Keir s RETIREMENT PLANNING

Transcription

1 Keir s RETIREMENT PLANNING Published by: KEIR EDUCATIONAL RESOURCES 4785 Emerald Way Middletown, OH Fax customerservice@keirsuccess.com

2 INTRODUCTION Keir s Companion Series Retirement Planning combines two of Keir s popular books that were originally offered separately the Summary Review and the Multiple Choice Question Workbook. This book will simplify the study process because each chapter now includes a detailed summary review of the important principles and concepts followed by numerous multiple choice questions with detailed answers. This guide provides a student with the essential elements needed for passing a college examination. The way a student uses this book will depend on the student s prior level of knowledge. Many will speedread this guide and then score adequately when answering the review multiple choice questions. Others will read more slowly, and for some people a second or third reading may be necessary. The essential substance is all here. The student can set his or her own pace for the journey. The use of chapter paragraph numbers is designed to assist the student in working through the practice questions at the end of each chapter. Paragraph numbers at the end of each question refer the student to the place in the chapter where the answer to the multiple-choice question can be found. These paragraph references may be helpful when the student is not sure of the answer or would like additional detail. However, in most cases, the Answers and Rationales provided give adequate information concerning each multiple-choice question, so referring to the chapter may be necessary only for more in-depth treatment of the subject matter. If a student does not score 75 percent or higher for a particular assignment, the student probably has not mastered the material in accordance with examination standards. A grade of less than 75 percent would suggest the student should, at a minimum, review the detailed answers for every question missed and the related paragraphs in the chapter. Students who need to review the concepts in more detail may want to refer to the primary textbook for the course. In the preparation of these multiple-choice questions, Keir made no attempt to anticipate specific cases or questions that are likely to appear on the final examination for a college course. No one can outguess the class professor. What we have attempted to do is select questions that test a student s understanding of important concepts presented in the study materials. Students will find these questions cover the material in an exceedingly thorough manner. Certified Financial Planner Board of Standards, Inc. owns the marks CFP, CERTIFIED FINANCIAL PLANNER, and CFP (with flame logo), which it awards to individuals who successfully complete initial and ongoing certification requirements. Keir Educational Resources is a Review Course provider for the CFP Certification Examination administered by Certified Financial Planner Board of Standards, Inc. CFP Board does not endorse any review course nor receive any financial remuneration from Review Course providers Keir Educational Resources ii

3 TABLE OF CONTENTS Chapter Title Page One Two Planning for Retirement One: Retirement, A Lifestyle 7 Two: Social Security and Medicare 7 Three: Tax-Advantaged Plans and Qualified Plans 20 Four: A Systematic Approach to Retirement Security 20 Introduction to Retirement Plans One: Introduction to IRAs 54 Two: IRA Distributions 59 Three: Qualified Retirement Plans 63 Four: Qualified Plan Benefits, Contributions, and Taxes 64 Five: Issues on Discrimination 65 Three Defined-Contribution Plans for the Private Sector One: Defined-Contribution Plans, the Basics 81 Two: Discretionary Contribution Plans 83 Three: Employee Contribution Plans 90 Four: Fixed-Contribution Plans 95 Five: Keogh (HR10) Plans 99 Six: Hybrid Plans: SEPs and SIMPLEs 100 Seven: Retirement Plan Comparisons 104 Four Defined-Benefit Plans for the Private Sector One: A Guaranteed Retirement Benefit 127 Two: Funding the Plan 131 Three: Which Plan for Which Company? 134 Five Six Retirement Plans for Nonprofit and Governmental Entities One: Section 403(b) Plans 141 Two: 403(b) and 401(k) Plans Compared 144 Three: Section 457 Plans 145 Plan Design, Installation, and Administration Issues One: Qualified Plan Appropriateness and Selection 153 Two: Qualified Plan Design 156 Three: Plan Installation 161 Four: Plan Administration Issues 163 Five: Special Plan Administration Issues 167 Six: Qualified Plan Investments 172 Seven: Qualified Plan Termination 175 Eight: Qualified Plan Development and Maintenance Process: Case Studies Keir Educational Resources iii

4 TABLE OF CONTENTS, CONTINUED Chapter Title Page Seven Retirement Plan Distributions One: Preretirement Distributions 211 Two: Distributions after the Participant s Death 213 Three: Postretirement Distributions 215 Four: Selecting the Appropriate Retirement Plan Distribution Alternative 216 Five: Nondeductible IRA, Nontraditional IRA, and Other Distributions 217 Eight Other Employee Group Benefits One: Group Life Insurance 227 Two: Income Tax Consequences of Group Life Insurance 229 Three: Employee Benefit Plans 233 Four: Income Tax Consequences of Group Health and Disability Coverage 239 Five: Group Insurance Provisions Required by the Federal Government 242 Six: Taxation of Noncash Fringe Benefits 243 Seven: Workers Compensation and Unemployment Insurance 243 Nine Non-Qualified Executive Benefit Plans One: Non-Qualified Executive Retirement Arrangements 265 Two: Income Tax Rules for Non-Qualified Deferred-Compensation Plans 267 Three: Tax Implications of Non-Qualified Deferred-Compensation Plans 269 Four: Informally Funding a Non-Qualified Deferred-Compensation Arrangement 270 Five: Non-Qualified Executive Incentive Plans 273 GLOSSARY 288 INDEX Keir Educational Resources iv

5 Chapter 1 Planning For Retirement Section One: Retirement, A Lifestyle The goal of retirement planning is to achieve financial security during the retirement phase of the life cycle. The three phases are: (1) growth and preparation, (2) production, and (3) retirement. Retirement is becoming the longest phase and thus increasingly important. The shift in the nation s age profile and the demographics portend greater poverty and a large (and unprepared for) growth in the need for long-term care. The proportion of Americans who are saving for retirement has not increased to correspond with the numbers of those who will retire in the next 15 years. Thus, many Americans are not actively preparing for these inevitable changes. Section Two: Social Security and Medicare 1. The Social Security system is funded by the Federal Insurance Contributions Act (FICA) taxes paid by workers and employers. The tax is 15.3% of compensation in 2017: workers pay 7.65%, and employers pay 7.65%. Self-employed persons pay the full tax of 15.3% on their earned income but receive an income tax deduction equal to one-half of the tax (based on the employer portion of the tax). The tax paid by employees for Social Security (OASDI) is 6.2% and employers also pay 6.2%. The Social Security tax is only assessed on the first $127,200 of compensation in The Medicare portion of the tax, which is 1.45% of compensation, is paid by employees and employers on all compensation, even compensation above the taxable wage base of $127,200. Beginning in 2013, the Patient Protection and Affordable Care Act (PPACA) imposes an additional.9% Medicare tax on the employee portion of income over $200,000 ($250,000 for joint returns; $125,000 for married taxpayers filing a separate return). Additionally, a new Medicare tax of 3.8% on investment income for taxpayers with a modified adjusted gross income of: $250,000 (married filing jointly), $125,000 (married filing separately), $200,000 for all other taxpayers was imposed in The FICA tax is collected on wages, salaries, bonuses, commissions, vacation pay, severance pay, and the first six months of sick pay. Social Security taxes are also collected on contributions an employee makes by means of salary reduction to 401(k) plans, 403(b) plans, and SARSEPs. Employer contributions are not subject to the tax, and distributions from qualified plans are not subject to the FICA tax. Employee benefit plan payments, such as to a cafeteria plan, are not subject to FICA tax, and the premiums paid by an employer on the first $50,000 of group term life insurance are not taxed. 2. The following are among the basic provisions of the various OASDI programs: (a) For 2017, employees and the self-employed receive one credit (a.k.a. quarter) of coverage for each $1,300 of covered annual earnings. No more than four credits (quarters) can be credited for a year. The $1,300 measure will increase automatically in the future to keep pace with average wages. (b) Fully insured refers to an insured status that makes covered workers and their dependents eligible for most types of Social Security benefits. A fully-insured status can be attained by having 40 credits (quarters) of coverage. In addition, a person born before 1929 is fully insured if he or she has one credit of coverage for each year between 1951 and the year he or she dies, becomes disabled, or attains age 62. For example, a person born in 1925 would attain age 62 in 1987 (1925 plus 62 years). Thus, Keir Educational Resources

6 Retirement Planning Summary Review Chapter One credits (quarters) of coverage would be required to attain fully-insured status ( = 36 years). A minimum of 6 credits is required. The maximum number of credits of coverage required is 40. (c) Currently insured refers to an insured status for a person who is not fully insured. A person is currently insured if he or she has at least 6 credits of coverage out of the last 13 credits, ending with the quarter of death. (d) If a person is currently insured, but not fully insured, his or her dependents are entitled to three types of survivor benefits: (1) A lump-sum death benefit of $255 (2) Monthly payments to the deceased s spouse while children are under 16 years of age (3) Monthly payments to the deceased s children while they are under 18 years of age or under 19 years of age and are full-time students in high school 3. (a) A worker s AIME is his or her average indexed monthly earnings a way of expressing the worker s covered earnings over his or her working life, in terms of their current dollar values. (It is determined by indexing the covered earnings for each year, selecting the years of highest earnings, as provided by law, totaling those earnings, and dividing by the appropriate number of years.) (b) The primary insurance amount (PIA) is the basic unit used to determine the amount of each monthly benefit payable under Social Security. Its value is determined by a formula applied to the AIME, but it is also available in published tables. The PIA for those becoming eligible for retirement or disability benefits in 2017 is given by the following formula: 90% of the first $885 of the worker s AIME, plus 32% of the worker s AIME over $885 and up to $5,336, plus 15% of AIME over $5,336 points. The dollar amounts of $885 and $5,336 in this formula are referred to as the bend 4. We should now discuss the basic provisions of the law applicable to Social Security retirement benefits. (a) Insured status required for benefits. Workers must be fully insured, that is: (1) have at least 40 credits (quarters) of coverage; or (2) if born before 1929, have one quarter of coverage for each year between 1951 and the year he or she attains age 62. A minimum of six quarters of coverage is required for persons born before (b) Age at which a worker may first apply for benefits. A worker may first apply for retirement benefits three months before the first month in which he or she becomes age 62 benefits may not be actually received until he or she is age 62. (c) amount). Amount of benefit, expressed as a portion of the worker s PIA (primary insurance 2017 Keir Educational Resources 6

7 Retirement Planning Summary Review Chapter One (1) The benefit for a worker at the full retirement age 100% of the PIA. Full retirement age is determined by the year of birth. Year Born Full Retirement Age (based on birth month) 1937 or earlier plus 2 months for each year born after plus 2 months for each year born after or later 67 (2) The benefit for a worker before the full retirement age If the worker is younger than the full retirement age, the retirement benefit is equal to the worker s PIA, reduced by 5/9 of 1% for each of the first 36 months he or she is under the full retirement age when the benefits begin, and by 5/12 of 1% for each such month in excess of 36. If a worker s full retirement age is 66 and the worker begins benefits at age 62, the benefit reduction is 25%. (3) The benefit for a worker who continues to work after retirement After a worker reaches the full retirement age, full benefits will be received, without any loss or reduction due to earnings. For those workers who will reach the full retirement age in 2017, there will be a reduction in benefits for the months before the worker attains retirement age, of $1 for every $3 of earnings over $44,880 annually ($3,740 monthly). Persons below the full retirement age lose $1 in benefits for every $2 of earnings above $16,920 in There is a 0.3% COLA beginning January (4) Benefits for a spouse, of full retirement age or older (assume the worker is entitled to benefits) A spouse whose benefits start at their own full retirement age or older is entitled to a benefit of ½ of the worker s PIA. (5) Benefits for spouses under full retirement age A spouse is entitled to a benefit of ½ of the worker s PIA, reduced by 25/36 of 1% for each of the first 36 months he or she is under the full retirement age when the benefits begin, and by 5/12 of 1% for each such month in excess of 36. (6) Benefits for a spouse under age 62, with no child who is under age 16 or disabled No benefit is available. (7) Benefits for a spouse under age 62, caring for a child who is under age 16 or disabled The benefit for such a child is ½ the worker s PIA. (8) Benefits for a divorced spouse of a worker (assume the worker is entitled to benefits) The benefit is the same as if he or she were still a spouse: ½ the worker s PIA, and this benefit is independent of other family benefits. (Some special provisions apply, for example, in certain cases of remarriage.) (d) The effect of unearned income or the value of assets owned by the worker on the amount of the benefit. Benefits are totally unaffected by assets or unearned income, regardless of age Keir Educational Resources

8 Retirement Planning Summary Review Chapter One (e) The effect of the worker s spouse receiving civil service retirement benefits on the amount of Social Security retirement benefits paid to the spouse. For spouses who become eligible for a government pension, the Social Security spousal benefit is reduced by $2 for every $3 of civil service retirement benefit received. (f) Determination of the benefit for the spouse of a worker, when the spouse would be entitled to both the worker s and the spouse s benefits. The spouse receives the higher benefit to which he or she is entitled, that is, either ½ of the worker s PIA as a spousal benefit, or his or her own PIA amount, if it is larger than the former. (g) The effect of the worker s death prior to retirement on the surviving spouse s benefit. If the worker was fully insured at the time of death, the widow(er) is eligible for a survivor s benefit at age 60. If he or she does not start benefits until full retirement age, the benefits will equal 100% of the deceased worker s PIA. For benefits commencing before full retirement age, the amount is reduced by 19/40 of 1% for each month that the widow(er) is under full retirement age when the benefits commence. A benefit starting at age 60 is 71.5% of the deceased worker s PIA. (h) The effect of the worker s death after retirement on a surviving spouse s benefit. Normally, the spouse s retirement benefit (1/2 of worker s PIA) will be automatically converted to a widow s benefit at the time of the retired worker s death. The widow s benefit is 100% of the deceased worker s PIA if the benefit begins when the widow(er) is full retirement age or over. This may be reduced under various circumstances, for example, if a widow(er) is less than full retirement age or is entitled to certain retirement funds on his or her own or if the maximum family benefit would be exceeded. (i) Cost-of-living increases in benefits. Benefits are automatically increased based on the change in the Consumer Price Index from the third quarter of one year to the third quarter of the following year. The percentage of the increase is for the December benefit, payable in January. Inflationary increases cause greater purchasing power losses for mid-to-upper-income retirees than for lower-income retirees. (j) A special minimum benefit can be paid to low-income workers who have been covered under the OASDI program for more than ten years. (k) The effect of delaying the receipt of Social Security benefits. A worker who does not receive benefits between their full retirement age and age 70 may increase benefits by up to 8% annually. After age 70, there is no additional increase for a worker delaying benefits. A spouse s benefit is not increased as a result of a worker s delaying retirement, nor is the spouse s benefit decreased from a worker s taking early retirement. The spouse s benefit is based on the worker s PIA, which is not affected by early or delayed retirement. A surviving spouse s benefit, however, will be reduced by a worker s early retirement or increased by a delayed retirement. (l) The effect of the maximum family benefit. When the total monthly benefits payable to all beneficiaries on one Social Security account exceed the family maximum (typically, between 150% and 188% of the worker s PIA), individual benefits must be adjusted as follows: maximum. (1) If the worker is alive, the worker s benefit is subtracted from the family (2) If the worker is dead, the beneficiaries are paid benefits, reduced proportionately Keir Educational Resources 8

9 Retirement Planning Summary Review Chapter One For example, Jones died, leaving a widow and two small children. The PIA for Jones is $1,000, so the widow and each child are entitled to 75% of the $1,000, or $750. In this case, the family maximum is $1,845. The sum of the benefits for the widow and two children is $2,250, which exceeds the family maximum. The benefits are all reduced, and each beneficiary will receive 1/3 of the family maximum of $1,845 or $615 (rounded down). Note that if the widow has earnings that reduce her benefits, the children may have their benefits increased up to the family maximum. 5. The following are the basic provisions of Social Security disability coverage: (a) The definition of disability: the inability to engage in any substantial gainful activity by reason of any medically-determinable physical or mental impairment that is expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. Coverage continues only until retirement age; thereafter, the benefits are paid from the retirement fund, NOT disability. (b) The insured status is required for benefits. A worker who is age 31 or older must be fully insured at the time a disability occurs, and, in addition, must have at least 20 credits of coverage during the last 40 credits. If a disability starts prior to age 31, but after age 23, the person must have worked under Social Security for at least ½ of the credits after reaching age 21 and before becoming disabled. (c) Waiting period. There is a minimum waiting period of five months, but the definition of disability, as stated, must be met. (d) The amount of the benefit expressed as a portion of the worker s PIA. (1) Benefits for a disabled worker 100% of the worker s PIA, determined as if the worker were at the full retirement age and eligible for old-age benefits. (2) Benefits for the spouse of a disabled worker 50% of the worker s PIA, provided the spouse is at the full retirement age when benefits start; or, at any age, if the spouse is caring for a worker s child/children who is/are disabled or under the age of 16. The benefit is reduced if the spouse elects to receive benefits at or after age 62 but before the full retirement age. (3) Benefits for the child/children of a disabled worker A child is entitled to a benefit of 50% of the parent s PIA, subject to a maximum family benefit. (4) Maximum family benefit If the entitlement for disability benefits came after June 30, 1980, the family benefit may not exceed the lesser of 85% of the AIME on which the worker s disability benefit is based or 150% of the disability benefit payable to the worker alone. However, in no case, will a family s benefit be reduced below 100% of the benefit that would be payable to the worker alone. (5) A cost-of-living increase is given each January 1st, in proportion to the Consumer Price Index increase for the year. (e) The effect of proceeds, collected from private disability insurance on the amount of the benefit. Private disability insurance benefits have no effect on the amount of the disability benefit under Social Security. (f) The effect of other sources of income and of the value of assets owned by the worker on the amount of the benefit. The benefit amount is totally unaffected by any unearned income, by income earned by a spouse, or by the value of assets owned by a worker. The benefit may be reduced to offset (fully or partially) workers compensation or disability benefits under federal, state, or local law, but this 2017 Keir Educational Resources

10 Retirement Planning Summary Review Chapter One reduction applies only if the total benefits received by the worker and dependents exceed 80% of the average current earnings. (g) Events that trigger the ending of benefits. Disability benefits are terminated during one of the following time periods: the second month after the month in which the disability ceases, the month before the worker attains the full retirement age (benefits are automatically converted to retirement benefits), or the month before the month in which the worker dies. 6. The following death benefits may be available at a worker s death: (a) Mother s or father s benefit. A surviving spouse of a fully or currently insured worker is entitled to a mother s or father s benefit of monthly cash in the amount of 75% of the deceased worker s PIA if the surviving spouse is caring for an unmarried child under age 16 (or a child disabled before the age of 22). The mother s or father s benefit will be reduced for excess earnings (see para. 4(c), this Chapter). A mother s or father s benefits are terminated when the youngest child reaches age 16 (unless the child is disabled). These benefits also terminate if the surviving spouse dies or remarries before the youngest child becomes 16 (with some exceptions) or if the child marries. (b) Child s benefit. When a fully or currently insured worker dies, each child is entitled to a child s benefit if he or she is under 18 (or under 19 and a full-time high school or elementary school student) or over 18 and was disabled before the age of 22. In addition, the child must not be married. The benefit amount is 75% of the deceased worker s PIA for each child, but this may be reduced proportionately because of the family maximum limit where several children and a mother s or father s benefit are all involved. The child s benefit can also be reduced if his or her earnings exceed the maximum permitted. The benefits terminate at death, at age 18, when disability ceases, (if it is the basis for the benefit), or when married. (c) Widow s or widower s benefit. These benefits are payable only if the deceased worker was fully insured and the widow(er) was married to the deceased worker for at least 9 months just prior to the death of the worker. To receive benefits, the widow(er) must be at least 60 years old (or between 50 and 60, if disabled). Furthermore, the widow(er) must not be remarried before age 60 (with some exceptions); also, the retirement benefit to which the widow(er) is entitled, based on his or her own work, may not be equal to or larger than the deceased worker s PIA. The benefit is equal to 100% of the deceased s PIA if the benefit begins when the widow(er) is full retirement age or over. The benefit is reduced, if started before full retirement age, if the widow(er) is entitled to retirement benefits based on his or her own work (reduced dollar-for-dollar, down to zero if his or her own PIA is equal to or greater than the deceased worker s PIA). It is also reduced if the widow(er) is entitled to retirement benefits from a state, local, or federal government, based upon his or her own work or if the maximum family benefit would be exceeded. Note that the 9-month duration-of-marriage requirement may be waived under certain circumstances (for example, accidental death). Widow(er) benefits terminate when the widow(er): (1) dies, (2) becomes eligible for a Social Security retirement benefit which is as large as or larger than the deceased worker s PIA, or (3) is no longer disabled. (d) Lump-sum death benefit. At the death of any fully or currently insured worker, a onetime lump-sum benefit of $255 is paid to the widow(er), if living with the worker at the time of death, or a spouse or child of the deceased worker who is eligible for Social Security benefits Keir Educational Resources 10

11 Retirement Planning Summary Review Chapter One Review of Six Steps In Calculating The Amount That Must Be Saved Each Year To Meet Retirement Goals Step 1: Project the future value of the assets at retirement. a. Future value calculation b. Periodic payment calculation Step 2: Project the net after-tax future value of the assets. a. Calculate the tax and the capital gain on the investments Step 3: Calculate the initial retirement income shortfall. Step 4: Calculate the retirement fund needed to meet the initial and subsequent retirement income shortfalls. a. Future value calculation b. PVAD calculation Step 5: Calculate the additional total savings needed for retirement. a. Capital utilization method b. Capital preservation method c. Present value calculation Step 6: Calculate the annual amount (periodic payment) that needs to be saved each year. a. Capital utilization method b. Capital preservation method c. Periodic payment calculation 1. Serial payments 2. Level payments 2017 Keir Educational Resources

12 Chapter 1 Planning For Retirement 1. The most fundamental reason for pension plans is to: (K. para. 1) A. Minimize employer-employee income tax burdens B. Permit early retirement for employees without a financial burden for employees C. Facilitate the accumulation of retirement savings for employees D. Implement the quantitative provisions of ERISA E. Encourage productive effort and initiative on the part of employees 2. Joseph retired at age 62 this year. To be eligible for full OASDI retirement benefits, how many credits (quarters) of coverage must Joseph have earned? (K. para. 2) A. 40 D. 13 B. 39 E. 6 C Mrs. A works part-time only during the peach-picking season. In 2017, her total annual earnings of $1,600 were received for picking fruit during July and August. How many credits (quarters) of OASDI coverage does Mrs. A receive for her 2017 earnings? (K. para. 2(a)) A. One D. Four B. Two E. Zero C. Three 4. Which of the following statements concerning the different types of insured status under the OASDI program is correct? (K. para. 2, 4-6, 7) A. Fully insured status gives eligibility for retirement benefits, but not for all survivorship benefits. B. Currently insured status gives eligibility for certain survivorship benefits. C. For a 35-year-old worker, disability insured status is easier to achieve than eligibility for survivorship benefits. D. A fully insured person may lose eligibility for some benefits if he or she is not also currently insured. E. The requirements for disability insured status are the same for all age groups. 5. Which of the following statements concerning OASDI retirement benefits is (are) correct? (K. para. 4) (1) A special minimum benefit can be paid to low-income workers who have been covered under the OASDI program for more than 10 years. (2) If the worker delays receiving retirement benefits after full retirement age, the benefit amount will be increased by a delayed retirement credit. A. (1) only C. Both (1) and (2) B. (2) only D. Neither (1) nor (2) 2017 Keir Educational Resources 12

13 Chapter 1 Planning For Retirement 1. C is the answer. E is also a reason for having a pension plan, but not the most important reason. 2. A is the answer. Joseph was born after 1929, so he needs 40 credits (quarters) of coverage to be fully insured and thus eligible for retirement benefits. 3. A is the answer. A person earns a credit (quarter) of coverage for each $1,300 of annual earnings in Thus, $1,600 of earnings means only one quarter of coverage under OASDI. Four quarters is the maximum number of quarters of credit a person can earn in one year. 4. B is the answer. A is not a correct statement. Fully insured status provides eligibility for both retirement and survivorship benefits. C is not correct. To be disability insured, a 35-year-old person must be fully insured and, in addition, must have 20 credits of coverage during the last 40 credits. Eligibility for survivorship benefits can be achieved by having either fully insured or currently insured status. D is not correct. Fully insured status provides a person with eligibility for all the benefits for which a currently insured person is eligible. E is not a correct statement. If disability occurs between age 24 and age 30, the person is eligible for benefits if he or she is fully insured and has been covered for one-half the credits after reaching age 21 and before becoming disabled. Such a person is not required to have 20 credits of coverage during the last 10 years. 5. C is the answer. Both (1) and (2) are correct statements Keir Educational Resources