1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 13
Retirement Savings and Deferred
Compensation

2. 13-2
Learning Objectives
1. Describe the tax and nontax aspects of employer-
provided defined benefit plans from both the
employer’s and employee’s perspective.
2. Explain and determine the tax consequences
associated with employer-provided defined
contribution plans, including traditional 401(k) and
Roth 401(k) plans.
3. Describe the tax implications of deferred
compensation from both the employer’s and
employee’s perspective.

3. 13-3
Learning Objectives
4. Determine the tax consequences of traditional and
Roth Individual Retirement Accounts and explain
the differences between them.
5. Describe the retirement savings options available
to self-employed taxpayers and compute the
limitations for deductible contributions to
retirement accounts for self-employed taxpayers.
6. Compute the saver’s credit.

4. 13-4
Employer Provided Plans
 Qualified Plans
 Must not discriminate between employees
 Two main types:
 Defined benefit plan
 Defined contribution plan

5. 13-5
Defined Benefit Plans
 Standard benefits based on fixed formula
 Average compensation
 Years of service
 Employers deduct liability as they contribute
to plan
 Funding requirements based on actuarial
assumptions
 Employer not employee bears investment risk

6. 13-6
Defined Benefit Plans
 Vesting schedules
 5-year cliff or
 7-year graded
 Distributions from defined benefit plans are
taxable to employee when received.
 Ordinary income
 Early distributions subject to 10% penalty

7. 13-7
Defined Contribution Plans
 Employer specifies up-front contribution on
employee’s behalf
 Employers typically match employee contributions
 Employees may contribute to plan
 Employees choose how to invest contributions
 Alternatives depend on employer’s plan
 401(k), 403(b), and 457

8. 13-8
Defined Contribution Plans
 Annual contribution limits for 2011
 Employee contributions
 $16,500 if not 50 years of age by year end
 $22,000 if at least 50 years old by year end
 Employer + Employee contributions
 Limited to lesser of $49,000 ($54,500 if at least 50
years old at end of year) or 100% of the
employee’s compensation.

9. 13-9
Defined Contribution Plans
 Vesting
 Employee contributions and earnings on
employee contributions
 Vest immediately.
 Employer contributions and earnings on employer
contributions
 Minimum vesting requirements
 3-year cliff or
 6-year graded schedule.

10. 13-10
Defined Contribution Plans

11. 13-11
Defined Contribution Plans
 Distributions
 Distributions are ordinary income
 Early distributions subject to a 10% penalty
 Before 59 ½ year of age if still working or
 Before 55 years old and separated from service
(retired)

12. 13-12
Defined Contribution Plans
 Required minimum distributions
 For the year in which employee reaches age 70 ½
or when the employee retires, if later (and each
subsequent year)
 May defer first required distribution to April 1 of next
year, otherwise distribution must be received by
December 31 of current year
 Based on applicable percentage of balance at end
of prior year
 50% penalty on undistributed portion of minimum
distribution requirement.

13. 13-13
Traditional 401k Plans
 Contributions are made with before-tax
dollars.
 Tax deductible
 Distributions:
 Same rules as other defined contribution plans

14. 13-14
Roth 401k Plans
 Contributions made with after-tax dollars.
 Not tax deductible
 Employer contributions must go into a
traditional 401k plan (not a Roth 401k plan)

15. 13-15
Roth 401k Plans
 Qualified distributions
 After account open for five years and employee
has reached age 59 ½.
 Non-qualified distributions
 Distributions of earnings are taxable and
subject to 10% penalty
 Distributions from contributions are not taxable
 Contributions divided by account balance multiplied
by amount of distribution equals distribution from
contributions

16. 13-16
Deferred Compensation
 “Nonqualified plans”
 May discriminate
 Generally provided to executives or highly
compensated rather than rank and file
 Can be used to make employee’s whole
when contributions to qualified plans would
be limited
 Deemed investment choices
 Risks to employees electing to defer salary?

17. 13-17
Deferred Compensation
 Employer deducts for tax purposes when
pays
 Compare to financial accounting
 Employee includes in income when
received
 If paid after retirement, §162(m) limitation
does not apply

18. 13-18
Deferred Compensation
 Relevant variables
 Employer and employee current tax rates
 Employer and employee future tax rates
 Employer’s cost of capital or discount rate
 Employee’s cost of capital or discount rate

19. 13-19
Individually Managed Qualified
Retirement Plans
 IRAs
 Roth IRAs

20. 13-20
Individual Retirement
Accounts (IRAs)
 For AGI deduction for contributions
 Generally not allowed if participant in employer-
sponsored plan unless
 For single taxpayers Taxpayer is single, deduction
allowed if participate in employer plan but income is
below certain thresholds
 In 2011, lesser of $5,000 in 2011 or earned income
 If 50 years or older at end of year limit is $6,000
 Additional “catch-up” contribution

21. 13-21
Individual Retirement
Accounts (IRAs)
 For AGI deduction for contributions
 Generally, not allowed if participant in employer-
sponsored plan unless
 For married taxpayers deduction is allowed if
participate in employer plan but income is below
certain thresholds
 In 2011, lesser of $5,000 in 2011 or earned income
of both spouses reduced by other spouse’s
contributions to IRA or Roth IRA
 If 50 years or older at end of year limit is $6,000
 Additional “catch-up” contribution

22. 13-22
Individual Retirement
Accounts (IRAs)
 May make nondeductible contributions
 Deductible + nondeductible cannot exceed
$5,000 for one taxpayer (plus catch-up)
 Must contribute by April 15th
of
subsequent year

23. 13-23
Individual Retirement
Accounts (IRAs)
 Distributions taxed as ordinary income
 10% penalty if before 59 ½
 Certain exceptions
 Medical expenses, insurance premiums, first
home
 Same minimum distributions apply as to
qualified contribution plans
 nontaxable percentage = nondeductible
contributions divided by balance of account

24. 13-24
Roth IRAs
 Nondeductible contributions
 Contributions to a Roth IRA
 Same $5,000 limit ($6,000 if 50 or older at year
end)
 Phase-out based on AGI

25. 13-25
Roth IRAs
 Distributions from a Roth
 Distributions of contributions never taxed
 Qualified distributions of earnings from Roth not taxed
 Account must be open for five years before can receive
qualified distributions and
 Taxpayer must be at least 59 ½ to receive qualified distribution or
 Distributions on death of taxpayer or
 Taxpayer is disabled or
 First home (limited to $10,000)
 No minimum distribution requirements

26. 13-26
Roth IRAs
 Rollover from traditional to Roth
 Tax consequences
 Why roll over?
 Marginal tax rates
 Contribution limits to Roth are effectively higher
 $5,000 limit of after tax vs. before-tax dollars

27. 13-27
Plans for Self-Employed
 SEP IRA
 Individual 401(k)

28. 13-28
SEP IRA
 Contribution limit
 Lesser of (1) $49,000 or (2) 20% of net earnings
from self employment
 Must provide plan to employees if taxpayer has
employees

29. 13-29
Individual 401(k)
 Contribution limit
 Lesser of (1) $49,000 or (2) 20% of net earnings
from self employment + $16,500
 Additional $5,500 if age by year end
 Maximum contribution is $54,500 ($49,000 + $5,500)

30. 13-30
Saver’s Credit
 Credit for taxpayers contributing to qualified
plans
 Credit in addition to deduction for contribution
 Available to lower income taxpayers
 Depends on filing status and AGI

31. 13-31
Saver’s Credit