Series 6: Retirement Plans (Retirement Plan Types and Features)

A self employed person earning $280,000 wishes to open a defined contribution Keogh Plan. The maximum deductible contribution is:

$56,000 The maximum deductible contribution to a defined contribution Keogh is effectively 20% of income (prior to taking the Keogh "deduction") or $56,000 in 2019, whichever is less. 20% of $280,000 = $56,000. The $56,000 maximum can be contributed. (Note that this amount is adjusted each year for inflation.)

Tax deferred annuities for employees of non-profit organizations are known as:

403(b) Plans Tax deferred annuities for employees of non-profit organizations are 403(b) plans. These retirement plans are for employees of non-profit institutions such as hospitals and universities. Contributions are excluded from taxable income, and must be used to purchase "tax sheltered" annuities or mutual funds.

Who is eligible to contribute to a 403(b) plan?

Teacher at a public high school A teacher at a public high school is eligible to contribute to a 403(b) plan, since he or she is an "employee." Independent contractors are not "employees" and cannot contribute to employer-sponsored plans. Thus, the maintenance contractor at a church and the doctor-contractor at the city hospital cannot contribute. Insurance companies are for-profit entities and cannot establish 403(b) plans for their employees (they can establish 401(k) plans, however).

An HR-10 plan must cover, at the employer's expense, an employee that meets all of the following conditions EXCEPT the employee:

is not covered by another qualified plan or an IRA To stop highly-compensated self-employed individuals from setting up a Keogh for themselves to take advantage of the large deductible contribution and excluding their employees from the plan, employers are required to include their employees in the plan at the employer's expense. The employees that must be included are those that are at least age 21, who have at least 1 year of service and who are "full time" - defined as working for at least 1/2 year (1000 hours or more). Any individual with earned income can contribute to an IRA in addition to any participation in a qualified retirement plan.

For a qualified retirement plan contribution to be deductible from that year's tax return, the contribution must be made by no later than:

the date the tax return is filed Contributions to qualified retirement plans (other than IRAs) must be made no later than the date the tax return is filed (even if it is filed with an extension). On the other hand, IRA contributions must be made no later than April 15th of the year after the tax year for which the deduction is claimed.

Your client has an annual income of $120,000. He asks you: "What is the largest tax-deductible contribution that I can make to my defined contribution Keogh plan?" You should tell him that this amount is:

$24,000 The maximum deductible contribution to a defined contribution Keogh is effectively 20% of income (prior to taking the Keogh "deduction") or $56,000 in 2019, whichever is less. 20% of $120,000 = $24,000. This is less than the $56,000 maximum that can be contributed, so only a $24,000 deductible contribution is permitted. (Note that this amount is adjusted each year for inflation.)

Which statement about the taxation of 403(b) plans is TRUE?

Employee salary deferrals reduce the employee's taxable income Employee salary deferrals contributed to a 403(b) plan reduce the employee's taxable income for that year. Employer matching contributions are not deductible by the employer, because the employer is a non-profit organization. Early withdrawals (prior to age 59 1/2) due to death or disability are subject to income tax but avoid the 10% penalty tax. Distributions at any age are 100% taxable.

All of the following can establish a 403(b) plan EXCEPT a public:

corporation Corporations are for-profit businesses. They cannot establish 403(b) plans, but they can establish 401(k) plans. Only not-for-profit organizations can establish 403(b) plans. These include public school systems, universities, and not-for profit hospitals.

Any distributions from a Keogh Plan must start no later than:

April 1st following the year the individual turns 70 1/2 Any distributions from a Keogh Plan must start no later than the April 1st following the year that the individual reaches the age of 70 1/2.

All of the following statements concerning taxation of 401(k) plans are correct EXCEPT:

Employer contributions are taxable to employees in the year contributed Employee contributions to a 401(k) reduce taxable income, so these are made with pre-tax dollars. Thus, they avoid taxation in the year contributed. Any matching employer contributions are not taxable to the employee when contributed; they are tax deductible to the employer, so these are also pre-tax dollars. Earnings in the account build tax-deferred, so these dollars have not been taxed. When distributions commence, none of the money has ever been taxed, so now each payment received is 100% taxable at ordinary income tax rates.

Which statement about a money purchase retirement plan is TRUE?

The maximum deductible annual contribution is 25% of income up to a maximum dollar amount A money purchase plan is a defined contribution pension plan - not a defined benefit plan. These are employer-established plans, where the employer contributes a percentage of the employee's salary each year. The maximum permitted contribution is 25% of compensation, capped to a maximum of $56,000 in 2019. With a money purchase plan, the employer contribution must be made each year, even if the company is operating at a loss. Only defined benefit plans can be underfunded. As a defined contribution plan, money purchase plans cannot be underfunded. In contrast, a profit sharing plan is also a defined contribution plan with the same maximum permitted contributions, but it gives the employer the flexibility to increase or decrease contributions depending on business conditions. These are both qualified plans that must comply with ERISA - the plans must be non-discriminatory and must vest employee benefits over a reasonable time frame (no more than 6 years).

A self-employed person earning $120,000 also has $30,000 of investment income. This person wishes to open a defined contribution Keogh Plan. The maximum permitted tax-deductible contribution is:

$24,000 Keogh (HR-10) contributions are based only on personal service income - not investment income. The maximum permitted deductible contribution to a defined contribution Keogh is the lesser of 20% of income or $56,000 in 2019. $120,000 of personal service income x 20% effective contribution rate = $24,000. This is less than the maximum $56,000 deductible contribution permitted, so the maximum deductible contribution amount is $24,000.

A customer earns $160,000 per year as a self employed foot doctor. The maximum deductible contribution to a defined contribution Keogh plan is:

$32,000 The maximum deductible contribution to a defined contribution Keogh is effectively 20% of income (prior to taking the Keogh "deduction") or $56,000 in 2019 whichever is less. 20% of $160,000 = $32,000. This is less than the $56,000 that can be contributed, so only a $32,000 deductible contribution is permitted. (Note that this amount is adjusted each year for inflation.)

A 50 1/2 year old self-employed individual has a balance of $200,000 in his HR 10 plan. This balance is composed of $140,000 of contributions and $60,000 of earnings. The individual decides to withdraw $100,000 from the plan. Which statements are true? I The entire withdrawal is taxed as ordinary income II Since half the account balance has been withdrawn, the withdrawal is taxed at 50% of ordinary rates III The entire withdrawal is subject to a 10% penalty tax IV Since half of the account has been withdrawn, the withdrawal is subject to half of the 10% penalty tax

I and III Since this individual is younger than age 59 1/2, any distribution from the Keogh plan is subject to both ordinary income tax plus the 10% penalty tax. If the distribution is made after age 59 1/2, it is subject only to ordinary income tax - there is no penalty tax. Please note that 100% of all distributions from Keoghs are taxable - these are tax qualified plans where all of the investment dollars were never taxed. Once distributions commence, both the original investment (that was never taxed), and the tax deferred build-up, are now taxable in full.

Which of the following statements are true? I Contributions to 401(k)s are made with before-tax dollars II Contributions to 401(k)s are made with after-tax dollars III Contributions to Roth 401(k)s are made with before-tax dollars IV Contributions to Roth 401(k)s are made with after-tax dollars

I and IV Roth 401(k)s are the same as Traditional 401(k)s in that: Both are employer-sponsored plans Both allow for the same maximum contribution amount ($19,000 in 2019) Both are available to high-earning individuals - there are no income phase out rules for either type of 401(k) Both require that distributions commence starting in the year after reaching age 70 1/2. Roth 401(k)s differ from Traditional 401(k)s in that: Contributions to a Roth 401(k) are not tax deductible - the contribution is made with after-tax dollars. In contrast, contributions to a traditional 401(k) are tax deductible - the contribution is made with before-tax dollars. Distributions from a Roth 401(k) are not taxable (as long as the account has been in existence for at least 5 years); distributions from a traditional 401(k) are taxable.

Which of the following terms apply to a money purchase plan? I Defined benefit plan II Defined contribution plan III Pension plan IV Profit sharing plan

II and III only A money purchase plan is a defined contribution pension plan. These are employer established plans, where the employer sets a percentage contribution to be made each year based on the employee's salary. The maximum permitted contribution is 25% of compensation, capped to a maximum of $56,000 in 2019. With a money purchase plan, the employer contribution must be made each year, even if the company is operating at a loss. In contrast, a profit sharing plan is also a defined contribution plan with the same maximum permitted contributions, but it gives the employer the flexibility to increase or decrease contributions depending on business conditions.

403(b) Plans are permitted to invest in which of the following? I Common stocks II Mutual Funds III Fixed Annuities IV Variable Annuities

II, III, IV The "big kahuna" of 403(b) plans is "TIAA-CREF" - Teacher's Insurance Annuity Association - College Retirement Equity Fund. TIAA-CREF administers retirement plans for not-for-profits, including school systems, universities and hospitals. Its name gives you the clue as to which investments are permitted in 403(b) plans. The permitted investments are life insurance, fixed annuities, variable annuities and mutual funds. Direct investments in common stocks are not allowed; the investments must be managed by a professional manager.

Among qualified plans, which of the following features is unique to 401(k) retirement plans?

Matching employer contributions 401(k) plans are unique among qualified plans in that employers may contribute to match contributions that the employees make. In other qualified retirement plans, either the employer or the employees make the contributions, but never both. The other features listed characterize all qualified plans - tax-deductible contributions, tax-deferred build-up of earnings, and commencement of distributions beginning at age 59½ without penalty.

All of the following retirement plans allow for the same maximum salary reduction contribution EXCEPT a:

Money Purchase Plan A 457 plan is similar to 401(k) and 403(b) plans, except that it can only be established by government employers (and certain non-profit employers). These are non-qualified plans because they are discriminatory. They generally are only available, as an added benefit, to higher earning government employees. The maximum salary reduction contribution is the same for 457 plans as it is for 401(k) and 403(b) plans - $19,000 in 2019 The actual percentage that can be contributed is set by the plan sponsor (the employer). Money purchase plans are defined contribution retirement plans that do not provide for salary reduction contributions. The employer can make a maximum annual contribution of 25% of income (statutory rate = 20% effective rate), up to $56,000 in 2019.

Which of the following persons is eligible to establish a Keogh plan?

Sterling, who participates in his employer's corporate pension plan, but operates his own boat repair business on weekends Sterling, as an owner-employee, may establish a Keogh plan based on the self-employed boat repair business (not on his corporate job earnings). Twombly may not establish a Keogh, because Keogh plans are for unincorporated businesses only (either sole proprietorships or partnerships).Victor's part-time work is without pay, so a Keogh cannot be established. Finally, Mary's other income is not self-employed "earned" income, so it is not eligible for a Keogh plan.

If an individual, age 69, takes a withdrawal from his Keogh Plan, which of the following is true?

The amount withdrawn is subject to regular income tax only Before age 59 1/2, distributions from a Keogh Plan are subject to regular income tax plus a 10% penalty tax. Afterwards, withdrawals are subject to regular tax but not to the 10% penalty tax.

A 55-year-old individual who is in good health wishes to take a lump sum distribution from his 401(k) plan. Which of the following statements concerning the tax treatment of the distribution is correct?

The distribution is subject to ordinary income tax and a 10% penalty tax Distributions from 401(k) plans are 100% taxable at ordinary income tax rates. In addition, because this individual is taking a distribution prior to age 59 1/2 and "is in good health," there will be a 10% penalty tax applied. Note that if the individual was "in bad health," he or she might qualify for a hardship withdrawal to pay for medical bills and not have to pay the penalty tax (but regular income tax would still apply).

The Glover Company has established an HR-10 plan. Which of the following conditions is NOT a requirement for an employee to be included in the plan at the employer's expense?

The employee must not be covered by a corporate employer's pension plan shit's true: The employee must work full-time The employee must have worked for at least 1 year The employee must be at least 21 years of age An employee may be a participant in a corporate employer's pension plan and can participate in an HR-10 Keogh plan based on other income. The employee may also have an IRA. The employer may not exclude employees based on their participation or contribution to other plans. The employer may exclude part-time or seasonal employees that work less than 1000 hours a year, employees who are not yet 21 years of age, and employees who have not worked for at least 1 year.

Which statement concerning profit sharing plans is TRUE?

The plan is categorized as a qualified defined contribution plan A profit sharing plan is a defined contribution plan. These are employer established plans, where the employer sets a percentage contribution to be made each year based on the employee's salary. The maximum permitted contribution is 25% of income, capped at a maximum of $56,000 in 2019. However, profit sharing plans give the employer the flexibility to increase or decrease contributions depending on business conditions. In contrast, with a money purchase plan, the employer contribution must be made each year, even if the company is operating at a loss. These are both qualified retirement plans. With all qualified retirement plans, distributions prior to age 59 1/2 (not 65) are subject to regular income tax plus a 10% penalty tax. With all qualified plans, employer contributions are tax-deductible to the employer.

All of the following statements concerning a 403(b) plan are correct EXCEPT:

contributions are determined by the employer's level of profits In essence, a 403(b) plan is equivalent to a 401(k) plan, with the difference being that 401(k) plans are established by for-profit companies while 403(b) plans are established by not-for-profit organizations. Contributions to 403(b) plans are not determined by the employer's level of profits because these are not-for-profit organizations! Some 403(b) plans provide only for employee contributions and other plans have matching contributions by the employer. This is the same as for 401(k) plans. While 401(k) plans can be invested in individual stocks and mutual funds, 403(b) plans cannot be invested in individual stocks. They can be invested in mutual funds and both fixed and variable annuities.

All of the following statements about contributions to 403(b) plans are TRUE EXCEPT:

the employer decides the amount of the contribution to be made on behalf of the employee 403(b) plans are only available to non-profit organization employees, such as school and hospital employees. These are tax deferred annuity plans, where contributions made by employees are made by salary reduction and thus reduce the employee's taxable income for that year. If an employee is eligible to participate in both a 401(k) plan and a 403(b) plan, the $19,000 contribution limit in 2019 is applied to both of these combined. Thus, if $10,000 is contributed to a 401(k) plan, that person could only contribute $9,000 to a 403(b). The employee decides the amount to be contributed for the year, not the employer.

A customer earns $400,000 per year as a self employed doctor, and contributes the maximum permitted amount to a defined contribution Keogh plan. The doctor has a full time nurse earning $40,000 per year. The contribution to be made for the nurse is:

$10,000 If an employer earns $280,000 or more and contributes the maximum of $56,000 to a Keogh, then 25% of "after Keogh deduction earnings" is used to compute the percentage to be contributed for employees. If the employer earns $280,000 and contributes $56,000 to the Keogh, the "after Keogh deduction earnings" are $224,000 (and 25% of $224,000 = $56,000). Thus, for the nurse, $40,000 income x 25% = $10,000 required contribution.

What is the maximum amount of deductible contributions an employer can make to a SEP for employees?

25% of employee's compensation SEPs are Simplified Employee Pension plans, which are employer sponsored defined contribution plans that are easier for employers to set up and administer, so they appeal to smaller employers. The maximum contribution is, by law, 25% of income, up to a maximum of $56,000 (in 2019). The statutory rate counts income after taking the deduction for the contribution. For self-employed individuals, this results in an effective contribution rate of 20% of "after-deduction" income. The employer must include employees in the plan, at the employer's expense. If the employer is making the maximum contribution, the contribution for employees is 25% of their income (this contribution amount is deductible to the employer).

Which of the following retirement plans permit loans to participants?

401(k) The loan provisions of 401(k) plans make them attractive to employees. IRAs, SEP IRAs, and SIMPLE IRAs do not permit loans.

Which statement is TRUE?

Distributions from both Roth IRAs and Roth 401(k)s are tax-free Roth 401(k) plans combine features of Roth IRAs and regular 401(k) plans. The maximum dollar contribution is the same as for regular 401(k) accounts, but the contribution is made with after-tax dollars - not pre-tax dollars. This is the same treatment as for a Roth IRA. Earnings build without annual taxes due. When distributions commence, each payment is tax-free - the same treatment as for a Roth IRA. Roth 401(k)s differ from Roth IRAs in that: A maximum of $6,000 (in 2019) can be contributed for an individual under age 50 to a Roth IRA, while up to $19,000 can be contributed to a Roth 401 (k); Roth 401(k)s require that distributions start after reaching age 70 1/2. This is not the case with distributions from Roth IRAs, which have no mandatory distribution age; Roth 401(k)s are available to high-earning individuals, while Roth IRAs are not. There are no high income phase-out rules for Roth 401(k)s.

Which of the following statement concerning 457 plans is correct?

They can be restricted to highly paid employees A 457 plan is similar to 401(k) and 403(b) plans, except that it can only be established by government employers (and certain non-profit employers). These are non-qualified plans because they are discriminatory. They generally are only available, as an added benefit, to higher earning government employees. The maximum contribution is the same as for 401(k) and 403(b) plans - $19,000 in 2019 The amount contributed is a salary reduction. Earnings build tax deferred. When distributions are taken, they are 100% taxable. A major difference is that there is no 10% penalty tax for early withdrawals from 457 plans. The employer receives no tax deduction - remember that the contribution is being made out of the employee's income, and is not being made by the employer.

Which TWO of the following are unique to 401(k) plans as compared to other qualified plans? I Contributions are made with before-tax dollars II Hardship withdrawals are permitted III Matching employer contributions are permitted IV Investment earnings are tax-deferred

II and III Contributions to all qualified plans are tax-deductible - they are made with before-tax dollars. Earnings in all qualified plans build tax-deferred. Hardship withdrawals are available only with 401(k) and 403(b) plans. Employers may make matching contributions only under 401(k) plans, 403(b) plans and SIMPLE plans.

The latest that a deductible contribution to a Keogh Plans can be made is:

The latest filing date permitted under an extension for the calendar year after which the contribution may be claimed on that person's tax return Contributions to qualified retirement plans (other than IRAs) must be made no later than the date the tax return is filed (even if it is filed with an extension). On the other hand, IRA contributions must be made no later than April 15th of the year after the tax year for which the deduction is claimed.

Which statement is true regarding profit sharing retirement plans?

These are qualified plans and the annual contribution can be lowered or skipped by the employer in an unprofitable year A profit sharing plan is a defined contribution plan. These are employer established plans, where the employer sets a percentage contribution to be made each year based on the employee's salary. The maximum permitted contribution is 25% of income, capped at a maximum of $56,000 in 2019. However, profit sharing plans give the employer the flexibility to increase or decrease contributions depending on business conditions. In contrast, with a money purchase plan, the employer contribution must be made each year, even if the company is operating at a loss. These are both qualified plans that must comply with ERISA rules - the plans must be non-discriminatory and must vest employee benefits over a reasonable time frame (no more than 6 years).

All of the following statements are true about 401(k) plans EXCEPT the plan:

must be a defined benefit plan 401(k) plans are employer sponsored qualified defined contribution plans. They are not defined benefit plans. 401(k) plans are different than other types of plans because the employee "chooses" to participate and decides the contribution to be made. Any contribution made is deducted from the employee's taxable income, so this is called a "salary reduction" plan. The actual percentage contribution is set by the employer, up to a maximum contribution of $19,000 in 2019. In addition, the employer can "match" employee contributions, usually up to 5% of the employee's salary.

Which of the following statements concerning the taxation of 403(b) plans are correct? I Distributions must begin by the year after the employee turns age 59 ½ II There is a 10% penalty tax for failure to take the minimum required distribution III An early withdrawal based on life expectancy is not subject to penalty tax when the employee terminates employment after age 55 IV Employee contributions reduce the employee's taxable income

III and IV only The rules for taxation of 403(b) distributions are basically the same as for distributions from 401(k) plans. Employee contributions to a 403(b) plan reduce the employee's taxable income. Earnings build tax-deferred. When distributions commence, since none of the dollars in the plan have ever been taxed, the distribution amounts are 100% taxable as ordinary income. Early withdrawals prior to age 59 1/2 are subject to 10% penalty tax. However, there is a permitted exception when the employee terminates employment after age 55 and takes distribution payments over his or her life expectancy, then regular income tax is due on each payment, but there is no 10% penalty tax. Distributions must begin by the year after the employee turns age 70 ½. The penalty for not taking minimum required distributions is 50% of the amount of under-withdrawal, in addition to regular income tax on the actual amount withdrawn.

Which statement is true regarding 457 plans?

They are established by government entities and are non-qualified plans A 457 plan is similar to 401(k) and 403(b) plans, except that it can only be established by government employers (and certain non-profit employers). These are non-qualified plans because they are discriminatory. They generally are only available, as an added benefit, to higher earning government employees. The maximum salary reduction contribution is the same for 457 plans as it is for 401(k) and 403(b) plans - $19,000 in 2019. The amount contributed is a salary reduction. Earnings build tax deferred. When distributions are taken, they are 100% taxable. A major difference is that there is no 10% penalty tax for early withdrawals from 457 plans.

Which statement about Roth 401(k) plans is FALSE?

Contributions to a Roth 401(k) account reduce the employee's taxable income for the year Roth 401(k) plans combine features of Roth IRAs and regular 401(k) plans. The maximum dollar contribution is the same as for regular 401(k) accounts, but the contribution is made with after-tax dollars - not pre-tax dollars. Earnings build without annual taxes due. When distributions commence, each payment is tax-free. Employer matching contributions are permitted, just like regular 401 (k) accounts. However, matching contributions must be made into a regular 401(k) account, not into the Roth 401(k) account. Roth 401(k)s differ from Roth IRAs in that they require that distributions start in the year after reaching age 70 1/2. This is not the case with distributions from Roth IRAs, which have no mandatory distribution age.

A SIMPLE design may be incorporated into which of the following retirement plans? I SEP II IRA III Profit sharing plan IV 401(k) plan

II and IV only The SIMPLE design can be adopted as a SIMPLE IRA or a SIMPLE 401(k) plan. SIMPLE (Savings Incentive Match Plans for Employees) retirement plans are another version (aside from a SEP) of an "easier to set up and administer plan" designed for smaller employers - specifically employers with no more than 100 employees.

A Keogh plan can be established by which of the following businesses? I Small corporation II Large corporation III Partnership IV Sole proprietorship

III and IV only A Keogh plan can only be established by "self-employed" individuals. In practical terms, this means that the business is formed as either a sole proprietorship or a partnership. Corporations cannot establish Keogh plans, but they can establish other types of retirement plans.

Which of the following statements are true about Keogh Plans? I Contributions are 100% deductible II Contributions are not deductible III Distributions are 100% taxable IV Distributions are partially taxed, with only the amount above what was contributed being taxed

I and III Keogh contributions are tax deductible (up to $56,000 in 2019), so the original investment was made with "before tax" dollars. In addition, earnings on Keogh investments are tax deferred. Once distributions commence from the Keogh plan, they are 100% taxable as ordinary income.

Hardship withdrawals without penalty prior to age 59 1/2 are permitted from a 401(k) plan to pay for all of the following EXCEPT:

wedding expenses The tax code allows a unique feature for salary reduction plans that is not available for other retirement plans. These are early withdrawals for "financial hardship." However, these hardship withdrawals are subject to income tax and may be subject to penalty tax for those under age 59 1/2. This provision covers all salary reduction plans, including 401(k), 403(b) and 457(b) salary deferral plans. 401(k) plans are salary deferral plans established by for-profit companies; 403(b) plans are salary deferral plans established by not-for-profit organizations such as schools; and 457(b) plans are deferred compensation plans established by governments. The plan must permit hardship withdrawals and can specify the conditions under which a hardship withdrawal will be permitted. The tax code permits hardship withdrawals from these plans to pay for "immediate and heavy" expenses including large medical bills, purchase of a principal (not a vacation) residence, educational expenses, payments necessary to prevent eviction from a principal residence and funeral expenses.

Hardship withdrawals are permitted from which retirement plan?

401(k) The tax code allows a unique feature for salary reduction plans that is not available for other retirement plans. These are early withdrawals for "financial hardship." However, these hardship withdrawals are subject to income tax and may be subject to penalty tax for those under age 59 1/2. This provision covers all salary reduction plans, including 401(k), 403(b) and 457(b) salary deferral plans. 401(k) plans are salary deferral plans established by for-profit companies; 403(b) plans are salary deferral plans established by not-for-profit organizations such as schools; and 457(b) plans are deferred compensation plans established by governments. The plan must permit hardship withdrawals and can specify the conditions under which a hardship withdrawal will be permitted. The tax code permits hardship withdrawals from these plans to pay for "immediate and heavy" expenses including large medical bills, purchase of a principal (not a vacation) residence, educational expenses, payments necessary to prevent eviction from a principal residence and funeral expenses.