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Topic 44: 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 44: Retirement Needs
Analysis




Financial Needs
 Medical/Long-term care
 Charitable
Projection of returns
 Straight-line
 Versus reality (Monte Carlo)
Capital preservation
 Preserve value as of retirement in:
 Nominal dollars (don’t inflate)
 Real dollars (inflate)
Capital utilization (depletion)
 Assets are liquidated during retirement
 Buy an annuity
 No legacy
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Topic 44: 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 44: Retirement Needs
Analysis

Projecting Required Savings
 Determine first year retirement income
 BEG mode problems
 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 45: Social Security


Contributions to Social Security and Medicare
 6.2% FICA on first $117,000 in 2014
 Employers match employees’ contributions
 Although in 2012 4.2%
 1.45% on all earnings for Medicare
 An additional .9% for compensation above $250,000 MFJ
beginning in 2013 (for employees only)
 Unearned income above $250,000 MFJ is subject to a 3.8%
Medicare tax beginning in 2013
 Self-employed
 Pay both employer and employee
Retirement benefits
 40 quarters of coverage
 $1,200 per credit in 2014; four credits per year
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Topic 45: Social Security
 Retirement benefits
 Highest 35 years of earnings
 AIME: monthly earnings
 PIA: replace 90% of first $816 but only
15% of AIME over $4,917 in 2014 40
quarters of coverage
 Children under 18 employed by family,
ministers, railroad workers: no coverage
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Topic 45: Social Security
 Retirement benefits
 Age at retirement
 Early retirement: 62
 Currently receive 75% normal benefits
 Normal retirement age: 66 years
 By 2027, will be age 67
 Delayed retirement: increase benefits up to
32% by delaying until age 70
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Topic 45: 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 45: Social Security
 Working after retirement
 Reduction of 50% of benefits for workers below
normal retirement age earning more than $15,840 in
2014
 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 45: 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 46: Types of Qualified Plans
Characteristics
Defined Benefit
Defined Contribution
What is the Annual
Contribution Limit?
Not less than the
unfunded current
liability*
25% of Covered
Compensation
Who assumes the
investment risk?
Employer
Employee
How are forfeitures allocated?
Reduce Plan Costs
Reduce plan costs or allocate
to other participants
Is the plan subject to Pension
Benefit Guaranty Corporation
(PBGC) coverage?
Yes (except professional
firms with less than 25
employees)
No
Does the plan have
separate investment
accounts?
No, they are
commingled
Yes, they are usually
separate
Can credit be given for
prior service?
Yes
No
* This is the annual contribution limit for 2006 and 2007.
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Topic 46: Types of Qualified Plans
Characteristic
Pension Plan
Profit Sharing Plan
Legal Promise of
the Plan
Paying a pension at
retirement
Deferral of
Compensation
In-Service
Withdrawals?
No*
Yes (after two years)
Mandatory Funding?
Yes**
No
Investment in ER
Securities
10%
100%
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 46: Types of Qualified Plans
Defined Benefit Pension
Plans
Cash Balance Pension
Plans
Profit Sharing Plans
Stock Bonus Plans
ESOPs
401(k) Plans
Money Purchase Pension
Plans
Target Benefit Pension
Plans
Thrift Plans
New Comparability
Plans
Age-Based Profit
Sharing Plans
Defined Contribution Plans
Defined
Defined
Contribution Benefit Plans
Plans
Pension Plans
Profit Sharing
Plans
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Topic 46: 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 46: 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 46: 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
$52,000 for 2014 per employee per year.
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Topic 46: Types of Qualified Plans

Cash or Deferred Arrangements (CODA) – 401(k)
 Permits employees to defer compensation to a qualified plan.
 Limited to $17,500 for 2014 per year, or $23,000 for 2014
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 $52,000
for 2014 per employee per year.
 Vest: three year cliff or 2 – 6 year graduated
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Topic 46: 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 46: 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 $260,000 of
compensation in 2014 (all qualified plans)
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Topic 46: Types of Qualified Plans


Simple 401(k) plans

Maximum deferral $12,000 in 2014; over 50 additional $2,500

Fully vested in both employer/employee contributions

< 100 employees to establish

Cover employees earning > $5,000

Not limited to 25% compensation
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 46: 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 46: Types of Qualified Plans
 New comparability
 Cross test for age; salary or job classification
 Increases benefits to owner
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Topic 46: 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 $210,000 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 46: 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 47: 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
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Topic 47: 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%
 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 47: 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 > $260,000 in
2014
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Topic 47: Qualified Plan Rules

Payroll taxes
 Imposed on employee contributions
 Not imposed on employer contributions
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Topic 47: 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
 Loans
 Maximum lesser of $50,000 or 50% balance
 Can always borrow $10,000 if have that much vested in
account
 Loans not repaid are distributions
 Up to five year term
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Topic 48: Other plans

Traditional IRA
 Contribute $5,500 in 2014
 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 $181,000 - $191,000
 Covered by plan
 MFJ phase out $96,000 - $116,000
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Topic 48: 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
 50% tax for failing to take RMD
 Inherited Roth IRAs also must take RMD

But not Roth IRA
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Topic 48: Other plans
 Roth IRA
 Contribute $5,500 in 2014
 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 $181,000 - $191,000
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Topic 48: 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
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Topic 48: 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
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Topic 48: Other plans
 SEPs
 Coverage: everyone 21, worked three of last five
years and earned $500
 Employer contributions only
 Up to $52,000 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
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Topic 48: Other plans
 SIMPLE 401(k)
 < 100 employees
 Employees can contributed up to $12,000 in
2014
 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
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Topic 48: Other plans
 SIMPLE IRAs
 Coverage: everyone making $5,000 in last two years
 No age 21 requirement
 Employee can contribute up to $12,000
 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 48: Other plans
 Section 403(b): TSA
 501(c)(3) and public schools
 Can only invest in annuities/mutual funds
 Employee can contribute up to $17,500
 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
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Topic 48: 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
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Topic 49: 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
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Topic 49: 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
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Topic 49: 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 49: Regulation of Plans
 Plan terminations
 Standard
 Enough assets to pay benefits
 Distress
 Bankrupt
 Not solvent, unable to pay bills
44
Topic 50: 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
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Topic 51: 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 52: 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 52: Distributions
 Premature distributions
 Exceptions to penalty
 Qualified Plans Only
 Early retire after 55
 IRAs Only
 Medical; tuition; first time home
48
Topic 52: 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 52: 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
50
Topic 52: 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 52: 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