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CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Retirement Planning & Employee Benefits
Module 7 Retirement Plan Distributions & Plan Selection
©2013, College for Financial Planning, all rights reserved.
Learning Objectives
7–1 Identify the characteristics of retirement plan distributions.
7–2 Analyze a situation to determine the income tax or benefit payment implications or requirements of a retirement plan distribution.
7–3 Identify and analyze lump sum options available to participants, including rollovers.
7–4 Identify minimum distribution requirements and distribution alternatives to calculate the required minimum distribution.
7–5 Identify a requirement for an IRA or qualified retirement plan distribution resulting from the death of the participant. 7–6 Use the appropriate distribution requirements and characteristics to calculate the taxable income on distributions from nondeductible and Roth IRAs.
7–7 Analyze and choose the best retirement plan for a given scenario.
7-2
Questions to Get Us Warmed Up
7-3
Learning Objectives
7–1 Identify the characteristics of retirement plan distributions.
7–2 Analyze a situation to determine the income tax or benefit payment implications or requirements of a retirement plan distribution.
7–3 Identify and analyze lump sum options available to participants, including rollovers.
7–4 Identify minimum distribution requirements and distribution alternatives to calculate the required minimum distribution.
7–5 Identify a requirement for an IRA or qualified retirement plan distribution resulting from the death of the participant. 7–6 Use the appropriate distribution requirements and characteristics to calculate the taxable income on distributions from nondeductible and Roth IRAs.
7–7 Analyze and choose the best retirement plan for a given scenario.
7-4
In Service Distributions
• • • IRA & IRA hybrid plans Profit sharing plans Pension plans 7-5
Hardship Withdrawals & Loans
Employer may offer, but are not required • •
Hardship withdrawals
Elective deferrals only 10% early withdrawal penalty does apply • •
Loans
$50,000 or 50% of balance maximum 5-year limit (except for home) •
QDROs
Exempt from 10% penalty 7-6
Early Withdrawal Penalty Exceptions
All Plans
• Death • Disability • Medical expenses above 7.5%
IRA Only
• Medical expenses above 7.5% • First-time home purchase up to $10,000 • Health insurance premiums while unemployed
All Except IRA
• Separation from service after age 55 • Qualified domestic relations order (QDROs do not apply to IRA accounts) IRA refers to Traditional IRAs. Roth IRAs have different withdrawal rules.
7-7
Substantially Equal Payments: Reg. 72(t)
Minimum age to begin Maximum age to begin Frequency of payments Duration of payments IRS-approved calculation methods Ordinary income tax applies 10 percent penalty tax applies None 59½ At least once a year Greater of five years or age 59½ • • • Life expectancy Amortization Annuitization Yes No
Must be separated from service for a 72(t) distribution from a qualified plan or TSA
7-8
Reg. 72(t) Withdrawal Example
Assumes male, age 56, $150,000 account, 8% annual return
Age
56 57 58 59 60
Life Expectancy
$5,357 $5,802 $6,284 $6,806 $7,374
Amortization
$13,573 $13,573 $13,573 $13,573 $13,573
Annuitization
$14,620 $14,620 $14,620 $14,620 $14,620 7-9
Separation from Service Options Several separation from service options are available for qualified and 403(b) plans.
• • • • • Available distribution options are: Leave with employer Transfer to new employer’s plan Annuitization Lump-sum distribution IRA rollover 7-10
Separation from Service Choices Made
Option
Annuitize Transfer to new employer’s plan Leave in the plan Cash payment IRA rollover Source: “Capturing the Opportunity of the 21st Century,” LIMRA 2003
Percentage
1% 5% 25% 31% 38% 7-11
Learning Objectives
7–1 Identify the characteristics of retirement plan distributions.
7–2 Analyze a situation to determine the income tax or benefit payment implications or requirements of a retirement plan distribution.
7–3 Identify and analyze lump sum options available to participants, including rollovers.
7–4 Identify minimum distribution requirements and distribution alternatives to calculate the required minimum distribution.
7–5 Identify a requirement for an IRA or qualified retirement plan distribution resulting from the death of the participant. 7–6 Use the appropriate distribution requirements and characteristics to calculate the taxable income on distributions from nondeductible and Roth IRAs.
7–7 Analyze and choose the best retirement plan for a given scenario.
7-12
“Lump Sum” Definition
Four conditions required for distribution to be considered a lump sum: 1.
Made from qualified pension, profit sharing, or stock bonus plan 2.
Represents full amount credited to participant accounts 3.
4.
Distributed in one taxable year Payable due to: o participant’s death o attainment of age 59½ o o separation from service disability 7-13
Ten-Year Forward-Averaging Tax Treatment
• • •
Eligibility
Participants must have been born in 1935 or earlier Distribution must be a “lump sum.” Forward-averaging treatment must be elected on all lump-sum distributions in tax year.
Only one forward-averaging election allowed in lifetime.
• •
Steps
Use 10-year averaging on ordinary income portion Treat pre-1974 portion of gain as long-term capital gain 7-14
Should you do an IRA rollover?
Leave with employer
Not always allowed Tax-deferred growth Limited investment choices Less beneficiary designation flexibility All withdrawals are taxed as ordinary income May be able to convert directly to Roth IRA Early withdrawal penalty age 55 if separate from service after age 55 RMD can begin later than age 70½
Rollover
Always allowed Tax-deferred growth Many investment choices More beneficiary designation flexibility Company stock may be partially taxed as capital gains May convert directly to Roth IRA Early withdrawal penalty age 59½ RMD must begin at age 70½ 7-15
Rollover Distributions
To preserve 10-year forward averaging: Time period for completion of rollover:
• Qualified plan to conduit IRA to qualified plan • Indirect rollover must be completed within 60 days
“Eligible rollover distributions” are distributions of all or any part of a qualified plan account, except:
• Nontaxable portion of distribution • Part of a series of substantially equal periodic payments over 10 years or relevant life expectancy • Required minimum distribution (age 70½) • Corrective distributions • Loan treated as a distribution • Dividends on employer securities in an ESOP • Cost of life insurance coverage • Hardship distribution 7-16
Types of Rollovers
• • • • • • Conduit IRAs Direct rollovers Trustee to trustee Indirect rollover (60-day limit, 20% withholding applies) Spousal beneficiary rollover Nonspouse beneficiary rollover 7-17
Permissible Rollovers
Roll to IRA SEP-IRA SIMPLE IRA Roth IRA 457(b)
YES, after two years NO YES YES, after two years NO YES
403(b) Qualified Plan Designated Roth Account IRA
YES YES YES YES NO
SEP-IRA
YES YES YES YES NO
SIMPLE IRA
NO NO YES NO NO NO NO NO
Roth IRA
YES, but taxable YES, but taxable YES, after two years, is taxable YES YES, but taxable YES, but taxable YES, but taxable YES
Government 457(b)
YES, must have separate accounts YES, must have separate accounts YES, must have separate accounts NO YES YES, must have separate accounts YES, must have separate accounts NO
403(b)
YES YES YES, after two years NO YES YES YES NO
Qualified Plan
YES YES YES, after two years NO YES YES YES NO
Designated Roth Account
NO NO NO NO NO NO NO YES, if a direct trustee to-trustee transfer
Learning Objectives
7–1 Identify the characteristics of retirement plan distributions.
7–2 Analyze a situation to determine the income tax or benefit payment implications or requirements of a retirement plan distribution.
7–3 Identify and analyze lump sum options available to participants, including rollovers.
7–4 Identify minimum distribution requirements and distribution alternatives to calculate the required minimum distribution.
7–5 Identify a requirement for an IRA or qualified retirement plan distribution resulting from the death of the participant. 7–6 Use the appropriate distribution requirements and characteristics to calculate the taxable income on distributions from nondeductible and Roth IRAs.
7–7 Analyze and choose the best retirement plan for a given scenario.
7-19
Required Minimum Distributions
• • • Qualified plan distributions must begin by April 1 of the calendar year following the later of: 1.
the calendar year in which employee attains age 70½, or 2.
the calendar year in which employee retires.
IRA distributions must begin in the calendar year in which the participant attains age 70½ 50% excise tax on any shortfall 7-20
1st and 2nd Distribution Years
Jan. 1
1 st distribution year
Jan. 1
2 nd distribution year Trigger year 70 1 / 2
Dec. 31
Balance on Dec. 31 of prior year
Dec. 31 Apr. 1
1 st distribution due by April 1 Required Beginning Date
Dec. 31
2 nd distribution due by Dec. 31 of 2 nd year 7-21
IRA Required Minimum Distributions
•
Minimum distribution amount:
Total IRA(s) balance must be distributed over the Uniform Table life expectancy of the owner or joint life expectancy of owner and spouse if the spouse is more than 10 years younger • •
Aggregation
Allowed o o Within IRA plans, including SEP-IRAs and SIMPLE programs Within 403(b) plans Not allowed o o Across plan types Between corporate plans, including 401(k)
50% penalty tax on RMD shortfall
7-22
Required Minimum Distribution Rates
Participant Age
70 75 80 85 90 95 100 105 110 115
Distribution Period (Years)
27.4
22.9
18.7
14.8
11.4
8.5
6.3
4.5
3.1
1.9
Percent of Balance
3.65
4.37
5.35
6.76
8.77
11.63
15.87
22.22
32.26
52.63
7-23
Annuity Payment Distribution Taxation
(if there is basis) • Age 75 or older
nontaxable portion
investment in contract anticipate d return
• Prior to age 75
nontaxable portion
investment in contract number of payments
7-24
Learning Objectives
7–1 Identify the characteristics of retirement plan distributions.
7–2 Analyze a situation to determine the income tax or benefit payment implications or requirements of a retirement plan distribution.
7–3 Identify and analyze lump sum options available to participants, including rollovers.
7–4 Identify minimum distribution requirements and distribution alternatives to calculate the required minimum distribution.
7–5 Identify a requirement for an IRA or qualified retirement plan distribution resulting from the death of the participant. 7–6 Use the appropriate distribution requirements and characteristics to calculate the taxable income on distributions from nondeductible and Roth IRAs.
7–7 Analyze and choose the best retirement plan for a given scenario.
7-25
Minimum Distributions Following Death
• •
No beneficiary
If death occurs before RBD, then the five-year rule applies If death occurs after RBD, then the distribution would be based on the deceased’s life expectancy using the RMD Single Life Table fixed term 7-26
Minimum Distributions Following Death
• • • •
Spouse beneficiary
(both before and after RBD) Roll into own IRA and start taking distributions when he/she reaches age 70½ Take RMDs starting by December 31st of the year following death based on surviving spouse’s life expectancy; using the RMD Single Life table and recalculating each year Distribute under the five-year rule Delay distributions until the deceased would have been age 70½ (if deceased spouse under age 70½) 7-27
Minimum Distributions Following Death
• • •
Nonspouse beneficiary
(both before and after RBD) Take RMDs starting by December 31st of the year following death based on beneficiary’s life expectancy; using the RMD Single Life table and then using fixed term Can roll over into an IRA—needs to be titled as a beneficiary account, and distributions must still be taken as outlined in #1 Distribute under the five-year rule 7-28
Nontaxable Portion of Nondeductible IRA Distributions
Total nondeducti ble IRA any contributi balances at distributi ons ons year for end the year Distributi ons for the year 7-29
Qualified Distributions from Roth IRA
For qualified distribution status, the owner must meet two requirements: • • • • Five-year holding period requirement and the owner is at least age 59½, or to a beneficiary or after the death of the owner, or to the owner because of the owner’s disability, or for a qualified special purpose distribution* *The only qualified special distribution currently available is for first-time homebuyer expenses of up to $10,000.
7-30
Categorization of Roth IRA Funds
• • • Funds are considered to be distributed in this order: Annual contributions Conversion amounts Earnings 7-31
Learning Objectives
7–1 Identify the characteristics of retirement plan distributions.
7–2 Analyze a situation to determine the income tax or benefit payment implications or requirements of a retirement plan distribution.
7–3 Identify and analyze lump sum options available to participants, including rollovers.
7–4 Identify minimum distribution requirements and distribution alternatives to calculate the required minimum distribution.
7–5 Identify a requirement for an IRA or qualified retirement plan distribution resulting from the death of the participant. 7–6 Use the appropriate distribution requirements and characteristics to calculate the taxable income on distributions from nondeductible and Roth IRAs.
7–7 Analyze and choose the best retirement plan for a given scenario.
7-32
Plan Selection Qualified & Nonqualified Plans
Qualified Plans Pension Plans
Defined Benefit (DB)
Profit Sharing Plans (DC)
Profit Sharing Cash Balance (DB) Thrift Plan Stock Bonus Money Purchase (DC) Target Benefit (DC) ESOP (LESOP) Age-Weighted Cross-Tested (Comparability) 401(k) Plan
Tax-Advantaged Plans
Traditional IRA Roth IRA SIMPLE IRA SEP (SARSEP)
Nonqualified Plans
403(b) (TSA)
Other Nonqualified Plans
Section 457 Plans ISO ESPP NQSO Deferred Compensation Plans SIMPLE 401(k) 7-33
Retirement Plan Selection Process: Business Environment
Determine how best to meet owner’s retirement savings through a qualified plan (Personal Objectives, Business Objectives, Altruistic Objectives) No Reassess retirement objectives/ alternate savings Reassess
Owner will commit to a retirement plan and owner has a savings need?
No Select discretionary plan. Is owner’s savings need <=25% of compensation?
Yes No Yes Stable cash flow and owner will make annual commitment?
Yes Select profit sharing or P/S 401(k) No SEP, profit sharing, stock bonus or ESOP plan.
Share ownership?
Yes Select stock bonus or ESOP Profit sharing plan (age weighted if over 45) Reassess No No Is owner’s savings need >25% of compensation?
Yes Is owner oldest and owner’s age >=45?
Yes DB plan 7-34
Qualified Plan Characteristics (1)
Basic Statutory Characteristic
Cont. Type
Defined Contribution Plans Profit Sharing/ Stock Bonus
Flexible contribution
Money Purchase Pension
Fixed annual requirement
Target Benefit
contribution to meet minimum funding Maximum Employer Deduction 25% of covered payroll
Defined Benefit Plans Cash Balance
Fixed % of comp.; annual actuarial adjustment
Defined Benefit
Annual actuarial determination Amount necessary to fund benefit up to IRS limits 7-35
Qualified Plan Characteristics (2)
Basic Statutory Characteristic
Minimum funding standard Employee Contribution
Defined Contribution Plans Profit Sharing/ Stock Bonus
Generally no
Money Purchase Pension
Yes
Target Benefit
Yes 401(k) provisions allowed May permit voluntary after-tax N/A Forfeitures Generally reallocated Reallocated or applied to reduce employer contribution
Defined Benefit Plans Cash Balance
Yes
Defined Benefit
Yes N/A May permit voluntary after tax Must be applied to reduce employer contribution 7-36
Qualified Plan Characteristics (3)
Basic Statutory Characteristic
Annual additions limit (415 limit) Annual benefit limit (415 limit)
Defined Contribution Plans Profit Sharing/ Stock Bonus Money Purchase Pension Target Benefit
Annual additions to a participant’s account may not exceed the lesser of 100% of compensation or $51,000 in 2013 N/A N/A N/A
Defined Benefit Plans Cash Balance
N/A
Defined Benefit
N/A Participant’s annual benefit may not exceed lesser of $205,000 or 100% of compensation in 2013 7-37
Other Qualified Plan Characteristics
Basic Statutory Characteristic
Most favored age group Investment risk Maintenance of plan funds Certainty of retirement benefits
Defined Contribution Plans Profit Sharing/ Stock Bonus
Younger
Money Purchase Pension
Younger
Target Benefit
Older Employee Individual Accounts Uncertain 1 PBGC insured
Defined Benefit Plans Cash Balance
Younger
Defined Benefit
Older Employer Pooled Funds Guaranteed minimum return on fund 1 Specific annual benefit 1 7-38
IRA Hybrid Retirement Benefits
Type of Plan Simplified Employee Pensions (SEPs) SIMPLE IRA SIMPLE 401(k) Limits on Employer Contribution
25% deduction limit 3% dollar-for dollar or 1% in 2 out of 5 years matching or 2% non-elective 3% dollar-for dollar matching or 2% non elective
Limits on Employee Deferrals
SARSEPs can no longer be established $12,000 (indexed) plus $2,500 age 50 catch-up if eligible $12,000 (indexed) plus $2,500 age 50 catch-up if eligible
Allocation of Employer’s Contributions
Allocation formula used—can include integration with Social Security Percentage of compensation Percentage of compensation
Administrative Costs/Burden
Low—employer has full discretion re: future contributions within the 25% limitation Low—no ADP or ACP testing; employer may reduce matching contribution to 1% in 2 out of 5 years Low—no ADP or ACP testing 7-39
Points to Consider in Selection of Most Appropriate Plan
• Seeks maximum tax shelter • Owner usually 45 or older and oldest or one of oldest employees, only one or two older • Rewards long-term employees, and favors older employees • Willing and able to make annual financial commitment in excess of 25% of compensation • Willing to accept investment risk • Allows owner to meet his/her retirement Defined Benefit Plan • Business has stable cash flow; owner is willing to make annual financial commitment, but unwilling or unable to commit more than 25% of compensation • Shift investment risk to employees • Easier to communicate plan to employees, and reduce administrative costs • Younger employees benefit from years of contributions and compounding Money Purchase or Target Benefit Plan (to provide age-weighted plan) 7-40
Points to Consider in Selection of Most Appropriate Plan
• Business cash flow fluctuates • Shift investment risk to employees • Desire plan that will motivate employees • Younger employees benefit from years of contributions and compounding
Profit Sharing, SEP, or Tandem Plan
• No other qualified plan or 403(b) • No more than 100 employees earning $5,000 or more • Owner willing to make minimal contribution— 2% or 3% of compensation • Desire to provide tax-deferred savings for employees • Desire very low administrative cost
SIMPLE IRA or SIMPLE 401(k)
7-41
Practice Problem 1
Match the following characteristics with the item that matches it best (one match each).
Plan or category
1. Money purchase 2. Stock bonus 3. Cash balance 4. ESOP 5. SEP 6. SARSEP 7. 403(b) plan 8. Qualified plans
Characteristic
A. Must be established by October 1 of plan year B. Can no longer be established, older plans are grandfathered C. One of the two defined contribution pension plans D. Must be established by calendar year end E. Subject to the ACP test, but not the ADP test F. Employer guarantees a certain return on plan assets G. Employer stock is limited to 10% of plan assets H. Can be established until tax due date, including extensions 9. SIMPLE IRA 10. Pension plans I. Has diversification requirement at age 55 & 10 years of service J. If company is publicly traded, must be able to diversify out after three years 7-42
Practice Problem 2
Indicate which type of employee is used for each test.
Test
50/40 Test (DB Plans) Ratio % (DB & DC Plans) Average Benefits (DB & DC Plans) ADP (401(k) Plans) ACP (401(k) Plans) Top-heavy (DB & DC Plans)
HCE Key Employee
7-43
Practice Problem 3
What is the maximum vesting schedule allowed for each of the types of plans indicated?
Defined benefit_________________________ Cash balance__________________________ Defined contribution_____________________
7-44
Practice Problem 4
What are the exceptions to the 10% early withdrawal penalty tax for the following scenarios?
a. Exceptions that apply to all plans 1.
___________________________ 2.
___________________________ 3.
___________________________ 7-45
Practice Problem 4
continued b. Exceptions that apply only to qualified plans and 403(b) plans 1.
________________________________ 2.
________________________________ 3.
________________________________ 7-46
Practice Problem 4
continued c. Exceptions that apply only to IRA accounts 1.
________________________________ 2.
________________________________ 3.
________________________________ 4.
________________________________ 7-47
Multiple Choice Question 5
Clark Benson was born in 1935, and he is still employed at Oak Enterprises, Inc. He has accumulated $250,000 in Oak Enterprises’ profit sharing 401(k) plan after more than 20 years of employment; to date, he has taken no distributions from the plan. He plans to take distribution of the full account when he retires next year.
Which of the following describe the tax consequences of Clark’s planned distribution schedule?
I.
not subject to 10% penalty II.
III.
IV.
subject to 15% mandatory withholding subject to 50% minimum distribution penalty eligible for 10-year forward averaging a. I and IV only b. II and III only c. III and IV only d. I, II, and III only e. I, III, and IV only 7-48
Multiple Choice Question 6
At age 57, Anita Buford retired from PQR Corporation in January this year after 15 years of service. She received a check for the distribution of her account in the PQR Money Purchase Plan. Her account balance was $60,000 on her final day of employment. Which of the following statements describe the income tax or penalty tax consequences of this distribution? I.
subject to 10% penalty II.
III.
IV.
subject to mandatory 20% withholding eligible for 10-year forward averaging exempt from the 10% early withdrawal penalty a. I and II only b. II and III only c. II and IV only d. I, II, and III only e. I, II, and IV only 7-49
Multiple Choice Question 7
Bob Wheeler is retired and wants to take out the minimum amount he can from his IRA account. He turned age 70½ on June 2nd of this year. He has come to you and wants to know what his minimum distribution amount will be for this year. His account balance at the end of this year is projected to be $190,500, and his account balance at the end of last year was $183,000. According to the Uniform Table, the life expectancy for age 70 is 27.4, and for age 71 it is 26.5. What is Bob’s minimum distribution amount? a.
$6,906 b.
c.
d.
$6,679 $6,953 $7,189 7-50
Multiple Choice Question 8
Which of the following distributions would be exempt from the 10% early withdrawal penalty for qualified plans, 403(b) plans, and IRA accounts? I.
distribution due to disability II.
III.
IV.
distribution due to death distribution for medical expenses in excess of 7.5% of AGI distribution for qualified postsecondary education expenses a. I and II only b. II and III only c. I, II, and III only d. I, II, III, and IV 7-51
CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Retirement Planning & Employee Benefits
Module 7 End of Slides
©2013, College for Financial Planning, all rights reserved.