Definitions (Chapter 10) Flashcards
Qualified Plan
is a retirement or employee compensation plan established and maintained by an employer that meets specific guidelines spelled out by the IRS and consequently receives favorable tax treatment. The plans must be permanent, in writing, communicated to employees, defined contributions or benefits, and cannot favor highly paid employees, executives, or stockholders. Qualified plans have the following features:
- Employer’s contributions are tax-deductible as a business expense
- Employee contributions are made with pretax dollars - contributions are not taxed until withdrawn
- Interest earned on contributions is tax-deferred until withdrawn upon retirement
- The annual addition to an employee’s account in a qualified retirement plan cannot exceed the maximum limits set by the IRS.
ERISA (The Employee Retirement Income Security Act of 1974)
is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.
Defined Contribution Plans
are a tax-qualified retirement plan in which annual contributions are determined by a formula set forth in the plan. Benefits paid to a participant vary with the amount of contributions made on the participant’s behalf and the length of service under the plan. Defined contribution plans do not specify the exact benefit amount until distribution begins. Two main types of plans are profit-sharing and pension plans. The maximum contribution is the lesser of the employee’s earnings or $49,000 per year.
Profit-Sharing Plans - Employer Sponsored Plan
are any plans whereby a portion of a company’s profits is set aside for distribution to employees who qualify under the plan.
Defined Benefit Plans
are pension plans under which benefits are determined by a specific benefit formula. Defined benefit plans pay a specified benefit amount upon the employee’s retirement. When the term pension is used it normally is referring to a defined benefit plan. The benefit is based on the employee’s length of service and/or earnings.
401(k) Plan - Employer Sponsored Plan
is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.
403(b) Plan - Employer Sponsored Plan
is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.
Keogh Plans - Small Employers
are designed to fund retirement of self-employed individuals; named derived from the author of the Keogh Act (HR-10), under which contributions to such plans are given favorable tax treatment. Keoghs may be defined contribution or defined benefit plans. Defined contribution Keoghs have a maximum contribution of $49,000 per year, while defined benefit Keoghs have maximum benefits of $195,000 per year. Contributions are tax-deductible, and interest dividends are tax deferred.
Simplified Employee Pension (SEP) - Small Employers
is a type of qualified retirement plan under which the employer contributes to an IRA account set up and maintained by the employee. A primary difference between a SEP and an IRA account is the much larger amount that can be contributed to an employee’s SEP plan is the lesser of 25% of the employee’s annual compensation.
SIMPLE (Savings Incentive Match Plan for Employees) - Small Employers
is a qualified employer retirement plan that allows small employers to set up tax-favored retirement savings plans for their employees. These plans are available to small businesses that employ no more than 100 employees who received at least $5000 in compensation from the employer during the previous year. An employer can choose to make nonelective contributions of 2% of compensation on behalf of each eligible employee.
Traditional IRA - Individual Retirement Plan
is a personal qualified retirement account through which eligible individuals accumulated tax-deferred income up to a certain amount each year, depending on the person’s tax bracket.
IRA Contributions/Withdrawals
provide generous tax breaks. But it’s a matter of timing when you get to claim them. Traditional IRA contributions are tax deductible on both state and federal tax returns for the year you make the contribution, while withdrawals in retirement are taxed at ordinary income tax rates. Anyone under the age of 70 1/2 with earned income may open a traditional IRA. Withdrawals must start no later than April 1 following the year in which the participant reaches the age of 70 1/2, and the law specifies a minimum amount that must be withdrawn every year. No cash withdrawals prior to the age of 59 1/2 are permitted without having to pay a 10% excise tax, with the following exceptions:
- if the owner dies or becomes disabled;
- if distribution is in equal payments over the owner’s lifetime
- if higher education expenses for a dependent are necessary
- to purchase a first home with up to 10,000 down payment
- if out-of-pocket medical expenses are in excess of 7.5% of adjusted gross
- to pay health insurance premiums while unemployed
- to correct or reduce an excess contribution
Roth IRA- Individual Retirement Plan
is an individual retirement account allowing a person to set aside after-tax income up to a specified amount each year. Both earnings on the account and withdrawals after age 59 1/2 are tax-free. The funds are taxed as income before the contribution is made. In other words, Roth contributions are made with after-tax dollars. Therefore, at the time of payout, the funds are tax free. Unlike the traditional IRA, the Roth imposes no age limits. Roth withdrawals are either qualified or non qualified. Also, unlike traditional IRAS, Roth IRA distributions are not mandatory and can therefore be inherited and passed down through generations.
Qualified Withdrawals
provide the tax-free distribution of earnings. To be a qualified withdrawal, the funds must have been held in the account for a minimum of five years; and if the withdrawal occurs for one of the following reasons, no portion of the withdrawal is subject to tax:
- The owner has reached age 59 1/2
- The owner dies or becomes disabled
- The distribution is used to purchase a first home
Non Qualified Withdrawal
If a withdrawal is taken without meeting the above criteria and the amount of the withdrawal exceeds the total amount contributed, it is a non qualified withdrawal. The earnings from the contributions become taxable.
