Planning for Retirement Needs

Pension and Retirement Planning Overview

Chapter 1

Chapter 1: Overview

• Business opportunities in the pension field• What types of plans are available?• Why have tax-advantaged retirement plans?

– From the employee’s perspective– From the employer’s perspective– From the small business owner’s perspective

Tax-Advantaged Retirement Plans

• Qualified Plans 401(a)– Defined benefit – Cash balance – Money purchase– Target benefit – Profit-sharing– 401(k) – Stock bonus– ESOP

• Other Plans– SEP 408 (k)– SIMPLE 408 (p)– Tax-sheltered

annuities 403(b)

Tax-Advantaged Plan Attributes

• Employer deduction at time of contribution • Income is not taxed at the trust level• Employees pay tax on distributions• Distributions can generally be rolled into other

tax- deferred vehicles

Additional Tax Advantages for Qualified Plans

• Investment in life insurance • Special tax treatment of lump sum

– Grandfathered rules for those born before 1936– Deferral of gain on unrealized appreciation

General Requirements—All Tax Advantaged Plans

• Broad participation by rank and file• Vesting• Employee communications• Nondiscrimination• Prefunded• Plan document

Nonqualified Deferred Compensation• For executives only• Few design restrictions• Employer deduction matched to the year in which the employee has income• Not prefunded

Individual Retirement Plans

• Deductible and nondeductible contributions

• Roth IRA• SEPs and SIMPLEs are funded with IRAs• Rollover business involves big dollars

Why Have Employer Plans?

• Employee motivation• Business reasons• Other businessowner concerns

The Power of Pre-tax Savings

• Deferring taxes is powerful• White-collar worker at age 65 in Table 1-1

has $207,047 saving with a qualified plan, compared to $166,240 after-tax

• The higher the tax rate the greater the savings with the pre-tax approach

Accumulation after One YearQualified After-tax

Savings $15,000 $15,000

Less taxes 0 $5,400 (36%)

Invested $15,000 $9,600

Earnings (5%) $750 $480

Less taxes 0 $173 (36%)

Total $15,750 $9,907

Word of Caution1040 Tax Table

Income Tax Rate Calculated Tax

Net Tax Rate

$217,450 33% $71,758.83

33%

217,450 33% 48,665 22%

Any example must at the top and stay at the top of income level.

Why Employers Need Qualified Retirement Plans

• Attraction and retention of employees• Avoidance or appeasement of unions• Employee motivation• Graceful transition in turning over the workforce (superannuated employees)• Social responsibility• Retirement saving as part of successful compensation planning

Why Businessowners Need Qualified Retirement Plans

• For maximizing tax shelter • For solving liquidity problems that

occur at retirement or death• For sheltering their assets from legal

liability and bankruptcy• For avoiding taxes on excess

accumulated earnings

Cost of Covering Employees

• Benefits for employees have value• May have to pay more cash if no benefits• There are ways to limit costs

Cross-tested profit sharing 401(k) and profit sharing SIMPLE

Setting Up a Retirement Plan

• Find service providers and choose a plan

• Design particulars of the plan based on goals and budget

• Write plan, submit to IRS for approval• Inform participants, enrollment

meetings• Establish trust or IRA accounts• Make first-year contributions

Administration• Invest contributions• Annual reporting to government• Financial reconciliation, report to company• Determine contributions• Notify participants of benefits

Benefit Management

• Calculate and notify participants• Payouts at termination of employment• Loan program

Plan Termination

• Plans are voluntary, can be terminated at any time

• Participants become fully vested• Notification to government• Benefits distributed

Key Term Review• Tax-advantaged retirement plans • Qualified plans • Nonqualified plan• Individual retirement account (IRA)• Superannuated employees• Accumulated earnings tax (S-Corp)

True/False Questions

1. The qualified pension trust is required to pay income tax on trust earnings. 2. Certain tax-advantaged retirement plans can cover the owners and exclude the nonhighly compensated employees. 3. In a nonqualified plan, the employer’s deduction occurs

at the same time the employees have taxable income. 4. Contributions to a qualified plan are deductible to the employer and taxable to the employee at the time they are made. 5. Participants in a tax-advantaged plan can generally delay paying taxes at termination of employment by rolling the benefit into another tax-advantaged plan or IRA.

True/False Questions

6. A SEP is categorized as a qualified plan. 7. Saving on a tax-deferred basis in a qualified plan generally results in a larger accumulation than saving on an after-tax basis. 8. The higher the employee’s tax bracket, the greater

the tax savings using a tax-advantaged retirement plan.

9. An employer that establishes a retirement plan is exempt from negotiating with the union concerning retirement benefits.

10.An employer may establish a retirement plan to create a graceful transition in the workforce because employees will have sufficient assets to retire.

True/False Questions

11. Business owners are often concerned about protecting assets from creditors in cases of bankruptcy or lawsuits.

12. A business owner is often concerned about the cost of providing benefits for the rank and file employees.

Chapter 1 Review

• Tax advantaged plans– Employer deduction– Tax exempt trust – Employee tax on withdrawal– Rollover

• 8 Qualified plans• 3 other tax-sheltered• Nonqualified

– No design restrictions– Matching tax rule

• Compare pre-tax and post-tax savings

• Employer reasons– Orderly transition– Attract and retain

• Unions and pensions– Must negotiate– Can exclude under coverage

• Small business– Maximize tax shelter– Creditor protection– Accumulated earnings tax– Liquidity