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.
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.
13-4Employer Provided Plans Qualified Plans Must not discriminate between employees Two main types: Defined benefit plan Defined contribution plan
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
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
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
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.
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.
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)
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.
13-13Traditional 401k Plans Contributions are made with before-taxdollars. Tax deductible Distributions: Same rules as other defined contribution plans
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)
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
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?
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
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
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
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
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
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
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
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
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
13-27Plans for Self-Employed SEP IRA Individual 401(k)
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
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)
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