12: Tax Advantaged Accounts

Tax advantaged accounts offer incentives for those who invest and save towards retirement or education goals through two mechanisms:

tax deferral or tax free

Tax deferred: (invest _, pay taxes _)

invest now, pay taxes later

For tax-deferred accounts: income contributed is … , earnings and growth grow tax …, and withdrawals are made after … nad are …

income contributed is not taxed, earnings and growth grow tax deferred, and withdrawals are made after 59.5 years old and are taxed as ordinary income

Tax free: (invest _, pay taxes _)

invest after tax income, pay taxes first

For tax-free accounts: income contributed is … , earnings and growth grow tax …, and withdrawals are made after … and are …

income contributed is taxed, earnings and growth grow tax free, and withdarwals are made after 59.5 years old and are tax free

Qualified retirement plans are tax-… accounts that let employees and employers contribute into a retirement account tax-…, earnings and growth are tax-… and distributions are …

qualified retirement plans are tax free accounts that let employees and employers contribute into a retirement account tax-free, earnings and growth are tax-deferred, and distributions are taxed as ordinary income

For a plan to be “qualified,” it has to meet … guidelines:

ERISA guidelines: corporate guidelines protecting employees’ retirement income, and this protects employee retirement assets in bankruptcy (no credit risk)

ERISA guidelines for qualified corporate retirement plans are:

non-discriminatory: offered to both full and part time employees, at least 21 years old AND worked there for at least a year; and the plan has a vesting schedule that specifies when participants have ownership rights to employer contributions

Defined Benefit Plans:

promises specific retirement benefits set by a formula (ex. years of service, average salary, position) rather than based on how much money you put in, and the sponsor (employer) determines required contributions, investments, and bears investment risk

Are there Roth Defined Benefit plans?

NO

Defined Contribution Plans:

retirement benefits very by the amount invested and performance of investments selected because contributions are decided by each participant, and investments and risks are beared by the participant

Post-tax “non-qualified” retirement plans:

contributions are made post-tax, earnings are growth are tax deferred, and only earnings and growth are taxed as ordinary income when withdrawn (contributions were already taxed)

Roth refers to what type of taxed accounts?

tax free

Most common tax free accounts are

Roth IRA, Roth 401k, 529 college savings accounts

What are the withdrawal requirements for all Roth accounts?

at least 59.5 years old and at least 5 years since the first contribution

The annual earned income contribution limit for an IRA is $… a year, but for individuals 50 or older can have a “catch-up” contribution of $…

is $7,500 a year, but for individuals 50 or older can have a “catch-up” contribution of $1,100

Individuals 50 or older have a total annual earned income contribution limit to their IRA is $…

8,600

Contributions into an IRA can be invested in the following assets:

stocks, bonds, mutual funds (mainly like securities, brokerage account for retirement)

IRA contributions can NOT be invested in:

stamp collections, collectibles, and life insurance

For married couples, if one spouse has no earned income, they can still have a … where up to …

Spousal IRA where up to the normal limit (up to $7500) can be contributed from the other spouse’s earned income IN the other spouse’s name

The excess contribution penalty for an IRA is … penalty on the excess contribution

6%

The consequence for taking distributions from an IRA before 59.5 years old is t

hat it is taxable as ordinary income and a 10% penalty (some exceptions)

Do original owners of Roth IRAs have to take RMDs?

No. You never have to take Required Minimum Distributions from your own Roth IRA during your lifetime.

Do inherited Roth IRAs have RMD requirements?

Yes. Most non-spouse beneficiaries must withdraw all funds within 10 years, though specific RMD rules vary based on the beneficiary's relationship to the deceased.

How can a spouse avoid RMDs on an inherited Roth IRA?

By rolling it over into their own Roth IRA or treating the inherited account as their own.

What is the RMD age if an (usually Traditional) IRA has them?

73 years old for Traditional IRAs

SEP IRA is

a Simplified Employee Pension plan where an employer (often a small business or self‑employed person) makes tax‑deductible contributions to employees’ Traditional IRA accounts.

SIMPLE IRA is

a Savings Incentive Match Plan for Employees that lets small employers and employees both contribute to a retirement account, similar to a lightweight 401(k) with required employer matching

What happens in an IRA transfer?

Funds are moved directly from one Traditional IRA to another

What happens in an IRA rollover?

Funds move from a qualified retirement plan to an IRA, or between different types of IRAs, and funds are sent directly to the new custodian, avoiding taxes and penalties (direct) or are sent to the individual before they must be invested with another custodian within 60 days once a year (indirect)

A 1035 Exchange is used for

non-qualified life insurance or annuities and allows you to "trade in" an old policy for a newer one with better features or lower fees without paying taxes on the gains

Can an investor contribute to both a traditional and Roth IRA in the same year, and what is the total contribution limit?

Yes, an investor can contribute to both a Traditional and Roth IRA up to $7500 a year split anyway between the accounts

Who cannot contribute to Roth IRAs?

High-income earners, they can just contribute to the traditional IRA

What is MAGI?

Modified Adjusted Gross Income. It’s your total income minus certain deductions, used by the IRS to determine if you're eligible for things like Roth IRA contributions.

Individuals who earned a Modified adjusted gross income of over $… (Single) or $… (Married Filing Jointly) cannot contribute directly to a Roth IRA account

$168,000 (single) or $252,000 (MFL)

Employees of public hospitals, public schools, and tax-exempt (non-corp.) organizations are often offered what type of retirement plan?

The 403B (tax-sheltered annuity)

The 403b retirement plan is also called ..

a tax sheltered annuity

401k are limited to be offered by … entities

corporate

In a 403(b), how are contributions, earnings & growth, and distributions treated?

403b contributions are pre-tax, earnings and growth are tax-deferred, and distributions are taxed as ordinary income

529 Plans are

municipal fund securities offered by the state, can be opened on behalf/by anyone (no age limit), and are tax-free (contributions are post-tax, grow tax free) for distributions that are used for education

Is there a federal annual contribution limit for 529s?

no federal limit, but there are state annual limits

For 529s, donors should be aware of

potential tax implications for large gifts

For unused assets in a 529 and a Coverdell account, the funds can be

transferred to another family member’s 529, or withdrawn for normal use but be taxed as ordinary income and a 10% penalty

A Coverdell account is a

federal, tax-free ESA account that can be opened for any student under the age of 18, distributions are tax-free (contributions are post-tax, grow tax free) for distributions that are used for education more broadly

Coverdell annual contributions are limited to …

$2,000 per child per year TOTAL (ex. if Mom puts in 1000 and Grandma puts in 1000 in the same year, it’s closed

An annuity is a

(fixed or variable) contract between an individual (annuitant) and a life insurance company (issuer/underwriter) in which the company promises to pays the investor retirement income for life

Longevity risk:

risk of outliving your funds

A fixed annuity is a security for which

return is guaranteed at a fixed rate by the issuing insurance company and its premiums (payments from the investor) are invested into the insurance company’s general account

The risks of fixed annuities are

credit risk (bankruptcy or otherwise unable to pay its claims) and purchasing power risk (general fixed rate security issue)

A variable annuity is a security for which

return varies with the performance of the investments the annuitant (individual owner) chooses, and premiums are invested into the insurance company’s separate account

Owners of a variable annuity … the investments of their variable annuity, so they bear … and … risk

select the investments, so they bear credit and market risk

In the accumulation period of a variable annuity, investors purchase … and the value of the contract …

purchase accumulation units and the value of the contract growhs

At 59.5 years old, the annuitant has to “…” and moves into the … period, where the accumulation units … whose value is …

“annuitize” and moves into the annuitization period (distribution period), where the accumulation units convert into a fixed number of annuity units at that moment whose value fluctuates with market performance, calculated by a formula

Annuitize:

turning your variable annuity account balance into a stream of guaranteed income

Annuity units determine

how much you’ll get paid each month; company fixes the number of annuity units but the value of the annuity units fluctuates based on market performance based on a formula

An annuitant may pay a … if they withdraw capital prior to annuitization (in the accumulation period) or in a 1035 Exchange, and it declines annually until there is no surrender charge

surrender charge

A surrender charge is

if you withdraw capital prior to annuitization (in the accumulation period) or in a 1035 Exchange, and it declines annually until there is no surrender charge

1035 Exchanges enable investors to

make a tax-free transfer of one annuity contract into another, still pay surrender charge (ex. surrender your variable annuity policy (pull out the money) and immediately put it into a different variable annuity)

Life annuity:

contract pays out until the owner dies (highest monthly payout, no payments to heirs)

Life annuity with period certain:

guarantees payments for life, but also guarantees a minimum number of years of payments (the “period certain”), even if the annuitant dies early

Joint life with last survivor annuity payout option:

specify that the annuity will continue to pay out until the owner and their spouse have both died according to their calculated life expectancies (map out both expected longevity of both)