Retirement Savings and Income Planning Flashcards
Features of Qualified Plans
- ER contributions are deductible
- EE contributions are deductible (except Thrift and Roth)
- ER contributions are never subject to payroll tax
- EE contributions are subject to payroll tax (except FSA)
- Earnings within the trust are tax deferred until distribution
- ERISA non-alienation of benefits (IRAs are protected under federal bankruptcy law, but not ERISA)
- NUA (no age requirement, taxation of cost basis is ordinary, taxation of NUA is LTCG - must be lump sum)
Highly Compensated
Either an owner >5% or compensation greater than $150,000.
Exception if compensation is greater than $150,000 and in the top 20% of employees ranked by salary (must be elected).
*>5% owner includes family attribution
Key Employees
> 5% owner
Officer with compensation > $215,000
1% owner with compensation > $150,000
Coverage Tests
All qualified plans must comply with one of three coverage tests - all concerned with the number of NHC employees who are covered.
1. General rule - plan must cover 70% NHC
2. Ratio percentage test - NHC% / HC% >= 70%
3. Average benefits percentage test - NHC AB% / HC AB% >= 70%
Additional coverage test for defined benefit plans only: 50/40 rule - must cover the lesser of 50 employees or 40% of nonexcludable employees.
Plan Selection
Age based profit sharing and DB plans - good for older owners
DB plans - allow for higher annual funding, generally benefit higher paid employees
DP plans and cash balance plans - require actuaries and have higher administrative costs
401k plans - allow for higher funding over SEP or PSP
SEPs and Qualified plans - can be set up after year end
PBGC
All DB plans are subject to PBGC except firms with fewer than 25 employees - if covered and under 25 employees, would not be deductible.
Pension plans pay yearly insurance premiums.
Profit Sharing Plans
Plan establishment by Dec. 31
Contribution by due date of tax return plus extensions
Generally cash contributions
Deductible contribution limit is 25% of covered comp
Valuation unnecessary
Eligibility is 21 and 1 year of service or 2 years if 100% vested (same as other qualified plans)
Allocation method of % of compensation or formula based on age/service of classification
Vesting of 3 year cliff or 2-6 year graduated
Provides portfolio diversification
No voting rights
Generally cash distributions
In service withdrawals after two years
Loans not usually allowed
Distributions fully taxable as ordinary income
Stock Bonus Plans
Plan establishment by Dec. 31
Contribution by due date of tax return plus extensions
Generally stock contributions
Deductible contribution limit is 25% of covered comp
Valuation generally annually
Eligibility is 21 and 1 year of service or 2 years with 100% vesting (same as other qualified plans)
Allocation method based on % of compensation or formula based on age/service of classification
3 year cliff or 2-6 year graduated vesting schedules
No portfolio diversification
Employee has voting rights
Generally stock distributions
In service withdrawals may be allowed after 2 years
Loans not usually allowed
Lump sum distributions will qualify for NUA tax treatment, otherwise taxed as ordinary income
*Similar to profit sharing
401k Hardship Distributions
- Must have immediate and heavy financial need and other funds are not available
- Amount available: total elective deferrals, QNECs, QMACs, and earnings on these contributions, less previous distributions
- Subject to ordinary income and possibly 10% penalty
- Can be for medical, residence, funeral, tuition, eviction, etc.
Multiple Plan Limitation
If an employer maintains both a defined benefit and a defined contribution plan, the maximum deductible amount is the GREATER of:
- 25% of the employer’s covered compensation, or
- The required minimum funding standard of the defined benefit plan
If multiple qualified plans, $22,500 (plus catch up) is a shared limit.
If a deferred compensation plan, can always contribute $22,500 limit.
Safe Harbor 401k Plans
Not required to pass ADP or ACP tests or top heavy rules.
Employer must provide one of the following:
1. 3% nonelective contribution to all eligible employees
2. matching contribution - 100% up to 3% and 50% from 3-5% (aka 100% up to 4%)
Employer contributions are 100% vested at all times.
SEPs
Can be established and funded as late as the due date of the return plus extensions.
Simplicity and ease of establishment.
Eligibility - 21 and earned $750 in 3 out of the last 5 years.
Contributions are discretionary and flexible.
Contribution limit is the LESSER of: 25% of covered comp. or $66,000. Max contribution includes the $66,000 PLUS IRA contribution of $6,500 (plus catch up).
No vesting since held in IRAs.
Can be integrated with social security income.
SIMPLE IRAs
Companies with 100 employees or fewer, each with $5k of compensation in preceding year. Mostly employee funded.
No other plans permitted.
Eligibility - $5k for previous 2 years and expected $5k in current year.
Uses IRAs as funding vehicle.
Limit EE $15,500, $3,500 catch up.
ER match $ for $ up to 3% or 2% NE.
Maximum match = $15,500.
*Early distribution - 25% penalty within two years from the period when the individual first participated.
*Primary difference of SIMPLE IRA and SIMPLE 401k is the loan provision in the 401k.
403b Plans
Typically employer deferrals only.
Limits are the same as 401k, including catch up.
ERISA plans must comply with ACP test (not ADP).
Additional catch up potential of $15,000:
- Limited to health, education, and religious employees.
- Limited to prior unused deferrals.
- Must have been employed for 15 years.
Only allowable investments are mutual funds and annuities.
Max contribution for 2023 is $33,000 (deferral + catch up + 15 year catch up)
Keogh Plans
Someone is self employed - entity must be sole proprietorship, partnership, LLC taxed as SP or partnership.
*No Keogh plans for corporations (do not have any self employed individuals).
Use earned income for the self employed.
Retirement plan contribution is based on self employment earnings.
Does not impact w-2 employees.
Restricted Stock
An employer provided plan designed to increase retention and compensate employees with a non-cash outflow.
Plan pays executives with shares of the employer’s stock.
Stock is restricted typically with a vesting schedule.
Restricted stock is taxable as ordinary income in the year it vests. Income = FMV on date of vesting minus any exercise price.
IRC Section 83b Election of Restricted Stock
Employee election to include value of stock in taxable income at date of grant rather than at date of vesting or when restrictions are lifted.
Any gain in value over the grant date is capital gain rather than w-2 income. *Effectively converts w-2 income into future capital gain.
If employee does not vest, or otherwise loses rights, no tax-deductible loss.
Employee’s holding period for stock received will be the date the amount was included in the employee’s gross income.
Election must be filed with the IRS no later than 30 days after the stock transferred.
Nondiscrimination testing for 401k plans
Benefits must be provided to a certain percentage of rank-and-file employees.
Negative elections are deemed to be an employee deferral unless the employee elects out.
ADP test and ACP test.
ADP Test (Actual Deferral Percentage Test)
Limits the employee elective deferrals for the HC based on the elective deferrals of the NHC.
AKA: HC employees are limited to what they can do based on what the NHCs are doing.
Looks at traditional and roth 401k contributions.
Failing the ADP Test
Corrective distributions: decreases ADP of HC - return portion of of contributions plus any earnings attributed.
Qualified non-elective contributions (QNEC): increases ADP of NHC, 100% vested, made to all eligible employees.
Qualified matching contributions (QMC): increases ADP of NHC, 100% vested, made only to employees who elected to defer in the current year.
ACP Test (Actual Contribution Percentage)
Like ADP, but utilizing employee after tax contributions (thrift and roth), and employer matching contributions.
Uses same scale as ADP and same corrective procedures.
Qualified Federal Disaster exception to 10% early withdrawal penalty
Must be a qualified individual with their principal place of residence in the disaster area and sustained economic loss due to disaster.
$22,000 aggregate over lifetime, included in gross income pro ratably over 3 years.
Repayment to a tax preferred retirement account within 3 years.
Retroactive for disasters on or after January 26, 2021.
72t Distributions
10% penalty exception for distributions from qualified plans.
Must be:
- substantially equal periodic payments
- made at least annually
- for the longer of 5 years or until 59.5
- for the life expectancy of the participant or joint lives of the participant and his designated beneficiary
- after separation of service
Methods of calculation: RMD method, fixed amortization method, fixed annuitization method
Important Numbers
- Covered Compensation
- Defined Benefit Maximum Limit
- Defined Contribution Maximum Limit
- 401k, SARSEP, 457, 403b, Employee Deferral Limit
- Highly Compensated Employee
- Key Employee
- Social Security Wage Base
- Covered Compensation: $330,000
- Defined Benefit Maximum Limit: $265,000
- Defined Contribution Maximum Limit: $66,000
- 401k, SARSEP, 457, 403b, Employee Deferral Limit: $22,500
- Highly Compensated Employee: $150,000
- Key Employee Officer: $215,000
- Key Employee 1% Ownership: $150,000
- Social Security Wage Base: $160,200
Standard eligibility requirements for qualified plans
An employee is eligible after 1 year of service (at least 1,000 hours) and age 21.
Part-time employees are now eligible to participate if they have completed at least 500 hours each year for 3 consecutive years and at least age 21 (SECURE act).
Standard exception to the specialty eligibility rules for qualified plans
As an exception, a qualified retirement plan may require that an employee complete 2 years of service to be eligible.
If elected by the employer, plan participants are 100% vested once eligible - NOT eligible for 401ks.
Top Heavy Defined Benefit Plan
More than 60% of the total accrued benefits of the plan are for the benefit of key employees.
Funding must be at least 2% x years of service x compensation factor.
Plan participants’ benefits must vest at least as quick as 2-6 year graduated or 3 year cliff schedules.
Top Heavy Defined Contribution Plan
More than 60% of the total account balances of the plan are for the benefit of key employees.
Funding is a 3% minimum to all eligible employees or less if less provided to the key employees.
Participants’ benefits must vest at least as quick as a 2-6 year graduated or 3 year cliff schedules.
Defined Benefit Maximum Plan Limitations
Covered comp - $330,000
Maximum benefit is the lesser of:
- $265,000 or
- Average of 3 highest consecutive years of compensation (or as defined in the plan summary documents)
Defined Contribution Maximum Plan Limitations
Covered comp - $330,000
Maximum benefit is the lesser of:
- 100% compensation or
- $66,000 (not including catch up)
25% Test
Consists of two tests - 25% and 50% depending on the type of life insurance provided.
- If term or universal policies purchased within the plan, aggregate premiums paid for the policy cannot exceed 25% of the employers aggregate contributions to the participant’s account.
- If whole lie purchased within the plan, the aggregate premiums paid for the policy cannot exceed 50% of the employers aggregate contributions to the participant’s account.
Defined Benefit Pension Plan
Annual actuary
Employer bears investment risk
Forfeitures must reduce plan costs
PBGC insurance
Credit for prior service
Social security integration to offset or excess
Commingled investment account
Favors older employees
Defined Contribution Pension Plans
No annual actuary (except target benefit at inception)
Employee bears investment risk
Forfeitures can reduce plan costs or allocate to other plan participants
No PBGC insurance
No credit for prior service
Social security integration for excess only
Separate investment accounts
Favors younger employees
Permitted Disparity
A technique of allocating plan contributions to employees’ accounts so that a higher contribution will be made for those employees whose compensation is in excess of the social security wage base.
Profit sharing plans only allow use of the excess method.
The excess rate is limited to the lesser of 2x the base rate or a difference of 5.7%. As a result, the excess rate is generally 5.7% higher than the base rate.
What entities are able to establish 401k plans?
Corporations
Partnerships
LLCs
Proprietorships
Tax-exempt entities
Roth 401k
$22,500 contribution limit
$7,500 catch up
No income limits, but must have income for the deferral
Does not allow conversions from a traditional IRA
Allows loans
A qualified distribution requires 5 years and on account of disability, death, or after 59.5
Non-qualified distributions consist of basis and earnings
Follow RMD rules
Stock Bonus Plan vs ESOP
Stock Bonus Plan
- Plan establishment by Dec. 31
- Contribution by due date of tax return plus extensions
- Generally stock contributions
- Deductible contribution limit of 25% of covered comp
- Valuation generally needed
- Eligibility is 21 and 1 year of service of 2 years with 100% vesting
- Allocation method is % of compensation or formula based on age/service of classification
- Integration with social security
- Vesting schedule of 3 year cliff or 2-6 year graduated
- No portfolio diversification
- Generally have voting rights
- Generally stock distributions
- In service withdrawals after two years
- Loans usually not allowed
- Distributions taxed as ordinary income with NUA treatment available
ESOP
- Plan establishment by Dec. 31
- Contribution by due date of tax return plus extensions
- Generally stock contributions
- Deductible contribution limit of 25% of covered comp plus interest paid on loan
- Valuation generally needed plus dividends
- Eligibility is 21 and 1 year of service or 2 years with 100% vesting
- Allocation method of % of compensation or formula based on age/service of classification
- No integration with social security
- Vesting schedule of 3 year cliff or 2-6 year graduated
- No portfolio diversification
- Voting rights
- Generally stock distributions
- In service withdrawals after two years
- Loans usually not allowed
- Distributions taxed as ordinary income with NUA treatment available
NUA
Taxpayers who receive a lump-sum distribution of employer securities (stock) may benefit from using a special tax treatment on distribution. Allows for the more favorable capital gain tax treatment instead of ordinary income tax treatment on the NUA portion until the distributed securities are sold.
The excess of the FMV of the employer stock at the date of the lump-sum distribution over the cost of the employer stock at the date the securities were contributed to the plan.
Eligible Designated Beneficiary
Surviving spouse
Child of employee/IRA owner who has not reached majority - at age of majority becomes designated beneficiary
Disabled or chronically ill
Any other individual NOT more than 10 years younger than the employee/IRA owner
Beneficiary can receive distributions over their remaining single life expectancy
Spouse only can rollover plan balance to their own IRA
Minor child must use designated beneficiary rules upon reaching age of majority
Designated Beneficiary (non-eligible)
Any individual designated as a beneficiary by the employee not meeting eligible requirements
Any beneficiary greater than 10 years younger
Account balance must be distributed by the 10th anniversary of the owner’s death
Non-Designated Beneficiary
Non listed beneficiary, charities, and some trusts
Before RMD - distribute account within 5 years
After RMD - distributions must continue over the remaining distribution period of the deceased owner - the decedent’s remaining distribution period is reduced by one each year
Disqualified person
A fiduciary of the plan
A person providing services to the plan
An employer, any of whose employees are covered by the plan
An employee organization, any of whose members are covered by the plan
Any direct or indirect owner of 50% or more of any of the following:
- The combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of a corporation that is an employer or employee organization
- The capital interest or profit interests of a partnership that is an employer or employee organization
- The beneficial interest of a trust or unincorporated enterprise that is an employer or employee organization
A member of the family of any individual
Catch Up (over 50) contribution amounts
Traditional IRA - $1,000
Roth IRA - $1,000
SEP - N/A
SARSEP - $7,500
Earned Income
W-2 income
Schedule C net income
K-1 income from an LLC (self employed income)
K-1 income from a partnership where the partner is a material participant (general partner)
Alimony payments for divorces pre-2019
Unearned Income
Earnings/profits from property, such as rental income, interest income, and dividend income
Capital gains
Pension and annuity income
Deferred compensation received
Income from a partnership for which you do not provide services that are a material income producing factor
Any amounts excluded from income - foreign income and housing costs
Unemployment benefits
Investment returns as a limited partner in a partnership
Income flowing from an S corporation via Schedule K-1
Social security benefits
Worker’s compensation
Alimony received post 2018
Prohibited Investments in an IRA
Mainly life insurance and collectibles. If either are purchased in an IRA, the purchase is deemed as distributions, and the value of the purchase is subject to tax and/or penalty.
Eagle coins are an exception.
Gold, silver, platinum, or palladium bullion are permitted as well.
Prohibited Transactions in an IRA
If an individual or beneficiary engages in any of the following, the account will cease to be an IRA as of the first day of the current taxable year:
- Selling, exchanging, or leasing any property to an IRA
- Lending money to an IRA
- Receiving unreasonable compensation for managing an IRA
- Pledging an IRA as security for a loan
- Borrowing money from an IRA
- Buying property for personal use with IRA funds
What entities can establish SIMPLE plans?
C Corporations
S Corporations
Limited Liability Companies (LLCs)
Partnerships
Proprietorships
Government Entities
SIMPLE eligibility
Employees who earned $5,000 or more from the employer in any two of the preceding calendar years
Employees are expected to earn $5,000 during the current calendar year
403b Plans
Available for not-for-profit institutions (ex. large universities)
Self-reliance savings plans - employee only contributions
If organized as a qualified plan, subject to ERISA
Establish by end of year
Elective deferral contribution limit $22,500 plus catch up
Available contribution $66,000 or 100% of compensation including elective deferrals
Additional after-tax contributions can be permitted by the plan
Employee has investment choices and bears risks
Limited to insurance annuities and mutual funds
10% early withdrawal penalty applies
Loans are permitted
Allows rollovers to IRA, qualified plan, or other 403b
Not ERISA protected if governmental or church TSA
100% vested at all times for contributions and earnings
457 Plans
Nonqualified deferred compensation plan
Employees of state and local government, tax-exempt governmental agencies, and 501 entities
Self-reliant, employee elective deferred savings
Not a qualified plan
Establish by end of year
Deferred compensation plan
Elective deferral contribution limit: lesser of $22,500 or 100% compensation plus catch up
Employee contribution is allowed but not usual
No additional after-tax contributions allowed
Employee selects investments and bears risk
Broad investment selection
10% early withdrawal penatly
Loans are NOT permitted
Public 457 plans can be rolled over
No ERISA protection
Allows in service withdrawals
ISO Holding Period Requirements
A qualified stock sale requires waiting 2 years from the date stock was granted and 1 year from the date the stock was exercised.
Sales prior to either holding period being met are disqualified dispositions and terminate most of the tax benefits - effectively it triggers similar treatment to NQSO.
ISO
Can only be granted to an employee of the issuing corporation
At the date of grant, the exercise price must be greater than or equal to the FMV
Cannot be transferred except at death
The aggregate FMV of ISO grants must be less than or equal to $100,000 per year per executive. Any excess grant is treated as NQSO
Executive must be an employee of the corporation continuously from the date of the grant until at least 3 months prior to exercise
Qualified Transportation and Parking
Regulations provide for an exclusion of the value of qualified transportation benefits from an employee’s gross income. This exclusion is subject to limitations:
- $300/month for commuter highway transportation and transit passes combined, and
- $300/month for qualified parking
For any given month, if the value of a benefit is more than the limit, any excess amount above the limit (less any amount the employee paid) is included in the employee’s income.
Taxation of Group Disability
Premiums paid by the employer are deductible by the employer and are not included in the employee’s gross income.
Any disability income benefit received by the employee is taxable if premium was paid for by the employer.
If the employee pays the entire premium with after-tax income or the employer pays the premium and the employee includes the payment in income, any benefits received will be considered tax exempt.
Allowed Cafeteria Plan Benefits
Accident and health benefits (but not medical savings accounts or long-term care insurance)
Adoption assistance
Dependent care assistance
Group term life insurance coverage (including costs that cannot be excluded from wages)
Cafeteria Plan Benefits NOT Allowed
Archer Medical Savings Account
Athletic facilities
De minimus benefits
Educational assistance
Employee discounts
Lodging on employer’s business premises
Meals
Moving expense reimbursements
No-additional-cost services
Transportation benefits
Tuition reduction
Working condition benefits
Split Dollar Insurance: Endorsement Method
The employer owns the life insurance policy on the employee and pays the policy premiums.
The employer withholds the right in the plan to be repaid for all of its premium either at the employee’s death or the surrender of the policy.
Usually any death benefit or cash surrender value in excess of the employer’s refund is paid to the beneficiary.
Split Dollar Insurance: Collateral Assignment Method
The employee owns the life insurance policy and the employer makes a loan to the employee to pay the policy premiums.
At the employee’s death or at the surrender of the policy, the employer loan will be repaid and any excess will be paid to the beneficiaries.
MSA
Established before 2006
For employers with less than 50 employees or self-employed individuals
Health insurance deductible: single $2,650 - $3,950; family $5,300 - $7,900
Max out of pocket: single $5,300; family $9,650
Max contribution: single is 65% of deductible; family is 75% of deductible
No catch up contribution
Nonqualified expenses taxed as ordinary income and a 20% penalty if under 65
HSA
Established 2004 or later
Any individual
Health insurance deductible: single at least $1,500; family at least $3,000
Maximum out of pocket: single $7,500; family $15,000
Max contribution: single is 100% of deductible limited to $3,850; family is 100% of deductible limited to $7,750
Catch up contributions of $1,000 if 55 and older after 2009
Nonqualified expenses taxed as ordinary income and 20% penalty if under 65
Social Security Eligibility Requirements
40 credits (quarters of coverage)
To earn 1 credit in 2023, worker must earn $1,640
Maximum of 4 credits earned per year
Social Security AIME
The worker’s average indexed monthly earnings - index the covered earnings for each year, selecting the 35 highest years, totaling those earnings and dividing by 420 (35 years x 12)
Social Security PIA
Primary Insurance Amount
The basic unit used to determine the amount of each monthly benefit payable under social security - the amount the worker will receive if they retire at full retirement age
Examples of non qualified deferred compensation arrangements
Golden Handshakes: severance package, often designed to encourage early retirement
Golden Parachutes: substantial payments made to executives being terminated due to changes in corporate ownership
Golden Handcuffs: designed to keep employee with the company
Disadvantages of qualified plans
Limited contribution amounts
Contributions cannot be made after money is received
Plans usually have limited investment options
No or limited access to money while an active employee
Distributions usually taxed as ordinary income above basis
Early withdrawal penalties
Mandatory distributions at 72
Only ownership permitted is by the account holder
Cannot assign or pledge collateral
Cannot gift to charity before 70.5 without tax consequences
Any year a deductible contribution is made to an IRA and a charitable distribution is made from an IRA, the allowable charitable deduction will be reduced by deductible contributions made after 70.5
Limited enrollment periods
Considered to be income in respect to a decedent asset, subject to income and estate tax and no step-up
Costs of operating the plan
PBGC Benefits at 65
Monthly - $6,750
Yearly - $81,000
Accrued Benefits vs Account Balance
Accrued Benefits - a defined benefit plan is subject to mandatory funding requirements calculated by an actuary. If termination prior to retirement, the benefit payable is equal to the benefit earned to date.
Account Balance - in a defined contribution plan the benefit is simply the account balance reduced by any non vested amounts.
Plan Loans
Qualified plans may permit loans up to the lesser of:
- 1/2 of the vested plan accrued benefit up to $50k, or
- the greater of $10,000 or the vested accrued benefit
Loans associated with 401k and 403b plans
Generally, must be repaid within 5 years, except if associate with the purchase of a personal residence, which must be reasonable and could be as long as 30 years
ESOP Requirements
The ESOP must own at least 30% of the corporation’s stock immediately after the sale.
The seller must reinvest the proceeds into qualified replacement securities within 12 months and hold them for 3 years.
The corporation must have no class of stock outstanding that is tradable on an established securities market.
The seller/relatives/25% shareholders in the corporation are precluded from receiving allocations of stock acquired by the ESOP through the rollover.
The ESOP may not sell the stock acquired through the rollover for 3 years.
The stock sold to the ESOP must be common or convertible preferred stock and must have been owned by the seller for at least 3 years prior to the sale.
*If the seller purchases and retains qualified replacement securities, there will be no taxable event.
