2. 13-2
Learning Objectives
1. Describe the tax and nontax aspects of employer-
provided defined benefit plans from both the
employer’s and employee’s perspective.
2. Explain and determine the tax consequences
associated with employer-provided defined
contribution plans, including traditional 401(k) and
Roth 401(k) plans.
3. Describe the tax implications of deferred
compensation from both the employer’s and
employee’s perspective.
3. 13-3
Learning Objectives
4. Determine the tax consequences of traditional and
Roth Individual Retirement Accounts and explain
the differences between them.
5. Describe the retirement savings options available
to self-employed taxpayers and compute the
limitations for deductible contributions to
retirement accounts for self-employed taxpayers.
6. Compute the saver’s credit.
4. 13-4
Employer Provided Plans
Qualified Plans
Must not discriminate between employees
Two main types:
Defined benefit plan
Defined contribution plan
5. 13-5
Defined Benefit Plans
Standard benefits based on fixed formula
Average compensation
Years of service
Employers deduct liability as they contribute
to plan
Funding requirements based on actuarial
assumptions
Employer not employee bears investment risk
6. 13-6
Defined Benefit Plans
Vesting schedules
5-year cliff or
7-year graded
Distributions from defined benefit plans are
taxable to employee when received.
Ordinary income
Early distributions subject to 10% penalty
7. 13-7
Defined Contribution Plans
Employer specifies up-front contribution on
employee’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. 13-8
Defined 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 50
years old at end of year) or 100% of the
employee’s compensation.
9. 13-9
Defined Contribution Plans
Vesting
Employee contributions and earnings on
employee contributions
Vest immediately.
Employer contributions and earnings on employer
contributions
Minimum vesting requirements
3-year cliff or
6-year graded schedule.
11. 13-11
Defined 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. 13-12
Defined Contribution Plans
Required minimum distributions
For the year in which employee reaches age 70 ½
or when the employee retires, if later (and each
subsequent year)
May defer first required distribution to April 1 of next
year, otherwise distribution must be received by
December 31 of current year
Based on applicable percentage of balance at end
of prior year
50% penalty on undistributed portion of minimum
distribution requirement.
13. 13-13
Traditional 401k Plans
Contributions are made with before-tax
dollars.
Tax deductible
Distributions:
Same rules as other defined contribution plans
14. 13-14
Roth 401k Plans
Contributions made with after-tax dollars.
Not tax deductible
Employer contributions must go into a
traditional 401k plan (not a Roth 401k plan)
15. 13-15
Roth 401k Plans
Qualified distributions
After account open for five years and employee
has reached age 59 ½.
Non-qualified distributions
Distributions of earnings are taxable and
subject to 10% penalty
Distributions from contributions are not taxable
Contributions divided by account balance multiplied
by amount of distribution equals distribution from
contributions
16. 13-16
Deferred Compensation
“Nonqualified plans”
May discriminate
Generally provided to executives or highly
compensated rather than rank and file
Can be used to make employee’s whole
when contributions to qualified plans would
be limited
Deemed investment choices
Risks to employees electing to defer salary?
17. 13-17
Deferred Compensation
Employer deducts for tax purposes when
pays
Compare to financial accounting
Employee includes in income when
received
If paid after retirement, §162(m) limitation
does not apply
18. 13-18
Deferred 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
20. 13-20
Individual Retirement
Accounts (IRAs)
For AGI deduction for contributions
Generally not allowed if participant in employer-
sponsored plan unless
For single taxpayers Taxpayer is single, deduction
allowed if participate in employer plan but income is
below 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. 13-21
Individual Retirement
Accounts (IRAs)
For AGI deduction for contributions
Generally, not allowed if participant in employer-
sponsored plan unless
For married taxpayers deduction is allowed if
participate in employer plan but income is below
certain thresholds
In 2011, lesser of $5,000 in 2011 or earned income
of both spouses reduced by other spouse’s
contributions to IRA or Roth IRA
If 50 years or older at end of year limit is $6,000
Additional “catch-up” contribution
22. 13-22
Individual Retirement
Accounts (IRAs)
May make nondeductible contributions
Deductible + nondeductible cannot exceed
$5,000 for one taxpayer (plus catch-up)
Must contribute by April 15th
of
subsequent year
23. 13-23
Individual Retirement
Accounts (IRAs)
Distributions taxed as ordinary income
10% penalty if before 59 ½
Certain exceptions
Medical expenses, insurance premiums, first
home
Same minimum distributions apply as to
qualified contribution plans
nontaxable percentage = nondeductible
contributions divided by balance of account
24. 13-24
Roth IRAs
Nondeductible contributions
Contributions to a Roth IRA
Same $5,000 limit ($6,000 if 50 or older at year
end)
Phase-out based on AGI
25. 13-25
Roth 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 receive
qualified 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. 13-26
Roth 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
28. 13-28
SEP IRA
Contribution limit
Lesser of (1) $49,000 or (2) 20% of net earnings
from self employment
Must provide plan to employees if taxpayer has
employees
29. 13-29
Individual 401(k)
Contribution limit
Lesser of (1) $49,000 or (2) 20% of net earnings
from self employment + $16,500
Additional $5,500 if age by year end
Maximum contribution is $54,500 ($49,000 + $5,500)
30. 13-30
Saver’s Credit
Credit for taxpayers contributing to qualified
plans
Credit in addition to deduction for contribution
Available to lower income taxpayers
Depends on filing status and AGI