Lesson 3 of Retirement Planning: Administration of Qualified Plans Flashcards
Distributions from Qualified Plans!
To recieve the tax-free growth of the assets within the qualified plan, the plan participants must follow precise rules and requirements regarding distributions from the plan.
- Distribution Options
- Taxation of Distributions
Distributions Options
Distributions are disbursements of assets from the qualified plan with no intention of returning the assets to the plan.
Distributions Include:
- In Service Withdrawals
- Payments made upon termination or retirement
- Distributions Related to Domestic Relations Orders
Distributions Do NOT Include:
- Loans, unless the loan is not repaid then it would be a distribution.
Qualified Plans offer many types of Distributions Options:
- Lump Sum
- Rollover
- Single Life Annuity
- Joint Life Annuity
- MAY Also offer In Service Distriubtions and hardship withdrawals BEFORE retirement,
Pension Plans + Profit Sharing Plans
Pension Plans
Distributions from pension plans are normally made because of the participant’s:
- termination employment,
- early retirement,
- normal retirement,
- disability, or
- death
Early Termination
A participant who terminates employment before normal retirement age may have up to three
options:
- (1) receive a lump-sum distribution of the qualified plan assets,
- (2) roll the assets over to an
IRA or other qualified plan, or - (3) leave the funds in the pension plan
Forced Payout: If the participants vested account balance is less than $5,000, then the plan may distribute the balance to the participant if the participant does not make a timely election.
- If Forced Payouts between $1,000 and $5,000 should be directly rolled to an IRA if participant has not made timely election.
Normal Retirement
At the participant’s normal retirement age, the pension plan will typically distribute retirement benefits through an annuity payable for the remainder of the participant’s life.
Single Participant:
- Single Life Annuity automatic form of benefit.
Married individuals, must be offered:
- a qualified joint and survivor annuity
Regardless, distributions from qualified pension plans are ORDINARY TAX.
Qualified Joint and Survivor Annuity (QJSA)
A Qualified Joint and Survivor Annuity (QJSA) generally must be provided to married participants of a pension plan and must also be provided to married participants of profit sharing plans, unless the benefit is payable to the surviving spouse upon the participants death.
The QJSA pays a benefit to the participant and spouse as long as either lives. At the death of the first spouse, the surviving spouse’s annuity payments can range from 50 percent to 100 percent of the joint life benefit.
The nonparticipant spouse beneficiary may choose to waive his or her right to a QJSA by executing a notarized, or otherwise official, waiver of benefits.
- The waiver may be made during the 90-day period beginning 90 days before the annuity start date.
Qualified Pre-Retirement Survivor Annuity (QPSA)
A Oualified Pre-Retirement Survivor Annuity (QPSA) generally must also be provided to married participants of a pension plan or a profit sharing plan, unless the benefit is payable to the surviving spouse upon the participant’s death.
A QPSA provides a benefit to the surviving spouse if the participant dies before attaining normal retirement age.
The nonparticipant spouse is offered the QPSA and may choose whether to accept or waive the
option. The QPSA may be waived by the nonparticipant spouse via a written notarized waiver.
Full Value of QPSA is taxed at:
- Ordinary Income Tax
- Estate Tax
Exam Question QPSA
Which of the following is/are elements of an effective waiver for a pre-retirement survivor annuity?
- The waiver must be signed within six months of death.
- The waiver must be signed by a plan participant.
- The waiver must be signed by the nonparticipant spouse and notarized or signed by a plan official.
a) 3 only.
b) 1 and 2.
c) 2 and 3.
d) 1, 2, and 3.
Answer. A
Only the nonparticipant spouse must sign the waiver
Rollover
A distribution from a pension plan may be rolled over into another qualified plan or an IRA
- provided the participant is not required to begin taking the required minimum distributions.
In certain situations, however, when a distribution is taken as a lump-sum distribution,
- the recipient may receive favorable tax treatment on the distribution (NUA for employer stock), 10-year forward averaging [participant born prior to 1936], and/or pre-74 capital gain treatment) as discussed below.
These favorable tax treatments will be lost if the distribution is rolled over
Profit Sharing Plans
At termination, the participant may be able to take distributions from a profit sharing plan as:
- ordinary taxable income,
- annuitize the value of the account (if the plan document permits), or
- roll the assets over into a rollover qualified plan or IRA.
Unlike pension plans, profit sharing plans are not required to offer survivor benefits:
- if the plan does not pay the participant in the form of a life annuity benefit and
- the participant’s nonforfeitable accrued benefit is payable to the surviying spouse upon the participant’s death
Taxation of Distributions
Distributions from qualified retirement plans are generally subject to ordinary income tax.
Plan account balances usually contain both contributions and earnings that have never been subjected to income tax.
Plan custodian is required to withhold a mandatory 20% from most distributions made to the participant.
- other than hardship distributions and loans.
- Witholding Requirement only is for qualified plans and not distributions of IRA’s.
Taxation of Distributions Covers:
- Rollovers
- After Tax Contributions
- Adjusted Basis
- Lump-Sum Distributions
- Special Taxation Options for Lump-Sum
- Net Unrealized Appreciation (NUA)
- Qualified Domestic Relations Order
Rollovers
The participant may elect to roll over or transfer the balance of the account into another tax advantaged qualified plan or an IRA account rather than taking a lump-sum distribution.
The decision to roll over qualitied plan assets into an IRA should be considered carefully.
While a rollover will allow the assets to continue to grow in a tax-deferred environment.
- IRAs are subject to limitations.
Rollers may be Acoomplished:
- Direct Rollover
- Indirect Rollover
Direct Rollover
which occurs when the plan trustee distributes the account balance directly to the trustee of the recipient account.
The original plan custodian is not required to:
- withhold 20 percent of the distribution for federal income tax if a direct rollover is made.
Indirect Rollover
Qhich occurs through a distribution to the participant with a subsequent transfer
another account.
In this instance the original custodian issues a check to the participant in the amount of the full
account balance reduced by the 20 percent mandatory withholding allowance.
In order to complete the rollover, the participant must then reinvest the full original account
balance of the qualified plan:
- (including the 20 percent mandatory withholding)
- within 60 days of the original distribution into the new qualified plan or IRA.
Example of a Direct vs Indirect Rollover
Roll From Roll To Chart
After-Tax Contributions
If a qualified plan consists of employee after-tax contributions, these contributions may be rolled over into:
- another qualified plan that accepts after-tax dollars or
- into a traditional IRA.
- It also results in a basis in the plan.
In the case of a rollover of after-tax contributions from one qualified plan to another qualified plan
the rollover can only be accomplished through a direct rollover.
A qualitied plan is not permitted to
accept rollovers of after-tax contributions:
- unless the plan provides separate accounting for such contributions and
- the applicable earnings on those contributions.
Conversely, after-tax contributions are not permitted to be rolled over from an IRA into a qualified plan.
Adjusted Basis
A participant will have an adjusted basis in distributions received from a qualified plan if either of the following have occirred:
- The participant made after-tax contributions to a contributory qualified plan, or
- The participant was taxed on the premiums for life insurance held in the qualified plan.
Adjusted Basis - Annuity Payments
Amounts distributed as an annuity are taxable to the participant of a qualified plan in the year in which the annuity payments are recieved.
Each annuity payment is considered partially tax-free return of adjusted basis and partially ordinary income using an inclusion/exclusion ratio.
( Cost Basis in the Annuity ) ÷ ( Total Expected Benefit ) = Exclusion Ratio
- Think Income TAXES!!
Once the participant has recovered the entire cost basis of the annuity, all future monthly payments will be fully taxed.
Distributions that are not lump-sum and are not part of an annuity are taxed pro rata to the account balance in comparison to the pretaxed portion.
Exam Question - Taxation of Distributions
On April 30, Ava, age 42, received a distribution from her qualitied plan of $150,000. She had
an adjusted basis in the plan of $500,000 and the fair market value of the account as of Apr 30
was $625, 000. Calculate the taxable amount of the distribution and any applicable penalty.
a) $30,000 taxable, $3,000 tax penalty
b) $30,000 taxable, $0 tax penalty
c) $120,000 taxable $12,000 tax penalty
d) $150,000 taxable, $15,000 tax penalty
Answer: A
Because the distribution to Ava does not quality for the exception to the 10 percent penalty, the
taxable amount of the distribution will be subjected a 10 percent penalty. To calculate the
amount of the distribution that is return of adjusted basis, the adjusted basis in the plan is divided by the fair market value of the plan as of the day of the distribution. This ratio is then multiplied times the gross distribution amount. As such, $120,000 [($500,000 ÷ $625,000) x $150,000] of the $150,000 distribution is return of adjusted taxable basis. Accordingly, $30,000 ($150,000 - $120,000) will be subject to income tax, and there will be a $3,000 ($30,000 x10%) tax penalty.
Lump Sum Distributions
Participants may take a full distribution, often calledva lump-sum distribution, from a plan upon
termination of employment
Lump-sum distributions from a qualified pension
or protit sharing plan may receive special income
tax treatment. To be considered a “lump-sum distribution.” the distribution must meet the following four requirements:
- The distribution must represent the employee’s entire accrued benefit in the case of a pension plan or the full account balance in the case of a defined contribution plan.
- The distribution must be on account of either the participant’s death, attainment of age 59½,
separation from service (does not apply to self-employed individuals in the plan), or disability. - The employee must have participated in the plan for at least five taxable years prior to the tax
year of distribution (waived if the distribution is on account of death). - The taxpayer must elect lump-sum distribution treatment by attaching Form 4972 to the
taxpayers federal income tax return. This must be filed by the participant or (in the case of the
participant’s death) by his estate within one year of receipt of the distribution.
All of the four requirements must be met in order for the distribution to quality as a lump-sum distributon and therefore quality for any of the special tax treatments described below:
- 10 year forward averaging
- Pre-Tax 1974 capital gains treatement
- NUA Treatment
Special Taxation Options for Lump-Sum Distributions
The full value of a distribution from a qualified plan is usually subject to ordinary income tax at the date of the distribution (except for the return of a participants adjusted basis from certain types of after-tax contributions).
In certain circumstances, however, when
an employee takes a lump-sum distribution from a qualified plan, that lump-sum distribution may be eligible to receive favorable income tax treatment.
Specifically, a lump-sum distribution may be eligible for ten-year forward averaging, pre-1974 capital gain treatment, or net unrealized appreciation treatment
10 Year Forward Averaging
Editor’s note: very unlikely to be tested, but may appear in an answer set.
A participant born prior to January 2, 1936 may be eligible for 10-year forward averaging when taking a lump-sum distribution from a qualified plan.
Pre-1974 Capital Gain Treatment
Editors note: very unlikely to be tested, but may appear in an answer set
Participants who are born prior to January 2, 1936 may be eligible to receive capital gain tax
treatment on the portion of a lump-sum distribution that is attributable to pre 1974 participation in a qualified plan.
The capital gain rate for this type of tax treatment is 20% and the distribution must be a lump-sum distribution.
Exam TIP
HINT! While you should be aware of the l0-year averaging and pre-74 gains methods, your time IS better spent on the NUA calculations.
Net Unrealized Appreciation (NUA)
Taxpavers who receive a lump-sum distribution of employer securities (such as stock) may benefit using a special tax treatment on the distribution. This tax treatment allows the more favorable capital gain tax treatment instead of ordinary income tax treatment on the NUA portion of the distribution as well as a deferral of recognition of the gain on the NUA portion until the distributed employer securities are sold.
Net Unrealized Appreciation (NUA) is defined as the excess of the fair market value of the employer securities at the date of the lump-sum distribution over the cost of the employer securities at the date the securities were contributed to the qualified plan.
FMV at Date of Distribution
(minus)
Value of Securities Used at the Date of the Employer Contribution
= Net Unrealized Appreciation
At the date of the subsequent sale of the employer secunties, the participant will be required to recognize the long-term capital gain deferred since the date of the distribution.
Any subsequent gain after the distribution date will be treated as either short-term capital gain or long-term capital gain based on the holding period beginning at the date of the distribution
Following Chart Illustrates NUA
Example of Utilizing NUA Rules for Employer Stock
Several Issues Involved in This Type of Transaction Are:
First, the participant must qualify for lump-sum distribution treatment.
Second, the NUA portion must be relatively high in comparison to the cost basis portion; otherwise, the recipient may be paying too much immediate ordinary income tax for the benefit of future long-term capital gain treatment.
The next issue concerns whether the stock is to be held by the recipient. If so then the investment risks of holding a large concentration of a single security must be considered.
Finally cash flow considerations must be evaluated to determine the impact of holding the
securities versus selling the securities. Note: The amount subject to ordinary income tax is subject to a penalty if there is no exception in the IRC.
Inherited Securities with NUA Resulting from a Qualified Plan Distributions
The inherited stock will receive an adjustment of basis to FMV at date of death less any unrecognized NUA.
- The tax will be paid when the assets are disposed of by the heirs.
Exam Question - Inherited Securities with NUA Treatment
Virginia recently found out an Uncle she had not seen since she was a child left her his brokerage account with Coca-cola stock. He had worked for Coca-cola for many years while he lived in Atlanta. The paperwork stated her Uncle had a basis of $100,000, Net Unrealized Appreciation of $150,000 and a date of death value of $325,000. This inhentance was a surprise to Virginia but came at a good time since she is getting marred soon and has been house shopping, so she can put the money to good use. Virginia has come to you, as her financial planner, and would like to know the tax ramifications of selling the stock now that the value has increased $350,000. What tax consequences will she face?
a) None, she inherited the stock and can sell without tax consequences.
b) She will pay short-term capital gains on $25,000
c) She will pay long-term capital gains on $325,000 and $25,000 short-term capital gains.
d) She will assume a basis of $325,000, the NUA portion will be taxed at long-term gain
and any gain at holding period of the beneficiary
Answer: D
When inheriting stock with NUA treatment, the beneficiary assumes the FMV minus the unused
NUA. This is different than typical inherited property or inherited IRAs. The NUA portion will
retain long-term capital gain rates. Any gain above the date of death value will be taxed based
on the beneficiaries holding period. Virginia will pay long-term capital gain rates on $150,000
and $25,000 will be taxed at short-term capital gains rate if she sells immediately.
Qualified Domestic Relations Order as applied to Retirement account distributions
An exception to the ERISA anti-alienation rules has been made if the assignment or alienation is at the direction of a Qualified Domestic Relations Order (QDRO).
A QDRO is an order, judgment, or decree pursuant to a state domestic relations law that creates or recognizes the right:
- of a third party alternate payee (nonparticipant) to receive benefits from a qualified plan.
There are two basic approaches that may be used to divide the benefit depending on the reason the QDRO is being used.
- One approach, often called the “shared payment approach,” splits the actual benefit payments made between the participant and the alternate payee.
- The second approach, often called the “separate interest” approach, divides the participant’s
retirement benefit into two separate portions.
A distribution pursuant to a QDRO will not be considered a taxable distribution to the third party alternate payee as long as the assets are deposited into the recipient’s IRA or qualified plan.
Distributions Prior to 59.5
To discourage taxpayers from using the funds before retirement tayable distributions before the age of 59½ will generally be subject to a 10% early withdrawal penalty.
Earl Withdrawal Penalty
- A distribution prior to the participant attaining the age of 59½ may be subjected to a 10% early withdrawal penalty unless the distribution meets one of several exceptions
Exceptions to 10% Early Withdrawal Penalty
EXAM TIP: Make a flashcard and memorize the exceptions to the 10% penalty!
“Attainment of Age 55 and seperation from service” make sure to understand. Exam Questio covers it, a few flashcards away.
If Distributions are Part of Section 72(t) or Substantially Equal Periodic Payments
If the distribution is part of a series of substantially equal periodic payments, also called Section 72(t) distributions, made at least:
- annally for the life
- or life expectancy of the participant
- or the joint lives
- or joint life expectancies of the participant and his designated beneficiary,
the payments will not be subjected to the 10% early withdrawal penalty. The payments must begin after the participant has separated from service, and to be considered substantially equal periodic payments the payments must be made in any one of the following three ways:
- Required Minimum Distribution Method: The payments are calculated in the same manner as required under minimum distribution rules (discussed below). Note that payments are recalculated annually.
- Fixed Amortization Method: The payment is calculated over the participant’s life expectancy if single, or the joint life expectancy if married, and the interest rate is reasonable. This method creates a series of installment payments that remain the same subsequent years
-
Fixed Annuitization Method: The participant takes distributions of the account over their life
expectancy determined by dividing the account balance by an annuity factor using a reasonable
interest rate and mortality table. - Under this method, the payment does not change in future years.
Payment Method Calculated Above?
??
The payment calculated under one of the methods determined above must continue exaclty as calculated for the later of five years from the date of the first payment or the participant attaining the age of 59½.
- If the payments change in any way, the participant will be considered to have made a
distribution equal to the full account balance of the qualified plan in the first year of the
substantially equal periodic pavments
Additional Ways to Avoid the 10% Penalty
First, the government provides an exception (E) to the 10% early withdrawal penalty if the distributions are dividends paid within 90 days of the plan year end from an ESOP.
Second, if the distribution is made to pay certain
unpaid income taxes (T) because of a tax levy
on the plan.
Third there is no 10% penalty if the distribution is made to the participant for certain
medical expenses (M) paid during the year greater than 7.5 percent of the participant’s adjusted gross income (whether the person itemizes or not).
Fourth. if the distribution is pursuant to a QDRO, (Q) there will be no 10% penalty on the distribution.
Fifth, if your primary residence is located in a federally declared disaster area and suffered
damages. The mandatory 20% withholding from qualified plans will not apply.
Sixth, if you have a medically declared terminal illness (employee must furnish sufficient evidence to the plan administrator), that will result in death with in 84 months.
Other exceptions to the 10 percent early withdrawal penalty are:
- plan rollovers and
- plan loans
Help: E, T, M, Q
Exam Tip
For Oualified Plans to avoid the 10% penalty, they make a “MESS AT D^3Q”
(Medical expenses, Equal periodic payments.
Separaton from service, Age, Tax levels (and terminal illness), Death, Disability, Disaster and
QDRO)
Exam Tip
For IRAs to avoid the 10% penalty, they say
“HIDE ME”
(first time Home purchase, health Insurance, Death and disability, Higher education,
Medical expenses, Equal periodic
payments, and of course, age,)
Exam Question - 10% Early Withdrawal Penalty
Which of the following qualified plan distributions will be subjected to a 10% early withdrawal penalty?
a) Ray, age 35, takes a $100,000 distribution from his profit sharing plan to pay for his
son’s college tuition.
b) Debra, age 56, was terminated from UBEIT Corporation. Debra takes a $125,000 distribution from the UBEIT retirement plan to pay for living expenses.
c) Frank, age 47, takes a $1,000 000 distribution from his employer’s profit sharing plan. Six weeks after receiving the $800,000 check (reduced for 20% withholding), Frank deposited $1,000,000 into a new IRA account.
d) Marie, age 22, begins taking equal distributions over her life expectancy from her qualified plan. The annual distribution is $2,000.
Answer: A
The distribution described in option A will be subjected to the 10% penalty. Education expenses are only an exception to the 10% penalty for IRAs, not qualified plans. All of the other options are exceptions to the 10% early withdrawal penalty.
Option B describes the exception for separation from service after age 55.
Option C describes the exception for the rollover of qualitied plan assets.
Option D describes the exception for substantially equal periodic payments.
Exam Question - 10% Early Withdrawal Penalty
Which of the following qualified plan distributions are subject to a 10% early withdrawal penalty?
- Debra, age 56, currently employed by UBEIT Corporation, takes a $125,000 distribution
from the UBEIT 401(k) plan. - Frank, age 60, takes a $1,000,000 distribution from his employer’s profit sharing plan. Ten
das after receiving the $800,000 check (reduced for 20% withholding), Frank deposited
the $800,000 into a new IRA account. - Mariee, age 22, withdraws $2,000 of her contributions from her 401(k).
a) 1 only.
b) 3 only.
c) 2 and 3.
d) 1 and 3.
Answer: D
Situation 1 is subjected to the 10% early withdrawal penalty because Debra has not separated from service.
Situation 2 will not be subjected to the 10% early withdrawal penalty because Frank is older than 59½.
Situation 3 will be subjected to the 10% penalty because Marie does not quality for any of the exclusions from the 10% penalty
Minimum Distributions
The minimum distribution rules require individuals to begin taking minimum distributions when the participant attains the age of 72 for tax payers that reached age 70½ after 12/31/2019 and before 1/1/2023.
Individuals attaining age 72 after 12/31/22 and before 1/1/33, will start minimum distributions at age 73. SECURE 2.0 Act of 2022 made adjustments to the minimum distribution age for 2023 and for the year 2033 (age 75 for those reaching age 74 after 12/31/32. Additional guidance should be released).
If the funds are not distributed by the required date, a 25 percent excise tax will be levied on the
participant for failure to take the Required Minimum Distribution (RMD). SECURE 2.0 Act of 2022 decreased the penalty amount.
- The 25% excise tax can be further reduced to 10% if the taxpayer takes the distribution from the same plan to which the tax relates, during the “correction window.”
Correction window end on the earlier of
- 1) the date
the IRS issues a notice of deficiency,
- 2) the dale
the IRS assesses the excise tax or,
- 3) the last day of the second taxable year that begins after the end of the year in which the tax is imposed.
The penalty is on an amount equal to the RMD less any distribution that was taken, but the result cannot be less than zero.
Exam Tip:
You must Know the Minimum Distribution Rules
Minimum Distribution Rules Apply To:
Minimum distributions apply to assets in a:
qualified plan,
- IRA,
- 403(b),
- SEP,
- SIMPLE, or
- 457 plan.
While minimum distribution rules do not apply to:
- Roth IRAs,
- they do apply to Roth accounts in a 401(k),
- 403(b) plan,
- or governmental 457(b) plan,
- and to inherited Roth IRAs.
First Distribution Must be Taken By?
The first distribution must be taken by April 1 of the year following the year the participant attains the age of 72 for those that reach 70½ after 12/31/2019.
Age 73 if the taxpayer attains age 72 after 12/31/22.
For each year thereafter, however, the RMD must be taken before December 31 of the tax year.
If the participant delays taking the first MD until April 1 of the year following the attainment of age 72 (or 73), the second MD must still be taken by December 31 of that same year. The delay results in a bunching of two MDs in the same year.
NOTE: There will be no first year calculated distributions in the year 2023. Those that would have reached RMD age this year, will now need to take their first MD for 2024.
Expect to see a taxpayer that is age 72 before 1/1/2023, and is delaying their first year distribution to April 1, 2023 in test questions, or a taxpayer needing to take their normal distribution.
EXCEPTION to RMD for Qualified Plans
EXCEPTION - There is an exception to the general RMD for qualified plans if a participant is still employed by the plan sponsor of a qualified plan upon attainment of age 72 (or 73 after 12/31/22).
A participant that is still employed by the plan sponsor of the qualified plan does not have to begin taking RMD until April 1 of the year after the participant terminates employment with the plan sponsor.
- The exception is NOT available for any participant that owns more than 5% of the ownership of the plan sponsor in the year he reaches the age of 72 (or 73 after 12/31/22).
Calculating Required Minimum Distribution
The required minimum distribution (RMD) is determined each year by dividing the account balance as of the close of business on December 31 of the year preceding the distribution year
by the distribution period determined according to participant’s age as of December 31 of the distribution year in the Uniform Lifetime Table.
If a question is asked about this on the CP® exam, the table below will be provided.
Exception to Using Uniform Lifetime Table
When calculating the RMD for the plan participant, always use the Uniform Lifetime Table, which accounts for the age of the account holder and one other person who is 10 years younger.
One exception to this rule occurs when the participant’s sole designated beneficiary is the
participant’s spouse and that spouse is more than 10 years younger than the participant.
-In that case, use the Joint Life Expectancy Table to calculate the RMD.
- Utilizing the Joint Life Expectancy Tables will result in a longer life expectancy and decrease the RMD
Uniform Lifetime Table Used by Participants
Example
Chart of the Beneficiaries Differences
EXAM TIP: Know this Chart
Business Objectives - Steps to Select a Qualified Retirement Plan.
Chart Summarizing Characteristics of a Qualified Plan
Plan Selection Process Chart
EXAM TIP: KNOW THE FOLLOWING CHART
Contributions in General
A qualified plan is generally funded by employer contributions (often called a noncontributory plan because employees do not contribute to the plan), but employees participating in the plan may also be permitted to make contributions (a contributory plan).
A company can make deducible contribuions for a tax year up (plus extensions) for the year of contributions. A promissory note made out to the plan for contributions is a prohibited transaction and is not a payment that qualifies for an income tax deduction.
While the employer generally applies contributions in the year in which they are paid the employer may apply the payment to the previous year if all the following requirements are met:
More about Contributions in General
Self-employed individuals can make contributions on behalf of themselves only if they have positive net earnings (compensation) from self employment in the trade or business for which the plan was established.
Catch-up contributions for those participants age 50 and over are not subject to the annual
defined contribution limit and thus can be in addition to these limits.
In the event that more money is contributed to a defined contribution plan than is allowed
under the limits above, the excess amount is called the excess annual addition. A plan can
correct excess annual additions if the excess was caused by a reasonable error in estimating a
participant’s compensation, determining the elective deferrals permitted, or because of
forfeitures allocated to participants’ accounts.
A plan can correct excess annual additions by using one of the following methods:
Participants may be permitted to make nondeductible contributions to a plan in addition to the employer’s contributions. Even though these employee contributions are not deductible, the earnings will accrue tax free until distributed in later years. These contributions must satisfy
certain nondiscrimination tests.
Self Employed Individual’s Contribution As:
To Caclulate Self-Employment Tax
Calculate the Self-Employed Individual’s Contribution
Example 1
C0ntribution Rate = 0.25
Exam Question Keough Plans
Dimitri operates Downtown Discount Pharmacy, a sole proprietorship. Downtown Discount
Pharmacy sponsors a profit sharing plan. Dimitri had net income of $205,000 and paid self employment taxes of $25,355 for the year. If Dimitri makes a 15% of salary contribution on
behalf of all of his employees to the profit sharing plan, how much is the contribution to the
profit sharing plan on behalf of Dimitri?
a) $22,642
b) $25,079
c) $29,010
d $30,750
Example
Isaiah has Schedule C net income of $200,000 and wants to know the maximum amount he can
contribute to a Keogh profit sharing plan. The contribution is calculated as follows.
In this instance Isaiah can contribute $37,641 to the
plan for himself.
Exam Question - Keogh Plans
Patrick, age 60, is a member of Worksalot, LLC. Worksalot sponsors a profit sharing plan. Patrick’s portion of the net income was $250,000 and one-half of his self-employment taxes were
$13,280 for this year. If Worksalot makes a 25% of salary contribution on behalf of all of its
employees to the profit sharing plan, how much is the contribution to the profit sharing plan on
behalf of Patrick?
a) $47,344.
b) $50,000
c) $48,780.
d) $66,000.
Chart Listing Characterisitcs of a Disqualified Person
Prohibited Transactions Charts
EXAM TIP: Be able to recognize.
Prohibited transactions generally include actions by a disqualified person that potentially could have adverse consequences to the plan or participants, including:
