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
