Novel Investor

Compounding investing wisdom...

  • Home
  • About
  • Library
  • Quotes
  • Tools

Retirement Planning Study Guide

Contains the notes on the Retirement Planning study book material for the CFP Board Exam. It covers the numerous qualified and non-qualified retirement plan options and additional employee benefits.

The Notes

  • Starred (*) topics are more likely to be on the exam (2021).
  • Qualified Plan Basics
    • All defined benefit plans are pension plans
    • Defined contribution plans can be pension or profit-sharing plans
    • Pension Plans (4-types)*
      • Defined Benefit
        • Defined Benefit Pension Plans
        • Cash Balance Pension Plans
      • Defined Contribution
        • Money Purchase Pension Plans
        • Target Benefit Pension Plans
    • Profit-Sharing (7-types)*
      • Profit-Sharing Plans
      • Stock Bonus Plans
      • Employee Stock Ownership Plans
      • 401k Plans
      • Thrift Plans
      • New Comparability Plans
      • Age-Based Profit-Sharing Plans
    • Pension Plan Characteristics*
      • Legal Promise = Pay pension at retirement
      • In-Service Withdrawals = Not allowed
      • Mandatory Funding = Yes
      • Invest in Employer Securities = up to 10% of plan
      • Must Provide QJSA/QPSA = Yes
    • Profit-Sharing Plan Characteristics*
      • Legal Promise = Defer compensation and taxes
      • In-Service Withdrawals = After 2 years, if plan permits
      • Mandatory Funding = No
      • Invest in Employer Securities = Up to 100%
      • Must Provide QJSA/QPSA = No
    • Defined Benefit Plan Characteristics*
      • Contribution Limits = No less than current unfunded liability
      • Assumes Investment Risk = Employer
      • Forfeiture Allocated = Reduce plan costs
      • PBGC Coverage = Yes
      • Separate Investment Accounts = No (commingled)
      • Credit for Prior Service =  Yes
    • Defined Contribution Characteristics*
      • Contribution Limits = 25% of employee covered compensation
      • Assumes Investment Risk = Employee
      • Forfeiture Allocated = Reduce plan cost or allocate to other participants
      • PBGC Coverage = No
      • Separate Investment Accounts = Yes
      • Credit for Prior Service =  No
    • Qualified Plan Advantages*
      • Employers
        • Employer contributions tax-deductible
        • Payroll tax savings on employer contributions
          • Does NOT apply to employee deferrals
          • Distributions not hit by payroll tax
      • Employees
        • Can use pre-tax contributions
        • Income tax deferral
        • ERISA = creditor asset protection
        • Lump-sum distribution options
    • Qualified Plan Disadvantages
      • Contribution amounts limited
      • Contributions end after distributions begin
      • Limited access to funds while employed
      • Early withdrawal penalties
      • Limited investment options
      • Distributions taxed as ordinary income
      • Mandatory distributions (age 72)
      • Income in Respect of a Decedent asset = distributions subject to estate taxes (no step-up in basis)
      • Only owner allowed is account holder
      • Can not use as collateral
      • No gifts to charity before 70 1/2 (tax consequences)
      • Limited enrollment periods
      • Plan costs
    • Requirements
      • Eligibility
        • Standard: age 21 or 12 months of service (at least 1,000 hours worked)
        • Employers can be more generous — under 21 or less than 12 months
        • Beginning 2021 for part-time employees: 500 hours worked minimum for 3 consecutive years
        • Entrance Date:*
          • Most qualified plans have 2 entrance dates.
          • Must wait till next entrance date after eligibility to join plan, so long as next entrance date is not 6 months after elgilibiliy.
        • Exception: Special Eligibility Rules
          • Deferred to 2 years of service before eligible
          • Immediately vested
          • Not for 401k
      • Coverage
        • Must provide to minimum number of non-highly compensated (NHC) employees
        • Nondiscrimination
          • all eligible employees must be considered, but not all must be covered.
        • Coverage Tests
          • Must cover at least 70% of non-highly compensated (NHC) employees
          • 3 Tests (must pass 1 of 3!)
            • General Safe Harbor Test
              • % of NHC covered >= 70%
            • Ratio Percentage Test
              • (% of NHC/% of HC) >= 70%
            • Average Benefit Test
              1. (AB% of NHC/AB% of HC) >= 70%
              2. Nondiscrimination Test
          • Defined Benefit Plans must also pass (in addition to 1 of 3 Coverage Tests):
            • 50/40 Test*
              • Benefits the lessor of 50 employees or 40% of all nonexcludable (eligible) employees
              • Coverage Minimums
                • 1 Nonexcludable Employee = 1 Employee must be covered
                • 2 to 4 NE = 2 Employees must be covered
                • < 125 NE = 40% of Employees
                • > 125 NE = 50 Employees
        • Highly Compensated Employees Defined*
          • Owner Employees
            • Over 5% owner for current or prior plan year, or
            • Paid over $130,000 (2021) for prior plan year
          • Non-Owner Employees
            • Paid over $130,000 (2021) for prior plan year
      • Vesting
        • Ownership of employer contributions transfer to employee
        • Termination before 100% vested = loss of portion of employer contributions
        • Employee contributions = 100% vested
        • Vesting Schedules:
          • Cliff
            • Immediate 100% vested after a number of years (usually 3)
          • Graduated
            • Grandual increase in vested percentage over certain number of years (like 2 to 6 years)
        • Note: 2 year eligibility deferral = 100% vested after 2 years
        • Employers can use faster vesting schedule
          • must be better than approved schedules
        • Years of Service
          • Based on starting date, not date employee is eligible for the plan
          • Employer does Not have to count:
            • Years of service before age 18 if not participating in a plan
            • Years of service before a qualified plan was put in place
            • Years of service when employee did not contribute to employee-contributory qualified plan
      • Top-Heavy Plans
        • Ensures that plans setup to benefit owners/key employees must also provide minimum benefits for other employees.
        • Plan is Top-Heavy if:
          • More than 60% of benefits or contributions go to key-employees
        • Key Employee (1 of following):
          • Greater than 5% owner
          • Greater than 1% owner, paid over $150,000
          • Officer, paid over $185,000 (2021)
          • Note: must be owner or officer
            • Officer = executive
            • If # of officers exceeds 50, than only top 50 by compensation are officers
        • Top-Heavy Vesting
          • Must use 3 year cliff or 2 to 6 year graduated schedules
        • Top-Heavy Funding
          • Must provide minimum contributions to non-key employees
          • Top-Heavy Defined Contribution Plan = Minimum 3% of compensation
            • Exception:  when total funding for all key employees is less than 3%, then non-key employee funding must equal key-employee funding.
          • Top-Heavy Defined Benefit Plan = At least 2% x Years of Service x Compensation Factor
            • Compensation Factor = average annual compensation of test period
    • Benefit/Contribution Limits
      • Max Covered Compensation Limit
        • Defined Benefit Plan
          • $290,000 (2021)
        • Defined Contribution Plan
          • $290,000 (2021)
      • Max Benefit Limit
        • Defined Benefit Plan
          • Lessor of:
            • $230,000 (2021)
            • Average 3 highest consecutive paid years
        • Defined Contribution Plan
          • Lessor of:
            • 100% of comp
            • $58,000 (2021)
              • Not including catch-up of $6,500
          • Includes: Employer and employee contributions (and forfeitures)
    • Controlled Groups Rules
      • Stops owners from splitting businesses to increasing retirement contributions
      • 2 or more businesses under common control
      • Relationships
        • Parent-Subsidiary
          • connected through stock ownership
          • 80% of the company’s stock is owned by one or more corporations in the group
        • Brother-Sister
          • 2 or more companies with 5 or fewer common owners with controlling interest and “effective” control
            • Control Interest = 80% or more of stock of each corporation
            • Effective Control = more than 50% of stock of each company, looking only at each owner’s “lowest common denominator” ownership interest
        • Combined Group
          • 3 or more organizations set up as:
            • Each organization is a member of a parent-subsidiary or brother-sister group
            • One corporations is parent of parent-subsidiary and member of brother-sister
    • Affiliated Services Group Rules
      • Treats all employees of group members as employed by single employer.
  • Pension Plans
    • Defined Benefit Plan Characteristics*
      • Actuary annually = yes
      • Investment risk = on employer
      • Forfeitures = must reduce plan costs
      • PBGC Insurance = Yes
      • Credit for Prior Service = Yes
      • Social Security Integration = Offset of Excess
      • Separate Investment Accounts = No (commingled)
      • Favors = Older employees
    • Defined Contribution Plan Characteristics*
      • Actuary annually = No (except target benefit at inception)
      • Investment risk = on employee
      • Forfeitures = reduce plan costs or fund other participants
      • PBGC Insurance = No
      • Credit for Prior Service = No
      • Social Security Integration = Excess Only
      • Separate Investment Accounts = Yes (usually separate)
      • Favors = Younger employees
    • Other Characteristics
      • Life insurance investment
        • Any qualified plan can purchase life insurance
        • Must not be primary focus of the plan
        • Premiums paid by employer are taxable to employee
        • Must pass 1 of 2 tests:
          • 25% Test
            • Term Life = premiums cannot exceed 25% of employers total contributions to participants account
            • Whole Life = premiums cannot exceed 50% of employers total contributions to participants account
          • 100-to-1 Ratio Test
            • Limits death benefit to 100x monthly retirement benefit
      • Benefits*
        • Defined Benefit
          • Accrued Benefit
            • Participant has accrued benefit equal to expected future payments
            • Calculated by actuary
            • subject to mandatory funding
        • Defined Contribution
          • Account Balance
            • Benefit is what the participant contributions, non-vested employer contributions, and earnings on contributions.
      • Social Security Integration (Permitted Disparity)
        • Allows higher contributions to those who’s pay exceeds Social Security wage base
        • Excess Method (DB and DC Plans)
          • only applies to income in excess of covered compensation limit
          • limited to lessor of:
            • 0.75% per year of service
            • benefit percentage for earnings below the covered compensation limit per year of service
          • max increase of 26.25% = o.75% x 35 years
        • Offset Method (DB Plans only)
          • applies formula to all earnings then reduces it for earnings below the covered compensation limit
            • Reduction of benefit limited to lessor of:
              • 0.75% per year of service up to 35 years
              • 50% of benefit funding percentage per year of service
            • max reduction of 26.25% = o.75% x 35 years
    • Defined Benefit Plans
      • Formulas for Benefits
        • Flat Amount Formula
          • Provides an amount participants receive at retirement
          • Not based on years of service or salary
          • Each participant gets the same amount
          • Disadvantage:  no incentive for employees to continue working after hitting max flat amount
        • Flat Percentage Formula
          • Benefit is a percentage of salary (usually final salary or average of highest salary)
          • Percentage is static, does not increase with years of service
          • Disadvantage: no incentive to continue work beyond desired benefit amount
        • Unit Credit Formula
          • Benefit is based on salary and years of service
          • Fixed percentage of salary multiplied by years of service
  • Cash Balance Pension Plans
    • Defined Benefit Plan
    • Creates a hypothetical account for participant with allocation and earnings
    • Contribution/Earnings
      • Funding formula based on Pay Credit and Interest Credit
      • Pay Credit
        • May integrate with Social Security
        • May use age and years of service
      • Interest Credit
        • Guaranteed interest return
      • Employer responsible for investment performance
    • Benefits younger participants more than older
    • 3-year cliff vesting
    • Conversions
      • Popular choice to replace old, expensive DB plans
      • Must meet 3 requirements:
        • Participants accrued benefit would be equal or greater than any similarly situated younger participant
        • Interest Credit = rate used must not be greater than market rate of return
        • 100% vesting after 3 years of service for plan years beginning 2007
  • Money Purchase Pension Plans
    • Defined Contribution Plan
    • Employer promises to make a contributions based on fixed percentage of employees pay
    • Does NOT guarantee specific retirement benefit
    • Contribution Limit
      • Limited to lessor off:
        • 100% of compensation
        • $58,000 (2021)
      • Employer can NOT deduct contributions over 25% of employees pays
    • Contributions made to separate accounts
    • Benefits younger participants more than older
    • Subject to shorting vesting requirements (3-year cliff or 2 to 6 year graduated)
  • Target Benefit Pension Plans
    • Defined contribution plan
    • Type of money purchase pension plan
    • Benefits older participants more than younger
    • Funding formula based on benefit paid at the participants retirement
    • Does NOT guarantee specific retirement benefit
    • Employee is responsible for choosing investments
  • Profit-Sharing Plans
    • Contribution/Allocation Formulas
      • Social Security Integration (Permitted Disparity)
        • Excess method only allowed.
        • Applies two rates:
          • Base contribution rate
            • applies to income up to Social Security wage base
          • Excess contribution rate
            • applies to income over SS wage base but up to $290,000 (2021)
            • Limited to lessor of:
              • twice the base rate, or
              • 5.7%
            • Excess rate is generally 5.7% higher than base rate*
          • Base Rate + Permitted Disparity = Excess Rate*
          • Permitted Disparity = lessor of Base Rate or 5.7%*
      • Age-Based Profit-Sharing Plans
        • Contributions based on age and compensation
        • Benefits older employees/owners
      • New Comparability Plans
        • Contributions based on employee classification in company
        • Must meet cross-testing rules, to be nondiscriminatory.
        • More expensive to manage
      • Forfeitures
        • Reduce plan contributions or reallocate to remaining participants
        • Reallocation can not be discriminatory
    • Vesting
      • Standard 3-year cliff or 2 to 6 year graduated
        • Exception: 2 year wait period is 100% vested
    • Cash Or Deferred Arrangements (CODA)
      • Allows employees to defer a portion of pre-tax salary
        • Exception: defer salary on a Roth basis
      • 401k Plans
        • Entities can establish 401k plans?*
          • Corporations
          • Partnerships
          • LLCs
          • Proprietorships
          • Tax-exempt entities
        • Eligibility
          • Year of service limits must NOT exceed 1 year
        • Vesting
          • Employee contributions = 100% vested
          • Employer contributions = 3-year cliff or 2 to 6 year graduated (or more generous)
        • Participation
          • Salary Reduction Agreement = employee agrees to reduce salary for ability to defer contributions to plan.
        • Contributions
          • Made as:
            • Employee elective deferral contributions (traditional or Roth)
            • Employee after-tax contributions
            • Employer match
            • Employer profit-sharing
            • Employer contribution to fix ADP/ACP issue
          • Employee Deferrals
            • Annual Limit = $19,500 (2021)
            • Catch-Up Limit = $6,500 (2021)
            • Tax Impact
              • Deferrals not taxed
              • Exception: Roth 401k and thrift plan contributions
            • Thrift Plan Contributions
              • Allow employee after-tax contributions
              • Can save more than elective deferral limit
            • Roth 401k Contributions*
              • Only after-tax contributions allowed
              • Limits
                • Annual Limit = $19,500 (2021)
                • Catch-Up Limit = $6,500 (2021)
                • Limits apply to both 401k and Roth 401k contributions combined.
              • Roth 401k Distributions
                • Follows minimum distribution rules
                • To be qualified = must be held for 5 years and made because of disability, death, or after age 59 1/2
          • Employer Contributions
            • Matching Contributions
              • Provided to employees that contribute
              • Vesting limits = 3-year cliff or 2 to 6 year graduated (or quicker)
            • Non-elective Contributions
              • Contribute to ALL employees if they contribute or not
            • Profit-Sharing Contributions (Stock Bonus)
              • Does not count against contribution limits of 25%
              • Still limited to $58,000 or $64,500 age 50 or more (2021)
        • Nondiscrimination Testing
          • Must meet 2 more tests
          • Test whether non-highly compensated employees (NHC) are discriminated against
          • Actual Deferral Percentage Test (ADP)*
            • Permissible Levels
              • If ADP for NHC is 0% to 2% = permissible ADP for HC is 2x ADP for NHCs
              • If ADP for NHC is 2% to 8% = permissible ADP for HC is 2 + ADP for NHCs
              • If ADP for NHC is 8% or more = permissible ADP for HC is 1.25x ADP for NHCs
            • Methods
              • Prior Year
                • uses prior years ADP for NHC employees to calculate max permissible deferrals for HCs
              • Current Year
                • uses current years ADP for NHC employees to calculate max permissible deferrals for HCs
                • offers higher deferral percentage to HCs (usually) and more flexibility in case of ADP failure
            • Failure
              • At risk of disqualification
              • Fixes:
                • Corrective Distributions
                  • Easiest/cheapest
                  • Return funds to HCs
                    • Earnings on returned funds must also be returned
                  • Must be done within 2 1/2 months after end of plan year or 10% excise tax imposed on amount
                • Recharacterization
                  • Excess recharacterized as after-tax contributions
                  • Recharacterized become taxable income to employee
                  • Must be done within 2 1/2 months after end of plan year or 10% excise tax imposed on amount
                • Qualified non-elective contributions (QNEC)
                  • Employer makes non-elective contribution to ALL NHC employees
                  • Discrimination test sees it as an elective deferral by employee
                  • Increases ADP of NHC
                  • 100% vested
                • Qualified matching contributions (QMC)
                  • Match only made to NHC employees that participate
                  • Increases ADP of NHC
                  • 100% vested
          • Actual Contribution Percentage Test (ACP)
            • Tests after-tax contributions and employer-matching contributions
            • Calculated the same as ADP
            • If failed, uses same corrective measures as ADP
          • Safe Harbor 401k Plans
            • Avoids the ADP/ACP and top-heavy tests
            • Employer Contributions either:
              • 3% minimum non-elective contribution
                • ALL employees
              • Match
                • 100% of first 3% employee elective deferrals, and
                • 50% of next 2% deferrals
            • Immediate 100% vested
            • Convert 401k to Safe Harbor 401k
              •  Must elect to convert within 30 days of plan’s year end
              • Non-elective contributions must be at least 4% for ALL employees
              • Only for plans beginning after 12/31/19
            • Automatic Enrollment
              • Negative Election feature = automatic enrollment
              • Employee must opt-out (opt-out must be an option)
              • Plans that offer “qualified automatic enrollment” eligible for nondiscrimination safe harbor
                • Treated as meeting ADP/ACP tests
              • Requirements (employee contribution must be at least):
                • 3% of comp the first year
                • 4% the second year
                • 5% the third year
                • 6% the fourth year and after
                • Percentage must be applied uniformly to ALL eligible employees
                • Matching Contributions
                  • 3% non-elective contribution, or
                  • NHC Match of 100% of first 1%, 50% of next 5% and
                    • rate of HCs match is not greater than NHCs
                  • Vesting = 2-year cliff (or sooner)
      • Plan Loans
        • Permitted but not required
        • If offered:
          • must be equally available
          • must be limited in amounts
          • must be paid back in certain time period
          • must charge reasonable interest rate
          • must be adequately secured
        • Characteristics
          • Usually with 401k or 403b plans
          • Limits to lessor of:
            • 1/2 vested plan benefit
            • $50,000
          • If vested benefit >= $10,000
            • limits to greater of:
              • $10,000
              • vested benefit
          • $50,000 max loan reduced by highest outstanding balance in prior 12 months
        • Repayment
          • Must be repaid in 5 years
          • Repayment is done at a “substantially level amortization” rate
          • Exception: loan for personal residence — repaid up to 30 years
          • Usually done through payroll deduction
          • Failure to repay treated loan as distribution — 10% penalty possible
          • Must be repaid on termination (grace period allowed)
      • Distributions
        • Hardship Distributions
          • Limited to maximum distribution amount
          • Max = employee’s total elective deferrals (less previous distributions)
            • Can include (not required) QNECs, QMCs, safe harbor contributions, and earnings on those amounts
        • Qualified Disaster Distributions
          • Up to $100,000 from qualified plan, IRA, 403b, 457 made before 6/25/2021
          • Taxes on amount spread over 3 years
          • Repayment in 3 years is not considered a rollover
          • NO 10% early withdrawal penalty
  • Stock Bonus Plans
    • Allow employers to contribute stock to qualified plan
    • Requirements
      • Must have pass through voting rights on stock
      • Be able to demand stocks on distributions
      • Employer must repurchase stocks if not publicly traded
      • Distributions must began within 1 year of normal retirement age, death, disability
        • Or 5 years of other termination
      • Distributions must be fully paid in 5 years\
    • Advantages
      • Employees
        • May encourage contributions
        • Increased stock value at retirement
        • Net Unrealized Appreciation (NAU) tax treatment on lump-sum stock distributions
      • Employers
        • FMV of stock tax deductible to employer = lower tax costs
        • Employees have vested interest in company’s success
    • Disadvantages
      • Employees
        • Diversification risk — 100% employer stock
      • Employers
        • Share dilution
        • Repurchase option requirement could deplete cash
    • Distributions
      • In stock or cash (if cash, NAU benefit is lost)
      • Taxation
        •  Lump-sum Distribution
          • Ordinary income tax on stocks FMV at time of contribution
          • Net Unrealized Appreciation (NAU) not taxed until sold — LTCG on appreciation
        • Installment Distribution
          • Everything taxed as ordinary income (NAU is lost)
            • Exception: stock bought with after-tax contributions
    • Deductible Contribution Limits
      • 25% of covered comp
    • Valuation
      • Appraisal generally needed
    • Eligibility
      • Same as Qualified Plans (21 and 1 year of service or 2 years w/ 100% vesting)
    • Allocation Method
      • % of comp or formula based on age and service
    • Social Security Integration = Allowed
    • Vesting
      • 3-year cliff or 2 to 6 year graduated
    • In-Service Withdrawals
      • Allowed (not required) after 2 years
    • Loans
      • Allows but not required (not usually)
  • Employee Stock Ownership Plans (ESOPs)
    • ESOP is controlled by a trust
    • Trust borrows money to buy stock
    • Companies repay loan with tax-deductible contributions  to ESOP (income and principal payments are tax-deductible)
    • Lets owners sell all/part interest in company and defer capital gains.
      • Requirements:*
        • ESOP must own at least 30% of stock after sale.
        • Seller(s) must reinvest proceeds into replacement securities within 12 months after sale and hold for 3 years
          • Qualified replacement securities = domestic company stocks, bonds, warrants, debentures (receive no more than 25% of income from passive investments).
        • Stock not tradable on exchange
        • Sellers, sellers relatives, and 25% shareholders cannot get stock through ESOP
        • ESOP may not sell stock from rollover for 3 years
        • Stock must be common or convertible preferred stock
        • Seller must own stock for 3 years before selling.
      • If seller buys/holds replacement securities for 3 years = no taxable event
    • Advantages
      • Employee
        • Retirement vehicle and ownership w/ voting rights
        • job preservation — buys companies from owner
        • Vested in company’s success
        • NAU tax treatment
      • Employers
        • ESOP is ready/available buyer with deferred tax treatment for retiring owners
        • Loan repaid with tax-deductible contributions
        • Owner can created diversified portfolio with sale proceeds
    • Disadvantages
      • Employee
        • Diversification risk — 100% employer stock
          • Exception: age 55 and 10 years service, employer must offer diversification options
        • Stock value subject to appraiser and fluctuations
        • Illiquidity
      • Employers
        • Dilutes ownership
        • Higher costs — admin and appraisal
        • Repurchase option requirement could deplete cash
        • Trustees of ESOP have personal liability concerns
    • Distributions
      • Subject to minimum distribution requirements
      • Lump-sum Distribution
        • Ordinary income tax on stocks FMV at time of contribution
        • Net Unrealized Appreciation (NAU) not taxed until sold — LTCG on appreciation
      • Equal Periodic Payments
        • NAU is lost
        • Taxed as ordinary income
        • Period no longer than 5 years
          • Exception: balances over $1,650,000 (2021), period is extended 1 year per each additional $230,000 up to 10 years max.
    • Deductible Contribution Limits
      • 25% of covered comp plus interest paid on loans
    • Valuation
      • Appraisal generally needed plus dividends
    • Eligibility
      • Same as Qualified Plans (21 and 1 year of service or 2 years w/ 100% vesting)
    • Allocation Method
      • % of comp or formula based on age and service
    • Social Security Integration = NOT allowed
    • Vesting
      • 3-year cliff or 2 to 6 year graduated
    • In-Service Withdrawals
      • Allowed (not required) after 2 years
    • Loans
      • Allows but not required (not usually)
  • Qualified Plan Distributions
    • Any money taken out with no intention of being returned (includes loans not being repaid)
    • Options
      • Pension Plans
        • Early Termination (before retirement age)
          •  Lump-sum distribution – taxed as ordinary income
          • Rollover assets to IRA or other plan
          • Leave funds in pension
          • Forced payout = balanced under $5,000 may auto-rolled into IRA without timely decision.
        • Normal Retirement
          • Standard: single life annuity payable over participants life
          • Subject to ordinary income tax
          • Married persons must be offered QJSA
          • Qualified Joint and Survivor Annuity (QJSA)
            • Must be offered to married participants or pension and profit sharing plans
            • Pays benefit as long as either spouse lives.
              • Payment ranges from 50% to 100% after first death
            • Nonparticipant spouse can waive right to QJSA via written notarized waiver
              • Must be waived during 90 day period before annuity start date
          • Qualified Pre-Retirement Survivor Annuity (QPSA)
            • Must be offered to married participants or pension and profit sharing plans
            • Provides benefit to spouse if participant dies before retirement age.
            • Nonparticipant spouse can waive right to QJSA via written notarized waiver
            • Subject to ordinary income and estate tax
      • Profit Sharing Plans
        • Early Termination
          • Lump-sum distribution – taxed as ordinary income
          • Rollover to IRA or other plan
          • Annuitize the account
        • Normal Retirement
          • Not required to offer annuity options
    • Distribution Taxation
      • Taxed as ordinary income (if pre-tax contributions)
      • Mandatory 20% withholding from qualified plan distributions
      • Rollovers
        • Direct Rollover
          • Balanced rolled “directly” into account in another plan or IRA
          • NO 20% withholding
        • Indirect Rollover
          • Balanced given to participant who transfers it to account in another plan or IRA
          • 20% withholding applies
          • Must transfer the full amount (including 20% withholding) to another plan or IRA within 60 days
        • After-Tax Contributions
          • Plans with after-tax dollars can only be rolled into other qualified plans that allow after-tax dollars or Traditional IRA
          • Direct rollover only
      • Adjusted Basis in Distributions if:
        • Made after-tax contributions to a plan, or
        • Taxed on life insurance premiums held in plan
        • Annuity Payments
          • Return of adjusted basis = tax free
          • Ordinary income
          • Think Exclusion Ratio
        • Lump-Sum Distribution
          • May get special tax treatment
          • Requirements (all 4 needed to qualify):
            • Must be entire accrued benefit/account balance
            • On account of death, age 59 1/2, disability, separation from service
            • 5 years of participation prior to distributions
            • Must elect lump-sum via Form 4972 attached to tax return
      • Special Tax Options Lum-Sum Distributions
        • 10-Year Forward Averaging
          • Not likely tested
          • Born before 1/2/1936 is eligible
          • Take taxable portion of lump-sum, divide by 10, apply 1986 income tax rates on amount, then multiple by 10 for tax owed.
          • Paid in year of lump-sum
        • Pre-1974 Capital Gains Treatment
          • Not likely tested
          • Born before 1/2/1936 is eligible
          • 20% capital gains tax on portion of lump-sum attributed to pre-1974 participation
        • Net Unrealized Appreciation (NAU)*
          • For lump-sum employer stock (or other securities) distributions
          • NAU = FMV at Date of Distribution – Value at date of Employer Contribution
          • Value at date of Employer Contributions = taxed as ordinary income
          • NAU = taxed as long term capital gains at sale of securities
          • Gains after the date of distribution is treated as short or long term capital gains
          • Potential Issues
            • Must qualify for lump-sum
            • NUA portion should be large enough to be worth the savings
            • Diversification Risk = large allocation in 1 stock
          • Inherited Securities w/ NUA
            • Step-up in basis to FMV at death less unrecognized NUA
            • Tax paid when heirs sell
      • Qualified Domestic Relations Order (QDRO) on Retirement Distributions
        • Order recognizing the right of a third-party to benefits from qualified plan
        • Two options:
          • Shared Payment Approach
            • splits the benefit payments between participant and third-party
          • Separate Interest Approach
            • divides participants benefit into two separate portions
        • Third-party may deposit distribution into IRA or qualified plan tax free.
    • Distributions Before 59 1/2
      • Subject to 10% early withdrawal penalty
      • Exceptions to 10% penalty:*
        • Death
        • Age 59 1/2
        • Disability
        • Substantially equal periodic payments (72t)
        • Medical expenses over 7.5% of AGI
        • $5,000 per taxpayer for Birth or Legal Adoption
        • Qualified Domestic Relations Order (QDRO)
        • Qualified public safety employee separated from service after age 50
        • Age 55 and separated from service
        • Dividends paid within 90 days of plan year end from ESOP
        • Tax levy on plan = used to pay unpaid income taxes
      • IRA Exceptions to 10% penalty*
        • First time home purchase
        • health insurance
        • death
        • disability
        • higher education
        • medical expenses
        • equal periodic payments
        • age
      • 72t — Substantially Equal Periodic Payments
        • Avoids 10% penalty if:
          • Must be made at least annually for life of participant or life of participant and beneficiary
          • Must begin after participant separates from service
        • 3 Payment Options:
          • Required Minimum Distributions
            • RMDs taken annually
          • Fixed Amortization Method
            • Fixed installment payments based on participants life expectancy (joint life expectancy if married)
          • Fixed Annuitization Method
            • Fixed distribution payments based on account balance and mortality tables
        • Payments must continue for later of 5 years or reaching age 59 1/2
          • Any payment changes = participant seen as taking a distribution of full account balance in first year of “substantially equal periodic payments”
    • Minimum Distributions*
      • Required minimum distributions must start:
        • At age 70 1/2 if reach 70 1/2 before/by 12/31/2019
        • At age 72 if reach 70 1/2 after 12/31/2019
      • 50% excise tax on RMD amount (less anything taken) if NOT taken by required date.
      • Apply to qualified plans, 401k, 403b, SEP, SIMPLE, 457, Roth 401k, Roth 403b, Roth 457, inherited Roth IRA
        • Do NOT apply to Roth IRA
      • Taken By:
        • First RMD Distribution
          • taken by April 1 of year after year attain age 72 (if reach 70 1/2 after 12/31/2019)
        • Otherwise, taken by 12/31 of same year
      • Exception:
        • If still employed by plan sponsor at age 72
        • Begin taking RMDs on April 1 of year after terminates employment
          • NOT available for greater than 5% owners of plan sponsor
      • Calculating RMDs
        • Divide account balance at 12/31/xx in year before distribution year by Distribution Period (based on age at END of distribution year) on Uniform Life Table
        • Exception:
          • If spouse is over 10 years younger than participant, use Joint Life Expectancy Table
      • Multiple Plans/IRAs
        • Qualified Plans — RMDs must be taken from EACH qualified plan i.e. RMD from each plan
        • IRAs — RMDs from IRAs can be taken from 1 or more IRAs based on total balance of all IRAs
      • RMDs and Participants Death*
        • RMDs are required after participants death
        • RMD calculated as though participant did not die
        • Death After Starting RMDs (death on/prior to 12/31/19)
          • Uses beneficiary’s life expectancy factor at the END of the year following year of death
          • Life expectancy is reduced by 1 every year after.
          • More than 1 beneficiaries = use oldest beneficiary (shortest life expectancy)
            • Can also divided plan into separate accounts and use life expectancy for each beneficiary
          • Trust as Beneficiary = use the beneficiary of trust, provided:
            • trust is valid
            • irrevocable trust (or will be at death)
            • can identify trust beneficiaries
            • documents get to plan admin
          • Spouse Beneficiary
            • Surviving spouse can get RMDs over remaining life based on single-life expectancy
            • If sole beneficiary, can rollover plan into own account and wait until they reach age 70 1/2
          • No Beneficiary
            • Distributions continue remaining period (reduced by 1) of deceased owner
        • Death Before Starting RMDs (death on/prior to 12/31/19)
          • If participant dies before the required beginning date, then rules depend on beneficiaries.
          • Spouse Beneficiary
            • Start RMDs in year deceased participant hit age 70 1/2.
            • If sole beneficiary, rollover plan and wait till they hit age 70 1/2
            • Distribute entire balance within 5 years of participants death
          • Nonspouse Beneficiary
            • Distribute entire balance within 5 years of participants death
            • Distribute based on remaining life expectancy (minus 1 year) of beneficiary (not recalculated)
            • Rollover plan but distribute within 5 years or remaining life expectancy of beneficiary
          • No Beneficiary
            • Distribute entire balance within 5 years of participants death
        • RMDs and Death Post 12/31/19
          • All eligible designated beneficiaries can distribute assets over their life expectancy
          • Eligible Designated Beneficiaries are:
            • Surviving Spouse
              • can rollover assets to own IRA
              • If deceased participant was under 72, can postpone RMDs until participant hit 72
            • Child participant, not age of majority
              • Distribute within 10 years after reaching age of majority
            • Disabled/Chronically Ill Person
            • Anyone else not more than 10 years old younger participant
            • If eligible beneficiary dies, their beneficiary must distribute assets within 10 years
          • Designated Beneficiary
            • Does not meet criteria for Eligible Designated Beneficiaries
            • Balance paid out within 10 years
          • Non-designated Beneficiary
            • Includes estates, charities, trusts
            • Use pre-Secure Act rules
            • After RMD
              • Use owners age as of birthday in year of death
              • Reduce life expectancy by 1 each year
              • Take RMD for year of death
            • Before RMD
              • Take entire balance within 5 years
  • Administration of Qualified Plans
    • Steps to Picking a Plan
      • Establish objectives for the plan.
        • to benefit owner, all employees, key employees, retain/reward employees, encourage early retirement, etc.
      • Prepare employee census to identify who benefits from various plans and the financial costs of those plans on business
      • Identify types of plan that meet objectives
      • Assess characteristics of each plan
      • Select plan
    • Employee Census
      • Identifies employees, age, pay, years employed, ownership interest
      • Sees which employees benefit from various plans
      • Review employee turnover and potential forfeitures
    • Establish a Qualified Plan
      • Adopting Written Plan
        • Plan must be detailed in writing.
        • Master/Prototype Plan
          • Standard forms, pre-approved by IRS, used by most companies
        • Individually Designed Plans
          • For companies with specific needs not in master/prototype plan
          • Plan must be permanent
          • Determination Letter
            • Used when plan is adopted, amended, terminated
            • Filed Form 5300
      • Notifying Eligible Employees
        • Info on plan must be sent to eligible and ineligible employees
        • Employer must provide IRS evidence in notified employees before it issues a determination letter
        • Summary Plan Description = summary of plan — must be provided to employees free of charge
          • Same for any plan changes
        • Summary Annual Report must be provided to participants
      • Qualified Trusts
        • Assets must be in a qualified trust or custodial account
      • Investing Plan Assets
        • Either managed by sponsor or participant depending on plan
        • Sponsors generally considered fiduciaries of plan
        • Must offer at least 3 investment option that meets this Criteria:
          • Be diversified
          • Different risk/return characteristics
          • Each option, when combined, with another should minimize overall risk
    • Administration
      • Ongoing admin and maintenance
      • Plan Operations
        • Cover Eligible Employees
          • run annual coverage testing
        • Make Appropriate Contributions
          • Meet Minimum Funding Requirements for pension plans each year
          • done by due date — due date of tax return
          • No promissory notes
          • Nondeductible contributions are allowed by participants
        • Take Deductions
          • Employer deductions
            • DC Plans – deductions can not be more than 25% of comp paid
            • DB Plans – deductions depend on actuarial assumptions for mandatory funding
            • Both DC and DB Plans — Max deduction is greater of 25% of comp paid or required minimum funding for DB plan
            • Employee elective deferrals not included
          • Self Employed Deduction Limits (Keogh Plans)
            • Self-Employed Contribution Rate = Contribution Rate/(1 + Contribution Rate)
            • Self-Employment Tax = (Net Income x 92.35%) x (12.4% up to $142,000 + 2.9%)
            • Self-Employed Contribution = (Net Income – 1/2 Self-Employment Tax) x Self-Employed Contribution Rate
            • The 25% limit is actually only 20% for Self-Employed contributions (Keogh Plans)*
              • Because self-employed pays employer’s share of self-employment tax
        • Carryover Excess Contributions
          • Excess contributions by employer carried forward to future years.
          • May be subject to 10% excise tax
        • Prohibited Transactions*
          • Transactions between plan and disqualified persons like:
            • Fiduciary of plan
            • Person providing service to plan
            • Employer, with employees in plan
            • Employee organization, members covered by plan
            • Direct or indirect owner of 50% of any of the following:
              • Combined voting power of all stock of corporation
              • Capital interest/profits interest of partnership
              • Beneficial interest of trust
            • Family member of the above
          • Examples:
            • Transfer plan income/assets to use for benefit of disqualified person
            • Self-delaing by fiduciary
            • Receipt of consideration by fiduciary for own account when working with another party (attorney, accounting)
            • Sell, exchange, lease, buy, lend, borrow between disqualified persons and plan
          • Penalty
            • No penalty if corrected in 14 days
            • Initial Penalty = 15% excise tax on amount involved
            • Additional 100% excise tax if not corrected in tax year
        • ERISA and Filing Requirements
          • Imposes fiduciary responsibility
          • Requires admin provide benefits statement
            • quarterly to participants who direct their own accounts
            • annually to participants with own account in plan
            • to other beneficiaries on written request
          • Pension Benefit Guaranty Corporation (PBGC)
            • guarantees pension benefits
            • does NOT cover DB plans w/ 25 or fewer participants
            • does NOT cover DC plans
            • Cost to plan of $86 per participant per year and $38 per $1,000 of underfunding per year (2021)
    • Amend/Terminate Plan
      • Employers can change or terminate the plan
        • Reasons
          • Changed to maximize benefits to key employees
          • Law changes make plan obsolete
          • Plan becomes too costly
          • No longer meets needs/objectives
      • Amending Plan
        • Amend plan document
        • Must revise Summary Plan Description
      • Terminating Plan
        • Participants become fully vested (assuming funds are available)
        • Permanency Requirement
          • “permanency” is not forever, just can not be temporary benefit to owners/key employees
        • DB Plan Termination
          • Standard Termination
            • Voluntary — employer has enough assets to cover all benefits
          • Distress Termination
            • Voluntary — employer in financial trouble unable to continue plan financially
          • Involuntary Termination
            • Involuntary — initiated by PBGC for plans unable to pay benefits
        • DC Plan Termination
          • Pass corporate resolution to terminate plan
          • Complete final contributions and distribute assets
        • Pan Freeze
          • Employer ends contributions but no termination
          • DC Plans — employer no longer contributes
          • DB Plans — participants no longer accrue benefits, sponsor maintains previous accrued benefits
  • Other Tax-Advantaged Plans
    • Individual Retirement Accounts (IRAs)
      • Traditional IRAs
        • Two Forms
          • IRA account — holds a variety of investments through variety of custodians
          • IRA annuity — held by insurance company
        • Contribution Limits
          • Requires Earned Income to contribute — lessor of earned income or annual limit
          • Limit — $6,000 (2021)
          • Age 50 catch-up limit – $1,000 (2021)
          • Note: Age 70 1/2 — no age restriction on contributions (removed by Secure Act)
        • Earned Income
          • No earned income — no contribution
          • Note: Alimony from divorce agreement after 2018 is NOT income
          • Exception: Spousal IRA
            • can be established for spouse with no earned income if other spouse has enough earned income
          • Earned Income Is:*
            • W-2 Income
            • Schedule C net income
            • K-1 income from LLC
            • K-1 income from partnership (material participant)
            • Alimony if divorce agreement prior to 12/31/18
          • NOT Earned Income:*
            • Earnings/profits from property — rental, interest, dividend income
            • Capital gains
            • Pension/annuity income
            • Deferred compensation received
            • Partnership income (non-material participant)
            • Anything excluded from income — foreign income
            • Alimony if divorce agreement after 12/31/18
            • Unemployment benefits
            • Investment returns (from limited partnership)
            • S-Corp income
            • Social Security benefits
            • Worker’s Comp
        • Excess Contributions
          • Subject to 6% excise tax per year excess remains in IRA
        • Contribution Due Date
          • April 15th after the tax year
          • Made in cash
        • Contribution Deductibility*
          • No Qualified or Other Retirement Plan
            • No income limits
            • Fully deductible
          • Active-Participant of Qualified or Other Retirement Plan
            • Fully deductible up to the AGI Phaseout
            • No deduction over the phaseout
            • AGI Phaseout
              • MFJ — $105k to $125k (2021)
              • Single — $66k to $76k (2021)
          • Solo Spouse Participant
            • one spouse is active participant, other is not
            • Fully Deductible for nonparticipant spouse if joint AGI does not exceed $208,000
            • AGI Phaseout = $198k to $208k (2021)
          • Active Participant Status
            • Employee with benefits from one following plans:
              • Qualified plan
              • Annuity Plan
              • 403b (Tax-Sheltered Annuity)
              • Government Plans
              • SEPs
              • SIMPLEs
        • NonDeductible Contributions
          • Allowed — adjusted basis on after-tax contribution
          • Withdrawals are mix of return of basis and taxable income
        • Disributions
          • Taxed as ordinary income
          • Exception: nondeductible contributions — return of basis and taxable ordinary income
            • Adjusted Basis Portion calculated:
              • AB Ratio = AB before withdrawal/FMV of account
              • Multiply ratio by distribution amount
            • Taxable Portion calculated:
              • OI Ratio = 1 – AB Ratio
              • Multiply ratio by distribution amount
          • RMDs
            • Must start no later than April 1 of year after owner hits age 72
            • 50% excise tax on RMDs not taken
        • 10% Early Withdrawal Penalty
          • 10% penalty on withdrawals before 59 1/2
          • Exceptions:
            • Death
            • Age 59 1/2
            • Disability
            • 72t — substantially equal periodic payments
            • Medical expenses over 7.5% of AGI
            • $5,000 for birth or adoption of child
            • Higher education expenses
            • First-time home purchase up to $10,000
            • Health insurance premiums if unemployed
        • IRA Annuity
          • Not transferable
          • Benefits not forfeitable
          • Benefits must go to owner or beneficiary
          • Premiums can not exceed $6,000 (2021)
          • If premiums cease, owner has the right to a paid-up annuity and forgo further premiums
          • Same distribution rules apply
      • Roth IRAs
        • Main Differences to Traditional IRA*
          • Contributions = not deductible
          • Distributions = nontaxable income
          • NO RMDs required (only after death)
        • Contributions
          • Funded with earned income
          •  Limit — $6,000 (2021)
          • Age 50 catch-up limit – $1,000 (2021)
          • Must be within AGI Limits to contribute
          • AGI Phaseout
            • Single = $125k to $140k
            • MFJ = $198k to $208k
            • MFS = $0 to $10k
        • Conversions
          • Convert Traditional IRA to Roth IRA
            • Conversion amount is taxable income in year of conversion!
        • Recharacterized Contributions
          • Owners may “recharacterize” contributions to one type of IRA, to another type for the year by tax return due date.
          • Cannot be used to for Roth conversions
        • Distributions
          • Not included in gross income if qualified
          • Qualified Distributions*
            • Must be:
              • Made after a 5 taxable year period beginning Jan. 1st of year of first contribution
              • Meets one of following:
                • Made at or after age 59 1/2
                • Made to beneficiary, owner’s estate, or after owner’s death
                • Due to disability
                • For first-time home purchase up to $10,000
          • NonQualfied Distributions
            • Treated on a FIFO basis
              • 1st = Regular annual contributions
              • 2nd = Conversion contributions
              • 3rd = Earnings on contributions
        • 10% Early Withdrawal Penalty
          • Applies to portion included in gross income (earnings portion)
          • Applies to non-qualified distributions of conversion contributions taken inside the 5-year window.
      • IRA Issues
        • Prohibited Investments*
          • Life Insurance
          • Collectibles
            • art
            • antiques
            • metal
            • gems
            • stamps
            • coins
            • wines
            • etc.
            • Exception: certain US minted coins and bullion and gold, silver, platinum, palladium
          • Purchase of either is treated as distribution, subject to tax and/or penalty
        • Tax-Free Charitable Distributions
          • Excluded from gross income up to $100,000 per taxpayer per year
          • Must be made directly from IRA to charity
        • IRA Rollovers
          • From Qualified Plans
            • Employees can roll qualified plan balance to IRA upon termination
            • IRA rollover funds can be rolled into another qualified plan, if permitted
          • To Qualified Plans
            • Only if permitted by qualified plan
          • Indirect Rollover
            • Distribution to participant then to IRA account
            • Must be completed in 60 days
            • Only one 60 day rollover from any one IRA per year
              • No direct rollover limits
        • ERISA Protections
          • IRAs exempt from debtor’s estate
            • $1 million in IRA assets is protected
              • Does not include rollover contributions or earnings on rollover contributions
        • Prohibited Transactions*
          • Ceases to be an IRA if owner/beneficiary does:
            • Sell, exchange, lease property to IRA
            • Lend money to IRA
            • Receive unreasonable compensation for managing IRA
            • Using IRA to secure loan
            • Borrowing from IRA
            • Buying property for personal use with IRA money
          • Treated as the entire balance is distributed! Subject to ordinary income tax on distribution and 10% penalty
        • Transfers Incident to Divorce
          • QDROs
            • Distributions subject to ordinary income tax and maybe 10% penalty
            • Exception:
              • change name on account to spouse’s name
              • Transfer funds directly to spouse’s IRA
    • SEPs — Simplified Employee Pension
      • Used by small businesses and sole proprietors
      • Easy to setup and no filing requirements
      • Eligibility
        • Employers must provide SEPs to almost all employees (even part-timers)
        • Requirements
          • age 21 or older
          • Performed service for 3 of last 5 years
          • Minimum compensation of $600 (2021) for year
      • Establishment Steps
        • Can be setup and funded no later than tax return due date (including extension)
        • 3 Steps
          • Formal written agreement to provide benefits to all employees
          • Give notice to all eligible employees
          • Setup SEP-IRA (receptacle account) for each employee
      • Contributions
        • limited to lesser of 25% of comp or $58,000 (2021)
          • Self-employed the 25% is really 20%
        • Employer contributions are discretionary
          • If made, must be to all employees
          • Cannot discriminate
        • May integrate with Social Security
      • Vesting
        • NO vesting of employer contributions
    • SARSEPs — Salary Reduction Simplified Employee Pension
      • NO new SARSEPs after 1996, but old SARSEPs exist
      • Easy to setup, minimal reporting and testing requirements
      • Establish:
        • At least 50% of employees must defer comp
        • No more than 25 eligible employees totals
        • Highly compensated had to meet ADP test
      • ADP Test
        • No more than 125% of ADP of all nonhighly compensated employees
        • ADP = elective employee deferral/Employee compensation
      • Elective Deferral Limit
        • Employee Limit = $19,500 (2021)
          • Age 50 Catch up = $6,500
        • NO double dipping. Limit applies to deferrals in SARSEP and other plans (401k, 403b, SIMPLEs)
        • Employer Limit = lesser of 25% of employee comp or $58,000 (2021)
      • Excess Deferrals
        • Must be given notice 2.5 months after year-end
          • No notice = employer pays 10% penalty on excess
        • Must be removed
    • SIMPLEs — Savings Incentive Match Plans for Employees
      • Avoid nondiscrimination rules
      • No annual filing requirements
      • Characteristics:
        • Employee elective deferrals not taxed but subject to payroll tax
        • Employer match tax deferred, no payroll tax
      • Requirements*
        • Companies with 100 or less employees with at least $5,000 comp for year
          • 2 year grace period for companies to exceed 100 employees limit
        • Entities:
          • C Corp
          • S Corp
          • LLC
          • Partnership
          • Proprietorship
          • Government entity
        • NO other plans allowed!
        • Employee Eligibility
          • Earned $5,000 any 2 previous years
          • Expected to earn $5,000 current year
        • Vesting
          • 100% vested
      • SIMPLE IRAs*
        • Companies with 100 or less employees with at least $5,000 comp for year
        • Establish By Date: Oct. 1 in year plan starts
        • NO other plans allowed!
        • NO annual filing requirements, low costs
        • NO testing for contributions requirements
        • Contributions
          • 100% fully vested
          • Employee Elective Deferrals
            • $13,500 Limit (2021)
            • $3,000 Catch up Limit at age 50
          • Employee Contributions Either:
            • Dollar for dollar match up to 3% of pay
              • Employer can elect to reduce 3% match for a year if:
                • reduced to no less than 1%
                • not more than 2 years out of a 5 year period
                • employees notified in reasonable time
            • 2% nonelective contribution (up to limit) for all eligible employees
        • NO loans allowed
        • In-Sevice Withdrawals allowed but 10% penalty if under 59 1/2
          • If in the first 2 years of participation, becomes a 25% penalty
      • SIMPLE 401k*
        • Companies with 100 or less employees with at least $5,000 comp for year
        • Establish By Date: Oct. 1 in year plan starts
        • NO other plans allowed!
        • Annual filing requirements, admin costs
        • NO testing for contributions requirements
        • Contributions
          • 100% fully vested
          • Employee Elective Deferrals
            • $13,500 Limit (2021)
            • $3,000 Catch up Limit at age 50
          • Employee Contributions Either:
            • Dollar for dollar match up to 3% of pay
            • 2% nonelective contribution (up to limit) for all eligible employees
        • Loans allowed
        • In-Sevice Withdrawals allowed but 10% penalty if under 59 1/2
    • 403b Plans — Tax Sheltered Annuities (TSAs)
      • Available to qualified nonprofits, public education systems, certain ministers
      • NOT a qualified plan
      • Two types:
        • Salary Reduction Plan — only employee deferrals
        • Employer Funded Plan — employee and employer contributions
      • Eligibility
        • Max wait period of 2 years and age 21 or 1 year and age 26 (education system only)
        • Exception: No immediate vesting = 1 year wait period and age 21
      • Contributions
        • 100% Vested
        • Employee Deferrals
          • $19,500 Limit (2021)
          • Catch-Up Contributions*
            • Age 50 Catch-Up
              • $6,500 limit (2021)
            • 15-Year Rule
              • Employees with at least 15 years of service, limit is the lessor of:
                • $3,000
                • $15,000, less elective deferrals previously excluded
                • $5,000 x employees years of service less total deferrals made
              • Note: lifetime limit of $15,000
        • Employer Contributions
          • Lessor of $58,000 or 100% employee comp
      • Investment Options = limited to annuities or mutual funds
      • Loans are allowed
      • In-Service Withdrawals not allowed
        • Subject to 10% early withdrawal penalty
        • Exception: Hardship distributions allowed
      • Rollovers to IRA, qualified plan, and other 403b
      • NOT subject to ERISA unless setup as qualified plan (is part of overall pension/retirement plan)
    • 457 Plans
      • Not qualified plan
      • Deferred compensation plan = deferrals do NOT count against 401k or 403b deferrals
      • 3 Types
        • Eligible government plans — Public 457b Plan — state, local governments
        • Eligible tax-exempt plans — Private 457b Plan — private hospitals, trade associations, religious orgs, cooperatives, unions, charities
        • Ineligible plans — 457f Plan — offer higher deferrals
      • Public 457b Plan
        • For government entities
        • Protected by trust
        • Participants
          • Rank and file and key employees
        • Contributions
          • Employee Deferral Limits
            • $19,500 Limit (2021) — for employer and employee contributions
            • $6,500 Catch-up at 50
            • 3-Year Catch Provision = $19,500 (2021)
          • Employers match or nonelective deferrals allowed but rare.
          • Contributions do NOT count against other plans
        • Distributions
          • taxed as ordinary income
          • Must begin no later than age 72
          • NO age 59 1/2 withdrawal rule
          • NO 10% early withdrawal penalty
            • Exception: Rollover contributions from other qualified plans and IRAs
        • Rollovers
          • Rollovers from other plans allowed
          • Rollover to new 401k, 403b, 457b plan or IRA allowed if permitted by new plan
      • Private 457b Plan
        • Tax-exempt organizations
        • Not protected by trust, available to creditors
        • Participants
          • Key and highly compensated employees
        • Contributions
          • Employee Deferral Limits
            • $19,500 Limit (2021) — for employer and employee contributions
            • 3-Year Catch Provision = $19,500 (2021)
          • Employers match or nonelective deferrals allowed but rare.
          • Contributions do NOT count against other plans
        • Distributions
          • Taxed as ordinary income
          • Must begin no later than age 72
          • NO age 59 1/2 withdrawal rule
          • NO 10% early withdrawal penalty
            • Exception: Rollover contributions from other qualified plans and IRAs
        • Rollovers
          • Rollovers from other plans allowed
          • Rollover only to another 457b plan, if permitted by new plan
      • 457f Plans
        • Ineligible aka Top Hat Plans
        • Participants
          • Key and highly compensated employees
        • No contribution limits
        • Rollover not allowed
        • Disadvantages:
          • Participant may forfeit all funds if terminated before stated payment period
          • Participant may be taxed on value of plan once funds vest (without a distribution occurring)
  • NonQualified Plans
    • Used to:
      • Defer compensation for key group of employees without limits/restrictions
      • Increase wage replacement ratio for highly paid employees
      • In lieu of a qualified plan — only for key employees
    • Characteristics:
      • No tax advantages like qualified plans
      • Employer gets NO tax deduction until key employee gets payment (recognized as taxable income)
      • Substantial risk of forfeiture requirement (to avoid constructive receipt)
    • Examples:
      • Golden handshake — severance package, may encourage early retirement
      • Golden parachute — payments to terminated execs
      • Golden handcuff — encourages employees to stay at company
    • Tax Benefits
      • Employee
        • Defer comp to future period in lower tax bracket
      • Employer
        • Public companies can only deduct $1 million of comp for top 5 executives.
        • Deferrals over the $1 million limit are deductible when the executive is paid in the future
    • Income Tax Issues*
      • Constructive Receipt
        • Income is “received”, and subject to taxes, when it is credited to account
        • Deferred Comp plans AVOID constructive receipt
      • Substantial Risk of Forfeiture
        • Income subject to forfeiture is NOT taxed until forfeiture is removed.
      • Economic Benefit Doctrine
        • Funds that are unrestricted or nonforfeitable are taxed to employee
      • Payroll Tax
        • Subject to payroll tax at the time it is earned income or forfeiture expires
      • Property Transfers in Performance of Service (Section 83)
        • Ordinary Income tax paid on difference between FMV and price paid for the property
        • Apply to stock grants, restricted stocks, employee stock options
      • Employer Income Tax Deduction
        • Matching Principle = employer gets the deduction when employee recognizes taxable income
    • NonQualified Deferred Compensation Plans (NQDC)
      • Employer promises to pay executive an amount in the future
      • Advantages to Employer
        • Unfunded promise to pay
        • Deferred cash outflows
        • Not a qualified plan
        • Saves on payroll taxes (except 1.45% Medicare match)
        • Income tax deduction deferred until paid
          • Useful is comp. exceeds $1 million
        • Only offer it to specific employees (discrimination allowed)
      • Advantages to Employee
        • No current taxable income
        • Saves on payroll taxes
        • May offer future cash flows at lower tax rate
      • Types
        • Salary Reduction Plans
          • Reduces employee salary, defers it to future
        • Salary Continuation Plans
          • Provides benefits after retirement for ongoing or specific period of time
        • SERPS — Supplemental Executive Retirement Plans
          • Provide added benefits at retirement
      • Unfunded Promise to Pay*
        • NOT funded — literally a promise to pay in the future
        • Risk of forfeiture if company is insolvent
        • Taxed as income when constructive received by employee
        • Deductible to employer when employee receives payment
      • Secular Trust*
        • Funded
        • Irrevocable trusts used to hold deferred comp
          • removes risk of forfeiture
        • Immediately taxed as income for employee
        • Immediately deductible to employer
          • Vesting schedule or employment term requirement fixes the deferral objectives
      • Rabbi Trust*
        • Funded
        • Treated as unfunded (purposes of ERISA)
        • Risk of forfeiture if company is insolvent
        • Taxed as income when constructive recieved by employee
        • Deductible to employer when employee receives payment
      • Funding with Insurance
        • Insurance products allow employers to avoid paying taxes on earnings in the plan
        • Increases in cash surrender value is not taxed
      • Phantom Stock Plans
        • Employer grants fictional shares to key employee
        • Employee, at termination/retirement, is paid the difference between stock value and value at time of grant
        • no stock changes hands
      • 401k Wrap Plans
        • Salary reduction plan that allows for higher contributions beyond typical 401k plan.
    • Employer Stock Options
      • Incentive Stock Options (ISOs)*
        • Right to purchase employer’s stock at stated exercise price
        • Taxation*
          • At Grant Date — Employee does NOT recognize taxable income
          • At Exercise Date — Employee NOT subject to income tax on difference between FMV and exercise price
            • Difference is a positive AMT adjustment
          • Adjusted Basis — Equal to exercise price
          • At Sale Date — Difference between sale price and exercise price is LTCG (if holding period is met)
            • Difference is a negative AMT adjustment
        • Requirements
          • Grated to an employee of corp. issuing ISO
          • Plan must be approved by stockholders
          • Must be granted within 10 years of plan date
          • Exercise is limited to 10 year period (5 years for over 10% owners)
          • Exercise price must be greater than or equal to FMV of stock at grant date
          • Cannot be transferred at death
          • ISOs for over 10% owners must-have exercise price 110% of FMV at grant date
          • Aggregate FMV of ISO grants when first exercisable must be less than or equal to $100,000 based on grant price per year per employee.
            • Excess is treated as NQSO
          • Qualified Sale = 2 years from grant date and 1 year from exercise date
          • Must be employed with company from grant date til 3 months before exercise.
        • Disqualifying Disposition
          • Sold before 2 years from grant or 1 year from exercise date
          • Lose favorable tax treatment
            • Ordinary income = difference between FMV at exercise and exercise price
            • Capital Gain (short or long term) = difference between sale price and FMV at exercise
        • Cashless Exercise (Disqualifying Disposition)
          • Third party lender lends employee cash to exercise option, stock is immediately sold, and lender is repaid
          • Fails to meet holding period requirements
        • Gifting ISOs NOT allowed
      • NonQualified Stock Options (NQSOs)*
        • Bonus program that is nonqualified or does NOT meet requirements of ISO
        • No favorable tax treatment
        • Taxation*
          • At Grant Date — NO taxable income to employee
          • At Exercise Date — Employee recognizes ordinary income on difference between FMV and exercise price
          • Adjusted Basis — Equal to FMV of stock at exercise
          • At Sale Date — Treated as capital gain/loss
        • Gifting NQSOs
          • NQSO can be gifted only if plan allows it.
            • No tax immediate tax consequences on transfer
            • At exercise — employee hit with ordinary income on difference between FV and exercise price
            • Donee’s Adjusted Basis — Equals FMV at exercise
      • Stock Appreciation Rights
        • Rights that grant holder cash equal to difference between FMV and exercise price of stock
        • Included in gross income at exercise
        • May be used to provide cash to exercise ISO/NQSO
      • Restricted Stock Plans
        • Pays employees in employer’s stock
        • Restricted from selling/transferring shares for a period of time
        • Employer can buy back stock for a period of time
        • Employee NOT taxed at receipt (risk of forfeiture exists)
        • Employee taxed as W-2 income on FMV of stock when forfeiture is removed.
        • Employer tax deduction when employee recognizes income
      • Employee Stock Purchase Plans (ESPP)
        • Gives employees chance to buy employer’s stock at a discount and get favorable tax treatment on gains
        • Discounted stock price can be no less than 85% of average stock price of date-determined price
        •  Employee Limits
          • $25,000 of employer stock per year based on FMV at grant date
        • Qualifying Disposition
          • Must hold stock for 2 years from grant date and 1 year from exercise date
          • At Sale — Discount portion at purchase is ordinary income and excess gain is LTCG.
        • Disqualified Disposition
          • Fails to hold stock for 2 years from grant date or 1 year from exercise date
          • At Sale — gain is W-2 income

Or read other book notes.

Print Friendly, PDF & Email

Want to compound your investing wisdom?

Find Out More

Learning

  • Library
  • Book Notes
  • Quotes

Return Tables

  • Asset Class Returns
  • Stock Sector Returns
  • International Stock Market Returns
  • Emerging Markets Returns
  • Historical Returns

Connect

Search

  • Home
  • About
  • Contact

© 2023 Novel Investor · All Rights Reserved · Terms of Use · Privacy Policy · Disclaimer