's plan), the required RMD must be taken from each plan; there is no combining as there is with IRAs Lifetime Distributions In general, withdrawals from both IRAs and qualified plans are taxed as ordinary income. However, withdrawals from such arrangements occurring before owners turn age 59½ are subject to an additional 10% premature withdrawal penalty. Withdrawals from both escape the penalty when they are made on account of death or total disability, correcting excess contributions, or as a series of substantially equal payments over the life of the plan participant and beneficiary, if applicable. Only in the case of a qualified plan is the penalty avoided by using a qualified domestic relations order (QDRO) TEST TOPIC ALERT Although pre-59½ withdrawals from IRAs for education and first-time home purchase escape the early withdrawal penalty, withdrawals from qualified plans for those purposes do not. The 10% tax will not apply on withdrawals from either of these before age 59½, however, if: • the distribution is made to a beneficiary on or after the death of the employee/individual; • the distribution is made because the employee/individual acquires a qualifying disability; or • the distribution is made as a part of a series of substantially equal periodic payments under IRS Rule72(t), beginning after separation from service with the employer maintaining the plan before the payments begin, and made at least annually for the life or life expectancy of the employee/individual or the joint lives or life expectancies of the employee/individual and his designated beneficiary. (Excepting in the case of death or disability, the payments under this exception must continue for at least five years or until the employee/individual reaches age 59½, whichever is the longer period.) TAKE NOTE After a person begins taking distributions from an IRA under Rule 72(t), contributions, asset transfers, or rollovers are not permitted while receiving payments. Penalty Tax on Failure to Make Required Minimum Distributions As with IRAs, other than a Roth IRA, failure to distribute the required amount from qualified plans generates a 50% penalty tax on the shortfall in addition to ordinary income taxation. However, as mentioned earlier, and of particular importance as employees are working to much later ages than in previous generations, there are no RMDs from a qualified plan while still employed by the sponsor of that plan, regardless of your age. Withholding on Eligible Rollover Distributions from Qualified Plans Distributions paid to an employee are subjected to a mandatory federal withholding of 20% if the distribution is an eligible rollover distribution. Eligible rollover distributions (those which can be rolled over or transferred without current taxation) do not include the following: • RMDs; • hardship distributions; • substantially equal lifetime payments (SEPP); • distribution of excess contributions; and • loans treated as deemed distributions. TAKE NOTE An employee may avoid the 20% withholding by having the distribution processed as a direct rollover to an eligible retirement plan. In a direct rollover the distribution check is made payable to the trustee or custodian of the receiving retirement plan

FAFSA and Custodial Accounts

In our discussion of educational funding programs, it was mentioned that money in Coverdell ESAs and Section 529 plans is only counted at a 5.64% rate when determining the family's financial contribution toward college. Assets held in a custodial account (UTMA or UGMA) are counted at a 20% rate—a true disadvantage when compared to the other plans.

Investment Options for 529 Plans

U.S. Savings Bonds are not avail as investment options in Section 529 plans

Roth IRA Eligibility

Unlike traditional IRA, there limits placed on Roth eligibility based on income. Anyone with earned income is eligible to open a Roth provided the persons AGI falls below specified #. Single < 122 (Full). Phaseout between 122K and 137K. Married < 193K. Phaseout between 193K and 203K.

SEP & Keogh plan (Diff)

small businesses can use retirement plans to reduce their tax burden, help fund retirement, shield assets and help recruit and retain employees. The options that exist depend on the business structure and the intended goal. For self-employed individuals and small-business owners two plans are often used: the Keogh and the Simplified Employee Plan IRA. Both the Keogh and the SEP-IRA offer compounded annual returns and an increase in value tax free until the assets are distributed. Which plan to choose for maximum benefit will depend upon whether you're self employed or a small business owner and how much money you make. The Keogh plan, also called an HR 10 plan, is a qualified retirement plan with use limited to self-employed individuals and small businesses operating as sole proprietorships or general partnerships. This includes single-member limited liability companies treated as disregarded entities for tax purposes. Keogh plans can be set up as defined benefit plans or defined contribution plans. Defined benefit plans-traditional pension plans-pay out a certain dollar amount per month in retirement. Defined contribution plans-like 401(k)s and 403(b)s-specify the monthly or annual contribution. A Keogh offers two types of defined contribution plans: money purchase plans and profit sharing plans. The profit sharing plan option provides the most flexibility. The Keogh profit sharing plan allows the contribution percentage to vary from year to year. However, the Keogh money purchase plan option requires the business owner to set the contribution percentage when she establishes the plan. This percentage must be met each year; otherwise, the individual will be subject to a penalty in the year the percentage is not met. A SEP-IRA is a self employed IRA also available to small businesses, including corporations and limited partnerships, with employees. The SEP must be established by and for each and every eligible employee. The laws governing the SEP-IRA mandate that the contribution percentage be the same for all employees and that the company, not the employee, contributes the funds to the plan. The company does not have to make contributions every year. Both SEP-IRAs and Keoghs can be established at brokerage firms, banks or insurance companies and can invest in stocks, bonds, mutual funds, money market funds, CDs and annuities. Neither type of plan can invest in real estate. Keoghs have more paperwork that requires professional administrative assistance and thus incurs a higher financial toll. If the defined benefit plan is elected, the complexity increases, but so do the contribution limits. All contributions to a SEP are completely tax deductible, but the Keogh has limitations for the defined contribution plan option. Because of these differences, highly compensated self-employed individuals typically prefer to use the Keogh plan, and small businesses with several employees prefer the SEP. For the 2018 tax year, the SEP-IRA has a maximum deductible contribution limit of the lesser of 25 percent of annual compensation or $55,000. The Keogh's defined benefit plan option allows a contribution of the lesser of $220,000 or 100 percent of the participant's average compensation over the last three years; however, if the plan is a defined contribution plan, the limit is the lesser of $55,000 or 100 percent of the participant's compensation for the year. For example, if you have a defined contribution Keogh plan and your compensation in 2018 was $100,000, your contribution limit for the year is $55,000. However, if you have a defined benefit plan, and your compensation was $100,000 in 2018, $120,000 in 2017 and $95,000 in 2016 (for a three-year average of $105,000), your contribution limit is $105,000. If you have a SEP and you made $100,000 in 2018, your limit is $25,000, which is 25 percent of $100,000.

529 Plans

* Note: these plans are considered municipal fund securities, and under the rules of the MSRB, require delivery of an official statement, sometimes called an offering circular, but never referred to as a prospectus. Two types: 1. Prepaid Tuition Plans - pay for tuition at today's rates; sponsored by state governments and have residency requirements ; 2. College Savings Plans Tax Treatment - earnings are not subject to federal and state tax so long as withdrawals are eligible college expenses, such as tuition and room and board and even a computer. $ used for ineligible expenses will be subject to income tax and additional 10% federal tax penalty. - Many states offer deductions or credits against income tax for investing in a 529 plan

Health Saving Account

- a tax-exempt trust or custodial account people can set up with a qualified HSA trustees to pay or reimburse certain medical expenses.

Keogh Plans

- are Employee Retirement Income Security Act (ERISA) qualified plans intended for self-employed individuals and owner-employees of unincorporated business concerns or professional practices. Included in the self-employed category are independent contractor, consultants, freelancers and anyone else who files and pays self-employment Social Security taxes. The term owner-employee refers to sole proprietors. A corporation cannot use a Keogh plan. Contributions - limits are higher than those of an IRA. For 2019, as much as 56K can be contributed on behalf of a plan participant. Those eligible may also maintain an IRA, but if the earning limits are exceeded, the IRA contribution will not be deductible. If the business has employees, they must be covered at the same contribution % in order for the plan to be nondiscriminatory. * only the earnings from self-employment count toward determining the max that may be contributed. If, for example, a corporate employee had a part time consulting job, only that income, not the corporate salary, could be included in the computation. Eligibility 1. Full-time employees - receive compensation for at least 1000 hours of work per year 2. Tenured employees - completed one or more years of continuous employment 3. Adult employees - are 21 years of age or older

Contributions to a 529 Plan

-Any adult can open a 529 plan for a future college student. -Contributions are made with after-tax dollars, but qualified withdrawals are exempt from federal taxation. If any tax is due on withdrawal, it is the responsibility of the student, not donor - a donor may contribute a max of 75K (150K if married) in a single year for each Section 529 Plan beneficiary without gift tax consequences. This represent 5 year advance on the (2019) 15K per recipient annual gift tax exclusion. After 5th year, this can be done again. - donor of 529 plan assets retains control of most 529 accounts and may take the money back at any time (although a 10% penalty tax may apply).

403(B) Plans (Tax-Exempt Organizations)

- are qualified tax deferred retirement plans for employees of public schools systems (403(b) employees, and tax-exempt non profit organizations such as churches and charitable institutions -Qualified employees may exclude contributions from their taxable (gross) incomes provided they do not exceed limits -Earnings accumulate tax free until distribution -Qualified annuity plans offered under 403(b) are sometimes referred to as tax sheltered annuities (TSAs) Investments - historically called TSA's because 85% of all 403(b) money is invested in either fixed or variable annuities. Mutual fund purchases are now permitted. -Guaranteed Investment Contracts (GICs): issued by insurance companies that offer a guaranteed return of principal at a certain date in the future and come with fixed rate of return that is a bit higher that a CD. Unlike CDs, GICS are not FDIC insured.

Nonqualified Plan

- does not allow employer a current tax deduction for contributions. Instead, the employer receives the tax deduction when the money is paid out to the employee. Normally, earnings accumulate on a tax-deferred basis. A non-qualified plan need not comply with nondiscrimination plans. The employer can make nonqualified benefits available to key employees and exclude others. - not subject to the same reporting and disclosure requirements as qualified plans. However, nonqualified plans must still be in writing and communicated o the plan participants. Sponsors of nonqualified plans are fiduciaries. Taxation -cant deduction nonqualified plan contributions made on behalf of a participants until paid to the participant, However, if the nonqualified plan is properly designed, contributions are not taxable to the employee until the benefit is received. -Contributions to NQ plans that have already been taxed make up the investors cost base. When the investor withdraws $, the cost base is not taxed. However, earnings are taxed. Types of Plans: 1. Payroll deduction plans; 2. deferred compensation plans; 3. Supp executive retirement (or retention) plans Payroll Deduction Plan - $ is deducted from employee's check (after tax) and invested in an investment vehicle. Deferred Compensation Plan - contract between employer and employee whereby employee agrees to defer receipt of current compensation in favor of a payout at retirement. SERP Plan - supp exec retirement plan (SERP) provides benefits to executives over and above the benefits available from a qualified plan and is funded entirely with employer funds. The plan is unfunded or funded. -rewards executives continued employment or encourages the early retirement of the executive. -established also to protect the executive from involuntary termination if company changes ownership. -frequently funded with cash value life insurance policies

Corporate Sponsored Retirement Plans

- include pension plans, profit-sharing plans, and 401(k) plans -established under a trust agreement. A trustee is appointed for each plan and has a fiduciary responsibility Defined Contributions and Defined Benefit Plans - all qualified retirement plans fall into one of two categories: those that offer no specific end result, but instead focus on current, tax deductible contributions, defined contribution plans. Those that promise a specific retirement benefit but do not specify the level of current contributions are defined benefit plans. Define Contribution Plans - include money purchase pension plans as well as profit sharing plans and 401(k) plans - Max employer contribution is currently 56,000 ultimate account value depends on total amount contributed, along with interest and capital gains from the plan investments. - plan participant assumes the investment risk - deduction for contributions cannot be more than 25% of the total payroll for the year Defined Benefit Plans - provides specific retirement benefits for participants, such as fixed monthly income or a specified sum at retirement (cash balance plan). - defined benefit plan sponsor assumes the investment risk Contributory vs. Noncontributory Plans - both the employer and employee make contributions to the account. In a noncontributory plan. Only the employer makes the contributions. The most common example of a contributory plan is the 401K plan where the employer determines how much to contribute and the employer may match up to a certain percentage. * employer contributions to defined benefit or defined contribution ( money purchase), pension plans are mandatory. Although profit sharing plans and 401K plans are technically defined contribution plans, they are not pension plans, and employer contributions are not mandatory. In all cases, allowable employer contributions are 100% deductible to the corporation. There is no tax obligation until withdrawal.

Section 457 Plans

- is a deferred compensation plan set up under Section 457 of the tax code that may be used by employees of ta state, political division of a state, and any agency or instrumentality of the state. This plan may also be offered to employees of certain tax-exempt organizations, unions, and so forth, but not churches. In a 457 plan. employees can defer compensation, and the amount deferred is not reportable for tax purposes. Therefore, the employee receives a deduction each year for the amount deferred. Important facts:

Roth 401K

- like a 401k plan, it has employer-matching contributions; however, the employer match me be deposited into a regular 401k plan and be fully taxable upon withdrawal. Thus, the employee has two accounts: a Roth and Roth 401K. - Unlike Roth IRAs, Roth 401k plans have no income limit restriction on who may participate. One may have both a Roth 401(k) and Roth IRA, but income limits would still apply to the Roth IRA. Also, Unlike Roth IRAs, Roth 401k plans require withdrawals to begin no later than age 70 1/2.

Coverdell Education Savings Account

- max annual contribution is 2K per beneficiary (phased out - see image) - contribution cut-off date 4/15 - allows after tax (non-deductible) contributions to accumulate on a tax deferred basis - earnings portion of a distribution is excluded from income when used to pay qualified education expenses. - Withdrawn earnings are taxed to the recipient and subject to a 10% penalty when they are not used to pay for qualified education expenses. Option: roll over into a different Coverdell for another family member to avoid penalty - if money is not used by a beneficiary's 30th birthday (except for a special needs beneficiary), it must be distributed and the earnings are subject to ordinary income taxes and a 10% penalty -Contributions must be made in cash and must be made on or before the date the beneficiary attains age 18 unless the beneficiary is a special needs beneficiary

Taxation of UGMA/UTMA account

- minor must file an annual income tax return and pay taxes on any earned income. IN the case of unearned income, such as dividends and interest, until the minor reaches age 19 , or the individual is a full time student under 24, that unearned income in excess of 2,100 is taxed using the trust tables where rates get as high as 37% when the income exceeds 12,750. This is referred to as the kiddie tax. - although the minor is responsible for the taxes, in most states, it is the custodian responsibility to see that the taxes are paid.

Disclaiming an IRA

- must be done within 9 months of death - must be in writing - must not have taken any of the money - assets pass to contingent beneficiaries according to decedents will (unless will gives the authority)

Profit sharing plans

-Profit sharing plans need not have a predetermined contribution formula. Plans that do include such a formula generally express contributions as a fixed % of profits. To be qualified, profit sharing plans must have substantial and recurring contributions - profit sharing plans are popular because they offer employers the greatest amount of contribution flexibility. The ability to skip contributions during years of low profits appeals to corporations with unpredictable cash flows. They are also relatively easy to install, administer, you communicate to your employees.

Non-taxable withdraws

-death -disability -first time purchase of primary residence -qualified higher education expenses for immediate -family members - certain medical expenses * note: one way to tap your IRA before 59 1/2 without penalty is through the substantially equal periodic payment (SEPP) exception. Rule 72(t) states that if you receive IRA payments at least annually based on your life expectancy, the withdraws are not subject to a 10% penalty

Net Unrealized Appreciation (NUA)

-employers enable employees to buy stocks or bonds of their company inside a 401(k) or other retirement plans. The distribution of employer securities is sometimes eligible for special treatment. Those receiving a distribution of employer securities may be able to defer the tax on the net unrealized appreciation (NAU) in the securities. The NUA is the net increase in the securities values while they were in the plans trust. If taken as a lump-sum distribution, the participant has the option of deferring tax on all of the NUA. A lump-sum distribution is defined as the disbursement of the entire vested account balance within one taxable year as a result of a triggering event. Triggering events are limited to: 1. separation from service; 2. attainment of age 59 1/2; or death.

Distributions from Qualified Plans

-if all funds were contributed by the employer (noncontributory plan), the employee tax basis (cost) is zero. If the employee contribution were pretax, the basis is zero as well. Because everything above cost is taxed at the employees ordinary income tax rate at the time of distribution, all funds received are fully taxable. Same for 403(b) plans.

Impact on Financial Eligibility

-investing in a 529 will generally impact a student's eligibility to participate in need based financial aid. Both types are treated as parental assets in the calculation of the expected family contribution toward college costs regardless of whether the owner is the parent or the student.

Simplified Employee Pension (SEP)

-offers self-employed persons and small businesses easy to administer pension plans. A SEP is a qualified plan that allows an employer to contribute money directly to an IRA set up for each employee. - must be at least 21 years of age, performed services for the employer during at least 3 of the last 5 years and received at least 600 (for 2019) in comp in current year. - employer can contribute up to 25% of an employees salary to the SEP IRA, up to a max of 56K per employee (2019). The employer determines the level of contributions each year and must contribute the same percentage for each employee, as well as the employer. -unlike an IRA and most qualified plans, there is no catch-up provision for a SEP. Note: SEP IRA permits non-SEP contributions, which means persons can make regular IRA contribution (including IRA catch-up contribution if they are 50 and older) to the SEP IRA, up to the maximum limit. -Participants in a SEP IRA are fully vested immediately. meaning that once the money is deposited in a an employee's SEP IRA, it belongs to the employee - distributions from IRAs and SEP IRAs: no-penalty after 58 1/2. Distributions must begin by 4/1 the year following the year an individual turns 70 1/2.

40lK

-permit an employer to make matching contributions up to a set percentage of the employee-directed contributions, making this a type of defined contribution plan. All contributions are made with pretax dollars. The W-2 will show the actual salary less the 401K contribution. Note: FIC and FUTA taxes are levied on gross salary, not the reduced amount. * there is one exception (not tested), but it is up to the employer to determine if it will incorporate matching contributions into the plan. * benefits of investing through 401K is dollar cost averaging * when one includes the catch-up amount, the max combined employer and employee contribution in a defined contribution plan increases from 56K to 62K

UGMA/UTMA Accounts

-require an adult or a trustee to act as custodian for a minor (the beneficial owner). Any kind of security or cash may be gifted to the account without limitation. -UTMA expands the types of property you can transfer to a minor and provides that you can make other types of transfers besides gifts. -account is not used to pay expenses associated with raising a child, such as the three basic needs of food, clothing, and shelter. - the minors SSA is used on the account - custodian assumes fiduciary responsibility in managing a minor's account. - a custodian may be reimbursed for any reasonable expenses. Compensation may be paid to the custodian unless the custodian is also the donor. - donor may not take the gift back (conveys an indefeasible title), nor may the minor return the gift (unless reaches age of majority) - all gifts are irrevocable. Gifts may be in the form of cash or fully paid securities - account may have only one custodian and one minor beneficial owner. - a donor of securities cab act as custodian or appoint someone to do so -unless they're acting as custodians, parents have no legal control over an UGMA/UTMA account or the securities in it. - a minor can be the beneficiary of more than one account, and a person may serve as custodian for more than one UGMA/UTMA, provided each account benefits only one minor - minor has the right to sue the custodian for improper actions. - any securities in an UGMA/UTMA account are generally registered in the custodian's name for the benefit of the minor and cannot be solely in the minor's name. -if the beneficiary of an UGMA/UTMA dies, the securities in the account pass to the minor's estate, not the parents or the custodian. If the custodian dies or resigns, either a court of law or the donor must appoint a new custodian. -UGMA accounts may not hold real estate (real property), certain partnership interest, and other types intangible property, UTMA accounts may. Thus UTMA accounts offer great investment choice. - in many states account assets are not required to be transferred at the age of majority of the beneficial owner. IN many UTMA states, the custodian may delay transferring the UTMA assets to the beneficial owner until he become the age of 21 or 25.

Hardship Withdrawals

401(k) plans are permitted to make hardship withdrawals. There are max limits; the amount withdrawn is not eligible for a rollover and therefore is taxable as ordinary income and possibly the 10% penalty. It differs from 401(k) loan which is not taxable as long as the repayment requirements of the IRS are met. The IRS max loan amount is 50% of the participant's vested share or 50,000, whichever is smaller. All loans must carry a reasonable rate of interest. Other than if used for a home mortgage, the loan must be paid back on a regular schedule (usually through payroll deduction) in a period not to exceed 60 months.

Moving IRAs

60-day roller over - IRA owner may take temporary possession, but must move funds to another custodian within 60 days or else unrolled balance will be subject income tax and early withdrawal penalty - permitted once per 12-month period * Note when participant of plan takes possession of the funds, the payor of the distribution must withhold 20% of the distribution as a withholding tax. The participant must roll over 100% of the plan distribution, including the funds withheld, or be subject to income tax and penalty Direct Rollover From Retirement Plans to IRAs - is a distribution from an employer-sponsored retirement plans to an IRA. - $ is never seen by the employee and move directly from the current plan administrator to another administrator Trustee to Trustee Transfers - sometimes simply referred to as IRA transfer - funds sends from one IRA customer to another - owner never takes possession of the funds - unlike IRA roller over, the # of transfers is unlimited. - 20% tax withholding does not apply or 60 days requirement * direct rollover is different from a transfer because it involves two different types of plans. One would use a direct rollover to move funds from a 401K to an IRA while the transfer is from IRA at one brokerage firm to an IRA at another.

Earnings limitations for Tax Benefits

A Roth IRA is the only IRA that has a strict income limit for eligibility to make any contributions. While there are ways to backdoor money into a Roth IRA, such as by contributing to a traditional IRA and doing a Roth conversion, you can't put money directly into a Roth if your income exceeds the annual cap. Traditional IRAs don't have this rule -- nor do other types of IRAs, such as SEP IRAs and SIMPLE IRAs, which are commonly used by self-employed individuals and small business owners. You can contribute to a SIMPLE or SEP IRA no matter how high your income is, provided you meet the eligibility requirements for these account types. Although there is no overall limit for contributing to a traditional IRA, there are income limits on tax-deductible contributions. In other words, if you want to claim a tax deduction equaling the amount of your contribution in the year you invest the funds in your traditional IRA, your income must be below a certain threshold. The table below shows the limit for making tax-deductible IRA contributions in 202 and 2022 if you are covered by a workplace retirement plan such as a 401(k).

Top Heavy Plan

A retirement plan in which more than 60% of the plan assets are in accounts attributed to key employees Because all qualified plans must be nondiscriminatory, the IRS has defined a top-heavy 401(k) plan as one in which a disproportionate amount of the benefit goes to key employees. The plan must be tested on an annual basis to ensure that it complies with the regulations. On the exam, you may be asked to define a top-heavy plan and will have to choose between key employees and highly compensated employees. The easiest way to remember is to match the (k) in 401(k) with the word key.

Nonqualified

An employer-sponsored plan, such as deferred compensation plan, where there are no tax advantages other than the pay is not received until sometime later when the person should be in a lower tax bracket. Another advantage is the employer can discriminate between employees. The term can also apply to an annuity purchased on an individual basis outside of a retirement plan

Contributions to an HSA

Any eligible individual can contribute to an HSA. For an employee's HSA, the employee, the employee's employer, or both may contribute to the employee's HSA in the same year. For an HSA established by a self-employed (or unemployed) individual, the individual can contribute. Family members or any other person may also make contributions on behalf of an eligible individual. Contributions to an HSA must be made in cash, but the law permits investments to be made into stocks, bonds, and mutual funds. Contributions of stock or property are not allowed. There is a limit on the amount that may be contributed, but because it is a number that changes each year, it will not be tested. The only facts that could be important are that the contribution for those with family coverage is higher (logically) than that for self-only coverage, and that the amount the individual may contribute is reduced by any amounts contributed by the employer. TAKE NOTE Do not confuse an HSA with a FSA (flexible spending account). The FSA account holds money deducted from the employee's pay and remains with the company—it is not investible, and, if you don't use it, you lose it.

EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974 (ERISA)

ERISA guidelines for the regulation of retirement plans include the following. • Eligibility. If a company offers a retirement plan, all employees must be covered if they are 21 years old or older, have one year of service, and work 1,000 hours per year. • Funding. Funds contributed to the plan must be segregated from other corporate assets. The plan's trustees have a fiduciary responsibility to invest prudently and manage funds in a way that represents the best interests of all participants. • Vesting. Employees must be entitled to their entire retirement benefit amounts within a certain time, even if they no longer work for the employer. • Communication. The retirement plan must be in writing, and employees must be kept informed of plan benefits, availability, account status, and vesting procedure no less frequently than annually. • Nondiscrimination. A uniformly applied formula determines employee benefits and contributions. Such a method ensures equitable and impartial treatment *ERISA regulations apply to private sector (corporate) plans only. Plans for federal or state government workers (public sector plans) are not subject to ERISA.

Investment Policy Statement

Investment Policy Statement Although it is not specifically mandated under ERISA, it is strongly suggested that each employee benefit plan have an investment policy statement (IPS), preferably in writing, which serves as a guideline for the plan's fiduciary regarding funding and investment management decisions. Investment policy statements address the specific needs of the plan. For employee benefit plans that use outside investment managers (such as mutual funds), the fiduciary must ensure that the investment alternatives available to plan members are consistent with the policy statement. A typical IPS will include: • investment objectives for the plan; • determination for meeting future cash flow needs; • investment philosophy including asset allocation style; • investment selection criteria (but not the specific securities themselves); and • methods for monitoring procedures and performance.

ERISA Prohibited Investments/Transactions

Prohibited Investments Under ERISA It is important to differentiate between prohibited investments and prohibited transactions. Similar to IRAs, qualified plans cannot invest in art, antiques, gems, coins, collectibles, or alcoholic beverages. They can invest in precious metals, such as gold and silver coins minted by the U.S. Treasury, only if they meet various federal requirements. ERISA also limits how much some plans can invest in the employer's stock. Although not specifically prohibited under ERISA, the exam will never find writing uncovered calls in a retirement plan to be a prudent decision. Prohibited Transactions by the Plan Fiduciary ERISA allows for a wide range of investments and investment practices, but a plan fiduciary is strictly prohibited from any conflicts of interest, such as: • self-dealing, dealing with plan assets in his own interest, or for his own account; • acting in a transaction involving the plan on behalf of a party with interests adverse to the plan; and • receiving any compensation for his personal account from any party dealing with the plan in connection with plan transactions. TEST TOPIC ALERT Under Section 407 of ERISA, a plan may not acquire any security or real (or personal) property of the employer, if immediately after such acquisition the aggregate fair market value of employer securities and employer real property held by the plan exceeds 10% of the fair market value of the assets of the plan. -Anyone in the position of trustee over the assets of a qualified plan may not use the plan assets to make loans to the employer, even if failure to do so could lead to the company suffering a financial failure.

Safe Harbor 401(k)

Safe Harbor 401(k) Plan Several years after the top-heavy rules were written, relief was offered in the form of the safe harbor 401(k). A plan does not have to undergo annual top-heavy testing if set up properly. There are two basic choices for setting up a safe harbor plan. The employer will either match employee contributions or use a nonelective formula (the employees don't have to contribute) of eligible employee compensation to satisfy IRS requirements. If a matching formula is elected: • the base formula is 100% of elective deferrals up to 3% of compensation and then 50% of elective deferrals on the next 2% of compensation. This means the maximum match is 4% (100% × 3% + 50% × 2% = 3% + 1%); or • the employer may elect the nonelective formula (minimum of 3%) of all eligible participants' compensation. Under this formula, all eligible employees would receive this nonelective contribution whether making salary reduction contributions or not. In either case, all employer contributions are immediately vested.

SIMPLE Plans

Saving Incentive Match Plans are retirement plans for a business with 100 or fewer employees who earned 5K or more during the preceding calendar year. - business can't currently have another retirement plan in place - plans are easy to setup and inexpensive to admin -employees contribution, up to 13K with 3k catch up (2019), is pretax and may be matched by the employer using either of the following options (image): * note: withdrawals from a SIMPLE IRA within the first two years after beginning participation in the plan are subject to a penalty tax of 25%

Safe Harbor Provision of Section 404(c)

Several times, we have mentioned the requirement for the plan fiduciary to diversify the plan's investments. There is a particular part of ERISA, Section 404(c) dealing with 401(k) plans that provides a safe harbor from liability for the trustee if certain conditions are met. Under ERISA Section 404(c), a fiduciary is not liable for losses to the plan resulting from the participant's selection of investment in his own account, provided the participant exercised control over the investment and the plan met the detailed requirements of a Department of Labor regulation—that is, the 404(c) regulation. There are three basic conditions of this regulation: • Investment selection • Investment control • Communicating required information Let's look at these individually. • Investment selection—A 404(c) plan participant must be able to: - materially affect portfolio return potential and risk level; - choose between at least three investment alternatives; and - diversify his investment to minimize the risk of large losses. The practical effect of this is that it would be highly unlikely for the plan to meet the requirements by limiting the available choices to highly speculative funds, such as junk bond funds and highly aggressive growth funds. TEST TOPIC ALERT The trustee of a 401(k) would be able to reduce her ERISA fiduciary exposure and meet the safe harbor provisions of 404(c) if the plan offered a broad index fund, a medium term government bond fund, and a cash equivalent fund. It isn't the number of funds that counts; it is the different asset classes available. For example, if the plan offered 10 investment options, instead of three, but they were all of the same asset class, such as 10 equity funds, or 10 bond funds, that would not comply with 404(c). • Investment control—control is defined as: - allowing employees the opportunity to exercise independent control over the assets in their account by letting them make their own choices among the investment options companies have selected (at least three); - informing employees that they can change their investment allocations at least quarterly (a growing number of plans allow employees to make plan changes daily); and - even though the employees maintain investment control, the plan fiduciary is not relieved of the responsibility to monitor the performance of the investment alternatives being offered and replace them when necessary. • Communicating required information means: - making certain information available upon request, such as prospectuses and financial statements or reports relating to the investment options (included must be information such as annual operating expenses and portfolio composition); - a statement that the plan is intended to constitute an ERISA Section 404(c) plan and that plan fiduciaries may be relieved of liability for investment losses; - a description of the risk and return characteristics of each of the investment alternatives available under the plan; - an explanation of how to give investment instructions; and - allowing real-time access to employee accounts either by telephone or the internet. TEST TOPIC ALERT Although we have made extensive reference to control in the previous pages, that must be taken in context. Participants in a 401(k) do have a choice of investments, but that choice is limited to the package included in the employer's plan. Participants in a 403(b) plan have even fewer choices; annuities are the primary investment asset in those plans. If investment choice is the criteria, then the greatest control is with an IRA (see the earlier discussion on IRA investments). EXAMPLE 1. To comply with the safe harbor requirements of Section 404(c) of ERISA, the trustee of a 401(k) plan must I. offer plan participants at least 10 different investment alternatives II. allow plan participants to exercise control over their investments III. allow plan participants to change their investment options no less frequently than monthly IV. provide plan participants with information relating to the risks and performance of each investment alternative offered D

Ineligible Investment Practices

Short sales of stock speculative options strategies margin account trading * covered call writing is allowed

Section 404 ofERISA

Specifically, there are a number of regulations that apply directly to retirement plan fiduciaries. The details are spelled out in ERISA Section 404. Under Section 404 of ERISA, every person who acts as a fiduciary for an employee benefit plan must perform his responsibilities in accordance with the plan document specifications. Under ERISA, trustees cannot delegate fiduciary duties, but they can delegate investment management responsibilities to a qualified investment manager. TEST TOPIC ALERT Although the UPIA permits the delegation of portfolio management decisions, trustees cannot delegate certain fiduciary duties, such as determining the amount and timing of distributions. Fiduciary responsibilities to the plan are explicit. With respect to the plan, fiduciaries must act: • solely in the interest of plan participants and beneficiaries; • for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable plan expenses; Unit 24 Retirement Plans Including ERISA Issues and Educational Funding Programs 541 • with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent professional would use (known as the prudent expert rule); • to diversify investments to minimize the risk of large losses, unless doing so is clearly not prudent under the circumstances; and • in accordance with the governing plan documents unless they are not consistent with ERISA. Under ERISA provisions, the fiduciary must be as prudent as the average expert, not the average person. To act with care, skill, prudence, and caution, the fiduciary must also: • diversify plan assets; • make investment decisions under the prudent expert standard; • monitor investment performance; • control investment expenses; and • not engage in prohibited transactions. *You may be required to know that transaction cost is not a determining factor in security selection. That is, when the fiduciary is deciding what security will fit the needs of the portfolio, the amount of commission involved in the purchase is not considered when determining if that security is an appropriate addition.

Summary Plan Description (SPD)

Summary Plan Description (SPD) Sometimes referred to as the summary plan document, one of the most important documents participants are entitled to receive automatically when becoming a participant of an ERISA-covered retirement plan or a beneficiary receiving benefits under such a plan is a summary of the plan, called the summary plan description (SPD). Under regulations of the U.S. Department of Labor (DOL), the plan administrator is legally obligated to provide to participants, free of charge, the SPD. The SPD is an important document that tells participants what the plan provides and how it operates. It provides information on when an employee can begin to participate in the plan, how service and benefits are calculated, when benefits become vested, when and in what form benefits are paid, and how to file a claim for benefits. Unlike the investment policy statement, it does not deal with the investment characteristics of the plan.

Inheriting an IRA: Spousal Beneficiary

When the beneficiary is a spouse, there are two choices that can be made: 1. Do a spousal rollover, meaning the among of the inheritance is rolled over into the spouses IRA; 2. Continue to own the IRA as beneficiary. Spouse may assume the IRA, transferring assets to a personal IRA and begin distributions no sooner than 59 1/2 (called "Treat as your Own"). Any distributions before then will be subject o the 10% penalty. If the spouse continues the account as a beneficiary there is no 10% penalty for withdrawals before age 59 1/2. The bad news is that the RMD's from a traditional or SEP IRA must begin when the deceased would have had to take them, a disappointment if the survivor is the younger partner. However the RMD's will be based on the beneficiary's age, not that of the deceased. Also, if it is a Roth IRA and the account hasn't been open for at least 5 years, any withdrawals of earning will be subject to income tax but not the 10% penalty.

Uniform Prudent Investor Act (UPIA)

With greater numbers of trustees delegating investment decisions to investment advisers, NASAA has determined that you must know how the UPIA affects your role. Here are some thoughts that will help you on the exam. • A trustee must invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee must exercise reasonable care, skill, and caution. • A trustee's investment and management decisions about individual assets must be evaluated not in isolation but in the context of the total portfolio and as a part of an overall investment strategy with risk and return objectives that are reasonably suited to the trust. • Among circumstances that a trustee must consider in investing and managing trust assets are any of the following that are relevant to the trust or its beneficiaries: - General economic conditions - The possible effect of inflation or deflation - The expected tax consequences of investment decisions or strategies - The role that each asset plays within the total portfolio, including financial assets, tangible and intangible personal property, and real property - The expected total return from income and the appreciation of capital - Other resources of the beneficiaries - Needs for liquidity, regularity of income, and preservation or appreciation of capital - An asset's special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries • A trustee who has special skills or expertise, or who is named trustee in reliance upon the trustee's representation that the trustee has special skills or expertise, has a duty to use those special skills or expertise. This particular item led to the most stringent standard, that of the prudent expert for one acting as a professional money manager • For those without special skills or expertise, a trustee may delegate investment and management functions as long as the trustee exercises reasonable care, skill, and caution in: - selecting the adviser, - establishing the scope and terms of the delegation, consistent with the purposes and terms of the trust, and - periodically reviewing the adviser's actions, to monitor the adviser's performance and compliance with the terms of the delegation. (However, something that cannot be delegated is the amount and timing of distributions. If it is for a trust, the trust document usually spells out those provisions and, in the case of a qualified retirement plan, the plan document accomplishes the same purpose.) • A trustee who complies with all of the previous is not liable to the beneficiaries or the trust for the decisions or actions of the adviser to whom the function was delegated. • In performing a delegated function, the adviser owes a duty to the trust to exercise reasonable care to comply with the terms of the delegation

529 Plans (continued)

Withdrawal Restrictions - you can rollover any unused funds to a member of the beneficiary's family without incurring any tax liability as long as the rollover is completed within 60 days of the distribution. Immediate family members includes (see image). * Note: earnings portion is taxable to the person who receives the payment, either the account owner or designated beneficiary. If the payment is not made to the designated beneficiary or to an eligible institution for the benefit of the designated beneficiary, it will be deemed to have been made to the account owner. * Rollover is permitted once in any 12-month period if you are unhappy with the plan you are invested in. Just as with IRA, if the proceeds are distributed, they must be reinvested in a new plan within 60 days. * the expense for room and board qualifies only to the extent that it isn't more than the greater of the following two amounts: 1. the allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student; or 2. the actual amount charged if the student is residing in housing owned or operated by the eligible education institution. Effect of TCJA 2017 * permits K-12 withdrawals as qualified expenses for attendance at a public, private or religious elementary or secondary school. Except qualified expenses are limited to 10K of tuition per student annually.

Inheriting an IRA: Non-spouse Beneficiary

the beneficiary will not be allowed to rollover an inherited IRA into their own IRA. Options: 1. Take Cash Now - 100% cash withdrawal 2. Cash out IRA in 5 years - if deceased was younger 70 1/2 (not obligated to take RMDs) the non-spouse is allowed to withdraw all of the funds from the IRA by 12/31 of the fifth year following the IRA account owners death. Each withdrawal will be included in taxable income. Frequency does not matter. That is, you can take a portion the first year and do nothing for next three years, but balance must be fully withdrawn by 12/31 of the fifth year. 3. Take out RMDs over the beneficiary's own life expectancy - to choose this option a sperate inherited IRA account in the deceased account owner's name for the benefit (FBO) of the beneficiary must be established and the first RMD must be taken by 12/31 of the year following the year of the account owners death. 4. RMD's based on the life expectancy of the oldest beneficiary - if there are multiple beneficiaries and the decision is to stretch withdrawals, the IRS requires that the life expectancy of the oldest beneficiary be used. This can be avoided if the inherited IRA accounts are setup for each beneficiary. * if the beneficiary does nothing, the default option used by the IRA is 5-year withdrawal option.