Chartered Retirement Planning Counselor SM Professional Designation Program

Chartered Retirement Planning CounselorSM Professional Designation Program Module 4Traditional, Roth & SIMPLE IRAs

Learning Objectives 4–1 Describe the basic characteristics and requirements of IRA accounts 4–2 Describe the basic characteristics of traditional IRAs, and analyze a situation to calculate the amount of an IRA contribution that is deductible. 4–3 Analyze a situation to determine the income tax or nontax requirements of a traditional IRA distribution.. 4–4 Describe the basic characteristics of Roth IRAs, and analyze a situation to calculate the eligible contribution amount. 4–5 Explain the basics of Roth conversions. 4–6 Describe the basic characteristics of SIMPLE IRA plans. 4–7 Describe the basic characteristics of a Simplified Employee Pension (SEP). 4–8 Describe the employer/employee factors to be considered in determining if a SEP or SIMPLE IRA would be appropriate.

Questions to Get Us Warmed Up

IRA Statutory Requirements • Eligibility: Compensation (earned income, alimony) and must be under age 70½ (no age limit on Roth IRAs) • Contribution limit: 100% of earned income up $5,500 (spousal IRAs allowed), $1,000 age 50 catch-up • Contribution deadline: April 15—no extensions • Taxation: Earnings are tax-deferred • Minimum: If an amount greater than $0, but less than $200 is deductible, then a $200 minimum deductible contribution is allowed.

IRA Statutory Requirements • Fully vested • No life insurance or collectibles • No loans • RMDs starting at age 70½ (not for Roth IRAs) • 6% penalty tax on excess contributions

IRA Deductibility Active Participant Status An employee is an active participant in a defined contribution plan if, during the taxable year, the employee received any annual additions to his/her account. An employee is an active participant in a defined benefit plan if the employee is eligible to participate in the plan and has not opted out. (Note that investment earnings do not affect active participant status.) Employee Contribution (either voluntary or mandatory) Employer Contribution Forfeiture or or To one of the following plans: • All qualified plans • Tax-sheltered annuity (TSA) under §403(b) • Simplified employee pension (SEP) & SIMPLE plans • Government pension plan

Traditional IRA Deduction Phaseout Amounts (2013)

Calculation of Deductible IRA Contribution • Determine the deductible percentage. • Multiply by the maximum contribution amount. • The result is the maximum dollar amount that can be deducted (rounded up to the next $10). Example: Single, Modified AGI $65,000

Calculation of Deductible IRA Contribution (1) • Determine the deductible percentage. • Multiply by the maximum contribution amount. • The result is the maximum dollar amount that can be deducted (rounded up to the next $10). Example: Married/Joint active participant, Modified AGI of $97,316

Calculation of Deductible IRA Contribution (2) • Same as previous scenario, except individual is age 50 or older • .8842 x $6,500 = $5,747.30 • Round up to nearest $10 = $5,750 deductible amount • Balance of $6,500 – $5,750 = $750can be a nondeductible IRA contribution

Required Minimum Distribution Beginning Dates

Required Minimum Distribution Rates (Uniform Table)

1st and 2nd Distribution Years Jan. 1 Jan. 1 2nd distribution year 1st distribution year Trigger year 70 1/2 Dec. 31 Dec. 31 Apr. 1 Dec. 31 Balance onDec. 31 of prior year 1st distribution due by April 1 Required Beginning Date 2nd distribution due by Dec. 31 of 2nd year

Distributions Upon Death

Learning Objectives 4–1 Describe the basic characteristics and requirements of IRA accounts 4–2 Describe the basic characteristics of traditional IRAs, and analyze a situation to calculate the amount of an IRA contribution that is deductible. 4–3 Analyze a situation to determine the income tax or nontax requirements of a traditional IRA distribution. 4–4 Describe the basic characteristics of Roth IRAs, and analyze a situation to calculate the eligible contribution amount. 4–5 Explain the basics of Roth conversions. 4–6 Describe the basic characteristics of SIMPLE IRA plans. 4–7 Describe the basic characteristics of a Simplified Employee Pension (SEP). 4–8 Describe the employer/employee factors to be considered in determining if a SEP or SIMPLE IRA would be appropriate.

IRA Early Distribution Requirements 10% penalty for withdrawals prior to age 59½, Exceptions include: • Made to beneficiary after death of participant • Made to a fully disabled participant • Medical expenses above 7.5% of AGI • Payment of medical insurance premiums while receiving unemployment insurance • To a first-time home buyer for the purchase of a primary residence ($10,000 max) • Used for qualified higher education expenses • Part of a series of substantially equal periodic payments

Qualified Education Expense Exemption • This is defined as tuition, fees, books, supplies, and equipment required for enrollment or attendance at postsecondary education institutions, including graduate schools. • This exception is applicable to the taxpayer, his or her spouse, or the child or grandchild of either the taxpayer or the spouse. • Qualified higher education expenses are reduced by any amounts excludible from gross income received on account of scholarships, veterans benefits, or the redemption of qualified U.S. savings bonds.

Substantially Equal Periodic Payments Payments must continue for at least five years, or until participant is age 59½, if later Use one of three methods to calculate payments: • Life expectancy—Required minimum distribution method • Amortization—Life expectancy table used in RMD method and reasonable interest rate • Annuitization—Divide account balance by a factor that reflects “reasonable” interest and mortality rates Distribution methods 2 and 3 may be changed once to the RMD method.

Reg. 72(t) Withdrawal Example Assumes male, age 56, $150,000 account, 8% annual return

Roth IRA Contribution 2013 Phaseouts

Roth IRA “Qualified Distributions” Must meet both of the following: • 5-year holding period (5-year “clock”) and • Attainment of age 59½, death, or disability

Roth Conversions • Income limitation of $100,000 lifted in 2010 • Assets may be converted from traditional IRAs, SEPs, SIMPLEs (after 2 years), and qualified plans • If nondeductible IRAs are involved, then a ratio of all nondeductible contributions to the total value of all IRAs must be used • There is no 10% penalty tax • Recharacterizations are allowed

Roth Order of Distributions • Return of contributions • Return of conversion amount • Return of earnings

When Establishing a Roth IRA Makes Sense • For a young person in a low tax bracket who expects to be in a much higher tax bracket at retirement • For anyone who suspects tax rates will be much higher in the future • For anyone who wants to shelter income and earnings from taxation after he or she reaches age 70½ • For anyone who wants to avoid required minimum distributions on IRA account balances • For anyone who wants tax-free income to be paid over the lifetime of much younger family members

Roth 401(k) or DRAC • Annual contribution limit of $17,500, with $5,500 age 50 catch-up • No income phaseouts • RMD rules do apply • Has own 5-year clock • ERISA protection

SIMPLE IRA • 100 or fewer employees paid at least $5,000 in any two preceding years and current year—must be only plan • Permits employee elective deferrals ($12,000 with $2,500 age 50 catch-up) • 100% immediate vesting • Nondiscrimination tests met if: 100% match on first 3% (1% match in 2 of 5 years), or 2% non-elective contribution to account of each employee earning more than $5,000 • IRA distribution rules apply, except • 25% penalty on withdrawals in initial two years • Rollovers limited during initial two years

SIMPLE Plan Employer Contributions

Simplified Employee Pensions: SEPs • Employer-sponsored retirement plan allowing flexible employer contributions • Employee contributions not allowed • Eligibility • Age 21 • Earned at least $550 during current year • Worked for employer at least 3 of the last 5 years • Vesting: 100% immediate (since IRA accounts) • IRA rules generally apply to distributions

Contributions • 25% of compensation or $51,000, whichever is less • Employer can integrate with Social Security • If employer is unincorporated then the Keogh plan rules apply

Plan Establishment Deadlines • Qualified plans: December 31st • SIMPLE plans: October 1st for the current year • SEP plans: tax filing deadline, including extensions

SEP versus SIMPLE (1)

SEP vs. SIMPLE (2)

Qualified & Nonqualified Plans

Question 1 For this question, assume that all IRA contributions are made for the current year. Allen Baker, a single 40-year-old taxpayer with an AGI of $67,800, is covered by his employer’s profit sharing/401(k) plan. During the plan year, no employer contribution was made and Allen did not make any salary reduction contributions to the 401(k) portion of the plan. Allen’s account balance increased by $120; this was attributable to investment earnings of $80 and forfeitures of $40. If he contributes $5,500 to his IRA, what is the amount of his allowable IRA deduction? • $0 • $100 • $660 • $5,500

Question 2 For this question, assume that all IRA contributions are made for the current year. Assume the same facts as question 1, except that Allen is married, his spouse is not an active participant, they file jointly, and their AGI is $106,000. What is the amount of their IRA deduction? • $0 • $900 • $5,500 • $6,160 • $11,000

Question 3 Identify the six listed exemptions from the 10% penalty tax on premature distributions from an IRA. (The remaining three apply to qualified plans only.) • series of substantially equal periodic payments • distribution following owner’s death • distribution to an employee age 55 following separation from service • distribution following disability • distribution to an alternate payee under a QDRO • distribution for medical expenses that exceed 7.5% of AGI • distribution as a series of substantially equal periodic payments after separation from service • distribution of up to $10,000 for a first-time homebuyer • distribution for qualified education expenses

Question 4 Boulder Bolter, Inc. is a hardware chain that offers its employees a 401(k) plan. Bolts are big, and profits are high. The company wishes to make the maximum contribution to the 401(k) plan. Assume the gross covered payroll is $10 million for 400 employees; on average, the employees defer 5% of their salaries. The first 3% is matched dollar for dollar. Total deferrals $500,000 Total match $300,000 What is the maximum discretionary contribution the company can make to the 401(k) plan? (Answer to the nearest $25,000.) • $600,000 • $1.7 million • $2.2 million • $2.5 million

Question 5 Ken and Barbie file jointly. Both work, and their combined AGI is $105,000. This year, Ken’s profit sharing account earned over $5,000, but the company made no contributions and there were no forfeitures. Barbie declined to participate in her company’s defined benefit plan in June because she wants to contribute to and manage her own retirement money. (Her benefit at age 65 under the plan was $240 per month.) How much of their $11,000 contribution can they deduct? • $0 • $5,500 • $8,250 • $11,000

Question 6 Lucy received a $1,200 profit sharing contribution this year. Lucy and George are married, filing jointly. George is an artist who had no earnings this year. Their combined AGI for this year is $108,000. How much of their $11,000 IRA contribution can they deduct? • $0 • $5,500 • $7,430 • $11,000

Question 7 Sally and Joe are married, filing jointly. Their combined AGI is $146,000. They are both active participants in their employers’ plans. After making the maximum qualified plan contributions, they wish to make contributions to their Roth IRAs. How much can they contribute to their Roth IRAs? • $0 • $1,000 • $5,500 • $11,000

Question 8 Jerry’s AGI totals $119,000 this year. He is single. What is the maximum amount he can contribute to his Roth IRA this year? • $0 • $1,000 • $2,940 • $5,500

Question 9 If a defined contribution plan provides a graded vesting schedule, which of the following statements can be correctly made about the plan? • The plan will generally require one year of service for eligibility. • The plan will generally require two years of service for eligibility. • At the end of his or her third year of service, a participant must be entitled to at least 40% of his or her benefit under the plan. • At the end of his or her fifth year of service, a participant must be entitled to the full amount of his or her accrued retirement benefit. • I only • I and III only • II and IV only • I, III, and IV only

Question 10 John Smith works for ABC Corp. and earns $295,000. ABC Corp. provides a nonelective contribution to its SIMPLE IRA plan. Which one of the following is the maximum amount that could go into John’s account? (The Section 401(a)(17) limit on includible compensation is $255,000 in 2013.) • $5,100 • $12,000 • $17,000 • $17,100 • $17,900

Question 11 Which of the following could be disadvantages of a SEP from the employer’s point of view? • mandatory annual contributions • statutory eligibility requirements • $12,000 (indexed) deferral limit in 2013 • lack of vesting schedules • III only • I and III only • II and IV only • II, III, and IV only

Question 12 Which one of the following is not a basic provision of a SEP? • individual ownership of accounts • 25% limit on employer contributions • forfeiture reallocations based on compensation • plan must not discriminate in favor of highly compensated employees

Question 13 Trent Tyley, age 55, has contributed $11,500 to his Roth IRA over the past six years. He also converted $20,000 just last year. Due to some very good investment returns, his total account value is now $53,000. Trent has decided to go on a dream vacation with his wife, and plans on withdrawing $15,000 from his Roth to help pay for the vacation. What are the tax ramifications, if any, of this withdrawal? • Since the Roth has been open for more than five years, the entire $15,000 would not be taxable. • The $11,500 in contributions would be considered withdrawn first and not taxable, but the additional $3,500 would be subject to a 10% penalty tax. • The $11,500 in contributions would be considered withdrawn first and not taxable, but the additional $3,500 would be subject to ordinary income taxes. • The $11,500 in contributions would be considered withdrawn first and not taxable, and a prorated amount from the remaining balance of $3,500 would be taxed as ordinary income and subject to the 10% penalty tax.

Chartered Retirement Planning Counselor SM Professional Designation Program