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Financial Planning - Paraplanner Course > Module 7 - Retirement Planning > Flashcards

Module 7 - Retirement Planning Flashcards

1
Q

What are the three basic sources for funding retirement - what’s the nickname?

A

“Three-Legged Stool”

> Personal savings and investments

> Employer-provided (and sponsored) retirement plan

> Social Security

(a fourth “leg” could also be working a part-time or full-time job while in retirement)

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2
Q

Using the Life Expectancy chart, find your own life expectancy and determine the life expectancy that a planner would provide for you, using an added cushion. What would you do if you forecast your retirement savings to last for 20 years of retirement and then lived longer than that?

A

If you are a 30-year-old female, your longevity is 52.1 years more according to the chart, which adds up to a life expectancy of 82.1 years. Not forecasting adequately leaves elderly retirees in a tough spot of outliving their savings (longevity risk; discussed later in this
module). Financial planners often add in a cushion, commonly making 70 (instead of 52.1) additional years of investing and retirement to come (sometimes 90 years) to avoid longevity risk.

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3
Q

If a client was choosing between an IRA and a Roth IRA, with the following
financial situation (with all other factors not applicable), which one would
you recommend?

1) Current annual earnings of $50,000
2) Savings account to use during retirement of $250,000
3) Trust fund that will begin distributions of $150,000 annually at retirement

A

Roth IRA would mean that contributions would be taxed at the present $50,000 income, and not subject to taxation during the higher income forecast for retirement, thus saving tax dollars.

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4
Q

Which one of the following employer-provided plans is the only one to
which employees will definitely have to contribute?

1) defined benefit plan
2) cash balance plan
3) 401(k) plan
4) profit sharing plan

A

3) 401(k) plan

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5
Q

Which one of the following not-for-profit retirement plans covers government employees (and other nonprofits)?

1) 403(b) plan
2) 457 plan

A

2) 457 plan

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6
Q

Which of the characteristics shown below are common and specific to the small business plans, SIMPLE IRA and SEP IRA?

A

Common to both SIMPLE & SEP Plans
> employer and employee contributions and earnings are tax-deferred
> immediate vesting
> employee controls the funds

SIMPLE Plan
> only for businesses with 100 or fewer employees
> operates like a 401(k) with less cost and reporting
> no age restriction

SEP Plan
> only employers can contribute
> can vary the contributions, which do not need to be regular
> must include employees who are age 21, have worked 3 of the last 5 years, and have earned $600 (not appropriate for companies with a lot of part-time help)

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7
Q

Your client, Francis, who was born in 1957, has 35 years of highest earnings that add up to $3,050,000. What is his AIME?

A

$3,050,000 / 420 = $7,261

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8
Q

What is Francis’s PIA (use the 2019 “bend points” provided in the text) based on the AIME calculated?

A

.9 x $926 = $833.40

($5,583 - $926) x .32 = $1,490.24

($7,261 - $5,583) x .15 = $251.70

$1,490.24 + $251.70 = $2,575.34

  • this would be rounded to $2,575
  • this is the benefit amount at full retirement age
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9
Q

Since forecasting the future is not certain, what can be done to avoid longevity risk (the risk that a retiree will run out of retirement funds)?

A
  • QLACs can be used to provide funds later in retirement if advanced ages are reached.
  • In addition, Monte Carlo simulations can be used to determine likely scenarios and adjust distributions accordingly and in this more realistic setting.
  • Also, larger cash balances than pre-retirement can ensure funds for living are not risked.
  • Finally, education about fraud should be provided in order to avoid this loss and preserve retirement funds.
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10
Q

Define and describe “longevity risk”

A

The risk of living too long and outliving your money

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11
Q

What is a common rule of thumb when planning for a retirement period?

A

Plan for a retirement period of 20 years or more.

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12
Q

What are three main sources of income in retirement?

A
  • personal savings and investments
  • employer sponsored retirement plans
  • social security
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13
Q

Define and describe “personal retirement savings” with regards to retirement planning.

A

Assets owned outside of any employer-funded retirement account.

These savings can be in investments of cash/cash equivalents, stocks, bonds, and real estate

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14
Q

Define and describe an IRA

A

A trust / custodial account created for the benefit of an individual.

> there is no such thing as a joint IRA

> only an individual may contribute to an IRA (with the exceptions of a few plans that allow employer / employee contributions)

> any person age 70.5 or under with earned income can contribute to an IRA
(contributions to a ROTH IRA are allowed for individuals older than 70.5)

> contributions can be maid up to the lesser of $6,000 or 100% of earned income per year

> all of an investment’s return (cap appreciation, dividends, interest) grow tax-deferred within the IRA

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15
Q

Define “earned income” as it relates to IRA requirements

A

“earned income” typically means wages from an employer reported on a W2 tax form, although income from self-employment, alimony, separate divorce maintenance pmts are also eligible.

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16
Q

Describe “catch up contributions” allowed for IRAs

A

Additional IRA contributions (up to $1,000) that may be made by individuals who are at least age 50 by the end of the year

  • benefits of making contributions earlier in the year is the added compounding growth
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17
Q

What are the two types of IRA account

A

Traditional IRA
- contributions can be deductible from your adjusted gross income, thus lowering your current tax bill. (depends on AGI of individual and if they are filing jointly)

  • IRA contributions are deductible with certain restrictions.
  • RMD distributions must start when an individual reaches age 70.5

ROTH IRA
- no deduction is available for contributions, as all contributions are made with after-tax dollars.

  • eligibility is subject only to the earned income requirement and the annual income limitations (indiv - $137k / MFJ - $203k)
  • not subject to RMD rules & individuals can contribute to ROTH IRAs after age 70.5 as long as they have earned income and don’t hit phaseouts
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18
Q

In what three scenarios for married taxpayers filing jointly to contribute to an IRA?

A

1) neither spouse is an active participant in a company retirement plan
- there are no limits on AGI, so both can make a deductible contribution of $6,000 each and an additional $1,000 each if they are age 50 or older.

2) both spouses are active participants in company retirement plans
- phaseout range for contribution deductibility is the same for both ($103k - $123k MFJ)
- if one’s income falls within the phaseout range, you can calculate the deductible amount of a contribution: ((top phaseout range - MAGI)/(top phaseout range - bottom phaseout range)) x max contribution = max deductible amount

3) one spouse is an active participant in a company retirement plan and the other is not.
- the phaseout range will be different for each spouse. the spouse who is NOT participating will receive a full deduction if their MAGI is between $0 - $193k. The spouse who IS participating would receive a full deduction with MAGI between $0 - $103k

NOTE: if nondeductible contributions are made to an IRA, the taxpayer files Form 8606 and should keep these forms until retirement, because nondeductible contributions to an IRA create a cost basis for the IRA. These contributions can be withdrawn at retirement tax-free as they are after-tax contributions.

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19
Q

In 2019, Mark and Elly’s AGI will be $113,000. Both Mark and Elly are active participants in their employer’s qualified retirement plan. They are joint tax filers.

How much could be deducted from IRA contributions?

A

((top phaseout range - MAGI) / (top phaseout range - bottom phaseout range)) x max contribution

((123,000 - 113,000) / (123,000 - 103,000) x 6,000 (max contribution) =

(10,000 / 20,000) x 6,000 = $3,000

If both spouses were to make contributions, then the max deductible contribution they could claim would be $3,000 each (total of $6,000)

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20
Q

Distributions from a ROTH IRA are either qualified or not qualified. What makes distribution “qualified”

A

Qualified - if distribution is qualified, there is no income tax and no 10% early withdrawal penalty tax on any earnings.
A distribution is qualified if:
- a 5 year holding period has been met AND
- the distribution is made after age 59.5, death, or disability, or if it is made to a first-time home buyer for the purchase of a home (limit up to $10k)

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21
Q

What are the three categories of ROTH IRA distributions and in what order are they considered?

A

1) Return of contributions - principal is returned first with no income tax / 10% penalty assessed
2) Return of conversion amount - amounts distributed from traditional IRAs. These are taxed and then converted into a Roth IRA. Individuals under age 59.5 will be subject to a 10% early withdrawal penalty if converted funds haven’t been in a ROTH IRA for at least 5 years from the date of conversion
3) Return of earnings - earnings come out last and will not be taxed if it is a qualified distribution. if it’s not a qualified distribution, it will be subject to income tax as well as a 10% early withdrawal penalty

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22
Q

Describe “spousal IRAs”

A

Spouses not working outside the home may contribute up to $6k to a spousal IRA based on their spouses income

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23
Q

How are transfers between IRAs typically accomplished?

A

> 60 day rollover: funds from an IRA are “distributed” to an individual. they then have 60 days to place an equivalent amount into another IRA.

  • any amount not transferred to another IRA by day 61 will be considered a “distribution” and will be subject to tax and potential penalty)
  • only one 60 day rollover per 12 month period

> trustee to trustee transfer: trustees handle moving the IRA, so funds never pass to the taxpayer, and there is no limit to how many times this type of transfer may be done in a year.
- this direct transfer method does NOT require any tax reporting.

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24
Q

List out several types of employer-provided retirement plans

A

Defined Benefit / Pension Plan
Cash Balance Plan
401(k) Plan
Profit Sharing Plan

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25
Q

Define and describe a Defined Benefit / Pension Plan

A
  • usually only employers contribute
  • funds are put into a general trust fund / no separate accounts
  • the benefit is a defined dollar amount or a formula amount
  • contribution limits are very generous
  • can have age / years of service restrictions
  • are being phased out in the private sector, though there are still some gov’t plans and small busn plans
26
Q

Define and describe a Cash Balance Plan

A
  • typically viewed as “hybrid” plans
  • usually only employers contribute
  • funds are put into a general trust fund / no separate amounts
  • the benefit is the accrued account balance
  • max benefits vary by age and are generous
  • resurgence of this plan type for small businesses
27
Q

Define and describe a 401(k) Plan

A
  • employees contribute; sometimes employers match contributions
  • employee has their own separate account
  • the benefit is the accrued account balance
  • must include employees who are at least age 21 and have at least 1 year of service
  • 10% penalty tax on early withdrawals and amount withdrawn is included as taxable income
  • more costly to administer than some other plans
  • max contributions (combined employer & employee) is the lesser of 100% of employee compensation or $56,000 (employee contribution max is $19,000)
  • you can take a loan from the 401(k), to be paid back with interest within 5 years
28
Q

Define and describe a Profit Sharing Plan

A
  • share of company profits
  • employer must make recurring and substantial contributions; contributions can be irregular
  • can structure so that more highly compensated / older employees receive more
  • vesting schedule
  • age 21 restriction with one year of service
29
Q

How do Cash Balance Plans differ from 401(k) plans?

A

1) participation doesn’t depend on employee contributions
2) the employer manages the investments and bears the risk of performance. Performance doesn’t directly affect the benefit amount participants receive
3) cash balance plans are required to offer employees the option to receive their benefits as a lifetime annuity
4) the benefits promised are typically insured by the pension benefit guaranty corporation (PBGC)

30
Q

What retirement plan options are available for “not-for-profit” entities?

A
  • 403(b) Plan

- 457 Plan

31
Q

Define and describe a 403(b) Plan

A
  • for employees of some tax-exempt organization
  • contribution limits are the same as with 401(k) plans - employee deferrals are limited to $19k per year with additional elective deferrals of $6k for those age 50 and up
  • 10% penalty tax on early withdrawals (and amount withdrawn is included in income)
  • employer & employee contributions and earnings are tax-deferred
  • employers may match employee contributions
  • employee controls the funds
  • catch up contributions are allowed
  • special catch up contribution is allowed: certain employees with at least 15 years service to contribute an additional $15k (if certain conditions are met)
  • loans can be made from this plan
32
Q

Define and describe a 457 Plan

A
  • for state / local gov’t employees & Section 501(c) nonprofit organizations
  • contribution limits are the same as with 401(k) plans - employee deferrals are limited to $19k per year with additional elective deferrals of $6k for those age 50 and up. the limit is NOT reduced by amounts contributed to other retirement plans. Max contributions allowable are $19k to 457 + $19k to alternate plan
  • Gov’t 457 assets must be held in a tax-exempt trust
  • Nonprofit 457 funds are considered deferred compensation and are at risk in legal proceedings
  • No penalty tax for early withdrawal (but amount withdrawn is included in income)
  • employer & employee contributions and earnings are tax-deferred
  • employers may match employee contributions
  • employee controls the funds
  • catch up contributions are allowed
  • special catch up contribution is allowed in last 3 years before retirement and have not fully used max annual deferrals in prior years. In this case, you can increase your contribution not to exceed 2x the deferral limit, so the catch up provision in your last 3 years would allow you to contribute $19k x 2.
33
Q

List out several types of small business retirement plans

A
  • Simple IRA

- SEP IRA

34
Q

Describe and define characteristics of a Simple IRA

A
  • employer and employee contributions and earnings are tax-deferred
  • immediate vesting
  • employee controls the funds
  • only for busn with < 100 employees
  • operates like a 401(k) with less cost and reporting
  • employers must match employee contributions up to 3% of salary / contribute 2% of employee compensation to all employees
  • no age restriction
  • catch up contributions allowed
  • 25% penalty tax for early withdrawal (and the amount withdrawn is included in income)
  • employee contributions limited to $13,000 per year with a max catch up contribution of $3,000 for those age 50 and above
35
Q

Describe and define characteristics of a SEP IRA

A
  • only employers contribute, not employees
  • can vary the contributions, which do not need to be regular
  • must include employees age 21, who have worked 3 of the last 5 years, and have earned $600
  • 10% penalty for early withdrawal (and amount withdrawn is included in income)
  • most similar to a Profit Sharing Plan
  • a max annual contribution can be made of up to 25% an employees compensation or $56,000
36
Q

Describe and define characteristics Employer Stock (ESOP) Plans

A
  • enable employers to have company stock exclusively in a retirement plan.
  • Can be for publicly traded stock or privately held companies
  • Special tax treatment is available for any gain on these shares (net unrealized appreciation / “NUA”). Any NUA amount is taxed at L/T capital gains rates rather than as ordinary income.
37
Q

Define and describe characteristics of Deferred Compensation Plans

A
  • main objective is to defer taxation, as the individual has yet to receive anything on which to be taxed.
  • intent is to provide benefits to executives at some future date in excess of those provided to other employees
  • this can occur one of two ways:
    1) there hasn’t been any money set aside exclusively for the individual, it’s just a promise to pay the employee (which may / may not happen). The money here is “at risk” and the company’s creditors may get to it before the employee does

2) having strings attached to $$, such as being subject to completing a certain number of years of service. once the employee is “vested”, that is when taxation occurs.

38
Q

What exceptions might there be to the 10% early withdrawal penalty?

A
  • distribution because of death
  • distribution because of disability
  • distributions made as a series of substantially equal period payments
  • distributions for medical expenses to the extent that they exceed 10% of AGI
  • distributions that are qualified reservist distributions (ppl called to active duty for at least 180 days)

Exceptions only to qualified plans (NOT IRAs)
- distributions made after separation from service (in / after age 55)

  • distributions made under a qualified domestic relations order (divorce)
  • distributions of dividends from employee stock ownership plans

Exceptions for IRAs only
- distributions to pay for higher education expenses (college)

  • first time home purchase of up to $10,000
39
Q

Define and describe “required minimum distributions” / RMD

A

> money goes into a retirement plan pre-tax and grows tax-deferred while in the plan - the IRS wants it’s money!

> ensures a minimum amount is withdrawn from your IRA each year starting at either age 70.5 or a person’s retirement year, if from an employer plan
- if a participant owns 5% or more of the company, they must start taking distributions at age 70.5

  • penalty tax for not taking your RMD is 50% of the distribution
40
Q

How to calculate RMD

A

RMD = account balance as of 12/31 of the prior year / life expectancy

41
Q

Define and describe characteristics of “vesting”

A
  • employees who leave before becoming fully vested will forfeit a portion of a benefit amount that had been set aside for them
  • the amount that is vested is the amount legally belonging to the employee at any given point in time
  • based on an employee’s years of service with an employer, not years in the plan.
42
Q

What vesting options are there for DB plans?

A

> 5 year cliff vesting: provides 100% vesting after the 5th year of “service”

> 7 year graded vesting: 20% vesting every year, starting in year 3, with 100% vesting at year 7

43
Q

What vesting options are there for DC plans?

A
  • employee deferrals are always 100% vested to the employee. employer contributions, however, can be subject to vesting schedules:

> 3 year cliff vesting: provides 100% vesting after the 3rd year of service

> 2-6 year graded vesting: 20% vesting every year, starting in year 2, with 100% vesting at year 6

44
Q

What is Social Security paid through?

A

OASDI - old age and survivors insurance (OASI) trust fund and disability insurance (DI) trust fund

45
Q

Describe how Social Security is funded?

A
  • the trust fund exists as an accounting entry in the federal gov’t. funds are set aside in the federal budget for SS use, but can then be used in the meantime as general revenue
  • reserves are only invested in gov’t bonds
  • not sustainable in its current form as there is likely to be a 25% shortfall after 2034.
  • adjusting the full retirement age to 70 for all born after 1960 would make up the 25% shortfall
  • SS taxes paid by current workers are directly applied to pay benefits of current recipients.
  • FICA is the payroll tax that is imposed on both employers and employees to fund, SS, disability, and Medicare (hospital insurance).
    ~ OASDI Tax: 12.4% of compensation up to taxable wage base ($132,000) with the employer paying half
    ~ Medicare (HI) Tax: 2.9% of all compensation with employer paying half
    ~ Total FICA Tax = 15.3%
46
Q

What category of workers are NOT paying SS taxes?

A
  • fed gov’t workers hired before 1984
  • railroad employees covered under the Railroad Retirement System
  • busn owners who receive only distributive (dividend) income for services performed
  • children under age 18 who are employed by a parent in an unincorporated busn
  • state & local gov’t employee groups who are members of state / local gov’t employer’s retirement system where the state / local gov’t has elected to excluded SS coverage for such a group
47
Q

What are the eligibility requirements to receive SS benefits?

A
  • quarters of coverage: a quarter of coverage is earned for each $1,360 that an employee / self-employed individual earns (up to four per year)
  • fully insured: SS benefits are available if a worker is “fully insured” - retirement, disability, and survivor benefits. Fully insured status is determined by having 10yrs of employment covered by SS (expressed in 40 quarters of coverage)
  • currently insured: an individual must have at least 6 quarters of coverage in the 13 quarter period preceding the event for which eligibility is sought
  • the age criteria: a fully insured worker isn’t eligible to begin receiving benefits unless the minimum age for retirement (age 62) has been attained.
    ~ for workers who turn 62 in 2022 or later, full retirement age has been increased to 67
48
Q

Define “Primary Insurance Amount” (PIA)

A
  • basic unit used to express the amount of a worker’s benefit. this is a monthly benefit that the worker would receive if they waited until FRA (full retirement age) to start receiving their retirement benefit.
  • any SS benefits are expressed as a percentage of a worker’s PIA and is based on a worker’s “average indexed monthly earnings”
49
Q

Define “Average Indexed Monthly Earnings” (AIME)

A
  • involves adjusting each year’s earnings total to reflect its value in the year for which eligibility is requested.
  • The amount is adjusted each year for inflation
50
Q

What do you need to know to understand your SS Retirement Benefit?

A

1) Eligibility: a worker must be fully insured and age 62 (67 for those reaching 62 after 2022)
2) Amount of benefit: determined by PIA
3) Worker’s benefit: a fully insured worker is entitled to a retirement benefit of 100% of PIA at FRA (full retirement age), a reduced benefit at retirement before FRA or an increased benefit at retirement after FRA

51
Q

What benefit adjustments might you see for SS?

A

1) Cost of living increase (COLA) - SS is one of the only retirement vehicles that is inflation-adjusted
2) Reduction of benefits received before FRA - receipt of certain SS benefits before FRA reduces the benefit amount that’s based on the worker’s number of month’s remaining before FRA.
3) Beginning after FRA means increased benefits - if a worker delays retirement past FRA date, the benefit will be increased 8% for each year of delay up to a max of age 70

52
Q

If you are still working and start accepting SS benefits prior to FRA, what might the effects be?

A
  • if you are still working while receiving SS benefits, there is a reduction in benefit payments (will be calculated back into the benefit when you hit FRA) and can be phased out completely if the income earned is too high.
    ~ $1 reduction for each $2 earned over $17,640 limit for an indiv who began pmts between 62 and the year prior to FRA.
    ~ if you had earnings in in excess of $42,920 in the year you attain FRA and start receiving SS benefits, there is a reduction of $1 for every $3 earned in excess of the limit

> unearned income (income from investments) has no effect on the SS benefits amount

53
Q

What spousal benefit opportunities are there for SS benefits?

A

variables to consider - age difference between spouses, did both spouses work, what’s the benefit amount for each spouse?

> if both spouses have earned retirement credits, and both decide to take SS before FRA, they will each get their own benefit, reduced by income restrictions

> if one spouse was non-working, they can choose a “spousal benefit” as it’s likely higher. The working spouse must file for SS benefits BEFORE the non-working spouse can file for spousal benefits

> a spouse with a lower PIA could file individually, and once the spouse with higher PIA files (after FRA), the lower PIA spouse could get an adjustment upward if the spousal benefit is higher.
~ they won’t, however, get the full 50% because they started receiving benefits early

54
Q

What does the SS earnings and benefits statement provide?

A

It provides a record of historical earnings (covered by SS) and an estimate of future benefits for those persons covered by SS.

  • individuals should review the earnings statement from SS to confirm their earnings have been properly credited to their SS account.
  • corrections can be made within 3yrs, 3mos, and 15 days unless the earnings recorded are less than earnings paid. there is no time limit for that.
55
Q

What does Medicare provide for (high level?

A

Hospital insurance and supplemental medical insurance

56
Q

List the various “Parts” included in Medicare

A

Part A - Hospital and skilled nursing care

Part B - Physician and outpatient hospital care (voluntary participation with premium fees deducted from SS pmt)

Part C - Medicare Advantage plans

Part D - Outpatient prescription drug plan (premium fees deducted from SS pmt / paid directly from indiv)

57
Q

How are the “Parts” of Medicare funded?

A

Part A - 2.9% HI tax on all earnings

Part B - premiums paid by participants and gov’t funding (voluntary participation)

Part C - plans offered through insurance company / org that are approved by Medicare

Part D - premiums paid by participants

58
Q

What are the eligibility requirements for the different “Parts” of Medicare?

A
  • Anyone receiving SS retirement benefits at least 3 months before age 65 are automatically enrolled in Medicare and don’t have to apply. If you enroll once attaining age 65, you will have to send in a separate application for Part A.
  • Medicare eligibility is based on attaining age 65, not FRA
59
Q

What coverage is included in each Medicare “Part”?

A

Part A (Hospital Insurance): helps pay for medical care / services at certified hospitals, hospices, nursing facilities (as long as custodial care isn’t the only care needed)

Part B (Supplemental Medical Insurance): covers 2 areas, medically necessary (dr services & others not covered under Part A) and preventative services.

Part D (Prescription Drug): coinsurance for prescription drugs until deductible is met

60
Q

What are the 6 significant Medigaps (gaps in Medicare coverage)

A

1) Deductibles for Part A and B
2) Cost of extended hospitalization under Part A
3) Coinsurance for Part B
4) Costs in excess of Medicare-approved charges
5) Costs for drugs not covered in Part D
6) Custodial care nursing home costs

61
Q

What are some of the pitfalls to retirement savings?

A

1) lump sum distributions when you leave an employer
- an advantage to leaving $$ with former employer if you are 55 or older, is ability to take distributions from plan without incurring 10% early withdrawal penalty
- distributions from qual retirement plans are subject to 20% fed withholding tax

2) how to handle loans from qualified plans
- loans are repaid with after-tax dollars and are taxed again when withdrawn
- if loan isn’t repaid, it’s considered a distribution and subject to tax and early withdrawal penalty (if under age 59.5)

3) longevity risks (outliving income)
- one strategy is having 3-5 years of living expenses in safe, liquid funds, so you handle a depressed market

4) avoiding large losses early in retirement
- your first decade of retirement will be indicative of how successful all of your retirement will be
- general guideline is to plan for a 4% withdrawal rate each year ($1m would give you income of $40k / yr)

5) avoiding fraud
- watch out for things that sound too good to be true, secrecy, lack of written info about the investment, pressure / urgency to act

62
Q

What is a QLAC?

A

Qualified Longevity Annuity Contract - used to help protect against longevity risk.

  • can be used in retirement plans (IRAs and 401ks)
  • a worker is permitted to use the lesser of 25% or $130k to purchase a QLAC and be exempt from 70.5 RMD requirement

Financial Planning - Paraplanner Course (18 decks)

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