Retirement Savings/Income Planning

Question 1

Qualified Plans: Defined Benefit - Types of Defined Benefit Plans

Answer 1

Traditional Defined Benefit Plan

Cash Balance Pension Plan

Question 2

Traditional Defined Benefit Plan

Answer 2

Guarantees the final monthly pension amount
A “fully insured” traditional defined benefit plan is funded EXCLUSIVELY by cash value life insurance or annuity contracts (IRC Section 412(c)(3))

Question 3

Characteristics of ALL Defined Benefit Plans

Answer 3

• pension plans
• guarantee final benefit
• maximum annual pension benefit $245,000 (2022)
• maximum compensation considered in benefit formula $305,000 (2022)
• Only qualified plans insured by PBGC
• must vest at least as generously as 5-year-cliff or 3-7-year graded vesting (Cash Balance plan may use only 3-year cliff vesting)
• must have joint and survivor payout unless waived
• 100% employer funded; mandatory annual employer contributions
• Funding limit is whatever it takes to provide guaranteed benefits; no predetermined annual limits
• No participant-directed accounts; sponsor bears investment risk
• No predetermined maximum deductible employer contribution
• Annual actuarial work required to determine needed funding each year
• DB Plans are the most administratively expensive
• can favor older participants in plan
• must also satisfy 50/40 rule

Question 4

50/40 rule

Answer 4

The basic rule set out in the Internal Revenue Code is that each qualified plan must “on each day of the plan year” benefit the lesser of: (i) 50 employees of the employer, or (ii) 40% or more of all employees of the employer. This is a new annual requirement that must become a part of the yearly administration.

In a Defined Benefit Plan, generally, at least 40% of qualifying employees (but not more than 50) need to receive a meaningful benefit every year. If there are only one or two qualifying employees, typically all of them must receive a meaningful benefit each year.

Question 5

When is a DB plan suitable?

Answer 5

• benefit guarantees are desired
• PBGC insurance coverage is needed
• stated goal is to skew older participants

Question 6

DB Pension formula calculation example

Answer 6

Stan is a long-time executive with XYZ Corporation, and he is retiring this year. XYZ Corporation sponsors a traditional defined benefit pension plan and Stan has participated in the plan for 35 years. The pension formula is 2% of Stan’s final salary per year of service. Stan’s salary is $500,000 per year. What is Stan’s annual pension under the plan?

35 x 0.02 x $305,000

Question 7

Additional characteristics of a Traditional DB Plan

Answer 7

• guarantees monthly pension
• older, high-earning participants can have substantial funding on their behalf
• common pension formula is a percentage of pay times the number of years of service
• no individual accounts
• accruing a benefit of any amount is active participation for IRA deduction purposes
• if participant is married the pension must be joint and survivor unless spouse waives (notarized!)

A traditional DB Plan provides the highest level of guarantees for the participant but is the most expensive plan to administer; may be correct answer if the sponsor has numerous older management/owner participants, and the company has good financial standing and stable cash flows.

Question 8

Section 403(b) Plan (TSA) - features

Answer 8

used by 501(c)(3) tax exempt organizations (hospitals) and public schools

Tax benefits:
pre-tax contributions
tax deferred growth and income

Salary reductions: up to $20,500

Age 50 Catch up: $6,500

Special Catch up:
minimum of 15 years of service with the sponsoring school or 501(c)(3) employer
Additional deferral allowance of $3,000/yr
May be used in the same year as 50+ catch up
Age 50+ with 15 years of service may defer up to $30,000: ($20,500 + $6,500 + $3,000)

RMD @ 72

10% penalty on distributions prior to 59 1/2

Can be rolled into IRA or Qualified Plans if withdrawal is allowed

AGGREGATED with other plan deferrals in applying annual maximums

Investment Choices limited to Mutual funds and Annuities

Question 9

Governmental Section 457(b) Plan - features

Answer 9

used by government and certain non-profit organizations

Tax advantages:
pre-tax contributions
tax deferred growth and income

Salary reductions:
$20,500

50+ catch up: $6,500

Special catch up:
for last 3 years of service (at plan normal retirement age)
unused deferrals from the past
Up to twice the normal contribution limit ($41,000)
50+ catch up may NOT be used in same tax year as special catchup allowance is used

NO 10% penalty for withdrawal prior to 59 1/2

RMD @ 72

Can be rolled into IRA or Qualified Plans if withdrawal is allowed

Section 457 deferrals are NOT AGGREGATED with other salary deferrals in applying annual maximums

NOT considered ACTIVE PARTICIPANT for IRA deduction purposes

Question 10

Capital Preservation Approach vs Purchasing Power Preservation Approach

Answer 10

Additional capital needed on day 1 of retirement to leave same amount at death as capital utilization approach requires

Begin with capital utilization annuity due PV (assume $1,000,000)
Nominal ROR = 7%
Inflation Adjusted ROR = 5.8%
20 years until retirement

$1,000,000 = FV
20N
7 I/YR
0 PMT
PV ? $258,419, add to $1,000,000

Purchasing Power Preservation Approach uses inflation adjusted ROR rather than nominal ROR

Question 11

Purchasing Power Preservation Approach

Question 12

Qualified Plans: Defined Contribution Plan

Answer 12

sponsor defines contribution formula rather than a guaranteed final benefit

mandatory employer contributions, substantial & recurring (no annual mandate)

favor younger participants with more years to accumulate

6 types: 4 profit-sharing, 2 pensions

all profit-sharing are DC plans

pension plan may be DB or DC

annual additions limit includes:
employer contributions
employee elective deferrals
reallocated forfeitures

Question 13

Profit-sharing plans

Answer 13

Traditional profit-sharing
401k
Stock bonus
ESOP

Question 14

DC Pension Plans

Answer 14

Money Purchase Pension Plan

Target Benefit Pension Plan

Question 15

Defined Contribution Plans - Features

Answer 15

Participant-directed accounts

Annual additions limit for combined EE/ER: $61,000

Maximum elective deferral: $20,500

Maximum compensation considered in benefit formula: $305,000

Participant bears investment risk

No guaranteed final benefit

Vesting must be at least as generous as 3-year cliff or 2-to-6-year graded

Maximum deductible ER contribution: 25% of covered payroll

Forfeitures may be reallocated or used by ER to offset plan expenses

Participant easy to understand

No PBGC insurance

Question 16

Traditional Profit-Sharing Plan

Answer 16

All DC plan features +

Flexible year-to-year contribution, must be substantial & recurring (3 out of 5 years) but not every year

100% ER funded

Yearly profit not mandatory for contributions, can be made from cash flow or retained earnings

in-service loans and hardship withdrawals permitted

Can be 100% invested in ER stock

not subject to QJSA

age-weighted, can skew higher contributions to older participants

Question 17

401k Plan

Answer 17

All DC plan features +

CODA provision added to underlying profit-sharing plan, stock bonus, or ESOP

EE can make annual elective deferrals up to $20,500 (catch up 50+ 6,500)

annual ER contributions not required but usual ER match, profit sharing contributions also possible

participant loans and hardship withdrawals permitted

ER contribution can be 100% ER stock

minimum of 3 diversification options for elective deferrals are required

participation in multiple 401ks: annual deferral limit is aggregated

EE contributions subject to ADP testing, ER contributions subject to ACP testing

Question 18

Money Purchase Pension Plan

Answer 18

All DC plan features +

Mandatory annual ER contributions, 100% ER funded

ER contribution is typically a percentage of EE’s compensation

May invest in no more than 10% ER stock

No in-service withdrawals until 62

Subject to QJSA

Question 19

Maximum retirement plan contribution for SE Owner

Answer 19

1. Subtract 1/2 SE tax from net earnings from SE
2. Multiply adjusted employer plan contribution rate
   a. adjusted rate: ER contrib rate % / 1+ER contrib rate %
   b. max rate of 25% becomes 20% for owner
   c. rate adjustment does not apply to EEs (if plan contrib
   rate is 25%, EE receives 25% contribution)
   If plan contribution rate is 25%, can use shortcut of 18.49% of net earnings from SE.

Example with SE with $100,000 net earnings:
$100,000 - 7.65% = $92,350
0.25 / (1+0.25) = 0.20
$92,350 x 0.20 = $18,470 = max contribution

Shortcut: $100,000 x 18.49% = $18,490

Question 20

SEP

Answer 20

easy to set up and maintain

ER with 1 or more EEs

No annual filing, can be established and funded up to ER’s tax return, incl. extensions

up to 20% of covered comp, not to exceed $61,000

ER discretion re: annual contributions

21 years old, 3 out of 5 years, comp of $650 or more

withdrawals permitted anytime subject to federal income tax and early withdrawal penalty, no loans

100% immediate vesting

Question 21

Simple IRA

Answer 21

EE salary reduction, and ER contributions (mandatory!)

Little administrative paperwork

ER with up to 100 EEs, no other retirement plan

No annual filing requirement

Max deferral: $14,000, catch up 50+ $3,000

ER 3% match (can be reduced to 1% in 2 out of 5 years) or 2% of each eligible EE’s comp

EEs who have at least $5,000 of comp in any 2 prior years and reasonably expected to earn $5,000 in current year

Withdrawals permitted subject to federal taxes and early withdrawal penalty of 10%; if withdrawals within first 2 years penalty tax of 25%

No loans allowed

All contributions are 100% immediately vested

Question 22

IRA Contribution Deduction Rules

Answer 22

Active Participation Status;
- Defined Contribution Plan: anyone who received annual additions (ER contributions, EE deferrals, forfeitures reallocated to remaining participants)

• Defined Benefit Plan: anyone who is eligible for the plan is accruing a benefit and is considered an active participant
• Participants in a SEP, Simple, Section 403(b) Plan (TSA) are active participants for IRA purposes

Participants in a 457 plan are NOT considered active participants for IRA purposes.

Question 23

IRA and Employer-Sponsored Retirement Plan Rollovers

Answer 23

Traditional Rollover:

• one traditional rollover allowed per year
• plan administrator transfers vested account balance or portion to participant
• within 60 days participant deposits funds into IRA or different employer plan
• traditional rollover from qualified plan requires mandatory 20% federal income tax withholding by employer (not for IRA to IRA!)
• if withheld amount is not replaced and deposited with the rollover the withholding amount is considered distributed and subject to income tax and possible 10% penalty

Direct transfer rollover:

• no annual limit on number of direct transfers per year
• plan trustee transfers rollover directly to IRA or another employer plan
• participant does not take possession of the funds
• no mandatory tax withholding

Question 24

Inherited IRA Distribution Requirements

Answer 24

Inherited traditional IRA, qualified plan, or tax-advantaged employer plan account

• Spouse beneficiary:
  
  • has choice of being treated as IRA owner or beneficiary of an inherited IRA
  • if spouse beneficiary chooses to be treated as owner, they may defer RMD until 72
  • may combine (roll) inherited IRA with own IRA
• Non-spouse beneficiary / See-Through Trusts / Successor Beneficiaries:
  
  • 10-year rule
• Eligible designated beneficiary: (distributions can be taken over life of beneficiary except for minor children, after maturity, 10-year rule applies)
  
  • Spouse
  • chronically ill beneficiary
  • disabled beneficiary
  • minor children (<18)
  • beneficiaries no more than 10 years younger than IRA owner
• Non-Designated Beneficiary (Estate, Charities, Trust not qualifying as Designated Beneficiary):
  
  • 5-year rule

Roth IRA:
NO RMD during life of owner
- Spouse beneficiary can become owner and forego RMDs for life
- Non-spouse beneficiary subject to RMDs

Question 25

Exceptions to Early Withdrawal Penalties: Traditional IRAs, IRA ER-Funded Plans, QPs

Answer 25

10% penalty on withdrawals before 59 1/2 unless exception applies (SIMPLE IRA first 2 years 25% penalty)

Exception When QPs Trad. IRA/ER-Funded IRA
Medical unreimbursed expenses >7.5% of AGI Y Y
Education qualified higher education N Y
Age after 59 1/2 Y Y
Death participant/IRA owner’s death Y Y
Disability total & permanent participant/IRA owner Y Y
Health Ins. premiums while unemployed N Y
Equal Payments series of substantially equal payments Y Y
Home Buyers first-time homebuyer, up to $10k lifetime N Y
Sep. from Service at/after EE reaches 55 Y N

Question 26

Penalty exception for separation from service applies to which types of retirement plan?

Answer 26

Qualified Plans only

Question 27

Which early withdrawal penalty exceptions are ONLY allowed by an IRA?

Answer 27

qualified higher education expenses
health insurance premiums
first-time homebuyers

Question 28

Roth IRA Distributions

Answer 28

Qualified distributions from a Roth IRA are TAX FREE

Qualified distribution requirements:
1. must be made after the 5-year period beginning with the first taxable year for which the individual made a Roth IRA contribution
AND
2. must occur in relation to one of the following:
- account owner’s death
- account owner being disabled
- first-time home purchase (lifetime $10k max)
- 59 1/2

Non-qualified Roth IRA distributions:

• account earnings: subject to regular income tax and 10% penalty
• Roth Conversion Contribution: no regular income tax, distribution within 5 years of conversion may be subject to 10% penalty
• Regular Roth Contribution: no regular income tax, no penalty

Question 29

Order of Distributions from Roth IRA

Answer 29

1. Contributions
2. Roth Conversions
3. Earnings

Question 30

Required Minimum Distributions

Answer 30

Penalty for failure to comply is 50% of the shortfall

                                                                         IRA                                                  401k

Deadline 1st RMD 4/1 after year of turning 72, Later of 4/1 after turning 72 or actual
even if employed retirement; not available to > 5% owners,
only for current ER plan

Deadline RMDs after
first RMD 12/31 of current year 12/31 of current year

Calculation of RMD FMV of combined accounts FMV of combined accounts
as of 12/31 prior year divided as of 12/31 prior year divided
by age factor by age factor

RMDs multiple accounts may distribute combined RMD each account RMD must be calculated
from 1 or more IRAs and distributed separately

Withdrawing more than
one RMD Allowed Allowed

Multiple withdrawals to
satisfy RMD Allowed Allowed

Penalty for failure to 50% on undistributed 50% on undistributed
distribute RMD amount amount

Question 31

Recommending a Qualified or Non-Qualified Plan

Answer 31

Qualified Plans:

• Pension
• Profit-sharing
  - Section 401k

Tax-Advantaged Plans (with characteristics like QP):

• SEP
• SIMPLE IRA

Non-Qualified Plans:

• Non-qualified deferred compensation
• Supplemental Executive Retirement Plan (SERP)
• Top Hat Plan
• Section 162 Bonus Plan

Choice between a qualified plan and a non-qualified plan can be determined by the employer’s ranking of 3 common elements:

1. currently deductible employer plan contributions
2. Benefits not currently taxable to the employee / participant
3. Employer can limit participation to select individuals (pick and choose)

An employer may select any 2 of the 3, and the choices will dictate the plan category.

Question 32

Non-Qualified Stock Options (NQSO)

Answer 32

Grant:
ER awards executive with option to purchase a specified number of shares of the ER’s stock at a specified price
- no tax consequence at grant
- options are subject to vesting schedule before they can be exercised

Exercise:
EE purchases ER stock at the price specified at grant
- difference between exercise (strike) price and FMV on date of exercise =
“bargain element”
- in year of exercise, executive recognizes compensation income in the amount of the bargain element (marginal regular income tax!)
- compensation income recognized is subject to payroll taxes
- ER claims deduction for compensation recognized by executive
- executive’s basis in the stock purchase is the sum of the
exercise price paid and the compensation income recognized

Sale:
Stock acquired at exercise is sold
- difference between sale price and basis is taxed at capital gain (STCG or LTCG)

No restrictions on the terms of the grant!
NQSOs may be issued to EE or a beneficiary of the EE!
NQSOs may be transferred (gifted) during lifetime of the original recipient!

Question 33

Incentive Stock Options (ISOs)

Answer 33

tax-favored plan for compensating executives by granting options to buy company stock at specific exercise prices
no taxable income to executive at time of grant or exercise - if ISO meets requirements of IRC Section 422, executive is taxed only when stock purchased under the ISO is sold, except for potential AMT

• corporation may not receive a deduction
• may create AMT
• no more than $100,000 per year may be granted

Question 34

3 Phases of an ISO

Answer 34

Grant:

• no taxable event
• strike price = market value

Exercise:

• stock is purchased for strike price
• positive AMT adjustment in the amount of bargain element
• bargain element [(Exercise Price - Strike Price) x # of shares] not subject to current taxation

Sale:
- stock is sold
- Negative AMT adjustment: if stock price at time of sale ≥ price of stock at the time ISOs were exercised, adjustment will be negative adjustment for the same amount as original positive AMT ISO adjustment
- Capital gain or loss on difference from strike price if Qualifying Disposition (sale at least 2 years from grant AND 1 year from exercise)
- Disqualifying Disposition: gain not taxed as capital gain
Taxation options:
- stock bought and sold in same year: ordinary income and
FICA
- employer receives deduction
- stock bought and sold within 1 year but not within same
calendar year: ordinary income

For a qualifying disposition, the entire spread from grant price to sale price multiplied by the number of shares qualifies for LTCG treatment.

Question 35

Non-Qualified Stock Options (NQSOs) & Incentive Stock Options (ISOs)

Answer 35

2 types of options:
- NQSOs:
- subject to vesting
- can be transferred or gifted to family members, trust, or
charitable organizations
- corporation receives deduction when EE pays tax at exercise

• ISOs:
  - corporation may not ever receive a deduction
  - may increase AMT
  - no more than $100,000 per year may be granted

                      NQSO                                  ISO Grant      no taxable event                     no taxable event

Exercise Bargain element Bargain element not subject
subject to W-2 tax current taxation, preference
item for AMT

Sale Capital gain or loss on Capital gain or loss on
difference from strike price difference from strike price
+ W-income recognized at if qualifying disposition (1 yr
exercise from exercise, 2 yrs from
grant)
If holding period not met,
disqualified and becomes
NQSO

                                                             Taxation of disqualifying 
                                                             disposition:
                                                             stock bought and sold in 
                                                             same year: OI & FICA,
                                                             ER receives deduction

                                                             stock bought and sold 
                                                             within 1 yr but not same
                                                             calendar year: OI not
                                                             subject to FICA, ER
                                                             receives deduction

Question 36

Social Security (OASDI)

Answer 36

funded through payroll taxes assessed on earned income:
7.65% from EE, 7.65% from ER on earned income up to $147,000; 1.45% from EE and ER is paid on unlimited earned income

1 quarter of coverage (SS credits) is earned for each $1,510 of earned income subject to SS taxes with a maximum of 4 credits earned per calendar year without regard to when in the year the income is earned

Retirement income benefits require fully insured status of 40 earned credits

Worker’s current spouse, former spouse, and dependents may also qualify for benefits under eligible worker’s record

Retirement benefits: 62 or older with at least 40 earned credits
Disability benefits: 18 or older and unable to work due to physical or mental disability expected to last at least 12 months or result in death
Survivor benefits: family members of deceased workers who qualified for SS

Question 37

Calculation of AIME and PIA for SS Retirement Benefits

Answer 37

AIME - Averaged Indexed Monthly Earnings:

• based on 35 best years of SS earnings
• adjusts (indexes) each year’s earnings to present day dollars
• calculates average monthly earnings in current dollars

AIME is then used to calculate Primary Insurance Amount (PIA):

• PIA = monthly retirement benefit at FRA
• breaks average earnings down based on bend points
• 2022: bend points = $1,024 and $6,172

Benefit formula:
90% of first $1,024
+ 32% of next $5,148 ($6,172-$1,024)
+ 15% of excess above $6,172

$2,500 AIME worker:
$1,024 x 90% = $922
($2500-1024) x 32% = $472
PIA = $922+$472 = $1394 (50% wage replacement)

$10,000 AIME worker:
$1024 x 90% = $922
($6172-$1024) x 32% = $1647
($10,000-$6172) x 15% + $574
PIA + $922 + $1647 + $574 = $3,143 (31% wage replacement)

Question 38

SS Early or Delayed Retirement

Answer 38

62 = earliest age one may claim SS retirement benefits

• reduced for early retirement (prior to FRA)
• benefit amount = permanently reduced
• COLA still applied

Benefits are increased by 8% per year if delayed beyond FRA to age 70
(= delayed retirement credits); no delayed credits are earned beyond 70

Reduction credits formula is applied to PIA:

• Early retirement formula (reduced benefit): 5/9% for each of first 36 months worker is claiming benefits prior to FRA PLUS 5/12% for each month over 36 months worker is claiming benefits prior to FRA up to an additional 24 months
• current maximum reduction is 30% for a worker whose FRA is 67 and claims benefits at 62 (60 months prior to FRA)

Delayed Retirement Formula (increased benefit):
- 2/3% per month or 8% annually until age 70 (over a maximum period of 48 months 32% increase)

Question 39

Taxation of SS Benefits

Answer 39

3 elements play a role:

• claiming benefits prior to or after FRA
• impact of earned income when claiming prior to FRA
• taxation of benefits

Tax structure for SS benefits is the same for retirement, survivor, and disability benefits.
Inclusion for income tax purposes is based on provisional income:
- 50% of SS benefits + tax exempt income + AGI (without SS) = provisional income
- no greater than 85% of a worker’s SS will be subject to income tax, a minimum of 15% will always be tax free

MFJ:
$0 - $32k not taxable
$32k - $44k 50% taxable
> $44k 85% taxable

Single:
$0 - $25k not taxable
$25 - $34k 50% taxable
> $34k 85% taxable

MFS (living in same household):
> $0 85% taxable

Question 40

Spousal SS Retirement Benefits

Answer 40

Eligible spouse or former spouse

• current spouse is eligible if the worker is receiving benefits
• former spouse

Age rules: minimum = 62

Payment amounts

• based on worker’s PIA
• max 50% at spousal claimant FRA
• prior to spousal claimant FRA: benefit reduction formula applies (max 50% benefit is reduced)
• If spouse has dual eligibility (own record and their spouse’s) spouse is required to file for both benefits, will receive the higher amount (not the combined total)

Government Pension Offset:
If beneficiary claiming spousal benefit receives a government pension benefit for which SS taxes were not paid the SS spousal retirement benefit will be reduced by 2/3 of the government pension amount.

Benefits for current spouse are subject to maximum family benefit rules (former spouse benefits are not)

Former spouse benefits are not included in application of maximum family benefit

Current spouse entitlement:

• worker must have filed for his/her own benefit
• must have been married for at least 1 year
• must still be married

Former spouse entitlement:

• worker must be at least 62
• must have been married for at least 10 years, currently unmarried, and divorced for at least 2 years

Eligibility for current and former spouse:

• Full benefit at FRA
• can start as early as 62 (reduced by 8.33% per year, plus 5% / year beyond 3 years early)
• no delayed retirement credits past FRA

Question 41

Medicare

Answer 41

funded by payroll tax (1.45% EE/ER) on unlimited income; additional 0.9% above $200,000/$250,000 MFJ

Part A: Hospital

• most participants pay no premium
• must be 65 or older and paid into Medicare for at least 10 years
• flat per hospitalization deductible for days 1-60; Co-pay for days 61-90; over 90 days uses lifetime reserve days up to 90 additional days and requires even higher co-pay
• costs beyond 180 days are paid by individual

Part B: Medical (non-hospital)

• optional but highly recommended; requires premium - most pay a standard premium; higher income individuals pay higher premium
• annual deductible - after deductible Medicare pays 80%, individual pays 20%

Part C: Medicare Advantage
- Alternative to A & B; typically vastly lower premiums than Medicare A and B combined with a Medicare Supplement (Medigap) insurance policy; some plans have zero premiums; gatekeeper concept, must use network providers

Part D: Prescription Drugs

• optional but highly recommended; requires premium; Medicare Advantage plan may include prescription drug coverage
• deductibles and co-pays can be paid by Medicare Supplement (Medigap) policy

Question 42

Social Security Retirement Benefits for Others Based on a Worker’s Record

Answer 42

Current Spouse Former Spouse Child

Married at least 1 yr Married at least 10 yrs < 18 or 19 if in high
school or adult
disabled < 22
62 or older (any age 62 or older
if caring for unmarried
child < 16)

Worker must be Worker does not need Worker must be
receiving benefits to receive benefits receiving benefits

Benefit subject to Benefit not subject to Benefit subject to
reduction under family max family benefit rules reduction under
max benefit rules family max benefit
rules

Max benefit at current Max benefit at former Max benefit
spouse’s FRA is 50% of spouse’s FRA is 50% of 50% of worker’s
worker’s PIA, reduced prior worker’s PIA, reduced prior PIA
to FRA to FRA

Question 43

Qualified Plan Net Unrealized Appreciation (NUA)

Answer 43

If a qualified plan participant’s account holds employer securities, special tax-advantaged treatment is available in a qualifying lump-sum distribution (NUA tax treatment)

• applies only to ER stock
• must be executed as part of a qualified lump-sum distribution (100% of EE’s account within 1 year)
• ER contribution basis is taxed as OI in year of distribution
• NUA at time of plan lump-sum distribution is tax-deferred:
  NUA = difference between FMV of ER stock and ER basis in the contributed
  stock at time of contribution
  - taxed as LTCG when subsequently sold without regard to holding period
  - subsequent appreciation is STCG/LTCG based on holding period after
  lump-sum distribution
  - no step-up in basis at death for NUA portion remaining

Example:
401k with $400k taxed at OI at 35% tax rate leaves $260k net
With NUA election, if $100k ER basis of stock, $100k taxed at OI, $300k taxed at 15% LTCG, leaves $400k - ($35k + $45k) = $320k net

Question 44

Qualified Domestic Relations Order (QDRO)

Answer 44

must contain certain specific information:

• participant and each alternate payee’s name and last known mailing address
• amount or percentage of participant’s benefits to be paid to each alternate payee

a spouse or former spouse who receives QDRO benefits from a retirement plan reports the payments received as if he/she were a plan participant

• may roll payout over to an IRA or another qualified plan
• if not rolled over, subject to income tax and possibly 10% penalty if (former) spouse < 59 1/2
• QDRO payor is not subject to income tax or penalty

QDRO distribution paid to a child or other dependent is taxed to the plan participant

Question 45

Provisional Income for Social Security Taxation Purposes

Answer 45

One-half of Social Security + tax-exempt interest + other AGI

Question 46

Medicare Part B provides what percentage after annual deductible?

Answer 46

provides coverage for outpatient physician care under Part B

After the annual deductible is satisfied Medicare Part B pays for 80% of eligible expenses

Question 47

SS sample calculation

Answer 47

Terry, age 65, claimed Social Security retirement benefits at age 62. In 2022, his annual income includes:

$12,000 Social Security
$4000 Qualified dividends
$24,000 Defined benefit plan pension
$6,000 Municipal bond interest
$6,000 Part-time job wages
If Terry files his taxes as married filing separately and claims the standard deduction for 2022, what is his marginal income tax rate?

0%
10%
12%
22%

Solution:
Taxable income = $10,200 Social Security (85% x 12,000) + $4,000 dividends + $24,000 pension + $6,000 wages.

$44,200 AGI – ($12,950 + $1,400 additional age 65+ standard deduction) = $28,850 taxable income. A MFS taxpayer uses the same tax brackets as a single taxpayer. Taxable income of $28,850 places Terry in a 12% marginal income tax bracket. The 12% bracket applies to taxable income of $10,276 to $41,775 for 2022.

Question 48

Which of the following plans is suitable for a company that wants to make currently deductible contributions to a retirement plan but does not want the contributions to be currently taxable to the participant?

A non-qualified deferred compensation plan
A Section 162 bonus plan
A supplement executive retirement plan (SERP)
A savings incentive match plan for employees (SIMPLE)

Answer 48

A SIMPLE meets the employer’s objectives. A NQ deferred compensation plan and a SERP are not currently deductible to the employer. A Section 162 bonus plan is currently taxable to the employee/participant.

Question 49

SERP

Answer 49

• deferred-compensation plan
• not a qualified plan, thus, no special tax treatment for the company or the employee
• offered to executives as a long term incentive
• no immediate tax advantages to the company or the executive
  When benefits are paid, the company deducts them as a business expense.
• used as a way to reward and retain key executives
• can be offered selectively to key executives, whose contributions to the company’s qualified plan, such as a 401(k), are limited by the maximum annual contributions or the income eligibility limits, or both.
• company and the executive sign an agreement that promises the executive a certain amount of supplemental retirement income based on various eligibility conditions that the executive must meet
• company funds the plan out of its current cash flows or through funding of a cash-value life insurance policy. The money, and the taxes on it, are deferred. After retiring, the executive can withdraw the money and must pay state and federal taxes on it as ordinary income.

Question 50

Net Unrealized Appreciation (NUA)

Answer 50

• special tax-advantaged treatment available in a qualifying lump-sum distribution from a qualified plan (= Net Unrealized Appreciation (NUA) tax treatment)
• Applies only to employer stock held in qualified plan.
• Must be executed as part of qualified lump-sum distribution.
• Qualified lump-sum distribution must be 100% of employee’s account within one year.
• Employer contribution basis is taxed as ordinary income in year of distribution.
• NUA at time of plan lump-sum distribution is tax-deferred.
• NUA = difference at the time of the lump-sum distribution between the FMV of the employer stock and the employer basis in the contributed stock at the time of the contribution.
• Taxed as LTCG when subsequently sold without regard to holding period.
• Subsequent Appreciation is STCG/LTCG based on holding period after lump-sum distribution.
• No step-up in basis at death for NUA portion remaining.

Question 51

Qualified Roth IRA Distributions

Answer 51

• distribution must be made after 5-year period beginning with first taxable year for which individual made a Roth IRA contribution
  AND
• distribution must occur in relation to one of the following circumstances:
  a. account owner’s death
  b. account owner’s disability
  c. first time home purchase ($10k lifetime max)
  d. made on or after individual attains 59 1/2

Question 52

Non-qualified Roth IRA distributions

Answer 52

Account Earnings: subject to regular income tax and 10% penalty

Roth Conversion Contribution: No regular income tax, distribution within 5 years of conversion may be subject to 10% penalty

Regular Roth Contribution: no regular income tax, no penalty

Question 53

Sophie has net earnings from self-employment of $130,000. How much will she pay in Social Security SE tax this year?

$19,890
$18,368
$16,964
$9,945

Answer 53

Sophie must pay a 15.30% SE tax on 92.35% of her net earnings from self-employment.

($130,000 x 0.9235) x 0.153 = $18,368

Question 54

What is the tax treatment of a disqualifying ISO?

Answer 54

When an ISO is sold and the transaction is categorized as a disqualifying disposition, the bargain element [(Exercise Price – Strike Price) x # of shares] will be taxed as ordinary income, subject to FICA tax.

Question 55

True or False: In retirement needs analysis, Social Security retirement benefits are adjusted for inflation to the retirement year and subtracted from the current income replacement need.

Answer 55

Social Security retirement benefits will automatically be adjusted for inflation so the currently projected benefit is subtracted from the current income replacement need.

Question 56

Who currently receives SS statements in the mail?

Answer 56

Individuals between 25 and 60 who are paying into the SS System.

Question 57

Under the excess method for integration with Social Security, what is the maximum excess contribution rate to the plan if the base contribution percentage is 6%?

10%
5%
11.7%
25%

Answer 57

Under the excess method, the maximum excess contribution rate for compensation above the compensation threshold is the lesser of:

2x the base contribution rate or
the base contribution rate plus 5.7%.
In this example, the base rate + 5.7% (6% + 5.7% = 11.7%) is the maximum excess contribution.

Question 58

When is a plan considered top-heavy?

Answer 58

A plan in which more than 60% of the plan benefits or contributions are for key employees is deemed top-heavy.

Question 59

Suzi, age 40, is paid a salary of $120,000 per year. Her employer sponsors a group term life insurance plan providing coverage of three times salary. If the IRC Section 79 rate for Suzi’s age is $0.10 per thousand, per month, what amount of Suzi’s taxable benefit must be recognized for this year if she contributes $10 per month for the coverage?

$0
$310
$36
$252

Answer 59

Suzi must recognize an economic benefit of $252:

3 x 120,000 = 360,000

360,000 – 50,000 = 310,000

310,000/1,000 = 310

310 x 0.10 x 12 = 372

372 – 120 = 252

Question 60

According to IRC Section 72(p), what aggregate amount can be borrowed from qualified plans?

Answer 60

IRC Section 72(p) provides that aggregate loans from qualified plans to any individual plan participant cannot exceed the lesser of:

$50,000, reduced by the excess of the highest outstanding loan balance during the preceding one-year period over the outstanding balance on the date when the loan is made, or
One-half the present value of the participant’s vested account balance or accrued benefit, in the case of a defined benefit plan.

Question 61

If ordinary (whole life) life insurance is used in a defined benefit plan, what is the maximum death benefit the life insurance may provide without violating the “incidental” test for life insurance in a qualified plan?

No more than 10 times the projected monthly pension benefit.
No more than 50% of plan contributions.
No more than 25 times the projected monthly pension benefit.
No more than 100 times the projected monthly pension benefit.

Answer 61

The participant’s insured death benefit must be no more than 100 times the expected monthly pension benefit (100 times limit).

Question 62

How is the economic value of pure life insurance in a qualified plan taxed?

Answer 62

The economic value of pure life insurance is taxable annually to the participant. Any premium contributed to the plan by the participant is subtracted from the taxable annual economic benefit amount.

Question 63

What is the maximum percentage of qualified plan contributions that may be allocated to ordinary (whole life) life insurance on behalf of a participant in a defined contribution plan to comply with the “incidental” regulations for life insurance in a qualified plan?

Answer 63

In a defined contribution plan, no more than 50% of contributions on behalf of a participant may be allocated to ordinary life insurance.

Question 64

What is the maximum possible contribution to a SEP IRA on behalf of a participant?

Answer 64

The 2022 annual SEP contributions are limited to the lesser of 25% of compensation (capped at $305,000), not to exceed $61,000.

Question 65

Early distributions from a governmental Section 457(b) plan are_________ to penalty.

subject
not subject

Answer 65

NOT SUBJECT!!!

Question 66

What happens if SS is claimed early and the worker is still working?

Answer 66

When claiming SS early, in all years except the year the worker reaches FRA, for earned income above $19,650, for every $2 earned over the threshold, the SS benefit is reduced by $1. (Excess income / 2 = reduction in benefit)

In the year the worker reaches FRA, the income threshold is $51,960, and for every $3 earned above the threshold, the benefit is reduced by $1. (Excess income / 3 = reduction in benefit)

Benefit is not reduced forever, just until FRA is reached.

Question 67

ADP Rules NHCE vs. HCE

Answer 67

If NHCE contribute ≤ 2%, HCE can contribute 2 times as much (up to 4%)

If NHCE contribute > 2% and ≤ 8%, HCE can contribute 2% more than NHCE

If NHCE contribute > 8%, HCE can contribute 1.25% x NHCE deferral

Question 68

Top Heavy Plan

Answer 68

60% of contributions go to Key Employees

When this happens, the plan is considered top heavy, and minimum contributions must be made on behalf of all NHCE (3%)

Question 69

Key Employee and HCE

Answer 69

Key Employee: A 5-percent owner of the employer, or a 1-percent owner of the employer having an annual compensation from the employer of more than $150,000.

HCE: An employee who earned more than $135,000 in 2022 is an HCE.

Question 70

What is the executive’s basis in the NQSO at exercise?

Answer 70

Sum of exercise price and income recognized at exercise