Topic 12 PDF

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Summary

Retirement Plans Pension Plans “Retirement Benefits”  Eligibility Standards o Minimum age cannot exceed 21 AND Minimum service requirement cannot exceed one year  Companies can make this lower  Retirement Age o Normal retirement age “NRA”  Earliest age at which an employee can retire and receive...

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Retirement Plans Pension Plans “Retirement Benefits”  Eligibility Standards o Minimum age cannot exceed 21 AND Minimum service requirement cannot exceed one year  Companies can make this lower  Retirement Age o Normal retirement age “NRA”  Earliest age at which an employee can retire and receive full benefits o Early retirement age  Earliest age at which employee may retire and receive some benefits  Usually paid reduced benefit (full actuarial equivalent) o Late retirement age  Retirement after normal retirement age  Employer should increase benefits but not required to do so Vesting: the degree to which a plan participants pension rights are non-forfeitable, regardless of whether the employee continues working for the employer  Employee is ALWAYS entitled to his/her contributions with interest  Vesting just refers to status of employer contributions  Vesting example: vesting standards permitted under ERISA (The law) o Employer can always be more generous but not more stingy o 5-year cliff vesting  if you leave a job before 5-year mark, you lose it all  if you work there 5 years and 1 day, you get it all  5 years is the maximum amount of time they can do  can do 1, 2, 3, 4 years o Graded 7-year vesting  20% vested after 3 years of service  40% vested after 4 years of service  60% vested after 5 years of service  100% vested after 7 years of service  if you leave before 7 years, you get bumped down 1 level but you don’t lose it all o 100% vested after 2 years of service with a 2-year waiting period (instead of one year waiting period)  social security isn’t guaranteed, a pension isn’t guaranteed, YOU SAVING is guaranteed  negative enrollment: do something to get out versus getting in

EXAMPLE: Supposed an employee has 4 years of service and has been participating in her employers pension plan The employee contributed $40,000 The employer contributed $60,000 If the employee were to leave today, how much would she be able to transfer to her new employers plan?  At a minimum, the employee can transfer $40,000  The amount of the employers contributions that could be transferred depends on vesting schedule 1. Under 5-year cliff vesting, none of the employer contribution is vested o She takes $40,000 2. Under the 7-year (3-7 rule), the employee can take 40% ($24,000) of the employer contribution o She takes $40,000+$24,000= $64,000 rd 3. 3 rule, the employee takes all $100,000 Pension Plan Types  Defined contribution plans o Known: Annual employer contribution o EX: 5% of annual salary employer contributed on behalf of employee o Unknown: annual retirement benefit received at retirement variables creating risk  WHY? BECAUSE: unknown salary, don’t know when you’ll retire, your investments until you retire are unknown, don’t know how much you’ll contribute  Risk is burdened by the employee o Key: uncertainty regarding future retirement income, investment, risk, ECT. Rests with the employee  Employee burdens the risk  Employer liability is limited to cash contributions in that specific year o Advantage to defined contribution plan  Employees see exactly the balance at all times  Employee who change jobs several times are easily able to move account balances to new employer plan (in most careers)  Defined benefit plan o Known:  Formula that determines benefit at retirement  With proper information, an employee may be able to calculate benefit at retirement more precisely o Unknown:  Amount that an employer must contribute in any particular year in order to fund the promised benefit

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o Key: Employer bears uncertainty and investment risk  creates future liability for employer Unit formula example: unit = % of variety o For every year of service an employer promises 2% of final average salary at NRA o Final average salary is the average of salary in the 5 years up to and including the year of retirement o Employee year of retirement at  Salary at:  65 = $50,000  64 = $49,000  63 = $48,000  62 = $47,000  61 = $46,000  years of service = 30 years  how much at retirement?  Final average salary = $48,000  = (# of service years) * (Final average salary) * 2%  = 30 * $48,000 * 2% = $28,800 Employee Savings Plans o Voluntary plans designed to supplement other qualified plans or to be used in place of employer sponsored plan  Most popular DC plan  Receive tax advantages for participation  401K (Profit) 403B (non-profit) 401K plans o also known as a cash or deferred arrangement o $52,000  (1000-900)* 25% = 225 = 675  $100 o immediate income tax deductions on employee contribution o employer may or may not match employee contribution o employee can contribute $18,000 annually (2016) o the employee contributions are referred to in the tax code as elective deferrals o employee generally have the choice of investment vehicles for their account IRA (Individual Retirement Account) o Individual retirement plan designed to supplement other types of retirement income o Funds are invested in a variety of financial instruments and on a tax-differed basis until distributed o Tax deduction for IRA is limited to individuals who don’t have access to 401K plans o Can put a maximum of $5,500 annually For an IRA and 401K o Funds can’t be withdrawn prior to age 59 ½ except in the case of death or disability

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 10% penalty for withdrawal o amount withdrawn after age 59 ½ is taxed as ordinary income IRA and 401K rollovers o Occurs when owner takes funds out of one account and places them in another (qualified retirement account) o What transfers are allowed?  Transfer from one IRA to another IRA  401K to IRA  Transfers from one 401K to another 401K  Cannot transfer from IRA into a 401K Roth IRA: 1997 tax reform act o No tax deduction for contribution o Interest grow tax-free o Withdrawals are tax-free o Can contribute up to $5,500 annually...