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.
Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.
Retirement and Other Tax-Deferred Plans and Annuities
“The income tax laws do not profess to embody
perfect economic theory.”
-- Oliver Wendell Holmes, Jr.
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.
Understand retirement plan terminology
Tax-deferred retirement (or other) plan
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.
Employer-sponsored plans include:
Qualified pension and profit-sharing plans
Simplified Employee Pensions (SEP)
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Plan assets or earnings are not taxable to employee until withdrawn.
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.
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
Must meet nondiscrimination rules
Employee can elect to defer up to $17,500 (additional $5,500 if age 50 or over)
Contribution limits generally the same as qualified plans
Simplified Employee Pensions (SEP)
Employer creates and contributes to employee IRAs
Maximum contribution is lower of 25% of compensation or $51,000.
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.
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.
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
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.
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
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.
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.
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.
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.
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.
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.
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
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.
An annuity is a series of payments pursuant to a contract.
Normally, annuity payments are partially taxable and partially tax-free to recipient
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.
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.