UNIT 11

Question 1

INDIVIDUAL RETIREMENT ACCOUNTS (IRAs)

Answer 1

To be eligible to set up a traditional IRA, the individual must have EARNED INCOME from a salary, wages, commissions, bonuses, or tips, money from a divorce decree.

Question 2

IRA CONTRIBUTIONS

Answer 2

Annual IRA contributions are capped at the lesser of:

• 100% of earned income; or
• a flat dollar amount- the tax law places limits on IRA contributions, the amount is adjusted annually for cost of living adjustments.
• The flat dollar amount also applies to spousal IRAs
• Individual’s age 50 or over have a catch-up provision available to increase the flat dollar amount.

Question 3

IRA DEDUCTIONS

Answer 3

Individuals may deduct IRA contributions from taxable income if:

• the individual or spouse is not covered by an employer-sponsored retirement plan; or
• the adjusted gross income is under a certain limit

IRA contributions can be deducted (partially or fully) on a federal income tax return and the income limit ranges are adjusted annually.

• The entire contribution is deductible for incomes below the range
• A portion of the contribution is deductible for incomes between the ranges
• No portion of a contribution is deductible for incomes above the range.
• A full annual limit contribution is allowed whether it will or will not be deducted from federal income taxes.

Question 4

PREMATURE WITHDRAWALS

Answer 4

Earnings on IRA contributions are tax deferred-income tax is not due until the earnings are withdrawn. A pre-mature withdrawal- taken before age 59 1/2– may incur a 10% penalty tax in addition to income tax due on the amount withdrawn. The 10% penalty is waived for the below reasons;

• periodic payments made over the owners life expectancy
• certain medical expenses
• payment of health insurance premiums while unemployed
• certain higher education expenses
• down payment for a first time home purchase 10k max
• birth and adoption expenses 5k max
• distributions made under divorce decree to an ex-spouse or dependent child
• correcting excess contribution

Question 5

ROLLOVERS AND TRANSFERS

Answer 5

There are 2 ways to move IRA accounts from one company to another of from one employer-sponsored plan to an individual IRA.

Rollover- The money from the original IRA or qualified plan is distributed to the owner and they deposit it to the new IRA carrier.

• *The money must be deposited within 60 days of its receipt by the owner or it becomes taxable, and if the owner is under 59 1/2, it will also incur a 10% penalty.
• If the rollover is coming from an employer-sponsored plan it is subject to withholding tax rate of 20%.
• an IRA may be rolled over only once in a 12 month period

Transfer- Called direct transfer- The money from the original IRA or qualified plan is distributed directly to the new IRA carrier without coming into the owner’s possession.

Question 6

REQUIRED MINIMUM DISTRIBUTION (RMDs)

Answer 6

RMDs of IRAs must begin with the owner turns age 72. The first distribution may be delayed until April 1 of the following year and each future distribution must happen by December 31.
The amount of the RMD is based on the owner’s life expectancy. Failure to take RMD results in a tax penalty equal to 50% of the amount that should have been received by the owner.

Question 7

TAXATION OF DISTRIBUTIONS

Answer 7

Deductible IRA contributions and earnings are taxed at distribution. Nondeductible contributions are distributed tax free.

Question 8

DISTRIBUTIONS AT DEATH

Answer 8

If the owner of an IRA dies, the requirements for distributions vary depending on the beneficiary.

• spouses may choose to treat the IRA as their own or they may choose a lump sum distribution.
• Non-spouse beneficiaries may take a lump sum distribution or distributions over 10 years following the owners death.

The entire value of the IRA is includable in the deceased owner’s estate

Question 9

ROTH IRAs

Answer 9

Introduced in 1997* They follow similar rules to traditional IRAs except:

• contributions are NEVER deductible
• qualified distributions are tax free if they meet these 2 requirements
  1) the Roth IRA has been set up for at least 5 years
  2) distribution is after age 59 1/2, or due to death, disability, or being a first time home buyer, first-time homebuyer subject to a $10,000 limit.

Roth IRAs have no RMDs and individuals may contribute to a Roth regardless of their age.

Individuals may have both a Roth and Traditional IRA but contributions may not exceed the maximum limit for one IRA. Contributions to Roth IRAs are phased out for higher income taxpayers.

Question 10

EMPLOYER SPONSORED QUALIFIED PLANS

Answer 10

All employee-sponsored qualified plans have the following tax advantages;

• employer contributions are tax deductible to the business
• employee contributions are tax deductible to the employee
• neither employer nor employee contributions are taxable as current income to employees
• All (except for the Roth 401(k) feature) earnings grow tax deferred)

Question 11

TAXATION OF DISTRIBUTIONS

EMPLOYER-SPONSORED PLANS

Answer 11

All(except for the Roth 401(k) feature) distributions from employer-sponsored qualified plans are taxable , because they come from deductible contributions and tax deferred earnings.

Tax rules for distributions from employer-sponsored qualified plans are similar to traditional IRAs

• withdrawals taken before age 59 1/2 are considered premature, unless there is an exception, a 10% penalty tax applies in addition to any ordinary income tax.
• Required minimum distributions must begin the year the individual turns age 72, the first payment may be delayed until April 1 the following year.

Question 12

GENERAL REQUIREMENTS

EMPLOYER SPONSORED PLANS

Answer 12

All employer sponsored qualified plans must be approved by the IRS to qualify for favorable tax treatment. The Employee Retirement Income Security Act of 1974 established the following requirements for retirement plans ((ERISA)

-Participation- Plans must benefit all regular employees, not just a few selected ones. Generally participation must be open to any employee age 21 or over with one year of service.
-Non-discrimination- Plans may not provide benefits to executives and other highly paid individuals that are out of proportion to those provided to rant and file employees. Plans may not discriminate on the basis of sex.
-Vesting- determines when employees own the money in their plan. Employees are always immediately 100% vested in their own contributions. As for employer contributions, employees generally must become 100% vested after 6 years.
Reporting and disclosure- each participant must receive in writing, when they enroll, a summary plan description, notification of any significant changes, and an annual report.
-fiduciary- anyone with control over the plan or its assets are fiduciaries. They must manage the plan solely in the best interest of its participants using the “prudent person rule”

Question 13

-Participation

Answer 13

-Participation- Plans must benefit all regular employees, not just a few selected ones. Generally participation must be open to any employee age 21 or over with one year of service.

Question 14

-Non-discrimination-

Answer 14

-Non-discrimination- Plans may not provide benefits to executives and other highly paid individuals that are out of proportion to those provided to rant and file employees. Plans may not discriminate on the basis of sex.

Question 15

-Vesting-

Answer 15

-Vesting- determines when employees own the money in their plan. Employees are always immediately 100% vested in their own contributions. As for employer contributions, employees generally must become 100% vested after 6 years.

Question 16

Reporting and disclosure

Answer 16

Reporting and disclosure- each participant must receive in writing, when they enroll, a summary plan description, notification of any significant changes, and an annual report.

Question 17

-fiduciary-

Answer 17

-fiduciary- anyone with control over the plan or its assets are fiduciaries. They must manage the plan solely in the best interest of its participants using the “prudent person rule”

Question 18

PENSION PLANS

Answer 18

may be either defined by benefit of defined by contribution plans. Pension plans require employers to make funding contributions to the plan every year.

Defined benefit pension plans are designed to provide a specific benefit to an employee upon retirement. The employee payout at retirement typically depends on how long they worked and their salary. They can choose a lump sum or a monthly “annuity” payment.

Question 19

PROFIT SHARING PLANS

Answer 19

Is a defined contribution plan that does not require an employer to make a funding contribution every year. Rather, the amount and timing of contributions is at the employer’s discretion. Contributions are dependent on the company making a profit.
The maximum amount that an employer man contribute to a profit sharing plan as a whole is limited to 25% of the company’s payroll for all employees.

Question 20

KEOGH PLANS

Answer 20

(HR-10 PLANS) are qualified retirement plans set up by self employed persons and non incorporated businesses such as sole proprietorships (individuals) and partnerships. keogh plans may be defined benefit or defined contribution.

Question 21

401 (k) Plans

Answer 21

Allow taxpayers a break on taxes on their deferred income. Employees can save and invest a piece of their paycheck before taxes are taken out. They wont be taxed on that money until it’s withdrawn.

Employers may make matching contributions up to a certain dollar amount or percentage of the employees contributions. The plan has annual contribution limits that are considerably higher than the limit on IRA contributions.

Question 22

403(b) Plans

Answer 22

Also known as tax sheltered accounts, work much like 401(k) plans, but they are for employees of non-profit organizations such as public school systems, churches, and hospitals. Employee and employer contribution limits are generally the same as those for 401(k) plans.

Question 23

SIMPLIFIED EMPLOYEE PENSION PLANS

Answer 23

Have significantly less paperwork and easier administration that qualified retirement plans. Essentially, each employee sets up an IRA and the employer makes contributions to them on the employees’ behalf. Employer contribution limits for SEP-IRAs are much higher than the usual IRA limits. Annual employer contributions may not exceed 25% if the employee’s compensation up to a specified maximum contribution amount.

Employees must be immediately 100% vested in employer contributions made under a SEP plan.

Question 24

SAVINGS INCENTIVE MATCH PLANS FOR EMPLOYEES

Answer 24

(SIMPLEs) are a simplified retirement plan for small employers with 100 or fewer employees and no other type of retirement plan. A SIMPLE may be structured as an IRA or 401(k) plan. SIMPLE plans allow employees to defer a portion of their compensation into the plan and employers are required to match those contributions dollar for dollar for at least 1% up tp 3% of each employee’s compensation.

• Employers with 100 employees or less
• Employees can contribute
• 100% immediate vesting for employer contributions
• All employees earning $5,000 or more per year must be allowed to participate
• 25% early withdrawal penalty for first 2 years of participation

Question 25

ERISA

EMPLOYEE RETIREMENT INCOME SECURITY ACT

Answer 25

ERISA was enacted to protect the interests of participants in employee benefit plans as well as the interests of the participants’ beneficiaries. Much of the law deals with qualified pension plans, but some sections also apply to group insurance plans.

• Mandates very detailed standards for fiduciaries and other parties-in-interest of employee benefit plans, including group insurance plans.
• Anyone with control over plan management or plan assets of any kind must discharge that fiduciary duty solely in the interests of the plan participants and their beneficiaries.
• Strict penalties are imposed on those who do not fulfill this responsibility.

Question 26

ERISA

continued..

Answer 26

Reporting and Disclosures

• ERISA requires that certain information concerning any employee welfare benefit plan, including group insurance plans be made available to plan participants, their beneficiaries, the Department of Labor and the IRS. Examples of the types of information include;
• summary plan description to each plan participant and the DOL
• summary of material modifications that details changes in any plan description to each plan participant and DOL
• annual return or report submitted to IRS
• summary annual report to each plan participant
• any terminal report to IRS

Question 27

NON QUALIFIED PLANS

Answer 27

Employers who want to provide a benefit for select employees can use a non-qualified plan, a bonus plan, or a deferred compensation plan. These plans do not get the favorable tax treatment given to qualified plans. They do not need to meet the participation, non discrimination, and other general requirements of qualified plans. Employers can design these plans any way they wish.