Chapter 11
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Chapter 11. Retirement and Other Tax-Deferred Plans and Annuities “The income tax laws do not profess to embody perfect economic theory.” -- Oliver Wendell Holmes, Jr. LO #1 – The Basics. Retirement plans are encouraged and receive tax advantages.

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Chapter 11

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Chapter 11

Chapter 11

Retirement and Other Tax-Deferred Plans and Annuities

“The income tax laws do not profess to embody

perfect economic theory.”

-- Oliver Wendell Holmes, Jr.


Lo 1 the basics

LO #1 – The Basics

Retirement plans are encouraged and receive tax advantages.

Encourage saving for retirement or education

Generally, taxation is deferred (not eliminated)

Retirement plans include employer-sponsored plans and individual-based plans.


Lo 1 the basics1

LO #1 – The Basics

Understand retirement plan terminology

Annuity

Beneficiary

Contributions

Distributions

Donor

Tax-deferred retirement (or other) plan

Trustee


Lo 1 the basics2

LO #1 – The Basics

Tax-deferred does not mean tax-free.

Generally, untaxed contributions are taxed when distributed. Previously-taxed contributions are not taxed on distribution.

Contributions can provide a tax deduction to the person/company that makes them.


Lo 2 employer sponsored retirement plans

LO #2 – Employer-Sponsored Retirement Plans

Employer-sponsored plans include:

Qualified pension and profit-sharing plans

401(k) plans

403(b) plans

Keogh plans

Simplified Employee Pensions (SEP)

SIMPLE plans


Lo 2 employer sponsored retirement plans1

LO #2 – Employer-Sponsored Retirement Plans

Plans provide benefits to employers and employees

Employer gets immediate deduction for contributions.

Employer contributions are not compensation to employee.

Earnings from plan investments are not taxed when earned.

Plan assets or earnings are not taxable to employee until withdrawn.


Lo 2 employer sponsored retirement plans2

LO #2 – Employer-Sponsored Retirement Plans

Defined-contribution plans pre-establish the amount of the contribution

The amount of the eventual distribution is not known with certainty and will vary.

Defined-benefit plans pre-establish the amount of the benefit

The amount of the contribution is not known with certainty and will vary.


Lo 2 employer sponsored retirement plans3

LO #2 – Employer-Sponsored Retirement Plans

Qualified pension & profit-sharing plans:

Nondiscriminatory, minimum vesting rules, contributory or noncontributory

Additions to defined-contribution plan can’t exceed lower of $51K or 100% of compensation

Additions to defined-benefit plan can’t result in benefits more than the lower of $205K or 100% of compensation


Lo 2 employer sponsored retirement plans4

LO #2 – Employer-Sponsored Retirement Plans

401(k) plans

Must meet nondiscrimination rules

Employee can elect to defer up to $17,500 (additional $5,500 if age 50 or over)

Keogh plans

For self-employed

Contribution limits generally the same as qualified plans


Lo 2 employer sponsored retirement plans5

LO #2 – Employer-Sponsored Retirement Plans

Simplified Employee Pensions (SEP)

Employer creates and contributes to employee IRAs

Maximum contribution is lower of 25% of compensation or $51,000.

SIMPLE plans

Employer creates IRA or 401(k) for employee

Employee contributes a % up to $12,000 (additional $2,500 allowed if age 50 or over)

Employer makes matching contribution of 3% for all employees or 2% for all eligible employees.


Lo 3 individual sponsored retirement plans

LO #3 – Individual-Sponsored Retirement Plans

Traditional Individual Retirement Account (IRA) and Roth IRA.

Contributions limited to smaller of $5,500 or 100% of compensation. If age 50 or over, the dollar limit is $6,500.


Lo 3 individual sponsored retirement plans1

LO #3 – Individual-Sponsored Retirement Plans

Individuals covered under an employer plan

Deductible contribution amount begins to phase out when AGI reaches $95K (married) or $59K (others) and is fully phased out at $115K and $69K, respectively.

Married filing separately, the phase out starts at $0.

Can still make nondeductible contribution up to the $5,500 or $6,500 limits


Lo 3 individual sponsored retirement plans2

LO #3 – Individual-Sponsored Retirement Plans

Married taxpayers

If both employed and neither are covered under an employer plan, then both spouses can make a deductible IRA contribution up to the $ limits.

If only one spouse is employed and that person is not covered under an employer plan, can contribute up to the maximum for both persons.

If one spouse is covered under an employer plan, and the other is not, the non-covered spouse can contribute up to the dollar limits if AGI < $178,000.


Lo 3 individual sponsored retirement plans3

LO #3 – Individual-Sponsored Retirement Plans

Roth IRA contributions are not deductible but withdrawals are not taxable

Contribution limits are the same as with a traditional IRA

Phase out starts at $178K (MFJ), $112K (single or HoH), $0 (MFS)

Phase out range is $10K MFJ, $15K others


Lo 3 individual sponsored retirement plans4

LO #3 – Individual-Sponsored Retirement Plans

Traditional IRA vs Roth IRA

Contributions are deductible for traditional IRA but not for Roth IRA

Distributions are taxable for traditional IRA but not for Roth IRA

Taxpayers are trading off the non-deductibility of contributions against the non-taxability of distributions.


Lo 4 tax deferred nonretirement plans

LO #4 – Tax-Deferred Nonretirement Plans

Coverdell Education Savings Account (CESA)

Contributions not deductible, account grows tax-free, distributions are not taxable if used exclusively to pay higher education expenses of beneficiary.

Any person can establish and fund a CESA for any person, him or herself included.


Lo 4 tax deferred nonretirement plans1

LO #4 – Tax-Deferred Nonretirement Plans

CESA contributions limited to $2,000 per beneficiary

From all sources combined

Contributions phased out when AGI of contributor reaches $190K (MFJ), $95K others.

Totally phased out at $30K or $15K above those numbers, respectively.


Lo 5 distributions

LO #5 - Distributions

Generally, distributions are taxable if contributions were deductible.

When some (but not all) contributions were made with previously taxed dollars, then distributions will be partially tax free and partially taxable. Use simplified method.


Lo 5 distributions1

LO #5 - Distributions

Simplified method. For cases where distributions are partially taxable.

Determine number of anticipated payments using single life or dual life tables in text

Determine total contributions from previously-taxed dollars.

Fraction: previously taxed $ / # payments

Fraction represents proportion of each payment that will be tax-free.


Lo 5 distributions2

LO #5 - Distributions

Other plans have required minimum distributions (RMD) that must begin by April 1 of year following the year taxpayer reaches age 70.5.

RMD is based on life expectancy tables from IRS (normally Table III in text)

Use these IRS tables to determine life expectancy each year.


Lo 5 distributions3

LO #5 - Distributions

Roth IRA distributions are generally not taxable.

Earnings are taxable if withdrawn prior to an initial five-year holding period.

Coverdell Education Savings Account distributions are tax-free if used to pay for qualified education expenses of beneficiary.

Can’t use education expenses paid by CESA also for American Opportunity/Hope or lifetime learning credits


Lo 5 distributions4

LO #5 - Distributions

Premature distributions generally subject to 10% penalty.

Some exceptions apply. See page 11-17

Rollovers are generally tax-free. Rollovers to a Roth IRA are taxable.

If rollover $ are distributed to the taxpayer, there is a 60-day window to deposit $ in new plan. Otherwise, the entire amount is taxable.


Lo 6 annuities

LO #6 - Annuities

An annuity is a series of payments pursuant to a contract.

Normally, annuity payments are partially taxable and partially tax-free to recipient


Lo 6 annuities1

LO #6 - Annuities

The tax-free component is based on the cost of the annuity contract and expected return

The cost of the annuity contract is the amount the recipient paid for the contract.

The portion of the payments that is represented by the cost of the contract is tax-free.


Lo 6 annuities2

LO #6 - Annuities

The expected return is the total amount the recipient anticipates receiving over the annuity contract.

For contracts that will last a specified amount of time, the expected return is the periodic payment × the number of payments.

For contracts that will provide payments for life, the recipient must refer to the life expectancy tables to determine length of time.


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