Retirement Savings / Income Planning

Question 1

Roth IRA Distribution Requirements: Qualified Distribution

Answer 1

The distribution must be made after a five-year period from the first contribution
AND
The distribution must occur in one of the four following circumstances:
* the account owner’s death
* the account owner being disabled
* first-time home purchase ($10k max), OR
* made on or after the individual attains age 59-1/2

Note that the person does NOT need to be 59-1/2 to receive a tax-free distribution.

Question 2

Roth IRA Distribution Requirements: Non-Qualified Distribution

Answer 2

Distributions are done in this order:

(GREEN) Regular Roth Contribution:
No regular income tax. No penalty.

(YELLOW) Roth Conversion Contribution:
No regular income tax. Within 5 years of conversion may be subject to 10% penalty (unless some IRA exception exists)

(RED) Account Earnings:
Subject to income tax AND 10% tax penalty

Question 3

Inherited IRA Distribution Requirements: Eligible designated beneficiary

Answer 3

Eligible designated beneficiary is still eligible to stretch:
* Spouse
* Chronically ill beneficiary
* Disabled beneficiary
* Minor children (under age 21), or
* Anyone no more than 10 years younger than the IRA owner

Question 4

Inherited Roth IRA Distribution Requirements

Answer 4

Spouse can become owner and continue to forego RMDs.

Non-spouse beneficiary (brother, cousin, uncle) is subject to 10-year RMD rule.

Question 5

Section 162

Answer 5

• A type of non-qualified retirement plan for executives.
• Tied to large CV life insurance policy
• ER pays premiums, but the executive pays taxes on the premiums paid as bonus comp, so the executive owns the policy.

Question 6

NQSOs (Non-qualified Stock Options)

Answer 6

Grant
* No tax consequence
* Strike price

Exercise
* EE purchases the stock at the strike price stated in the grant. Difference between grant price and FMV at exercise date is the “bargain element”. This is income recognized, so the EE pays taxes and the ER claims deduction.
* EE’s basis is established.

Sale
Difference between sale price and basis is taxed at capital gains (either STCG or LTCG).

Question 7

ISO (Incentive Stock Options)

Answer 7

Grant date: No tax consequence.

Exercise date: EE purchases the stock at the price stated in the grant. Difference between exercise price (AKA grant price or strike price) and FMV at exercise date is the “bargain element”. EE does NOT pay tax, but it is a positive AMT adjustment.

Sale date: If the price of the stock at the time of sale is greater than or equal to the price of the stock at the time the ISOs were exercised, the adjustment will be a negative AMT adjustment for the same amount as the original positive AMT ISO adjustment.
Capital gain or loss on the difference from the strike price if Qualifying Disposition.

Qualifying Disposition = Sale occurs at least:
* two years from grant AND
* one year from exercise

With a qualifying disposition, the entire spread of gains, from grant to sale, multiplied by the number of shares is treated as a LTCG:
(Sale Price – Grant Price) x # of shares = LTCG of a Qualifying Disposition

If the EE did not meet either of the above requirements, it is a Disqualifying Disposition and taxed as ordinary income and FICA, so the ER gets a tax deduction.

Question 8

Capital Utilization Approach

Retirement Income Needs calculation

3-step calculation

Answer 8

Step 1 (INFLATING RETIREMENT): If it says to calculate the income needed for the first year of retirement “in today’s dollars”, use the inflation rate to inflate today’s income to the retirement date. Back out Soc Sec benefits. Time (n) is retirement age minus current age. PMT is 0. Solve for FV.

Step 2 (BIG PILE OF MONEY): Use BEG mode. Step 1 answer becomes PMT because that’s the amount of income we need each year to fund all the years of retirement. Use the inflation-adjusted rate (real interest rate). Time (n) is retirement age to death age. FV = 0. Solve for PV. This equals the capital utilization amount.

Step 3 (INVESTING): Calculating how much the client needs to invest as a lump sum or payment stream. END or BEG mode. Step 2 answer becomes FV. Use the investment return rate (because you already adjusted for inflation in Step 1). RTFQ as it may ask for monthly, annually or a lump sum. Solve for PV or PMT.
* If the question asks for the lump sum investment today (one-time deposit), solve for PV.
* If it asks for annual savings (one deposit per year), solve for PMT.
* If it asks for monthly savings, use the g key and solve for PMT.

Inflation-adjusted return calculation: [(1 + investment Return) divided by (1 + Inflation Rate)] minus 1 X 100

Question 9

Calculation for estimating pre-tax retirement income

Answer 9

Retirement income ÷ (1 - tax rate)

This is NOT inflation-adjusted.

Question 10

Withdrawals taken from an IRA or qualified plan prior to what age are subject to a 10% penalty on the taxable portion of the distribution unless an exception applies.

Answer 10

59 ½

Question 11

Social Security

To be eligible for Social Security retirement benefits what is considered “fully insured” status?

Answer 11

40 earned credits

A maximum of 4 “quarters of credit” can be earned per calendar year without regard to when in the year the income is earned. Therefore, it takes a total of 10 earning years to be fully ensured.

One quarter of coverage (i.e., “Social Security credits” or “worker credits”) is earned for each $1,640 (2023) of earned income subject to Social Security taxes with a maximum of 4 credits earned per calendar year without regard to when in the year the income is earned.

Question 12

Social Security

AIME & PIA

Answer 12

AIME is used to calculate PIA. Based on **35 best years **of earnings.

PIA is the benefit paid at FRA.

Use tax table to confirm FRA

Question 13

Social Security: Early Retirement formula

Claiming benefits prior to FRA

Answer 13

Reduced benefit is 5/9% for each of the first 36 months,
PLUS
5/12% for each month over 36 months up to an additional 24 months.

36 months = 20% reduction
24 months = 10% reduction

TIP: 20 divided by 36 = 5/9%.

Maximum reduction of 30%.

Question 14

Social Security: Delayed Retirement formula

Claiming benefits after FRA

Answer 14

Increased benefit is 2/3% for each month following FRA (8% per year)

36 months = 24% increase

8% annually up to age 70.

Question 15

Social Security

Impact of benefits when claiming prior to FRA and still earning income

Answer 15

Prior to FRA
* $1 for every $2 earned above $21,240 is withheld

Special “first year rule”
In the first year of claiming benefits, income earned is not considered, and a special “first-year” rule applies for the balance of that year.

Year of FRA
* $1 for every $3 earned above $56,520 is withheld

$21,240 and $56,520 are provided in the tax table.

When the earned income exceeds the threshold, the withholding of benefits is temporary; the amounts are reincorporated into the monthly benefit at FRA.

Question 16

Social Security: Funding

Funding Social Security benefits from EE and ER

Old Age, Survivors, Disability Insurance (OASDI)

Answer 16

6.2% of an EEs compensation up to the wage base limit ($160,200) funds Social Security retirement, disability, and survivor benefits.

1.45% on unlimited compensation funds Medicare.

Total of 7.65% from EE (and 7.65% from ER) on earned income up to $160,200*

*Provided on tax table

Question 17

Social Security

Determining what portion of income is subject to Social Security taxation
and
Taxation of Social Security benefits

Answer 17

Provisional Income = AGI (without Social Security) PLUS tax-exempt income PLUS 50% of Social Security benefits

MFJ: $0 to $32k = 0% taxable; $32 to $44k = 50% taxable; $44k and up = 85% taxable
(remember it’s both spouse’s income, even if only one is claiming)

Single: $0 to $25k = 0% taxable; $25k to $34k = 50% taxable; $34k and up = 85% taxable

MFS: 85% taxable!!
(must live in the same household)

Provisional income may be referred to as ‘combined income’

32, 44…25, 34

Question 18

Social Security

Spousal Benefits - current spouse

Answer 18

Worker spouse must be receiving benefits for a current spouse to claim her own benefits.

Current spouse must be at least age 62

Maximum benefit is 50% of worker spouse’s PIA. If the worker spouse claimed early, the spouse will get a reduced amount that is less than the 50%.

Question 19

Social Security

Spousal Benefits - former spouse

Answer 19

Eligible for a benefit of a former worker spouse’s record even if he isn’t claiming benefits but meets the following criteria:
* 62 or older
* divorced at least 2 years before applying
* previously married at least 10 years, and
* currently unmarried.

Payment amounts
* Based on the worker spouse’s PIA
* Max 50% at spousal claimant FRA
* Prior to spousal claimant FRA - benefit reduction formula applies (the max 50% benefit is reduced)

Benefits are NOT included as part of maximum family benefit.

Question 20

Medicare

Medicare parts and cost structures

Answer 20

Part A: Hospital. No premium. No annual deductible, only a flat deductible per hospitalization (per admission) 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. Skilled nursing care in a facility for up to 100 days per benefit period. Some home health care. NO custodial care (support of ADLs).

Part B: Medical (outpatient doctor / medical supplies / preventative). Premium. Annual deductible; after deductible, co-pay is 20%.

Part C: Medicare Advantage. Very low premiums (some plans offer zero premiums), which are tempting to select but it’s HMO-style (in-network) that requires doctor referral (“gatekeeper”). All-in-one alternative to original Medicare with bundled plans that include Parts A and B and sometime Part D. Sometimes covers dental, vision, prescriptions.

Part D: Prescription drugs. Premium. Deductibles and co-pay can be paid by Medicare Supplement (Medigap) policy.

IRMAA: Higher Parts B and D premiums for income beneficiaries. Medicare-specific MAGI = AGI + Tax-exempt income.

Recommend Part B (or Part C) if the client has neither.

Medicare DOES NOT pay for custodial care (getting through the day – ADLs).

Question 21

Social Security Survivors Benefits

Eligibility age for Widower? What % of PIA?

Answer 21

Widower is eligible at age 60.

Can receive up to 100% of deceased work’s PIA, but if you elect prior to the widower’s FRA, benefits will be reduced.

With widower’s benefits—unlike spousal benefits—you may switch over to your own benefits, if they are higher, at any time after age 62. In addition, you could collect your survivor’s benefit early and allow your own benefit to grow until you are 70.

Question 22

Social Security Survivors Benefits

What is the amount of the social security survivors death benefit?

Answer 22

One-time lump sum family benefit of $255.

NOT per beneficiary.

Question 23

Social Security Survivors Benefits

Eligibility age for Dependent Parent? What % of PIA?

Answer 23

Dependent Parent is eligible at **age 62 **and can receive 82.5% of deceased work’s PIA if one parent is eligible, or 75% if two parents are entitled.

Question 24

Defined Contribution Pension Plans

Money Purchase Pension Plan

Answer 24

• ER contributes guaranteed % of comp
• But the final benefit amount is NOT guaranteed.
• Contribution % is fixed for all participants.
• Simplest / easiest to understand of the DC pension plans.

Question 25

Defined Contribution Pension Plans

Target Benefit Pension Plan

Answer 25

Same features as a Money Purchase Pension Plan but also has a DB feature as an Actuary is needed (year 1 only) to determine the target benefit amount.

Final benefit amount is not guaranteed as it is a “target”.

Can skew higher plan contributions for older EEs.

Question 26

Defined Contribution Pension Plans

Features of Money Purchase Pension Plan and Target Benefit Pension Plan

Answer 26

• Only ER contributions. Contribution subject to the annual additions limit of the lesser of 100% of covered compensation or $66,000 on behalf of a participant. (example: If EE earns $59k, that is the max ER can contribute).
• ER required to make contributions.
• The maximum compensation considered in benefit formula is $330k per participant.

** 25% is the maximum deductible contribution.**

• EE manages their own investments.
• Vesting must be at least as generous as a 3-year cliff, or 2 to 6-year graded.
  3-to-5-year graded vesting is not permitted for a DC pension plan.

3-year cliff means EE must complete 3 years of service to be fully vested.

Question 27

Distributions from a SIMPLE IRA in the first two years are subject to how much penalty?

Answer 27

25% penalty

Question 28

Retirement Income Needs Analysis

Calculating Capital Preservation Approach and Purchasing Power Preservation Approach

Answer 28

Capital Preservation Approach
Retiree wants to leave the same balance at death as the capital utilization approach requires, so additional capital is needed on day 1 of retirement.
FV = capital utilization amount
i = investment return
n = number of years in retirement
Solve for PV.
Add the capital utilization amount to the additional amount.

Purchasing Power Preservation Approach
Maintains the same purchasing power throughout the retirement period.
Same calculation as above except use the inflation-adjusted rate (real interest rate).

More likely to get a capital preservation question.

Question 29

IRA and Employer-Sponsored Retirement Plan Rollovers

What are the two types of rollovers?

Answer 29

Traditional Rollover
* Only one traditional rollover is allowed per year.
* Within 60 days the participant deposits the funds into an IRA or different employer plan.
* Traditional rollover from a qualified plan requires mandatory 20% federal income tax withholding by the employer (not required for IRA-to-IRA traditional rollover).
* If the 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 the number of direct transfers in a year.
* No mandatory tax withholding applies.

Question 30

Net Unrealized Appreciation (NUA)

When taking an NUA lump-sum distribution, how is the ER basis taxed?

Answer 30

ER contribution basis is taxed as ordinary income in the year of distribution.

NUA at time of lump-sum distribution is tax-deferred.

NUA is the difference at the time of the lump-sum distribution between the FMV of the stock and the ER 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 31

What % of ER stock can be funded in a profit-sharing plan? In a pension plan?

Answer 31

Profit-sharing can be 100% ER funded with ER stock.

Pension plans are limited to 10% of ER stock.

Question 32

If the majority of the EEs are older and not key EEs, which retirement plan would be less expensive between a target benefit pension plan and a money purchase pension plan?

Answer 32

A money purchase plan may be less expensive because the contribution is fixed for everyone and will not reflect age, whereas a target benefit will reflect age and require a higher contribution for older participants who are closer to the plan retirement age.

Question 33

For profit-sharing plans, what is the combined EE/ER* annual additions limit*? And, what are the three components that comprise the annual additions limit?

Answer 33

$66,000

Includes three components:
1. ER contributions - NOT aggregated across unrelated companies.
2. EE elective deferrals - Aggregated (except 457 plans).
3. Reallocated forfeitures to the remaining EEs.

Catch-up contributions are NOT included in the $66,000 annual additions limit.

Question 34

What is the maximum deductible ER contribution to a DC pension plan?

Answer 34

25% of the aggregate participants covered payroll, regardless of whether EE contributes.

Combined EE/ER contributions is subject to annual additions limit of $66,000, which includes three components:
* ER contributions - NOT aggregated across unrelated companies.
* EE elective deferrals - Aggregated (except 457 plans).
* Reallocated forfeitures to the remaining EEs.

Don’t get tripped up by an answer of $66,000

Question 35

Maximum Retirement Plan Contribution for Self-Employed (aka Sole Proprietor or Partner)

Answer 35

The most likely exam question will feature a plan contribution rate of 25%, so use the shortcut of 18.59% multiplied by SE net earnings.

If the plan contribution rate is other than 25%, do the calculation:

Step 1 (ADJUST EARNINGS): SE Net Earnings minus 50% of SE tax.
Step 2 (ADJUST CONTRIBUTION RATE): Rate ÷ (1 + Rate)
Step 3: Multiply Step 1 by Step 2.

Question 36

IRA Contribution Deduction Rules

Partial Deduction Phaseout calculation

Answer 36

If an active participant, IRA contribution depends on MAGI. Use Tax Table to determine the amount that is above the entry phase-out threshold, and then calculate the percentage of the total phaseout range, which is non-deductible (phased-out). Use the remaining % and multiply it by the total contribution (including catch-up) to get the deductible portion.

Question 37

403(b) Plans

Answer 37

Annual $3,000 special catch-up for 15 years of service in the same school district. This can be elected in addition to age 50+ catch-up. Age 50+ with 15 years of service may defer up to $33,000 ($22,500 + $7,500 + $3,000).

Question 38

457(b) Plans

Answer 38

Special catch-up: You can double the elective deferral to $45,000 for each of the last 3 years of service at plan normal retirement age. (elective deferral of $22,500 x 2).

CANNOT use the age 50+ catch-up in the same year as the special catch-up allowance.

NO 10% penalty for withdrawal prior to age 59½.

NOT considered an active participant for IRA deduction phaseout purposes.

Deferrals are NOT aggregated with other salary deferrals in applying annual max limits.

Question 39

Qualified Retirement Plans

Vesting for Defined Contribution & Defined Benefit Plans

Answer 39

DC Plans
At least as rapidly as a 3-year cliff or 2 to 6-year graded. 3-to-5-year vesting is not permitted.

DB Plans
At least as rapidly as a 5-year cliff or 3 to 7-year graded.
If the plan is top-heavy, you must use an accelerated vesting schedule (i.e. 3-year cliff, 2 to 6-year graded).

Cash Balance Plans must use 3-year cliff vesting.

You can be generous and adopt an accelerated vesting schedule.

Question 40

What is the absolute requirement for a Roth IRA qualified distribution?

Answer 40

Five-year holding period

Question 41

Qualifying Incentive Stock Option (ISO) distributions involve a sale that occurs how many years from grant? And, how many years from exercise?

Answer 41

Sale is 2 years from Grant

Sale is 1 year from Exercise

Question 42

With non-qualified retirement plans, the executive does not recognize income and the employer does not receive a deduction until when?

Answer 42

until there is no longer a substantial risk of forfeiture

Question 43

Qualified Retirement Plan

Non-discrimination testing

Answer 43

Must meet one of the three tests:

Safe Harbor Test – plan must cover at least 70% of the non-highly compensated employees (NHCE).

Ratio Percentage Test - plan must cover a percentage of NHCE equal to at least 70% of the percentage of highly compensated employees (HCE) covered
% of NHCE covered ÷ % of HCE covered ≥ 70% = PASS

Average Benefits Test - the percentage of benefits received by NHCE must equal at least 70% of the percentage of benefits received by HCE.

Additional testing includes ADP / ACP testing.

Question 44

Qualified Retirement Plan

Additional non-discrimination testing for 401k

Answer 44

The actual contribution percentage (ACP) test applies to ER matching contributions to a 401(k) plan.

The actual deferral percentage (ADP) test applies to EE elective deferrals to a 401(k) plan.

Question 45

Self-employment Tax

Calculating SE tax when SE net earnings are ≤ $160,200

Answer 45

Use shortcut to multiply SE net earnings by 14.13%

Question 46

Self-employment Tax

Calculating SE tax when SE net earnings are > $160,200

Answer 46

Step 1: Multiply SE net earnings by 92.35% (this is the most common mistake!) to reduce the ER’s taxable portion of 7.65% (100 - 7.65 = 92.35).
Step 2: Subtract $160,200 (Soc Sec wage base).
Step 3: Multiply $160,200 by 15.3% (this is EE portion of Soc Sec + Medicare up to the Soc Sec wage base).

Step 4: Now, you need to calculate the taxable portion of Medicare above the $160,200:
Multiply Step 2 amount by 2.9% (EE portion of Medicare).

Add together Step 3 and Step 4.

Question 47

Retirement Plans

Early withdrawal penalties

Answer 47

Qualified Plans
* 10% penalty for distribution used for qualified higher education expenses
* 10% penalty for distribution used for first-time home purchase
* 10% penalty for distribution used for health insurance premiums paid while unemployed.

IRAs (Traditional and Roth) & Tax-efficient retirement plans
* 10% penalty for distribution used when separation of service even after reaching age 55

No penalty after age 59-1/2

Question 48

Defined Benefit Pension Plan

How are forfeitures used in DB plans?

Answer 48

Forfeitures MUST be used to offset plan expenses (i.e., Actuarial). The ER does NOT have the option to reallocate forfeitures among the remaining participants.

Question 49

What is a “fully insured” Traditional DB plan?

Answer 49

A “fully insured” Traditional DB plan (Sec 412i) is funded exclusively using CV life insurance or annuity contracts. There are no other investments in the plan.

Question 50

Qualified Plans

Top-heavy requirements for non-key EEs

vesting, minimum benefits for DC and DB plans

Answer 50

The plan must use accelerated vesting (2-6 year graded or 3-year cliff vesting.

The plan must provide minimum benefits to non-key employees of:
For DB plans, a minimum defined benefit of 2% of compensation multiplied by the years of service up to 10 years.
“B is 2nd letter”

For DC plans, a minimum defined contribution of 3% of covered compensation.
If the defined contribution for key employees is less than 3%, non-key employees must receive a contribution equal to the key employee contribution rate.
“C is 3rd letter”

Question 51

Highly Compensated Employees (HCE)

Answer 51

Any EE with more than 5% ownership is automatically considered HCE, regardless of compensation.

When an employer has made the top 20% election, only employees with income more than $150,000 (2023) who are ranked in the top 20% based on compensation are considered HCE.

Question 52

Qualified Plan Social Security Integration

For EEs participating in a qualified plan with high comp, how do you calculate the Maximum Excess Contribution Rate?

Answer 52

The lesser of 2x the base rate or base rate + 5.7%.

To calculate:
Step 1: subtract $160,200 from comp
Step 2: Multiply $160,200 x Base Rate
Step 3: Multiply step 1 x excess contribution rate.
Step 4: add step 3 and 4 together.