Retirement Saving & Income Planning 18% (31 Questions) Flashcards
Qualified Plan Coverage Rules
(ratio test)
- % Test (Safe Harbor Test)
The plan MUST cover at least 70% of eligible non-HCE.
*If % Test (Safe Harbor) not met then plan must meet 1 out of 2 plans below:
- Ratio Test
% of non-HCE covered
÷
% of HCE covered
= or > 70% - Avg. Benefits % Test
avg benefits % non HCEs
÷
avg. benefits % HCEs
= or > 70%
Qualified Plans Ratio Test Example
Employer employs 200 eligible employees of whom 10 are highly compensated.
9 of the 10 highly compensated and 120 of the 190 non-highly compensated employees benefit from the plan.
The average benefit for the highly compensated is 8%, and the average benefit for the non-highly compensated is 6%.
Safe harbor test: has to cover 70% of NHCE
120 NHCE ÷ 190 NHCE (eligible) = 63% “X”
Ratio Test:
120/190 NHCE ÷ 9/10 HCE = 70% “ √ “
Avg. Benefits Test:
6% NHCE ÷ 8% HCE = 75% “ √ “
Highly Compensated Employee (HCEs)
- Greater than 5% owner of employer at anytime
- Salary > $135K (2022) or salary > $150K (2023)
If the employer makes an election, only persons ranked in the top 20% of compensation and having income greater than $150,000 (2023) or $135,000 looking back to 2022 are included as HCE.
Family ownership attribution rules apply to determine 5% owners and 1% owners. [Other family member’s (spouse, child, grandparent, or parent) ownership is added to the employee’s ownership. For example, if the employee owns 4% and his father owns 2%, then they are both HCEs, even though neither worker individually owns more than 5%.] Note that siblings do not count for family attribution rules.
DB Pension
50/40 Test
Covered: lesser of 50 people or 40%
All defined benefit pension plans MUST benefit no fewer than the lesser of:
a. 50 employees
b. 40% or more of all nonexcludable employees
Top Heavy Plans
A top-heavy plan is one that provides more than 60% of its aggregate accrued benefits or account balances to key employees.
Top-heavy plans must meet certain additional qualification rules.
DB Pension plan is top heavy if the present value of accrued benefits for key employees is greater than 60% of the present value of accrued benefits for all employees.
DB Vesting Options:
100% after 3 years or 2-6 yr graduated vesting
DC Plan is top heavy if the aggregate of account balances of key employees exceeds 60% of the aggregate account balances of all employees.
DC Vesting:
3 year cliff or 2-6 year graded
Funding: DB pension plans must provide a minimum benefit accrual of 2% x the # of years of service (up to 10yrs)
Key Employees
Has to meet one of the following during the yr:
a. Compensation > $215K
b. > 5% owner
c. >1% owner w/ compensation >$150K
The number of key EE who may be considered key EE is limited to the lesser of
a. 50 EE
or
b. the greater of 3 EE or 10% of all EEs
Social Security Integration
EP = BP + PD
DC Plans permitted disparity rules:
the max allowable excess contribution percentage is the lesser of:
a. 2x the base percentage
b. base percentage + 5.7%
Integration level: $162,200
Excess Deal = Base Deal + Permitted Disparity
EP = BP + PD
Excess Deal:
The total that ER does for pay over the integration level. It can be benefit or contribution
Base Deal:
What the ER contributions is doing for pay under the integration level. It can be benefit or a contribution
Permitted Disparity:
Is the amount the ER can do that is extra for pay above the integration level only
Defined Contribution Plan can ONLY use “excess method” of integration.
DC Plans permitted disparity rules:
the max allowable excess contribution percentage is the lesser of:
a. 2x the base percentage
b. base percentage + 5.7%
Ex:
If the base contribution percentage for for an integrated defined contribution plan is 5%, the permitted disparity is also 5%, making the excess percentage no more than 10% (5% + 5%) of compensation above the integration level.
Alternatively if the base contribution percentage is 6% their permitted disparity is 5.7% resulting in an excess percentage amount of no more than 11.7% (6% + 5.7%).
Qualified Plan Loans
- All loans must be repaid in 5 yrs.
- Must be available to all EE
2a. Loans cant exceed $50K
2b. If account balance < $10K then entire balance is available for loan
2c. If account balance btwn $10K-$100K then 50% of vested balance available for loan - Max loan amount is reduced by previous loan balance participant had in 12 mos preceding loan.
- Loans must be repaid in full upon separation of service or they’ll be treated as taxable distro & maybe subject to 10% penalty.
- Interest paid on loans NOT deductible
- Retirement loans CANT be offered using credit cards
- Disaster loans up to $100K
Traditional Defined Benefit Plan
Subject to ERISA
ER contributions = deductible
EE taxed at distributions
Benefits older EE
EE CANT contribute to plan
- To provide defined level of retirement income/benefits to EEs
- ER must have stable cash flow to meet mandatory annual funding requirements.
- ER has investment risk
Cash Balance
(Defined Benefit Plans)
Subject to ERISA
For younger middle income EEs
ER contributions = deductible
EE CANT contribute to plan & taxed at distributions
- Provides annual contributions at specified rate in indvl. accounts for each plan participant
- ER GUARANTEES rate of return & contribution level & interest rate credit to each account.
- ER has investment risk
- 3 yr cliff vesting schedule.
Money Purchase Pension Plan
(Defined Contribution Plan)
For younger EEs
ER contributions = deductible
EE taxed at distributions
- ER makes annual mandatory contributions to each EE’s account (fixed or flat $ amount)
- EE has investment risk
- Simple & inexpensive to design
- ER can deduct up to 25% annual ER contribution of countable compensation.
Traditional Profit Sharing Plan
(Defined Contribution Plan)
Young EEs
EE has investment risk
Permit in service w/d’s under 62 y/o
- ER contribution purely discretionary but contributions must be made in every 3/5 yrs.
- ER can deduct 25% of total includable compensation
- Plan have 3 investment choices (MMF, bond fund, & stock fund)
Stock Bonus Plan
(Defined Contribution Plan)
- Benefits distributed in form of ER stock
- NUA (net unrealized appreciation) defer on securities. Can be taxed as cap gain when EE sells stock.
- EE has voting rights dependent on # of shares held.
ESOP
Employee Stock Ownership Plan
(Defined Contribution Plan)
- Is the type of stock bonus plan which individual participant accounts are invested primarily in employee stock .
- ESOP may borrow money in the name of the plan
- If the ESOP does borrow money in the plane’s name is commonly referred to as LESOP.
- EE receives ownership interest and ER may provide performance incentive.
- EE NOT taxed until shares are distributed.
Thrift/Savings Plan
- Provides for and encourages after tax employee contributions to the plan.
- The typical thrift plan provides for after tax employee contributions with matching employer contributions.
- 3 years is the maximum service requirement that a thrift plan may impose as a condition of participation
401K Plan
For young EE that have time to accumulate retirement savings
EE willing to accept investment risk
- When ER wants to provide QRP for EE w/o being required to make ongoing ER contributions
- Can be funded by EE elective deferrals
- EE willing to accept investment risk
- Hardship w/d’s & loans OK
- $22.5 max contribution (+7.5K over 50 )
401K Hardship W/D Rules
Must meet following test:
1. Financial Needs:
Hardship due to an immediate/heavy financial need of EE
- Resource Test:
The EE must NOT have other financial sources sufficient to satisfy need
$ can only be w/d for following reasons:
a. Medical Expenses
b. Purchase Primary Residence
c. Education Payment
d. Prevent Foreclosure on Primary Residence
e. Funeral Expenses
f. safe harbor
Safe Harbor 401K Plan Rules
- ER can avoid ADP/ACP Testing if the plan meets one of the provisions
- The following contributions made by the ER must be 100% vested at all times.
Matching contributions for NHCEs
2a. 100% match up to 3% of deferred compensation plus 50% match for contributions btwn. 3-5% of compensation
2b. Matching contribution percentage for HCEs CANNOT exceed those for NHCEs
- Elect to match 100% up to 4% of compensation
Roth 401K Plans
Contribution (after tax) max elective deferral is $22.5K (+$7.5K is 50)
- Distribution of basis (contributions) are received income tax free
- Distributions of earnings are income tax free as long as the following test are met:
2a. Distro must be made after a period of 5 years after 1st contribution was made (Jan 1 of that yr)
2b. Must satisfy the following
-After EE turns 59 ½
-Disability
-Distro to estate or beneficiary after EEs death
- 1st time homebuyer exception
- RMD which EE reaches 73
- NQ distributions will be treated as contributions (excludable from income) & a distribution from accumulated earnings.
Keogh Plans
(for Self Employed Individuals)
- Covers one or more self employed individuals.
- Most common types of QP adopted by SE are: profit share, money purchase, & target benefit.
- Max contribution = [(contribution formula ÷ (1- contribution formula)]
- Entities that may adopt Self Employed Plans: Sole Proprietorship, Partnerships, LLP, LLC taxed as sole pro. or partnership
SEP IRA
Social Security Integration
EE bears investment risk.
EE CANT contribute
1.ER sponsored IRA in which the ER agrees to contribute retirement monies on behalf of the employees on a nondiscriminatory and fully vested basis (this avoids nondiscrimination testing).
- Cannot deny participation to any employee 21 years of age or older based on age or EE who earns at least $750 BUT the worker must have also worked for the employer for at least three of the preceding five years (including working part-time).
- Used by sole employed individuals, sole proprietors.
- Employers can make discretionary contributions to a SEP IRA of up to $66,000 or 25% of compensation ($330K ceiling) in 2023.
5. Contributions are currently excludible from the employee’s gross income. Employer contributions to a SEP are not subject to FICA, FUTA, or income tax withholding. NOT SUBJECT TO 20% mandatory federal income tax withholding for rollover
Traditional IRA
- $6500 contribution limit (+ $1K if 50)
- Contributions can continue past 70/ y/o as long as earned income or married to someone w/ earned income to cover contributions.
- Income not taxed until w/d from account
- Loans NOT permitted
- W/Ds may be subject to 10% penalty (less exclusions)
- RMDs required by April 1 of the year following the year the person turns 73.
Deduction Rules (MFJ):
1. Both spouses NOT active in ER QP = contributions fully deductible (no MAGI limits)
- Both spouses Active in ER QP = deduction limited or phaseout MAGIs of ($116K-136K)
- 1 spouse Active & 1 spouse NOT Active = Not active spouse MAGI deduction phaseout $218K-$228K Active spouse MAGI phaseout of ($116K-136K)
EXAMPLE: James and Donna are married and file a joint return. Their AGI in 2023 is $200,000, and James is covered by his employer’s pension plan. James and Donna earned interest of $1,000 in 2023 on their joint savings account. Donna is not employed, and the couple has no other income. For the year 2023, James contributes $6,500 to a traditional IRA for himself and $6,500 to a traditional IRA for Donna. The maximum allowable IRA deduction on their 2023 joint return is
A)$0
B)$8,500
C)$13,000
D)$6,500 √
When one MFJ spouse is an active participant and one is not an active participant, two separate phaseout limits apply for IRA deductibility.
The nonactive participant phaseout is $218,000-$228,000 (2023) and the active participant phaseout is $116,000-$136,000.
Because their AGI is less than the lower end of the phaseout range for the nonactive participant spouse, Donna’s IRA contribution is deductible but James’s contribution is not deductible. While Donna does not have earned income, a spousal IRA may be established based on James’s income.
ROTH
Qualified Distribution Rules
*F-A-D-D
*First Home
*Age 59½
*Death
*Disability
- 5 year rule (Jan 1 of the taxable year for which the first contribution is made to a Roth
- Must satisfy any of the following:
F-A-D-D
First Home purchase ($10K cap)
Age: 59 ½
Death
Disability
Distributions that are taxable but NO 10% early w/d penalty:
Higher education
Unreimbursed medical expenses excess 7.5% MAGI
Med. insurance premiums while unemployed
Substantially equal periodic payments
Inherited IRA Rules
Distribution Rules:
The decedent spouse’s holding period carries over, and the 5 year holding period must be satisfied for distributions to be tax free.
Spouse Beneficiary:
Elect 1. beneficiary OR 2. owner of Roth
*if BENEFICIARY elected then spouse can defer distros until the yr in which the original owner would have turned 73.
*if OWNER elected, then the spouse may continue making contributions into Roth &
The decedent spouse’s holding period carries over, and the 5 year holding period must be satisfied for distributions to be tax free.
IRA Prohibited Transactions
- Borrowing $ (loans not OK)
- Selling property to it
- Receiving unreasonable compensation for managing it
- Using it as a security for a loan
- Buying property for personal use w/ IRA funds
If any prohibited transaction occurs then:
1. IRA not treated as an IRA as of the 1st day of the yr.
2. Person must include full value of IRA in gross income
3. May have to pay 10% premature distribution penalty
IRA CANT invest in collectibles or life insurance
IRA CAN hold US Treasury minted gold/silver coins
Simple IRA
ER w/ < 100 EE
EE eligible if they make at least $5K & don’t have another retirement plan
- Contribution 15.5K (+3.5K if 50)
- Not subject to nondiscrimination & ADP rules
ER Contributions:
1. Match dollar for dollar up to 3%
2. Give all EE 2% compensation elective contribution
3. Match as little as 1% no more than 2 out 5 yrs
*EE who makes distributions w/in 2 yr of setup = 25% premature distribution penatly
403b Plan
Tax exempt organizations, governmental organizations, & public schools/colleges
- Contributions not taxable to EE
- Account balances tax deferred until w/d
- EE has investment risk
- Stocks & Bonds NOT permitted as investments in plan
- Life insurance only incidental to plan benefit.
457 Plan
For state & local gov’t agencies
Non church controlled tax exempt orgs.
- Contributions are pretax & grow tax deferred
- EE has investment risk
- During last 3 yrs before retirement, EE can double contribution (catch up provision CANT be included though)
- EE include distro of 457 in gross income when taken
SERP
Supplemental Executive Retirement Plan
NQP for “BIG WIGS”
- NQP that provides retirement income to top execs.
- Can bring income up to exec’s highest 3 yrs of compensation
- Social Security integration allowed
Nonqualified Stock Options
NQSOs
Grant: No taxable event occurs
Exercise: Bargain Element (FMV - Exercise Price) = W2 Income
Sale: Capital gain or loss
Incentive Stock Options
ISOs
Grant: No taxable event occurs
Exercise: NO ordinary income received
Sale:
Option 1: after 1 year from exercise & 2 yrs from grant = LTCG
Option 2: Within one year of exercise or within two years of grant, W-2 compensation income not subject to payroll taxes to extent FMV at exercise > exercise price, capital gain for any amount the sale price is > FMV on exercise date
RDM Rules
- Must be taken by April 1 the year AFTER person turns 73. Following RMDs must be taken by Dec 31
- 25% penalty on difference of RMD not distributed
Distribution Amount:
1. Dividing account balance (as of Dec 31st of previous yr) by distribution period.
Social Security
Must be fully insured in order to be eligible for Social Security retirement benefits.
Fully Insured Eligibility: (Persons age - 22)
6 credits minimum- 40 credits max
*Currently insured status will provide coverage for survivor benefits.
- Full old age (retirement) benefits for many individuals began as early as age 65 and provide a lifetime income based on the worker’s average earnings during the work years.
NOT COVERED:
1. Railroad workers
2. Certain Federal civil service workers
3. Certain state/local gov’t EE
Benefits:
1. Earliest a person can receive Soc. Sec benefits is age 62
2. Reduction in benefits for the worker if retirement benefits begin before FRA
3. Yearly benefits increase up to 8%/yr for delayed retirement up to age 70.
4. a. A person who is under FRA throughout the entire year in 2023 can earn up to $21,240 without impacting benefits.
b. A person who attains FRA in 2023 can earn up to $56,520 in the period before the month in which FRA is reached.
If provisional income exceeds all the thresholds given, then a maximum of ___________ of Social Security benefits are subject to taxation.
A maximum of 85% of the excess amount is taxable as ordinary income.
Social Security Benefits Thresholds
If provisional income is between:
$32,000 and $44,000 (MFJ) then the max
amount of Social Security benefits subject to tax is 50%.
If provisional income exceeds
$44,000 (MFJ) then max amount of Social Security benefits subject to tax is 85%
Fully Insured v. Currently Insured
Social Security Survivor Benefits
Fully Insured:
1. Income payable to a deceased worker’s spouse at age 65 OR at age 50 if the widowed spouse is disabled.
2. Monthly retirement income of 100% of the worker’s primary insurance amount at the insured’s full retirement age.
Currently Insured:
1. A $255 lump-sum death benefit, which is generally payable to the insured’s spouse.
2, A widow or widower’s income payable to a surviving or divorced spouse with a dependent child under the age of 16.
% Test to Determine if life insurance is an incidental benefit provided by a retirement plan
TERM & UNIVERSAL: 25%
WHOLE LIFE: 50%
Term insurance or Universal life: premiums CANT exceed 25% of the plan contributions for the participant.
Whole life policy =
premiums CANT exceed 50% of the plan contributions for the participant.
