Chapter 11

Question 1

Qualified Versus Nonqualified Plans

Answer 1

Qualified plans are those that meet federal requirements and receive favorable tax treatment.

Employer contributions to a qualified retirement plan are considered a deductible business expense. They are not currently taxable to the employee in the years they are contributed. However, they are taxable when paid out as a benefit (typically when the employee is retired and in a lower tax bracket).

Question 2

Employee Retirement Income Security Act (ERISA)

Answer 2

The Employee Retirement Income Security Act (ERISA) is a federal law that establishes minimum standards for most private-sector retirement and health plans. Its purpose is to protect these plans from fraud and mismanagement and ensure that employees have enough information to monitor them.

Question 3

Profit-Sharing Plans

Answer 3

An employer establishes and maintains profit-sharing plans and allows employees to participate in the company’s profits. They set aside a portion of the firm’s net income for distributions to employees who qualify under the plan. The IRS also states that withdrawals of funds from a profit-sharing plan may be subject to a 10% tax penalty in addition to income taxes if they are made before the age of 59 1/2.

Question 4

Stock Bonus Plans

Answer 4

A stock bonus plan is similar to a profit-sharing plan, except that the employer’s contributions do not depend on profits. Benefits are distributed in the form of company stock.

Question 5

Cash or Deferred Arrangements (401(k) Plans)

Answer 5

Another form of qualified employer retirement plan is known as the 401(k) plan. Employees can elect to reduce their current salaries by deferring amounts into a retirement plan.

Question 6

Tax-Sheltered Annuities (403(b) Plans)

Answer 6

A tax-sheltered annuity is a unique tax-favored retirement plan available only to specific groups of employees. Tax-sheltered annuities may be established for the employees of specified nonprofit charitable, educational, religious, and other 501(c) (3) organizations, including teachers in public school systems. Such plans generally are not available to other kinds of employees.

Funds are contributed by the employer or by the employees (usually through payroll deductions) to tax-sheltered annuities and are thus excluded from the employees’ current taxable income.

Question 7

IRC Section 457 Deferred Compensation Plans

Answer 7

The 401(k) and the 457 are retirement plans offered by employers to their employees to save for retirement. They are similar in almost every way with a few distinctions, the primary one being that private employers offer 401(k)s while local governments and some non-profits offer 457 plans.

Question 8

Keogh Plans (HR-10)

Answer 8

“Keogh plan” is a term used to describe qualified plans that cover self-employed people. This includes defined-benefit plans and defined-contribution plans, though most plans are set as the latter. Contributions are generally tax-deductible up to a certain percentage of annual income, with applicable absolute limits in U.S. dollar terms, which the Internal Revenue Service (IRS) can change from year to year.

Keogh plans are subject to the same nondiscrimination rules as qualified corporate plans, and the maximum contribution is $57,000.

Question 9

Simplified Employee Pensions (SEPs)

Answer 9

A Simplified Employee Pension (SEP) is a retirement plan that allows employers to contribute to their employees’ and their own retirement accounts. SEPs are a good option for small businesses and self-employed individuals.
Here are some benefits of a SEP:
1. Tax deductible: Contributions to a SEP are tax deductible for the employer.
No taxes on investment earnings: The business does not pay taxes on the investment earnings.
1. Low operating costs: SEPs are easier to set up and have lower operating costs than other retirement plans.
1. Tax credit: Business owners may be eligible for a tax credit of up to $500 per year for the first three years of the plan.

Question 10

Traditional IRA

Answer 10

An individual retirement account, commonly called an IRA, is a means by which individuals can save money for retirement and receive a current tax break, regardless of any other retirement plan. Basically, the amount contributed to an IRA accumulates and grows tax-deferred. IRA funds are not taxed until they are taken out at retirement.

IRA Participation

Anyone under the age of 70 1/2 who has earned income may open a traditional IRA and contribute up to the contribution limit or 100% of compensation each year, whichever is less. A non-wage-earning spouse may open an IRA and contribute up to the limit each year.

Since 2002, people who are age 50 and older have been allowed to make “catch-up” contributions to their IRAs, above the scheduled annual limit, enabling them to save even more for retirement. These catch-up contributions can be either deductible or made to a Roth IRA.

Question 11

Traditional IRA Withdrawals

Answer 11

At retirement, or after age 59 1/2, an IRA owner can choose to receive either a lump-sum payment or periodic installment payments from their fund. Traditional IRA distributions are taxed similarly to annuity payments: the portion representing nondeductible contributions is tax-free, while the portion from deductible contributions and interest earnings is taxable. This allows for a tax-free return of the IRA owner’s cost basis, with taxes applied only to the remaining balance (interest earnings).

Question 12

Roth IRA

Answer 12

Roth IRAs are unique in that they provide for back-end benefits. No income tax deductions can be taken for contributions made to a Roth, but the earnings on those contributions are entirely tax-free when they are withdrawn.

Question 13

Roth Withdrawal

Answer 13

Qualified Roth Withdrawals
Withdrawals from Roth IRAs are either qualified or nonqualified. A qualified withdrawal is one that provides for the full-tax advantage that Roths offer (tax-free distribution of earnings). To be a qualified withdrawal, the following two requirements must be met:

1. The funds must have been held in the account for a minimum of five years.
2. The withdrawal must occur because the owner has reached age 59 ½, the owner dies, the owner becomes disabled, or the distribution is used to purchase their first home.

Question 14

Spousal IRA

Answer 14

A Spousal IRA allows a working spouse to contribute to an IRA on behalf of a non-working or lower-earning spouse, helping both partners save for retirement. This is useful for couples where one spouse has little to no income, ensuring that both can benefit from tax-advantaged retirement savings. Contributions can be made to a traditional or Roth IRA, and the same annual contribution limits apply. The spousal IRA helps maximize retirement savings for both spouses, providing financial security for the future.

Question 15

Conduit IRA

Answer 15

A Conduit IRA is used as a temporary holding account for retirement funds that are being rolled over from one retirement plan to another, such as from a 401(k) to an IRA. Its primary purpose is to maintain the tax-deferred status of the funds during the rollover process without triggering taxes or penalties. Once the funds are transferred to the final retirement account, the Conduit IRA is no longer needed.

Question 16

Rollover IRA

Answer 16

A Rollover IRA is a type of Individual Retirement Account designed to receive funds from a qualified retirement plan, such as a 401(k) or 403(b), without incurring taxes or penalties. The primary purpose of a Rollover IRA is to maintain the tax-deferred status of retirement funds when moving them from one account to another, typically after leaving a job or retiring. This allows the individual to continue growing their savings without immediate tax consequences.

Question 17

Does surviving spuse will have to pay tax on the passing IRA?

Answer 17

Assets passing to a surviving spouse generally are not subject to estate taxes at the time of death due to the Unlimited Marital Deduction.

Question 18

Tax withhold on rollover IRA

Answer 18

A rollover must be made** directly from one IRA to another** to avoid a 20% withholding, even within the 60-day limit. The key is that the funds must not be under the recipient’s control at any point. If control occurs and 20% is withheld, the recipient must cover this amount with other funds, or it will be taxed and possibly penalized for early distribution. The withheld amount is applied to any tax liability. This withholding rule also applies to trustee-to-trustee transfers.

Question 19

Pension protection act

Answer 19

The Pension Protection Act of 2006 is a U.S. law designed to strengthen retirement savings by ensuring that pension plans, particularly defined benefit plans, are adequately funded. It requires employers to fully fund their pension obligations, increases transparency by providing employees with more information about their retirement plans, and encourages greater participation in 401(k) plans through automatic enrollment. The Act also introduced new rules for individual retirement accounts (IRAs) and charitable donations from retirement funds.

Question 20

Education IRAs

Answer 20

Education IRAs (also referred to as Coverdell Education Savings Accounts) are also available where an investor can make nondeductible contributions of up to $2,000 per child under age eighteen. The funds saved can be used for primary and secondary school expenses (i.e., tuition, books) in addition to higher education fees (i.e., college). Any funds leftover (i.e., if a child does not attend college) may be rolled over into another Education IRA before age 30.

Question 21

Section 529 Plans

Answer 21

Section 529 plans are state-run investment plans that offer families a tax-free way to save for higher education expenses, including college, vocational school, and graduate programs. There are two types: college savings plans, which can be used at any college, and prepaid tuition plans, which lock in tuition rates at in-state public colleges. Earnings and withdrawals for qualified education expenses are exempt from federal taxes, and some states offer additional tax benefits. Contributions are considered gifts and may be subject to gift taxes. Withdrawals for non-education purposes incur a 10% penalty and federal income tax.

Question 22

What is vesting?

Answer 22

Vesting refers to the process by which an employee gains full ownership of employer-provided benefits, such as retirement funds or stock options, over time. In the context of retirement plans like a 401(k), vesting determines how much of the employer’s contributions an employee can keep if they leave the company. There are typically two types:

1. Cliff Vesting: Full ownership is granted after a specific period (e.g., three years of service).
2. Graded Vesting: Ownership increases gradually over time (e.g., 20% ownership after one year, 40% after two years, etc.).

Employee contributions are always fully vested, while employer contributions may follow a vesting schedule.

Question 23

What is maritial deduction?

Answer 23

The marital deduction on an individual IRA account allows for the transfer of IRA assets between spouses without incurring estate or gift taxes. When one spouse passes away, the surviving spouse can inherit the IRA and benefit from the marital deduction, which means the IRA assets are not subject to estate taxes at the time of transfer. The surviving spouse can then roll over the inherited IRA into their own IRA or treat it as an inherited IRA, allowing for continued tax-deferred growth. This deduction helps in estate planning by deferring taxes until the surviving spouse withdraws the funds.