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Topic 59: Retirement Needs
Analysis
 Assumptions
   Inflation
   Retirement life expectancy
   Lifestyle
   Returns on investments
 Income Sources
       Pension
       Deferred compensation
       Social security: inflation indexed
       Investments
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Topic 59: Retirement Needs
Analysis
 Financial Needs
   Medical/Long-term care
   Charitable
 Projection of returns
   Straight-line
   Versus reality (Monte Carlo)
 Capital preservation
   Live on earnings
 Capital utilization
   Assets are liquidated during retirement
   Buy an annuity
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Topic 59: Retirement Needs
Analysis
 Projecting Financial Needs
     Estimate of the percentage of an individual’s
      income earned prior to retirement needed
      during retirement.
     Methods of Calculating
        Top-Down Approach
          Uses percentages and common sense.
          “Best guess” when not close to retirement

        Bottom-Up (Budgeting) Approach
          Determines which preretirement expenses are
           needed during retirement.
          More accurate when close to retirement
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Topic 59: Retirement Needs
Analysis
   Projecting Required Savings
         Determine first year retirement income
             Keir: BEG mode problems (59.1 and 59.5)
             Want to have funds at start of year; not end
         Determine funds needed at retirement to fund income
             Use real rate of return to discount
         Determine required annual savings to accumulate funds
             Use actual rate of return
             Use present savings as present value
             Serial payments: increase investment each
               year
                Consequently, initial payment is smaller
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Topic 60: Social Security
 Contributions to Social Security
     6.2% FICA on first $106,800 in 2009
     1.45% on all earnings
       Employers match employees’ contributions
     Self-employed
       Pay both employer and employee
 Retirement benefits
     40 quarters of coverage
       $1,000 per credit; four credits per year
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Topic 60: Social Security
 Retirement benefits
     Highest 35 years of earnings
       AIME: monthly earnings
       PIA: replace 90% of first $744 but only
        15% of AIME over $4,483
     40 quarters of coverage
       $1,000 per credit; four credits per year
       Children under 18 employed by family,
        ministers, railroad workers: no coverage
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Topic 60: Social Security
 Retirement benefits
     Age at retirement
       Early retirement: 62
         Currently receive 75% normal benefits
       Normal retirement age:65 year, 10 months
         By 2027, will be age 67
       Delayed retirement: increase benefits up to
        32% by delaying until age 70
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Topic 60: Social Security
 Retirement benefits
        Spouse over 62
          50% of employee’s benefit
             If higher than own benefits
          Spouse caring for child under age 16
          Ex-spouse: married 10 years
        Children
          Under age 18
             Retired parent: 50% of employee’s benefit
             Deceased parent: 75% of benefit
        Widows at age 60
        Family limitation: 1.5 times employee benefit
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Topic 60: Social Security
 Working after retirement
   Reduction of 50% of benefits for workers below
     normal retirement age earning more than $14,160
 Death benefits: $255 to widow or child
 Taxation of benefits:
        Up to 85% of benefits taxable if MAGI exceeds $55,000
         MFJ
        Muni bond interest income included in calculating taxable
         social security benefits
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Topic 60: Social Security
 Disability benefits
        Five month waiting period
        Disability must last a year
        Can’t do any work suited for
        Benefits stop at retirement age
        Benefits also paid to:
          Children under 18
          Spouse over 62
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Topic 61: Types of Qualified Plans
      Characteristics                Defined Benefit                Defined Contribution
                                        Not less than the
      What is the Annual                                                    25% of Covered
                                        unfunded current
      Contribution Limit?                                                    Compensation
                                            liability*
       Who assumes the
                                            Employer                           Employee
       investment risk?

                                                                     Reduce plan costs or allocate
 How are forfeitures allocated?         Reduce Plan Costs
                                                                        to other participants

 Is the plan subject to Pension     Yes (except professional
 Benefit Guaranty Corporation        firms with less than 25                       No
       (PBGC) coverage?                    employees)
       Does the plan have
                                          No, they are                  Yes, they are usually
      separate investment
                                          commingled                          separate
           accounts?
      Can credit be given for
                                                 Yes                               No
          prior service?
                      * This is the annual contribution limit for 2006 and 2007.
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Topic 61: Types of Qualified Plans
  Characteristic                      Pension Plan                  Profit Sharing Plan

 Legal Promise of                 Paying a pension at                     Deferral of
     the Plan                         retirement                         Compensation

    In-Service
                                             No*                    Yes (after two years)
   Withdrawals?

Mandatory Funding?                          Yes**                                No

 Investment in ER
                                            10%                                100%
    Securities

  QJSA & QPSA?                               Yes                                 No

  *Under the PPA 200, defined benefit pension plans can provide for in-service distributions to
                            participants who are age 62 or older.
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Topic 61: Types of Qualified Plans
                                                           Profit Sharing
                             Pension Plans                     Plans

                             Defined Benefit Pension   Profit Sharing Plans
                             Plans
Contribution Benefit Plans




                                                        Stock Bonus Plans




                                                                                Defined Contribution Plans
                             Cash Balance Pension
               Defined




                                                        ESOPs
                             Plans                      401(k) Plans



                             Money Purchase Pension    Thrift Plans
                             Plans
  Defined




                                                        New Comparability
   Plans




                             Target Benefit Pension    Plans
                             Plans                      Age-Based Profit
                                                        Sharing Plans
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Topic 61: Types of Qualified Plans
 Money Purchase Pension Plans
        Mandatory funding of a fixed percentage of the employee’s
         compensation – up to 25%
          Can integrate with Social Security
        Participant bears investment risk
        Not likely to be established after EGTRRA 2001
          Shift to profit sharing plans as no mandatory contributions
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Topic 61: Types of Qualified Plans
 Target Benefit Pension Plan
   Special type of money purchase pension plan
 Actuary determines annual funding needed for
  target benefit
   Then contributions are made to achieve
     target benefit
   Contribution based on the participant’s age
   Participant selects investments and bears risk
      May not achieve target benefit
   Favors older plan entrants: can make larger
     contributions
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Topic 61: Types of Qualified Plans
 Profit sharing plans
   Contributions must be made by the due date of the
      company’s income tax return (including extensions)
       Plan must be established by end of year, however
   Contributions are discretionary, but must be
      “substantial and recurring.”
       No requirement of company profit for contribution.
   Limited to 25% of total employer covered
      compensation.
   Limited to the lesser of 100% of compensation, or
      $49,000 for 2009 per employee per year.
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Topic 61: Types of Qualified Plans
    Cash or Deferred Arrangements (CODA) – 401(k)
      Permits employees to defer compensation to a qualified plan.
          Limited to $16,500 for 2009 per year, or $22,000 for 2009
             for those age 50 and over.
          Employers may (buy are not required to) match the
             employee’s deferral.
          Can treat as Roth contribution
              No AGI limitation on contribution
          Always vested
          Subject to social security taxes; not income tax
      Employer contributions
          Limited to 25% of total employer covered compensation.
          Limited to the lesser of 100% of compensation, or $49,000
             for 2009 per employee per year.
          Vest: three year cliff or 2 – 6 year graduated
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Topic 61: Types of Qualified
Plans
    Cash or Deferred Arrangements (CODA) – 401(k)
      Benefits must be provided to a certain percentage of
        rank-and-file employees.
         Two tests for 401(k) in addition to qualified plan tests
             Actual Deferral Percentage Test (ADP Test)
             Actual Contribution Percentage Test (ACP Test)
         Limits the employee elective deferrals for the HC
            based on the elective deferrals of the NHC.
      ADP test:
         Top Dogs: >5% owner; or comp>$100K
         Peons < 2%; Top Dogs= 2 x Peon%
         Peons 2 – 8%; Top Dogs= 2 + Peon%
         Peons >8%; Top Dogs= 1.25 x Peon%
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Topic 61: Types of Qualified
Plans
  Cash or Deferred Arrangements (CODA) – 401(k)
    ACP test:
       Same scale for testing as ADP
       Includes both
           Employee contributions
           Employer matching contributions
  Age-Based (Cross Testing) Profit Sharing Plans
    Use a combination of age and compensation to
      allocate the plan contribution.
    Larger contributions for older workers
    Can only take into account $245,000 of
      compensation in 2009 (all qualified plans)
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Topic 61: Types of Qualified Plans
    Simple 401(k) plans
      Maximum deferral $11,500 in 2009; over 50 additional $2,500
      Fully vested in both employer/employee contributions
      < 100 employees to establish
      Cover employees earning > $5,000
    Safe Harbor 401(k) Plans
      Not required to pass ADP or ACP tests.
      Employer must provide any one of the following:
          3% nonelective contribution
              To all eligible employees
          Matching contribution
              100% up to 3%, and
              50% from 3% to 5%
      Employer contributions are 100% vested at all times.
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Topic 61: Types of Qualified Plans
 Stock bonus plans
   Employer contributes company stock
   Distributions typically is company stock
      Appreciation taxed as capital gains
      Value at time of contribution ordinary income at
        time of distribution
 ESOPs
   Participant receives allocations of the employer stock
     from the ESOP.
      At age 55 with 10 YOS, can diversify 25% of stock
        each year
   Employer receives a tax deduction for the value of
     the stock contributed to the plan.
   Allows owner to diversify holding without capital
     gains tax if reinvests
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Topic 61: Types of Qualified Plans
 New comparability
   Cross test for age; salary or job classification
   Increases benefits to owner
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Topic 61: Types of Qualified Plans
 Defined Benefit Plans
   Pension benefit based on a defined funding formula
      Flat Amount Formula – $600 per month
      Flat Percentage Formula – 60% of salary
      Unit Credit Formula –2% x YOS up to 70% of
        average salary
   Maximum benefits
        Lesser of $195,000 per year
        Average compensation in three highest years of
         earnings
      May still have five year cliff vesting or 3 to 7
       year vesting
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Topic 61: Types of Qualified Plans
 Defined Benefit Plans
   Cash balance plans
        Employer guarantees rate of return
      412(i) plan
        Funded with life insurance or annuities
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Topic 62: Qualified Plan Rules
 Age and service requirements
   Qualified plans
        Enter plan within six months after reaching later
         of
          Age 21
          One year of service
        Can require two YOS if immediately vest
      SEP
        Made $500 three of last five years and age 21
      SIMPLE IRA
        Earned $5,000 in last two years
26


Topic 62: Qualified Plan Rules
 Coverage requirements: all qualified plans meet one of
  these tests
   Cover 70% of peons
   Peons covered/Top dogs covered > 70%
   Peon benefits/Top dog benefits > 70%
   Topic 62, Q. 8, 12
 Defined benefit plan: cover lesser of
   50 employees or
   40% of employees
 Top dogs
   Own 5% of company
   Make > $100,000 and in top 20% of compensation
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Topic 62: Qualified Plan Rules

    Vesting
      Employee contributions: always vested
      Employer contributions:
         Three year cliff
         Two to six year graduated
         SEP and SIMPLE: vest immediately
    Social security integration: defined benefit plans
      Excess method: 26.25% increase in monthly benefit or double
        monthly benefit if it’s less than 26.25%
      Offset method: reduce benefits up to 50%
    Social security integration: defined contribution plans
      Twice lower contribution rate; 5.7% max additional rate
    Compensation: can’t consider compensation > $245,000 in
     2009
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Topic 62: Qualified Plan Rules

    Payroll taxes
      Imposed on employee contributions
      Not imposed on employer contributions
29
Topic 62: Qualified Plan Rules

 Top Heavy plan: > 60% of benefits go to top dogs
   Top dogs:
      Own more than 5%
      Own more than 1% and make > $150,000
      Officer make > $150,000
      Topic 62, Problem 3
 Loans
      Maximum lesser of $50,000 or 50% balance
         Can always borrow $10,000
      Loans not repaid are distributions
      Up to five year term
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Topic 63: Other plans
    Traditional IRA
      Contribute $5,000 in 2009
         Over 50: $1,000 catch up
      Must be under age 70 ½
      Must have earned income
         Can use spouse’s earned income
         6% excise tax on excess contributions
      Limitation on deducting contribution
         Not covered by plan; spouse not covered
              No AGI limitation
         Not covered by plan; spouse is covered
         Active participant if could but don’t participate
              Phase out $166,000 - $176,000
         Covered by plan
              MFJ phase out $89,000 - $109,000
      Topic 63, Problem 11
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Topic 63: Other plans
 Traditional IRA
      Distributions: income not taxed until
       distributed
        Ordinary income
           Unless made nondeductible contributions
        Must begin by April 1 of year following turn 70 ½
           Unless still working for 401(k); not IRA
             No RMD for 2009
           50% tax for failing to take RMD
           Inherited Roth IRAs also must take RMD
                But not Roth IRA
32


Topic 63: Other plans
 Roth IRA
      Contribute $5,000 in 2009
        Over 50: $1,000 catch up
      Can be any age
      Must have earned income
        Can use spouse’s earned income
      Limitation on making contributions
        MFJ phase out $166,000 - $176,000
33


Topic 63: Other plans
 Roth IRA
      Conversions of Traditional to Roth
         Ordinary income
           No 10% penalty early withdrawal
         AGI must be less than $100,000
           Does not include income from conversion
           No limit in 2010 and two years to pay tax on
            conversion
      Distributions not taxable if
        Made five years after contribution and
        After 59 ½, dead, disabled or buying first home
34


Topic 63: Other plans
 Roth IRA
      Distributions ordering
        First, contributions so no tax or penalty
        Then, conversions so no tax but maybe penalty
        Then, earnings so maybe tax and maybe
          penalty
35


Topic 63: Other plans
 SEPs
      Coverage: everyone 21, worked three of last five
       years and earned $500
      Employer contributions only
         Up to $49,000 or employee comp
         25% of payroll
      Plan can be established up to due date of return
       including extensions
      Contributions can be skipped in any year
      Considered an active participant in a plan
         May not be able to deduct IRA contribution
36


Topic 63: Other plans
 SIMPLE 401(k)
      < 100 employees
      Employees can contributed up to $11,500 in
       2009
      Over 50; $2,500 additional
      Employer contributes:
        100% of employee’s deferral up to 3% or
        2% to all employees
        Employer contributions are immediately vested
      No ADP/ACP testing
      Employer can not have any other type of plan
37


Topic 63: Other plans
 SIMPLE IRAs
      Coverage: everyone making $5,000 in last two years
         No age 21 requirement
      Employee can contribute up to $11,500
         Over 50: additional $2,500
         Considered an active participant in a plan
              May not be able to deduct personal IRA contribution
      Employer contributes:
         100% of employee’s deferral up to 3% or
         2% to all employees
         Employer contributions are immediately vested
38


Topic 63: Other plans
 Section 403(b): TSA
      501(c)(3) and public schools
        Can only invest in annuities/mutual funds
      Employee can contribute up to $16,500
        Over 50: additional $5,500.
        Complicated additional $3,000 for geezers who
         forgot to save
        Considered an active participant in a plan
           May not be able to deduct IRA contribution
39


Topic 63: Other plans
 Keogh plans
      For self-employed
      Can be defined benefit/contribution
      Can contribute 20% of S-E income after
       subtracting one-half of S-E taxes
      Can make loans
40


Topic 64: Regulation of Plans
 ERISA
   Governs qualified and nonqualified plans
   Established PBGC
      Employers pay premiums to guarantee defined
        benefit plan benefits
   Fiduciary standard: client best interest
      Also requires diversification; act as prudent man
      Also must invest consistent with time horizon and
        risk tolerance
 Department of Labor
   Polices investment of plan assets
   Polices prohibited transactions
41


Topic 64: Regulation of Plans
 Prohibited transactions
      Fiduciary/owner/investment advisor/officer
       self-dealing with plan
        Exception: providing investment advice, office
         space
      Penalties
        15% annual penalty until corrected
           If not corrected, 100% penalty
42


Topic 64: Regulation of Plans
 Reporting requirements
      Plans must receive IRS approval
        Prototype
      Summary Plan Descriptions
        Sent to Department of Labor
        Give to employees when starting plan
        And when employees enter plan
43


Topic 64: Regulation of Plans
 Plan terminations
      Standard
        Enough assets to pay benefits
      Distress
        Bankrupt
        Not solvent, unable to pay bills
44


Topic 65: Plan Selection
 Owners’ needs at retirement
   Defined benefit plan: larger benefits
     If young peons
   Old owner, well-paid peons
     Age-weighted plan
   Old owner, under-paid peons
     Integrate with social security
 Cash flow predictability
   Unstable: profit sharing
 Administration: SIMPLEs and SEPs are easy
45
Topic 66: Investing Retirement
Plan Assets
 Fixed income versus equities
   Ordinary income versus capital gain
   OID bonds
 Muni bonds; life insurance; annuities
 ERISA required diversification of employee assets
 Must also be consistent with time horizon, risk tolerance
 Unrelated Business Taxable Income
   If plan owns financed real estate; stock bought on
     margin
46


Topic 67: Distributions
    Premature distributions
      Penalty: 10% tax in addition to income tax
         25% tax on SIMPLEs in first 2 years
      Exceptions to penalty
         Both IRAs and Qualified Plans
            After age 59 1/2
            Death, disability
            Equal payments
               Must continue until for at least five years or age
                  59 1/2
            QDRO
                  Must be consistent with terms of plan
47


Topic 67: Distributions
 Premature distributions
   Exceptions to penalty
      Qualified Plans Only
        Early retire after 55
      IRAs Only
        Medical; tuition; first time home
48


Topic 67: Distributions
 Hardship withdrawals
      Can withdraw elective deferrals for financial
       need due to:
        Illness, mortgage payments, prevent eviction
      Still subject to 10% penalty and taxes
        Better to take loan?
49


Topic 67: Distributions
    Joint and survivor annuity mandatory for qualified plans
      Can waive with spouse’s written consent
    Annuity
      Portion reflecting basis not taxable
    NUA in lump sum distributions of plans holding employer stock
    Rollovers
      Must be made within 60 days
           Subject to 20% withholding if not direct to another plan
    RMD
      By April 1 of year after turn 70 ½
           Balance at end of prior year / divisor for age at end of year
           Trophy spouse – use different table
      Not required in 2009
50


Topic 67: Distributions
 Death before distributions begin
   If spouse beneficiary, roll to her IRA or
    take distributions based on her life
    expectancy
   Other beneficiary, over life expectancy for
    IRAs or roll 401(k) into beneficiaries own
    IRA
   No beneficiary or estate beneficiary
      Distribute over five years
51


Topic 67: Distributions
    Death after distributions begin
      Over life expectancy of beneficiary
          Can roll into spouse’s IRA
    If beneficiary is not charming spouse, two choices
      Cash out the IRA within five years of owner’s death or…
      Or elect to have distributions made over their life
         expectancy
             Name grandchild to delay distributions
      No beneficiary or estate beneficiary
          Distribute over deceased’s life expectancy

				
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