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Basic Retirement Plans: Qualified, Nonqualified, and Tax-Advantaged

This chapter provides an overview of basic retirement plans, including qualified plans (pension plans, profit-sharing plans), tax-advantaged plans (IRAs, SEP, SIMPLE), and nonqualified plans. It covers the characteristics, benefits, and disadvantages of qualified retirement plans, as well as the different types of plans available.

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Basic Retirement Plans: Qualified, Nonqualified, and Tax-Advantaged

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  1. Chapter 19 Basic Retirement Plans Chapter 19: Basic Retirement Plans

  2. Basic Retirement Plans • Qualified Plans • Other tax-advantaged plans • Nonqualified plans Chapter 19: Basic Retirement Plans

  3. Qualified Plans • Pension plans • Profit-sharing plans Chapter 19: Basic Retirement Plans

  4. Characteristics of Qualified Retirement Plans • Employer contributions are not subject to federal income tax or payroll tax • Employee contributions are not subject to federal income tax • Employee contributions are subject to payroll tax • Tax-deferred growth • Special income tax averaging/NUA • ERISA protection • Timing of income tax deduction • Small business tax credit • Retirement plans as part of a compensation package Chapter 19: Basic Retirement Plans

  5. Disadvantages of Qualified Retirement Plans • Costs to qualify, fund, and administer the plan • Annual compensation limit • Eligibility requirements • Coverage of employees • Vesting requirements • Top-heavy plans • Disclosure requirements • Annual testing Chapter 19: Basic Retirement Plans

  6. Benefits of Tax Deferral • Tax deferral is perhaps the biggest benefit for an employee who participates in a qualified retirement plan. • Neither plan contributions nor earnings on contributions are currently subject to income tax. • In retirement, when distributions begin, the plan participant generally will be in a lower income tax bracket than during the working years. Chapter 19: Basic Retirement Plans

  7. Types of Qualified Retirement Plans • Classified as: • Pension or Profit-sharing • Defined-benefit or Defined-contribution • Contributory or Noncontributory • Corporate or Keogh Chapter 19: Basic Retirement Plans

  8. Pension Plan vs. Profit-Sharing Plan • A pension plan is a qualified plan structured to provide a regularly paid fixed sum at retirement • A profit-sharing plan is a qualified defined-contribution plan featuring a flexible (discretionary) employer-contribution provision Chapter 19: Basic Retirement Plans

  9. Defined-Benefit Plan vs. Defined-Contribution Plan • A defined-benefit plan specifies the actuarially determined benefit that each employee receives at retirement. • A defined-contribution plan specifies the annual employer current contribution. The amount of benefit received by an employee depends on what the account balance is at retirement. Chapter 19: Basic Retirement Plans

  10. Contributory Plan vs. Noncontributory Plan • Qualified retirement plans may be distinguished as either contributory (employee makes some contribution) or noncontributory (employer pays all). • Most pension and profit-sharing plans are noncontributory. • Exceptions are the 401(k) and thrift plan (an after-tax savings plan). Chapter 19: Basic Retirement Plans

  11. Corporate Plan vs. Keogh Plan • Corporate-sponsored plans • Regular C corporations or S corporations • Keogh plans (a qualified plan for unincorporated businesses) • Self-employed, Schedule C, partnerships, LLCs filing as partnerships Chapter 19: Basic Retirement Plans

  12. Other Tax-Advantaged Plans • Individual Retirement Account (IRA) or IRA Annuity • Traditional – pretax • Roth – after tax • Simplified Employee Plan (SEP) • Savings Incentive Match Plan for Employees (SIMPLE) • 403(b) Plan Chapter 19: Basic Retirement Plans

  13. Distributions from Qualified and Other Tax-Advantaged Plans • If the contributions were pretax, then both contributions and earnings are treated as ordinary income equal to the distribution, and thus receive ordinary income tax treatment. • If the contributions were after tax, the contributions are treated as a return of capital and the earnings are treated as ordinary income. Each distribution is prorated as to return of taxable basis and ordinary income subject to income tax. Chapter 19: Basic Retirement Plans

  14. Nonqualified Plan • A retirement plan that can discriminate in favor of executives, but which is not eligible for the special tax benefits available for qualified or other tax-advantaged retirement plans. • Deferred-compensation plans • Split-dollar life insurance • Employee stock option plans (ESOP) Chapter 19: Basic Retirement Plans

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