How are distributions from defined benefit plans treated for tax purposes quizlet?

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Terms in this set (55)

what are the 2 categories retirement plans fall under

1. qualified
2. nonqualified

qualified plans

are retirement plans that meet federal requirements and receive favorable tax treatment. provide tax benefits and must be approved by the IRS. The plans must be permanent, in
writing, communicated to employees, defined contributions or benefits, and cannot favor highly paid employees, executives, or stockholders

The primary type of qualified plans

defined benefit and defined contribution plans.

To comply with ERISA minimum participation standards, qualified retirement plans must

allow the enrollment of all employees over age 21 with one year experience.

If more than 60% of a qualified retirement plan's assets are in key employee accounts, the plan is considered

"top heavy"

Qualified plans have the following features

• Employee contributions are made with pretax dollars - contributions are not taxed until withdrawn.
• Interest earned on contributions is tax-deferred until withdrawn upon retirement
• The annual addition to an employee's account in a qualified retirement plan cannot exceed the maximum limits set by the Internal Revenue Service

Nonqualified plans are characterized by the following:

• Do not need to be approved by the IRS
• Can discriminate in favor of certain employees
• Contributions are not tax-deductible
• Interest earned on contributions is tax-deferred until withdrawn upon retirement

Employer's contributions are

tax-deductible and not treated as taxable income to the employee. are made with pre-tax dollars, and any interest earned on both employer and employee contributions are tax-deferred. Employees only pay taxes on amounts at the time of withdrawal.

Withdrawals by the employee are treated as

taxable income. Withdrawals by the employee made prior to age 59 ½ are assessed an additional 10% penalty tax. Distributions are mandatory by April 1st of the year following age 70½, and failure to take the required withdrawal results in a 50% excise tax on those funds.

Funds may be withdrawn prior to the employee reaching age 59 ½ without the 10% penalty tax: if

the employee dies or becomes disabled; if a loan is taken on the plan's proceeds; if the withdrawal is the result of a divorce proceeding; if the withdrawal is made to a qualified rollover plan; or if the employee elects to receive annual level payments for the remainder of his life.

the exclusive benefit rule

states that assets held in a company's qualified retirement plan must be maintained for the exclusive benefit of the employees and their beneficiaries

the survivor ship benefits under a qualified retirement plan can be waived with what

only with the written consent of a married worker's spouse

The Employee Retirement Income Security Act of 1974 (ERISA)

was enacted to provide minimum benefit standards for pension and employee benefits plans, including fiduciary responsibility, reporting and disclosure practices, and vesting rules. The overall purpose of (fill in) is to protect the rights of workers covered under an employer-sponsored plan. all qualified employer plans must comply with this

who is exempt form ERISA regulations

church, governmental, and collectively bargained plans

Under the IRS "minimum coverage" rules,

a qualified retirement plan must benefit a broad cross-section of employees.
The purpose of coverage requirements is to prevent a plan from discriminating against rank and file employees in
favor of the "elite" employees (officers, and highly compensated employees) whose positions often enable them to
make basic policy decisions regarding the plan. The IRS will subject qualified employer plans to coverage tests to
determine if they are discriminatory. A qualified plan cannot discriminate in favor of highly-paid employees in its
coverage provisions or in its contributions and benefits provisions. Form 5500 is a disclosure document that employee
benefit plans use to satisfy annual reporting requirements under ERISA.

vesting schedule and nonforfeitable rights at any
specified time. Vesting means the right that employees have to their retirement funds. Benefits that are "vested"
belong to each employee even if the employee terminates employment prior to retirement. For all plans, an
employee always has a 100% vested interest in benefits that accrue from the employee's own contributions.
Benefits that accrue from employer contributions must vest according to vesting schedules established by law.

All qualified plans must meet standards that set forth the employee (fill in) and (fill in)

For a retirement plan to be qualified, it must be

funded, here must be real contributions on the part of the
employer, the employee, or both. These funds must be held by a third party and invested. The funding vehicle is
the method for investing the funds as they accumulate.

Federal minimum funding requirements are set to ensure that an employer's annual contributions to a pension
plan are sufficient to cover the costs of benefits payable during the year, plus administrative expenses.

all retirement plans must restrict

the
amount of contributions that can be made for, or accrue to, any one plan participant.

Defined benefit plans

pay a specified benefit amount upon the employee's retirement. When the term pension is used, it normally is referring to a defined benefit plan. The benefit is based on the employee's length of service and/or earnings. Defined benefit plans are mostly funded by individual and group deferred annuities.

Defined contribution plans

do not specify the exact benefit amount until distribution begins. Two main types of plans are profit-sharing and pension plans. The maximum contribution is the lesser of the employee's earnings or $49,000 per year

Profit-Sharing Plan

is an example of a contribution plan. A type of retirement plan that sets aside a portion of the firm's net income for distributions to employees who qualify under the plan. Plans must provide participants with the formula the employer uses for contributions. The contributions may vary year to year, and contributions and interest are tax-deferred until withdrawal.

Pension Plans

an example of a contribution plan, Employers contribute to a plan based on the employee's compensation and years of service, not company profitability or performance.

Money Purchase Plans

an example of a contribution plan. Allow employers to contribute a fixed annual amount, apportioned to each participant, with benefits based on funds in the account upon retirement. Target benefit plans have a target benefit amount.

Stock Bonus Plans

an example of a contribution plan. These plans are similar to a profit-sharing plan, except that contributions by the employer do not depend on profits, and benefits are distributed in the form of company stock.

Defined Benefit Plans

establishes a definite future benefit, pre determined by a specific formula. When the term pension is used, the
reference is typically to a defined benefit plan. Usually the benefits are tied to the employee's years of service,
amount of compensation, or both. For example, a defined benefit plan may provide for a retirement benefit equal
to 2% of the employee's highest consecutive five-year earnings, multiplied by the number of years of service. Or
the benefit may be defined as simply as $100 a month for life.

Employee Stock Ownership Plans

are employee-owner programs that provide a company's workforce with
an ownership interest in the company. Shares are allocated to employees and may be held in an ESOP trust until the employee retires or leaves the company.

To qualify for federal tax purposes, a defined benefit plan must meet the following basic requirements

The plan must provide for definitely determinable benefits, either by a formula specified in the
plan or by actuarial computation.
► The plan must provide for systematic payment of benefits to employees over a period of years
(usually for life) after retirement. Thus, the plan has to detail the conditions under which benefits
are payable and the options under which benefits are paid.
► The plan must provide primarily retirement benefits. The IRS will allow provisions for death or
disability benefits, but these benefits must be incidental to retirement.
► The maximum annual benefit an employee may receive in any one year is limited to an amount
set by the tax law.
► The appropriate choice of a qualified corporate retirement plan (defined contribution or defined
benefit) requires an understanding of the operation and characteristics of each plan as they relate
to the employer's objectives.

Cash or Deferred Arrangement (401(k) Plans)

allow employers to make tax-deferred contributions to the participant, either by placing a cash bonus into the employee's account on a pre-tax basis or the individual taking a reduced salary with the reduction placed pre-tax in the account. The account's funds are taxable upon withdrawal

Tax-Sheltered Annuity (403(b) Plans)

are a special class of retirement plans available to employees of certain charitable, educational, or religious organizations.

IRC Section 457 Deferred Compensation Plans

plans for employees of state and local governments and nonprofit organizations became
popular in the 1970s. Congress enacted Internal Revenue Code Section 457 to allow participants in such plans to
defer compensation without current taxation as long as certain conditions are met.

Simplified Employee Plans (SEPs) for small employers

are basically an arrangement where an employee (including a self-employed individual) establishes and maintains an IRA to which the employer contributes. Employer contributions are not included in the employee's gross income. A primary difference between a SEP and an IRA is the much larger amount that can be contributed to an employee's SEP plan is the lesser of 25% of the employee's annual compensation

Savings Incentive Match Plan for Employees (SIMPLE) for small employers

are available to small businesses (including tax exempt and government entities) that employ no more than 100 employees who received at least $5,000 in compensation from the employer during the previous year. An employer can choose to make nonelective contributions of 2% of compensation on behalf of each eligible employee. To establish a SIMPLE plan, the employer must not have a qualified plan in place.

Keogh Plans

or HR-10 plans are for self-employed persons, such as doctors, farmers, lawyers, or other sole- proprietors. Keoghs may be defined contribution or defined benefit plans. Defined contribution Keoghs have a maximum contribution of $49,000 per year, while defined benefit Keoghs have maximum benefits of $195,000 per year. Contributions are tax-deductible, and interest and
dividends are tax-deferred

Salary Reduction SEP Plans

SARSEPs incorporate a deferral/salary
reduction approach in that the employee can elect to have employer contributions directed into the SEP or paid
out as taxable cash compensation. The limit on the elective deferral to a SARSEP is the same as a 401(k).
SARSEPs are reserved for small employers (those with 25 or fewer employees) and had to be established
before 1997. As a result of tax legislation, no new SARSEPs can be established. However, plans that were
already in place at the end of 1996 may continue to operate and accept new employee participants.

Catch-Up Contributions

Both SARSEP and SIMPLE plans allow participants who are at least 50 years old by the end of the plan year
to make additional "catch-up" contributions.

Traditional IRAs

allow for an individual to contribute a limited amount of money per year, and the interest earned is tax-deferred until withdrawal. Contribution limits are indexed annually, currently at $5,000 per year, with $6,000 for individuals age 50 or older. Some individuals may deduct contributions from their taxes based on their adjusted gross income (AGI), but all withdrawals are taxable income. If an individual or spouse does not have an employer retirement plan, the entire
contribution is tax-deductible, regardless of AGI. Withdrawals made prior to age 59 ½ are assessed an
additional 10% penalty tax.

To avoid penalties, traditional IRA owners must

begin to receive payment
from their accounts no later than April 1 in the year following the attainment of age 70 ½. Funds may be withdrawn prior to the employee reaching age 59 ½ without paying the 10% penalty tax (but the interest is still taxable) to the following: death, disability, first-time homebuyers up to $10,000, education (no dollar maximum), health insurance premiums if unemployed, qualified medical expenses.

IRA Participation

Anyone under the age of 70 1/2 who has earned income may open a traditional IRA and contribute up to the
contribution limit or 100% of compensation each year, whichever is less. A non-wage earning spouse may open
an IRA and contribute up to the limit each year.

the amount an individual contributes to a traditional IRA can be

deducted from that individual's
income in the year it is contributed. The ability of an IRA participant to take a deduction for her contribution rests
on two factors:
► Whether or not the participant is covered by an employer-sponsored retirement plan
► The amount of income the participant makes

Failure to withdraw the minimum amount can result in a traditional IRA

can result in a
50% excise tax that will be assessed on the amount that should have been withdrawn.

At retirement, or any time after age 59 1/2, the IRA owner can elect to

receive either a lump-sum
payment or periodic installment payments from his or her fund. Traditional IRA distributions are taxed in
much the same way as annuity benefit payments are taxed

If an IRA owner dies before receiving full payment, the remaining funds in the deceased's IRA will be
paid

to the named beneficiary

If the IRA owner is a military reservist called to active duty (between September 11, 2001 and
December 31, 2007) for more than 179 days or for an indefinite period, what does not apply

the 10-percent early-withdrawal
penalty does not apply. However, regular income taxes will apply.

An ideal funding vehicle for IRAs is

a flexible premium fixed deferred annuity. Other acceptable IRA funding
vehicles include bank time deposit open accounts, bank certificates of deposit, insured credit union accounts,
mutual fund shares, face amount certificates, real estate investment trust units, and certain US gold and silver coins

Roth IRAs are

designed so that withdrawals are received income tax-free. Contributions to Roth IRAs are subject to the same limits as traditional IRAs, but are not tax-deductible. Interest on contributions is not taxable as long as the withdrawal is a qualified distribution. Qualified distributions must occur after five years in the event of death or disability of the individual, up to $10,000 for first-time homebuyers, or at the age of 59 ½.

Rollovers are what

transfer of funds from one IRA or qualified plan to another

Rollovers are subjected to

20% withholding tax if eligible rollover funds are received personally by a participant in a qualified plan, unless the funds are deposited into a new IRA or qualified plan within 60 days of distribution

Funds that are transferred directly from one qualified IRA to another qualified IRA are not subject to what

the withholding tax of 20%

A surviving spouse who inherits IRA benefits from a deceased spouse's qualified plan is eligible to what

to establish a rollover IRA in their own name.

Rollover contributions to an individual retirement annuity (IRA) are

unlimited by dollar amount

The Pension Protection Act of 2006

embodied the most sweeping
reform of America's pension laws in over 30 years. It improves the
pension system and increases opportunities to fund retirement plans.

The act encourages workers to increase their contributions to
employer sponsored retirement plans and helps them manage
their investments. For example, automatic enrollment is a means of increasing participation in 401(k) plans,
especially among young workers entering the workforce. The act also provides for automatic deferrals into
investment funds and automatic annual increases in employees' salary deferral rates beginning in 2008.
Since 2007, plan sponsors can offer fund-specific investment advice to participants through their retirement
plan providers or other fiduciary advisers. Counseling in person is also allowed under strict guidelines.

Section 529 Plans

is a vehicle for providing for higher education expenses and is named after the tax code that
governs it. don't restrict eligibility or limit the amount of contribution based on the income of the contributor.
State residency also is not a restriction. The beneficiary of a Section 529 plan does not need to report income when
withdrawals are used for qualified college costs.

There are two types of Section 529 plans:

Prepaid tuition plans
College savings plans

Prepaid tuition plans:

Allows contributors to prepay college tuition and other fees for a designated beneficiary

College savings plans

Allows contributors to invest after-tax dollars in professionally managed accounts

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