BU - Retirement Flashcards
Capital Preservation approach
additional capital needed on day 1 of retirement to leave same account balance at death
Purchasing Power Preservation Approach
maintains the same purchasing power throughout the retirement period
Types of Defined Contribution
Profit sharing Plans
- Traditional profit sharing
- section 401k
- stock bonus plan
- ESOP
DC Pension Plans
- Money purchase pension Plan
- Target benefit pension plan
Characteristics of Defined Contribution Plans
Participant directed accounts
Combined EE/ER contributions subject to annual additions limit to $61,000
Max elective deferral $20,500
Max comp considered in benefit formula $305k
Participant bears investment risk
No guaranteed final benefit amount
Vesting must be at least 3 year cliff or 2-6 year graded
Max deductible ER contribution is 25% of covered payroll
Tends to favor younger participants
Easy to understand
No PBGC insurance
No more than 50% of contributions on behalf of a participate may be allocated to ordinary life insurance
Traditional Profit Sharing Features
All the DC features
Contributions are not mandatory, just substantial and recurring, 3 of last 5 years
100% ER funded
Yearly profits are not required, can be made from retained earnings or cash flow
Typically allows hardship withdrawals
May invest 100% in ER stock
“Age-Weighted” plans can skew higher for older participants
Characteristics of Section 401k Plan
All DC Features
- Cash or Deferred Arrangement (CODA) provision added to an underlying profit-sharing plan, stock bonus and ESOP
- Participants can make annual elective deferrals up to the lesser of 100% comp or $20,500 (50+ can make catch up annually)
- ER not required to contribute annually, but usually makes some kind of matching contribution
- Plan often offer loans and hardship withdrawals
- As a profit sharing plan, ER contribution can be 100% ER stock
- Participants must be given a min of 3 diversification alternatives for elective deferrals
- If EE participates in multiple 401k plans, deferrals are aggregated
- EE contributions are subject to ADP testing
- ER contributions are subject to ACP testing
Characteristics of Money Purchase Pension Plan
All DC Features
- mandatory annual ER contributions - 100% ER Funded
- Defines the ER contributions - typically a percentage of EE compensation
- May invest no more than 10% in ER stock
- Typically no in-service withdrawals until 62
- Subject to QJSA
Characteristics of Target Benefit Pension Plan
All of the DC Features
- Requires mandatory annual ER contribution - 100% ER funded
- Actuary in initial year, and contributions are not adjusted
- Benefit amount is not guaranteed, only targeted
- Plan can be skewed for older participants
- May invest no more than 10% in ER stock
Annual Additions Limit
Catch up contributions are NOT included
Employer contributions
Employee elective deferrals
Reallocated forfeitures
$61K (2022)
Defined Benefit Plans
2 types: Cash Balance Pension Plan & Traditional defined benefit pension plan
Only plans that guarantee the final benefit
Max annual pension $245k
Max compensation considered $305k
Insured by PBGC
Must vest at least 5 year cliff or 3-7 year graded
Must have joint and survivor payout unless waived
No participate directed accounts - sponsor bears investment risk
Funding limit is whatever it takes to provide guaranteed benefits
Annual actuarial work required
Must satisfy 50/40 rule
Traditional DB Pension
Guarantees the final MONTHLY pension amount
Fully insured plan is exclusively funded by cash value life ins or annuity contracts (IRC 412 e 3)
Older, high earning participants can have substantial funding on their behalf
Common pension formula is a % of pay x # of years of services
No individual accounts
Accruing a benefit of any amount is “active participation” for IRA deduction purposes
If participant is married, pension much be joint and survivor until spouse waives
Most expensive, may want to use if:
numerous older management/owner participants, good financial stand and stable cash flows
Calculating defined benefit payout
- % x # of years of service = %
- % x final salary or max comp considered (whichever is lesser)
- Final benefit
Cash Balance Pension
May use only 3yr cliff vesting
Hypothetical participant accounts for record keeping only
Guaranteed cash balance at plan’s normal retirement age
Each year participate accrues a plan contribution based on a pay credit + interest rate credit
Provides uniform benefit accrual for all employees
Participant can convert guaranteed cash balance into lifetime pension
Considered easier for participants to understand than traditional defined benefit
Section 403(b)
Used by tax-exempt organizations
Special Catch-up: EE with 15+ years with the organization get add’l $3000 deferral allowance per year & can be used with 50+ catchup feature
Deferrals are aggregated with other plans
Participants may invest only in approved mutual funds and annuities
Section 457(b)
Gov’t plan and some non-profit organizations
Special Catch-up: available for last 3 years of services (at normal retirement age), up to double the normal contributions, and CANNOT use with 50+ catch up
No 10% penalty for withdrawal prior to 59.5
Not aggregated with other plans
Not considered an active participant
SEP IRA
Easiest to set up, can establish and fund previous year
ER contributions only
Up to 25% of covered compensation, up to $61K - EXCEPT the ER is reduced to 20%
Annual contributions are not required
Offer to all employees 21 and have worked for ER in the 3 of last 5 year and paid $650+
Withdrawal permitted but subject to federal withholds and early penalties
No loans
Contributions 100% vested
SIMPLE IRA
Little admin work
100 or less employees and not currently maintaining another plan
EE and ER contributions
Max EE contribution = $14k and $3000 for 50+
Max ER contribution = 100% of the first 3% match, or 2% of EE comp
Must be offered to all employees with comp of $5k+ in any 2 prior years and expected to earn at least that in current year
10% early withdrawal penalty
Withdraws within 2 years of enrollment are subject to 25% penalty tax
100% vested
Aggregate with other qualified plans
Calculate Retirement Contribution for ER & EE (Self Employed)
The max contribution for EE’s follow the qualified plans
Modifications for the Self Employed Employee
- Subtract 1/2 the SE tax from Net Earnings
- Adjust contribution rate (Plan % / (1+plan %))
- Multiply step 1 by step 2 = max contribution
IRA Contribution Deduction Rules: Active participant
Defined Contribution: receives any annual additions
Defined Benefit: anyone who is eligible for plan is accruing a benefit
SEP, SIMPLE and 403(b) are active
457 is NOT active
Traditional IRA Deductibility
If dealing with spouses, calculate their contributions separately
Pay attention to thresholds
Traditional Rollovers from EMPLOYER-SPONSORED PLANS
1 per year
Admin transfers balance to participant
60 day to deposit into IRA or new ER plan
20% federal withholding mandatory (not IRA-IRA)
If withholding is not replaced then it is considered a distribution and taxed + possible 10% penalty
Direct Transfer FROM EMPLOYER SPONSORED PLANS
No annual limit of transfers
Plan trustee transfers directly to new plan
No mandatory withholding
RMD
Penalty is 50% of the shortfall
IRA - 1st distribution may be taken April 1 of the year following turning 72, even if still working
401k - 1st distribution may be taken April 1 following turning 72, or the year of actual retirement.
Not available to more than 5% owners of the company, and only applies for current employer’s plan
IRA - may combine values of more than 1 and distribute from one
401k - must be calculated and distributed separately
Inherited IRA Distribution Requirements
Spouse has the choice to treat it as their own or combine with their own IRA
Non-spouse = 10 year rule
Exceptions to the 10 year rule are eligible beneficiaries: spouse, chronically ill beneficiary, disabled beneficiary, minor children until 18, beneficiary less than 10 years younger
5 year rule applies to estates, charities and trusts not qualifying as a designated beneficiary
Exceptions to early withdraw penalties
Medical in excess of 7.5% AGI
Age of 59.5
Death
Disability (total or permanent)
Equal payments
Separation from ER & 55+ (qualified plans only)
Education expenses - higher ed (IRA only)
Health Insurance premiums while unemployed (IRA only)
Home buying - $10k for a lifetime (IRA only)
ROTH Distributions- Qualified
Qualified distributions are tax free
The distributions must have been made after 5 years of the first taxable year a contribution was made
AND AND AND
One of the following:
- Owner dies
- Owner turned 59.5
- Owner is disabled
- Owner purchase home $10k lifetime
ROTH Distributions - Non-qualified
Order the funds are pulled:
- Contributions = no tax or penalty
- Roth conversions = no tax, contributions less than 5 years are subject to 10% penalty
- Earnings = subject to income tax and 10% penalty
Pick 2 and what 2 types of plans would you recommend
- Currently deductible ER plan contributions
- Benefits not currently taxable to the EE
- ER can limit participation to select individual
1 & 2 = Qualified plan or tax-advantage plan
Any combination = non-qualified plan
Incentive Stock Options
Corporation may not receive a deduction
May create ATM
No more than $100k per year may be granted
Grant - Strike price = FMV at time of grant
Exercise - Stock is purchased at strike price, positive AMT adjustment = bargain element
Sale - negative AMT adjustment, if the stock FMV is greater than or equal to the price of the stock at exercise, the adjustment will be negative for the same amount as the original positive AMT adjustment
Capital gains/loss on the difference between from the strike price if QUALIFYING DISTRIBUTION
Nonqualified Stock Options (NQSO)
Grant - ER awards options to purchase > typically subject to vesting schedule
Exercise - EE purchases at “Strike Price”. The difference between the FMV and strike price is the bargain element
In the year of exercise, the bargain element is recognized as compensation and subject to payroll taxes (ER claims deduction for compensation)
EE’s basis is the strike price + bargain element (also know as FMV at the time of exercise)
Sale - The difference between the sale price and the basis is capital gain, either ST or LT depending on holding period
ISO Qualifying Disposition Rule
Sale occurs at least 2 years from grant and 1 year from exercise
ISO taxation if disqualifying disposition
Gain will not be taxed capital gains
Taxation options:
- If stock is bought and sold in the same year > ordinary income and FICA & ER receives a deduction
- If stock is bought and sold within 1 year, but not within the same calendar year > ordinary income
Social Security provides benefits for
retirement, disability and survivors of a deceased worker
Social Security Quarter of Coverage
1 quarter of coverage “credit” is earned for every $1510 of earned income subject to SS taxes
Max of 4 credit can be earned per year
40 credits = fully insured
AIME
Average Indexed Monthly Earnings
Based on 35 best years of social security earnings
Used to calculate PIA - Primary Insurance Amount
PIA
Primary Insurance Amount
is the monthly retirement benefit at Full Retirement Age
Formula: (90% on the first $1024 of monthly income) + (32% on the next $5148 (which is 6172-1024)) + 15% on excess above $6172 = PIA
PIA divided by the workers monthly income = wage replacement percentage
Example: Worker’s monthly income = $2500/month (.90*$1024)+(.32*$1476) = $1394/month in PIA. $1394/$2500 = 56% wage replacement
Spousal Social Security Retirement Benefits: Eligible spouses
current spouse if 62 yrs old, married for at least 1 year and worker is currently receiving benefits
ex-spouse if 62 yrs old, was married for 10+ years, currently unmarried and divorced for 2 years
Spousal Social Security Retirement Benefits: Eligible spouses Payment amounts
Based on the worker’s spouse’s PIA
Max 50% of spousal claimant FRA, if prior to FRA the max 50% is reduced
If spouse has dual eligibility, he/she is required to file for both and will receive the higher of the two
Spousal Social Security Retirement Benefits: Max Family Benefit
current spouse is subject to the max family benefit rules
ex spouse is not included in application of the max family benefit
Social Security: Early
Earliest age to claim SS is 62, but FRA is 67
If elect to collect prior to 67, benefits are permanently reduced + cost of living adjustments
Reductions is 5/9% per month for the 36 months prior to FRA (ages 64, 65, 66), 20% max
Reduction is 5/12% per month for the 24 months prior 3 years before FRA (ages 62, 63),
10% max 30% is the most social security PIA can be reduced
Social Security: Delayed Retirement
Benefits are increased 8% per year social security is not claimed at FRA
Max is age 70
Social Security Taxation Formula
1/2 of SS benefits + Tax exempt income + AGI (w/o SS benefits) = Provisional Income
Social Security Tax Rates
If provisional income is $XX+ = XX% of SS benefits is taxable
MFJ: $32k+ = 50%, $44k+ = 85%
Single: $25k+ = 50%, $34+ = 85%
MFS: all of it is 85% taxable
Social Security for Worker’s Child
Child must be under 18, or 19 and in high school, or disabled before 22
Worker must be receiving benefits Benefit is subject to family max rules
Max benefit is 50% of worker PIA
Medicare - how is it funded
- 45% is contributed by the ER
- 45% is contributed by the EE
.09% is additionally contributed by the EE if their income is more than $200k/$250k
Medicare Parts (high level)
A - hospital
B - medical
C - Medicare Advantage
D - Prescription Drugs
Medicare: Part A
Hospital
most participants pay no premium
must be 65 or older and paid into Medicare for 10+ years
Flat hospitalization deductible for 1-60 days, co-pay for 61-90 days, 90-180 days use lifetime reserve days, beyond 180 days the patient is out of pocket
Inpatient hospital stays, skilled nursing, hospice care and some home health care.
Medicare: Part B
Medical
Optional by recommended, requires premium (higher income individuals pay higher premium)
Annual deductible and then pays 80%,
Certain doctors, outpatient care, medical supplies, preventive services
Medicare: Part C
Medicare Advantage “all in one” alternative
Alternative to A&B
Vastly lower premiums than A & B combined with supplement.
Uses “gatekeeper” - must use network providers
Medicare: Part D
Prescription
coverage is optional, requires premium
Deductibles and co-pays
Net Unrealized Appreciation (NUA): conceptual
Qualified plans that hold ER securities
special tax treatment is available in lump-sum distributions
At time of the lump sum distribution, the NUA is tax deferred
Net Unrealized Appreciation (NUA): calculation
At the time of lump-sum
ER contribution basis is taxed at ordinary income in year of distribution
NUA is the difference between the FMV at the time of the lump sum distribution and the ER basis
The NUA is taxed at LTCG regardless of holding period
No step up basis at death for NAU remaining
Qualified Domestic Relations Orders (QRDOs)
judgement, decree or order for a qualified retirement plan to pay child support, alimony or marital property rights to an alternate payee
QRDO must contain the participant and each alternate payee’s name and last known address AND the amount or percentage of the benefits to be paid to each alternate payee
Spouse/former spouse who receives QDRO benefits reports the payment received as if he or she were a plan participant - may roll into a IRA or other qualified plan.
If payout isn’t put into another plan, it is subject to income tax and possible 10% penalty
Payor is NOT subject to income tax or penalty, unless the distribution is paid to a child or other dependent.
What is the maximum possible contribution to a SEP on behalf of a participant this year?
the lesser of 25% of compensation (capped at $305,000), not to exceed $61,000.
Correct statements regarding a breach of fiduciary duty by a qualified plan fiduciary
No fiduciary shall be liable with respects to a breach of fiduciary duty if breach was committed before or after fiduciary duties
The fiduciary may be subject to equitable or remedial relief to the plan
The fiduciary will have to restore any profits to the plan, which have been made through the fiduciary’s use of the plans assets
The fiduciary may be removed form the role for a violation
Fully insured qualified pension plan
is one that is funded exclusively by life insurance or annuity contracts
A trust is not used to hold the plan assets
Fully insured plans may be a solution to resolve an over funded plan issue
Were common until high interest rates in the late 70’s lured many pension investors away
golden parachute plan
a compensation arrangement that provides special severance benefits to executives in the event that the corporation changes ownership and the covered executives are terminated
method for split-dollar life insurance, who is responsible for premium payments
Endorsement method - Employer
Collateral assignment method - Employee
which entity administers the taxation of contributions and benefits and enforces funding, participation, and vesting standards
IRS
Summary Plan Description (SPD)
intended to describe the major provisions of the plan to participants in simple language
must be furnished automatically to participants within 120 days after the plan is established, or 90 days after a new participant enters an existing plan
Employee Retirement Income Security Act of 1974 (ERISA)
imposes extensive reporting and disclosure requirements on a broad range of employee benefit plans
various forms and information must be disclosed to plan participants and/or filed with the IRS or the Department of Labor
Summary Annual Report
a summary of financial information from the Annual Report (Form 5500 series) that must be provided to plan participants each year within nine months of the end of the plan year.
primary responsibility of a qualified plan fiduciary
to run a plan solely in the interest of participants and beneficiaries
