Maryland Life Chapter 6

Earned income

salary, wages, or commissions; but not income from investments, unemployment benefits, and similar

Gross income

a person's income before taxes or other deductions

Nonprofit organization

an organization that uses its surplus to fulfill its purpose instead of distributing the surplus to its owners or members

Pretax contribution

contribution made before federal and/or state taxes are deducted from earnings

Rollover 

withdrawal of the money from one qualified plan and placing it into another plan

Vesting

the right of a participant in a retirement plan to retain part or all of the benefits

qualified retirement plan

approved by the IRS, which then gives both the employer and employee benefits such as deductible contributions and tax-deferred growth.

• Designed for the exclusive benefit of the employees and their beneficiaries;

• Are formally written and communicated to the employees;

• Use a benefit or contribution formula that does not discriminate in favor of the prohibited group — officers, stockholders, or highly paid employees;

• Are not geared exclusively to the prohibited group;

• Are permanent;

• Are approved by the IRS; and

• Have a vesting requirement.

Qualified plans

have tax advantages

nonqualified plans

require no government approval and are used as a means for an employer to discriminate in favor of a valuable employee with regard to employee benefits

QUALIFIED

Contributions currently TAX DEDUCTIBLE

Plan APPROVED by the IRS

Plan CANNOT DISCRIMINATE

Earnings grow TAX DEFERRED

ALL WITHDRAWALS are TAXED

NONQUALIFIED

Contributions NOT currently TAX DEDUCTIBLE

Plan DOES NOT NEED IRS APPROVAL

Plan CAN DISCRIMINATE

Earnings grow TAX DEFERRED

EXCESS over cost basis is TAXED

Individual Retirement Account (IRA)

allows individuals with earned income to make tax deductible contributions regardless of age

Roth IRA

form of an individual retirement account funded with after-tax contributions. An individual can contribute 100% of earned income up to an IRS-specified maximum, as with traditional IRAs (the dollar amounts change every year). Roth IRA contributions can continue regardless of the account owner's age, and in contrast with a traditional IRA, distributions do not have to begin at a specified age. Roth IRAs grow tax free as long as the account is open for at least 5 years

HR-10 or Keogh plans

make it possible for self-employed persons to be covered under an IRS qualified retirement plan

Simplified Employee Pensions (SEPs)

a type of qualified plan suited for the small employer or for the self-employed

employee establishes and maintains an individual retirement account to which the employer contributes. Employer contributions are not included in the employee’s gross income

SIMPLE (Savings Incentive Match Plan for Employees) plan

available to small businesses that employ no more than 100 employees who receive at least $5,000 in compensation from the employer during the previous year

Employees who elect to participate may defer up to a specified amount each year, and the employer then makes a matching contribution, dollar for dollar, up to an amount equal to 3% of the employee's annual compensation. Taxation is deferred on both contributions and earnings until funds are withdrawn

401(k) qualified retirement plan

allows employees to take a reduction in their current salaries by deferring amounts into a retirement plan. The company can also match the employee's contribution, whether it is dollar for dollar or on a percentage basis.

Plans permit early withdrawal for specified hardship reasons such as death or disability. Loans are also permitted in certain instances up to 50% of the participant's vested accrued benefit or the annual IRS-established dollar amount.

403(b) plan or a tax-sheltered annuity (TSA) 

qualified plan available to employees of certain nonprofit organizations under Section 501(c)(3) of the Internal Revenue Code, and to employees of public-school systems

Contributions can be made by the employer or by the employee through salary reduction and are excluded from the employee’s current income

If the general requirements for qualified plans are met, the following tax advantages apply:

• Employer contributions are tax deductible to the employer, and are not taxed as income to the employee;

• The earnings in the plan accumulate tax deferred; and

• Lump-sum distributions to employees are eligible for favorable tax treatment

The following types of distributions are considered exceptions to the early distribution rule and, therefore, are not subject to the 10% early withdrawal penalty:

• Death of the participant;

• The participant's disability;

• A divorce decree requiring a distribution to a spouse as part of the settlement;

• As a series of equal payments (at least annually) over the participant's life expectancy;

• A loan from the plan; or

• As part of a qualified rollover.