Retirement

Voluntary Employees Beneficiary Association (VEBA)

- A Voluntary Employees Beneficiary Association (VEBA) is a welfare benefit plan into which employers deposit funds that will be used to provide specified employee benefits in the future. Technically, the VEBA is either a trust or a corporation set up by an employer to hold funds used to pay benefits under an employer benefit plan. - The payments made to the VEBA are deductible by the employer and the income of the VEBA is tax exempt.

Non-qualified stock options (NQSOs)

- An NQSO is an option that does not meet the requirements of an incentive stock option or it is explicitly identified as non-qualified. Basically it is a bonus program - additional compensation, nothing more. - As such, the exercise of NQSOs do not receive favorable capital gains treatment, but also are not subject to the holding period associated with ISOs. - From a risk perspective, the executive takes no risk in an NQSO. If the stock price falls below the exercise price, the executive simply does not exercise. If the stock appreciates, the executive may choose to exercise and may immediately sell the stock or hold it (there is investment risk to holding the stock). - The security holding period in the case of a non-qualified options begins on the date the option is exercised.

Incentive stock options (ISOs)

- An incentive stock option (ISO) is a right given to an employee to purchase an employer's common stock at a stated exercise price. - If the requirements of IRC Section 422 are met when the incentive stock option is granted (provided the exercise price is equal to the fair market value of the stock), the employee will not recognize any taxable income at the date of grant. - Further, at the date of exercise, the employee will also not be subject to ordinary income tax on the difference between the fair market value of the stock and the exercise price (bargain element). HOWEVER, this difference (the bargain element) is a positive adjustment for the Alternative Minimum Tax (AMT) calculation. - When the employee sells the stock subsequent to the exercise, the difference between the sales price of the stock and the original exercise price is considered long-term capital gain (assuming the holding period requirements are met), and there is a negative adjustment for the alternative minimum tax calculation.

Once the qualified retirement plan is determined to be top heavy, the plan must (1) use top heavy vesting schedules and (2) provide a minimum level of funding to non-key employees

- If the qualified defined benefit retirement plan is top heavy, the plan must accelerate the vesting from the standard vesting schedules to either a 2-to-6-year graduated or a 3-year cliff vesting schedule to maintain qualified status. All qualified defined contribution retirement plans automatically meet these requirements as they must use a 3-year cliff or 2-to-6-year graduated vesting schedule The sponsor of a top-heavy plan MUST provide its non-key employees with a minimum level of funding. • Minimum Funding for Defined Contribution Plans o A defined contribution plan that is considered top-heavy must provide each of its nonexcludable, nonkey employees a contribution equal to at least three percent of the employee's compensation. --An exception to the three percent minimum funding requirement occurs when the largest funding made on behalf of all key employees is less than three percent. In such a case, the employer must provide non-key employees with a contribution equal to that of the key employees. minimum funding for defined benefit plan - A top-heavy defined benefit plan must provide a benefit to its nonkey employees equal to two percent per the employee's years of service multiplied by the employee's average annual compensation over the testing period.

Defined benefit 50/40 test

- In addition to meeting one of the three coverage tests, a defined benefit plan must satisfy the 50/ 40 coverage test. The 50/40 coverage test requires the defined benefit plan to benefit the lesser of 50 nonexcludable (eligible) employees or 40 percent of all nonexcludable (eligible) employees on each day of the plan year

Qualified Roth IRA distribution

- Must be made after a five-year taxable period which begins January 1st of the taxable year for which the first regular contribution is made to the IRA AND satisfy one of the following: - made on or after the date on which the owner attains the age 59.5 - made to a beneficiary or estate of the owner on or after the date of the owner's death - is attributable to the owner being disabled - for first time home purchase (lifetime cap of 10,000 for first time home buyers includes taxpayer, spouse, child, or grandchild who has not owned a house for at least 2 years)

Health Savings Account (HSA)

- Similar to MSAs but less restrictive - HSAs can be established by anyone with a high deductible health insurance plan, • allow a higher contribution amount, and • reduce the penalty for non-medical distributions. - To qualify for an HSA, the individual's health insurance plan's deductible must be at least $1,400 for single coverage and the annual out-of-pocket costs cannot exceed $7,000 for 2021. For family coverage under an HSA, the health insurance plan deductible must be at least $2,800, and the annual out-of-pocket costs cannot exceed $14,000 for 2021. - Contributions to the HSA can be made by the individual or by the individual's employer. In either case, the aggregate contributions cannot exceed the health insurance plan deductible subject to a maximum contribution of $3,600 for individuals and $7,200 for families for 2021. Individuals between 55 years old and 64 years old, however, can make additional catch-up contributions of $1,000 over these limits for 2021. - Earnings within the HSA are not taxable, and amounts distributed from an HSA are also not taxable provided the distributions are used to pay for qualified medical expenses. If a distribution is not for qualified medical expenses, the entire distribution is taxable as ordinary income. If the distribution is

Medical Savings Account (MSA)

- The MSAs could be established after 1996 and before 2006 for employers with 50 or fewer employees and self-employed individuals. Employees could not establish the MSA but could contribute (subject to the limitations discussed below) to the account if their employer established an MSA on their behalf. - After 2005, MSAs were replaced by the Health Savings Account (HSA). However, the MSAs that were established prior to 2006 are still in existence, may still be maintained, and retain their tax-favored status. - Contributions can be made to the MSA by the employee or the employer. Employee contributions are deductible from the employee's gross income. In addition, employer contributions are tax deductible by the employer, not subject to payroll taxes, and not taxable income to the employee. The aggregate contributions to the plan by the employee and the employer cannot exceed 65 percent of the deductible for individual coverage and 75 percent of the deductible for family coverage. - The earnings on the assets within an MSA are tax deferred until a distribution is taken from the account. If a distribution is for qualified medical expenses, the distribution, including any earnings, is not taxable. If the distribution is not for qualified medical expenses, the entire distribution is taxable as ordinary income. In addition, if the distribution is taken before the

Taxation of NQSOs

- The grant of an NQSO will not create a taxable effect assuming that there is no readily ascertainable value for the NQSO. - If, however, the option does have a readily ascertainable value at the date of grant, the executive will otherwise have W-2 income equal to the value and the employer will have an income tax deduction. - Not taxed at the grant if the exercise price is equal to or greater than the fair market value of the stock - At the exercise date of the NQSO, the executive will deliver to the employer both the option and the exercise price per share. - The executive will recognize W-2 income for the appreciation of the fair market value of the stock over the exercise price (often referred to as the bargain element), income and payroll tax withholding will apply, and the employer will have an income tax deduction for the same amount. - The amount paid for the stock at exercise plus the bargain element included in the executive's W-2 will form the basis for the stock. - Stock acquired through the exercise of an NQSO does not have a specified holding period requirement. - When the stock is sold, the executive's gain or loss will be considered capital gain or loss and will receive short or long-term capital gain treatment according to the elapsed time between the date of the sale and the exercise date.

Savings Incentive Match Plan for Employees (SIMPLE)

- are retirement plans for small employers. - SIMPLE plans are attractive to employers because they are NOT required to meet all of the nondiscrimination rules applicable to qualified retirement plans, and they do not have the burdensome annual filing requirements. • Employer establishes written SIMPLE plan. • Employer contracts with employee to have salary reduction. • Employer withholds employee deferral over the course of a year. • Employee elective deferrals are not subject to income tax but are subject to payroll tax. • Employer deposits match on a regular basis tax deferred without payroll tax. • Earnings grow tax deferred on all contributions. Maximum amount for employer to contribute is dollar for dollar up to 3% of covered compensation

A retirement plan must annually satisfy at least one of the following tests to be considered a qualified retirement plan

-General safe harbor test - Ratio percentage test - Average benefits test

Retirement funding example currently 30 years old and plans to retire at 60 expects to live another 35 years at retirement current salary 100k and wants to live off 65% in retirement social security will provide 15k can earn 12% return and inflation 3% how much needs to be saved at beginning of each year?

0 CF 30 Nj 50,000 CF 35 Nj (1.12/1.03) - 1 x 100 = 8.7379 I/yr NPV = 47,724.0245 NPV = PV 30 N 12 I/yr 0 FV PMT = beg mode = 5,289.8526

Requirements for incentive stock option

1. ISOs can only be granted to an employee of the corporation issuing the ISOs. 2. The ISO plan must be approved by the stockholders of the issuing corporation. 3. The ISOs must be granted within 10 years of the ISO plan date. 4. The exercise of the ISO is limited to a 10-year period (5 years for 10%+ owners). 5. At the date of the ISO grant, the exercise price must be greater than or equal to the fair market value of the stock. 6. An ISO cannot be transferred except at death. 7. An owner of more than 10% of a corporation cannot be given ISOs unless the exercise price is 110% of the fair market value at the date of grant and the option term is less than 5 years. 8. The aggregate fair market value of ISO grants at the time the option is first exercisable must be less than or equal to $100,000 based on the grant price per year per executive. Any excess grant over the $100,000 is treated as a NQSO. 9. To qualify as an ISO, the executive must not dispose of the stock before the later of two years from the grant of the ISO or within one year of the exercise of the ISO. 10. The executive must be an employee of the corporation continuously from the date of the grant until at least three months prior to the exercise. *** item 8 tested occasionally and 9 tested often

Which vesting schedules may a non-top heavy profit sharing plan use?

2 to 6 year graduated. 3-year cliff. 1 to 4 year graduated.

Beth works for MG Inc. and was hired right out of school after graduating with a double major in marketing and advertising four years ago. Beth receives a $12,000 distribution from her designated Roth account in her employer's 401(k) plan as a result of her being disabled. Immediately prior to the distribution, the account consisted of $15,000 of investment in the contract (designated Roth contributions) and $5,000 of income. What are the tax consequences of this distribution?

3000 of income Non qualified distributions from a designated Roth account associated with a 401k are subject to tax on a pro-rata basis. Her total account is the 15,000 invested and the 5,000 of income for a balance of $20,000. Since 75% (15,000/20,000) of the value in the account consists of basis and the remaining 25% consists of earnings (5,000/20,000), that same ratio of basis to income will apply to the $12,000 distribution. It is not a qualified distribution because she has not held the account for at least five years.

Penalty for contributing more than 6,000 to an IRA

6%

Your client wants to retire in 10 years. Upon retirement she wants to receive equal payments of $100,000 each year for 25 years (which is her life expectancy). Upon her death she wants to leave $1,000,000 to her children. Her current portfolio value is $715,000. What is the IRR?

715,000 +/- CFj 0 CFj 9 Nj 100,000 CFj 25 Nj 1,000,000 CFj IRR = 7.0898

Match the following statement with the type of retirement plan which it most completely describes: "A qualified plan that is not a pension plan" is...

A Profit sharing plan.

Match the following statement with the type of retirement plan which it most completely describes: "A qualified plan which allows employee elective deferrals of 100% of includible salary and has a mandatory employer match" is...

A SIMPLE 401(k).

The capital preservation model

A capital needs analysis method that assumes that at client's life expectancy, the client has exactly the same account balance as he did at the beginning of retirement assumes at life expectancy, as estimated in the annuity method, the client has exactly the same account balance as he/she started with at retirement. So if life expectancy is exceeded there is still capital available.

How is life insurance utilized to finance the obligation of an employer under a non-qualified deferred compensation plan?

A company can defer compensation that would otherwise be due an employee and use the amount to purchase life insurance on the employee in the company's own name while paying the premiums for the policy.

Key employee

A key employee (decision-makers as opposed to just highly paid) is any employee who is any one or more of the following: - A greater than five percent owner, or - A greater than one percent owner with compensation in excess of $150,000 (not indexed), or - An officer (defined below) with compensation in excess of $185,000 for 2021. - Notice that a key employee must be an owner or an officer. Compensation by itself will not make an employee a key employee. Officer: - Whether an individual is an officer shall be determined upon the basis of all the facts, including the source of his authority, the term for which elected or appointed, or the nature and extent of his duties. Generally, the term "officer" means an administrative executive who is in regular and continued service. - No more than 50 employees must be treated as officers. If the number of officers, as defined above, exceeds 50, then only the first 50 ranked by compensation will be considered officers under the key employee definition.

Negative election clause

A negative election clause can assist a 401(k) plan in meeting the ADP test because it automatically deems that an employee defers a specific amount unless he elects out of the automatic deferral amount.

Supplemental Executive Retirement Plan (SERP)

A nonqualified deferred compensation plan that allows employers to provide additional retirement income to key, highly compensated employees. It allows employers to provide benefits beyond those of traditional qualified plans, such as 401(k) plans.

In order for a group term life insurance plan to be non-discriminatory,

A plan must benefit 70% of all employees or a group of which at least 85% are not key employees. If the plan is part of a cafeteria plan, it must comply with Section 125 rules.

Advantages of qualified plans to the employer and to the employee

Advantages to employer: • Employer contributions are currently tax deductible • Employer contributions to the plan are not subject to payroll taxes Advantages to employee: • Availability of pretax contributions for employees • Tax deferral of earnings on contributions • ERISA protection • Lump-sum distribution options (ten-year averaging, NUA, Pre-1974 capital gain treatment) ten-year forwarding average only applies to those born prior to 1936

Hot Dog Moving Company (HDM) sponsors a 401(k) profit sharing plan. In the current year, HDM contributed 20% of each employee's compensation to the profit sharing plan. The ADP of the 401(k) plan for the NHC is 2.5%. Alex, who is age 57, earns $177,778 and owns 7.5% of the company stock. What is the maximum amount that he may defer into the 401(k) plan for this year?

Alex is highly compensated because he is more than a 5% owner, so the maximum that he can defer to satisfy the ADP Test requirements is 4.5% (2.5% + 2%) and because he is over 50, he can defer the additional $6,500 (2020) as a catch-up contribution. Alex can defer $8,000 (4.5% × $177,778) and $6,500 (the catch-up) for a total of $14,500.

When does an ESOP need diversification?

An employee, age 55 or older, who has completed 10 years of participation in an ESOP may require that 25 percent of the account balance be diversified.

Wilber receives incentive stock options (ISOs) with an exercise price equal to the FMV at the date of the grant of $15. Wilber exercises these options 3 years from the date of the grant when the FMV of the stock is $35. Wilber then sells the stock 3 years after exercising for $45. Which of the following statements is (are) true?

At the date of sale, Wilber will have long-term capital gain of $30.

Rocco and Adrianne Balboa are near retirement. They have a joint life expectancy of 25 years in retirement. Adrianne anticipates their annual income in retirement will need to increase each year at the rate of inflation, which they assume is 3.5%. Based on the assumption that their first year retirement need, beginning on the first day of retirement, for annual income will be $90,000, of which they have $45,000 available from other sources, and an annual after-tax rate of return of 7%. Calculate the total amount that needs to be in place when Rocky and Adrianne begin their retirement.

BEGIN MODE N = 25 I = [(1.07 / 1.035) - 1] x 100 = 3.3816 PV = $776,692.59 PMT = $45,000 FV = 0

When Clarice and Hannibal retire together, they wish to receive $30,000 additional income (in the equivalent of today's dollars) at the beginning of each year. They assume inflation will be 3% and they expect to realize an after-tax return of 7%. Based on life expectancies, they estimate their retirement period to be about 25 years. They want to know how much they will require in their fund at the time of their retirement

Begin mode N= 25 I = [(1.07 / 1.03) - 1] x 100 = 3.8835 PV = ? = 492,914.07 PMT = 30,000 FV = 0

Bob Thornton received his NonQualified Stock Option (NQSO) from his company (publicly traded on the NYSE), one year ago last week, with an option exercise price and stock price of $30. He told you recently, as his trusted financial adviser, that he desperately needed cash, and so he exercised the options last week on the one year anniversary with the stock price at $40 per share, and he sold the stock as it climbed to $45 per share. What will the tax ramifications of these transactions be?

Bob will be taxed as W-2 income for the fair market value of the stock less the exercised price when it is exercised, and then he will be taxed at capital gain rates for the balance when the stock then subsequently sold (long or short term).

Entities which may establish a 401k plan

Corporations Partnerships LLCs Proprietorships Tax-exempt entities

Donald and Daisy are married and file jointly. They are both age 42, both work, and their combined AGI is $116,000. This year Donald's profit sharing account earned over $5,000. Neither he nor the company made any contributions and there were no forfeitures. Daisy declined to participate in her company's defined benefit plan because she wants to contribute to and manage her own retirement money. (Her benefit at age 65 under the plan is $240 a month.) How much of their $12,000 IRA contribution can they deduct? Assume that $6,000 is contributed to each account.

Daisy is an active participant. She cannot opt out of a defined benefit plan. Reduction = 6,000 × [(116,000-105,000) ÷ 20,000] Reduction = 3,300 $6,000 - $3,300 = $2,700 deductible contribution. Donald is not active in the current year so he is eligible for a spousal IRA of $6,000 Their total deductible contribution would be: $6,000 + $2,700= $8,700 Formula: Contribution × [(your AGI - the bottom of the phase out range) divided by the amount of the range (125,000-105,000 is where the 20k comes from)]

Bobby's Bar-b-que wants to establish a social security integrated plan using the offset method. Which of the following plans should he establish?

Defined Benefit Pension Plan

Defined benefit pension plan

Defined benefit pension plans Cash balance pension plans

Match the following statement with the type of retirement plan which it most completely describes: "A plan with mandatory annual contributions where the employer bears the risk of providing a predetermined retirement benefit" is a...

Defined benefit plan

Maximum plan limitations for defined benefit and defined contribution

Defined benefit: 290k covered compensation and the maximum benefit is the lesser of 230,000 or average of 3 highest consecutive years of compensation Defined contribution: 290k covered compensation and the maximum benefit is the lesser of 100% of compensation or 58k (not including catch up provision of 6500)

When do you have to take distributions from IRA?

Distributions to the IRA owner must begin by April 1 of the year following the year in which the owner reaches age 70 1/2 (if by 12/31/2019) or age 72 (if 70 1/2 after 12/31/2019).

Spenser is covered under his employer's top-heavy New Comparability Plan. The plan classifies employees into one of three categories: 1) Owners, 2) Full-time employees, 3) Part-time employees. Assume the IRS has approved the plan and does not consider it to be discriminatory. The employer made a 4% contribution on behalf of all owners, 2% contribution on behalf of all Full-time employees and 1% contribution on behalf of all part time employees. If Spenser currently earns $50,000 per year and is a full-time employee, what is the contribution that should be made for him?

For a profit sharing plan the contribution is limited to the lesser of $58,000 (2021) or covered compensation. Since the plan is top heavy, the plan must provide a benefit to all non-key employees of at least 3%, therefore; 50,000 × 3% = $1,500.

A Rabbi trust

Grantor trust designed to segregate nonqualified deferred compensation benefits from an employer's general accounts. A rabbi trust is a irrevocable trust but, unlike a funded deferred compensation plan, the assets are subject to the claims of the employer's creditors. This avoids constructive receipt by the employee and delays income taxation until distribution.

Marilyn Hayward is the sole proprietor and only employee of unincorporated Graphics for Green Promotions. In 2021, Marilyn established a profit sharing Keogh plan with a 25% contribution formula. As of December 31, 2021, Marilyn has $140,000 of Schedule C net earnings. The deduction for one-half of the self-employment tax is, therefore, $9,891. What is the maximum allowable Keogh contribution that Marilyn can make?

Half of the self-employment tax is given, you can skip the 1st step in the self-employment contribution formula (multiplying by 92.35%) 140,000 - $9,891 = 130,109 x 20%*= 26,022*The 20% is from the contribution rate formula: contribution rate / (1 + contribution rate) = self-employment contribution rate.25/ (1+.25) = .20. Note that if the employer has employees and contributes 15% for them, that is the contribution rate to use in this formula.

Jane P. Lane is a clerical worker who has been with her employer for the last 20 years. Last year, she got married in the Swiss Alps, which was quite out of character for her. She participates in an employer-paid group term life plan and selected term insurance in the amount of $200,000, which is three times her salary. She has named her spouse as the beneficiary of the policy. What is the tax consequence of this policy?

Her employer is permitted to deduct the premiums paid on the entire amount of coverage.

To obtain preferred tax treatment on ISOs the following requirements need to be met

In addition, a strict dual holding period must be met. A qualified sale requires waiting until 2 years from the date stock was granted and 1 year from the date the stock was exercised. Sales prior to either holding period being met are disqualified dispositions and terminate most of the tax benefits - it effectively triggers similar treatment as a NQSO.

Your client, Jill, age 49 in the current year, has earned income of $3,500. Her spouse, James, is retired. They also receive $30,000 per year from his pension and $100,000 in installment income from the sale of a business. Jill put $1,000 into a traditional IRA. They each decide to invest in a Roth IRA. What is the most Jill can put into her personal Roth IRA?

Jill is limited to a maximum IRA contribution of $6,000 (2021) or 100% of earned income ($3,500) since their joint AGI is below the Roth IRA phase-out threshold. She has already contributed $1,000 to traditional IRA, so maximum available for the Roth is $2,500 ($3,500 earned less $1,000).

Defined contribution pension plans

Money purchase pension plans Target benefit pension plans

Lois and Ken Clark are age 32. They want to retire at age 62. They have calculated they will need a lump sum of $4,300,000 to provide the inflation-adjusted income stream they desire. Current investment assets are projected to grow to $3,100,000 by age 62. They project they will earn 6% after-tax on their investments and inflation will average 4% over the next 30 years. They would like to fund their retirement in level annual payments. They assume their retirement will last 26 years. Using the capitalization utilization method, what annual end-of-year savings will the Clarks need to deposit during their pre-retirement years?

N=30 (62-32) i=6 PV=0 PMT=? FV=1,200,000

How to calculate self employment tax

Net earnings x .9235 = net earnings subject to self employment tax x 12.4% up to 142,800 +2.9% on all income = self employment tax

Calculate the self employed individuals contribution

Net self employment income - 1/2 self employment tax = adjusted net self employment earnings x self employed contribution rate = self employed individual's plan contribution

Kyle had contributed $20,000 in nondeductible contributions to his traditional IRA over the years. This year the account balance was $52,000 and he made a withdrawal of $5,000. What amount is reported on Kyle's Form 1040?

On Form 1040 Kyle will report the total distribution of $5,000 and the taxable amount of the distribution of $3,077 calculated as $32,000 ÷ $52,000 × $5,000. account balance = $52,000 non-deductible contributions = $20,000 (not taxed at distribution) $32,000 would be taxable. Because there is both taxable and non-taxable money, each distribution is a pro-rata distribution of both. 32k/52k = .6154 5,000 × 61.54% = 3,076.92

How much of group term life insurance is a nontaxable fringe benefit?

Only $50,000 of group term life is a qualified benefit. Amounts of term life insurance in excess of $50,000 is taxable to employee using Section 79, Table 1. Medical benefits are a tax-free employee benefit. Cafeteria plans cover LT Disability (employee is taxed if they receive disability benefits). Group life is only provided up to $50,000 in a cafeteria plan.

Characteristics of highly compensated employees

Owner employees: either an owner of > 5% for current or prior plan year or compensation in excess of 130,000 for 2021 for prior plan year Non-owner employees: compensation in excess of 130k for 2021 for prior plan year

Short term disability plans premium and benefits taxation

Premiums under an employer-paid plan are deductible to the employer when paid to the insurance company. The employee must claim the benefits from the employer-paid policy as taxable income. If employees pay for the premium on an after-tax basis, benefits are tax exempt. Premiums paid by the employee are deductible only though a Section 125 cafeteria plan, then benefits are taxable. Definitions of disability are much more liberal under short-term disability than under long-term disability.

Defined contribution profit sharing plans

Profit sharing plans Stock bonus plans Employee stock ownership plans 401k plans Thrift plans New comparability plans Age based profit sharing plans

Match the following statement with the type of retirement plan which it most completely describes: "This plan can provide for voluntary participant contributions which must be matched by the employer."

SIMPLE IRA.

Kyle is 56 and would like to retire in 11 years. He would like to live the "high" life and would like to generate the equivalent of 90% of his current income. He currently makes $150,000 and expects $24,000 (in today's dollars) in Social Security. Kyle is relatively conservative. He expects to make 8% on his investments, that inflation will be 4% and that he will live until 104. How much does Kyle need at retirement?

Salary = 111,000 (150,000* 90%) - 24,000 = 111,000 N = 11 years to retirement I = 4% inflation PV = 111,000 in salary FV = 170,879.40 BEG PMT = 170,879.40 N = 37 104 - 67 I = 3.8462 Inflation adjusted rate of return = [(1.08/1.04) - 1] × 100 Solve for PV Answer = 3,471,896.37 When finding present value of annuity due you have to have in BEG mode

Vijai, age 40, recently left his employer, GoGoRoller, a roller blade manufacturer. He left after 10 years because the working conditions became unbearable. GoGoRoller sponsored a SIMPLE IRA. Vijai deferred $30,000 into the plan during his time there and the employer contributed $15,000. When he terminated he requested the entire account balance of $55,000. How much would his check have been for?

Simple IRAs do not require the 20% withholding because they are not qualified plans. Therefore, the entire account balance would have been distributed to him. The 10% early withdrawal penalty is not assessed at the time of distribution from the plan, but on the 1040. The 25% penalty on a SIMPLE only applies in the first two years.

Maria, age 28, has just expressed an interest in retiring at age 55 and having an income of the equivalent of $40,000 per year in retirement income in today's dollars. She assumes that she can make 8% interest after tax and expects inflation to average about 4% per year. Her life expectancy is 85 years old and she wants to know how much she should be saving each year in her savings plan to reach her goal between now and her retirement.

Step #1 - NPV at time period zero: 0 CFj, 0 CFj, 26 shift Nj, 40,000 CFj, 30 shift Nj, 1.08/1.04 = -1 = × 100 = i/yr, Shift NPV gives $264,184.34; Step #2 - Annual savings required: N = 27, I = 8, PV = $264,184.34, PMT = ?, FV = 0, Answer: $24,159.

Farmer Fred wants to retire in 20 years when he turns 64. Fred wants to have enough money to replace 75% of his current income less what he expects to receive from Social Security at the beginning of each year. Fred's full benefit at age 67 is $25,000 in today's dollars. Fred is conservative and wants to assume a 7% annual investment rate of return and assumes that inflation will be 3% per year. Based on his family history, Fred expects that he will live 30 years in retirement. Fred just received his brokerage account statement, which he is using to fund his retirement, and it has a balance of $340,596.44. If Fred currently earns $100,000 per year, approximately how much does he need save at the end of each of the next 20 years to fund his retirement?

Step 1: Determine amount to be funded $100,000 income today 75% WRR $75,000 needs ($20,000*) less social security & pension. $55,000 amount to be funded Step 2: inflate funds to retirement age PV ($55,000), N 20, i 3.00%, Pmt 0, = FV $99,336.12 Step 3: PV of retirement annuity due (BEG Mode) Pmt $99,336.12, N 30, i 3.8835%, FV 0, = PV ($1,809,946.67) Step 4: Annual funding amount FV $1,809,946.67, N 20, i 7.00%, PV ($340,596.44), = Pmt ($12,000) *For this problem you must account for the face that he plans to retire at age 64, his benefit is stated at age 67. Thus, you will have a reduction in social security retirement benefits: Reduced by 5/9 for each month, for the first three years that a worker retires early. Reduced by 5/12 for each month beyond three years. In this case you are starting three years early so you will have a 20% reduction (5/9 × 36). 20% × $25,000 = $5,000. $25,0000-$5,000 = $20,000

Cher, who just turned 57 years old, took early retirement so she could spend more time with her three grandchildren and to work on her golf game. She has the following accounts: 401(k) Roth account - she has a balance of $100,000. She only worked for the company for four years and contributed $15,000 each year to the Roth account. The company never contributed anything to her account. Roth IRA - she has a balance of $80,000. She first established the account by converting her traditional IRA ($50,000 all pretax) to the Roth IRA 4 years ago and has contributed $5,000 each of the last 4 years. Cher decided that she would take a distribution of half of each account ($50,000 from the Roth 401(k) and $40,000 from the Roth IRA) for the purpose of purchasing a Porsche Cayenne, which of course would be used to carry her new Ping golf clubs. Which of the following is correct regarding the tax treatment of her distributions?

Taxation on $20,000 from the 401(k) Roth and a penalty on $20,000 from the Roth IRA.

Actual deferral percentage (ADP) test

Test required by the ERISA to ensure that highly compensated employees (HCEs) do not receive greater benefits from a 401(k) plan than those received by other employees

Robert Sullivan, age 56, works for Dynex Corporation, and earns $295,000. Dynex Corp. provides a non-elective 2% contribution to its SIMPLE IRA plan. Which one of the following is the maximum amount that could go into Robert's account this year?

The compensation limit of $290,000 applies to SIMPLE IRAs when non-elective contributions are made. Therefore the employer contribution is $5,800 (290,000 x 2%) and the employee can contribute up to $13,500 for 2021. In addition, Robert is 50 years old or older so he may make an additional catch-up contribution of $3,000. His total contribution is $5,800 + $13,500 + $3,000 = $22,300.

Match the following statement with the type of retirement plan which it most completely describes: "The plan permits the employer match to deviate below the required percentage in two of the last five years" is a...

The match for a profit sharing plan with 401(k) provisions can vary every year and there is no required percentage. However, a SIMPLE can vary the match in only 2 of 5 years.

James is covered under his employer's top heavy Defined Benefit Pension Plan. He currently earns $120,000 per year. The Defined Benefit Plan uses a funding formula of Years of Service × Average of Three Highest Years of Compensation × 1.5%. He has been with the employer for 5 years. What is the maximum defined benefit that can be used for him for funding purposes?

The maximum defined benefit is the lesser of $230,000 (2021) or his compensation. However, the funding formula will limit his defined benefit to $12,000 (5 × 120,000 × .02). Note that you would use 2% instead of the 1.5% because the plan is top heavy. He is not a key employee because he is not a 1) greater than 5% owner, 2) greater than 1% owner with compensation greater than $150,000 or 2) an officer with compensation greater than $185,000 (2021). Therefore the plan must use a defined benefit limit of 2% instead of 1.5%.

qualified group life insurance plan

The plan must benefit 70% of all employees, or a group consisting of 85% non-key employees, or a non-discriminatory class, or meet the non-discrimination rules of Section 125. Employees who can be excluded are: those with fewer than 3 years service, part-time / seasonal, non-resident aliens, or those covered under a collective bargaining unit. The minimum group size is 10.

Top heavy plans

The top-heavy rules were designed to ensure that qualified plans that significantly benefit owners and executives of the company (the "key employees") must provide some minimum level of benefits for the rank-and-file employees

Kevin's non-qualified stock options are as follows: 2,000 shares, strike price $34 5,000 shares, strike price $30 Current stock price: $65 Kevin's tax bracket: 42% (federal and state) Kevin has decided to exercise the above stock option awards which will expire in the next 2 years. Assuming he exercises them today, what is his tax liability (CFP® Certification Examination, released 8/2012)?

Therefore, on the first NQ grant of 2,000 shares the tax is: ($65-34) × 2,000 shares = $62,000 in ordinary income. At 42% tax rate the tax is $62,000 × .42 = $26,040.00 And On the second NQ grant of 5,000 shares the tax is: ($65-30) × 5,000 = $175,000 in ordinary income. At 42% tax rate the tax is $175,000 × .42 = $73,500.00 Total tax therefore is $26,040.00 + $73,500.00 = $99,540.00

COBRA provisions

Under the Combined Omnibus Budget Reconciliation Act of 1986 (COBRA), an employer that maintains a group health plan and employs 20 or more people on more than 50 percent of the calendar days in a year is required to continue to provide coverage under the plan to covered employees and qualified beneficiaries following the occurrence of a statutorily defined qualifying event. This is depicted in the following exhibit. COBRA Premiums • The employer may pay for the COBRA coverage either directly or by reimbursing the employee, or the employer may shift the burden of paying for the benefit to the beneficiaries. • During the statutory COBRA period, the premium cannot exceed 102 percent of the cost to the plan for similarly situated individuals who have not incurred a qualifying event. • If a qualified beneficiary receives the 11-month disability extension of coverage, the premium for the additional 11 months may be increased to 150 percent of the plan's total cost of coverage. COBRA premiums may be increased if the costs to the plan increase, but generally must be fixed in advance of each 12-month premium cycle

Who pays the premium for a group universal life insurance plan?

Usually, the employee is required to pay part or all of the premium cost of group universal life insurance.

VEBA can and cannot provide

VEBAs can provide: • life insurance before and after retirement. • fitness and accident benefits (health). • severance benefits paid through a severance pay plan. • unemployment and job training benefits. • disaster benefits. • legal service payments for credits. VEBAs cannot provide: • savings. • retirement. • deferred compensation. • commuting expenses. • accident or home owners insurance (property and causality).

WestN, Inc. sponsors a 401(k) profit sharing plan with a 50% match. In the current year, the company contributed 20% of each employee's compensation to the profit sharing plan in addition to the match to the 401(k) plan. The company also allocated a forfeiture allocation of $4,000. The ADP of the 401(k) plan for the NHC is 4%. Wade, who is age 45, earns $195,000 and owns 19% of the company stock. If Wade wants to maximize the contributions to the plan, how much will he defer into the 401(k) plan?

Wade is highly compensated because he is more than a 5% owner, so the maximum that he can defer to satisfy the ADP Test requirements is 6% (4% + 2%). Wade is also limited by the 415(c) limit of $58,000. Since the company contributes $43,000 (20% of $195,000 + $4,000 of forfeiture allocations), he only has $15,000 to split between the deferral and the match. Thus, he contributes $10,000* and the match is $5,000, which when added to the $43,000 totals $58,000. 6% of his salary of $195,000 is $11,700. However, he cannot defer this amount due to the 415(c) limit. *When he contributes they match 50%, so for every dollar he contributes 1.5 × that amount goes into the plan. Take 15,000/1.5 = $10,000

Why would a company issue both ISOs and NQSOs to an employee?

When both ISOs and NQSOs are available in the same year the individual can exercise and sell the unfavored NQSOs to generate enough cash to purchase and hold the favored ISOs. It would also be valuable to have both if they issued over $100,000 in options exercisable in the same year because there is a $100,000 limit on ISOs.

Keogh Contribution Calculation

contribution rate / (1 + contribution rate) = self-employment contribution rate 25% = 20%

Prohibited transactions If an individual or beneficiary of an IRA engages in any of the following transactions, then the account will cease to be an IRA as of the first day of the current taxable year

o Selling, exchanging, or leasing of any property to an IRA; o Lending money to an IRA; o Receiving unreasonable compensation for managing an IRA o Pledging an IRA as security for a loan; o Borrowing money from an IRA; or o Buying property for personal use (present or future) with IRA fund

Which vesting schedules may a top-heavy qualified profit sharing plan use?

qualified profit sharing plans must use a vesting schedule that provides participants with vested benefits at least as rapidly as either a 2 to 6 year graduated vesting schedule or a 3-year cliff vesting schedule.

Life insurance in qualified plans

the entire premium for universal life cannot exceed 25% of the employer's aggregate contributions, and 50% for whole life insurance. Any pension contributions used to purchase life insurance inside a qualified plan are deductible to the employer.

Short term disability benefits

usually start the eighth day of an illness (first day for an accident) and generally last no more than six months. The definition of disability under short-term disability coverage is defined as the inability to perform the normal duties of one's position. Generally, short-term disability coverage will start after sick pay benefits have been provided to a covered employee.

Advantages of qualified plans

• "Qualified plans" under Section 401(a), provide employers with: (1) current income tax deductions and (2) payroll tax savings. They provide plan participants with (1) income tax deferrals, (2) payroll tax savings and (3) federally provided creditor asset protection. • The trade-offs for the tax advantages of qualified plans are the cost of the plan (both the operational expenses and contributions) and compliance, including vesting, funding, eligibility, nondiscrimination testing, IRS reporting, and employee disclosure.

Cafeteria plans

• A cafeteria plan is a written plan under which the employee may choose to receive cash as compensation or tax-free fringe benefits. • Provided the cafeteria plan meets the requirements defined below, the value of the fringe benefit, if chosen by the employee, will be a deductible expense for the employer and will not be included in the employee's gross income.

Cash balance pension plans

• A cash balance plan is a defined benefit pension plan that shares many of the characteristics of defined contribution plans but provides specific defined retirement benefits. • From the participant's perspective, a cash balance plan is a qualified plan that consists of an individual account with guaranteed earnings attributable to the account balance. HOWEVER, the account that the employee sees is merely a hypothetical account displaying hypothetical allocations and hypothetical earnings. • Because the cash balance pension plan is a defined benefit pension plan, it is subject to all of the requirements of defined benefit plans and pension plans - When a cash balance pension plan is established, the plan sponsor develops a formula to fund the cash balance hypothetical allocation. This formula consists of a Pay Credit and an Interest Credit. - The pay credit may be integrated with Social Security to produce a higher benefit percentage to those participants who earn a salary above the Social Security wage base or may be based on a combination of age and years of service - thus rewarding participants for longer service. - The plan sponsor is responsible for the investment performance of the plan's assets and earnings. The benefit, which is a guaranteed return and is determined under the plan document, will be payable to the participant at retirement regardless - Uses a 3 year cliff vesting

a plan is considered top heavy under either of the following two definitions

• A defined benefit plan is considered top-heavy when the present value of the total accrued benefits of key employees (defined below) in the defined benefit plan exceeds 60 percent of the present value of the total accrued benefits of the defined benefit plan for all employees. • A defined contribution plan is top-heavy when the aggregate of the account balances of key employees in the plan exceeds 60 percent of the aggregate of the accounts of all employees. • Simply stated, if > 60 percent of the benefits or contribution are going to key employees-THINK top heavy!

Flexible spending accounts

• A flexible spending account (FSA) is a cafeteria plan that is funded by employee deferrals rather than employer contributions. Because of the consequences of forfeiture of unused benefits, these are often referred to as "Use It or Lose It" accounts. However, after 2012, the IRS permits FSA funds to be used in the "grace period," which must not extend beyond the 15th day of the third calendar month after year-end. • Since the ACA 2010, FSAs have an annual limit that is indexed. The limit for 2021 is $2,750.

Money purchase pension plans

• A money purchase pension plan is a defined contribution pension plan that provides for a contribution to the plan each year of a fixed percentage of the employees' compensation. • Specifically, the employer promises to make a specified contribution to the plan for each plan year, but the employer is not required to guarantee a specific retirement benefit. - An employer cannot deduct contributions to the plan in excess of 25 percent of the employer's total covered compensation paid. - Defined contribution plans are limited to contributing, on behalf of each participant, the lesser of 100 percent of the participant's compensation or $58,000 for 2021 to the plan. - uses either a 2 to 6 year graduated or 3 year cliff vesting schedule

Pension plans vs profit sharing plans

• A pension plan is a qualified retirement plan that pays a benefit, usually determined by a formula, to a plan participant for the participant's entire life during retirement. • Under profit sharing plans, plan participants usually become responsible for the management of the plan's assets (investment decisions) and sometimes even responsible for personal contributions to the plan (contributory plans).

Target benefit pension plans

• A special type of money purchase pension plan, known as a target benefit pension plan, determines the contribution to the participant's account based on the benefit that will be paid from the plan at the participant's retirement. • The plan formula may be written to provide a contribution to each participant during the plan year that is actuarially equivalent to the present value of the benefit at the participant's retirement. This will provide a greater contribution for older participants. • An actuary is required at the establishment of the target benefit pension plan, but unlike a defined benefit plan or a cash balance pension plan, an actuary is not required on an annual basis. • This plan does not fund the plan with the amount necessary to attain the target at retirement rather the employer promises a contribution to the participant's individual account based on the original actuarial assumptions. Once the contribution has been made, the participant is responsible for choosing investments. Like any defined contribution plan, the participant, at retirement, is entitled to the plan balance regardless of its value, be it greater than or less than the intended target benefit. • The target benefit pension plan is a form of money purchase pension plan; consequently, the target benefit pension plan is subject to all of the same contribution, eligibility, coverage, vesting, and distribution limitations as the money purchase pension plan.

Allowed benefits under cafeteria plan

• Accident and health benefits (but not med-ical savings accounts or long-term care insurance). • Adoption assistance. • Dependent care assistance. • Group term life insurance coverage (including costs that cannot be excluded from wages)

Defined benefit vs defined contribution plans

• All defined benefit plans are pension plans, but defined contribution plans can be either pension plans or profit sharing plans. • Pension plans can be either defined benefit or defined contribution, while all profit sharing plans are defined contribution plans.

Benefits not allowed under cafeteria plan

• Archer Medical Savings Accounts (see accident and health benefits). • Athletic facilities. • De minimis (minimal) benefits. • Educational assistance. • Employee discounts. • Lodging on employer's business premises. • Meals. • Moving expense reimbursements. • No-additional-cost services. • Transportation benefits. • Tuition reduction. • Working condition benefits

Cashless exercise of ISO

• At the time of a cashless exercise, a third-party lender lends the executive the cash needed to exercise the option and the lender is immediately repaid with the proceeds of the almost simultaneous sale of the stock. • A cashless exercise of incentive stock options automatically triggers at least a partial disqualifying disposition since the holding period requirements will not be met.

Withdrawals and distribution of SIMPLE

• Distributions from a SIMPLE are includable as ordinary income in the individual employee's taxable income in the year in which they are withdrawn. SIMPLE plan distributions are taxed in the same manner as distributions from a traditional IRA; the SIMPLE 401(k) does not have any "lump-sum provision." • A distribution or transfer made from a SIMPLE during the first two years of an employee's participation in the SIMPLE must be contributed to another SIMPLE to avoid taxation and penalty. If the distribution is subject to the early withdrawal penalty, the penalty tax increases from 10 percent to 25 percent. After the employee's first two years of plan participation, the 10 percent penalty for early withdrawal will apply if the distribution is not because of a penalty-excluded reason. • After the two-year participation period, a SIMPLE can be transferred or rolled over tax free to an IRA other than a SIMPLE IRA, a qualified plan, a 403(b) account or a tax-sheltered annuity; or a deferred compensation plan of a State or local government (457 plan).

Income tax on qualified plan contributions

• Employers receive a current income tax deduction for contributions made to plans; they are an ordinary and necessary cost of business. • Employers are limited to a maximum of 25 percent (or as actuarially determined for defined benefit plans) of the total of covered compensation paid to its employees as a contribution to a qualified plan. • Employees are not currently taxed on the related plan contribution; employees will be taxed when the funds are distributed from the plan. • This tax structure is an exception to the "normal" matching principle that allows the employer a deduction only when the employee has in

Disqualifying disposition of ISOs

• If stock acquired after exercising an ISO is disposed of before either two years from the date of the grant or one year from the date of exercise, the sale is known as a disqualifying disposition and some of the favorable tax treatment is lost (see above). -- For such a sale, any gain on the sale of the stock attributable to the difference between the exercise price and the fair market value at the date of exercise will be considered ordinary income, but it will not be subject to payroll tax or federal income tax withholding. • Any gain in excess of the difference between the exercise price and the FMV at the date of exercise will be short-or long-term capital gain considering the executive's holding period.

Payroll tax on qualified plan contributions

• In addition to income taxes, an employee's wages are subject to payroll taxes equal to 6.2 percent for Old Age Survivor and Disability Insurance (OASDI) on their compensation up to $142,800 for 2021 and 1.45 percent for Medicare tax on 100 percent of the employee's compensation. The employer is required to match any payroll taxes paid by the employee, creating a combined total payroll tax of 12.4 percent for OASDI up to $142,800 and 2.9 percent for Medicare (100 percent of compensation). • However, employers and employees are exempt from payroll taxes on employer contributions to a qualified retirement plan, providing up to a 15.3 percent (12.4 percent OASDI and 2.9 percent Medicare tax) savings on taxes for employer contributions into a qualified plan. • An individual is liable for Additional Medicare Tax of 0.9% if the individual's wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount (which is not indexed) for the individual's filing status: - Married filing jointly $250,000 - Married filing separate $125,000 - Single $200,000 - Head of household (with qualifying person) $200,000 - Qualifying widow(er) with dependent child $200,000 • This payroll tax exclusion does not apply to employee elective deferrals to retirement plans such as 401(k), 403(b), SIMPLEs, SARSEPs, and 457 plans. • Tax deferred funds will be taxable when distributed from the qualified retirement plan; at that point the recipient of the distribution will have taxable income. But, the distributions will not be subjected to any payroll taxes.

Disadvantages of qualified plans

• Limited contribution amounts • Contributions cannot be made after money is received • Plans usually have limited investment options • No or limited access to money while an active employee • Distributions usually taxed as ordinary income (Basis = $0) • Early withdrawal penalties may apply • Mandatory distributions at age 72 • Only ownership permitted is by the account holder • Cannot assign or pledge as collateral • Cannot gift to charity before age 701⁄2 without income tax consequences. Charitable gifts from IRAs post age 70.5 and pre age 72 will not count towards RMDs for those turning 70.5 after December 31, 2019 • Any year a deductible contribution is made to an IRA and a charitable distribution is made from an IRA, the allowable charitable deduction will be reduced by deductible contributions made after age 70 1/2. • Limited enrollment periods • Considered to be an Income in Respect of a Decedent asset, subjecting distributions to both income and estate taxes with no step-up in basis • Costs of operating the plan

Who can establish a SIMPLE?

• SIMPLE plans can only be established for companies who employ 100 or fewer employees who earned at least $5,000 of compensation from the employer for the preceding calendar year. • Whether the employees are eligible to participate in the SIMPLE or not, all employees who earned $5,000 or more in the previous year that are employed at any time during the calendar year are taken into consideration for purposes of counting the 100 employee limitation, regardless of whether they meet other eligibility requirements. C Corporations S Corporations Limited Liability Companies (LLC) Partnerships Proprietorships Government Entities An employer may not establish a SIMPLE if the employer contributes to a defined contribution plan for its employees during the year, if its employees accrue a benefit from a defined benefit plan during the year, or if the employer contributes to a SEP or 403(b) during the year