Retirement Flashcards
Net Unrealized Appreciation (NUA) - Stock Plans
At Time of Distribution From Plan
- basis taxed at ordinary income
At Sale After Distribution
- taxed at LTCG: Market Value at Distribution Date - Basis
- taxed at STCG or LTCG: FMV at Sale Date - Market Value at Distribution Date
*The distribution date is like the exercise date
Net unrealized appreciation (NUA) is the difference between the original cost basis and current market value of shares of employer stock. The IRS offers a provision that allows for a more favorable capital gains tax rate on the NUA of employer stock upon distribution, after certain qualifying events.
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 (HR-1) Plans: Contributions for Self-Employed
For sole proprietors 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.
Owner/Employee Contributions
- based on net earnings instead of salary
Max Contribution Calculation for Owner
- plan % / (1+ plan %)
Example
- plan has a 15% contribution for employees
- business net income = $100,000
- max owner contribution is (15%) / (1 + 15%) x $100,000 = $13,04348
Example
- plan has a 25% contribution for employees
- business net income = $70,000
- max owner contribution is (25%) / (1 + 25%) x $70,000 = $13,043.48
Full Example
- plan has a 25% contribution for employees
- Net Income = $70,000
Net Income = $70,000
Subtract Self-Employment Tax (0.07065) = $4,945.50
= $65,054.50
Multiply by Owner Contribution Rate = (.25)/(1.25) x $65,054.50 = $13,101.90
Owner Contribution = $13,101.90
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
Retirement Plan: SEP (Simplified Employee Pension)
- NO Salary Deferrals - Employer contributions only
- have to contribute same % to everyone when made
- no requirements to make contributions, doesn’t have to be substantial or recurring
- Up to 25% contribution for owner (W-2)
- Keogh rules for self-employed
- Maximum of $66K (2023)
- Account immediately vested
- CAN be integrated with social security (SIMPLE cannot)
- Special Eligibility: 21+ years old, paid at least $750 and worked 3 of the 5 prior years
- Good for part time workers with high turnover (don’t work 3 out of 5 years)
- no loans
- easier than a profit sharing plan
- max $66,000 with $330,000 salary cap
Retirement Plan: SIMPLE
- Fewer than 100 employees
- Employer CANNOT have a SIMPLE and any other plan at the same time
- Participants fully vested
- Easy to administer
- Both employee deferrals and employer contributions / match
- Max contribution: $15,500
- REQUIRED 100% match up to 3% or 2% of salary for everyone (so max match $15,500)
- cover anyone that made $5,000 in any two years and should make it the current year
- no social security integration
- 25% withdrawal penalty within first 2 yrs
- rollovers: penalty if rollover into non-SIMPLE account within first two years.
SIMPLE 401K
- the $15,500 deferral applies plus salary calc on match of $330,000 also applies
- also 100% vested
Retirement Plan: Profit-Sharing Plan
- Up to 25% Employer Deduction
- Flexible contributions (must be recurring and substantial)
- Maximum Annual Contribution lesser of 100% of salary or $66K (2023)
- Can have 401(k) provisions
- Allows for loans
- No hardship provisions
- good for younger to motivate
Rollovers: Qualified Plan or IRA
If spouse beneficiary rolls over proceeds into…
Qualified Plan
- can get assets at age 55 if separate from employer
- can take RMD when retire later
- creditor protected
IRA
- subject to IRA distribution rules
- rollover into own account (RMD of survivor)
- keep in decedent IRA (use the decedent RMD calculation)
Missed RMDs
- take the missed RMD
- request a waiver from the IRS to avoid the excise tax: prove it was a reasonable error and taking steps to remedy the situation
RMDs: Non-Spousal
- Need to take before 10 years is up. Don’t have to take it each year.
RMD: Calculations
Single Person: new uniform life table
Married with Spouse 10 Years Younger and Sole Beneficiary: Can use joint and last survivor table.
- Non-spouses can’t use joint and last survivor
Social Security: Coverage
Coverage: Nearly every worker is covered under OASDI.
Excluded
- 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:
Before Full Retirement Age (FRA) = Reduction of Benefits
No withholding of benefits after FRA (67) regardless of additions income earned.
RETIRE EARLY
Reduced PIA = PIA - (# of months before FRA/180 x PIA)
WORKING AND TAKING SS EARLY
Before FRA (Full Retirement Age): Benefits reduced $1 for every $2 earned over $21,240 (2023 threshold): 50% reduced
Year in which you reach FRA (Full Retirement Age): Benefits reduced $1 for every $3 earned over $56,520 (2023 threshold): 33% reduced
Income above limit x withholding % (50 % or 33%) = social security payment withheld
Social Security:
Too Much Income Generated: Taxation of Benefits
Must include Muni Bond Income to calculate MAGI
% Social Security Benefits Taxable
- based on MAGI + 50% of Social Security Benefits
Single
- $25k+: 50%
Married Filing Jointly
- $44k+: 85%
Qualified (ERISA) Plans
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)
Non-Qualified Retirement Plans
No Vesting / Limited Admin Costs
- SEP
- SIMPLE
- SAR-SEP
- Thrift or Savings Plans
- 403(b)/TDA/TSA
Qualified Plan: Defined Benefit
- Favors older employee/owner (50+)
- Certain retirement benefit; Max $265K (2023)
- Meet a specific retirement objective
- Company must have very stable cash flow
- employer contributions fluctuate each year based on actuarial assumptions
- Past service credits allowed
- Forfeitures MUST be applied to reduce employer contributions
- PBGC Insured (along with Cash Balance Plan)
- Stuff it like a pig
- maximum yearly pension payout benefit of $265,000/yr or 100% of average of three highest consecutive years compensation
- allows for past service credits if plan is new
Unit Benefit Formula: percentage of earnings per year of service
Final Average: average over years, subject to $330,000 max in a year for calculating
Qualified Plan: Money Purchase
- Up to 25% Employer Deduction
- Fixed Contributions
- Need stable cash flow
- Maximum Annual Contribution lesser of 100% or salary of $66K (2023)
Qualified Plan: Target Benefit
- Up to 25% Employer Deduction
- Fixed Contributions - need stable cash flow
- Maximum annual contribution lesser of 100% of salary or $66K (2023)
- Favors older workers
- benefit not guaranteed
- a actuarial target benefit for retirement for an older worker may be higher than what the annual $66,000 max contribution may allow
- easier to manage than a defined benefit plan because nothing is guaranteed
Qualified Plan: Profit Sharing
- Up to 25% Employer Deduction
- Flexible contributions (must be recurring and substantial)
- Maximum Annual Contribution lesser of 100% of salary or $66K (2023)
- Can have 401(k) provisions
- SIMPLE 401(k) exempt from creditors
Qualified Plan: 401(k) Plan
- can be added to a profit sharing plan or stock bonus plan
- allows employee deferrals and employer contributions
- Max $22,500 (2023) deferral for participants under 50
- Additional $7,500 catch-up for age 50 and over (2023)
- federal tax excluded but subject to FICA and FUTA
Qualified Plans: Section 415 (aggregate contributions)
- Lesser of 100% of compensation or $66K (2023)
- Includes employer contributions, employee salary reductions and plan forfeitures
Maximum Salary Calculation: $330,000
Qualified Plans: Safe Harbor
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.
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.
Qualified Plan: Stock Bonus/ESOP
- stock bonus plan may invest in company stock, an ESOP MUST invest in company stock
- Up to 25% employer deduction
- Flexible contributions
- Maximum Annual Contribution lesser of 100% of salary or $66K (2023)
- 100% of contribution can be invested in company stock
- ESOP cannot be integrated with Social Security or cross-tested
Qualified Plan*: 403(b)/TDA/TSA
Tax-Deferred Annuity (TDA)
Tax Sheltered Annuity (TSA)
403(b)
*Subject to ERISA only if employer contributes
- For 501(c)(3) organizations and public schools
- Salary reduction limit up to $22,500 (2023) plus $7,500 catch-up if 50 or over
- extra $3,000 deferral for any age with 15 yrs of service
- may have vesting if employer contributes
- can only hold mutual funds or insurance/Annuity contracts
Qualified Plans: Eligibility (Age, Service)
- 21-and-one-rule
- 2-year/100% vested
- Year of service is 1,000 hours (includes vacations, holidays and illness time)
- 500 hours if worked 3 consecutive years
Highly Compensated Employee (HCE)
- 5%+ owner OR
- $150,000+ salary last year
- related to a HCE
Key Employee
- 5%+ owner OR
- 1%+ owner AND $150,000 salary
- $215,000+ salary and officer
Qualified Plans: Vesting
Fast: DB Top-heavy Plans / All DC Plans
- 3-year cliff
- 2-6 year graded
- 100% vested after 2 years
Slow: Non-top-heavy DB Plans only
- 5-year cliff
- 3-7 year graded
- 100% vested after 2 years
Qualified Plans: Social Security Integration
Base % + Permitted Disparity = Excess %
Defined Benefit
Permitted Disparity: lessor of base % or 26.25%
Defined Contribution
Permitted Disparity: lessor of base % or 5.7%
Employee Deferrals: Multiple Plans
Elective Deferrals to multiple plans are always aggregated (2023)
401k/403(b)/SIMPLE/SARSEP
-$22,500 plus catch up $7,500
SIMPLE and other SIMPLE
-$15,500 plus catch up $3,500
457 Plans are NOT part of aggregated amounts.
Qualified Plans: Insurance as an Option
Insurance premiums and/or benefits must be incidental to the expected benefits of the qualified plan.
Premiums
- needs to be less than the following percentages of the plan cost for that participant
- Ordinary life insurance 50%
- Term Insurance 25%
- Universal Life 25%
Benefits: defined benefit vs. life insurance benefit
- 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: Exclusions
Distributions from retirement plans that are excluded from rollovers into a new plan:
- non-governmental 457 plan to anything else (needs to roll over into another non-govt 457)
- Hardship distributions
- Required minimum distributions
Qualified Plans: Distributions (penalty exceptions)
These avoid 10% penalty if withdraw before age 59 1/2
- Death
- Disability
- Substantially equal periodic payments following separation from service
- Distribution following separation from service at age 55
- QDRO
- Medical expenses > 7.5% of AGI
- health insurance costs while unemployed
- insurance premiums after separation from employment (must file for unemployment)
- birth/adoption ($5,000)
- Federal declared disaster (limited)
RMD: Required Beginning Date (RBD)
Retirement Plans (IRAs / SEPs / SARSEPs / SIMPLEs)
- Required Beginning Date (RBD): 73
Qualified Plans/403(b)/457
- Required Beginning Date (RBD): 73 (if retired)
- RMDs not required until retired (can still work past 73 without RMD)
- 5% owners need to take at 73 even if still working
IRAs: Deductibility
Active Participant: any employee deferrals, employer contributions, forfeitures in a work plan
- neither spouse active participant in work plan: both IRAs fully deductible
- one spouse active participant: one spouse deductible subject to joint AGI
- both spouses active participants: single/married AGI limits
IRAs: Distributions (exceptions for early withdrawal)
- Death
- Disability
- Substantially equal periodic payments
- FIRST home purchase
- Qualified EDUCATION
- Medical expenses > 7.5% of AGI
- insurance premiums after separation from employment (must file for unemployment)
- birth/adoption ($5,000)
- Federal declared disaster (limited)
Roth IRA: Distribution Rules
1) Contributions
2) Conversions
3) Earnings
Distributed within 5 years of owner’s death, or
Distributed over 10 years
Where sole beneficiary is owner’s surviving spouse, the spouse may delay distributions until the Roth owner would have reached age 73, or may treat the Roth as his or her own (roll it to her/her Roth)
Non-Qualified Plans: Deferred Compensation
These plans can be structured for anyone and anything, above qualified plans limits, can discriminate, etc.
Salary Reduction Plan: Uses some portion of the employee’s current compensation to fund the ultimate compensation benefit (also called Pure Deferred Compensation)
Salary Continuation Plan: Uses employer contributions to fund ultimate benefit
Insurance: Employer Owned
- considered informally funded
- employer owns the policy and is the beneficiary
- any benefits paid to employee or employee beneficiary from the employer, that gets reimbursed from the policy
- taxed to the employee as deferred compensation and taxed as income if benefits distributed to them
- if the company owns and is the beneficiary of the insurance plan, it’s an unfunded non-qualified deferred compensation plan
Insurance: Employee Owned (Section 162 bonus structure)
- employee “pays” premium through bonus structure, with comp deducted to cover the cost of the insurance premiums
- employer actually pays the insurance directly to the insurance company
- employee gets the benefits
- thia is NOT a deferred compensation plan
Rabbi / Secular Trusts
Key Words: Merger, Acquisition, or Change of Ownership
RABBI TRUST
Assets in Rabbi Trust available for company’s creditors
Fear that ownership / management may change before deferred compensation is paid
SECULAR TRUST
- a FUNDED non-qualified deferred compensation plan
- an irrevocable trust for the exclusive benefit of the employee
- out of reach of creditors and management
- employee pays the tax on the contributions.into the trust but grows tax deferred
Informal Funding: company pays tax until distributed to the employee
Formal Funding: employee pax tax on the contributions to a secular trust
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
Retirement Plan: 457 Plan
- a deferred compensation plan
- Non-Qualified Deferred Compensation Plans of governmental agencies and non-church controlled tax exempt organizations
- Deferral limited to $22,500 or 100% of compensation (2023)
- Catch-up of $7,500 allowed for those 50 and over ONLY for governmental plans (2023)
- Salary deferrals NOT aggregated with other plans (401k, etc.)
- Non-governmental plans can ONLY be rolled into another 457 plan
Retirement Plans: SIMPLE, SEP, SARSEP
- No Loans
- No Life Insurance
- Immediate Vesting
- May not be creditor protected (state specific)
- 59½ for no 10% penalty
- Must take RMDs at 73 (even if not owner)
Cross-Testing: DB/DC Plans
Defined Benefit Plans: tested against contributions
Defined Contribution Plans: tested against benefits
Allows to separate HCE and NHCE but rules need to be obeyed, allowing for maximum benefits for HCE but still providing minimums for NHCE
“Gateway” Requirement: NHCE needs lessor of 1/3 of highest HCE contribution % or 5%.
Cash Balance Plan
- guaranteed contribution as % of salary
- guaranteed minimum rate of return
- less expensive and simpler than defined benefit plan
- less attractive for older workers vs DB plan
Qualified Plans: HCE/NHCE Coverage
% NHCE >= % HCE x 70%
For total average benefits provided (average benefit test) and # of people (ratio percentage test) covered
E.g. 80% HCE Covered, then 80% x 70% = 56% of NHCE needs to be covered
Top Heavy Qualified Plans
Top Heavy if
Total Key Employee Benefits / Total Benefits > 60%
If Top Heavy, minimum contributions are…
DB: 2% of compensation x # of years plan was top Heavy for max 10 years
DC: no less than 3% of each non-key employee compensation
Qualified Plans: Loans
Need to be secured
Lessor of 50% of vested balance Max $50,000
Term max 5 yrs, unless to purchase first home
Repaid quarterly, if not,.it’s a taxable distribution with penalty
Interest can be deducted if non-key employee and secured by primary residence
IRAs: Beneficiary Distribution at Death
SPOUSE
Dead under Required Begin Date age (73)
- rollover into spouses IRA: use spouses RBD
- keep in decedent’s account: take distributions based on decedent’s RBD and spouses life expectancy
Dead Over RBD
- rollover into spouse’s account: use spouses RBD
- keep in decedent’s account: use espouse’s life expectancy
NON- SPOUSE
- distribute within 10 years
- unless under 18, disabled, chronically ill, less than 10 years younger than the decedent
NO BENEFICIARY
- distribute in 5 years
Stock Options
ISO
- vesting: 1 year, max $100,000/yr otherwise NSO
- At Exercise: No tax. AMT Bargain Element EP - GP
- At Sale: Cap gains tax on EP - GP
- Cap gains tax: LTCG if meet holding period
- Holding Period: EGG - one year from exercise, 2 yrs from grant date, otherwise NSO
NSO
- no vesting
- At Exercise: ordinary income tax on EP - GP
- At Sale: cap gains tax on SP - EP
- Cap Gains Tax: STCG/LTCG depending on holding period from exercise date
Restricted Stock
Restricted Stock Units (RSU) given at a discounted price
Income tax as compensation when received
Cap gains tax when sold
