Retirement Management Flashcards
(46 cards)
What is a qualified plan?
An employer-sponsored retirement plan that follows IRS and US Department of Labor requirements and offers various benefits to employees and employers.
Describe the structure and plan rules of a 401(k)
A type of defined contribution plan where employee makes elective salary deferrals to contribute some of their income to the plan. The employer can match a certain % of that
- Limited to contribute $23,000, $7,500 catch-up for 50 and older
- Combined employee and employer contributions cannot exceed $69,000
- Overcontributing will cause a 10% fine plus any unpaid income taxes
- Qualified distributions begin at 59.5. If you retire at 55, can begin to take distributions without penalty
- Early withdrawals are subject to penalties and income tax
- RMDs
Describe the structure and plan rules of a profit sharing plan
It’s an incentive plan (A type of defined contribution plan) for distributing bonuses to employees when company profits rise above a certain level
- No annual contribution requirement for employer, entirely discretionary
- Contributions are allocated among participants
- Utilize a formula to define what the contribution amounts will be for employees
Describe the structure and plan rules of a defined benefit plan
A type of plan that promises the employee a retirement benefit based on the formula. May offer up to the lesser of 100% of the average compensation in the highest three years of service or $275,000 per year for the year 2024
No individual accounts. Various formulas used to determine the benefit. Age limit 65
Describe the structure and plan rules of a hybrid plan
An option is a target-benefit pension plan
It’s a combination of a defined contribution and defined benefit plan. Target benefit is determined and then a contribution is allocated to a participant’s account that’s in proportion to achieving that benefit. Typically, larger contributions are made to older participants
- Determined by a formula
- Limitation of lesser of 25% or $69,000 for 2024
Describe the structure and plan rules of a cash balance plan
Retirement plan in which the employer sets up an individual account for each employee and contributes a percentage of the employee’s salary; the account earns interest at a predefined rate. Both the level of contribution and a minimum rate of return are guaranteed by the employer. More beneficial to younger employees with shorter service with low benefits than to older employees with longer service
- Fixed percentage of each employee’s salary is contributed each year
- Contributions may be weighted for age or years of service
What are the advantages and disadvantages of qualified retirement accounts for retirement planning?
Advantages
* Can receive employer contributions/payments during work phase or retirement phase (defined benefit provides a pension)
* Typically larger contribution limit compared to IRAs
* More protection against creditors
Disadvantages
* Subject to early withdrawal penalties
* Some may have limited investment options
* Distributions are taxed at ordinary income levels if tax-deferred
What are the advantages and disadvantages of individual retirement accounts (IRAs) for retirement planning?
Advantages
* Tax-deferred or after-tax growth that is withdrawn tax-free at retirement (Roth)
* Can buy and sell in the account and not realize gains. Only distributions are taxed
* Can save additional money for retirement on top of qualified retirement plan
Disadvantages
* Traditional IRAs are taxed at ordinary income level, no preferential cap gains treatment
* Limitations on what you can distribute money for if you are below 59.5
* If you withdraw from the account and it’s a nonqualified distribution, 10% tax penalty
* Limitation on how much you can contribute each year
* There are income phaseouts for both Traditional IRAs and Roth IRAs if you are looking to either contribute or receive the tax deduction (for traditional IRAs)
What are the advantages and disadvantages of personal taxable accounts for retirement planning?
Advantages
* Preferential capital gains treatment if holding securities for more than one year
* No limit on how much can be placed in the account
* No restrictions on when to withdraw the assets
Disadvantages
* Taxed during any transaction. Buy, sell, withdrawal
* Can also receive ordinary income tax treatment if held for less than one year
* Can generate wash sales
Explain the impact of return sequencing on sustainability of retirement distributions
- With return sequencing, the rate of return an account receives at the beginning of retirement distributions can greatly impact the success of a client’s retirement outcome
- Despite the thought that the market volatility averages out, this doesn’t really apply when taking distributions
Explain the methods for forecasting retirement outcomes such as linear forecasting
- Views historical data and plots various returns throughout that period
- A linear trendline is established based on the historical returns
- Limited with it’s projection capabilities because it only goes off historical data, may not provide varying return options to test a portfolio
Explain the methods for forecasting retirement outcomes such as Monte Carlo simulation
- It is the process of assessing the likelihood of an expected outcome. Typically a computer program
- Randomly choose returns from an expected distribution of returns for each period
- Also can adjust standard deviation to make those changes in returns close together or far apart
- Can be run 100 times, 1000, times, 10000 times, etc.
- Provides more flexibility and “stress testing” of portfolios to see how it fares under a number of different scenarios
What are the tax treatments of distributions from qualified accounts?
- May have required minimum distributions
- Distributions are taxed at ordinary income level when they are taken
- Distributions from any Roth portion may be withdrawn tax-free
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What are the tax treatments of distributions from non-qualified accounts?
- May have a schedule to distribute money, even if the individual does not need the assets
- May be subject to taxation at vesting
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What are the tax treatments of distributions from Roth accounts?
- If over age 59.5, assets have been held in the account for over five years, distributions are tax free
- Contributions made to a Roth can be distributed tax-free from account at any time
- Early withdrawals may be subject to a tax penalty, or will be taxable
- Qualified withdrawals can be done at any age tax-free
- No required minimum distributions
How do you calculate required minimum distributions (RMDs)?
- Take the value of the account at the end of the previous year (i.e. 2024 RMD, look at balance of account on 12/31/2023) and divide it by the account owner’s life expectancy (there’s a table)
- Each retirement account must have it’s RMD calculated. For qualified plans, the RMD must be taken from that account
- For individual retirement accounts, the RMDs can be taken out of any of the accounts to count for all the RMDs (if you have three IRAs, you can take the RMDs for the three IRAs out of one of the accounts if you want)
What is sustainable withdrawal rate?
- The maximum amount of money that you can withdraw from a portfolio throughout retirement with an acceptable risk of depletion
- Typically expressed as a percentage
- Helps to determine the various buckets of expenses down to essential, basic, and discretionary
Describe sustainable withdrawal rate methodologies
- Breaking down assets as essential, basic, and discretionary. Utilizing income sources first to fill essential expense needs, and then utilizing retirement savings to fill basic and discretionary expense needs/wants
- 4% rule considers only withdrawing 4% from the portfolio every year. This comes from the idea that the lowest initial withdrawal rate in history, and using that as benchmark for withdrawal rate
- Bucket approach - set aside cash for the first three years of retirement, the next seven years can go into fixed income for a little more return but a little more safety than equities, and then equities covers years 11 and on. Short, medium, and long-term buckets. Often, the math comes out to be a 60/40 portfolio
- Annuity bucket approach is similar to bucket approach and the asset breakdown. Utilize SSI and any annuity payments to cover essential expenses that need to be covered, and utilize portfolio withdrawals for discretionary expenses
- Dynamic spending deals with adjusting the amount that the individual spends throughout retirement. To appropriately withdraw during various market periods, recommend increase or decreasing spending. Can adjust spending by the ratcheting method or with dynamic spending (upper and lower limits)
Discuss the effects of market conditions during retirement on withdrawal strategies and outcomes
- Sequence of returns risk can have a large impact on a portfolio and an individual’s likelihood for success in retirement. If withdrawals are not carefully monitored, especially in the early years of retirement and if the markets are performing poorly, this could drastically impact success, often it will make a client’s retirement outcome unsuccessful
- If withdrawals are made and the markets are performing well, this could lead to a client passing away with more money than they originally began with, potentially creating an estate transfer issue, and/or not properly utilizing retirement funds for retirement
- Adjusting withdrawal rates appropriately to manage these types of market downturns will help mitigate the risk of running out of funds during one’s life. It will also help make sure that an individual is appropriately spending their retirement money throughout retirement
What is sequence of return risk?
Sequence of returns is the risk of negative market returns occurring late in your working years and/or early in retirement, which can deplete your retirement nest egg and significantly impact long-term retirement security
What is net unrealized appreciation (NUA)?
- Allows those with company stock in their 401(k) plan to have it taxed as a capital gain instead of ordinary income
- The cost basis would be taxed as ordinary income
- The growth of the stock would be taxed as capital gains
Rules
* Employer stock must be distributed in-kind, make a lump-sum distribution, and must be made after a triggering event
* Not eligible for a step-up in basis after death
* Not subject to the NIIT
What are the NUA rules as they apply to distributions of highly appreciated company stock from a 401(k) plan?
- Allows those with company stock in their 401(k) plan to have it taxed as a capital gain instead of ordinary income
- The cost basis would be taxed as ordinary income
- The growth of the stock would be taxed as capital gains
Rules
* Employer stock must be distributed in-kind, make a lump-sum distribution, and must be made after a triggering event
* Not eligible for a step-up in basis after death
* Not subject to the NIIT
* At the triggering event, must do full distribution. If a person retires at 55, they potentially have two opportunities to initiate NUA. First at 55, then at 59.5 at the retirement age. If retirement is on or after 59.5, only have one opportunity to complete the NUA distribution
What are the investment vehicles available for use in an effective asset location plan?
- Taxable account - Place rapidly growing investments that have lower dividends, capital gains consequences in these accounts. Allows for tax free growth, and then at the time of selling, if held for more than one year, will receive capital gains treatment. More tax efficient holdings should be placed here first
- Traditional IRA - Place more income producing assets, least to moderate tax efficient holdings can be placed here
- Roth IRA - For maximizing tax-free growth potential, placing assets that are the least tax-efficient should be placed here
- Place assets from the “outside in” of an asset location line. Fill up allocation working from the most tax-efficient holdings and the least tax-efficient holdings and work your way to the middle
- Assets that have moderate tax-efficiency can be placed in any account where there is room remaining in the investment accounts
Analyze the “tax-friendliness” of a traditional IRA
- Useful when you have assets that generate a lot of income or dividends. Can defer the tax until distribution, and at the time, the tax will be ordinary income
- No capital gains preference
