Chapter 11
Retirement and Other
Tax-Deferred Plans
and Annuities
“The income tax laws do not profess to
embody
perfect economic theory.”
-- Oliver Wendell Holmes, Jr.
McGraw-Hill Education
Copyright © 2015 by the McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or
distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website in whole or part.
LO #1 – The Basics
• Retirement plans are encouraged and
receive tax advantages.
– Encourage saving for retirement or
education
– Generally, taxation is deferred (not
eliminated)
• Retirement plans include employersponsored plans and individual-based
plans.
11-2
LO #1 – The Basics
• Understand retirement plan terminology
– Annuity
– Beneficiary
– Contributions
– Distributions
– Donor
– Tax-deferred retirement (or other) plan
– Trustee
• See buzzwords box on page 11-3.
11-3
LO #1 – The Basics
• Tax-deferred does not mean tax-free.
• Generally, untaxed contributions are
taxed when distributed. Previouslytaxed contributions are not taxed on
distribution.
• Contributions can provide a tax
deduction to the person/company that
makes them.
11-4
LO #1 – The Basics – Concept Check
11-1
1. Tax-deferred retirement accounts are, essentially,
tax-free accounts.
False
2. The period in which accumulated assets are paid to
plan beneficiaries is known as the _________ period.
Distribution
3. A Keogh plan is an example of an individual-based
retirement plan.
False
11-5
LO #1 – The Basics – Concept Check
11-1
4. Two examples of employer-based retirement
plans are _____________ and ___________.
Pick any 2 of: qualified pension/profit-sharing,
401(k), 403(b), Keogh, SEP, SIMPLE
5. Distributions from pension plans are taxable
if the contributions were made using dollars
that were not previously taxed.
True
11-6
LO #2 – Employer-Sponsored
Retirement Plans
• Employer-sponsored plans include:
– Qualified pension and profit-sharing plans
– 401(k) plans
– 403(b) plans
– Keogh plans
– Simplified Employee Pensions (SEP)
– SIMPLE plans
11-7
LO #2 – Employer-Sponsored
Retirement Plans
• Plans provide benefits to employers and
employees
– Employer gets immediate deduction for
contributions.
– Employer contributions are not
compensation to employee.
– Earnings from plan investments are not
taxed when earned.
– Plan assets or earnings are not taxable to
employee until withdrawn.
11-8
LO #2 – Employer-Sponsored
Retirement Plans
• Defined-contribution plans pre-establish
the amount of the contribution
– The amount of the eventual distribution is
not known with certainty and will vary.
• Defined-benefit plans pre-establish the
amount of the benefit
– The amount of the contribution is not known
with certainty and will vary.
11-9
LO #2 – Employer-Sponsored
Retirement Plans
• Qualified pension & profit-sharing plans:
– Nondiscriminatory, minimum vesting rules,
contributory or noncontributory
– Additions to defined-contribution plan can’t
exceed lower of $52K or 100% of
compensation
– Additions to defined-benefit plan can’t result
in benefits more than the lower of $210K or
100% of compensation
11-10
LO #2 – Employer-Sponsored
Retirement Plans
• 401(k) plans
– Must meet nondiscrimination rules
– Employee can elect to defer up to $17,500
(additional $5,500 if age 50 or over)
• Keogh plans
– For self-employed
– Contribution limits generally the same as
qualified plans
11-11
LO #2 – Employer-Sponsored
Retirement Plans
• Simplified Employee Pensions (SEP)
– Employer creates and contributes to employee
IRAs
– Maximum contribution is lower of 25% of
compensation or $52,000.
• SIMPLE plans
– Employer creates IRA or 401(k) for employee
– Employee contributes a % up to $12,000
(additional $2,500 allowed if age 50 or over)
– Employer makes matching contribution of 3% for
all employees or 2% for all eligible employees.
11-12
LO #2 – Employer-Sponsored
Retirement Plans – Concept Check 11-2
1. Qualified pension plans are either defined-_______
plans or defined-_______ plans.
Benefit; contribution
2. Employees must make contributions to qualified
pension plans.
False
3. The maximum contribution to a 401(k) plan is
_______ for individuals under age 50.
$17,500
11-13
LO #2 – Employer-Sponsored
Retirement Plans – Concept Check 11-2
4. A Keogh plan can be used by selfemployed individuals.
True
5. A SIMPLE plan can be used by
employers with 100 or fewer employees
who also meet other requirements.
True
11-14
LO #3 – Individual-Sponsored
Retirement Plans
• Traditional Individual Retirement
Account (IRA) and Roth IRA.
• Contributions limited to smaller of
$5,500 or 100% of compensation. If age
50 or over, the dollar limit is $6,500.
11-15
LO #3 – Individual-Sponsored
Retirement Plans
• Individuals covered under an employer
plan
– Deductible contribution amount begins to
phase out when AGI reaches $96K
(married) or $60K (others) and is fully
phased out at $116K and $70K,
respectively.
• Married filing separately, the phase out starts at
$0.
– Can still make nondeductible contribution
up to the $5,500 or $6,500 limits
11-16
LO #3 – Individual-Sponsored
Retirement Plans
• Married taxpayers
– If both employed and neither are covered under an
employer plan, then both spouses can make a
deductible IRA contribution up to the $ limits.
– If only one spouse is employed and that person is
not covered under an employer plan, can
contribute up to the maximum for both persons.
– If one spouse is covered under an employer plan,
and the other is not, the non-covered spouse can
contribute up to the dollar limits if AGI < $181,000.
11-17
LO #3 – Individual-Sponsored
Retirement Plans
• Roth IRA contributions are not
deductible but withdrawals are not
taxable
• Contribution limits are the same as with
a traditional IRA
• Phase out starts at $181K (MFJ), $114K
(single or HoH), $0 (MFS)
– Phase out range is $10K MFJ, $15K others
11-18
LO #3 – Individual-Sponsored
Retirement Plans
• Traditional IRA vs Roth IRA
– Contributions are deductible for traditional
IRA but not for Roth IRA
– Distributions are taxable for traditional IRA
but not for Roth IRA
• Taxpayers are trading off the nondeductibility of contributions against the
non-taxability of distributions.
11-19
LO #3 – Individual-Sponsored Retirement
Plans – Concept Check 11-3
1. Two types of individual-sponsored retirement plans are
______________ and ____________.
Traditional IRA and Roth IRA
2. A single individual, age 58, with wages of $30,000 can make a
tax-deductible contribution of up to $_______ to a traditional IRA.
$6,500
3. A married couple with earned income of $200,000 is ineligible to
make a deductible contribution to a traditional IRA. True or
false?
False
4. Generally, distributions from a Roth IRA are not taxable. True or
false?
True
11-20
LO #4 – Tax-Deferred
Nonretirement Plans
• Coverdell Education Savings Account
(CESA)
– Contributions not deductible, account grows
tax-free, distributions are not taxable if used
exclusively to pay higher education
expenses of beneficiary.
– Any person can establish and fund a CESA
for any person, him or herself included.
11-21
LO #4 – Tax-Deferred Nonretirement
Plans
• CESA contributions limited to $2,000 per
beneficiary
– From all sources combined
• Contributions phased out when AGI of
contributor reaches $190K (MFJ), $95K
others.
– Totally phased out at $30K or $15K above
those numbers, respectively.
11-22
LO #4 – Tax-Deferred Nonretirement Plans –
Concept Check 11-4
1. Contributions to Coverdell Education Savings
Accounts (CESAs) are not deductible. True or false?
True
2. The maximum annual contribution to a CESA is
$___________.
$2,000
3. Contributions to CESA accounts begin to be phasedout when AGI reaches $__________ for a single
taxpayer.
$95,000
11-23
LO #5 - Distributions
• Generally, distributions are taxable if
contributions were deductible.
• When some (but not all) contributions
were made with previously taxed dollars,
then distributions will be partially tax free
and partially taxable. Use simplified
method.
11-24
LO #5 - Distributions
• Simplified method. For cases where
distributions are partially taxable.
– Determine number of anticipated payments
using single life or dual life tables in text
– Determine total contributions from
previously-taxed dollars.
– Fraction: previously taxed $ / # payments
– Fraction represents proportion of each
payment that will be tax-free.
11-25
LO #5 - Distributions
• Other plans have required minimum
distributions (RMD) that must begin by
April 1 of year following the year
taxpayer reaches age 70.5.
• RMD is based on life expectancy tables
from IRS (normally Table III in text)
• Use these IRS tables to determine life
expectancy each year.
11-26
LO #5 – Distributions – Concept
Check 11-5
1. A participant in a defined-benefit plan is only entitled to only a
stream of payments.
True
2. Distributions from qualified pension plans may be taxable,
nontaxable, or both.
True
3. The number of anticipated payments from a pension plan for a
single individual, age 68, is ______.
210
4. The number of anticipated payments from a pension plan for a
married couple ages 59 and 63 is ______.
310
5. Distributions are required from a traditional IRA.
True
11-27
LO #5 - Distributions
• Roth IRA distributions are generally not
taxable.
– Earnings are taxable if withdrawn prior to
an initial five-year holding period.
• Coverdell Education Savings Account
distributions are tax-free if used to pay
for qualified education expenses of
beneficiary.
– Can’t use education expenses paid by
CESA also for American Opportunity/Hope
or lifetime learning credits
11-28
LO #5 - Distributions
• Premature distributions generally subject to
10% penalty.
– Some exceptions apply. See page 11-17
• Rollovers are generally tax-free. Rollovers to
a Roth IRA are taxable.
– If rollover $ are distributed to the taxpayer, there is
a 60-day window to deposit $ in new plan.
Otherwise, the entire amount is taxable.
11-29
LO #5 – Distributions – Concept
Check 11-6
1. IRA distributions are taxable if funded with deductible
contributions.
True
2. Distributions are never required from a Roth IRA.
True
3. For an individual age 65, Roth IRA distributions are not taxable if
they have been held for at least five years.
True
4. Distributions from Coverdell Education Savings Accounts can be
used for any purpose once the beneficiary reaches age 30.
False
11-30
LO #6 - Annuities
• An annuity is a series of payments
pursuant to a contract.
• Normally, annuity payments are partially
taxable and partially tax-free to recipient
11-31
LO #6 - Annuities
• The tax-free component is based on the
cost of the annuity contract and
expected return
• The cost of the annuity contract is the
amount the recipient paid for the
contract.
– The portion of the payments that is
represented by the cost of the contract is
tax-free.
11-32
LO #6 - Annuities
• The expected return is the total amount
the recipient anticipates receiving over
the annuity contract.
– For contracts that will last a specified
amount of time, the expected return is the
periodic payment × the number of
payments.
– For contracts that will provide payments for
life, the recipient must refer to the life
expectancy tables to determine length of
time.
11-33
LO #6 – Annuities – Concept Check
11-7
1. An annuity is a ______ of payments under a ______.
Series; contract
2. Annuity payments are always the same amount each
period.
False
3. Annuity payments often have a taxable component
and a nontaxable component.
True
11-34