Chapter 10 Retirement plans
Individuals age 49 and below can contribute a maximum of ___________ in their 401k plan annually
$18,500
Individuals age 50 and above can contribute a total of
$24,500 per year, which allows for annual "catch-up" contributions up to $6,000 per year. This limit is also subject to cost-of-living adjustments in future years.
The IRS has established two acceptable vesting schedules for qualified defined benefit plans:
-5-year cliff vesting 7-year graded vesting:
Target Benefit Pension Plan
-a combination of a defined contribution plan and a defined benefit plan. The plan functions as in a money-purchase pension plan, but a target benefit amount is identified. This target benefit is a goal and is not always attained.
Money-purchase Pension Plan
-also a type of defined contribution plan. -the employer contributes a fixed amount to the plan every year, and this amount is apportioned among each participant's account. -participants' benefit amounts are based on the funds in their accounts. In other words, money-purchase plans have fixed contributions and undefined benefits.
Employee Retirement Income Security Act (ERISA)
-was instituted to enact minimum standards for pension plans and employee benefit plans. -assures that retirement plan participants and their beneficiaries receive financial information disclosures about the plan and establishes standards for fiduciaries.
2 types of retirement plans:
1. qualified 2. nonqualified
Rollovers are taxable at a
20% withholding rate, unless the plan participant deposits the funds into a new IRA or qualified plan within 60 days of receiving the funds from the prior IRA.
For qualified defined contribution plans with voluntary employee contributions and matching employer contributions, the following vesting schedule options apply:
3-year cliff vesting 6-year graded vesting: after 2 years of service, employer contributions must be 20% vested. In each year thereafter, the percentage vested increases 20%, until employer contributions are 100% vested by the end of year 6 -
403(b) tax-sheltered annuities
401(k) retirement plans specifically available to employees of nonprofit 501(c)(3) organizations and public school employees.
All of the following are CODA plans
401(k), 403(b) and tax-sheltered annuities.
Contributions to a Roth IRA can continue beyond the age of
70.5
Roth IRAs do not have to begin payout by the time the participant reaches the age of
70.5
An owner of a traditional IRA must begin receiving payments by April 1st of the year following the year they become
70½.
What retirement plan blends an IRA with a profit-sharing plan and allows the employer to deduct up to 25% of contributions made to all employees?
A SEP is available to small employers. Contributions made to employees are deductible up to 25%.
There are two ways to defer compensation: (CODA)
A cash bonus is put into the participant's account on a pre-tax basis, or The participant takes a reduced salary, and the amount of the reduction is put into the plan on a pre-tax basis.
There are two primary types of employer-sponsored qualified plans:
A defined benefit plan A defined contribution plan.
How much is the maximum annual contribution limit for an individual age 35 that has a traditional IRA?
A maximum of $5,500 may be contributed per year for individuals age 49 and below.
A qualified plan that is a combination of a defined contribution and defined benefit plan, in which a set contribution amount is made is called a:
A target benefit pension plan is a combination of a defined contribution plan and a defined benefit plan. Contributions are made as in money-purchase pension plans, but a target benefit amount is identified. This target benefit is a goal and is not always attained.
ROTH IRA: The interest is not taxable as long as the withdrawal is a "qualified distribution":
After five years, if the account owner dies or becomes disabled Up to $10,000 for first-time home buyers After the age of 59½
IRAs may be funded by a number of investment vehicles including:
Annuities, Savings accounts, Bank accounts, or Mutual funds.
Employees working for a self-employed individual who has a Keogh plan must be included in the Keogh plan if they:
Are at least 21 years old, Have been employed for at least one year and Work over 1,000 hours a year.
In order for a retirement plan to be qualified, it must meet the following IRS requirements:
Be approved by the IRS Be established for the exclusive benefit of the employees and/or their beneficiaries Cannot discriminate in favor of highly-paid employees, officers, or stockholders Be in writing and communicated to the employees in writing Explicitly define the plan's contributions or benefits Be permanent Meet vesting and benefit requirements Nonqualified plans do not meet these requirements.
SARSEP
Both the employer's and employee's contributions are tax deductible. The maximum annual contribution for employees is $18,500 for individuals under age 49 and below and $24,500 for individuals that are age 50 or older. The maximum annual contribution for employers is 25% of the employee's compensation, up to $55,000. In addition, if the SEP-IRA permits non-SEP contributions, employees can make contributions to the IRA of up to $6,000.
There are two types of vesting:
Cliff vesting and Graded vesting.
SIMPLE: The employer has two choices for contributing to employee's accounts:
Contribute 2% of employee's compensation, without regard to whether the employee makes contributions; or Match the employee's contributions dollar-for-dollar up to a maximum of 3% of the employee's annual earnings. Contributions are fully vested immediately. Contributions and interest earned are tax-deferred until withdrawn.
Qualified plans have special tax advantages.
Contributions made by the employer are tax-deductible and are not treated as taxable income for the employee. Interest on the contributions grows tax-deferred. Distributions are taxed, both principal and interest, because neither the contributions nor interest was previously taxed.
Distributions from an IRA may occur for the following:
Death or disability without penalty Retirement after age 59½ First time home-buyers up to $10,000 without penalty, but with taxes Education - no dollar maximum - without penalty, but with taxes Catastrophic medical expenses, without penalty, but with taxes
The number of years for vesting varies depending on the type of retirement plan:
Defined benefit or Defined contribution.
A Keogh plan may be organized as a:
Defined contribution plan - the maximum annual contribution is limited to the individual's annual earnings, up to $55,000. Defined benefit plan - the maximum annual contribution is limited to the individual's annual earnings or $220,000. Contributions are tax-deductible as long as the maximum contribution limits are not surpassed. Dividends and interest are tax-deferred.
A defined benefit plan has the following characteristics, which qualify the plan for federal tax purposes:
Definite determinable benefits Systematic payment of benefits Primarily retirement benefits
Nonqualified plans are characterized by the following:
Do not need to be approved by the IRS Can discriminate in favor of certain employees Contributions are not tax-deductible Interest earned on contributions is tax-deferred until withdrawn upon retirement
What qualified plan resembles a profit-sharing plan, in which the employer establishes a trust fund and uses cash or new shares of stock to purchase existing shares?
ESOP Employee stock ownership plans (ESOPs) are employee benefit plans. ESOPs are similar to profit-sharing plans. Here's how an ESOP works: the employer establishes a trust fund, and uses cash or new shares of its stock to purchase existing shares.
Some tax advantages of ESOPs:
Employer contributions are tax-deductible. Dividends are tax-deductible. Employee contributions are made pre-tax.
Qualified plans have the following features:
Employer's contributions are tax-deductible as a business expense. Employee contributions are made with pretax dollars - contributions are not taxed until withdrawn. Interest earned on contributions is tax-deferred until withdrawn upon retirement.
Fiduciary Responsibility
Fiduciaries are people that have a financial interest in the plan assets or management, such as plan administrators. Fiduciaries must execute their duties in the best interest of the plan participants and beneficiaries.
George is contributing to a qualified retirement plan at his company. What percentage of his contributions are vested immediately?
George's contributions are 100% vested immediately and cannot be forfeited.
An IRA transfer occurs when
IRA funds are moved from one trustee/custodian to another, such as transferring funds from one bank to another.
Individuals may establish their own retirement investment accounts, known as
IRA's
George has been at the company for 7 years. Which type of vesting is characterized by employer contributions that are vested completely after a period of time?
In 5-year cliff vesting, the employer's contributions must be completely vested after the employee has worked five years. This means that during years 1 through 4 employer contributions are 0% vested; however, by the end of year 5 and in future years, employer contributions must be 100% vested.
The special benefits of section 529 plans include:
Income tax breaks; State tax breaks; Funds may be reclaimed by the plan owner at any time and for any purpose; and The amount of deposit is large - up to $300,000 for each plan beneficiary.
Other types of employer-sponsored qualified retirement plans include:
Individual and group deferred annuity, Profit-sharing plans, ESOP (Employee stock ownership plans), Pension plans, Money-purchased pension plans, Target benefit pension plan, CODA plans (Cash or deferred arrangement plans), 401k plans, 403b Tax Sheltered Annuities, and Deferred compensation. (nonqualified employer-sponsored retirement plans.)
Which of the following may not be used as an IRA investment tool?
Life insurance policies cannot be used to fund IRAs. annuities, mutual funds and savings accounts can
The amount of money an individual can contribute to their traditional IRA is:
Limited, Indexed annually Set by law. extra notes on trad IRA: A maximum of $5,500 may be contributed per year for individuals age 49 and below. The limit is $6,500 for individuals age 50 and above, which includes a "catch-up" contribution of $1,000. These limits apply to Roth IRAs, as well. However, if the individual or the individual's jointly-filed spouse does have an employer-sponsored retirement plan, the full contribution up to the annual limit is fully tax-deductible if an individual's modified AGI is $63,000 or less, or a married couple filing jointly has a modified AGI of $101,000 or less.
There are two main types of defined contribution plans:
Profit-sharing plans and Pension plans.
401(k) plans are __________ retirement plans.
QUALIFIED
Catch-up Contributions
SARSEP and SIMPLE plans allow plan participants age 50 and above to make "catch-up" contributions each year. The catch-up is $6,000 for SARSEPs and $3,000 for SIMPLE plans.
There are two types of section 529 plans:
Savings plans (similar to a 401(k) plan or IRA), and A prepaid plan.
Common nonqualified plans for retirement include:
Split dollar plans, Deferred compensation Executive bonus plans. There are numerous other types of nonqualified plans - such as a personal savings account or an individual deferred annuity.
Plan administrators must disclose the following information about pension plans and employee benefit plans to plan participants, beneficiaries, the IRS and Department of Labor:
Summary Plan Description - includes information about the plan and how the plan works Summary of Material Modification - includes pertinent changes to the plan Summary Annual Report (Form 5500) Plan administrators are subject to civil and criminal proceedings and monetary fines for violating ERISA reporting and disclosure requirements.
qualified =
TAX BENEFIT
TSA annuities
Tax sheltered annuities are also called tax deferred annuities. The employee makes contributions to the TSA by salary reduction. The employee's gross income is reduced by the amount of salary reduction used for contributions. The employer purchases a deferred annuity with the employee's contributions. Contributions made by the employee and earned interest are not taxed until withdrawn. The maximum that can be contributed to a TSA is $18,500 for individuals age 49 and below. The limit is $24,500 for individuals age 50, which includes the "catch-up" contributions up to $6,000 per year.
To qualify as a SARSEP:
The SEP must have been set up before 1997, The employer must have 25 or fewer employees, and At least 50% of eligible employees must choose to make salary-reduction contributions.
Distributions from a qualified retirement plan may be made regardless of the following:
The age when an employee retires, The employee ceases employment, or The plan is terminated.
Which of the following statements is true regarding IRAs?
The amount that can be contributed to an IRA is limited by an indexed annual maximum set by the law.
Here's how an ESOP works:
The employer establishes a trust fund, and uses cash or new shares of its stock to purchase existing shares. Each employee over age 21 who works on a full-time basis is permitted to participate in the plan. Each participating employee has their own account to which shares from the trust are allocated. Depending on the vesting schedule used, all funds must be completely vested in the employee accounts within 3 to 6 years.
ERISA has a set of vesting rules for how participants achieve ownership of contributions made by employers.
The longer an employee works for an employer, the greater the percentage of ownership the employee has over the employer's share of contributions, resulting in the employee eventually having 100% ownership of the employer's contributions after a certain number of years. Participants' contributions are 100% vested immediately and cannot be forfeited.
SEPs allow a greater annual contribution amount compared to IRAs.
The maximum annual contribution for employers is 25% of the employee's compensation, up to $55,000. Contributions made by the employer are not part of the employee's gross income.The employer may deduct the lesser of its contributions or 25% of the employee's compensation. Only up to $275,000 of an employee's compensation may be considered. In addition, if the SEP-IRA permits non-SEP contributions, employees can make contributions to the IRA of up to $6,000.
However, distributions made for the following reasons are not subject to the early distribution penalty tax:
The plan participant dies or incurs a disability A loan is taken from the plan Distribution made as part of a divorce decree Level payments made at least annually to the participant over their life Distribution made as a qualified rollover Example: Tom has a qualified plan in which he must withdraw $3,000 per month upon reaching age 70½. The penalty amount for a $2,000 withdrawal is half of the difference between the amount withdrawn and the required amount. $3,000 - $2,000 = $1,000 $1,000 ÷ 2 = $500 Tom's penalty is $500.
contribution limits with ROTH IRA
The traditional IRA contribution limits also apply to Roth IRAs. The sum of contributions made to all IRAs (Roth and traditional) cannot exceed the annual limit. The contribution limits are the lesser of an individual's modified AGI and the annual IRA contribution limit. For married couples, each spouse may contribute up to the annual IRA contribution limit. A maximum of $5,500 may be contributed per year for individuals age 49 and below. The limit is $6,500 for individuals age 50 and above. An individual can contribute the maximum amount to a Roth IRA if their annual income is below $120,000. For a married couple filing jointly, the maximum annual income is $189,000.
Defined benefit plans must meet the 50/40 rule
This means the plan must cover 50 eligible employees, or 40% of all employees, with at least two participants.
A spousal IRA may be established for a married spouse who doesn't work.
This would allow a married couple to double their annual individual contribution limit and double the tax-deductible contribution if the working spouse does not have an employer-sponsored retirement plan.
There are two main groups of IRAs:
Traditional IRAs and Roth IRAs.
SIMPLE: The employer can deduct contributions pretax, so they are not part of the employee's taxable income.
Withdrawals made from a SIMPLE within the first two years are subject to a 25% penalty tax. The maximum contribution amount is $12,500 for individuals age 49 and below. The limit is $15,500 for individuals age 50 and above. Individuals age 50 and above can make catch-up contributions in an amount of $3,000 per year.
Distributions must begin by April 1 in the year after the plan participant reaches the age of 70½ or
a nondeductible 50% penalty is assessed on the difference between the amount withdrawn and the required benefit amount. This applies to qualified plans and IRAs, except Roth IRAs.
A top-heavy plan
a pension plan providing 60% or more of its benefits to the company's key employees. - For a top-heavy plan to remain qualified, all non-key employees must receive employer contributions in an amount of 3% of compensation or a percentage equivalent to the highest paid employee's contribution rate.
Simplified Employee Pension (SEP) or 408(k)
a qualified plan for small employers. SEPs are a mix of an IRA and profit-sharing plan. Employees have their own IRA. The employer makes contributions into the employees' IRAs. They are similar to 401(k) plans, but are intended for smaller companies with 25 or fewer employees. However, any employer may set up an SEP.
Contributions made to_____________________ WITH taxed dollars are not taxed upon withdrawal.
a retirement plan Distributions may be made to the recipient in installments, in which case interest and previously untaxed principal are taxable income. If the plan participant dies and the funds are paid out in a lump sum, then the interest earned and any portion of principal that was contributed with pre-tax dollars is taxable income.
Participants can contribute to their 401(k) plan through
a salary reduction, cash bonus or thrift plan.
Rollovers
a transfer of funds from one IRA to another or one qualified plan into another.
profit-sharing plan
a type of defined contribution plan. Plan administrators must provide participants with a clear formula for how company profits are contributed to participants. The employer's contribution amount may vary from year to year. The employee receives all contributions plus interest upon retirement. Contributions and interest are tax-deferred until withdrawn.
All of the following are true regarding traditional IRAs, EXCEPT:
a. If an individual does not have a retirement plan through their employer, the entire contribution to the IRA may be deducted from gross income up to the annual contribution limit. c. All withdrawals are taxed. d. The amount of money an individual can contribute to their IRA is limited, and indexed annually. NOT TRUE: b. Interest earned on IRA contributions is taxable in the year earned. (An IRA may be deducted from gross income up to the annual contribution limit. Interest earned on IRA contributions is tax-deferred until withdrawn. )
Which of the following qualified plans uses employer contributions to a pension plan based on the employee's compensation and years of service with the company?
a. Pension plan b. Target benefit pension plan c. Money-purchase pension plan d. All of the above ALL Your answer is correct In a pension plan, employer contributions to a pension plan are based on the employee's compensation and years of service with the company, not the company's profitability or the employer's preference. Money-purchase and target benefit are types of pension plans.
When can an individual make a distribution from a traditional IRA?
a. Upon retirement after age 59 1/2 b. For education expenses c. For death or disability Distributions from an IRA may occur for the following: death or disability without penalty; retirement after age 59 1/2; first time home-buyers up to $10,000 without penalty, but with taxes; education no dollar maximum without penalty, but with taxes; catastrophic medical expenses, without penalty, but with taxes.
6-year graded vesting
after 2 years of service, employer contributions must be 20% vested. In each year thereafter, the percentage vested increases 20%, until employer contributions are 100% vested by the end of year 6 - Year 1: 0% vested Year 2: 20% vested Year 3: 40% vested Year 4: 60% vested Year 5: 80% vested Year 6+: 100% vested
Employee Stock Ownership Plan (ESOP)
also a defined contribution plan. ESOPs are similar to profit-sharing plans.
Keogh Plans
also known as HR-10 plans, are qualified retirement plans for self-employed individuals. This includes sole-proprietors, partnerships, physicians, attorneys and farmers.
SIMPLE plans may be organized as
an IRA or 401(k) established by the employer. Employees may make contributions by salary deferral, up to an annual maximum.
If Becky wants to take a distribution from her qualified retirement plan, she should know that distributions can be made:
at any time Distributions from a qualified retirement plan may be made regardless of age when an employee retires, the employee ceases employment, or the plan is terminated. However, if distributions from a qualified plan are made prior to the age of 59 , then a 10% penalty tax is imposed.
Defined benefit plans focus on
definite determinable benefits
Nonqualified plans are used just as frequently as qualified plans,
despite the fact that they do not have the tax advantages of qualified plans.
non qualified plans
do not meet the federal government's requirements to receive special tax benefits.
With an individual annuity
each employee is issued an individual deferred annuity. The annuity is rated individually. The employee pays level premiums. If an employee desires more benefits, an extra annuity must be purchased. (think that belonged here? i think its both indiv and group)
Anyone with_____________ can contribute to an IRA
earned income
3-year cliff vesting:
employer contributions must be fully vested by the end of year 3. In years 1 and 2, employer contributions are 0% vested, but by the end of year 3 and in future years, employer contributions must be 100% vested.
7-year graded vesting
employer contributions must begin vesting after the employee has worked three years in an amount of 20%. Each year thereafter, the plan must vest 20% until employer contributions are completely vested after the employee has worked seven years. This means that in years 1 and 2 employer contributions are 0% vested. In the following years employer contributions are vested in increasing increments of 20%, until they are 100% vested, occurring after 7 years of employment: Year 1: 0% vested Year 2: 0% vested Year 3: 20% vested Year 4: 40% vested Year 5: 60% vested Year 6: 80% vested Year 7+: 100% vested
One non-tax advantage to retirement plans for employees, but not for employers is:
forced savings
Contributions made into a 401(k) plan are not part of the employee's
gross income for tax purposes.
Contributions to a Roth IRA are not permitted if
if annual income exceeds the upper limit. Individuals or married couples whose annual earnings surpass a certain amount are ineligible for Roth IRAs.
The amount that can be contributed to an IRA is limited by an
indexed annual maximum set by the law
The most common funding tool used for defined benefit plans is
individual or group deferred annuities.
The Employee Retirement Income Security Act (ERISA)
instituted to enact minimum standards for pension plans and employee benefit plans and to regulate retirement plans throughout the various states. assures that retirement plan participants and their beneficiaries receive financial information disclosures about the plan and establishes standards for fiduciaries. imposes certain requirements on qualified plans. a set of vesting rules for how participants achieve ownership of contributions made by employers.
Salary Reduction SEP (SARSEP)
is a SEP that allows for employees to make salary-reduction contributions into the SEP.
Cash or Deferred Arrangement (CODA) Plan
is a modified profit sharing or pension plan. These plans are termed CODA because part of the participant's compensation is deferred by putting it into the plan.
CODA plans defer taxation until the participant
is retired (presumably in a lower tax bracket). The funds are taxed when disbursed.
non qualified
no tax benefits
A section 457 plan is a
nonqualified deferred compensation plan for government and nonprofit employees. The maximum amount of compensation that may be deferred is $18,500. Individuals age 50 or over may contribute an additional $6,000 in "catch-up" contributions. If an employer also offers a 401(k) or a 403(b) plan, the individual can contribute to both the 457 and the other plan.
Employer contributions to a pension plan are based on
on the employee's compensation and years of service with the company, not the company's profitability or the employer's preference.
SEP: An eligible employee includes any individual
over age 21, who has worked for the employer for at least three of the past five years, and is making at least $550 annually.
Defined benefit plans are established to
pay a certain benefit amount when the employee retires. The benefit amount is based on the employee's length of service with the employer and level of earnings.
Tax-deferral is an advantageous benefit in retirement plans because
plan participants are usually in a lower tax bracket upon retirement, so income tax from a qualified retirement plan is lower than if the contributions were made with taxed dollars.
A cash or deferred arrangement plan is a variation on the
profit sharing or pension plan.
SIMPLE PLANS Savings Incentive Match Plans for Employees
qualified retirement plans available to small businesses. The employer must have no more than 100 employees earning more than $5,000 during the prior year. The employer cannot have another qualified plan in effect.
tax-deferred
refers to investments on which applicable taxes (typically income taxes and capital gains taxes) are paid at a future date instead of in the period in which they are incurred. accumulate tax-free until the investor takes constructive receipt of the profits. this is good
Single 401k plans are designed for
self-employed individuals or the sole owner-employee of a corporation. They have high annual contribution limits and give the individual more freedom to make investments.
If withdrawals are not used for eligible college expenses,
tax and a 10% federal penalty on the interest portion of the withdrawal applies. To avoid taxes and penalties, withdrawals must be made strictly for eligible college expenses. The plan is managed by an educational institution or by the state.
qualified
tax benefits
section 529 plan
tax-advantaged savings plan to fund higher education costs. In most cases, interest is not subject to federal tax. In some states, interest earned in 529 plans is exempt from state income tax, as well. Contributions are not federally tax-deductible, but some states may allow the contributor to deduct all or part of the state income tax. Distributions used for college costs are tax-free.
Interest earned on traditional IRA contributions is
tax-deferred until withdrawn. Some individuals can make tax-deductible contributions, but all withdrawals are taxed.
Traditional IRAs may be converted (rolled over) to Roth IRAs as long as
taxes are paid on the contributions that were deducted.
defined contribution plans concentrate on
the amount of contributions made
Deferred Compensation (Also Section 457 Plan)
the employee is not receiving all of their salary at the time it normally would be paid. Rather, the employee's current salary is reduced and part of it is deferred to a later time. The result is a reduction in the employee's salary.
The maximum annual benefit for defined benefit plans is
the employee's mean annual earnings, but no more than $220,000. The limit is subject to COLA (cost-of-living) adjustments in future years. A stated formula to determine the benefit amount must be stated in the plan
For a group deferred annuity,
the employer is issued the master contract and each employee covered by the plan is issued a certificate. In order to fund the annuity, certain amounts of coverage are bought each year.
5-year cliff vesting
the employer's contributions must be completely vested after the employee has worked five years. This means that during years 1 through 4 employer contributions are 0% vested; however, by the end of year 5 and in future years, employer contributions must be 100% vested.
If the individual or the individual's jointly filed spouse does not have a retirement plan maintained by their employer
the entire contribution may be deducted from taxable gross income up to the annual contribution limit, regardless of the individual's adjusted gross income (AGI).
defined contribution plan
the exact benefit amount isn't known until distributions begin.
The maximum contribution under a defined contribution plan is
the lesser of the employee's annual earnings, or $55,000 per year. This limit is also subject to COLA (cost-of-living) adjustments in future years.
Roth IRAs are arranged so that
the withdrawals are tax-free. Unlike the traditional IRA, contributions made to a Roth IRA are not tax-deductible.
However, if distributions from a qualified plan are made prior to the age of 59½
then a 10% penalty tax is imposed.
An individual or married couple can have a Roth IRA regardless of whether or not
they have an employer-sponsored retirement plan.
qualified plans
those offering special tax benefits. A retirement plan must meet a set of requirements established by the Internal Revenue Service (IRS) in order to be classified as a qualified plan.
Nonqualified plans permit employers to offer retirement plans only to
to their key employees.
401k plans
typical corporate retirement plans. 401(k) plans are a type of CODA plan. The employee elects a percentage of their salary to be withheld. An employer contribution, sometimes referred to as the "matching element," is based on a percentage or amount of the employee's contribution.
individual retirement accounts may be established by individuals who
who have earned income to save for their retirement. Unlike the employer-sponsored retirement plans, IRAs are established and funded by individuals.