5. Other Tax-Advantaged Plans

Question 1

Traditional IRA

Answer 1

Contributions and investment earnings are free of federal income tax until withdrawn

Question 2

When is IRA Used

Answer 2

Individual savings:
- need to shelter current compensation or earned income from taxation
- defer taxes on investment income
- long-term accumulation, especially for retirement, is an important objective
- supplement or alternative to a qualified pension/ profit sharing plan is needed.

Question 3

IRA Contributions

Answer 3

Max contribution: $6,500
If 50 before the close of the tax year, an additional $1,000 brings total maximum contribution amount to $7,500 (2023)

Question 4

IRA Cons

Answer 4

needs earned income or taxable alimony to contribute to an IRA

Withdrawals are subject to 10% penalty on premature withdrawals, not eligible for special averaging tax computation and required by April 1 of the year after they reach 73

Question 5

IRA Deduction

Answer 5

The maximum annual deductible IRA contribution for an individual is the lesser of the $6,500 or 100% of the individual’s earned income (provision for spousal IRA to be allowed in additional to max)

Alimony received pursuant to a divorce finalized prior to January 1, 2019, is considered compensation for IRA contribution purposes.

Question 6

Active-Participant Restrictions

Answer 6

Active Participant is when the taxpayer either received any annual additions within a defined contribution plan during the year or was eligible for any benefits in a defined benefit plan during the year. Annual additions consist of employer contributions, employee contributions, or reallocated forfeitures.

If an individual is not an active participant, but the spouse is, then ze is entitled to use the spousal phaseout limit of $218,000 and can deduct the full $6,500 if under; however if spouse is an active participant and MAGI was over $136,000, then ze can contribute but not deduct $6,500

*Participation in a 457 plan will not affect the deductibility of an IRA contribution since not considered active participant for IRA contribution deduction purposes

Question 7

Nondeductible IRAs

Answer 7

Excess of max annual contribution over amount deductible- nondeductible contributions will be tax free when distributed, but income earned will be taxed. Taxpayer’s responsibility to track contributions made with after tax dollars

Question 8

IRA Contribution

Answer 8

• Lesser of $6,500 or 100% compensation income. 50+ catch up contribution of $1,000.
  -spouse without compensation income can contribute to an IRA based on their spouse’s compensation income.

Question 9

IRA Distributions and rollovers

Answer 9

Withdrawals are not penalized if:
- Age: On/after 59.5
- Death: IRA participant’s beneficiary/estate on/after participant’s death
- Disability: participant’s disability
- Annual payments: part of series of equal periodic payments made at least annually over the life or life expectancy of the participant, or the participant and a designated beneficiary
- Medical Care: exceed 7.5% AGI
-Unemployed: For health insurance premiums
-Higher education: tuition, fees, books, supplies and equipment for the taxpayer, spouse, child or grandchild
-Home: acquisition costs of a first home for the participant, spouse, child, grandchild or ancestor of the participant or spouse, up to a $10,000 lifetime maximum.

must begin by no later than April 1 of the year after the year in which age 73 (2023) is reached, in which case 2 distributions must be taken

May be transfer/rollover

federal spousal consent requirements enacted under the Retirement Equity Act of 1984 only apply to qualified plans, not to IRAs

all pension plans must automatically provide survivorship benefits for a spouse, unless the spouse opts out in writing

Question 10

When IRA Owner passes

Answer 10

entire inherited account balance must be distributed within 10 years after the date of death after 12/31/2019, unless “eligible designated beneficiary: surviving spouse/Chronically ill or disabled beneficiaries, Minor children, up to the age of majority, Individuals not more than 10 years younger than the IRA owner” in which case to be made over the life or life expectancy of the eligible beneficiary beginning in the year following the year of death

Question 11

Coverdell ESA (Education IRA)

Answer 11

trust or custodial account that is created for the express purpose of funding the qualified education expenses of the designated beneficiary, life-in-being at the time it is established. Contributions cannot exceed the annual cumulative limit of $2,000 must be made in cash, and are not tax-deductible before beneficiary is 18.

Qualified higher-education expenses, elementary and secondary public, private or religious school expenses

Question 12

Dan, age 56, wants to contribute the maximum allowable amount to his IRA account for 2023. His MAGI is $167,000 and he actively participates in his 401(k) plan. What amount can he contribute?

Answer 12

He can contribute $7,500, the $6,000 regular contribution and an additional $1,000 as a “catch-up” contribution as he age 50 or older. He may not be able to deduct his contribution but he can make it.

Question 13

Roth IRA

Answer 13

-defer taxes on investment income
-LT accumulation for retirement purposes is an important objective,
- supplement or alternative to a qualified pension / profit-sharing plan is needed.

Question 14

Roth Pros

Answer 14

-Contributions/basis can be redeemed at any time without tax liability/penalty
- all growth and income are tax-sheltered and can be distributed if held for 5 years and:
-death of the owner
- disabled
- first-time home purchase ($ 10,000-lifetime limit), or
- owner is age 59 1/2 or older

-distribution from a Roth IRA are first considered return of principal and thus nontaxable, even before age 59½.
-No age limit for Roth IRA contributions and no RMDs

Question 15

Roth Cons

Answer 15

• Contribution is limited
  -Premature Roth IRA withdrawals in excess of contributions are taxed in full and are also subject to a 10% penalty on early withdrawal

Question 16

Roth Contribution Rules

Answer 16

The maximum Roth IRA contribution for an individual is the lesser of $6,500 or 100% of the individual’s earned income, less contributions to traditional IRAs (not including rollovers to such IRAs)

Question 17

IRA-Roth IRA Conversion

Answer 17

All money converted is treated as a distribution; however the 10% penalty will not apply if under 59.5. If removed from Roth IRA during the 5 years following the conversion, then it will be subject to the 10% penalty.

Question 18

Roth IRA Distribution

Answer 18

Within a Roth-IRA, the order of withdrawals is:
Contributions
Conversions (FIFO)
Gain

Question 19

Earned income comprises of

Answer 19

Earned income refers to income from employment or self-employment as well as alimony payments

Question 20

Simplified Employee Pensions (SEPs)

Answer 20

-alternative to a qualified profit sharing plan that’s easier and less exp for employers with <10 employees

PROS: low installation costs, flexibility and benefits that are portable by employees, can adopt as late as tax return filing date for given year including extensions

CONS: may not provide adequate retirement benefit as regular contributions are not required, distributions are not eligible for special averaging.
-Not great for those entering at an older age

Employer can deduct contributions up to 25% of total payroll. Each employee can receive and exclude from income the lesser of 25% of income or $66,000

-Not required to fill out 5500 for ERISA if filling out Form 5306-SEP

Question 21

SIMPLE IRA

Answer 21

-Small employers, <100 employees, one of simplest tax-deferred employee retirement plans OR Individual with small self-employment income who wants to contribute more as SIMLPE IRA contribution > other tax-favored plans like SEP/Keogh plan

-Employer has to contribute 3% match to participating or 2% to all eligible employees earning at least $5,000 in previous 2/5 years and current year). Can lower down to 1% in 2 out of 5 years.

-may not provide adequate retirement benefit as annual contribution amounts are generally restricted to lesser amounts than qualified plan ($15,500 + $3,500 catch up) . Not great for those entering at an older age. Distributions are not eligible for 10-year averaging available for certain qualified plan distributions.

• cannot also maintain a qualified plan, SEP, 403(a) annuity, 403(b) tax-sheltered annuity, or a government plan (other than Section 457 plan) for that year. However, certain collective bargained plans will not affect an employer’s eligibility to establish a SIMPLE IRA.

-Installation involves Form 5304-SIMPLE or 5305-SIMPLE

-Not required to fill out 5500 for ERISA

-Penalty on premature distributions is 25% for first 2 years of participation, aside from a rollover to IRA

Question 22

403(b) / TDA/TSA plan

Answer 22

tax-deferred employee retirement plan that can be adopted only by 501(c)(3) certain tax-exempt organizations and certain public school systems
-Salary deferral plan can’t > compensation: limit $22,500 + $7,500 catch up (50+)
Additional catch up if at least 15 yr with employer:
Special catch-up contribution is the lesser of:
1. $3,000
2. $15,000, reduced by the amount of additional elective deferrals made under this
rule in prior years
3. $5,000 times the employee’s number of years with the organization minus the total
elective deferrals made for previous years o If the over age 50 catch up and the special catch up are available, the special catch up is
applied first

-May not be adequate for those entering at an older age. Written plan document must share participant information. Employees bear investment risk under the plan

-Salary reductions are subject to salary reduction limit. Total amount of employer and employee contributions (plus forfeitures) to employee’s account is subject to annual Section 415 limitation of lesser of 100% of compensation or $66,000.

Contributions or benefits must not discriminate in favor of HCEs
Integration w Social Security is rarely used

Employer matching contributions are subject to the same vesting requirements as are applied to top-heavy plans. That is, 100% cliff vesting after three years, or graded vesting starting with 20% after two years, increasing by 20% each year until 100% is reached after six years.

Employer contributions for 403(b) will most likely occur in colleges and universities as well as non-profit 501(c)(3) corporations.

RMDs at 73, unless transferred to Roth IRA, but subject to another 5 year rule

Plan Document Required
o Plan Loans Allowed; Hardship Withdrawals Allowed
o Plan may offer Roth 403(b) option for deferrals
o May only use Annuities or Mutual Funds 403(b)(7) * Annuities may be fixed or variable

Question 23

Salary reductions elected after compensation is earned are ineffective as a result of the tax doctrine of

Answer 23

constructive receipt

Question 24

HR10 (Keogh) Plan

Answer 24

qualified retirement plan that covers one or more self-employed individuals (sole proprietor or partner who works in his or her unincorporated business)-works like a corporate qualified plan

Used:
-owner of an unincorporated business wishes to adopt a plan providing retirement benefits for regular employees as an incentive and employee benefit, as well as retirement savings for him or herself
-self-employed person wants to shelter current earnings from federal income tax
-employee has self-employment income as well as income from employment and wishes to invest as much as possible of the self-employment income and defer taxes on it.

Plan loans to owner-employees are subject to the same rules as applied to regular employees, generally the lesser of $50,000 or half the vested benefit.

maximum contribution= $66,000 and fully deductible

Types of Keogh plans can be designed to cover self-employed persons. Such plans include the profit-sharing plan, money purchase plan, target benefit plan, and defined benefit plan.
Certain employers adopting a plan may be eligible for a business tax credit of up to $500 for qualified startup costs.

same tax (including 10% penalty for early withdrawal) and ERISA implications as regular qualified plans

The “alternative” fraction for contributions in Keogh and SEP-IRA plans for owners is determined by dividing the regular contribution (expressed as a decimal) by 1 plus the decimal amount. For example, if the normal contribution is 25%, the net fraction for the owner is determined by the formula:
.25 / 1.25 = .20 = 20%

LI for pure protection value for regular employees is deductible as a plan contribution, but not for self-employed, also not included in cost basis

Qualified plans can make loans to employees, within a $50,000 maximum

two-level penalty tax on prohibited transactions/loans (max $50k). The initial tax is 15% of the amount involved, with an additional tax of 100% of the amount involved if the transaction is not rescinded.

Question 25

What is the maximum possible contribution to a SEP on behalf of a participant for 2023?

Answer 25

The 2023 annual employer SEP contributions on behalf of a participant are limited to the lesser of 25% of compensation (capped at $330,000), not to exceed $66,000.

Question 26

Maria has net earnings from self-employment of $100,000 this year. Her self-employment tax is $14,130. What is the maximum amount she may contribute to a SEP on her behalf this year?

Answer 26

Maria may contribute up to $18,587 to a SEP plan on her behalf this year.

Net earnings from self-employment ($100,000) minus ½ of the SE tax ($7,065) = $92,935

$92,935 x 0.20 (0.25/1.25) = $18,587

Question 27

Jerome, age 40, was divorced in 2020. He currently receives $3,000 per month in alimony and earns $5,000 annually working a part-time job with no benefits on weekends.

What is the maximum amount Jerome can contribute to an IRA this year?

Answer 27

Jerome can contribute $5,000 (2023) to an IRA. Because his divorce was finalized after January 1, 2019, the alimony he receives is not considered compensation for IRA contribution purposes. He may contribute the lesser of $6,500 (2023) or 100% of his compensation income.

Question 28

Sue, age 50, has taught in the same public high school for 20 years but is participating in the school district’s Section 403(b) for the first time this year. What is the maximum contribution Sue may make to the plan this year if her annual salary is $90,000?

Answer 28

Sue may contribute up to $33,000 (2023). Because Sue has been employed by the same school for at least 15 years and has not previously contributed the maximum amount, she is eligible for a special catch-up contribution allowance of $3,000 in addition to the regular contribution limit of $22,500 and the age 50+ catch up allowance of $7,500.

Question 29

SIMPLE IRA facts

Answer 29

• distribution within the first two years of participation may be subject to a 25% penalty
  -An employer may exclude from SIMPLE IRA participation employees who have not earned at least $5,000 from the employer in any two preceding years, and are reasonably expected to earn at least $5,000 in the current year.
  -An eligible employer may have no more than 100 employees
  -Employee deferrals into a SIMPLE IRA are aggregated with qualified plan deferrals in applying maximum annual limits.

Question 30

Jolene, age 40, was divorced in 2018. She currently receives $3,000 per month alimony and earns $5,000 annually working a part-time job with no benefits on weekends.

What is the maximum amount Jolene can contribute equally to a traditional IRA and a Roth IRA this year?

Answer 30

Jolene can contribute $3,000 (2023) equally to a traditional IRA and a Roth IRA. Because her divorce was finalized prior to 2019 the alimony she receives is considered compensation for IRA contribution purposes. IRA contributions must be aggregated for purposes of applying the annual maximum.

Jolene’s alimony ($36,000, annually) + earned income ($5,000) = $41,000 of total income. Therefore, she can fund a total of $6,500 to the IRAs, $3,250 each if evenly split.

Question 31

Maria has net earnings from self-employment of $100,000 this year. Her self-employment tax is $14,130. What is the maximum amount she may contribute to a SEP on her behalf this year?

Answer 31

Maria may contribute up to $18,587 to a SEP plan on her behalf this year.
Net earnings from self-employment ($100,000) minus ½ of the SE tax ($7,065) = $92,935
$92,935 x 0.20 (0.25/1.25) = $18,587

Question 32

Sally, age 50, is a freelance photographer and earns $200,000 per year. She wants to open a traditional IRA as she has not yet started a retirement plan and wants to know the maximum amount she can deduct for an IRA contribution for 2023 year assuming she contributes the maximum allowable.

What amount can Sally deduct?

Answer 32

Sally can contribute and deduct $7,500 (2023). She is not an active participant in a retirement plan, therefore, her earnings do not prohibit her from deducting the full contribution. She is eligible for a $6,500 regular contribution plus a $1,000 age 50+ catch-up contribution.

Question 33

For 2023, what is the maximum salary deferral into a newly established Simplified Employee Pension (SEP) for a participant who is age 45?

Answer 33

0: A SEP plan is 100% employer funded. Participants do not make salary deferrals into a SEP.

Question 34

Antoine, age 55, participates in his employer’s SIMPLE IRA plan. He earns $70,000 per year and defers the maximum possible into the plan each year. His employer uses the matching contribution option.

What is the total amount contributed to Antoine’s account in 2023?

Answer 34

In 2023, Antoine may defer $15,500 plus a $3,500 catch-up contribution. His employer uses the matching contribution option, which is a 100% match of the first 3% deferred by the employee. This adds $2,100 for Antoine (3% x $70,000). $15,500 + $3,500 + $2,100 = $21,100.

Question 35

Which of the following statements is correct regarding an educator who participates in a Section 403(b) plan being eligible for the special catch-up allowance?

Answer 35

The minimum requirement is at least 15 years with the same school system, not cumulative as an educator in multiple school systems.

Question 36

Joanie has been an educator the past 15 years, teaching elementary school in three different states. She has always participated in a Section 403(b) plan through her employer. She just turned age 50 and has decided to begin maximizing her retirement savings. Her teaching salary is $80,000 per year. She also earns $12,000 per year as a private tutor during the summer. What is the maximum amount Joanie can defer into the Section 403(b) plan sponsored by her current employer for 2023?

Answer 36

Joanie may defer $22,500 under regular limits for 2023 plus $7,500 under the age 50+ catch-up provision. She does not have 15 years of service with her current employer, so she is not eligible for the special Section 403(b) catch-up provision.

Question 37

Joanie has been a schoolteacher the past 17 years in the same school district. She just turned age 50 and has decided to begin maximizing her retirement savings. Her teaching salary is $80,000 per year. She also earns $12,000 per year at a part-time job during the summer.

What is the maximum amount Joanie can save in the Section 403(b) plan for 2023

Answer 37

Joanie may defer $22,500 under regular limits for 2023 plus $7,500 under the age 50+ catch-up provision and $3,000 under the special Section 403(b) catch-up provision.