aaec 4104 final study guide

8/2/2019 AAEC 4104 Final Study Guide

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AAEC 4104: Retirement Planning

Exam 2 Review Guide

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I. Chapter 2: Retirement Accumulations and Distributionsa. Factors Affecting Retirement Planning--generally know how each of the following would

influence the amount one would need to save for retirement:

i. Retirement Income Sources, Remaining Work Life Expectancy (RWLE), RetirementLife Expectancy (RLE), Investment Returns, Inflation, Wage Replacement Ratio

ii. Retirement Income Sources(Sometimes called the Three-legged stool. Money can come from your employerqualified and nonqualified, from you IRA, personal savings, reverse mortgage, or

from the government SS and Medicare)

iii. Remaining Work Life Expectancy (RWLE)(This is the amount of years you have left til you retire. During these years you will

build your retirement income. 93% of people retire between ages 62-65. Working

means you would need to save less each year but if you have a shorter RWLE you

need to save more each year)

iv. Retirement Life Expectancy (RLE)(This is the amount of time you will live in retirement beginning of retirement til

death. This is the time period we are trying to prepare for)

v. Savings(Important concepts related to savings include the savings amount, the savings rate,

and the timing of the savings.)

-Should start to save early (power of tvm/compounding), here are some

recommended savings rates:

25-35: 10-13%

35-45: 13-20%

45-55: 20-40%

vi. Investment ReturnsBasically asks: How/what should I invest in? Its important to get the individuals risk

tolerance both objective (basic things needed to invest) and subjective (how the

client feels about investing). The persons age is also important because we willbase the risk level off of it (early person more compounding periods, can assume

more risk; older person closer to retirement, should be more conservative and tone

down the risk level)

vii. Inflation(the silent killer. Inflation can easily erode away our savings loss of purchasing

power. Ex. 100,000 turns out to only 20,000 after 50 years). To adjust inflation use

IARR : (1+R)/(1+I) - 1

viii. Wage Replacement Ratio (WRR)Is an estimate of the percent of annual income needed during retirement compared

to income earned prior to retirement (what percent of what you currently make do

you plan to spend per year in retirement).1. How to calculate WRR - Calculated as follows: WRR = Annual Income Needsin Retirement/Annual Income Earned before retirement

ix. Retirement Income Needs--Be able to recognize adjustments which increase ordecrease retirement income needs (Exhibit 2.15)

Adjustments that would decrease income needs:

No longer pay social security taxes No longer need to save No longer pay house mortgage


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No longer pat work related expenses Auto insurance may be reduced Possible lifestyle adjustments

Adjustments which may increase income needs

Increasing cost of health care Lifestyle changes Increase in travel Second home Clubs and activities Expenditures on family/gifts/grandchildren Increased property taxes

b. General definition of longevity risk Basically a risk of you outliving your money. Can alsooccur in life insurance or annuity companies when their payouts are higher than expected

c. Capital Needs Analysisi. Be able to perform capital needs analysis (with calculator or TVM formulas) using

the annuity method

II. -Annuity (least Conservative method) retiree meets assumptions and dies brokeIII. 1-2) Calculate the WRR and figure out total needs in todays dollarsIV. 3) Subtract any additional retirement income (ex. Social security)V. 4) Find the future value needed of todays dollars by using the inflation rateVI. 5) Figure out the final amount needed by using the PVAD with an inflation adjusted rate of returnVII. Chapter 3: Qualified Plan Overview

a. Be able to identify Advantages of Qualified Plans (Exhibit 3.4, slides)Advantages to the Employer Contributions are currently tax deductible and contributions to the

plan are not subject to payroll taxes

Advantages to the Employee Availability of pretax contributions, Tax deferral of earnings, ERISA

protection, Lump-sum distribution options

i. ERISA protectiongeneral protection from creditors/bankruptcyERISA provides protection from creditors, bankruptcy and plan sponsors; ERISA can be seized to pay

federal tax liens; Also, assets are not protected from QDRO (court order related to divorce, property

settlement, or child support)

b. Qualification Requirementsi. Eligibility

1. Standard eligibilityone year service (1,000 hrs/yr) and age 212. 2 year election, -if elected the employee will be100% vesting after the two

year period. This is most useful for companies with high employee turnover

rates

3. Educational institutionthey can elect to make participant wait until theage 26, but then he/she is 100% vested at that point

ii. Coveragereceive any benefit/contribution to plan1. Know how to calculate 3 Coverage Tests (4 tests for DB Plans)

First know what a HC employee is - $110k in 2011, >5% owner


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a. General Safe Harbor (Easiest test in order to pass, more than 70%of the NHC employees need to be included in the plan)

b. Ratio Percentage (if the % of NHC to HC employees covered isgreater than 70%, then pass)

c. Average Benefits (will tell you if nondiscriminatory class. test met)(AB% of NHC/ AB% of HC > 70 then pass)

d. 50 Employees/40% eligible test (DB plans only) This additional test isfor Defined Benefit Plans onlyeither must benefit at least 50

(nonexcludable) employees or 40% of all (nonexcludable)

employees)

iii. Vesting1. Employee Contributionsalways are 100% vested2. Employer Contributions

a. DC plans2 to 6 yr graded, or 3 yr cliff; unless 2-yr, 100% electionb. DB plans3 to 7 yr graded, or 5 yr cliff; unless 2-yr, 100% election

iv. Top-Heavy Plans (>60% accrued benefits or >60% balances in DC to key employees)1. Being top heavy influence generally requires vesting to be accelerated and

funding to non-key employees to increase

c. Plan Limitations on Benefits and Contributionsi. Covered Compensation $245k in 2011--max. salary that can be used in plan funding

formulas in qualified plans (both DB and DC plans)

ii. DB Plansmax. annual benefit at retirementup to 100% of avg. 3 highest yrs salary(but not more than $195k)

iii. DC Plansmax. total contribution (employer, employee, forfeitures) in plan yearupto 100% salary (but not more than $49k; $54.5k if catch-up contributions > age 50)

iv. Employer Contributions Limit1. DC PlansEmployers can only deduct up to 25% of total covered

compensation or payroll of all participants

2. DB Plans25% rule does not apply, generally deduct whatever contribute

VIII.Chapter 4: Qualified Pension Plansa. Pension Plan Requirements

i. Mandatory Annual Funding1. DB Pension Plans--annual funding required,100% funding of all plans by 20152. DC Pension Plansfund plan annually w/ amount or % per plan documents

ii. In-Service Withdrawalsare these generally permitted for DB and DC plans?(in service withdrawals are not permitted in pension plans. DB plans never allowed, but DC profit

sharing plans they are)iii. Investment in employer securities: 10% DB plan, 100% DC plans (but allow diversify)iv. General differences b/w DB Pension and DC Pension Plans related to:

1. Actuarieswhen needed? How different assumptions change plan costs?(DBPP and CBPP need actuaries annually higher costs. They will help

determine the amount of target normal cost)(MPPP no actuary is needed

at all, whereas a TBPP needs an actuary for set up)

2. Investment risk--who maintains? (In a DB plan the employer assumes all therisk)(In a DC plan the employee assumes the risk)


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3. Plan Forfeitureswhat are they; how can they be used? (DB plan forfeitureswill be used to reduce the plans costs)(DC plan forfeitures can either be

used to reduce the plans costs or be allocated amongst the participants)

4. PBGCgeneral purpose (to protect the assets of the plan for theemployees. DB plans pay a premium for this type of insurance; $54k maxPBGC guarantee; not used in DC plans

5. Accrued Benefit (DB) vs. Account Balance (DC) (Accrued Benefit DB -roughly the PV of the benefits you should receive at retirement Ex. You will

get 1.5% x Your Salary x Years of service when you retire)(Account

Balance DC measured by the account balanceeasy, its the dollar

amount in your account minus any unvested amount)

6. Credit for prior servicewhat is this; used for both DB and DC plans? Theemployer can choose to give credit for years of service before the plan was

implemented once elected for one individual it must be provided for all.

Only available for DBs

Social Security Integration--what is this basically? (Basically this is a

method of allocating plan contributions to employees that provides

higher contributions to those employees whose compensation is in

excess of the Social Security wage base for the year) Permitted with

pensions? Defined Benefit Plans can utilize the excess method or

the offset method while defined contribution plans are only

permitted to use the excess method

7. Commingled (DB) vs. Separate Accounts (DC)b. Defined Benefit Pension Plans (DB plan)

i. Know general difference b/w flat amount (ex. Fully invested earns you 500/month inretirement) lowest work incentive), flat % (the benefit received is based on a

percent of the employees final salary) higher work incentive, and unit credit

(Benefit received is based on years of service and compensation ex. 1%Xy.o.sXavg. 5highest salaries) highest work incentive

ii. Generally favors older participants--receive larger % overall contribution to planc. Cash Balance Pension Plans (DB plan)

i. Guarantees both annual contribution rate and annual earningsii. Generally favors younger participants--more potential years in plan, compounding

d. Money Purchase Pension Plans (DC plan)i. Guarantees contribution (% of compensation each year) but not earningsii. Generally favors younger participants--more potential years in plan, compounding

e. Target Benefit Pension Plans (DC plan)i. Guarantees contribution based on schedule determined by actuary when plan set up

ii.

Earnings are not guaranteed similar to Money Purchase Pension Plansiii. Generally favors older participants-- receive larger % overall contribution to planIX. Chapter 5: Profit Sharing Plans (all defined contribution plans)

a. Contributions and Deductionsi. When must contributions must be made? (Must be made by the due date of the

companys tax return) Are they mandatory? No, not required

ii. Total contributions (employer, employee, forfeitures) for each employee in 2011:$49k or $54k catch up if >50 (but never more than employee earned income)


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iii. Employer Deduction limited up to 25% of total employer covered compensationiv. General diff. b/w allocation methods-Standard (stated percentage x each employee

salary), Social Security Integration (take percentage times salary (up to 106,800),

then times the remaining difference by the stated percentage (probably .157))),

Age-Based (first calculate the PV of 1 dollar from now til the employee retires; Next

multiply that percentage by the employees compensation; Next, get the percentageof the employees compensation to the total; Take that percent and multiply it by

the predetermined Dollar contribution)

New Comparability Plans--generally what it is; why are these far less common? -Retirement

plans that provide higher benefits for certain classes of employees. Far less common due

to IRS scrutiny, more expensive

b. Cash or Deferred Arrangements (CODA)- also known as 401(k) plani. Basics about a CODA or 401k plans

1. CODA= option to receive cash or defer taxation of compensation to futureHow are elective deferrals and earnings on those deferrals taxed? They are

sheltered until withdrawn

2. 401k= CODA attached to Profit Sharing (most frequent) or Stock Bonus PlanMajor advantages of 401k plans to employers? Can government establish?

Mainly funded by employee deferral contributions and have minimal

expenses (government cannot establish one of these)

ii. Contributions to CODA or 401(k)1. Employee contributions (aka Elective Deferrals) may be made in--traditional

401k, Roth 401k (if offered in plan), after-tax contributions (Thrift plan)

a. Know $16.5k 2011 deferral limit ($5.5k catch-up if 50 or older)b. Roth 401(k)--irrevocable, included in gross income (but not taxed

when withdraw)

c. Individual 401(k) plan--basic understanding what they are, whyused? Low-cost, easy to administer for owner-only business

2. Employer contributions--employer matching (be able to calculate example),employer profit sharing, or employer contrib. used to resolve ADP/ACP tests

iii. Nondiscrimination tests for CODAs/401ks--in addition to meeting coverage tests andbeing subject to top heavy rules (Ch 3), also meet both ADP and ACP tests (unless

meet one of two safe harbor tests):

1. Actual Deferral Percentage (ADP) test--test to make sure average deferral %of NHC not too much below average deferral % of HC

a. What happens if fail test? Must correct. How?i. Corrective distributions--return contrib. to HCii. Recharacterization--change to after-tax contrib.

iii. Qualified Non-Elective contributions--employer makes toincrease deferral % of NHC (100% vested)iv. Qualified Matching--additional match to NHC who electedto defer during plan year (100% vested)

2. Actual Contribution Percentage (ACP) test-- test to make sure average othercontribution (employee after-tax + employer matching) % of NHC not too

much below that % of HC

a. Use same corrective procedures as ADP if fail test


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3. Also 2 general Safe harbor options to comply with ADP, ACP, or top-heavyrulesjust know that deal with employer making some min. contrib./yr, or

automatically enrolling participants to defer % of salary

iv. Hardship Distributions--Generally what are these; taxed as ordinary inc (possible10% penalty); major examples--medical, funeral, purchase of home, education

X. Chapter 6: Stock Bonus Plans and Employee Stock Ownership Plans (ESOPs)a. Stock Bonus Plans

i. What essentially is a stock bonus plan and ways different from profit sharing plans Astock bonus plan is a defined contribution plan established/maintained by an

employer to provide benefits similar to those of a profit sharing plan.

Contributins to the plans are in the form of company stock, not cash, and are

not depended on the profitability of the company. Thus, a stock bonus plan

does not require the corporation to use currently needed cash flow.

Subject to the same basic qualified plan requirements as profit sharing plans.

Contributions are discretionary, but must be substantial and recurring.

ii.

Special requirements--right to demand employer securities, put option, votingrights, when distributions must begin and be fully paid (different than RMD rules)

right to demand employer securities (when taking distributions), put option (allows

the terminating employee the choice to receive the cash equivalent of the

employers stock if the stock is not readily tradeable on an established market),

voting rights (pass through the plan, all the way to the participant: except for

nonmaterial matters of closely-held corporations), when distributions must begin

and be fully paid (different than RMD rules) (Distributions must begin within 1 year

of normal retirement, death or disability, or within 5 years for other termination and

distributions must be fully paid within 5 years of commencement of distributions).

iii. Be able to recognize Major advantages to Employer, Major advantages to EmployeeEmployer - Contributions made by the employer are tax deductible (up to 25% of

total covered compensation). Flexible funding for the corporation becausecontributions are not required to be fixed in amount as there is no annual

mandatory contribution requirement. Incentive for workers because they have a

vested interest in the company. Good for cash limited (start-up companies) because

it will not disrupt the cash flow of the company.

Employee - They have a vested interest in the company. Deferral of compensation

and earnings. They have the put option with regards to shares. In service

withdrawals can be allowed

iv. Recognize that Eligibility (same as other qualified plans including age of 21 and oneyear of service. Company could require a two year eligibility period but employeewill be 100% vested after that point in time),, Allocation (standard - based on a

percentage of each employees compensation therefore the stock must be valued

each year to determine the correct amount),, age-weighted (age plays a factor in

determining the amount),, SS integration - (better for employees whose earnings

are above the social security base of 106,800)), vesting requirements - requirements

(same as other DC plans 2 6 graduated or 3 year cliff), deductible contribution

limit same as profit sharing plans (same as other profit sharing plans 25% of

covered compensation limited up to $245,000)


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v. Distributions100% lump sum distribution--how is original value employer contributions,

NUA, appreciation after lump-sum dist. made taxed? (Know how to

calculate example) If there is a lump-sum distribution, the employee is

subject to ordinary income tax in the year of the distribution based on the

fmv of the employer stock at the time of the original contribution. The NUAof the stock (appreciation of stock while held in plan) is not taxed at the

time of the lump sum but rather is taxes as a long-term capital gain when

the stock is ultimately sold.

Example: Joe receives $2000 of stock in his Stock Bonus Plan (no tax

implications yet). When he retires the stock is worth $10,000. Joe receives

a lump sum distribution. The original $2000 will be taxes as ordinary

income. The $8000 capital gain (NUA) is not taxed until Joe sells the stock

and will be taxed at the LT capital gains rate (unless the stock was sold


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stockholder(s) who generally also guarantee the loan. (Stock also usually

used as collateral for loan)Company contributes annually (tax deductible)

to the ESOP Trust, and the ESOP Trust repays the bank both principal and

interest.Employees receive distributions of the company stock when

they retire or terminate employment with the company.

iii. Be able to recognize Major Advantages and Disadvantages of ESOPs and LeveragedESOPS (Exhibit 6.6, also shown in slides) Employer Advantages Creates a market;helps retain employees; improves employee loyalty; diversified portfolio without

recognition of capital gain; can improve current cash flow of the company.

Employer Disadvantages Dilutes ownership; administrative costs; may strain cash

flow to meet payout requirements of departing employees; periodic appraisals costs

can be expensive

Employee Advantages ownership; better attitude towards company; NUA

treatment; put option

Employee Disadvantages bears risk of insolvency and diversification; value of stock

fluctuates and based on the appraiser; stock not liquid

iv. Why are ESOPs great for retiring or departing owners of closely held companies?Because it creates a ready market How is retiring owner taxed on the sale of

securities to ESOP in year of sale if meet certain requirements (sells > 30%

securities (owned for 3 years) to ESOP, reinvest proceeds w/n 1 yr in new domestic

securities (which hold onto for 3 years)? Owner sells/rolls over shares to ESOP.

owner then reinvests proceeds within 1 year of new domestic securities. ESOP

must hold sold shares for 3 yearsno taxes on owner until securities are sold (now

there is a carryover of the original basis)

v. Can an LESOP deduct more than 25% of covered compensation?Contributions are deductible (limit up to 25% of covered payroll for S Corp. For a C

corp they get the 25% and 100% of interest.

vi. Allocation methodsstandard, age-based (but no SS integration allowed)vii. Distributions--similar to Stock Bonus Plans (i.e. NUA, distrib. before age 59 1/2)

1. Similar to Stock Bonus Plans (i.e. NUA rules, distributions before age 59 1/2),but ESOPs subject to RMD rules (Chapter 7)

Why, in general, is setting up an ESOP in a S-Corp a great planning strategy?

Background S Corporations are a pass through entity, with only one class of stock

and no more than 100 individual shareholders

Great Planning Strategy Profits of S-Corp flow through to the ESOP but the ESOP

doesnt have to pay federal income taxes on these profits.

XI. Chapter 7: Distributions from Qualified Plans (QP)a. Pension Plans

i. Generally Allow in-service withdrawals? Are Permitted (if participant is over 62)ii. Normal Retirement--usually paid as annuity, must generally offer QJSA & QPSA (or

QOSA if plan participant waived QJSA); How are distributions generally taxed?

Regardless of the option chosen, it will probably be taxed as ordinary income.

b. Are income taxes deferred? The Income taxes will be deferred until withdrawn .


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c. What distribution options may a profit-sharing plan have?i. At retirement or termination--lump sum, annuitize (if plan permits), rollover lump

sum, annuitize (if plan permits), rollover (generally same rules as pension plans)

ii. QJSA and QPSA not required unless what? Unless 1) Plans do not pay participant inthe form of a life annuity and 2) Plans pay remaining benefit to spouse at the

participants deathiii. In-service withdrawals permitted at any age (with taxes, penalties)? Loans allowed?

Yes they are generally allowed (no age limits)

d. How are distributions from Qualified Plans taxed? Typically as ordinary income, except for?Direct and Indirect rollovers to IRAs and other QPs; Roth type accounts tax free;

Stock Bonus and ESOPS NUA, ST/LT gains; Thrift Plans taxed only on earnings but

not the basis; QDRO. Non-periodic payments mandatory withholding 20% except

for hardship, loans, direct rollovers. Is a tax refund available? Yes, tax refund

available after the filing

e. Rolloversi. What are advantages of rolling over from QP to another QP or IRA? Maintain the

tax-deferred growth; More control over investments and plan assets. But lose NUA,

10-yr forward avg, pre-1974 capital gains if roll over to IRA. (Also, will lose the ERISA

protection)

ii. Direct Rollovers--what generally are they? When a plan is directly rolled over fromtrustee to trustee. Must they be offered and accepted by QP? Must be offered by

a plan but another plan does not have to accept the rollover. 20% withholding?

The orgininal plan custodian is not required to withhold 20 percent of the

distribution for federal income taxes if direct rollover. Can directly rollover now to

Roth IRA? It is allowed but the participant will have to pay ordinary income tax on

the amount rolled over (or else he/she would never be taxed on it)

iii. Indirect Rollovers--what generally are they? A plan assets is first distributed to theparticipant with a subsequent transfer to another account. 20% withholding? The

original trustee will withhold 20%. Must reinvest full amount (including 20% w/h)within 60 days. A check will be issued to the participant for 80% of the value.

Therefore, it is up to the participant to get the remaining 20% because the rolled

over account will need 100% of the full balance.

f. Lump-Sum Distributions (LSDs)i. Be able to recognize 4 general requirements100% distribution; w/n 1 yr; death,

disability, separation from service, at least 59 ; participated in plan at least 5 years

ii. Net Unrealized Appreciation (NUA)LSD employer securities; know how tocalculate example , how are subsequent gains/losses taxed? When generally not

take advantage of NUA? Dont want to take advantage when the NUA is relatively

small compared to the cost basis. Or when concerned with holding one single

stock/lack of diversification. Would make more sense to rollover a smaller NUA.g. Plan Loanscan never be more than $50k; if not repay loan generally taxed as ordinaryinc.+ possibly 10% penalty.

h. Distributions prior to age 59 subject to 10% early withdrawal penalty. Also, be able toidentify major exceptionsdeath, disability, medical expenses >7.5% AGI, QDRO, 72t

distributions, separation from service after reaching age 55.

i. Generally, what are Substantially Equal Periodic 72(t) Distributions? a 72t is a series ofsubstantially equal periodic payments (think: can terminate employment earlier and still


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receive payments) Subject to 10% penalty? These payments will not be subjected to the

10% early withdrawal penality

j. Required Minimum Distributions (RMDs)i. When, in general, must RMDs begin? By April 1 of year following year participant

turns 70 . (unless still employed, then RMD required ____ of year after terminate

- If still employed, the worker has the option to delay distributions until April 1st

after terminated employment UNLESS they are more than 5% owner (then they

need to start making distributions on time)

1. All other RMDs after the first year must occur by December 31 of the year.2. Note: Individuals can always withdraw more than RMD.

ii. If RMDs not made on time, what % excise tax will apply to the undistributed RMD?50%

iii. RMDs apply to Qual. plans, IRAs, other tax-advantaged plans--but not Roth IRAs.iv. In general, are RMDs still required after a participant dies? Yes

XII.Chapter 8 Qualified Plan (QP) Installment, Establishment, Administration, Terminationa. Qualified Plan Selectionbe familiar with major pros/cons, purposes of different QPs, so

that can select and justify selection of retirement plan given a situation Defined Benefit(Pensions) Biggest requirement is steady cash flows. Becoming increasingly rare so

probably wont be suggested.

Profit Sharing Plans Profit Sharing, Stock Bonus, ESOP, 401k, Roth 401k, Thrift Plan, Age-

Based profit Sharing, New Comparability, etc.

1. Establishing a QPmust be in writing, contributions may be made up to taxreturn due date, Individually designed (more expensiveERISA attorney) vs.

Master or Prototype (master and prototype plans are plans that have

already been approved by the IRS and are available for employer selection)

Master Single trust or account used by all adopting employersPrototype Each employer establishes their own separate trust or account,

employees must be notified, QPsplaced in qualified trust or custodial

account, Plan sponsors (fiduciary) may hire out to asset mgmt firm (become

fiduciary)

b. Keogh Plansin general, what is a Keogh Plan?A Keogh Plan is a qualified plan designed for self-employed individuals or unincorporated

businesses.

c. ForfeituresDB plans (must reduce employer funding costs), DC plans (reduce employerfunding costs, or allocate to remaining participants)

d. Prohibited transactionsin general, what are they? These are transactions between aqualified plan and a disqualified person that are prohibited by law (such as a plan fiduciary,

service providers, plan sponsor, owners, family members of owners, officers and directors)

Can financial planner or advisor be compensated as a fiduciary for giving participants

investment advice? Yes, as long as its fee does not vary depending on the investment

choices the participants make or if the recommendations are based on a model certified by

an independent third party. Who pays penalties? The disqualified person (15 % of amount

involved per year, 100% if not corrected within the taxable year)

e. ERISAprotects employee benefits, fiduciary responsibility on plan management


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f. Department of Laborenforces rules governing plan managers, investments, reporting anddisclosure of plan info, workers benefits

g. Form 5500information return generally filed with Dept of Labor annuallyh. Plan termination--Employees become 100% vested (all contributions) with termination

XIII.Chapter 9: Individual Retirement Accounts (IRAs) and Simplified Employee Pensions (SEPs)a. Qualified Plans (QPs)--more admin./reporting, ERISA protection, Loans permitted, 10-yr avg,pre-74 cap gain treatment, NUA--while these not present in IRAs, SEPs, SIMPLE IRAs

b. General differences b/w Types of IRAsi. Traditional--1. Deductible (Distrib. taxable), 2. Non-Deductible (Distrib. not taxable)ii. RothNondeductible contributions, Qualified distributions tax-free

iii. SEP IRAsIRAs provided by employers, greater funding limits than other IRAsc. IRAs Contributions

i. Limits generally lesser of $5k ($6k if 50 or older) or earned income (exceptionSpousal IRA), may be subject to AGI limitations

ii. Age > 70 1/2 can no longer make traditional IRA contrib. Apply to Roth IRAs? Doesnot apply to Roth IRAs

iii. Timing of IRA contributionsby due date of individuals tax return (usually 4/15)iv. Nondeductible contributionstax-deferred growth, adjusted basis (know how to

calculate how distributions are taxed)

d. Distributions from Traditional IRAsi. Generally taxed as ordinary income (unless non-deductible contributions made)ii. RMDssame as for Qualified Plans (Chapter 7)

iii. Distributions subject to 10% penalty if prior to age 59 1. Be able to identify general differences in exceptions to 10% penalty for QP

vs. IRA (Exhibit 9.9, power point slides)

e. Roth IRAsi. Similarities and differences b/w Traditional vs. Roth IRAsii. Traditional--1. Deductible (Distrib. taxable), 2. Non-Deductible (Distrib. not taxable)

iii. RothNondeductible contributions, Qualified distributions tax-free


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iv. Contribution Limits--$5k (or $6k if 50 or older), know that a phase-out limit existsv. Roth IRA conversionsno AGI limit starting 2010, taxpayers may elect to defer

payment of taxes over 2 year period (in 2010, 2011)

vi. Qualified Roth IRA Distributions are income-tax free and not subject to 10% penalty1. Not subject to RMD rules

f. IRA/Roth IRA invest. options-- life ins, collectibles, other coins not permitted (although USGold, Silver, Platinum coins permitted)g. Simplified Employee Pensions (SEPs)

i. What is it basically? How is it generally different than QP?Practical retirement plan alternative to a QP that can be used by small businesses

and sole proprietors. Easier to establish and have no filing requirements. No trust

accounting for the plan sponsor (because SEPs use IRAs as the receptacle)l

ii. Has less restrictive coverage requirements than in QP and more liberal participationrequirements

iii. ContributionsEmployer funded only; Discretionary but must be made to alleligible employees; contributions generally limited to lesser of 25% employees

covered compensation or $49k; can integrate with Social Security

iv. Vestingemployees 100% vested at all times, withdrawals taxed similar totraditional IRAs (ordinary income, possible 10% penalty)

XIV.Chapter 10 SIMPLE, 403(b), and 457 Plansa. SIMPLEs

i. What are they basically and major advantages over other qualified plans?1. SIMPLEs- (Savings Incentive Match Plans for Employees) for small

employers (100 employers or less) . Easy to establish and maintain. Possess

similar tax advantages as QPs. Attractive to Employers bc they are not

required to meet nondiscrimination rules and they dont have annual filing

requirements. Allows employer to make elective defferal cont. similar to

401 (k).ii. Establishing

1. Small employers (< 100 total employees w/ earnings > $5k previous year)a. 2 Year Grace Period--can exceed 100 employee limit for 2 years

2. Relatively easy to establish (IRS form) Must be a calendar year plan3. Employer cannot also maintain a qualified plan, SEP, or 403b4. The participant is 100% vested in all contributions to the SIMPLE

iii. Eligibility--employer cannot have more than 100 employees, and all eligibleemployees must benefit.

1. What is an eligible employee? >$5k earnings any2 preceding years, andexpect to earn >$5k in current year

iv.

SIMPLE IRAs1. Employee Elective Deferrals--$11,500 (2011), plus $2,500 (2011) as catch-up2. Employer Contributions--mandatory Matching orNon-elective Contributions

a. Employer Matching Contributions-- 100% match up to 3% salary(may be as low as 1% if used infrequently)

b. Non-elective Contributions--2% of compensation3. Contributions to SIMPLEs--Tax deductible, tax-free growth (similar to 401k)

subject to payroll taxes to Employee, not ER

4. Withdrawals and Distributionsgenerally ordinary income to recipient


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a. May rollover to non-QP or QP, but only rolloverfrom a SIMPLE IRAb. May be subject to early withdrawal penalties, same IRA early

withdrawal exceptions (but 25% rather than 10% penalty)

v. SIMPLE 401(k) Plans1. Similar to SIMPLE IRAs, but major differences:

a. SIMPLE 401(k)s permits loansb. Non-elective contributions and matching similar to SIMPLE IRA (butno option to reduce matching in some years down to 1%)

c. SIMPLE 401(k) annual filing requirement and admin. Costsd. Loans are permitted in SIMPLE 401(k)

b. 403b Plansi. What are they basically? Retirement plans for Public Schools and educational

organizations and tax-exempt orgs. Who can generally establish? ERISA and

additional requirements does not apply to what organizations? Governmental

403(b) abd Church Related 403(b).

1. ERISA applies when the plan meets the following tests:a. Nondiscrimination testb. Matching cont. must satisfy ACP Testc. Plan must offer the preretirement Joint and survivor annuity and

Qualified Joint and survivor

ii. Eligibility--May require employees to meet the general eligibility requirements of:1. Age 21 and one year of service, or2. Age 26 and one year of service (educational institutions)

iii. Contributions may be made through:1. Employee elective deferrals: Tax deductible, Limited to $16,500 per year for

2011, plus $5,500 for 2011 for catch-up (50 and over)

2. Non-elective contributions: Tax deductible by Employer3. After-tax contributions4. 15-Year Catch-Up Contributions--work at least 15 years, additional

$3,000/yr contributions, but no more than $15,000 total cont. over years

5. SO.. MAX deferral Contribution COULD be $25,000a. 16,500 ER deferralb. 5,500 Age 50 and over catch-upc. 3000 15- year catch up

iv. Vesting--participant is 100% vested in all contributions to a 403(b) planv. Investing--employee assumes risk; can only in mutual funds or annuity contracts

vi. Roth 403b--similar to Roth 401ks (but not subject to AGI limitations)1. Good for HC employees bc they can participate2. 16.5k cont limit, 22k incl. catch up3.

cont. made on after-tax basis4. dist not taxable if qualifying

vii. Limit on Total Contributions (from employee and employer)--same as 401k 100%of compenstion up to $49k 54.5k with catch up

viii. Loans--only allowed in ERISA 403b plans- subject to same limits and rules as loansfrom 401(k) plans

ix. Distributions--generally only be made after age 59, Death, Separation from ServiceDisability, Hardshipfrom CH5


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1. Generally taxed as ordinary income (unless after-tax contributions or Roth403b), and potential 10% penalty

2. Subject to RMD rules (even for Roth 403b)3. Dist. From nonelective contributions are not restricted

x. Rollovers from 403(b) Plans1. Can be made to QP, Trad. IRA, Roth IRA, another 403b2. Indirect rollovers subject to same rules as QPs. 20% mandatory

withgholding 100% dist. Must be deposited into new account w/n 60 days

c. 457 Plansi. What are they basically? Non-Qualified Defferal Compensation Plan - Generally Tax-

exempt and governmental entities form.

ii. Contributions (or elective deferrals)1. Not combined with other plans--so can defer max $16,500 (2011) in 457

and max $16,500 (2011) for 403(b) or 401(k)

2. 3 Year Catch-up provision (457b)--additional $16,500 contribution/yr (in 3years prior to normal retirement age) if previous unused deferrals.

iii. 3 Types1. 457(b) Governmental Entities--$5,500 catch up (50 or older), assets

protected in a trust

2. 457(b) Tax-Exempt Entities--no catch up and assets not protected in trust3. 457(f) Ineligible Entitities-- no catch up and assets not protected in trust;

unlimited deferrals, but subject to "substantial risk of forfeiture"

XV.Chapter 11 Social Securitya. How is it funded? FICA--7.65% (6.2% SS up $106,800, 1.45% Medicare on all salary), Self-

employed: 12.4% up to 106,800, 2.9% Medicare --> but deduction 1/2 S/E taxes paid

i. Know how to calculate S/E taxes and how much deduct example (In-Class Assign)b. Social Security Retirement Benefits

i. Status1. Fully Insured = 40 quarters (1 quarter ~ $1k/earnings), max. 4 quarters/year2. Currently Insured=6 quarters (out of last 13);survivorship benefits

ii. Normal Retirement Age (full benefits PIA available)--ages 65 up to 67 (you and I)iii. Know how to calculate a participant's PIA and monthly benefit given: AIME, bend

points (but know 90%, 32%, 15%), COLA adjustments (In-Class Assign)

1. 90% of the first $749/ 32% of the AIME over $749 - $4,517/ 15% of the AIMEthat exceeds $4,517 ---- Max PIA = $2,346

2. COLA (Cost of living adjusted) adj for inflation3. What happens to benefit if... retire early and not working ( MAX - 20% 1st 3

years early, 25% 4 years early, 30% 5 years early) or....retire later (8%

increase/year after full retirement age)

a. 1/180 for each month of early retirement up to 36 months earlyb. an additional 1/240 for each additional month over 36months (3yrs)c. SO maximum reduction is 30% if began retirement at 62 and full

retirement was 67

4. Do benefits increase or decrease, in general, for early retirees still working?a. In crease the benefit by 3-8% for each year delayed until age 70.

iv. Taxation of Social Security benefitswhat is max. % of SS benefits are taxable?What is the min. % of benefits that are taxable?

1. 85% Max of the SS benefits may be taxable.


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v. Limitations Test1. Retirement Earning Limitations Test- SS is reduced for early-retirees who

have earning from continued employment. This does NOT include pension

income, investment income, Cap gains, Rental income

2. $1 reduction for every $2 of earnings above 14,1603. In the year retiree reaches normal retirement age- $1 reduction for every $3above $37,680. ONLY applies to earning in the months before attaining

normal retirement age.

4. After normal retirement age, $0 reductionc. Disability Benefits

i. Benefits payable to workers with: Severe physical or mental impairments whichprevents them from performing substantial work

1. Fully insured with >20 quarters coverage (in last 40), can be fewer if under31 age

d. General Beneficiaries of SS Retirement and Disability Benefits (Family Benefits)i. Worker, spouse ( >62, caring for child


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XVI.Chapter 12 Deferred Compensation and Nonqualified Plansa. Why are deferred compensation plans offered? How are they typically used?

i. Provide benefits to a select group of employees without limitations, restrictions,rules of QPS

ii. To discriminate the provision of benefits to key employeesiii. QPs cannot provide sufficient retirement resources for key executives who earn >the CC limit 245k

iv. DO NOT have tax advantages of QPs,b. What is the main benefit to an executive deferring compensation in a NQDC plan? Main

benefit to the employer?

i. To increase Executives WRR or to defer the Exectutives compensation/ retain keyemployees

ii. Employer1. Avoid payroll taxes2. Can discriminate in favor key employees3. $1 mil deductable compensation over the years

iii. Executive1. Reduce taxable income2. Avoids payroll taxes (except 1.45% medicare) on appreciation

c. What basically is constructive receipt? Establishes when income is included in a taxayerstaxable income

d. How does this relate to NQDC plans? When an executive defers income there is no aconstructive receipt ( meaning its an unsecured promise to pay)

e. Generally describe substantial risk of forfeiture. How does this relate to NQDC plans?Occurs when the rights in trasfered property are conditioned, directly or indirectl, uponsome future occurance. MEANING>>> No income tax consequences

i. Risk is on the Employeef. What in general is a salary-reduction plan?

i. The executive or indiv. Defers receipt of salary to the future. EX pro athlete. Mustelect to defer compensation before earning.

g. Nonqualified deferred compensation plan (NQDC)basically what is this?i. What basically is a phantom stock plan and when might they typically be used?ii. What basically are Supplemental Retirement Plans (SERPs)?

iii. Major Differences b/w Unfunded Promise to Pay, Rabbit Trust, Secular Trust1. Secular Trust irrevocable usually no substantial risk of forfeiture ( unless

on vesting schedule) . taxable when funded

2. Rabbi trust- irrevocable Are available to creditors under bankruptcy,Substantial risk of forfeiture exists not taxable


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Unfunded Promise to Pay Rabbi Trust Secular Trust

Funded with assets? No Yes Yes

Employer has access? Yes No No

General Creditors have

access?

Yes,

claim below gen creditors

Yes,

claim below gen creditors

No

When is income taxable to

executive?

Actually or

"constructively received

Actually or

"constructively received

Immediately as funded by

employer (or vesting)

When is the payment

deductible to employer?

When payment is made When payment is made Immediately as funded +

"constructively received"

h. Employer Stock Optionsi. Basically what are stock options? What are the 3 types?ii. Incentive Stock Options (ISOs)1. ISOs--better tax treatment (if sell stock after 2 years from grant and1 year

from exercise date), but more restrictive (only issue ISOs to employees, no

more than


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iii. Nonqualified Stock Options (NQSOs)Ties an employee benefit to the performaceof the company stock. not as many restrictions (i.e. no >$100k/yr per executive

limit), but less favorable tax treatment

1. Know how to calculate tax consequences (W-2 Income, AMT adj., capitalgains, employer deduct.) related to Grant, Exercise, Sale date

a. Exercise DOES NOT recive favorable tax treatmentb. NO statory holding period requirements ER may place them on

stock

c. Grant Date-No Taxable income unless EX price is less than FMVd. Upon exercise W-2 income for appreciation over the ex pricee. Payroll tax and withholding are also required( NOT required for

ISOs) income tax deduction for same amt

f. Sale of stock capital gains with holding period beg. At ex dateiv. Stock Appreciation Rightsbasically what are these? Rights that grant the holder

cash = Excess of FMV of stock above the ex price>> Essentially cashless exercise w/o

right to purchase stock

1. Know how to calculate tax consequences (W-2 Income, AMT adj., capitalgains, employer deduct.) related to Grant, Exercise, Sale date

a. No taxation on grant date ( unless IRC Sec. 83(b))b. EE- W-2 income for excess value over the ex price (income and

payroll taxes)

c. ER Tax deduction for W-2 amti. Restricted Stock Planswhat basically are they? Plan which pays executives with shares of

employer stock/ Stock has restrictions preventing them from selling or transferring Why are

they used?Increases executive retention, aligns executive and shareholders interests,compensates w/o use of company cash flow

i. Know how to calculate tax consequences (W-2 Income, AMT adj., capital gains,employer deduct.) related to Grant, Exercise, Sale date

1. At receipt of the restricted stock: No Taxable income/deductionunless IRCsec 83(b)

2. At the time restriction is lifted W-2 income for FMV of stock includingincome and payroll taxes. ER has tax deduction equal to W-2

3. Holding period begins at the date the restriction is liftedii. IRC Section 83bwhat is this basically? Employee election to include value of stock

in taxable income at the date of grant rather than at date of vesting or whenrestrictions are lifted. What is the benefit of making this election? Any subsequent

gain in value over the grant date is Capital gain rather than W-2. If an employee

does not vest and losses rights- no tax deduction is lost. ER holding period return

begins the date the amt was included in gross income. MUST be filed no later than

30 days after stock is transferred.

j. Employee Stock Purchase Plan (ESPP)allows employees to purchase employer stock (nomore than $25k/year) at discounted price (no less than 85% FMV)


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i. ESPP Qualifying Disposition (hold stock >2 years from grant date and >1 year fromexercise date)

1. Ordinary Income = Gain from discount, No Payroll Taxes though,LTCG=Gain in excess of ordinary income

ii. ESPP Disqualifying Disposition (dont hold for required holding period)1. W-2 Income = Gain from discount (also employer deduction), Payroll Taxes,

STCG/LTCG=Gain in excess of ordinary income

XVII. Chapter 13 Employee Fringe Benefitsa. What are the general tax consequences to employers and employees of fringe benefits?

i. Taxable as wages to the employee (unless specifically excepted by the IRC provisionor employee pays FMV for benefit)

ii. Tax deduction generally for the employerdeductable as compensation expensegenerally unless fringe benefit not taxable to the employee ( employer may still be

able to deduct as ordinary and nessary bus. Expense)

iii. Withholding for federal, state, payroll taxes may be requiredb. Mealsvalue of meal excluded from employees gross income if1) for convenience of

employer and 2) On employer premises

c. Lodging-- value of lodging provided to employee excluded from employees gross income ifi. 1) for convenience of employerii. 2) On employer premises

iii. 3) Employee required to accept lodging as condition for employmentd. Athletic facilitiesvalue of on-premise facilities provided by employer not included in

employees gross income if facility is:

i. 1) operated by employer,ii. 2) located on employers premises,

iii. 3) Substantially all of use of facility by employee, spouse, dependent children (maybe discriminatory)

e. Educational Assistanceup to $5,250may be excluded from employees gross income (noexclusion if employee given choice of cash or educational assistance)

f. Dependent Care Assistanceup to $5k MFJ/$2,500 Single may be excluded fromemployees gross income (but no more than earned income of employee or spouse)

i. Qualifying personsdependent children


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iv. EX: PIRATE TICKETSi. Working condition fringe benefits-- what are these basically and when will the value of this

fringe benefit generally be excluded from the employee's taxable income?

i. Any property or service provided to employee that enables employee to perform hiswork and IF paid for by the employee would be deductable as a trade or business

expense. EX. Company car.

ii. Excluded from an employees gross income only the business part is excluded (may be discriminatory)

j. De minimis fringe benefitswhat are these basically and when will the value of this fringebenefit generally be excluded from the employee's taxable income?

i. Any property or service provided to the employee bby the employer this is so smallthis it makes accounting for it unreasonable

ii. Generally excludable from employee gross incomek. Qualifying Moving Expense Reimbursement

i. Qualifying movedistance b/w new job location and old home must be >50 milesgreater than distance between old job location and old home (old commute).

1. Also, employee must be full-time (FT) in new location >39 weeks (w/n 1 yearof move), or combined FT/self-employed > 78 weeks (w/n 2 years of move)

ii. Deductible Moving Expenses (for qualified move)1. Moving household goods (moving co.actual expenses, yourselfactual

expenses or 19 cents/mile (2011)

2. Traveling and Lodging (travelingactual or 19 cents/mile, lodgingactualexpenses)

iii. Examples of nondeductible moving expensestemporary living expenses, meals,pre-housing hunting, costs to purchase new home or sell previous home

l. Qualified Tuition Reduction Programs what are these basically and when will the value ofthis fringe benefit generally be excluded from the employee's taxable income?

i. An employee may exclude from gross income any amt representing a qualifiedtuition reduction

ii. Generally only for edu below graduate leveliii. Employee,spouse,child may be eligible

m. Adoption Assistance Programsmust be in writing, exclusion limited (~$12k per child),know that there generally is an AGI phase out (dont have to memorize)

n. Discriminationi. Fringe benefits must generally be provided on a nondiscriminatory basis (otherwisemust be included in employees taxable income)

ii. Be able to recognize exceptions of benefits that can discriminate-- Athletic facilities,working condition fringe benefits, de minimis, qualified transportation & parking

o. Valuation Rules Applying to Fringe Benefitsi. General ruleValue=FMV of fringe benefitsii. Exception for special valuation of employer-provided vehicle (may choose):


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1. Cents per mile rule (Amt included Gross Income=51 cents/mi*personal mi.)a. To use this rule, must use vehicle regularly for business (includes

commuting pool with 3 or more employees)

2. Commuting rule--Amt included Gross Income=$1.5*each one-way commutea. To use this rule, generally employer must have written policy that

requires vehicle only to be used for commuting

3. Lease Value RuleAmt included Gross Income=Annual Lease Value*%personal use

a. Lease Valuei. Employer purchased vehicleuse Annual Lease Tableii. Employer leased vehiclevaluation primarily based on

invoice, suggested retail, or nationally recognized retail

iii. Know how to calculate value of employer provided vehicle to be included in annualgross income (if provided Annual Lease table)

1. Annual Lease Value x %personal use =Amt included in EE Gross incomeXVIII. Chapter 14 Employee Group Benefits

a. Describe in general what the COBRA provisions requires employers to do. Requiresemployer to continue to provide benefits to covered employees and qualified beneficiaries

such for; normal termination (18month), Qualified dependant reaches age no longer

eligibile for plan (36 months) and death of employee (36months) Can employers require

that employees pay COBRA insurance premiums? Yes If so, up to what amount? Premiums

can never exceed 102% of plan costs.

b. Describe cafeteria plans generally and how they are used to provide employer benefits. Canyou discriminate using these plans?

i. Written plan that allows employees to receive cash or defer receipt of the cash topurchase various tax-free fringe benefits

ii. Qualified benefits include medical insurance, dependant care, adoption assistance,group term life insurance

iii. NONDISCRESIONARYc. Describe flexible spending accounts (FSAs). When would one generally prefer using an FSA

to cover dependent care expenses versus using the dependent care credit?

i. A type of cafeteria plan where employeees can defer salary into a flexible spendingaccount, defferd amts not subject to income or payroll taxes

ii. Major disadvantage Unused funds each year are forfeited !!!iii. Uses- dependant care expenses

d. Describe Health savings accounts (HSAs). Can only be set up with what type of deductibleinsurance plan? High deductable insurance plan How are these similar to IRAs? Earning aretaxed deffered until distribution How are they generally different (i.e. withdrawals for

medical expenses, age can begin using for retirement)?65 years old and , dist for medical

expenses is completely tax free

e. Describe, in general, the two types of business continuation plans. Which results in morelife insurance policies needing to be purchased and unfair costs for younger owners?

i. Salary continuation plans unfunded arrangement btw an employee and hisemployer Employer continues to pay employee after his retirement Discretionary

basis


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ii.f. Generally describe what split-dollar life insurance is and why it is used. Also, generally

describe the two types of methods that can be used to provide split-dollar coverage. Can

you discriminate?

g. Group term life insurancebe able to calculate portion of employer premiums taxable asW-2 income to employee given example (i.e. above $50k, Uniform Table would be provided)

h. Group Disabilitybe able to calculate portion of disability payments that would be includedin taxable income given example (use % total premiums paid by employer)

i. What basically is key personal life insurance?j. What basically is a VEBA?k. What basically is a salary continuation plan?l. General taxation of Employee Group Benefits

i. Employer contributions for group benefits generally deductible1. Except key personal life insurance, entity-purchase insurance

ii. Employer contributions generally excluded from employee gross income1. Except salary continuation, split-dollar endorsement

iii. Employee contributions generally do not reduce employee gross income1. Except medical insurance, flexible spending, health savings accounts

iv. Final Benefits Received (i.e. payment for medical costs) generally excluded fromemployee gross income (although some is partly included, i.e. disability)

1. Except salary continuation plan

aaec 4104 final study guide

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