Insurance Chapter 8

Unlike the employer-sponsored retirement plans, IRAs are established and funded by individuals.

IRAs may be funded by a number of investment vehicles including: Annuities, Savings accounts, Bank accounts, or Mutual funds. There are two main groups of IRAs: Traditional IRAs and Roth IRAs.

If Becky wants to take a distribution from her qualified retirement plan, she should know that distributions can be made:

at anytime

George is contributing to a qualified retirement plan at his company. What percentage of his contributions are vested immediately?

100%

Keogh Plans, also known as HR-10 plans, are qualified retirement plans for self-employed individuals. This includes sole-proprietors, partnerships, physicians, attorneys and farmers.

A Keogh plan may be organized as a: Defined contribution plan - the maximum annual contribution in 2014 is limited to the individual's annual earnings, up to $53,000. Defined benefit plan - the maximum annual contribution in 2016 is limited to the individual's annual earnings or $210,000. Contributions are tax-deductible as long as the maximum contribution limits are not surpassed. Dividends and interest are tax-deferred. Employees working for a self-employed individual who has a Keogh plan must be included in the Keogh plan if they: Are at least 21 years old, Have been employed for at least one year and Work over 1,000 hours a year.

In order for a retirement plan to be qualified, it must meet the following IRS requirements:

Be approved by the IRS Be established for the exclusive benefit of the employees and/or their beneficiaries Cannot discriminate in favor of highly-paid employees, officers, or stockholders Be in writing and communicated to the employees in writing Explicitly define the plan's contributions or benefits Be permanent Meet vesting and benefit requirements

Distributions from an IRA may occur for the following:

Death or disability without penalty Retirement after age 59½ First time home-buyers up to $10,000 without penalty, but with taxes Education - no dollar maximum - without penalty, but with taxes Catastrophic medical expenses, without penalty, but with taxes An owner of a traditional IRA must begin receiving payments by April 1st of the year following the year they become 70½.

money-purchase pension plan is also a type of defined contribution plan:

In a money-purchase pension plan, the employer contributes a fixed amount to the plan every year, and this amount is apportioned among each participant's account. Upon retirement, participants' benefit amounts are based on the funds in their accounts. In other words, money-purchase plans have fixed contributions and undefined benefits.

employer-sponsored qualified retirement plans include:

Individual and group deferred annuity, Profit-sharing plans, ESOP (Employee stock ownership plans), Pension plans, Money-purchased pension plans, Target benefit pension plan, CODA plans (Cash or deferred arrangement plans), 401k plans, 403b Tax Sheltered Annuities, and Deferred compensation- are nonqualified employer-sponsored retirement plans.

Rollovers are a transfer of funds from one IRA to another or one qualified plan into another.

Rollovers are taxable at a 20% withholding rate, unless the plan participant deposits the funds into a new IRA or qualified plan within 60 days of receiving the funds from the prior IRA. An IRA transfer occurs when IRA funds are moved from one trustee/custodian to another, such as transferring funds from one bank to another.

Distributions from a qualified retirement plan may be made regardless of the following:

The age when an employee retires, The employee ceases employment, or The plan is terminated.

target benefit pension plan is a combination of a defined contribution plan and a defined benefit plan:

The plan functions the same way as a money-purchase pension plan, but a target benefit amount is identified. This target benefit is a goal and is not always attained.

Defined benefit plan

*Definite determinable benefits *Systematic payment of benefits *Primarily retirement benefits established to pay a certain benefit amount when the employee retires. The benefit amount is based on the employee's length of service with the employer and level of earnings. The maximum annual benefit for defined benefit plans is the employee's mean annual earnings, but no more than $210,000 in 2016. The most common funding tool used for defined benefit plans is individual or group deferred annuities must cover 50 eligible employees, or 40% of all employees, with at least two participants.

qualified defined contribution plans with voluntary employee contributions and matching employer contributions, the following vesting schedule options apply:

3-year cliff vesting: employer contributions must be fully vested by the end of year 3. In years 1 and 2, employer contributions are 0% vested, but by the end of year 3 and in future years, employer contributions must be 100% vested. 6-year graded vesting: after 2 years of service, employer contributions must be 20% vested. In each year thereafter, the percentage vested increases 20%, until employer contributions are 100% vested by the end of year 6 -

qualified defined benefit plans:

5-year cliff vesting: the employer's contributions must be completely vested after the employee has worked five years. This means that during years 1 through 4 employer contributions are 0% vested; however, by the end of year 5 and in future years, employer contributions must be 100% vested. 7-year graded vesting: employer contributions must begin vesting after the employee has worked three years in an amount of 20%. Each year thereafter, the plan must vest 20% until employer contributions are completely vested after the employee has worked seven years. This means that in years 1 and 2 employer contributions are 0% vested. In the following years employer contributions are vested in increasing increments of 20%, until they are 100% vested, occurring after 7 years of employment:

The section 529 plan is a tax-advantaged savings plan to fund higher education costs. In most cases, interest is not subject to federal tax. In some states, interest earned in 529 plans is exempt from state income tax, as well.

Contributions are not federally tax-deductible, but some states may allow the contributor to deduct all or part of the state income tax. Distributions used for college costs are tax-free. Distributions used for college costs are tax-free. If withdrawals are not used for eligible college expenses, tax and a 10% federal penalty on the interest portion of the withdrawal applies. To avoid taxes and penalties, withdrawals must be made strictly for eligible college expenses. The plan is managed by an educational institution or by the state. The special benefits of section 529 plans include: Income tax breaks; State tax breaks; Funds may be reclaimed by the plan owner at any time and for any purpose; and The amount of deposit is large - up to $300,000 for each plan beneficiary. There are two types of section 529 plans: Savings plans (similar to a 401(k) plan or IRA), and A prepaid plan.

two primary types of employer-sponsored qualified plans: A defined benefit plan and A defined contribution plan

Defined benefit plans focus on definite determinable benefits; whereas, defined contribution plans concentrate on the amount of contributions made.

Nonqualified plans are characterized by:

Do not need to be approved by the IRS Can discriminate in favor of certain employees Contributions are not tax-deductible Interest earned on contributions is tax-deferred until withdrawn upon retirement

tax advantages of ESOPs:

Employer contributions are tax-deductible. Dividends are tax-deductible. Employee contributions are made pre-tax.

Pension plan:

Employer contributions to a pension plan are based on the employee's compensation and years of service with the company, not the company's profitability or the employer's preference. A top-heavy plan is a pension plan providing 60% or more of its benefits to the company's key employees. For a top-heavy plan to remain qualified, all non-key employees must receive employer contributions in an amount of 3% of compensation or a percentage equivalent to the highest paid employee's contribution rate.

Qualified plans have the following features:

Employer's contributions are tax-deductible as a business expense. Employee contributions are made with pretax dollars - contributions are not taxed until withdrawn. Interest earned on contributions is tax-deferred until withdrawn upon retirement. Distributions are taxed, both principal and interest, because neither the contributions nor interest was previously taxed.

George has been at the company for 7 years. Which type of vesting is characterized by employer contributions that are vested completely after a period of time?

In 5-year cliff vesting, the employer's contributions must be completely vested after the employee has worked five years. This means that during years 1 through 4 employer contributions are 0% vested; however, by the end of year 5 and in future years, employer contributions must be 100% vested.

401(k) plans are typical corporate retirement plans. 401(k) plans are a type of CODA plan.

Participants can contribute to their 401(k) plan through a salary reduction, cash bonus or thrift plan. Contributions made into a 401(k) plan are not part of the employee's gross income for tax purposes. The employee elects a percentage of their salary to be withheld. An employer contribution, sometimes referred to as the "matching element," is based on a percentage or amount of the employee's contribution. In 2016, individuals age 49 and below can contribute a maximum of $18,000 to their 401(k) plan annually. Individuals age 50 and above can contribute a total of $24,000 per year, which allows for annual "catch-up" contributions up to $6,000 per year.

profit-sharing plan is a type of defined contribution plan:

Plan administrators must provide participants with a clear formula for how company profits are contributed to participants. The employer's contribution amount may vary from year to year. The employee receives all contributions plus interest upon retirement. Contributions and interest are tax-deferred until withdrawn.

A Simplified Employee Pension (SEP) plan or 408(k) is a qualified plan for small employers:

SEPs are a mix of an IRA and profit-sharing plan. Employees have their own IRA. The employer makes contributions into the employees' IRAs. They are similar to 401(k) plans, but are intended for smaller companies with 25 or fewer employees. However, any employer may set up an SEP. An eligible employee includes any individual over age 21, who has worked for the employer for at least three of the past five years, and is making at least $550 annually. SEPs allow a greater annual contribution amount compared to IRAs. The maximum annual contribution for employers in 2016 is 25% of the employee's compensation, up to $53,000. Contributions made by the employer are not part of the employee's gross income. The employer may deduct the lesser of its contributions or 25% of the employee's compensation. Only up to $265,000 for 2016 of an employee's compensation may be considered.

Plan administrators must disclose the following information about pension plans and employee benefit plans to plan participants, beneficiaries, the IRS and Department of Labor:

Summary Plan Description - includes information about the plan and how the plan works Summary of Material Modification - includes pertinent changes to the plan Summary Annual Report (Form 5500)

Traditional IRAs *fully tax-deductible if an individual's modified AGI is $61,000 or less, or a married couple filing jointly has a modified AGI of $98,000 or less.

The amount of money an individual can contribute to their traditional IRA is: *Limited, *Indexed annually and ***Set by law. Interest earned on traditional IRA contributions is tax-deferred until withdrawn. Some individuals can make tax-deductible contributions, but all withdrawals are taxed. a maximum of $5,500 may be contributed per year for individuals age 49 and below. The limit is $6,500 for individuals age 50 and above, which includes a "catch-up" contribution of $1,000. These limits apply to Roth IRAs, as well.

Savings Incentive Match Plans for Employees (SIMPLE) are qualified retirement plans available to small businesses. Withdrawals made from a SIMPLE within the first two years are subject to a 25% penalty tax. In 2016, the maximum contribution amount is $12,500 for individuals age 49 and below. The limit is $15,500 for individuals age 50 and above. Individuals age 50 and above can make catch-up contributions in an amount of $3,000 per year. In 2016 $3,000 for SIMPLE plans.

The employer must have no more than 100 employees earning more than $5,000 during the prior year. The employer cannot have another qualified plan in effect. SIMPLE plans may be organized as an IRA or 401(k) established by the employer. Employees may make contributions by salary deferral, up to an annual maximum. The employer has two choices for contributing to employee's accounts: Contribute 2% of employee's compensation, without regard to whether the employee makes contributions; or Match the employee's contributions dollar-for-dollar up to a maximum of 3% of the employee's annual earnings. Contributions are fully vested immediately. Contributions and interest earned are tax-deferred until withdrawn. The employer can deduct contributions pretax, so they are not part of the employee's taxable income.

Roth IRAs are arranged so that the withdrawals are tax-free. Unlike the traditional IRA, contributions made to a Roth IRA are not tax-deductible.

The interest is not taxable as long as the withdrawal is a "qualified distribution": After five years, if the account owner dies or becomes disabled Up to $10,000 for first-time home buyers After the age of 59½ a maximum of $5,500 may be contributed per year for individuals age 49 and below. The limit is $6,500 for individuals age 50 and above. An individual can contribute the maximum amount to a Roth IRA if their annual income is below $116,000. For a married couple filing jointly, the maximum annual income is $183,000. Contributions to a Roth IRA are not permitted if annual income exceeds the upper limit. Individuals or married couples whose annual earnings surpass a certain amount are ineligible for Roth IRAs.

distributions made for the following reasons are not subject to the early distribution penalty tax:

The plan participant dies or incurs a disability A loan is taken from the plan Distribution made as part of a divorce decree Level payments made at least annually to the participant over their life Distribution made as a qualified rollover

Cash or deferred arrangement (CODA) plan is a modified profit sharing or pension plan:

These plans are termed CODA because part of the participant's compensation is deferred by putting it into the plan. There are two ways to defer compensation: 1. A cash bonus is put into the participant's account on a pre-tax basis, or 2. The participant takes a reduced salary, and the amount of the reduction is put into the plan on a pre-tax basis. CODA plans defer taxation until the participant is retired (presumably in a lower tax bracket). The funds are taxed when disbursed.

Single 401k plans are designed for self-employed individuals or the sole owner-employee of a corporation.

They have high annual contribution limits and give the individual more freedom to make investments.

Salary Reduction SEP (SARSEP) is a SEP that allows for employees to make salary-reduction contributions into the SEP: the catch-up is $6,000 for SARSEPs

To qualify as a SARSEP: The SEP must have been set up before 1997, The employer must have 25 or fewer employees, and At least 50% of eligible employees must choose to make salary-reduction contributions. Both the employer's and employee's contributions are tax deductible. The maximum annual contribution for employees in 2016 is $18,000 for individuals under age 49 and below and $23,000 for individuals that are age 50 or older. The maximum annual contribution for employers is 25% of the employee's compensation, up to $53,000. In addition, if the SEP-IRA permits non-SEP contributions, employees can make contributions to the IRA of up to $6,000 in 2016.

403(b) tax-sheltered annuities are 401(k) retirement plans specifically available to employees of nonprofit 501(c)(3) organizations and public school employees.

also called tax deferred annuities. The employee makes contributions to the TSA by salary reduction. The employee's gross income is reduced by the amount of salary reduction used for contributions. The employer purchases a deferred annuity with the employee's contributions. Contributions made by the employee and earned interest are not taxed until withdrawn. The maximum that can be contributed to a TSA in 2016 is $18,000 for individuals age 49 and below. The limit is $24,000 for individuals age 50, which includes the "catch-up" contributions up to $6,000 per year.

Plan vesting requirements on qualified plans are imposed on:

employer contributions

defined contribution plan (two types): Profit-sharing plans and Pension plans.

exact benefit amount isn't known until distributions begin. Maximum contribution is the lesser of the employee's annual earnings, or $53,000 per year in 2016

employee stock ownership plan (ESOP) is also a defined contribution plan. ESOPs are similar to profit-sharing plans.

how an ESOP works: The employer establishes a trust fund, and uses cash or new shares of its stock to purchase existing shares. Each employee over age 21 who works on a full-time basis is permitted to participate in the plan. Each participating employee has their own account to which shares from the trust are allocated. Depending on the vesting schedule used, all funds must be completely vested in the employee accounts within 3 to 6 years.

deferred compensation plan also a 457 plan:

the employee is not receiving all of their salary at the time it normally would be paid. Rather, the employee's current salary is reduced and part of it is deferred to a later time. The result is a reduction in the employee's salary. A section 457 plan is a nonqualified deferred compensation plan for government and nonprofit employees. The maximum amount of compensation that may be deferred is $18,000 in 2016. Individuals age 50 or over may contribute an additional $6,000 in "catch-up" contributions. *If an employer also offers a 401(k) or a 403(b) plan, the individual can contribute to both the 457 and the other plan.