Module 4 Bridging The Income Gap Flashcards
Chapter 1: Traditional IRAs (1974)
Funded with pretax dollars and grow tax deferred
Trust/custodial account
Not a qualified plan
May not borrow from IRA and most withdrawals are penalized before retirement age
Never joint accounts
Tax Advantages:
-Amount of owners contribution may be fully or partially tax deductible
-Assets within IRA accumulate tax deferred
Contribution Rules:
-Max contribution 5,500 per investor (1,000 catch up above 50 yrs old)
- Must have earned income or alimony to contribute, and under age 70.5
- Must be made in cash not securities
- IRA contributions must be made by April 15th of following year
- May not invest in life insurance of collectibles except certain coins/gold
- Distributions must begin by April 1st year after turning 70.5
- 6% penalty on excess contributions and earnings if over
Key Ingredients: Regular contributions, compounding, time
Deductible IRAs
- Under age 70.5, and not participating in a qualified retirement plan, SEP, or Simple IRA can contribute regardless of AGI
- Under 70.5, under an income limit who participate in a qualified plan can also deduct
- Earned income limit applies to employment income and taxable alimony
Active Participants in Qualified Plan:
-Qualified Plans include: 401 (K)s, government plans, 403(b), SEP, Simple IRA
-Participating if making contributions, not if earning income from investments
-AGI Phaseout ranges are:
Joint= $99,000-$119,000
Single= $62,000-72,000
-To find deductibility in phaseout range
IRA contribution limit X (UL - AGI)/phaseout range = Deductible amount
5,500 x (72,000 - 68,000)/10,000 = 2,200 deductible
One spouse contributes to a qualified plan / one doesn’t:
- Spouse contributing range is 99-119
- Spouse not range is 186-196k
One spouse works, one doesn’t:
-Allowed to contribute 5,500 for other spouse in an IRA
Chapter 1 Questions
- Limits for IRA contributions both deductible and non-deductible
A. 5,500 B. 11,000 C. 13,000 D. 11,000 E. 6,500
2A. What retirement plans must be considered when determining whether an active participant?
401k, SIMPLE IRA, SEP, …
B. Criteria for being active
- Active regardless unless frozen
- Contribution made by either employee or employer, or a forfiture
C. Must be contributing to be active, unless in a defined benefit plan
D. No effect
E. Investment income, capital gains
- Contributed 5.5k, earns 105k, not participating in 401k
A. Eligible to make contribution? Yes
B. Is she an active participant? No
C. Able to deduct? Yes - 85k earning, defined benefit plan, 5.5k in contributions
A. Eligible? Yes
B. Active Participant? Yes
C. Eligible to deduct full? No, falls above 62-72k phase out
5A 5,500* (72k-63k)/10k= 4950
B. 2475
C. 5,500* (119k-100k)/20k= 5225 + 5,500 = 10,725
D. 5,500 , spouse may deduct because under non-participating range of 186-196k
Chapter 2 Roth IRA Basics (1997)
Tax-free distributions, no tax deduction for contribution
Still subject to contribution rules
Single: Under MAGI of 118-133k
Joint: Under MAGI 186-196
No required minimum distribution and can contribute after 70.5 unlike IRAs
Same calculation for phaseout as IRAs Contribution x (UL - MAGI) / range
May take an early distribution for first home
Not included in Social Security taxation or Medicare premiums
Roth Conversions and Recharacterizations
Converted IRA funds will be taxed at conversion but not subject to early withdrawl fee of 10% under 59.5
Unless within first 5 years after conversion
Non-deductible contributions have cost basis but if mixed with deductible all must be taken into consideration
May be converted from traditional IRAs, SEPs, SIMPLEs (after 2 yrs) and qualified plans
Not restricted by age when converting
Recharacterization- If account value drops significantly, may not want to pay tax on Roth contributions
Must do by October 15 of following tax year
Roth 401(k) and 403(b)
Available for 401k and 403b participants
Annual contribution limit is higher (18k vs 5.5k) plus 6k in catch up
No Phase-out for Roth 401k/403b
18k and 6k catch-up is overall limit for 401k and 403b
5 year holding period and attaining age 59.5 must be met before taking a distribution tax free
Potential issues with 401k Roth:
-If an individual has a 401k Roth and a Roth IRA, each must meet their own individual 5 year hold before making a distribution
-401k accounts have an RMD at 70.5 or retirement
Can solve by rolling into existing Roth IRA
ERISA Protection:
- IRAs are protected up to $1MM
- 401ks are fully insulated
- Rollover from qualified plans are only protected completely if in the initial IRA rollover account (IRA 2 could produce problem)
Chapter 2 Questions
- Qualified distribution from Roth IRA
- Held for 5 years in the account and over 59 1/2 (or disabled, dead, first time home buyer up to 10k) - If not qualified, then 10% early withdraw fee too?
- Not necessarily. Exception same as IRAs for Education spending, med in excess of 10%, periodic payments - NO
- Nothing to Roth, 11,000 to IRA
- Buster: 4,950
Prunella: 5.5k * (196k-187k)/10k= 4.95
Chapter 3 Annuities
Form of insurance where investor makes payments to get a set payment in future
Annuitant receives payment, can be two different annuitant’s
Two types of annuities:
1. Immediate- Distribution phase begins immediately after initial deposit (within a year)
- Deferred- Make payments and allows investment to grow tax-deferred
Methods of Accumulation
Fixed: Deposited in general account and earns the current interest rate (usually there’s a floor)
-Investment risk stays with company
Variable: Separate account, purchase into an open-end investment company (mutual fund). May Cary a Daily NAV.
-Investment risk is with investor, but most guarantee at least the amount of investment at DEATH
Distribution options for Annuities
Lump sum, interest only, or annuitize the contract
Fixed Amount- Will receive payments until value of annuity goes to 0, remainder paid to beneficiary
Period Certain- Pay for specific length of time, beneficiary would assume payments
Interest income- Only pays out interest, without decreasing base
Life income (pure life)- Annuitized, upon death payments likely stop
Life Income with Refund- If payments do not exceed annuity value, then lump sum is paid to beneficiary
Life Income with Period Certain- Guaranteed amount of payments for specific period
Joint Life- Only pays until one person of two dies
Joint and Survivor- Pays as long as either is living
Joint and Survivor Period Certain- If both die, a beneficiary would receive payments
Pension Maximization
Purchase a pure single life annuity and use the difference between the joint and single to by life insurance
Used if expecting an age gap between death years
Taxation of Annuity Distributions
Ordinary Income only
No capital gains
Annuitization:
Part of each annuity payment is ordinary. Income and part is cost basis
Exclusion ratio determines tax-free portion
Total premium paid / total exp. payout
Distributions:
Completely taxed until all earnings have been withdrawn
10% early withdraw fee if before 59.5 (immediate annuities do not have 10% fee)
Fees and Expenses of Annuities
Usually have a surrender charge for 4-9 years
May have management, distribution and/or administration fees
Need to make sure client is aware of fees before
Longevity Annuities
Sort of like an immediate annuity, only you pick a date to begin receiving payments 1-40 years in advance
Must receive payments before hitting 85 and have a cap of $125k
Chapter 3 questions
- Two phases of deferred annuity?
- Accumulation and annuitization - Benefit of variable annuity
- Receives stock market type return instead of fixed rate that might not keep up with inflation - Define following settlement options
A. Straight life income- annuitized, payments stop at death
B. Life with period certain- Certain period of years where payments continue regardless of death
C. Life with refund- If total annuity balance not paid, then refunded to a beneficiary
D. Joint and survivor income- Pays till death of both
E. Interest only- pays on interest only
- Considerations to be made by individual purchasing
- Life expectancy, need for income, wealth accumulated, income, risk tolerance, liquidity need
Chapter 4 Mutual Funds
46.3% of households own a mutual fund
Pools money of many investors and hires manager to invest to achieve one or more financial objectives
Transfers of dollars to different fund in family is still a taxable event
Some funds allow checks to be written against mutual funds (usually a minimum limit
Can also set up systematic withdrawl plans
Fund Organization
Have a BOD, Officers, shareholders and outside personnel
BOD hires officers to manage the funds assets
Mutual funds used qualified banks to hold assets
Transfer agents handle the recordkeeping
Custodian holds the fund;s assets
Costs of owning a mutual fund share
Load funds- Sold with assistance of a salesperson and have sales charges
A shares- Front end load, typically 2-5% upto max of 8.5%
B Shares- Assessed a fee upon selling the share called a CDSC fee
-Converted to A shares after holding long enough
C Shares- 12b-1 fees annually charged, max is 0.75%
Some funds are considered no-load funds and can charge redemption fees in short term
Operating expenses:
Management fees, 12b-1 (marketing), other expenses
Expense Ratio= Annual opex/ Avg NAV
Type of Mutual Funds
High Yield- Invest in bonds below investment grade
GNMA- Mortgage backed securities
Money Market- Typically sell for $1 per share
Flexible portfolios include- Asset allocation, target date, income replacement (stream of income)
ETFs
Priced throughout the day
Track broad based indexes and specific individual sectors
First ETF tracked S&P 500 offered in 1993
Generally low cost and tax efficient
Can be bought on margin and sold short unlike mutual funds
Usually 9-20 BPS in fees
Tax circumstances of ETFs
Bond ETFs and REITs pay non qualified dividends which are taxed as ordinary income
Commodity ETFs use futures contracts and 40% of gains are short, 60% long each year regardless if sold
Gold and Silver ETFs are taxed as collectibles at 28%
Most currency funds are taxed as ordinary income
Mutual Fund Returns
Amount of increase / Amount at beginning = ROR
Should look at returns in context of risk reward
Chapter 4 Review
- identify three broad based objectives
- Capital Appreciation, Income, Capital preservation
Chapter 5: Life Insurance
Term Life vs Permanent
Term Life- Pays nothing unless a loss occurs, lowest premium
Premiums typically rise with age
Permanent Life (Cash Value)- Death benefit and a tax deferred savings element
Typically pay tax on earnings over premium paid if surrendering the policy
DO NOT pay taxes on dividends unless earning interest on the dividend
Modified Endowment Contract
Fails seven pay test
Seven pay test- Funded with more premium than normal
LIFO if withdrawing funds before 59.5
If the beneficiary does not take the lump sum, payments would be slightly taxed
Borrowing against cash value life insurance
Typically able to borrow up to the current surrender value - 1 years interest
Would be subtracted from death benefit if not paid back
Insurance versus investment
Argument over whether to buy cash/permanent life insurance vs term
Whether cash saved from only buying term could save you money
Settlement Options for Insurance (still living)
Installments:
1. Installments of a fixed amount- Lasts until cash value is completely drawn
- Installments over a fixed period- Last for specific amount, payment is determined based on length
Remaining funds for installments would be paid to beneficiary or estate
Income for Life:
-Same as annuities: Straight life income, life income with period certain, life income with refund, joint and survivor income options
Interest Only:
-Pay interest on principal (all taxed), may be limited on amount of time it will continue
Life Insurance as a Retirement Planning Tool
Use the difference in pension payout plans (joint vs single) to pay for life insurance
Should apply and qualify for the life insurance before making the decision joint vs single
Viatical settlement- Could sell the policy to a third party to receive payments later in life
Potential drawbacks of using life insurance as a retirement vehicle
Cash Value is funded by excess of premiums paid
Could withdraw cash value cost basis tax free and then use interest on cash value as a loan
If cash value of policy lapses, the whole outstanding loan is subject to taxation
Chapter 5 Review Qs
- Difference between term life and cash value life?
-Term life only lasts for a certain period and only pays out if the person covered dies.
Cash Value develops an amount that can be drawled on as a loan, but has higher premiums to build that amount
- Loan provision option in cash value
- Allows for the cash value to be drawled upon as a loan. Do not necessarily have to pay back the loan but if the cash value drops to 0 you may have to pay taxes on it. - Pension Maximization?
Using the difference between a single and joint annuity to pay for cash value or term life insurance
Chapter 6: Home Equity
80% of individuals age 65 and older owners their homes in 2014
Downsizing, refinancing to a lower interest rate are options
Home Equity Loan or Home Equity Lines of Credit (HELOC)
- Using the home as collateral for a loan
- Lower upfront costs than reverse mortgages
Reverse Mortgages
- Doesn’t have to be repaid until you retire or move
- Amount available depends on home value, market interest rates and homeowners age
- Interest payments are tax deductible
- Must be 62, own home
- Still responsible for taxes, insurance and maintenance
- Sale proceeds for heirs are guaranteed to cover loan, even if amount does not
- 10% of all reverse mortgages go into default
Chapter 6 review
- Benefits of the following
A. Downsize- Less to maintain, lower taxes, possible sale benefit in form of cash
B. Refinance- Lowers interest payment on remainder of the loan
C. Reverse mortgage- Don’t have to leave home - Risks with a reverse mortgage
- Could lose the home if borrow too early or not planned correctly
Chapter 7- Post Retirement Employment
40% of retirees between age 51-61 will end up going back to full time work
Could lower SS benefit if working before FRA
Take advantage of employer healthcare
Part time workers in retirement suffer from the least amount of depression
