Chapter 15 Retirement
Reporting and Disclosure
a summary plan description to each plan participant and the Department of Labor; a summary of material modifications that details changes in any plan description to each plan participant and the Department of Labor; an annual return or report (Form 5500 or one of its variations) submitted to the IRS; a summary annual report to each plan participant; and any terminal report to the IRS.
a profit-sharing plan
is not a fixed liabilit
Qualified plan—
qualified plan is one that, by design or definition, meets certain requirements established by the federal government and, consequently, receives favorable tax treatment.
vesting schedule
reflects the employee percentage of ownership in benefits resulting from employer contributions
Popular vehicles used to fund an IRA include:
*mutual funds; *bank, savings and loan, or credit union accounts or CDs; *bank trust accounts; and *fixed or variable flexible-premium annuities.
A 401(k) plan
allows an employee to reduce his compensation by a stated percentage and have this amount placed in the 401(k) plan on a tax deductible and tax deferred basis. Often the employer will match employee contributions by contributing a percentage or dollar amount, such as $.50 for each $1 contributed by an employee.
Group Deferred Annuity
the employer holds a master contract and certificates of participation are given to the persons covered by the plan. Specified amounts of deferred annuity are purchased each year in order to provide a specified retirement income to an employee.
Incidental Limitations 1
A portion of the cost for life insurance provided under a qualified pension or profit-sharing plan may be included as part of an employee's taxable income for the year. However, the employee only pays tax on the cost of that portion of insurance protection that provides an economic benefit to the employee, such as any death benefit payable to the employee's beneficiary or estate. The cost for any benefits that are payable to the plan, trustee, or employer, such as key person life insurance, is not taxable as income to the employee.
Individual Deferred Annuity
Another means of funding a defined benefit plan is to take out individual deferred annuities on each plan participant. The premium rate is determined individually, on the basis of attained age and sex. Premiums are level to retirement.
Pension Plans
Defined benefit pensions/pure defined benefit plan target benefit pensions/hybrid plan money purchase pension/defined contribution plans
Fiduciary Responsibility
ERISA mandates very detailed standards for fiduciaries and other parties-in-interest of employee welfare benefit plans, including group insurance plans. This means that anyone with control over plan management or plan assets of any kind must discharge that fiduciary duty solely in the interests of the plan participants and their beneficiaries. Strict penalties are imposed on those who do not fulfill this responsibility.
Pension plans
are established and maintained by employers interested in providing systematically for the payment of definitely determinable benefits to retired employees over a period of years—usually for life. Retirement benefits are generally based on such factors as years of service and compensation.
Money purchase plans
considered defined contribution plans with required (as opposed to discretionary) contributions. A money purchase plan states the required contribution percentage. For example, a money purchase plan that has a contribution of 5% of each eligible employee's pay would require the employer to make a contribution of 5% of each eligible employee's pay into each employee's separate account. A participant's benefit is based on the amount of contributions to the account over time and the gains or losses associated with the account at time of retirement.
income in respect of a decedent
generally subject to income tax when received by the estate or other beneficiaries, less any amount the plan participant contributed using after-tax dollars. An itemized deduction may be available to the beneficiary for any federal estate taxes paid on income in respect of a decedent, even if the beneficiary is not the one who paid the estate tax. Tax treatment of benefits received as annuity installments by beneficiaries after the plan participant's death are usually treated like those received by the participant—a portion of the payments may be income tax free if the participant made contributions to the plan with after-tax dollars.
IRAs
help individuals save money to finance their retirement by allowing them to make pre-tax contributions to the IRA. An IRA allows an individual to contribute 100% of that person's earned income (wages) up to the limits (a specific dollar amount) established by the IRS. Almost any individual with earned income (wages) who is under the age of 70½ is eligible to open an IRA.
incidental determination
Another way to make the incidental determination is the 100-to-1-ratio test, which provides that life insurance is incidental to a qualified plan as long as the death benefit does not exceed 100 times the expected monthly benefit.
Profit Sharing Plans/Defined Contribution Plans
Profit Sharing ESOP SEP Stock bonus Thrift Money Purchase Pensions 401k
Taxation of Plan Benefits
The only funds that escape taxation at distribution are those that have already been taxed. For example, some plans allow participants to make voluntary, after-tax contributions to their plans. These funds would not be taxed at distribution.
Tax-Deferred Annuity Arrangements (403(b) Arrangements)
Under a 403(b) plan, employees of organizations such as school systems, churches, and hospitals are eligible to set aside portions of their current income by means of a salary reduction or an elective deferral. This elective deferral is not currently taxed, will grow tax deferred, and will be taxed as current income when received at retirement. Salary reduction deferrals by an individual may not exceed $15,000 per year.
no early withdrawal penalty is charged for the following exceptions:
*Medical expenses in excess of 7.5% of adjusted gross income *Distributions toward the purchase of a first home *Distributions used toward qualified higher education expenses *Distributions due to death or disability of the participant *Distributions to a former spouse or dependent child as a result of a divorce decree *Distributions which are part of a series of periodic payments under a life annuity arrangement
General qualification requirements for employer-sponsored retirement plans include the following.
*The plan must be for the exclusive benefit of the employees and their beneficiaries. *The plan must be communicated to employees in writing and be permanent. *The plan must be established by the employer. *The plan must not discriminate in contributions or benefits on the basis of income or sex. *The plan must have a defined vesting schedule. *The plan must be approved by the IRS.
Reporting and Disclosur
*a summary plan description to each plan participant and the Department of Labor; *a summary of material modifications that details changes in any plan description to each plan participant and the Department of Labor; *an annual return or report (Form 5500 or one of its variations) submitted to the IRS; *a summary annual report to each plan participant; and *any terminal report to the IRS.
rollover
*is a tax free withdrawal of cash or other assets from one retirement program and its reinvestment in another retirement program. The amount rolled over is not counted as current income and is not taxable until later withdrawn. *However, a rollover must be completed within 60 days after the distribution is received, or else the full amount becomes taxable as current income.
Contributions to an IRA could be tax deductible depending on the income level of the participant and the participant's spouse if married. For example, contributions are tax deductible/or partially tax deductible if the following apply.
IRA contributions are always tax deductible if the participant is not eligible to contribute to an employer sponsored plan, regardless of the participant's income. IRA contributions are tax deductible to an individual who has a qualified plan only if the individual's income level is below a level set by the IRS.
two types of Section 529 or Qualified Tuition Plans
*prepaid tuition plans and college savings plans. Prepaid tuition plans allow contributors to prepay college tuition and other fees for a designated beneficiary for a set number of academic periods or course units while locking in current tuition costs *College savings plans allow contributors to invest after-tax dollars in professionally managed accounts that contain a mix of stocks, bonds, and other investments. Contributors assume both inflation and investment risk.
defined benefit plan
is a qualified plan in which the employer agrees to make necessary contributions on behalf of eligible employees in order to provide a specific retirement benefit. The amount of the retirement benefit is clearly defined (usually as a percentage of salary), but the amount of the employer's contribution is not specifically known.
IRS Rules
*A participant must complete a rollover to another qualified plan within 60 days or the distribution is considered a non-qualified distribution and is subject to taxes and penalties. *Qualified rollovers must include the total amount that was in the account. This includes the 20% withheld plus 80% received by plan participant or else there will be taxes and penalties on any portion of the total amount that was not reinvested within 60 days. *A plan sponsor must withhold 20% of the distribution in federal taxes on a rollover, and there is no withholding on a transfer. Once the rollover takes place to the new custodian, the remainder of the distribution is made.
Taxation of Plan Benefit
Distributions may be made in the form of annuity installments or, in the case of a defined contribution plan, in a lump sum. Those made in the form of installments may be made partially income tax free. The portion of each payment that represents money that has already been taxed to the recipient, if any, is excluded from gross income. The remainder is taxed as ordinary income in the recipient's tax bracket.
Incidental Limitations
For term and universal life policies, the death benefit is considered incidental if the aggregate premiums are less than 25% of the aggregate contributions for any participant. (Only the pure insurance portion of a UL premium is used in this calculation.) For whole life policies, the death benefit is incidental if the aggregate premiums are less than 50% of the aggregate contributions for any participant.
Plan Distributions
all withdrawals are taxable as current income, but any withdrawal before age 59½ is subject to an additional tax penalty of 10% of the amount withdrawn.
SEP Established
Once an SEP is established, the employer must make contributions for each employee who is at least 21 years of age, who has performed services for the employer during the current year, and has performed services for at least three of the previous five years.
Common characteristics of a qualified retirement plan include the following.
*Employer contributions to a qualified retirement plan are considered a deductible business expense, which lowers the business's income taxes. *The earnings of a qualified plan are exempt from income taxation for the employee and the ac cumulated values grow tax deferred. *Employer contributions to a qualified plan are not currently taxable to the employee in the years they are contributed, but these contributions are taxable when they are paid as a benefit (and, typically, when the employee is retired and in a lower tax bracket). *Contributions to an individual qualified plan, such as an individual retirement account or annuity (IRA), are deductible from income under certain conditions.
Simplified Employee Pensions (SEPs)
*small employer can contribute specific amounts directly into IRA accounts on behalf of eligible employees. This is a simplified method of establishing a pension plan because an IRA is already a qualified plan and it is easier for an employer to establish and administer. *Contributions to the plan are not included in the employee's taxable income for the year made, to the extent that the contribution does not exceed 25% of the employee's compensation or $40,000.
A target benefit pension plan
is a cross between a defined-contribution and defined-benefit plan that works much like a money purchase plan except that a target benefit is specified. This target benefit looks like a defined-benefit plan, but it's only a target and may or may not be reache
defined contribution plan
is a qualified retirement plan in which the employer agrees to make a specific contribution on behalf of all eligible employees, which is usually expressed as a percentage of compensation. The amount of the contribution is clearly specified, but the amount of the retirement benefits to be received is not specified.
Other IRA Tax considerations
*Distributions must be made by April 1 following the year the participant turns age 70½ or a 50% excise tax will be assessed on the amount that should have been withdrawn. *If the beneficiary is the spouse, the spouse can collect the interest in an IRA starting no later than December 31 of the year immediately following the owner's death or no later than December 31 of the calendar year in which the owner would have reached age 70½. *If the beneficiary is anyone other than a spouse, the entire interest must be paid in full on or before December 31 of the calendar year of the fifth anniversary of the owner's death.
Qualified rollovers
*must include the total amount that was in the account. This includes the 20% withheld plus 80% received by plan participant or else there will be taxes and penalties on any portion of the total amount that was not reinvested within 60 days. *A plan sponsor must withhold 20% of the distribution in federal taxes on a rollover, and there is no withholding on a transfer. Once the rollover takes place to the new custodian, the remainder of the distribution is made.
transfer
occurs when amounts in a qualified plan are transferred into another qualified plan. For example, when an employee changes jobs and the new employer's plan allows for acceptance of transferred amounts, a transfer occurs. A transfer is a distribution that goes directly from one qualified plan sponsor to another qualified plan sponsor. The participant is never in possession of the funds.
cash value insurance
the taxable cost would be the one-year term rate for the amount of protection at risk (face value minus accumulated cash value), regardless of the premium actually being paid by the plan. For term insurance, the full premium for amounts payable for the employees' benefit is taxable because it represents the cost for pure protection.
Non-qualified plan—
A non-qualified plan does not meet federal guidelines and is not eligible for certain tax benefits.
ROTH IRA QUALIFICATIONS
Interest earned and distributions made are tax free if the IRA is maintained for at least five years and the distribution meets specific qualifications (the attainment of age 59½, death, disability, the purchase of a first home, or qualified higher education expenses). There is no requirement in a Roth IRA for distributions to begin before age 70½.
SIMPLE (Savings Incentive Match Plan for Employees) IRA A SIMPLE IRA
Is a simplified retirement plan for small employers (100 or fewer employees) who do not have another type of retirement plan available to their employees. A SIMPLE plan may be structured as an IRA or a 401(k), and allows for elective contributions by employees as well as matching or nonelective contributions by employers. Plans must meet vesting and participation requirements, but they are generally not subject to the nondiscrimination rules applicable to other qualified plans.
ROTH IRA
Roth IRAs are different that a traditional IRA in the fact that contributions to the Roth IRA are not tax deductible but distributions are received tax free (this includes contributions and interest earned)
Plan Distribution Penalties
There is a 6% excess contribution penalty that applies to IRAs. There is also a requirement that distributions from any qualified plan must begin at a certain age. For example, amounts in a traditional IRA must start to be withdrawn by April 1 of the year following the year in which the individual reaches age 70½; the individual must take a distribution from the account or at least begin a plan of distribution. Failure to do so results in a late withdrawal penalty equal to 50% of the amount that should have been received by the participant. Individuals over age 50 are allowed to make an additional contribution per year, called the catch-up provision.
extent that the cost for incidental life insurance
To the extent that the cost for incidental life insurance protection is taxable as current income to the employee, the employee only pays tax on the cost for pure protection.