ch 13 gottlieb tax

Learning Objectives

• Defined Benefit Plans: Understand tax and nontax aspects from employer’s and employee’s perspectives.

• Defined Contribution Plans: Explain tax consequences for traditional 401(k) and Roth 401(k).

• Deferred Compensation: Describe tax implications for both employer and employee.

• IRAs: Compare traditional and Roth IRAs tax consequences.

• Self-Employed Options: Describe retirement account options and deductible limitations.

• Saver’s Credit: Compute the saver’s credit.

Types of Retirement Plans

• Defined Benefit Plans (employer-provided)

• Defined Contribution Plans (employer-provided)

  • 401(k) and Roth 401(k)

• Individually Managed IRAs

  • Traditional IRAs

  • Roth IRAs

• Self-Employed Retirement Plans

  • SEP IRA

  • Individual 401(k)

• Allow taxpayers to defer or exclude income for retirement savings.

Employer-Provided Qualified Plans

• Characteristics of Qualified Plans: Must provide equal treatment among employees.

• Types:

  • Defined Benefit Plans: Fixed benefits determined by a formula based on years of service and average compensation.

  • Defined Contribution Plans: Employer specifies contribution, employees choose investment.

Defined Benefit Plans

• Standard Benefits: Based on years of service and average compensation.

  • Annual compensation limitation for 2024: $345,000.

  • Maximum benefit: Lesser of 100% of the highest three-year average salary or $275,000.

• Tax Implications:

  • Taxed as ordinary income when received.

  • Early distributions (< 59.5) incur a 10% penalty.

• Vesting Schedules:

  • 5-year cliff or 7-year graded.

Example of Defined Benefit Calculation

• Scenario: Tina works 4 years, with annual salaries of $60k, $65k, $70k, $75k.

  • Average of three highest salaries: $70,000.

  • Benefits accrue at 2% per year: 4 years x 2% = 8%.

  • Full annual benefit before vesting: $5,600.

  • Vesting after 4 years at 7-year graded schedule: 40%.

  • Vested Benefit: $2,240 ($5,600 x 0.40).

Defined Contribution Plans

• Employee Contributions:

  • Limit (2024): $23,000 + $7,500 catch-up (age 50+).

• Employer Contributions: Match and limit to the lesser of employee's salary or total contribution limits.

• Tax Treatment:

  • Distributions taxed as ordinary income.

  • Early distributions incur a 10% penalty.

• Vesting: Immediate for employee contributions; minimum requirements (3-year cliff or 6-year graded) for employer contributions.

Example of Defined Contribution Contributions

• Jason’s Contribution:

  • Salary: $700,000, contribution: $30,500.

  • CBA match (2-for-1 up to 5%): CBA can contribute $46,000 (limited).

Traditional vs Roth 401(k)

• Traditional 401(k): Contributions are pre-tax, tax-deductible.

• Roth 401(k): Contributions after-tax, not deductible. Qualified distributions after 5 years and if age 59.5 or conditions met.

Deferred Compensation

• Nonqualified Plans: May discriminate, often for high earners.

• Tax Treatment: Employer deduction at payment; employee recognizes income upon receipt. Factors include current and future tax rates, and cost of capital.

Individual Retirement Accounts (IRAs)

• Contribution Limits (2024):

  • $7,000 for individual contributors, $8,000 if 50+ with catch-up.

• Tax Treatment:

  • Distributions taxed as ordinary income, penalties may apply before age thresholds.

• Qualified Charitable Distributions: Count towards RMD, excluded from taxable income.

Comparison of Traditional and Roth IRAs

• Traditional IRA: Deductible contributions for qualifying individuals.

• Roth IRA: Post-tax contributions; distributions of contributions are tax-free, qualified distributions of earnings not taxed if criteria are met.

Saver’s Credit

• Available for lower-income taxpayers contributing to retirement plans.

• Credit based on filing status and AGI.

• Applicable percentages for 2024: 50% for AGI ≤ $46,000 (married), phased down based on AGI levels.