Retirement Plans

  1. Qualified Retirement Plans
    • -Contributions Tax Deductible
    • -Plan approved by the IRS
    • -Plan Cannot Discriminate
    • -Tax on accumulation is deferred
    • -All withdrawls taxed
    • -Plan is a trust
  2. NonQualified Retirement Plans
    • -Contributions not tax deductible
    • -Plan does not need IRA approval
    • -Plan can discriminate (may favor certain employees - typically execs)
    • -Tax on accumulation is deferred
    • -Excess over cost base taxed
    • -Plan is not a trust

    *Deferred compensation & payroll deduction (NOT 401(K), which is considered a salary reduction plan by FINRA) plans are 2 types of nonqualified retirement plans
  3. Deferred Compensation Plans
    • -Agreement between a company and an employee in which the employee agress to defer receipt of current income in favor of payout at retirement
    • -It is assumed the employee will be in a lower tax bracket at retirement age
    • -Risky because the employee covered by the plan has no right to plan benefits if the business fails, becomes a general creditor of the firm
    • -Covered employees may also forfeit benefits if they leave the firm before retirement
    • -Taxed @ ordinary income & employer is entitled to the tax deduction at the time the benefit is paid out
  4. Payroll Deduction Plans
    • -Allow employees to authorize their employer to deduct a specified amount for retirement savings from their paychecks
    • -Money is deducted after taxes are paid and may be invested in any number of retirement vehicles at the employee's option
  5. IRAs
    • -May make an annual contribution of up to $5,000 or 100% of earned income, whichever is less (individuals over 50 are allowed a $1,000 catch-up contribution); 6% penalty for excess contributions; must be made by April 15th of the year following the tax year
    • -Individuals with non working spouses may contribute up to a total of $10k split between 2 accounts (spousal IRA & only available if filing joint tax returns)
    • -May contribute until age 70.5, provided they have earned income
  6. IRA Distributions
    • -May begin without penalty at age 59.5, and must begin by April 1 of the year after the individual turns 70 1/2 (subject to a 50% insufficient distribution penalty if they do not begin by April 1)
    • -Distributions are subject to a 10% penalty tax except in the event of:
    • 1)Death
    • 2)Disability
    • 3)First-Time homebuyer for purchase of a principal residence
    • 4)Education expenses for the taxpayer, spouse, child, or grandchild
    • 5)Medical premiums for unemployed individuals
    • 6)Medical expenses in excess of defined adjusted gross income (AGI) limits
  7. IRA Contributions
    • -Contributions are fully deductible, regardless of income, if the investor is ineligible to participate in any other qualified plan
    • -If the investor is eligible to participate in other qualified plans, contributions are deductible (or partially deductible) if the taxpayer's AGI (adjusted gross income) falls within established income guidelines
    • -This means, high earning individuals, if covered by another qualified plan, may not take a tax deduction for an IRA contribtuion, but they may still make a contribution
    • -FDIC Insurance on retirement accounts held at banks is $250k
  8. Ineligible Funding & Practices
    • -Certain investments not permitted for funding IRAs: collectibles, antiques, gems, rare coins, works of art, stamps
    • -Life insurance contracts cannot be purchased within an IRA
    • -Muni bonds are considered inappropriate bc of their low yields and tax exempt status (why buy tax-free interest income that will be fully taxable on withdrawal)
    • -Other inappropriate investment practices:
    • 1)Short sales of stock
    • 2)Speculative option strategies
    • 3)Margin account trading

    -Covered Call writing is permissable bc it does not increase risk
  9. Investments appropriate for IRAs
    • 1)Stocks
    • 2)Bonds
    • 3)Mutual Funds
    • 4)UITs
    • 5)Government Securities
    • 6)US Government-issued gold and silver coins
    • 7)Annuities
  10. IRA Rollovers
    Qualified plan to Qualified plan, but may not do so more than once per year

    Must be completed within 60 days of withdrawal

    Direct transfer does not require a withholding tax (usually 20% otherwise)
  11. IRA Transfer
    IRA assets may be directly transferred from and IRA or qualified plan, assets are sent directly from one custodian to another, and the account owner never takes possession of the funds

    No limit on the # of transfers that may be made during a 12-month period
  12. Health Savings Account One Time Funding Distribution
    HSA are qualified employer sponsored plans that allow before-tax contributions to a savings account to be used for medical expenses

    IRS allows a one time funding distribution from an IRA to a qualified HSA without paying federal income taxes or penalties on the IRA Distribution
  13. Roth IRA
    Allow after-tax contributions up to a maximum annual allowable limit per individual per year

    Contributions to other IRAs when combined with contributions to a Roth may not exceed the maximum annual allowable limit

    Earnings are not taxed as they accrue or when they are distributed from an account as long as the money has been in an account for 5 taxable years and the IRA owner has reached age 59 1/2

    Required minimum distribution does not apply (tax has already been paid on the contributions)

    The 10% penalty for distributions before age 59 1/2 is waived for 1st time homebuyers if they use the funds to purchase a principal residence
  14. Coverdell (Education IRA)
    Allow after-tax contributions of up to $2,000/student per year for children under 18

    Contribution limits may be reduced or eliminated for higher-income tax payers

    Distributions are tax free as long as the funds are used for qualified education expenses

    If an account is not depleted by age 30, the funds must be distributed to the individual subject to income tax and 10% penalty or rolled into an education IRA for another family member beneficiary
  15. Section 529 Plans
    • 2 Types:
    • 1)Prepaid Tuition plans for state residents
    • *Allow resident donors to lock in current tuition rates by paying now for future education costs
    • 2)College savings plans for residents and nonresidents
    • *Allows donors to save money to be used later for college tuition

    • -Adult does not have to be related to the student
    • -Can invest a lump sum or make periodic payments
    • -Contributions are considered gifts under federal tax law; contributions are made with after-tax dollars, so withdrawls are tax free if used for qualified education expenses
    • -Certain tax advantages may not be available if the customer wishes to open an out-of-state plan
  16. Relevant points on Section 529 Plans
    • 1)Overall contribution levels vary from state to state
    • 2)Assets in the account remain under the donor's control even after the student becomes of legal age
    • 3)There are no income limitations on making contributions to a 529 plan
    • 4)Plans allow for monthly payments if desired by the account owner
    • 5)Account balances may be transferred to a related beneficiary

    • *Contributions follow the gift tax rule - therefore, to avoid the gift tax, contributions are limited to the max allowable amount per year per donor (double for spouses)
    • *Donor may aggregate contributions for up to 5 years, but then make no further contributions for those years without being subject to tax
  17. Simplified Employee Pensions (SEP IRAs)
    Qualified individual retirement plans that offer self-employed persons and small businesses easy to administer pension plans

    SEPs allow an employer to contribute money to SEP IRAs that its employees set up to receive employer contributions

    Self-employed individuals and corporations may contribute up to a maximum amount each year to a SEP IRA

    Generally, an employer can take an income tax deduction for contributions made each year to each employee's SEP

    Amounts contributed to a SEP by an employer on behalf of an employee are excludable from the employee's gross income
  18. Keogh (HR-10) Plans
    Qualified plans intended to self-employed persons and owner-employees of unincorporated businesses of professional practices filing Schedule C with the IRS

    Planholder is permitted to make tax-deductible cash contributions each year up to a maximum amount

    May make contributions until age 70 1/2

    • Employers must make contributions into the Keogh plans of eligible employees
    • *The contribution rate for eligible employees is complicated - a high-income employer make the maximum contribution to his own Keogh must contribute to the Keogh of an eligible employee at a rate of 25%

    • Employees are eligible if:
    • 1)Have worked at least 1000 hours in the year
    • 2)Have completed one or more years of continuous employment
    • 3)Are at least 21 years of age

    10% penalty for excess contributions
  19. Permissable Investments in Keogh Plans
    • 1)Most equity and debt securities
    • 2)US government-minted precious metal coins
    • 3)Annuities
    • 4)Cash-value life insurance
  20. Tax-Sheltered Annuities (403(b) Plans)
    AKA - TSA

    • Available to employees of:
    • 1)Public educational institutions
    • 2)Tax-Exempt organizations
    • 3)Religious Organizations

    Funded by elective employee deferrals - the deferred amount is excluded from the employee's gross income, and earnings accumulate tax free until distribution. A written salary reduction agreement must be executed between the employer and the employee.

    Distributions are 100% taxable, and a 10% penalty applied to distributions before age 59 1/2
  21. Corporate Retirement Plans
    • 1)Defined Benefit Plans
    • 2)Defined Contribution Plans

    • *All corporate retirement plan administrators have fiduciary responsiblity
    • *Risk must be the first consideration in investment of plan assets. Short sales, uncovered options, and margin account transaction are not suitable within corporate retirement plans.
  22. Defined Benefit Plan
    Promises a specific benefit at retirement determined by a formula involving retirement age, years of service, and compensation

    May be used by firms who wish to favor older key employees because a much greater amount may be contributed for those with only a short time until retirement

    Unfunded Pension Liability: adquate reserves have not been set aside to meet this future obligation - poor investment performance of the monies set aside today can lead to an unfunded liability
  23. Defined Contribution Plan
    Much easier to administer than defined benefit plans

    Contribution amount is specified by the plan (trust agreement), however, the benefit that will be paid at retirement is unknown

    Typical defined contribution formula might be expressed as a percentage of income

    • 1)Profit Sharing Plans
    • 2)Savings Incentive Match Plans for Employees (SIMPLEs)
    • 3)401(k) Plans
  24. Profit Sharing
    Do not require a fixed contribution formula and allow contributions to be skipped during years of low profits

    Flexibility and ease of administration had made them a popular retirement plan option
  25. Savings Incentive Match Plans for Employees (SIMPLEs)
    Retirement plans for businesses with fewer than 100 employees that have no other retirement plan in place

    Employee makes pretax contributions into SIMPLE up to an annual contribution limit & the employer makes matching contributions (requirements and limits for employers specified by the IRS)
  26. 401(k) Plans
    AKA Thrift Plans

    Allows the employee to elect to contribute a percentage of salary to his retirement account

    Contributions are excluded from the employee's gross income & accumulate tax deferred

    Employers are permitted to make contribution matches up to a specified percentage of the employee's contributions

    Permit hardship withdrawls
  27. Self-Employed 401k Plan
    Can be set up by a business with no full-time employees - only the owner(s), spouse(s), and part-time employees

    Offer higher contribution limits than other plans, greater flexibility as to when and how often contributions will be made, and penalty-free loans from the plan's funding, provided the loan is paid back on time

    The business can be a sole proprietorship, a partnership, or a C corporation, S corporation, or limited liability corporation
  28. Roth 401(k) Plan
    Requires after-tax contributiosn but allows tax-free withdrawls, provided the plan owner is at least 59 1/2 and the distribution occurs at least 5 years after the participants first contribution

    Lake a 401(k) it allows the employer to make matching contributions, but the employer's contribtions must be made into a traditional 401(k) account

    The employee would then have 2 401k accounts could make contributions into either but cannot transfer money from one to the other once it is deposited

    • Unlike a Roth IRA:
    • 1)There are no income limitations on who may have such a plan
    • 2)The account owner must begin withdrawals by age 70 1/2
  29. The Employee Retirement Income Security Act of 1974 (ERISA)
    Established to prevent abuse and misuse of pension funds - guidelines apply to private sector (corporate) retirement plans and certain union plans, not public plans like those for government workers

    • Provisions include the following:
    • 1)Participation - all employees must be covered if they are 21 years or older and haev performed one year of full-time service (defined as 1,000 hours)
    • 2)Funding - funds contributed to the plan be segregated from other corporate assets
    • 3)Vesting
    • 4)Communication - Plan document must be in writing and employees must be given annual statements of account and updates of plan benefits
    • 5)Nondiscrimination - All eligible employees must be impartially treated through a uniformly applied formula
    • 6)Beneficiaries - Must be named to receive an employee's benefits at his death
Card Set
Retirement Plans
Retirement Plans