©The McGraw-Hill Companies, Inc. 2008McGraw-Hill/Irwin Chapter 11 Retirement and Other Tax- Deferred Plans and Annuities “The income tax laws do not profess to embody perfect economic theory.” -- Oliver Wendell Holmes, Jr.

11-2 LO #1 – The Basics Retirement plans are encouraged and receive tax advantages. –Encourage saving for retirement or education –Generally, taxation is deferred (not eliminated) Retirement plans include employer- sponsored plans and individual-based plans.

11-3 LO #1 – The Basics Understand retirement plan terminology –Annuity –Beneficiary –Contributions –Distributions –Donor –Tax-deferred retirement (or other) plan –Trustee

11-4 LO #1 – The Basics Tax-deferred does not mean tax-free. Generally, untaxed contributions are taxed when distributed. Previously taxed contributions are not taxed on distribution. Contributions can provide a tax deduction to the person/company that makes them.

11-5 LO #1 – The Basics – Concept Check Tax-deferred retirement accounts are, essentially, tax-free accounts. True or false? False 2. The period in which accumulated assets are paid to plan beneficiaries is known as the _________ period. Distribution 3. A Keogh plan is an example of an individual-based retirement plan. True or false? False

11-6 LO #1 – The Basics – Concept Check Two examples of employer-based retirement plans are _____________ and ___________. Qualified pension/profit sharing, 401(k), Keogh, SEP, SIMPLE 5. Distributions from pension plans are taxable if the contributions were made using dollars that were not previously taxed. True or false? True

11-7 LO #2 – Employer-Sponsored Retirement Plans Employer-sponsored plans include –Qualified pension and profit sharing plans –401(k) plans –Keogh plans –Simplified Employee Pensions –SIMPLE plans

11-8 LO #2 – Employer-Sponsored Retirement Plans Plans provide benefits to employers and employees –Employer gets immediate deduction for contribution. –Employer contributions are not taxable to employee. –Earnings from plan investments are not taxed. –Plan assets are not taxable to employee until withdrawn.

11-9 LO #2 – Employer-Sponsored Retirement Plans Defined contribution plans pre-establish the amount of the contribution –The amount of the eventual distribution is not known with certainty and will vary. Defined benefit plans pre-establish the amount of the benefit –The amount of the contribution is not known with certainty and will vary.

11-10 LO #2 – Employer-Sponsored Retirement Plans Qualified pension & profit sharing plans: –Non-discriminatory, minimum vesting rules, contributory or non-contributory –Additions to defined contribution plan can’t exceed lesser of $44K or 100% of compensation –Additions to defined benefit plan can’t result in benefits more than the lesser of $175K or 100% of compensation

11-11 LO #2 – Employer-Sponsored Retirement Plans 401(k) plans –Meet nondiscrimination rules –Employee can elect to defer up to $15K (additional $5K if age 50 or over) Keogh plans –For self-employed –Contribution limits generally the same as qualified plans

11-12 LO #2 – Employer-Sponsored Retirement Plans Simplified Employee Pensions (SEP) –Employer creates and contributes to employee IRA’s –Maximum contribution is lesser of 25% of compensation or $44K. SIMPLE plans –Employer creates IRA or 401(k) for employee –Employee contributes a % up to $10K (additional $2.5K allowed if age 50 or over) –Employer makes matching contribution of 3% or 2%.

11-13 LO #2 – Employer-Sponsored Retirement Plans – Concept Check Qualified pension plans are either defined-_______ plans or defined-_______ plans. Benefit; contribution 2. Employees must make contributions to qualified pension plans. True or false? False 3. The maximum contribution to a 401(k) plan is _______ for individuals under age 50. $15,000

11-14 LO #2 – Employer-Sponsored Retirement Plans – Concept Check A Keogh plan can be used by self- employed individuals. True or false? True 5. A SIMPLE plan can be used by employers with fewer than 100 employees who also meet other requirements. True or false? True

11-15 LO #3 – Individual-Sponsored Retirement Plans Traditional Individual Retirement Accounts (IRA) and Roth IRA. Contributions limited to smaller of $4,000 or 100% of compensation. If over age 50, the dollar limit is $5,000.

11-16 LO #3 – Individual-Sponsored Retirement Plans Individuals covered under an employer plan –Deductible contribution amount begins to phase out when AGI reaches $75K (married) or $50K (others) and is fully phased out at $85K and $60K, respectively. Married filing separately, the phase out starts at $0. –Can still make non-deductible contribution up to the $4K or $5K limits

11-17 LO #3 – Individual-Sponsored Retirement Plans Married taxpayers –If both employed and neither are covered under an employer plan, then both spouses can make a deductible IRA contribution up to the $ limits. –If only one spouse is employed and that person is not covered under an employer plan, can contribute up to the maximum for both persons. –If one spouse is covered under an employer plan, and the other is not, the non-covered spouse can contribute up to the dollar limits if AGI < $150K.

11-18 LO #3 – Individual-Sponsored Retirement Plans Roth IRA are not deductible but withdrawals are not taxable Contribution limits are the same as with a traditional IRA Phase out starts at $150K (MFJ), $95K (single or HoH), $0 (MFS) –Phase out range is $10K joint, $15K others

11-19 LO #3 – Individual-Sponsored Retirement Plans Traditional IRA vs Roth IRA –Contributions are deductible for traditional IRA but not for Roth IRA –Distributions are taxable for traditional IRA but not for Roth IRA Trading off the non-deductibility of contributions against the non-taxability of distributions.

11-20 LO #3 – Individual-Sponsored Retirement Plans – Concept Check Two types of individual-sponsored retirement plans are ______________ and ____________. Traditional and Roth 2. A single individual, age 58, with wages of $30,000 can make a tax-deductible contribution of up to $_______ to a traditional IRA. $5, A married couple with earned income of $200,000 is ineligible to make a deductible contribution to a traditional IRA. True or false? False 4. Generally, distributions from a Roth IRA are not taxable. True or false? True

11-21 LO #4 – Tax-Deferred Nonretirement Plans Coverdell Education Savings Account (CESA) –Contributions not deductible, account grows tax free, distributions are not taxable if used exclusively to pay higher education expenses of beneficiary. –Any person can establish and fund a CESA for any other person, themselves included.

11-22 LO #4 – Tax-Deferred Nonretirement Plans Contributions limited to $2,000 per beneficiary –From all sources combined Contributions phased out when AGI of contributor reaches $190K (MFJ), $95K others. –Totally phased out at $30K or $15K above those numbers, respectively.

11-23 LO #4 – Tax-Deferred Nonretirement Plans – Concept Check Contributions to Coverdell Education Savings Accounts (CESA) are not deductible. True or false? True 2. The maximum annual contribution to a CESA is $___________. $2, Contributions to CESA accounts begin to be phased- out when AGI reaches $__________ for a single taxpayer. $95,000

11-24 LO #5 - Distributions Generally, distributions are taxable if contributions were deductible. Often some (but not all) contributions were made with previously taxable dollars. In this case, distributions will be partially tax free and partially taxable. Use simplified method.

11-25 LO #5 - Distributions Simplified method. For cases where distributions are partially taxable. –Determine number of anticipated payments using single life or dual life tables in text –Determine total contributions from previously-taxed dollars. –Fraction: previously taxed $ / # payments –Fraction represents proportion of each payment that will be tax-free.

11-26 LO #5 - Distributions Other plans have required minimum distributions (RMD) that must begin by April 1 of year following after taxpayer reaches age RMD is based on single or dual life expectancy tables from IRS (in book) Can use “term certain” method or refigure life expectancy from IRS tables each year.

11-27 LO #5 – Distributions – Concept Check A participant in a defined benefit plan is only entitled to a stream of payments. True or false? True 2. Distributions from qualified pension plans may be taxable, nontaxable, or both. True or false? True 3. The number of anticipated payments from a pension plan for a single individual, age 68, is ______ The number of anticipated payments from a pension plan for a married couple aged 59 and 63 is ______ Distributions are required from a traditional IRA. True or false? True

11-28 LO #5 - Distributions Roth IRA distributions are generally not taxable. –Earnings are taxable if withdrawn prior to an initial five-year holding period. Coverdell Education Savings Account distributions are tax free if used to pay for qualified education expenses of beneficiary. –Can’t use education expenses paid by CESA to determine Hope or lifetime learning credits

11-29 LO #5 - Distributions Premature distributions generally subject to 10% penalty. –Some exceptions apply Rollovers are generally tax free. Rollovers to a Roth IRA are taxable. –If rollover $ are distributed to the taxpayer, there is a 60-day window to deposit $ in new plan. Otherwise, entire amount is taxable.

11-30 LO #5 – Distributions – Concept Check IRA distributions are taxable if funded with deductible contributions. True or false? True 2. Distributions are never required from a Roth IRA. True or false? True 3. Roth IRA distributions are not taxable if they have been held for at least five years. True or false? True 4. Distributions from Coverdell Education Savings Accounts can be used for any purpose once the beneficiary reaches age 30. True or false? False

11-31 LO #6 - Annuities An annuity is a series of payments pursuant to a contract. Normally, annuity payments are partially taxable and partially tax-free to recipient

11-32 LO #6 - Annuities The tax-free component is based on the cost of the annuity contract and expected return The cost of the annuity contract is the amount the recipient paid for the contract. –The portion of the payments that is represented by the cost of the contract is tax-free.

11-33 LO #6 - Annuities The expected return is the total amount the recipient anticipates receiving over the annuity contract. –For contracts that will last a specified amount of time, the expected return is the periodic payment × the number of payments. –For contracts that will provide payments for life, the recipient must refer to the life expectancy tables to determine length of time.

11-34 LO #6 – Annuities – Concept Check An annuity is a ______ of payments under a ______. Series; contract 2. Annuity payments are always the same amount each period. True or false? False 3. Annuity payments often have a taxable component and a non-taxable component. True or false? True