Retirement Flashcards
Basic Concepts of Social Security
Coverage: Nearly every worker is covered under OASDI.
Employment categories not covered by Social Security include:
- Federal employees who have been continuously employed since before 1984.
- Some Americans working abroad
- Student nurses and students working for a college or college club
- Railroad Employees
- A child, under age 18, who is employed by a parent in an unincorporated business
- Ministers, members of religious orders and Christian Science practitioners if they claim an exemption
- Members of Tribal Councils
Social Security
(Reduction of Benefits)
Before FRA (Full Retirement Age): Benefits reduced $1 for every $2 earned over $18,960 (2021 threshhold)
Year in which you reach FRA (Full Retirement Age): Benefits reduced $1 for every $3 earned over $50,520 (2021 threshhold)
Social Security
(Taxation)
- Must include Muni Bond Income to calculate MAGI
- If income (MAGI) plus ½ of Social Security Benefits is:
- Above $25K for a single taxpayer, then 50% of the total Social Security is included in Income.
- Above $44k for MFJ, then 85% of the total Social Security is included in Income.
Types of Qualified Plans / ERISA
(Vesting /Admin Costs / Exempt from Creditors / Integrate with Social Security)
- Defined Benefit
- Cash Balance
- Money Purchase
- Target Benefit
- Profit Sharing
- Profit Sharing 401(k)
- Stock Bonus ESOP (NOT integrated with Social Security or cross-tested)
Types of Retirement Plans
(No Vesting / Limited Admin Costs)
- SEP
- SIMPLE
- SAR-SEP
- Thrift or Savings Plans
- 403(b)
Defined Benefit - Qualified Plan
- Favors older employee/owner (50+)
- Certain retirement benefit; Max $230K (2021)
- Meet a specific retirement objective
- Company must have very stable cash flow
- Past service credits allowed
- Forfeitures MUST be applied to reduce employer contributions
- PBGC Insured (along with Cash Balance Plan)
Money Purchase - Qualified Plan
- Up to 25% Employer Deduction
- Fixed Contributions
- Need stable cash flow
- Maximum Annual Contribution lesser of 100% or salary of $58K (2021)
Target Benefit - Qualified Plan
- Up to 25% Employer Deduction
- Fixed Contributions
- Need stable cash flow
- Maximum annual contribution less of 100% of salary or $58K (2021)
- Favors older workers
Profit Sharing - Qualified Plan
- Up to 25% Employer Deduction
- Flexible contributions (must be recurring and substantial)
- Maximum Annual Contribution lesser of 100% of salary or $58K (2021)
- Can have 401(k) provisions
- SIMPLE 401(k) exempt from creditors
Section 401(k) Plan
Qualified profit sharing or stock bonus plan that allows plan participants to defer salary into the plan.
- Max $19,500 (2021) deferral for participants under 50 (subject to FICA)
- Additional $6,500 catch-up for age 50 and over (2021)
Section 415 Annual Additions Limit
- Lesser of 100% of compensation or $58K (2021)
- Includes employer contributions, employee salary reductions and plan forfeitures
Safe Harbor Non-Discrimination
A Safe Harbor 401(k) plan automatically satisfies the non-discrimination tests involving highly compensated employees (HCEs) with either an employer matching contribution or a non-elective contribution.
Safe Harbor Match / Vesting
The statutory contribution using a match is $1/$1 on the first 3% employee deferral and $0.50/$1 on the next 2% employee deferral.
- If the employer chooses to use the non-elective deferral method, the employer must contribute 3% of all eligible employees’ compensation regardless of whether the employee is deferring or not.
- Employer contributions must be immediately vested.
Stock Bonus / ESOP - Qualified Plan
- Up to 25% employer deduction
- Flexible contributions
- Maximum Annual Contribution lesser of 100% of salary or $58K (2021)
- 100% of contribution can be invested in company stock ESOP cannot be integrated with Social Security or cross-tested
Net Unrealized Appreciation (NUA)
NUA Example:
Stock is contributed to the retirement plan with a basis of $20k. The stock is distributed at retirement with a market value of $200k. The NUA, $180k, is not taxable until the employee sells the stock, but the $20k is taxable now as ordinary income.
The $180k is always LTCG. If the client sells the stock for $230k, the $30k of extra gain is either STCG or LTCG depending on the holding period after distributed at retirement.
Keogh Contribution
- Only for sole proprietor and partnerships
- Self-Employment Tax must be computed and a deduction of one-half of the Self-Employment Tax must be taken before determining the Keogh deduction.
Shortcut below takes into account Self-Employment Taxes:
- If contribution 15%: multiply by 12.12% of net earnings
- If contribution 25%: multiply by 18.59% of net earnings
SIMPLE Plan
- Fewer than 100 employees
- Employer cannot maintain any other plan
- Participants fully vested
- Easy to administer and funded by employee salary reductions and an employer match
SEP (Simplified Employee Pension)
- NO Salary Deferrals - Employer contributions only
- Up to 25% contribution for owner (W-2) / treated like Keogh contributions for self-employed
- Maximum of $58K (2021)
- Account immediately vested
- Can be integrated with social security
- Special Eligibility: 21+ years old, paid at least $650 (2021) and worked 3 of the 5 prior years
Tax-Deferred Annuity (TDA)
Tax Sheltered Annuity (TSA)
403(b)
- For 501(c)(3) organizations and public schools
- Subject to ERISA only if employer contributes
- Salary reduction limit up to $19,500 (2021) plus $6,500 catch-up if 50 or over
Age and Service Rules - Qualified Plans
- Max age and service are age 21 and one year of service (21-and-one-rule)
- Special provision allows up to 2-year service requirement, BUT then employee is immediately vested (2-year/100%)
- Year of service is 1,000 hours (includes vacations, holidays and illness time) or 500 hours if worked 3 consecutive years
Highly Compensated Employee (HCE)
- A greater than 5% owner, OR
- An employee earning in excess of $130,000 during the preceding year (2020)
Key Employee
An individual is a Key Employee if at any time during the current year he/she has been one of the following:
- A greater than 5% owner, or An officer and compensation > $185,000 (2021), or
- Greater than 1% ownership and compensation > $150,000 (2021)
Vesting - Fast / Slow
Fast:
- DB Top-heavy Plans / All DC Plans
- 3-year cliff or 2-6 year graded or 100% vested after 2 years
Slow:
- Non-top-heavy DB Plans only
- 5-year cliff or 3-7 year graded or 100% vested after 2 years
Defined Contribution Plans
(Integration with Social Security)
Base % + Permitted Disparity = Excess %
Base % - DC plan contribution for compensation below integration level
Permitted Disparity - Lesser of base % or 5.7%
Excess % - DC plan contribution for compensation above integration level
Defined Benefit Plans
(Integration with Social Security)
Base % + Permitted Disparity = Excess %
Base % - DB plan contribution for compensation below integration level
Permitted Disparity - Lesser of base % or 26.25%
Excess % - DB plan contribution for compensation above integration level
Multiple Plans 2021
Elective Deferrals
Elective Deferrals: More than one employer (2021)
- Elective Deferrals to multiple plans are always aggregated (2021)
401k/403(b)/SIMPLE/SARSEP
- $19,500 plus catch up $6,500
SIMPLE and other SIMPLE
- $13,500 plus catch up $3,000
457 Plans are NOT part of aggregated amounts.
Life Insurance as a Funding Vehicle
According to the Treasury Regulations, life insurance benefits must be merely “incidental” to the primary purpose of the plan. If the amount of insurance meets either of the following tests, it is considered incidental:
- The aggregate premiums paid for a participant’s insured death benefit are all times less than the following percentages of the plan cost for that participant:
- Ordinary life insurance 50%; Term Insurance 25%; Universal Life 25%
- The participant’s insured death benefit must be no more than 100 times the expected monthly benefit. Defined benefit plans typically use the “100 times” limit.
Rollovers NOT Permitted
- Transfers to another 457 plan remain the only option for non-governmental tax exempt organizations
- Hardship distributions can not be rolled into any other qualified plan
- Required minimum distributions
Qualified PlanEarly (age 59½) - 10% Tax Penalty Exceptions
- Death
- Disability
- Substantially equal periodic payments following separation from service
- Distribution following separation from service after age 55
- Distribution in accordance with QDRO (to any alternative payee)
- Medical expenses in excess of 7.5% of AGI or health insurance costs while unemployed
- Distribution used to pay insurance premium after separation from employment (must file for unemployment)
Required Beginning Date (RBD) for
IRAs / SEPs / SARSEPs / SIMPLEs
The required beginning date is April 1st of the year following the year in which the covered individual attained 72.
Subsequent distributions must be made by December 31st of each year thereafter.
Required Beginning Date (RBD) for
Qualified Plans / 403(b) / 457 plans
The required beginning date, with the exception of 5% owners, is the later of April 1st following the year in which the individual attained 72 or retired.
Subsequent distributions must be made by December 31st of each year thereafter.
5% owner RBD is the same as IRA/SEP RBD.
IRA Deductibility Keys
- If neither spouse (or single person) is an active participant in an employer plan, the IRA is deductible.
- Employer plans that affect participant status include almost all plans EXCEPT for 457 plans.
- If one spouse is an active participant, the other spouse (not active) can do a deductible IRA if combined AGI is less than $198K-$208K (2021)
- If both spouses are active, AGI limits apply: $66K-$76K (single) and $105K-$125K (Married) (2021)
NOTE: Activity that results in active status: annual additions to a DC account or benefits accrued to a DB plan.
IRA Exceptions to 10% Penalty for Early Distributions before age 59½
- Death
- Substantially equal payments
- Disability
- First home expense up to $10,000
- Qualified education expense
- Medical expense greater than 7.5%
- Distribution used to pay insurance premium after separation from employment (must have received unemployment compensation for 12 weeks)
Roth IRA
Ordering Rules for Distribution
- Any contributions (not conversions) are withdrawn first
- Conversions are withdrawn second
- Earnings are withdrawn last
Roth IRA
Required Minimum Distributions
- Distributed within 5 years of owner’s death (no named beneficiary), or
- Distributed over 10 years of the designated beneficiary with distributions commencing prior to the end of the calendar year following death (stretch)
- Where the sole beneficiary is the owner’s surviving spouse, the spouse may delay distributions until the Roth owner would have reached 72, or may treat the Roth as his or her own (roll it to her/her Roth)
Non-Qualified Deferred Compensation Plans
- Salary Reduction Plan: Uses some portion of the employee’s current compensation to fund the ultimate compensation benefit (also called Pure Deferred)
- Salary Continuation Plan: Uses employer contributions to fund ultimate benefit
Rabbi Trust
- Key Words: Merger, Acquisition, or Change of Ownership
- Assets in Rabbi Trust available for company’s creditors
- Fear that ownership / management may change before deferred compensation is paid
Incentive Stock Option (ISO)
Holding Period
Holding Period:
- 1 year from Exercise Date and 2 years from Grant before selling ISOs
- Violating either rule results in a Disqualifying Disposition
Section 457
Deferred Compensation Plan
- Non-Qualified Deferred Compensation Plans of governmental agencies and non-church controlled tax exempt organizations
- Deferral limited to $19,500 or 100% of compensation (2021)
- Catch-up of $6,500 allowed for those 50 and over ONLY for governmental plans (2021)
- Salary deferrals NOT aggregated with other plans (401k, etc.)
- Non-governmental plans can ONLY be rolled into another 457 plan
IRA Keys
(SIMPLE, SEP, SARSEP)
- No Loans
- No Life Insurance
- Immediate Vesting
- May not be creditor protected (state specific)
- 59½ not 55 for no 10% penalty
- Must take RMDs at 72 (even if not owner)
Assumptions for Retirement Planning
- Inflation
- Retirement period and life expectancy
- Add 5-10 years to life expectancy
- Lifestyle
Pension maximization application
Because a pure life annuity provides the highest payout, the selection of pure life is referred to as a pension maximization or pension max application.
Alternatives to compensate for projected cash-flow shortfalls
- Saving more in each preretirement year
- Increasing investment risks to achieve higher returns
- Retiring later than expected or working part-time in the early retirement years
Social Security benefits
The following social insurance programs are covered by the Social Security Act:
- Social Security (Old Age, Survivor, and Disability Insurance—OASDI)
- Medicare
- Federal Unemployment Insurance
- Supplemental Security Income (SSI)
Fully insured
- Workers who have acquired 40 quarters or credits of coverage are fully insured for life.
- workers are eligible for both survivor benefits and retirement benefits.
Currently insured
A currently insured worker has only attained 6 quarters of coverage and is only eligible for the following:
- A lump-sum death benefit ($255) for spouse or dependent
- A surviving spouse’s benefits (if children are under age 16)
- A dependent benefit
Employment categories not covered by Social Security
- Federal employees who have been continuously employed since before 1984 unless they elected to switch
- Some Americans working abroad
- Student nurses and students working for a college or college club
- Railroad employees
- A child, under age 18, who is employed by a parent in an unincorporated business
- Ministers, members of religious orders, and Christian Science practitioners if they claim an exemption
- Members of tribal councils
- Some state employees and teachers
Railroad employees
- Railroad employees are excluded from Social Security coverage.
- They have a separate retirement system – Railroad Retirement Board.
- They are eligible for Medicare
Social Security and Disability Eligibility
- A retired fully insured worker age 62 or over is entitled to retirement benefits.
- A worker is entitled to disability benefits if he/she is under age 65 and
- disabled for 12 months, is expected to be disabled for at least 12 months, or
- has a disability which is expected to result in death and
- has completed a 5-month waiting period.
Spouse Benefits
The spouse of a retired or disabled worker
qualifies for Social Security payments if
he/she meets any of the following requirements:
- Is age 62 or over or at any age if
- the spouse
- Has a child in care under age 16
- Has a child age 16 and over and disabled before age 22
- the spouse
- The surviving spouse (including a surviving divorced spouse) of a deceased insured worker qualifies if the widow(er) is age 60 or over.
The death benefit is only $255. A spouse who was living in the same household.
Divorce Spouses eligible for Social Security if
- married to the worker for at least 10 years and generally must not be remarried.
-
at least age 62 and has been divorced from the worker for at least 2 years
- even if the worker claims no retirement benefits
Dependent benefits of a Worker from Soc Sec
- The surviving dependent, unmarried child of a deceased, disabled or retired insured worker, qualifies for Social Security payments if the dependent is either
- Under 19 and a full-time elementary or secondary school student
- Age 18 or over but has a disability began before age 22
Taking Social Security Benefits Before Full Retirement Age
Formula
PIA - [( # of mths b4 FRA / 180 ) x PIA]
Deductions of benefit if working
- For workers younger than full retirement age
- deduct $1 from benefits for each $2 earned income above $18,960.
- Workers at FRA during 2021
- $1 deducted from benefits for each $3 of earned income above $50,520
Taxation of Social Security benefits and Provisional Income
Provisional Income = Income + (soc sec x 50%)
- If Provisional Income > $25,000 Single or $32,000 MFJ THEN
- Taxed at 50%
- If Provisional Income > $34,000 Single or $44,000 MFJ THEN
- Taxed at 85%
Municipal bond interest is considered income for the purposes of determining the taxation of Social Security benefits.
Social Security disability benefits entitlement
- Is insured for disability benefits, is under age 65
- Has been disabled for 12 months, is expected to be for at least 12 months or expected to result in death
- Has filed for disability benefits, and has completed a 5-month waiting period
Withdrawing a Social Security Application
- one-time right to withdraw application for benefits within 12 months of the initial claim.
- Benefits received prior to the withdrawal must be repaid (no interest applies).
Qualified Plan vs Non Qual
- Qualified May NOT discriminate, NonQual CAN
- Qualified: Erisa, NonQual Exempt from ERISA
- Qualified: Immediate Tax ded for empR; NonQual No empR ded until empEE taxed
- Qual earnings accrue deferred; Non Qual Earnings are taxable to empR
- Qual Distributions tax at ord inc EXCEPT for 10yr avg, NUA under Stock Bonus, ESOP and 401k
- NonQual Distrib Tax at ord income
Defined Benefit Pension (qualified plan / ERISA/PBGC)
(vesting schedule/administration costs/exempt from creditors/integrate with Social Security)
- favors older employee/owner (age 50+)
- guaranteed retirement benefit amount (can meet a set retirement objective)
- requires very stable cash flow
- past service credits allowed
Cash Balance Plan (a Pension type of DB plan)
Defined Contribution
(vesting schedule / administration
costs / exempt from creditors /
integrated with social security)
Left side of roadmap
(qualified plans/ERISA)
Other retirement plans
Right Side of roadmap
(no vesting schedule / lower administration costs)
457 plans operate as nonqualified deferred compensation
Keogh plans are qualified plans for the self-employed.
They may be offered as either defined benefit or defined contribution plans.
Defined contribution plans and retirement plan
benefits are based on the account balance at retirement.
- Money purchase
- Profit-sharing 401(k)
- Target benefit
- Stock bonus / ESOP
- Profit-sharing
Retirement plans (Not qualified)
- SEP
- SIMPLE
- SARSEP
- Thrift or savings plans
- 403(b)
Qual NonQual Chart
DC Plans Affected by:
- Years to retirement: Better for younger empEE. Inadequate for employees who enter the plan at older ages.
- Investment returns: Employees assume the investment risk under the plan.
- Salary levels: based on the participant’s salary level for each working year rather than on the salary at retirement.
- Employer contributions: subject to minimum funding standards, but employers may make contributions as low as 3%.
- Forfeitures: can be reallocated to the participants or applied to reduce employer contributions.
Section 415
Max Contribution
or additions
- LESSER OF:
- 100% of salary OR
- $58,000
MPP
Money Purchase Plans
Why and When
- Employer wants to
- retain key employees and stable work force
- Simple to administer and explain (stated % of pension)
- Employees young and well paid
- Contributions are MANDATORY
Target Benefit (DC Plan) but has DB features
When and Why
Provisions shared with defined contribution plans
• Maximum contribution is the lesser of 100% of compensation or $58,000 (2021)
• Retirement benefit is determined by account balance
• Employee assumes investment risk
• No annual actuarial determination is required
• Forfeitures may be reallocated to remaining participants or used to reduce employer contribution
Provisions shared with defined benefit plans
• Plan generally benefits older employees
• Fixed mandatory contributions
• Actuary determines initial contribution level but it’s not guaranteed
Profit-sharing plan
What and when and why
- qualified defined contribution plan featuring flexible employer contribution provisions up to 25% of compensation.
- empR contributions are discrtionary, but MUST be substantial and recurring
- Forfeitures are normally reallocated to the plan participants
Selecting a profit-sharing plan
• Variable profit margin or financial stability
• When an employer wants to adopt a qualified plan with an incentive feature to motivate employees to make a company profitable
• When the employees are young, well-paid, and have substantial time to accumulate retirement
savings
401(k) Plan (19,500 w 6,500 catch up)
CODA (cash or deferred arrangement)
can be added to a qualified profit sharing or stock bonus
401(k) plans make sense when:
• An employer wants to provide a qualified retirement plan for employees but can afford only minimal extra expense beyond existing salary and benefit costs
• The employees want to increase their savings on a tax-deductible basis
Solo 401k / Uni 401k
- No coverage and discrimation rules
- 2 contributions
- Elective deferral 19,500 PLUS
- employer contribution cap of $58,000 (also, 6,500)
generally permitted when the only participants are the owner and spouse or two partners.
Safe Harbor 401(k)
- automatically satisfies the nondiscrimination tests which involve (HCEs) with either an employer matching contribution or a non-elective contribution.
- If the employer chooses the non-elective deferral method, the employer must contribute 3% of all
eligible employees’ compensation regardless of whether the employee is deferring. - Safe harbor plans are exempt from top heavy (key employees) rules if the only deposits are employee deferrals and employer contributions (3% non-elective or safe harbor match)
Stock bonus plans and Employee stock ownership plans (ESOP)
vairation of profit sharing
• A stock bonus plan may invest plan assets in employer stock;
however, an ESOP must invest plan assets primarily in employer stock
• Participants’ accounts are stated in shares of employer stock
• Benefits are generally distributable in employer stock (certificates)
• Employers may deduct dividends with respect to stock held in an ESOP
To be deductible, dividends must satisfy at least one of the following requirements:
• Paid in cash directly to participants or beneficiaries
• Paid to the plan and then distributed in cash <90 days after the close of the plan year
• Used to make payments (of principal and interest) on loans used to acquire employer securities
• Paid to the plan and reinvested in qualifying employer securities
When do Stock Bonus plans or ESOPs make sense?
- A company wants to broaden ownership ,create a market , provide liquidity for estates, or for business continuity
- A company wants to provide its employees with a tax-advantaged means to acquire company stock
- An employer wants its workers to feel a sense of ownership
(NUA) may not be taxed to the employee at the receipt of distributions from the plan (retirement).
Participants age 55 or older having ten years of participation in the ESOP have the right to diversify up to a total of 50% of their account balance. The ESOP must offer at least 3 investment alternatives or distribute cash or certificates to the participant.
New Comparability Plan
In a new comparability plan, the contribution % formula for one category of participants (such
as managers) is greater than for other categories of participants.
AKA age based plans, new comparability plans are tested under cross-testing rules.
Cross-Testing measures
except ESOPs
-
Cross Testing Measures
- DC plans for nondiscrimination on the basis of benefits, and
- DB plans are tested on the basis of contributions.
-
Results in
- higher contribution rates for older employees, (“age-weighted.”)
- A cross-tested plan does not apply a fixed age-weighted formula – designed to provide maximum benefits to highly compensated employees
- *can have age weighting w/o cross testing
- differentiates btwn HCE and NHCEs
Traditional DB plans
- Defined benefit plans make sense when:
- An employer wants to maximize plan contributions to older employees
- An older controlling employee wants to maximize tax-deferred retirement savings
- New plans take past service credits into account
Forfeitures must be applied to reduce employer contributions because the actuarially determined annual contribution must be made—not more and not less
Section 415
BENEFIT limit
- At age 65
- The LESSER OF
- (1) $230,000 (2021) or
- (2) 100% of compensation
- The LESSER OF
- averaged over 3 highest earning consecutive years.
- The plan is not required to reduce benefits to a participant who retires as early as age 62.
Unit Benefit Formula
% of Earnings per year of Service
% x yrs x $salaryCareerAverage = benefit
1.5% x 30yrs x $100,000 = 45,000
Final Average Method
% x #yrs x $Average of a number of years ($209 max) = annual benefit
Cash balance pension plan
- a qualified employer pension plan that provides for annual employer contributions at a specified rate
- employer guarantees contribution leveland a minimum rate of return on each participant’s account.
- Like a money purchase plan, but
- money purchase plans do not require employer guarantees of minimum rates of return.
- The disadvantage to older employees when a traditional DB plan is converted to a cash balance plan is that the lump sum payout at termination is smaller. (beneft based on all working years rather than highest 3).
412(i) plan
i for insurance
also known as a 412(e) 3 insurance contract plan
- A 412(i) is a defined benefit plan funded entirely with insurance products such as life insurance and annuities.
- appeals to employers that have some need for life insurance.
- The plan allows for a large contribution, but the plan return would typically be lower than those of other DB plans.
Qualified DB/DC Plans and Non Qual
Age and Service Requirements for Qualified Plans
- 21 and 1
- 2 year special provision 2yr/100% vested
- must be allowed to participate no later than the earlier of
- (1) the first day of the first plan year beginning after the date the employee first met the age and service requirement or
- (2) the date 6 months after these conditions are met.
Coverage Requirements
in addition to age and service for qual plans
Ratio percentage test
The plan must cover a percentage of NHCEs ≥ 70% of cpvered HCE
Average benefit test
The average benefits for NHCEs ≥ 70% HCEs
Minimum participation (defined benefit plans only)
- A defined benefit plan must benefit the lesser of:
- 50 employees OR
- The greater of
- 40% of all employees or
- 2 employees (or if there is only one employee, that employee)
What is a HCE
- Either:
>
- 5% owner OR
- employee earning > $130,000
What is a Key Employee?
> 5% ownerAn officer AND com > $185k> 1% owner AND comp > 150k
When is a plan Top Heavy?
If > 60% of aggregate accrued benefits or account balances are allocated to KEY employees
Vesting Schedules based on Date of Hire
ADP/ACP testing
Actual Deferral percentage/Actual Contribution percentage
- In both tests, the HCEs rate must be both of the following:
- ≤ 125% of the NHCE rate (ADP is 8% or greater) or
- ≤ 200% of the NHCE rate and ≤ 2% NHCE rate (ADP is between 1% and 8%)
Shorthand method: 0 to 2% is “times 2,”and 2 to 8% is “plus 2”.
NHCE HCE
Deferral 1% x2 2%
Deferral 2% x2 4%
Deferral 3% +2 5%
Deferral 4% +2 6%
Controlled Groups
necessary for evalutation Max Benefits and NonDisc Testing
Annual Additions are limited to 58k or 110% of comp
Parent-subsidiary: parent company) owns at least 80% of one (or more) of the other entities.
Brother-sister: Five (or fewer) owners of two or more entities own 80% or more of each entity.
Affiliated service group: The affiliated service group (ASG) rules apply primarily to service organizations that provide professional services in the field of health, law, accounting, engineering, etc.
Employee leasing: Provisions were adopted to reduce the discrimination potential from an employer’s
choosing to lease employees
Defined Benefit Plan
Integration with Social Security/disparity
TWO METHODS
PURPOSE:
Equalize empR contributions to retiement plans for
rank and file empEEs while
maintaining same level of contrib/cost for higher paid
- Excess Method
- Integration level: level of comp above the excess contrib. May not exceed the soc sec taxable base
- Base benefit %: below integration
- Excess benefit %: above integration
Using the excess method, the permitted disparity is the lesser of the base benefit percentage or 26.25%.
Base Percentage + Permited Disparity = Excess Percentage
10% + 10% = 20%
30% + 26.25% = 56.25%
- Offset Method
Defined contribution plan integration
- *Integration level**: $ up to ss wage base ($142,800 for 2021)
- *Base contribution percentage**: contrib below the integration level
- *Excess contribution percentage**: contrib above the integration level
- *Permitted disparity**: Lesser of the base contribution percentage or the 5.7% formula for determining components of integrated DC plan
Base % + Permited disparity = Excess %
10% + 5.7% = 15.7%
Section 404c
Employer can DEDUCT a maximum of 25% of ALL pp eligible comp
Sectio 415 annual additions limits for DC plans
includs:
employer contributions
employee salary reductions AND
plan forfeitures
What happens if limits are exceeded?
- May be reallocated among other employees
- May be applied in a later year to the same employee (funds held in a suspense account)
- May be used to reduce future plan contributions
What is compensation?
Taxable comp paid during the year
ALSO includes elective deferrals (401k and 457 plans) and salary reduction to 125 plans
Multiple Employers
Elective deferrals for workers with more than one employer Always aggregated
Annual Additions are NOT as long as employers are unrelated
A Keogh (HR-10) plan
qualified retirement plan for sole proprietorships and partnerships
The owner-employee contribution or benefit is based on net earnings instead of salary
Employee contributions
The IRS has ruled that the self-employment tax must be computed and a deduction of one-half of the self-employment tax must be taken before determining the deductible contribution of the employee
Shortcut: Take the net schedule C income, then:
Multiply by 12.12% for 15% contribution for non-owner employees or
Multiply by 18.59% for 25% contribution for non-owner employees
Top Heavy Definition
more than 60% of the total amount in the accounts of all employees is allotted to key employees.
DB beneift must be 2% of comp x years of service (B 2nd letter of the alphabet)
DC benefit must be 3% of comp x years of service (C 3rd letter of the alphabet)
LOANS from Qualified Plans
- lesser of 50% of the participant’s vested plan benefit or $50,000.
small accounts up to $10,000 - repaid over a period ≤ 5 years (unless for principal residence.
- Must be made in level installments at least quarterly.
If you miss a payment the entire balance due is a taxable distribution 10% penalty and ord inc tax. - Interest is consumer interest (but not deductible unless for residence)
IRAs taken before 59½ tribber a 10% penalty and ordinary income
EXCEPTIONS
- Death
- Substantially equal payments
- Total, permanent disability
- First home expense up to $10,000
- Qualified education expenses
- Medical expense > 10% of AGI
- Distribution used to pay medical insurance premium after separation from employment*
- $5,000 for qualified birth/adoption
*Subject to floor of 10% of AGI unless unemployment compensation has been received for at least 12 weeks
and the withdrawal was made in year of unemployment or year immediately following unemployment.
If all or part of the IRA is pledged as security for a loan, the portion that is pledged is treated as a distribution.
Conversion distributions from Roth IRAs
Roth EARNINGS distributions
Roth IRA Distributions at death
similar to regular IRA
- Distributed within five years of the owner’s death
- Distributed over 10 years to the designated beneficiary following the owner’s death
- Where the sole beneficiary is the owner’s surviving spouse, the spouse may delay distributions until the Roth owner would have reached age 72 or may treat the Roth as his or her own (roll it into his/her Roth).
No RMDs required
Roth 401(k)
- Only 401(k) and 403(b) plans and governmental 457 plans may offer a qualified Roth contribution program.
- included in the participant’s gross income
- employer contributions (including matching) are made into traditional 401(k) pre-tax accounts
- qualified distribution from a Roth 401(k) account will not be includable in the participant’s gross income
- The tax-free status of a Roth 401(k) is subject to a 5-year term after the first contribution.
- No income limits; 19500 and 6500 catch up
SEP
- A SEP can be easily adopted by completing a Form 5305-SEP.
- contributions are limited to the lesser of 25% (not 100%) of compensation ($290,000 maximum) or $58,000
- appropriate when the employer wants an alternative to a qualified profit-sharing plan that is easy and inexpensive to install
- Contributions for employees must be the same percentage as the owners contribution percentage
- must cover all employees who are at least 21 years of age and who have worked for the employer during 3 out of the preceding 5 calendar years and made more than $650. Part-time employment counts
Salary reduction SEP (SARSEP)
Grandfathered
no new ones
- no more than 25 employees
- 50% of all eligible employees must participate
- Newly hired employees may join the grandfathered plan
SIMPLE IRA
- pretax contributions of up to $13,500* ; 3,000 catch up
- Employer contributions represent dollar-for-dollar matching contribution up to 3%
- employer can elect a lower percentage, not less than 1%, in no more than 2 out of the 5 years
- easy-to-administer plan funded through employee salary reductions and an employer match
- adopted by completing IRS form 5304- or 5305-SIMPLE
- must cover any employee who earned $5,000 in any two previous years and is reasonably expected to earn $5,000 in the current year.
- *Note:**
- *A SIMPLE plan cannot be terminated mid-year.**
- *Termination must occur on January 1 of the year following notification of employees. Contribution opportunities must be available until then.**
Unique things about a SIMPLE IRA
- cannot maintain any other qualified plan, 403(b), or SEP at the same time
- Participants are fully vested at all times
- penalty is increased to 25% during the first 2 years of participation
SIMPLE 401(k)
- A SIMPLE 401(k) is a plan in which a traditional 401(k) adopts SIMPLE provisions.
- A 401(k) plan that adopts SIMPLE provisions is exempt from both ADP and ACP tests.
- exempt from the top-heavy requirements. This is an advantage, but it comes at the cost (rigid design)
- Still an ERISA plan.
- May not choose the special 1% match
Section 403(b) plans aka Tax-deferred annuity (TDA) plans or Tax-sheltered annuity (TSA)
- adopted only by certain tax-exempt organizations and certain public-school systems
- must be a 501(c)(3) organization
- elective deferrals to 403(b) plans is $20,500/6500 catch up
- Special addition: 15 years of service additional $3,000
- Employees who are both 50 or older and have 15 years of service qualify for both catch-up contributions
- 403(b) investments are limited to annuity contracts or mutual funds.
Section 457 plans
- nonqualified deferred compensation plans of governmental units, governmental agencies and certain non-church controlled tax-exempt organizations
- special catch-up contribution provision applies during the participant’s final three years of participation before Normal Retirement Age (but not the last year of employement.
- limit on deferrals is increased to the lesser of 2 times the normal limit $39,000 ($19,500 × 2) or some other limit
Employee Retirement Income Security Act (ERISA)
ERISA imposes various duties, standards, and prohibitions on plan fiduciaries
ERISA defines fiduciary as a person who
“renders investment advice for a fee or other compensation, directly or indirectly, with respect to any monies or other property of a qualified plan or has the authority or responsibility to do so.”
Department of Labor (DOL) regulations
The DOL regulations further define “investment advice,”
discretionary authority or control
Regularly renders any advice that will serve as a primary basis for investment decisions with MUTUAL AGREEMENT, written or otherwise.
Fiduciary liability issues
Prohibited transactions
- Anti self Dealing Rule: Furnishing of goods or services between the plan and the party in interest
- Anti Kickback rule: Transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan == no personal use
Benefits guaranteed by the PBGC
When plans lack sufficient assets to pay benefits, the PBGC guarantees a monthly benefit (no lump sums) of NON FORFEITABLE BENEFITS and PENSION BENEFITS.
Defined benefit plan terminations
Voluntary and Involutary
- A voluntary termination, also called a standard termination, occurs when there are sufficient assets to fund accrued benefits
- A distress termination occurs when there are insufficient assets to fund accrued benefits.
- Bankruptcy liquidation
- bankruptcy reorganization
- employer proves to the PBGC that plan termination is necessary to pay debts
Only the PBGC can initiate an involuntary termination of a DB plan.
Investment considerations for retirement plans
Premature distributions from a PROFIT SHARING PLAN
- A hardship withdrawal is allowed at any age in any type of profit-sharing plan. (NOT IRAs)
- Financial Needs test (immediate and heavy
- Resources test: cannot exceed the amount needed to satisfy the need
- The hardship withdrawal is subject to ordinary income tax and often the 10% early withdrawal penalty
- EXCEPT FOR:
- Medical
- Tuition, room and board and other education expenses for POST secondary ed
- Funeral expenses
- Principal residence
- Purchase
- to prevent foreclosure
- repair from damage
- Cannot be in excess of immediate need.
Hardship distributions from any retirement plan cannot be rolled into any other qualified
plan.
Penalties and requirements that apply to qualified plans and TSA distributions
TSA and QUALIFIED Plan exceptions
Exceptions to the 10% tax penalty for early distribution (before age 59½) from a qualified plan include
the following:
• Death
• Disability
• Substantially equal periodic payments following separation from service
• Distribution following separation from service at age 55 or later
• Distribution in accordance with a QDRO (to any alternative payee)
• Medical expenses in excess of 10% of AGI
• $5,000 distribution for qualified birth/adoption
Substantially equal payments (§72t)
Substantially equal payments must meet all the following requirements:
• Paid not less frequently than annually
• Paid without changing the amount for the longer of 5 years or until the payee reaches age 59½
• Based upon the life expectancies of the recipient or recipients
• Based upon a reasonable rate of interest
• If applicable, based upon reasonable mortality assumptions
no modification of substantially equal payments, generally.
One-Time election allows a switch from the annuity/amort method to the RMD method with no penalty. Reduces payout levels and preserves the retirement fund
Annuity distribution options
- Qualified Joint and Survivor Annuity (QJSA)
- the survivorship annuity must be ≥ 50% - 100% of the annuity payable during the joint lives of the participant and spouse
- Qualified Optional Survivor Annuity (QOSA)
- must be a 50% joint and survivor annuity. Many at 75%. The participant can elect out of this benefit only with written spousal consent.
- Qualified Preretirement Survivor Annuity (QPSA)
- preretirement death benefit for the plan participant’s spouse payable upon the death of the
participant who dies before the starting date of the QJSA.
- preretirement death benefit for the plan participant’s spouse payable upon the death of the
IRA 60 day rule
- This can occur only once each year (one-year period) per taxpayer (not per IRA).
- To ensure tax-deferred treatment on the entire rollover amount (no 20% withholding), rollovers must be completed by means of a direct transfer (also called a direct rollover or trustee-to-trustee transfer).
- The plan’s trustee must convey the funds directly from the qualified plan to the rollover account (another qualified plan or an IRA).
Conduit IRA
holds the funds that have been distributed from the qualified plan for the subsequent transfer to a new/different qualified plan
Required Begin Date (RBD)
IRAs, SEPs, SARSEPs and SIMPLEs
April 1st of the year following the year in which the covered individual attained age 72.
Subsequent distributions must be made by December 31st of each year thereafter.
Owners of 5% or more of the equity of a corporation sponsoring a qualified plan are also subject to this rule.
RBD for
Qualified plans, governmental 457 plans and 403(b)s
Same as IRAs And Seps and SIMPLES EXCEPT
> 5% owners MUST take RMDs the year AFTER turning 72They may continue to contribute
RMD Calculations and Uniform Lifetime Table
- If the beneficiary > 10 years younger than the owner
- the actual joint life expectancy of the owner and spouse based on the regular joint life expectancy table is used.
- Look up age of employee and use Distribution period # for the divisor of the year end balance
RMD Exception for Joint Life Distributions
- If the employee’s sole beneficiary is the employee’s spouse and the spouse is> 10 years younger than the employee,
- the employee is permitted to elect the longer distribution period measured by the joint life and the last survivor life expectancy of the employee and spouse (provided).
- RMDs are calculated by dividing the year end balance by the Uniform Lifetime Table
Penalties for not taking your RMD
A 50% excise tax is imposed on the amount by which a distribution in a given year falls short of the minimum required
Qualified Charitable Distribution (QCD)
A Qualified Charitable Distribution (QCD) is a direct transfer from an IRA to a qualified charity.
Individuals age 70½ (not 72) or older may make QCDs of up to $100,000 annually and have the amount excluded from taxable income.
Owner dies with no specified beneficiary
In the year of death, the minimum distribution is still calculated
In the years after, if the owner died before the required beginning date (72) and there is no living beneficiary as of the owner’s death, the five-year rule applies
Retiring early
Participants in 401(k) plans who retire between ages 55 and 59½ take withdrawals directly from their 401(k)s without paying a 10% early withdrawal penalty.
The age 55 early retirement provision is not available for IRAs.
Non-spouse beneficiaries for IRA OR No beneficiary
For Non Spouse Must be withdrawn in 10 years
- Exceptions to the 10-year rule are:
- surviving spouse,
- person not more than 10 years younger than the plan participant,
- minor child,
- disabled person, and
- a chronically ill person.
For no bene, withdraw in 5 years
Qualified domestic relations order (QDRO)
Qualified plan can be tapped for:
- The IRS – to collect federal taxes owed OR
- A spouse or former spouse may attach a qualified plan through a QDRO (typically operating in conjunction with a divorce decree
- A QDRO cannot require the trustees to make a cash payment if it’s not available
- QDROs can require that plan assets be segregated for the benefit of the spouse making the claim, with cash distributions made at the earliest time permitted under plan provisions.
Special penalty waiver rule for public service employees
enforcement, customs and border patrol officers, and firefighters.
- 10% early withdrawal is waived from qualified plan (not ira) age 55 and older
- Penatly free from governtment plance (NOT 457 plans) age 50 and older
Net unrealized appreciation (NUA) of employer stock
- The difference between the employer cost basis and market value at lump-sum distribution to the employee
- not subject to taxation until employee sells the stock
- always taxed at long-term capital gain rates
- Basis is taxed at ordinary income at DISTRIBUTION
Choosing to offer nonqualified plans vs qualified
- NonQual May discriminate (quals can’t)
- Exempt from most ERISA
- No employer tax deductions until employee is taxed (quals get an immediate deduction)
- Fund earnings may be taxable to employer
- Distributions are taxable at Ordinary tax rates (except ISO)
Salary reduction vs Salary continuation
Salary reduction plans (also called pure deferred compensation arrangements) use some portion of employees’ current compensation to fund the ultimate compensation benefit.
Salary continuation plans use employer contributions to fund the ultimate compensation benefit
Unfunded plans
unfunded deferred compensation plans and nonqualified stock-
based compensation/bonus plans
- To maintain deferral the plan must be UNFUNDED.
- UNFUNDED may be a mere promise (naked promis) or
- informally funded with Life insurance, annuities, MFs or other (assets are owned by the company and subject to creditors)
- The employee has no access to the compensation that has been deferred.
- As a result, there are no tax deductions for contributions until the employee is ultimately taxed
Life insurance and Section 162
- In 162: Direct cash bonus made to insurance company
- The employer will own the policy and be its beneficiary
- Premiums are not currently deductible
- Death proceeds paid to the employer are not taxable as income to the employer.
- This is because the premiums paid were not deductible. The proceeds remain tax-free death benefits.
- Benefits paid to the covered employee (or to surviving dependents) are a deductible expense to
- *the employer as paid.**
- When the employee has constructive receipt, or benes economic benefit. This payment is deferred compensation, not a death benefit. Either way, it is taxable income.
- The PV of payments to the surviving beneficiaries are included in the employee’s gross estate for estate tax purposes.
- This is because under the deferred compensation plan, the employee had a right to name the beneficiaries (creates an incident of ownership).
Rabbi trust
- Private Letter Ruling
- assets in a rabbi trust must be available to all general creditors
- participant must not have greater rights than other unsecured creditors
- company must notify the trustee of any bankruptcy or financial hardship
- When a bankruptcy or financial hardship occurs, the trustee must suspend payment to the trust beneficiary and hold assets for the employer’s general creditors
Rabbi trust are often used in the following situations:
• Possibility that ownership or management might change before the deferred compensation benefits are paid (takeover/acquisition)
• New management might be hostile to the key employee in the future and fail to honor the compensation agreement
• Risk that litigation to enforce payment of deferred compensation in the future would likely be too costly to be practical
Secular trusts
Irrevocable trust established for
the exclusive benefit of the employee.
Solves 2 problems with a Rabbi Trust
- The lack of security in relying on an informally funded plan
- The fear that the tax savings will disappear because tax rates after retirement may be higher
funded nonqualified deferred compensation arrangement
Taxation occurs in the year in which the assets are placed in the trust with a corresponding deduction to the employer in that year or when a substantial risk of forfeiture no longer exists.
Economic benefit doctrine
economic or financial benefit is conferred on an individual by an employer as compensation in a taxable year, it is taxable to the individual in that year.
Income tax implications of informal funding
- funds set aside to fund the plan TAXED at corporate level (as are accumulated earnings)
- Earnings on the funds set aside as reserve (may create additional tax)
If an annuity contract is held by an entity, the annuity rules change. The income on the contract must be treated as ordinary income received or accrued by the holder during that year.
Constructive Receipt and Substantial risk of foreiture
Income is not treated as constructively received if the taxpayer’s control of its receipt is subject to substantial risk of forfeiture (income is taxable to a cash basis in the year paid)
- Substantial risk of foreiture test: If depended upon the performance of services for a period of time.
- includes employee’s relationship to other stockholders and degree of control, and to corporate officers
Incentive stock options (ISOs)
Only the first $100,000 worth of ISOs granted to any employee that vest in one calendar year is entitled to favorable ISO treatment.
Options granted which exceed that amount are non-qualified. The excess is treated as a regular nonqualified stock option for tax purposes (ordinary income tax)
Nonqualified stock options (NSOs)
A nonqualified stock option is the right to purchase a specified number of shares of the employer’s stock at a given time and a given price.
ISO and NSO events
- Grant: The date the employee is given the shares and the date the shares are typically valued
-
Exercise: The date the employee chooses to exercise the right to buy the shares awarded.
- The spread between the exercise price and the market price is known as the bargain element.
- If ISO terms are bargain element is taxable subject to FICA/FUTA becomes NSO
- IF ISO is within terms, bargain element is ordinary income NO FICA/FUTA
- The spread between the exercise price and the market price is known as the bargain element.
-
Sale: The date the employee sells the exercised shares.
- The amount of time between exercise and sale determines whether the gain or loss is long-term or short-term.
Holding period requirements for ISOs
Grant — one year —- Exercise — one year —– Sale
If either term (1 year) is violated, the ISO becomes an NSO (a discqualifying disposition.)
Disqualifying dispositions
ISOs and NSOs
Employees are taxed (at the 15% or 20% capital gains rate if they’ve held the shares long term) only when they sell the acquired stock.
ISO: Upon exercise, income tax is due on any gains: (the difference between the strike price and the shares’ current MP). NOT subject to regular tax when exercised.
NSO: subject to tax again when they sell the stock (on the difference between the share price at acquisition and the sale price). ARE subject to regular tax when exercised.
Choosing to offer ISOs
They are most often granted to key employees to motivate productivity. However, the employer receives no tax deduction when the shares are exercised.
ISO and NSO taxation
Election to include in gross income in the year of transfer
Election 83b for NSO tax treatment
- Under an 83(b) election, the employee elects to recognize the tax at the time of the award instead of at the time of exercise.
- excess of the fair market value of the stock awarded (granted) over the employee’s cost is taxed as ordinary compensation
- appreciation in the stock after the date of the award (grant) will not be taxed to employee
- Grantees may choose to elect 83(b) tax treatment when the stock is expected to substantially appreciate over time.
Employee stock plans
Restricted Stock Stock appreciation rights, Phantom stock
- A restricted stock plan normally involves a sale of stock (not options) to an employee at a bargain price. No taxation occurs if a substantial risk of forfeiture exists
- SARs are rights to be paid an amount of money = difference between the value of a specified # of shares of stock on the grant date and the value of the stock on the exercise date.
- Phantom stock is a right to a cash (generally) bonus based on the performance of phantom shares of a
- *corporation’s common stock** over a predetermined period of time.
- No options
- has dividend equivalet rights
Choosing to offer SARs and phantom stock
- The company’s owners want to share the economic value of equity, but not equity
- The company is a division of another company, but it can create a measurement of its equity value and wants employees to have a share in that
- The company is not a company; it is a nonprofit or government entity
- The company cannot offer conventional kinds of ownership because of restrictions, for example, an S corporation may be concerned about the 100-owner rule
Junior Class Shares JCS
A JCS is a junior stock plan.
After expiration of a substantial risk of forfeiture, the junior class shares (B) are converted into regular shares (A).
Employee stock purchase plan (ESPP)
- Section 423 stock purchase plan.
- Under this plan the employer is allowed to discount the price of stock up to 15% (charge 85%) of the market value.
- No taxes when purchased under ESPP.
- Taxes are paid at the time of the sale of stock.
- The tax treatment applicable to both the corporation and the employee with respect to the ESPP is similar to the tax treatment of ISOs
