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)
