Retirement Plans

Question 1

Qualified plan

Answer 1

s a retirement or employee compensation plan established and maintained by an employer that meets specific guidelines spelled out by the IRS and consequently receives favorable tax treatment.

Question 2

ERISA (The Employee Retirement Income Security Act of 1974) i

Answer 2

is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.

Question 3

Defined contribution plans

Answer 3

are a tax-qualified retirement plan in which annual contributions are determined by a formula set forth in the plan. Benefits paid to a participant vary with the amount of contributions made on the participant’s behalf and the length of service under the plan.

Question 4

Profit-sharing plans

Answer 4

are any plans whereby a portion of a company’s profits isset aside for distribution to employees who qualify under the plan.

Question 5

Defined benefit plans

Answer 5

are pension plans under which benefits are determined by a specific benefitformula

Question 6

The 401(k) Plan

Answer 6

is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.

Question 7

The 403(b) Plan

Answer 7

s a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.

Question 8

Keogh plans

Answer 8

are designed to fund retirement of self-employed individuals; name derived from the author of the Keogh Act (HR-10), under which contributions to such plans are given favorable tax treatment.

Question 9

Simplified employee pension (SEP)

Answer 9

s a type of qualified retirement plan under which the employer contributes to an individual retirement account set up and maintained by the employee.

Question 10

SIMPLE

Answer 10

is a qualified employer retirement plan that allows small employers to set up tax-favored retirement savings plans for their employees.

Question 11

Traditional IRA

Answer 11

is a personal qualified retirement account through which eligible individuals accumulate tax- deferred income up to a certain amount each year, depending on the person’s tax bracket.

Question 12

IRA Contributions/Withdrawals

Answer 12

provide generous tax breaks. But it’s a matter of timing when you get to claim them. Traditional IRA contributions are tax deductible on both state and federal tax returns for the year you make the contribution, while withdrawals in retirement are taxed at ordinary income tax rates. Anyone under the age of 70 1/2 with earned income may open a traditional IRA. Withdrawals must start no later than April 1 following the year in which the participant reaches the age of 70 1/2, and the law specifies a minimum amount that must be withdrawn every year. No cash withdrawals prior to the age of 59 1/2 are permitted without having to pay a 10% excise tax, with the following exceptions:

• if the owner dies or becomes disabled;
• if distribution is in equal payments over the owner’s lifetime;
• if higher education expenses for a dependent are necessary;
• to purchase a first home with up to $10,000 down payment;
• if out-of-pocket medical expenses are in excess of 7.5% of adjusted gross;
• to pay health insurance premiums while unemployed; or
• to correct or reduce an excess contribution.

Question 13

Roth IRA

Answer 13

s an individual retirement account allowing a person to set aside after-tax income up to a specified amount each year. Both earnings on the account and withdrawals after age 59 1/2 are tax-free. The funds are taxed as income before the contribution is made. In other words, Roth contributions are made with after-tax dollars. Therefore, at the time of payout, the funds are tax free. Unlike the traditional IRA, the Roth imposes no age limits. Roth withdrawals are either qualified or nonqualified. Also, unlike traditional IRAs, Roth IRA distributions are not mandatory and can therefore be inherited and passed down through generations.

Question 14

Qualified Withdrawals

Answer 14

provide the tax-free distribution of earnings. To be a qualified withdrawal, the funds must have been held in the account for a minimum of five years; and if the withdrawal occurs for one of the following reasons, no portion of the withdrawal is subject to tax.

• The owner has reached age 59 1/2
• The owner dies or becomes disabled
• The distribution is used to purchase a first home

Question 15

Nonqualified Withdrawal

Answer 15

If a withdrawal is taken without meeting the above criteria and the amount of the withdrawal exceeds the total amount contributed, it is a nonqualified withdrawal. The earnings from the contributions become taxable.

Question 16

Rollovers

Answer 16

are an individual retirement account established with funds transferred from another IRA or qualified retirement plan that the owner had terminated.

Question 17

QUALIFIED PLANS VERSUS NONQUALIFIED PLANS

Answer 17

Qualified plans are retirement plans that meet federal requirements and receive favorable tax treatment. Qualified plans provide tax benefits and must be approved by the IRS. The plans must be permanent, in writing, communicated to employees, defined contributions or benefits, and cannot favor highly paid employees, executives, or stockholders. The primary type of qualified plans includes defined benefit and defined contribution plans.

• To comply with ERISA minimum participation standards, qualified retirement plans must allow the enrollment of all employees over age 21 with one year experience.
• If more than 60% of a qualified retirement plan’s assets are in key employee accounts, the plan is considered “top heavy”

Question 18

Qualified plans have the following features:

Answer 18

• Employer’s contributions are tax-deductible as a business expense.
• Employee contributions are made with pretax dollars - contributions are not taxed until withdrawn.
• Interest earned on contributions is tax-deferred until withdrawn upon retirement
• The annual addition to an employee’s account in a qualified retirement plan cannot exceed the maximum limits set by the Internal Revenue Service

Question 19

Nonqualified plans are characterized by the following:

Answer 19

• Do not need to be approved by the IRS
• Can discriminate in favor of certain employees
• Contributions are not tax-deductible
• Interest earned on contributions is tax-deferred until withdrawn upon retirement

Question 20

Tax Benefits of Qualified Plans

Answer 20

Employer’s contributions are tax-deductible and not treated as taxable income to the employee. Employee contributions are made with pre-tax dollars, and any interest earned on both employer and employee contributions are tax- deferred. Employees only pay taxes on amounts at the time of withdrawal

Question 21

Withdrawals and Taxation

Answer 21

Withdrawals by the employee are treated as taxable income. Withdrawals by the employee made prior to age 59 1/2 are assessed an additional 10% penalty tax. Distributions are mandatory by April 1st of the year following age 70 1/2, and failure to take the required withdrawal results in a 50% excise tax on those funds.

Funds may be withdrawn prior to the employee reaching age 59 1/2 without the 10% penalty tax: if the employee dies or becomes disabled; if a loan is taken on the plan’s proceeds; if the withdrawal is the result of a divorce proceeding; if the withdrawal is made to a qualified rollover plan; or if the employee elects to receive annual level payments for the remainder of his life.

Question 22

The Employee Retirement Income Security Act of 1974 (ERISA)

Answer 22

ERISA was enacted to provide minimum benefit standards for pension and employee benefits plans, including fiduciary responsibility, reporting and disclosure practices, and vesting rules. The overall purpose of ERISA is to protect the rights of workers covered under an employersponsored plan.

Question 23

EMPLOYER-SPONSORED PLANS

Defined Benefit Plans

Answer 23

Defined benefit plans pay a specified benefit amount upon the employee’s retirement. When the term pension is used, it normally is referring to a defined benefit plan. The benefit is based on the employee’s length of service and/or earnings. Defined benefit plans are mostly funded by individual and group deferred annuities.

Question 24

Defined Contribution Plans

Answer 24

Defined contribution plans do not specify the exact benefit amount until distribution begins. Two main types of plans are profit-sharing and pension plans. The maximum contribution is the lesser of the employee’s earnings or $49,000 per year. Here are some examples of defined contribution plans:

Question 25

Profit-Sharing Plans

Answer 25

A type of retirement plan that sets aside a portion of the firm’s net income for distributions to employees who qualify under the plan. Plans must provide participants with the formula the employer uses for contributions. The contributions may vary year to year, and contributions and interest are tax-deferred until withdrawal.

Question 26

Pension Plans

Answer 26

Employers contribute to a plan based on the employee’s compensation and years of service, not company profitability or performance.

Question 27

Money Purchase Plans

Answer 27

Money Purchase Plans

Question 28

Stock Bonus Plans

Answer 28

These plans are similar to a profit-sharing plan, except that contributions by the employer do not depend on profits, and benefits are distributed in the form of company stock.

Question 29

Cash or Deferred Arrangement (401(k) Plans)

Answer 29

401(k) plans allow employers to make tax-deferred contributions to the participant, either by placing a cash bonus into the employee’s account on a pre-tax basis or the individual taking a reduced salary with the reduction placed pre-tax in the account. The account’s funds are taxable upon withdrawal.

Question 30

Tax-Sheltered Annuity (403(b) Plans)

Answer 30

Tax-sheltered annuities are a special class of retirement plans available to employees of certain charitable, educational, or religious organizations.

Question 31

Simplified Employee Plans (SEPs

Answer 31

SEP’s are basically an arrangement where an employee (including a self-employed individual) establishes and maintains an IRA to which the employer contributes. Employer contributions are not included in the employee’s gross income. A primary difference between a SEP and an IRA is the much larger amount that can be contributed to an employee’s SEP plan is the lesser of 25% of the employee’s annual compensation.

Question 32

Savings Incentive Match Plan for Employees (SIMPLE)

Answer 32

SIMPLE plans are available to small businesses (including tax exempt and government entities) that employ no more than 100 employees who received at least $5,000 in compensation from the employer during the previous year. An employer can choose to make nonelective contributions of 2% of compensation on behalf of each eligible employee. To establish a SIMPLE plan, the employer must not have a qualified plan in place.

Question 33

Keogh Plans

Answer 33

Keogh or HR-10 plans are for self-employed persons, such as doctors, farmers, lawyers, or other sole- proprietors. Keoghs may be defined contribution or defined benefit plans. Defined contribution Keoghs have a maximum contribution of $49,000 per year, while defined benefit Keoghs have maximum benefits of $195,000 per year. Contributions are tax- deductible, and interest and dividends are tax-deferred.

Question 34

Traditional IRAs

Answer 34

Traditional IRAs allow for an individual to contribute a limited amount of money per year, and the interest earned is tax- deferred until withdrawal. Contribution limits are indexed annually, currently at $5,000 per year, with $6,000 for individuals age 50 or older. Some individuals may deduct contributions from their taxes based on their adjusted gross income (AGI), but all withdrawals are taxable income. If an individual or spouse does not have an employer retirement plan, the entire contribution is tax-deductible, regardless of AGI. Withdrawals made prior to age 59 1/2 are assessed an additional 10% penalty tax.

Question 35

Roth IRAs

Answer 35

Roth IRAs are designed so that withdrawals are received income tax-free. Contributions to Roth IRAs are subject to the same limits as traditional IRAs, but are not tax-deductible. Interest on contributions is not taxable as long as the withdrawal is a qualified distribution. Qualified distributions must occur after five years in the event of death or disability of the individual, up to $10,000 for first-time homebuyers, or at the age of 59 1/2.

Question 36

Rollovers

Answer 36

Rollovers are a transfer of funds from one IRA or qualified plan to another.

• Rollovers are subjected to 20% withholding tax if eligible rollover funds are received personally by a participant in a qualified plan, unless the funds are deposited into a new IRA or qualified plan within 60 days of distribution.
• Funds that are transferred directly from one qualified IRA to another qualified IRA are not subject to this withholding tax. This also includes a trustee-to-trustee transfer of rollover funds instead of personally receiving the funds and then rolling them over. This election permits the participant to avoid mandatory income tax withholding on the amount transferred.
• A surviving spouse who inherits IRA benefits from a deceased spouse’s qualified plan is eligible to establish a rollover IRA in their own name.
• Rollover contributions to an individual retirement annuity (IRA) are unlimited by dollar amount

Question 37

FEDERAL PENSION ACT OF 2006

Answer 37

This law sets forth standards for funding, participating, vesting, disclosure, and tax treatment of retirement plans.

• This Act improves the pension system and encourages employees to increase contributions to their employer- sponsored retirement plans. The provisions of the act have two main goals: addressing employers pension funds and assisting employees who are saving for retirement.
• It addresses employer responsibilities by requiring additional premiums for underfunded plans. It does this by requiring employers to obtain accurate assessments of the pension’s financial obligations. It also closes loopholes by which underfunded plans skip payments and prevents employers with under-funded plans from promising extra benefits without first funding those benefits.
• It helps employees who save for retirement through qualified plans by: allowing employers to automatically enroll employees in defined compensation plans; provide more accurate information about accounts; increase access to professional advice about investments; allow for direct deposit of income tax refunds into IRA’s; allow active military to make early penalty-free withdrawals; increase limits on contributions to all qualified plans; and provide for better portability for those plans.

Question 38

1035 EXCHANGES

Answer 38

All of the following are types of insurance policy exchanges that can be made without current taxation:

• The exchange of a life insurance policy for an annuity
• An annuity exchanged for another annuity contract
• A life insurance policy exchanged for another life policy

The exchange of an annuity for a life insurance policy is NOT permitted