Preliminary Concerns Chapter 3
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Transcript of Preliminary Concerns Chapter 3
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Preliminary ConcernsChapter 3
Planning for Retirement Needs
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Chapter 3: Preliminary Concerns
• Fact-finding• Qualified versus other tax-sheltered
plans• Defined-benefit vs defined-
contribution• Pension versus profit-sharing• Keogh plans
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Fact-Finding• Determine company objectives• Due diligence review• Coordinate with other advisors• Identify company budget• Review employee census• Identify affiliated companies
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Qualified vs Other Tax-Sheltered
Qualified– Defined-benefit– Cash-balance– Money-purchase– Target-benefit– Profit-sharing– 401(k)– Stock bonus– ESOP
Other– SEP– SIMPLE– 403(b)
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Qualified Plan Characteristics
• Complex documentation and reporting
• Complex yet flexible coverage• Complex yet flexible vesting• Complex yet flexible benefit
structure• Loans
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• SEP– Profit-sharing look-alike– Simple documentation, reporting – Retains look and feel of profit-sharing
• SIMPLE– 401(k) look-alike– Simple documentation, reporting– Incredibly inflexible
• 403(b)– 401(k) for nonprofit and public schools– Simple and flexible
Other Tax-Sheltered Plans
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DB/DC Defined-benefit
plans• Defined-benefit PP• Cash-balance PP
Defined-contribution
• Money-purchase PP
• Target-benefit PP• Profit sharing• 401(k)• Stock bonus• ESOP
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DB versus DC Approach• What is defined?
– Money going in – Define Contribution– Money going out – Define Benefit
• Define Contribution– Define what goes in.– Who knows what comes out
• Define benefit– Define what the benefit is and do the math– No one cares, except for the employer, what needs to go in!
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DB versus DC ApproachDefined-benefit• Specifies benefit• Assets not allocated• Investment risk with
employer• Can count past
service• Costly to administer• Difficult to
understand• Unpredictable costs
Defined-contribution• Contribution/allocation• Individual accounts• Investment risk with
employees• No past service• Less costly• Easy to understand• Predictable costs
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DB versus DC Rule Differences
Defined-benefit• Maximum benefit
$205,000 (2013)• Deduction limited
by actuarial cost• Subject to PBGC• Minimum
participation rule• Longer vesting
Defined-contribution
• Maximum contribution $51,000 a year (2013)
• Deduction 25 percent of compensation
• Not subject to PBGC• Not subject to
minimum participation rule
• Shorter vesting
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415(b) Defined-Benefit Limits
• Life annuity at age 65 of the lesser of 100 percent of the highest consecutive 3-year average compensation or $205,000 (2013)
• No actuarial reductions 62-65 • Reductions prior to age 62• Actuarial increases post age 65
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415(c) Defined-Contribution Limits
• Annual additions can not exceed the lesser of $51,000 (2013) or 100% of salary
• Include employer & employee contributions and forfeitures
• Exception: Age 50 catch up salary deferrals
• Compensation ⁻ Taxable wage income ⁻ Salary deferral contributions tax-sheltered
plans, cafeteria plans and fringe benefit programs
⁻ Compensation cap $245,000 (2009)
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Today’s Market• One-third of employees in mid-to-large
companies covered by DB plan • Less than 10% of small employers
maintain DB plans (may still be tax shelter opportunity)
• More than 50 million covered in DC plans
• Most new plans are DC plans, in the small plan market most 401(k) and SIMPLE
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Pension vs Profit-Sharing
Pension• Defined benefit• Cash balance• Money purchase• Target benefit
Profit Sharing• Profit sharing• 401(k)• Stock bonus• ESOP
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Pension vs Profit-Sharing
Pension• Required funding• 10% of assets in
sponsor’s stock• Distribution requires
termination of employment (exception at age 62)
Profit-Sharing• Discretionary
funding• 100 percent invested
in sponsor’s stock• In-service
withdrawals• 2 years after
contribution is made • 5 years of plan
participation
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Keogh• Not a type of plan• Maximum deduction based on
income after contribution
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Keogh Calculation• Pre-contribution salary ($100,000)• Social Security deduction ($7,200)• Contribution rate (.25/1.25=.2)• Allowable contribution .2 x reduced
salary ($92,800 x .2 = $18,560
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Vocabulary Review• defined-benefit plan• defined-contribution plan• minimum-participation rule• pension plan category• profit-sharing plan category• Keogh plans
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True/False Questions1. Using a fact finder provides a method for systematically
gathering information necessary to make appropriate recommendations.
2. A thorough understanding of the ages and salary levels of employees who will be covered by the plan is essential to making the correct plan choice.
3. A fact finder can help the employer prioritize retirement plan objectives.
4. Understanding the ownership structure is important to ensure that controlled group problems do not exist.
5. SEPs and SIMPLEs will generally cost less to maintain than a qualified plan, but in exchange the employer will have fewer design options.
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True/False Questions6. A defined-benefit plan specifies the amount of contribution made annually to each employee’s account. 7. Defined-contribution plans can gear their retirement payments to salary levels used just prior to retirement. 8. Under a defined-contribution plan the employer bears the risk of preretirement inflation. 9. The maximum annual deductible employer contribution to a defined-contribution plan is 25 percent of aggregate participant payroll. 10. Individual accounts are established for each participant in a defined-benefit plan. 11. Defined contribution plans provide benefits based on a participant’s earnings each year.
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True/False Questions12. From the employer’s perspective, defined-benefit plans are more economically risky than defined-contribution plans. 13. From the employee’s perspective defined-benefit plans provide a more predictable benefit. 14. Defined-contribution plans can never base benefits on past service. 15. Plans from the pension category can invest up to 25 percent of their assets in employer stock. 16. Under a profit-sharing plan an organization is committed to making annual payments to the plan. 17. Joe, a sole proprietor has a profit-sharing plan. He has Schedule C earnings of $210,000 and a deduction on his tax return for Social Security of $10,000. Joe’s maximum contribution is $40,000.
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Chapter 3 Review• Fact finding
– Objectives– Budget – Employee census– Affiliation– Coordinate
professionals– Due diligence
• 415(b) DB limit– $195,000 life annuity– No reduction age 62
• 415(c) DC limit– 100% or $49,000
limit– Annual additions– Exception catchup
• 415 rules– All comp or test for
nondiscrimination– Aggregate plans of
related employers
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Chapter 3 Review (Cont.)• DB features
– Promised benefits– Unallocated funds– Past service – Er financial risk– Hard to explain
• DC features– Predictable cost– Individual accounts– Uncertain benefits– Easy administration– Easy communication
• DB rules– 415(b)– PBGC– Additional coverage rule– Longer vesting– Deduction tied to
funding• DC rules
– 415(c)– Shorter vesting– Max deduction 25%
payroll
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Chapter 3 Review (Cont.)• Pension
– No in-service prior to 62
– 10% assets in er stock
– Required funding • Profit-sharing
– In-service withdrawals
– 100% assets er stock– Discretionary
funding
• Keogh– Unincorporated
entity sponsoring plan
– Deduction limit for owner• 20% not 25%• Reduce Schedule C
by social security deduction (1/2 of SS taxes)