Retirement Plans Flashcards
(38 cards)
Qualified plan
s a retirement or employee compensation plan established and maintained by an employer that meets specific guidelines spelled out by the IRS and consequently receives favorable tax treatment.
ERISA (The Employee Retirement Income Security Act of 1974) i
is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.
Defined contribution plans
are a tax-qualified retirement plan in which annual contributions are determined by a formula set forth in the plan. Benefits paid to a participant vary with the amount of contributions made on the participant’s behalf and the length of service under the plan.
Profit-sharing plans
are any plans whereby a portion of a company’s profits isset aside for distribution to employees who qualify under the plan.
Defined benefit plans
are pension plans under which benefits are determined by a specific benefitformula
The 401(k) Plan
is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.
The 403(b) Plan
s a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.
Keogh plans
are designed to fund retirement of self-employed individuals; name derived from the author of the Keogh Act (HR-10), under which contributions to such plans are given favorable tax treatment.
Simplified employee pension (SEP)
s a type of qualified retirement plan under which the employer contributes to an individual retirement account set up and maintained by the employee.
SIMPLE
is a qualified employer retirement plan that allows small employers to set up tax-favored retirement savings plans for their employees.
Traditional IRA
is a personal qualified retirement account through which eligible individuals accumulate tax- deferred income up to a certain amount each year, depending on the person’s tax bracket.
IRA Contributions/Withdrawals
provide generous tax breaks. But it’s a matter of timing when you get to claim them. Traditional IRA contributions are tax deductible on both state and federal tax returns for the year you make the contribution, while withdrawals in retirement are taxed at ordinary income tax rates. Anyone under the age of 70 1/2 with earned income may open a traditional IRA. Withdrawals must start no later than April 1 following the year in which the participant reaches the age of 70 1/2, and the law specifies a minimum amount that must be withdrawn every year. No cash withdrawals prior to the age of 59 1/2 are permitted without having to pay a 10% excise tax, with the following exceptions:
- if the owner dies or becomes disabled;
- if distribution is in equal payments over the owner’s lifetime;
- if higher education expenses for a dependent are necessary;
- to purchase a first home with up to $10,000 down payment;
- if out-of-pocket medical expenses are in excess of 7.5% of adjusted gross;
- to pay health insurance premiums while unemployed; or
- to correct or reduce an excess contribution.
Roth IRA
s an individual retirement account allowing a person to set aside after-tax income up to a specified amount each year. Both earnings on the account and withdrawals after age 59 1/2 are tax-free. The funds are taxed as income before the contribution is made. In other words, Roth contributions are made with after-tax dollars. Therefore, at the time of payout, the funds are tax free. Unlike the traditional IRA, the Roth imposes no age limits. Roth withdrawals are either qualified or nonqualified. Also, unlike traditional IRAs, Roth IRA distributions are not mandatory and can therefore be inherited and passed down through generations.
Qualified Withdrawals
provide the tax-free distribution of earnings. To be a qualified withdrawal, the funds must have been held in the account for a minimum of five years; and if the withdrawal occurs for one of the following reasons, no portion of the withdrawal is subject to tax.
- The owner has reached age 59 1/2
- The owner dies or becomes disabled
- The distribution is used to purchase a first home
Nonqualified Withdrawal
If a withdrawal is taken without meeting the above criteria and the amount of the withdrawal exceeds the total amount contributed, it is a nonqualified withdrawal. The earnings from the contributions become taxable.
Rollovers
are an individual retirement account established with funds transferred from another IRA or qualified retirement plan that the owner had terminated.
QUALIFIED PLANS VERSUS NONQUALIFIED PLANS
Qualified plans are retirement plans that meet federal requirements and receive favorable tax treatment. Qualified plans provide tax benefits and must be approved by the IRS. The plans must be permanent, in writing, communicated to employees, defined contributions or benefits, and cannot favor highly paid employees, executives, or stockholders. The primary type of qualified plans includes defined benefit and defined contribution plans.
- To comply with ERISA minimum participation standards, qualified retirement plans must allow the enrollment of all employees over age 21 with one year experience.
- If more than 60% of a qualified retirement plan’s assets are in key employee accounts, the plan is considered “top heavy”
Qualified plans have the following features:
- Employer’s contributions are tax-deductible as a business expense.
- Employee contributions are made with pretax dollars - contributions are not taxed until withdrawn.
- Interest earned on contributions is tax-deferred until withdrawn upon retirement
- The annual addition to an employee’s account in a qualified retirement plan cannot exceed the maximum limits set by the Internal Revenue Service
Nonqualified plans are characterized by the following:
- Do not need to be approved by the IRS
- Can discriminate in favor of certain employees
- Contributions are not tax-deductible
- Interest earned on contributions is tax-deferred until withdrawn upon retirement
Tax Benefits of Qualified Plans
Employer’s contributions are tax-deductible and not treated as taxable income to the employee. Employee contributions are made with pre-tax dollars, and any interest earned on both employer and employee contributions are tax- deferred. Employees only pay taxes on amounts at the time of withdrawal
Withdrawals and Taxation
Withdrawals by the employee are treated as taxable income. Withdrawals by the employee made prior to age 59 1/2 are assessed an additional 10% penalty tax. Distributions are mandatory by April 1st of the year following age 70 1/2, and failure to take the required withdrawal results in a 50% excise tax on those funds.
Funds may be withdrawn prior to the employee reaching age 59 1/2 without the 10% penalty tax: if the employee dies or becomes disabled; if a loan is taken on the plan’s proceeds; if the withdrawal is the result of a divorce proceeding; if the withdrawal is made to a qualified rollover plan; or if the employee elects to receive annual level payments for the remainder of his life.
The Employee Retirement Income Security Act of 1974 (ERISA)
ERISA was enacted to provide minimum benefit standards for pension and employee benefits plans, including fiduciary responsibility, reporting and disclosure practices, and vesting rules. The overall purpose of ERISA is to protect the rights of workers covered under an employersponsored plan.
EMPLOYER-SPONSORED PLANS
Defined Benefit Plans
Defined benefit plans pay a specified benefit amount upon the employee’s retirement. When the term pension is used, it normally is referring to a defined benefit plan. The benefit is based on the employee’s length of service and/or earnings. Defined benefit plans are mostly funded by individual and group deferred annuities.
Defined Contribution Plans
Defined contribution plans do not specify the exact benefit amount until distribution begins. Two main types of plans are profit-sharing and pension plans. The maximum contribution is the lesser of the employee’s earnings or $49,000 per year. Here are some examples of defined contribution plans:
