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  1. 1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter 13Retirement Savings and DeferredCompensation
  2. 2. 13-2Learning Objectives1. Describe the tax and nontax aspects of employer-provided defined benefit plans from both theemployer’s and employee’s perspective.2. Explain and determine the tax consequencesassociated with employer-provided definedcontribution plans, including traditional 401(k) andRoth 401(k) plans.3. Describe the tax implications of deferredcompensation from both the employer’s andemployee’s perspective.
  3. 3. 13-3Learning Objectives4. Determine the tax consequences of traditional andRoth Individual Retirement Accounts and explainthe differences between them.5. Describe the retirement savings options availableto self-employed taxpayers and compute thelimitations for deductible contributions toretirement accounts for self-employed taxpayers.6. Compute the saver’s credit.
  4. 4. 13-4Employer Provided Plans Qualified Plans Must not discriminate between employees Two main types: Defined benefit plan Defined contribution plan
  5. 5. 13-5Defined Benefit Plans Standard benefits based on fixed formula Average compensation Years of service Employers deduct liability as they contributeto plan Funding requirements based on actuarialassumptions Employer not employee bears investment risk
  6. 6. 13-6Defined Benefit Plans Vesting schedules 5-year cliff or 7-year graded Distributions from defined benefit plans aretaxable to employee when received. Ordinary income Early distributions subject to 10% penalty
  7. 7. 13-7Defined Contribution Plans Employer specifies up-front contribution onemployee’s behalf Employers typically match employee contributions Employees may contribute to plan Employees choose how to invest contributions Alternatives depend on employer’s plan 401(k), 403(b), and 457
  8. 8. 13-8Defined Contribution Plans Annual contribution limits for 2011 Employee contributions $16,500 if not 50 years of age by year end $22,000 if at least 50 years old by year end Employer + Employee contributions Limited to lesser of $49,000 ($54,500 if at least 50years old at end of year) or 100% of theemployee’s compensation.
  9. 9. 13-9Defined Contribution Plans Vesting Employee contributions and earnings onemployee contributions Vest immediately. Employer contributions and earnings on employercontributions Minimum vesting requirements 3-year cliff or 6-year graded schedule.
  10. 10. 13-10Defined Contribution Plans
  11. 11. 13-11Defined Contribution Plans Distributions Distributions are ordinary income Early distributions subject to a 10% penalty Before 59 ½ year of age if still working or Before 55 years old and separated from service(retired)
  12. 12. 13-12Defined Contribution Plans Required minimum distributions For the year in which employee reaches age 70 ½or when the employee retires, if later (and eachsubsequent year) May defer first required distribution to April 1 of nextyear, otherwise distribution must be received byDecember 31 of current year Based on applicable percentage of balance at endof prior year 50% penalty on undistributed portion of minimumdistribution requirement.
  13. 13. 13-13Traditional 401k Plans Contributions are made with before-taxdollars. Tax deductible Distributions: Same rules as other defined contribution plans
  14. 14. 13-14Roth 401k Plans Contributions made with after-tax dollars. Not tax deductible Employer contributions must go into atraditional 401k plan (not a Roth 401k plan)
  15. 15. 13-15Roth 401k Plans Qualified distributions After account open for five years and employeehas reached age 59 ½. Non-qualified distributions Distributions of earnings are taxable andsubject to 10% penalty Distributions from contributions are not taxable Contributions divided by account balance multipliedby amount of distribution equals distribution fromcontributions
  16. 16. 13-16Deferred Compensation “Nonqualified plans” May discriminate Generally provided to executives or highlycompensated rather than rank and file Can be used to make employee’s wholewhen contributions to qualified plans wouldbe limited Deemed investment choices Risks to employees electing to defer salary?
  17. 17. 13-17Deferred Compensation Employer deducts for tax purposes whenpays Compare to financial accounting Employee includes in income whenreceived If paid after retirement, §162(m) limitationdoes not apply
  18. 18. 13-18Deferred Compensation Relevant variables Employer and employee current tax rates Employer and employee future tax rates Employer’s cost of capital or discount rate Employee’s cost of capital or discount rate
  19. 19. 13-19Individually Managed QualifiedRetirement Plans IRAs Roth IRAs
  20. 20. 13-20Individual RetirementAccounts (IRAs) For AGI deduction for contributions Generally not allowed if participant in employer-sponsored plan unless For single taxpayers Taxpayer is single, deductionallowed if participate in employer plan but income isbelow certain thresholds In 2011, lesser of $5,000 in 2011 or earned income If 50 years or older at end of year limit is $6,000 Additional “catch-up” contribution
  21. 21. 13-21Individual RetirementAccounts (IRAs) For AGI deduction for contributions Generally, not allowed if participant in employer-sponsored plan unless For married taxpayers deduction is allowed ifparticipate in employer plan but income is belowcertain thresholds In 2011, lesser of $5,000 in 2011 or earned incomeof both spouses reduced by other spouse’scontributions to IRA or Roth IRA If 50 years or older at end of year limit is $6,000 Additional “catch-up” contribution
  22. 22. 13-22Individual RetirementAccounts (IRAs) May make nondeductible contributions Deductible + nondeductible cannot exceed$5,000 for one taxpayer (plus catch-up) Must contribute by April 15thofsubsequent year
  23. 23. 13-23Individual RetirementAccounts (IRAs) Distributions taxed as ordinary income 10% penalty if before 59 ½ Certain exceptions Medical expenses, insurance premiums, firsthome Same minimum distributions apply as toqualified contribution plans nontaxable percentage = nondeductiblecontributions divided by balance of account
  24. 24. 13-24Roth IRAs Nondeductible contributions Contributions to a Roth IRA Same $5,000 limit ($6,000 if 50 or older at yearend) Phase-out based on AGI
  25. 25. 13-25Roth IRAs Distributions from a Roth Distributions of contributions never taxed Qualified distributions of earnings from Roth not taxed Account must be open for five years before can receivequalified distributions and Taxpayer must be at least 59 ½ to receive qualified distribution or Distributions on death of taxpayer or Taxpayer is disabled or First home (limited to $10,000) No minimum distribution requirements
  26. 26. 13-26Roth IRAs Rollover from traditional to Roth Tax consequences Why roll over? Marginal tax rates Contribution limits to Roth are effectively higher $5,000 limit of after tax vs. before-tax dollars
  27. 27. 13-27Plans for Self-Employed SEP IRA Individual 401(k)
  28. 28. 13-28SEP IRA Contribution limit Lesser of (1) $49,000 or (2) 20% of net earningsfrom self employment Must provide plan to employees if taxpayer hasemployees
  29. 29. 13-29Individual 401(k) Contribution limit Lesser of (1) $49,000 or (2) 20% of net earningsfrom self employment + $16,500 Additional $5,500 if age by year end Maximum contribution is $54,500 ($49,000 + $5,500)
  30. 30. 13-30Saver’s Credit Credit for taxpayers contributing to qualifiedplans Credit in addition to deduction for contribution Available to lower income taxpayers Depends on filing status and AGI
  31. 31. 13-31Saver’s Credit