Chapter 17
What are the federal income-tax advantages to employers in a qualified retirement plan?
The federal income tax advantages to employers in a qualified retirement plan are: Employer's contributions to the retirement plan are tax deductible up to a certain limit It helps employers retain good employees
What are the federal income-tax advantages to employees in a qualified retirement plan?
The federal income-tax advantages to employees in a qualified retirement plan are: Reduces employee's current tax liability Earnings on assets are accumulated on tax deferred basis
What is a Roth 401(k) plan?
A Roth 401(k) plan you make contributions with after-tax dollars, and qualified distributions at retirement are received income-tax free. Investment earnings accumulate on a tax-free basis, and distributions from the plan are income-tax free if you are at least 59.5 and the account is held for at least 5 years.
Cash-balance plan
A defined-benefit retirement plan in which benefits are defined in terms of a hypothetical account balance; the actual benefit paid depends on the partici-pant's account at retirement.
Money purchase plan
A defined-contribution retirement plan in which each participant has an individual account, and the employer's contribution is a fixed percentage of the participant's compensation.
Qualified retirement plans must meet certain requirements to receive favorable federal income-tax treatment. Briefly explain each of the following: d. Early distribution tax penalty
An employee is charged 10% tax penalty if he/she makes withdrawal from a qualified retirement plan before the age of 59.5.
Pension Benefit Guaranty Corporation (PBGC)
A federal corpo-ration that guarantees the payment of vested or nonfor-feitable benefits up to certain limits if a private defined benefit pension plan is terminated.
Funding agency
A financial institution that provides for the accumulation or administration of the contributions that will be used to pay pension benefits.
Qualified retirement plans must meet certain requirements to receive favorable federal income-tax treatment. Briefly explain each of the following: b. Vesting provisions
A qualified defined-benefit plan must meet a minimum vesting standard · Under five-year cliff vesting, the worker must be 100 percent vested after 5 years of service · Under three- to seven-year graded vesting, the worker must be 20 percent vested by the 3rd year of service, and the minimum vesting increases another 20 percent for each year until the worker is 100 percent vested at year 7
Section 401(k) plan
A qualified profit-sharing or thrift plan that allows participants the option of putting money into the plan or receiving the funds as cash. The employee can voluntarily elect to have his or her salary reduced up to some maximum annual limit, which is then invested in the employer's Section 401(k) plan.
Section 403(b) plan
A qualified retirement plan designed for employees of public educational systems and tax-exempt organization, such as hospitals, nonprofit groups, and churches. See also Tax-sheltered annuities
Roth 401(k) plan
A qualified retirement plan in which con-tributions are made with after-tax dollars and qualified distributions at retirement are received income-tax free; investment earnings also accumulate on a tax-free basis.
Individual 401(k) retirement plan
A qualified retirement plan with significant tax savings for self-employed individuals or businessowners with no employees other than a spouse, which combines a profit-sharing plan with an individual 401(k) plan.
Qualified plan
A retirement plan that meets certain Internal Revenue Service (IRS) requirements and receives favor-able income tax treatment.
Ratio percentage
A test that a qualified pension plan must meet to receive favorable income-tax treatment. Under this test, the percentage of those not highly compensated employees covered under the plan must be at least 70 per-cent of the percentage of highly compensated employees who are covered.
Minimum coverage requirements
A test that must be met to pre-vent employers from establishing a qualified pension plan that covers only the highly compensated.
Simplified employee pension (SEP)
An employer-sponsored individual retirement account that meets certain requirements. Paperwork is reduced for employers who wish to cover employees in a retirement plan.
Funding instrument
An insurance contract or trust agreement that states the terms under which the funding agency will accumulate, administer, and disburse the pension funds.
Career-average earnings
In a defined-benefit pension plan, the benefit amount may be based on career-average earnings, which is an average of the worker's earnings while partici-pating in the plan.
Employee Retirement Income Security Act of 1974 (ERISA)
Legislation passed in 1974 applying to most private pension and welfare plans that require certain standards to protect participating employees.
Minimum vesting standards
Qualified retirement plans must meet certain minimum vesting standards. Vesting refers to the employee's right to the employer's contributions or benefits attributable to the contributions if employment terminates prior to retirement.
Describe the basic characteristics of a Section 401(k) plan.
The basic characteristics of a section 401(k) plan are: Allows employees to decide how funds should be invested Elective deferral annual limit Actual deferral percentage test Highly compensated employee Limits on distributions
Normal retirement age
The normal retirement age is the age that a worker can retire and receive a full, unreduced ben-efit. Age 65 is the normal retirement age in the majority of retirement plans.
Identify the major problems that are currently present in tax-deferred retirement plans.
The problems that are currently present in tax-deferred retirement plans are: Incomplete coverage of labor force Lower benefit for women Limited protection against inflation Leakages from 401(k) plans and IRA Plans
Qualified retirement plans must meet certain requirements to receive favorable federal income-tax treatment. Briefly explain each of the following: a. Minimum age and service requirement
To participate in retirement plans employees must have be 21 years of age and completed one year of service.
Defined-benefit plan
Type of pension plan in which the retire-ment benefit is known in advance but the contributions vary depending on the amount necessary to fund the desired benefit.
Separate investment account
Used in group pension plans in which the plan administrator has the option to invest in separate accounts offered by the insurer, such as stock funds, bond funds, and similar investments. Assets are segregated from the insurer's general investment account and are not subject to claims by the insurer's creditors.
Trust-fund plans
all contributions are deposited with a trustee who invests the funds according to the trust agreement between the employer and trustee.
SIMPLE retirement plan
allows employ-ees and employers to contribute to a traditional IRA established for the employees. Such plans are limited to employers that employ 100 or fewer eligible employees and do not maintain another qualified plan. Under a SIMPLE IRA plan, smaller employers are exempt from most nondiscrimination and admin-istrative rules that apply to qualified plans.
Tax-sheltered annuities (TSAs)
also known as Section 403(b) plans
SEP-IRA
as known as SEP
Vesting
refers to the employee's right to the employer's contributions or benefits attributable to the contribu-tions if employment terminates prior to retirement.
Defined-contribution plan
ype of pension plan in which the contribution rate is fixed but the retirement benefit is variable. Most qualified retirement plans are defined- contribution plans.
Retirement plans for the self-employed (Keogh plans)
. The contributions to the plan are income-tax deductible up to certain limits; the investment income accumulates on a tax-deferred basis; and the amounts deposited and the investment earnings are not taxed until the funds are distributed.
Final average pay
A method of calculating a private pension benefit based on an average of the worker's earnings over a three-to five-year period just prior to retirement.
Guaranteed investment contract (GIC)
An arrangement in pri-vate pension plans in which the insurer guarantees the interest rate on a lump-sum pension deposit and also guarantees the principal against loss.
Past-service credits
Pension benefits awarded to employees based on service with the employer prior to the inception of the plan.
Roth 403(b) plan
Section 403(b) plans are retirement plans for public education systems and tax-exempt organizations. Employers have the option of allowing employees to invest in a Roth 403(b) plan, which is similar to a Roth 401(k) plan. Contributions are made with after-tax dollars; investment earnings accumulate on a tax-free basis; and qualified distri-butions at retirement are received income tax free.
Qualified retirement plans must meet certain requirements to receive favorable federal income-tax treatment. Briefly explain each of the following: c. Limitations on contributions and benefits
The amount of benefit that can be funded is equivalent to the lower of 100% of the average compensation of the highest three consecutive years of compensation.
Briefly explain the basic characteristics of a SIMPLE retirement plan.
The basic characteristics of a SIMPLE retirement plan are: Employees eligible to undergo SIMPLE plan are those who have either earned a minimum amount of $5,000 during any two consecutive or nonconsecutive previous years. Employees can make before tax contributions up to $12,500. Employers can contribute by matching contributions or non-elective contributions
Describe the basic characteristics of a Section 403(b) plan (also called a tax-sheltered annuity).
The basic characteristics of a Section 403(b) plan are: Employees voluntarily invest a fixed amount of their salaries in the plan Employers may make a matching contribution The plan can be funded by purchasing an annuity or by investing in mutual funds The employer must purchase the annuity and it is nontransferable
Deferred retirement age
The deferred retirement age is any age beyond the normal retirement age; employees work-ing beyond the normal retirement age continue to accrue benefits under the plan. Under current law, with certain exceptions, workers can defer retiring with no maximum age limit as long as they can do their jobs.
Early retirement age
This is the earliest age that workers can retire in a qualified retirement plan and receive retirement benefits.
Pension Protection Act of 2006
increased the funding obligations of employers, made permanent the higher contribution limits that were scheduled to expire at the end of 2010, and encouraged automatic enrollment of employees in Section 401(k) plans and defined- contribution plans.
Profit-sharing plan
is a defined-contribution plan in which the employer's contributions are typically based on the firm's profits
