Retirement Accounts

Different types and how they work, IRS rules, maximum contribution etc.

IRA, 401k, SEP, Pensions, Roth, etc. 403b, 457plan


expand on all

Keep retirement, 1st part on this page and make links and separate pages for each type of account etc.

clean up all, take out crap

Individual Retirement AccountFrom Wikipedia, the free encyclopediaJump to: navigation, search
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An individual retirement arrangement (IRA) is the blanket term for a form of retirement plan that provides tax advantages for retirement savings in the United States. The term encompasses an individual retirement account — a trust or custodial account set up for the exclusive benefit of taxpayers or their beneficiaries — and an individual retirement annuity, by which the taxpayers purchase an annuity contract or an endowment contract from a life insurance company.[1]

Contents [hide]
1 Types
2 Funding
3 Valid investments
4 Distribution of funds
5 Bankruptcy status
6 Protection from creditors
7 Borrowing
7.1 Rollovers as Business Start-Ups (ROBS)
7.1.1 ROBS Project Findings: New Business Failures
8 Double taxation
9 Similar schemes in other countries
10 See also
11 Notes
12 References
13 External links

[edit] TypesIndividual retirement arrangements were introduced in 1974 with the enactment of the Employee Retirement Income Security Act (ERISA). Taxpayers could contribute up to $1,500 a year and reduce their taxable income by the amount of their contributions. Initially, ERISA restricted IRAs to workers who were not covered by a qualified employment-based retirement plan. In 1981, the Economic Recovery Tax Act (ERTA) allowed all taxpayers under the age of 70½ to contribute to an IRA, regardless of their coverage under a qualified plan. It also raised the maximum annual contribution to $2,000 and allowed participants to contribute $250 on behalf of a nonworking spouse. The Tax Reform Act of 1986 phased out the deduction for IRA contributions among higher-earning workers who are covered by an employment-based retirement plan. However, those earning above the amount that allowed deductible contributions could still make nondeductible contributions to their IRA. The maximum amount allowed as an IRA contribution was $1500 from 1975 to 1981, $2000 from 1982 to 2001, $3000 from 2002 to 2004, $4000 from 2004 to 2007, and $5000 from 2008 to 2010. Beginning in 2002, those over 50 could make an additional contribution called a "Catch-up Contribution."[2]

Roth IRA - contributions are made with after-tax assets, all transactions within the IRA have no tax impact, and withdrawals are usually tax-free. Named for Senator William V. Roth, Jr.. The Roth IRA was introduced as part of the Taxpayer Relief Act of 1997.
Traditional IRA - contributions are often tax-deductible (often simplified as "money is deposited before tax" or "contributions are made with pre-tax assets"), all transactions and earnings within the IRA have no tax impact, and withdrawals at retirement are taxed as income (except for those portions of the withdrawal corresponding to contributions that were not deducted). Depending upon the nature of the contribution, a traditional IRA may be referred to as a "deductible IRA" or a "non-deductible IRA."
SEP IRA - a provision that allows an employer (typically a small business or self-employed individual) to make retirement plan contributions into a Traditional IRA established in the employee's name, instead of to a pension fund in the company's name.
SIMPLE IRA - a simplified employee pension plan that allows both employer and employee contributions, similar to a 401(k) plan, but with lower contribution limits and simpler (and thus less costly) administration. Although it is termed an IRA, it is treated separately.
Self-Directed IRA - a self-directed IRA that permits the account holder to make investments on behalf of the retirement plan.
There are two other subtypes of IRA, named Rollover IRA and Conduit IRA, that are viewed as obsolete under current tax law (their functions have been subsumed by the Traditional IRA) by some; but this tax law is set to expire unless extended. However, some individuals still maintain these arrangements in order to keep track of the source of these assets. One key reason is that some qualified plans will accept rollovers from IRAs only if they are conduit/rollover IRAs.

What was formerly known as an Educational IRA is now called a Coverdell Education Savings Account.

Starting with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many of the restrictions of what type of funds could be rolled into an IRA and what type of plans IRA funds could be rolled into were significantly relaxed. Additional acts have further relaxed similar restrictions. Essentially most retirement plans can be rolled into an IRA after meeting certain criteria, and most retirement plans can accept funds from an IRA. An example of an exception is a non-governmental 457 plan which cannot be rolled into anything but another non-governmental 457 plan.

The tax treatment of the above types of IRAs except for Roth IRAs are substantially similar, particularly for rules regarding distributions. SEP IRAs and SIMPLE IRAs also have additional rules similar to those for qualified plans governing how contributions can and must be made and what employees are qualified to participate.

[edit] FundingAn IRA can only be funded with cash or cash equivalents. Attempting to transfer any other type of asset into the IRA is a prohibited transaction and disqualifies the fund from its beneficial tax treatment.
Rollovers, transfers, and conversions between IRAs and other retirement arrangements can include any asset.
The maximum for an IRA contribution in years 2006 and 2007 is 100% of earned income or $4,000, whichever is less, for an individual under the age of 50. Individuals aged 50 and older can contribute up to 100% of earned income or $5,000, whichever is less. For 2008 through 2010, the limit is $5,000 for those under age 50, and $6,000 for those over 50.
This limit is for Roth IRAs, traditional IRAs, or some combination of the two. You cannot put more than $5,000 into your Roth and traditional IRA combined ($6,000 for individuals aged 50 or more).
For example, if you are 45 and put $3,500 into your traditional IRA this year so far, you can either put $1,500 more into your traditional IRA or $1,500 in your Roth IRA. There may be an additional administrative step needed so that the trustee which holds the IRA proceeds actually retitles or transfers the $3,500 Traditional proceeds into the Roth category for their internal bookkeeping to survive an IRS audit.
There is a deductibility phaseout limit on Traditional IRAs (if covered by a work retirement plan) as well as income level phaseout for Roth IRAs (see IRS Publication 590, "Individual Retirement Arrangements"). For 2010, married filing jointly, the phaseout is $177,000 (modified AGI).
[edit] Valid investmentsOnce money is inside an IRA, the IRA owner can direct the custodian to use the cash to purchase most types of securities, and some non security financial instruments. Some assets cannot be held in an IRA such as collectibles (e.g., art, baseball cards, and rare coins) and life insurance. Some assets are allowed, subject to certain restrictions by custodians themselves. For example an IRA cannot own real estate if the IRA owner receives or provides any immediate gain from/to this real estate investment. Examples of such gain would be the use of the property as the owner's personal residence or the benefit paid to an owner as property manager in the form of personal compensation for this service. The IRS specifically states that custodians may impose their own policies above the rules imposed by the IRS.[3] It should also be noted that custodians cannot provide advice.

Many IRA custodians limit available investments to traditional brokerage accounts such as stocks, bonds, and mutual funds, and do not permit real estate in an IRA unless the real estate is held indirectly via a security such as a real estate investment trust (REIT). Self-directed IRA custodians/administrators can allow real estate and other non-traditional assets. For example, some options brokers allow their IRA accounts to hold stock options, which are derivatives, not securities.[4] They typically charge fees based on asset values. There are certain special restrictions on real estate held in an IRA (the IRA owner cannot benefit from the property in any way, i.e. he or she cannot use it). Self Directed IRA's allowing non security investments are more complicated.

While certain types of investments are prohibited in an IRA, real estate is not one of them. As a result, real estate owned by an IRA can generate rental income and gain on a sale which escapes immediate taxation. However, the IRA does not get (or, need) the related deductions (e.g., depreciation, mortgage interest,property taxes, etc.).

An IRA may borrow money but any such loan must not be personally guaranteed by the owner of the IRA, and also the loan must be secured solely by assets in the IRA (in other words, a non-recourse loan). Also, the owner of the IRA may not pledge the IRA as security against a debt.

Even if a particular investment is permitted to be held in an IRA, care should be taken to optimize the location of the investment in a taxable account, a traditional IRA or a Roth IRA. For example, interest on municipal bonds is generally not taxable; it is thus generally not optimal to hold municipal bonds in an IRA.[5]

[edit] Distribution of fundsAlthough funds can be distributed from an IRA at any time, there are limited circumstances when money can be distributed or withdrawn from the account without penalties. Unless an exception applies, money can typically be withdrawn penalty free as taxable income from an IRA once the owner reaches age 59 and a half. Also, non-Roth owners must begin taking distributions of at least the calculated minimum amounts by April 1 of the year after reaching age 70 and a half. If the required minimum distribution is not taken the penalty is 50% of the amount that should have been taken. The amount that must be taken is calculated based on a factor taken from the appropriate IRS table and is based on the life expectancy of the owner and possibly his or her spouse as beneficiary if applicable. At the death of the owner, distributions must continue and if there is a designated beneficiary, distributions can be based on the life expectancy of the beneficiary.

There are several exceptions to the rule that penalties apply to distributions before age 59½. Each exception has detailed rules that must be followed to be exempt from penalties. The exceptions include:[6]

The portion of unreimbursed medical expenses that are more than 7.5% of adjusted gross income
Distributions that are not more than the cost of medical insurance while unemployed
Disability (defined as not being able to engage in any substantial gainful activity)
Amounts distributed to beneficiaries of a deceased IRA owner
Distributions in the form of an annuity, see Substantially equal periodic payments
Distributions that are not more than the qualified higher education expenses of the owner or their children or grandchildren
Distributions to buy, build, or rebuild a first home. ($10,000 lifetime maximum)
Distribution due to an IRS levy of the plan
There are a number of other important details that govern different situations. For Roth IRAs with only contributed funds the basis can be withdrawn before age 59½ without penalty (or tax) on a first in first out basis, and a penalty would apply only on any growth (the taxable amount) that was taken out before 59½ where an exception didn't apply. Amounts converted from a traditional to a Roth IRA must stay in the account for a minimum of 5 years to avoid having a penalty on withdrawal of basis unless one of the above exceptions applies.

If the contribution to the IRA was nondeductible or the IRA owner chose not to claim a deduction for the contribution, distributions of those nondeductible amounts are tax and penalty free.

[edit] Bankruptcy statusIn the case of Rousey v. Jacoway, the United States Supreme Court ruled unanimously on April 4, 2005 that under section 522(d)(10)(E) of the United States Bankruptcy Code (11 U.S.C. § 522(d)(10)(E)), a debtor in bankruptcy can exempt his or her IRA, up to the amount necessary for retirement, from the bankruptcy estate.[7] The Court indicated that because rights to withdrawals are based on age, IRAs should receive the same protection as other retirement plans. Thirty-four states already had laws effectively allowing an individual to exempt an IRA in bankruptcy, but the Supreme Court decision allows federal protection for IRAs.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 expanded the protection for IRAs. Certain IRAs (rollovers from SEP or Simple IRAs, ROTH IRAs, individual IRAs) are exempt up to at least $1,000,000 (adjusted periodically for inflation) without having to show necessity for retirement.[8] The law provides that "such amount may be increased if the interests of justice so require."[9] Other IRAs (rollovers from most employer sponsored retirement plans (401(k)s, etc.) and non-rollover SEP and SIMPLE IRAs) are entirely exempt.[10]

The 2005 BAPCPA also increased the Federal Deposit Insurance Corporation insurance limit for IRA deposits at banks.

Note that if an IRA engages in a "prohibited transaction," the assets in the IRA will no longer qualify for bankruptcy protection, according to one Federal Circuit Court of Appeals. See Willis v. Menotte, 11th Circuit Court of Appeals, 2011.

[edit] Protection from creditorsMany states have laws that prohibit judgments from lawsuits to be satisfied by seizure of IRA assets. For example, IRAs are protected up to $500,000 in Nevada from Writs of Execution.[11] However, this type of protection does not usually exist in the case of divorce, failure to pay taxes, deeds of trust, and fraud. Assets in the IRA must have been deposited before a lawsuit exists to receive this protection.[citation needed]

[edit] BorrowingAn IRA owner may not borrow money from the IRA except for a 2-month period in a calendar year.[12] Such a transaction disqualifies the IRA from special tax treatment. An IRA may incur debt or borrow money secured by its assets but the IRA owner may not guarantee or secure the loan personally. An example of this is a real estate purchase within a self-directed IRA along with a non-recourse mortgage.

Note that some minor planning can turn the 2-month period mentioned in the preceding paragraph into an indefinite loan as explained in this detailed post on IRA Loans.

Income from debt-financed property in an IRA may generate unrelated business taxable income in the IRA.

The rules regarding IRA rollovers and transfers allow the IRA owner to perform an "indirect rollover" to another IRA. This can be used to temporarily "borrow" money from the IRA, once in a twelve month period. The money must be placed in an IRA arrangement within 60 days, or the transaction will be deemed an early withdrawal (subject to the appropriate withdrawal taxes and penalties) and may not be replaced.

[edit] Rollovers as Business Start-Ups (ROBS)ROBS is an arrangement in which prospective business owners use their 401(k) retirement funds to pay for new business start-up costs.[13] ROBS is an acronym from the United States Internal Revenue Service for the IRS ROBS Rollovers as Business Start-Ups Compliance Project.

ROBS plans, while not considered an abusive tax avoidance transaction, have been considered questionable because they may solely benefit one individual – the individual who rolls over his or her existing retirement 401(k) withdrawal funds to the ROBS plan in a tax-free transaction. The ROBS plan then uses the rollover assets to purchase the stock of the new business. A C corporation must be set up in order to roll the 401(k) withdrawal.

[edit] ROBS Project Findings: New Business FailuresPreliminary results from the ROBS Project indicate that, although there were some success stories, most ROBS businesses either failed or were on the road to failure with high rates of bankruptcy (business and personal), liens (business and personal), and corporate dissolutions by individual Secretaries of State. Some of the individuals who started ROBS plans lost not only the retirement assets they accumulated over many years, but also their dream of owning a business. As a result, much of the retirement savings invested in their unsuccessful ROBS plan was depleted or ‘lost,’ in many cases even before they had begun to offer their product or service to the public.[14]

[edit] Double taxationDouble taxation still occurs within these tax-sheltered investment arrangements. For example, foreign dividends may be taxed at their point of origin, and the IRS does not recognize this tax as a creditable deduction. There is some controversy over whether this violates tax treaties, such as the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital.

Individual Retirement Account - IRAWhat Does Individual Retirement Account - IRA Mean?
An investing tool used by individuals to earn and earmark funds for retirement savings. There are several types of IRAs: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs.

Traditional and Roth IRAs are established by individual taxpayers, who are allowed to contribute 100% of compensation (self-employment income for sole proprietors and partners) up to a set maximum dollar amount. Contributions to the Traditional IRA may be tax deductible depending on the taxpayer's income, tax filing status and coverage by an employer-sponsored retirement plan. Roth IRA contributions are not tax-deductible.

SEPs and SIMPLEs are retirement plans established by employers. Individual participant contributions are made to SEP IRAs and SIMPLE IRAs.

Also referred to as "individual retirement arrangements." Investopedia explains Individual Retirement Account - IRA
With the exception of Roth IRAs, where eligible distributions are tax-free, eventual withdrawal from an IRA is taxed as income; including the capital gains. Because income is likely to be lower after retirement, the tax rate may be lower. Combined with potential tax savings at the time of contribution, IRAs can prove to be very valuable tax management tools for individuals. Also, depending on income, an individual may be able to fit into a lower tax bracket with tax-deductible contributions during his or her working years while still enjoying a low tax bracket during retirement.

Traditional IRAFrom Wikipedia, the free encyclopediaJump to: navigation, search
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Established by the Tax Reform Act (TRA) of 1986, (Pub.L. 99-514, 100 Stat. 2085). A Traditional IRA is an individual retirement account (IRA) in the United States. The IRA is held at a custodian institution such as a bank or brokerage, and may be invested in anything that the custodian allows (for instance, a bank may allow certificates of deposit, and a brokerage may allow stocks and mutual funds). Unlike the Roth IRA, the only criterion for being eligible to contribute to a Traditional IRA is sufficient income to make the contribution. However, the best provision of a Traditional IRA — the tax-deductibility of contributions — has strict eligibility requirements based on income, filing status, and availability of other retirement plans (mandated by the Internal Revenue Service). Transactions in the account, including interest, dividends, and capital gains, are not subject to tax while still in the account, but upon withdrawal from the account, withdrawals are subject to federal income tax (see below for details). This is in contrast to a Roth IRA, in which contributions are never tax-deductible, but qualified withdrawals are tax free. The traditional IRA also has more restrictions on withdrawals than a Roth IRA. With both types of IRA, transactions inside the account (including capital gains, dividends, and interest) incur no tax liability.

According to IRS pension/retirement department as of July 13 2009, Traditional IRAs (originally called Regular IRAs) were created in 1975 and made available for tax reporting that year as well. Information pertaining to them from 1980 through the present is available at the website. by reviewing the instructions for the form 1040. The original contribution amount in 1975 was limited to $1,500 or 15% of the wages/salaries/tips reported on line 8 of the Federal form 1040 (1975).

Contents [hide]
1 Advantages
2 Disadvantages
3 Income limits
4 Converting a Traditional IRA to a Roth IRA
5 Transfers vs. Rollovers
5.1 "Borrowing Money" from an IRA
6 See also
7 External links
8 Notes and references

Traditional IRA contributions are limited as follows:

Year Age 49 and Below Age 50 and Above
2005 $4,000 $4,500
2006–2007 $4,000 $5,000
2008–2010[1] $5,000 $6,000
2011 and beyond[1] Indexed to inflation (in $500 increments) Indexed to inflation (in $500 increments)

[edit] AdvantagesThe main advantage of a Traditional IRA, compared to a Roth IRA, is that contributions are often tax-deductible. For instance, if a taxpayer contributes $4,000 to a traditional IRA and is in the twenty-five percent marginal tax bracket, then a $1,000 benefit ($1,000 reduced tax liability) will be realized for the year. Because qualified distributions are taxed as ordinary income (the taxpayer's highest rate), the long-term benefits of the traditional IRA are only comparable to those of a Roth IRA (whose qualified distributions are tax free) if the current year tax benefit ($1,000 above) is reinvested, or if the pre-tax amount going into both is the same.
Also, if a taxpayer expects to be in a lower tax bracket in retirement than during the working years, then a traditional IRA offers an increased incentive over the Roth IRA.
Another advantage of a Traditional IRA is that the taxpayer gets the tax benefit immediately.
With the Roth IRA, there may be a risk that over the next several decades Congress will decide to tax Roth IRA distributions; or that a national Value Added Tax will be imposed on purchases. Either alternative would subject the Roth beneficiary to effective double Federal taxation, once at the time of the deposit, once at the time of withdrawal.
[edit] DisadvantagesThere are the eligibility requirements for the tax-deductibility. If one is eligible for a retirement plan at work, one's income must be below a specific threshold for your filing status.
All withdrawals from a Traditional IRA are included in gross income and subject to federal income tax (with the exception of any nondeductible contributions; there is a formula for determining how much of a withdrawal is not subject to tax). If one's investment style is buy-and-hold or dividend-seeking, then a Traditional IRA is at a disadvantage since holding stocks in an IRA means they lose their favorable tax treatment given to dividends and capital gains.
If one has a lot of disposable income, a Roth IRA in effect shelters more assets from taxes on gains than a Traditional IRA does, because the contribution limits are the same, but the Traditional IRA is pre-tax, so it is equivalent to a lesser amount of Roth IRA money post-tax. Suppose someone in the 25% tax bracket has $5333 pre-tax income to invest. He can invest all of this post-tax (which is $4000) to a Roth IRA. But he can only invest a portion of it ($4000 pre-tax) to a Traditional IRA. In the future, again assuming 25% taxes, this will be equivalent to an initial post-tax investment of $3000. One would have to invest the remainder of the money that could not be contributed to the Traditional IRA to try to make up some of this difference; however, such an investment would not be tax-sheltered, so does not grow as fast as a tax-sheltered investment.
Perhaps the greatest disadvantage of the Traditional IRA is its forced distributions based on age. Withdrawals must begin by age 70½ (more precisely, by April 1 of the calendar year after age 70½ is reached) according to a complicated formula. If an investor fails to make the required withdrawal, half of the mandatory amount will be confiscated automatically by the IRS. The Roth is completely free of these mandates.
In addition to the distribution being included as taxable income, the IRS will also assess a 10% early distribution penalty if the participant is under age 59½. The IRS will waive this penalty with some exceptions, including first time home purchase (up to $10,000), higher education expenses, death, disability, unreimbursed medical expenses, health insurance, annuity payments and payments of IRS levies, all of which must meet certain stipulations.
[edit] Income limitsAll United States taxpayers can make IRA deposits and defer the taxation of earnings. However, as explained below, the deposits are not deductible from income under certain circumstances. Accordingly, traditional IRAs are sometimes referred to as either "deductible" or "non-deductible."

If a taxpayer's household is covered by one or more employer-sponsored retirement plans, then the deductibility of traditional IRA contributions are phased out as specified income levels are reached (Modified Adjusted Gross Income is between).

Year Married Filing Jointly or Qualified Widow Married Filing Jointly (and you were not covered by an employee-sponsored retirement plan but your spouse was) Single, Head of Household or Married Filing Separately (and you did not live with your spouse) Married Filing Separately (and you lived with your spouse at any time during the year)
2007 $83,000 and $103,000 $156,000 and $166,000 $52,000 and $62,000 $0 and $10,000
2008 $85,000 and $105,000 $159,000 and $169,000 $53,000 and $63,000 $0 and $10,000
2009 $89,000 and $109,000 $166,000 and $176,000 $55,000 and $65,000 $0 and $10,000
2010 $89,000 and $109,000 $167,000 and $177,000 $56,000 and $66,000 $0 and $10,000
2011 $90,000 and $110,000 $169,000 and $179,000 $56,000 and $66,000 $0 and $10,000

The lower number represents the point at which the taxpayer is still allowed to deduct the entire maximum yearly contribution. The upper number is the point as of which the taxpayer is no longer allowed to deduct at all. The deduction is reduced proportionally for taxpayers in the range. Note that people who are married and lived together, but who file separately, are only allowed to deduct a relatively small amount.

To be eligible, you must meet the earned income minimum requirement. In order to make a contribution, you must have taxable compensation (not taxable income from investments). If you make only $2000 in taxable compensation, your maximum IRA contribution is $2000.

[edit] Converting a Traditional IRA to a Roth IRAConversion of a Traditional IRA to a Roth IRA results in the converted funds becoming taxed in the year they are converted (with the exception of non-deductible assets).

Prior to 2010, two circumstances prohibit a conversion to a Roth IRA: Modified Adjusted Gross Income exceeding $100,000 or the participant's tax filing status is Married Filing Separately. With recent legislation, as part of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), the modified AGI requirement of $100,000 and not be married filing separately criteria was removed in 2010.

[edit] Transfers vs. RolloversTransfers and rollovers are two ways of moving IRA sheltered assets between financial institutions.

A transfer is normally initiated by the institution receiving the funds. A request is sent to the disbursing institution for a transfer and a check (made payable to the other institution) is sent in return. This transaction is not reported to the IRS

A rollover (sometimes referred to as a 60 day rollover) can also be used to move IRA money between institutions. A distribution is made from the institution disbursing the funds. A check would be made payable directly to the participant. The participant would then have to make a rollover contribution to the receiving financial institution within 60 days in order for the funds to retain their IRA status. This type of transaction can only be done once every 12 months with the same funds. Contrary to a transfer, a rollover is reported to the IRS. The participant who received the distribution will have that distribution reported to the IRS. Once the distribution is rolled into an IRA, the participant will be sent a Form 5498 to report on their taxes to nullify any tax consequence of the initial distribution.

[edit] "Borrowing Money" from an IRAA loan from an IRA is prohibited. It is considered a prohibited transaction and the IRS may disqualify your plan and tax you on the assets. Some use the 60 day rollover as a way to temporarily take funds from an IRA. A participant will take a distribution and, in turn, all or some of the distribution that the participant takes may be rolled back into the same IRA plan within the allowed period to retain its tax deferred status. One 60 day rollover is allowed every rolling 12 months, per IRA[2]. For instance, if you withdraw any amount from IRA-1 and deposit it into IRA-2 (as a tax-free rollover), you cannot make another tax-free rollover of any funds from IRA-1 or IRA-2 for 365 days. However, this would not prevent you from making a tax-free rollover from another IRA.

Roth IRAWhat Does Roth IRA Mean?
An individual retirement plan that bears many similarities to the traditional IRA, but contributions are not tax deductible and qualified distributions are tax free. Similar to other retirement plan accounts, non-qualified distributions from a Roth IRA may be subject to a penalty upon withdrawl. Investopedia explains Roth IRA
A qualified distribution is one that is taken at least five years after the taxpayer establishes his or her first Roth IRA and when he or she is age 59.5, disabled, using the withdrawal to purchase a first home (limit $10,000), or deceased (in which case the beneficiary collects). Since qualified distributions from a Roth IRA are always tax free, some argue that a Roth IRA may be more advantageous than a Traditional IRA.

Roth IRAFrom Wikipedia, the free encyclopediaJump to: navigation, search
A Roth IRA (Individual Retirement Account) is a special type of retirement plan under US law that is generally not taxed, provided certain conditions are met. The tax law of the United States allows a tax reduction on a limited amount of saving for retirement. The Roth IRA is named for its chief legislative sponsor, the late Senator William Roth of Delaware. The Roth IRA's principal difference from most other tax advantaged retirement plans is that, rather than granting a tax break for money placed into the plan, the tax break is granted on the money withdrawn from the plan during retirement.

Established by the Taxpayer Relief Act of 1997 (Public Law 105-34), a Roth IRA can be an individual retirement account containing investments in securities, usually common stocks and bonds, often through mutual funds (although other investments, including derivatives, notes, certificates of deposit, and real estate are possible). A Roth IRA can also be an individual retirement annuity, which is an annuity contract or an endowment contract purchased from a life insurance company. As with all IRAs, the Internal Revenue Service mandates specific eligibility and filing status requirements. A Roth IRA's main advantages are its tax structure and the additional flexibility that this tax structure provides. Also, there are fewer restrictions on the investments that can be made in the plan than many other tax advantaged plans, and this adds somewhat to the popularity, though the investment options available depends on the trustee (or the place where the plan is established).

The total contributions allowed per year to all IRAs is the lesser of your taxable compensation (which is not the same as adjusted gross income) and the limit amounts as seen below (this total may be split up between any number of traditional and Roth IRAs. In the case of a married couple, each spouse may contribute the amount listed):

Age 49 and Below Age 50 and Above
1998–2001 $2,000 $2,000
2002–2004 $3,000 $3,500
2005 $4,000 $4,500
2006–2007 $4,000 $5,000
2008–2011* $5,000 $6,000

For example, if you are single, aged 49 or under, and earn $10,000, you can contribute a maximum of $5,000 in 2008. However, if you are single and earn $2,000, you can contribute only a maximum of $2,000 in 2008 ($2,000 is the lesser of $2,000 and $5,000).

* Starting in 2009, contribution limits will be assessed for a potential increase based on inflation, though the 2009 contribution limits have remained unchanged.

Contents [hide]
1 Differences from a traditional IRA
1.1 Advantages
1.2 Disadvantages
2 Double taxation
3 Eligibility
3.1 Income limits
3.2 Contribution Limits
3.3 Conversion limit
3.4 Distributions
4 See also
5 Further reading
6 References
7 External links

[edit] Differences from a traditional IRAIn contrast to a traditional IRA, contributions to a Roth IRA are not tax-deductible. Withdrawals are generally tax-free, but not always and not without certain stipulations (i.e., tax free when the plan has been opened for at least 5 years for principal withdrawals and the owner's age is at least 59½ for withdrawals on the growth portion above principal). An advantage of the Roth IRA over a traditional IRA is that there are fewer withdrawal restrictions and requirements. Transactions inside an account (including capital gains, dividends, and interest) do not incur a current tax liability.

[edit] AdvantagesDirect contributions to a Roth IRA may be withdrawn tax free at any time.[1] Rollover, converted (before age 59½) contributions held in a Roth IRA may be withdrawn tax and penalty free after the "seasoning" period (currently 5 years). Earnings may be withdrawn tax and penalty free after the seasoning period if the condition of age 59½ (or other qualifying condition) is also met. This differs from a traditional IRA where all withdrawals are taxed as Ordinary Income, and a penalty applies for withdrawals before age 59½. In contrast, capital gains on stocks or other securities held in a regular taxable account for at least a year would be taxed at the lower long-term capital gain rate, which is currently 15%. This potentially higher tax rate for withdrawals of capital gains from a traditional IRA is a quid pro quo for the deduction taken against ordinary income when putting money into the Roth IRA.
If there is money in the Roth IRA due to conversion from a traditional IRA, the Roth IRA owner may withdraw up to the total of the converted amount without penalty, as long as the "seasoning" period (currently five years) has passed on the converted funds.
Up to a lifetime maximum $10,000 in earnings withdrawals are considered qualified (tax-free) if the money is used to acquire a principal residence for a first time buyer. This house must be acquired by the Roth IRA owner, their spouse, or their lineal ancestors and descendants. The owner or qualified relative who receives such a distribution must not have owned a home in the previous 24 months.
Contributions may be made to a Roth IRA even if the owner participates in a qualified retirement plan such as a 401(k). (Contributions may be made to a traditional IRA in this circumstance, but they may not be tax deductible.)
If a Roth IRA owner dies, and his/her spouse becomes the sole beneficiary of that Roth IRA while also owning a separate Roth IRA, the spouse is permitted to combine the two Roth IRAs into a single plan without penalty.[2]
If the Roth IRA owner expects that the tax rate applicable to withdrawals from a traditional IRA in retirement will be higher than the tax rate applicable to the funds earned to make the Roth IRA contributions before retirement, then there may be a tax advantage to making contributions to a Roth IRA over a traditional IRA or similar vehicle while working. There is no current tax deduction, but money going into the Roth IRA is taxed at the taxpayer's current marginal tax rate, and will not be taxed at the expected higher future effective tax rate when it comes out of the Roth IRA.
Assets in the Roth IRA can be passed on to heirs.
The Roth IRA does not require distributions based on age. All other tax-deferred retirement plans, including the related Roth 401(k),[3] require withdrawals to begin by April 1 of the calendar year after the owner reaches age 70½. If you don't need the money and want to leave it to your heirs, this is a great way to accumulate income tax free. Beneficiaries who inherited Roth IRAs are subject to the minimum distribution rules.
Roth IRAs have a higher "effective" contribution limit than traditional IRAs, since the nominal contribution limit is the same for both traditional and Roth IRAs, but the post-tax contribution in a Roth IRA is equivalent to a larger pre-tax contribution in a traditional IRA that will be taxed upon withdrawal. For example, a contribution of the 2008 limit of $5,000 to a Roth IRA may be equivalent to a traditional IRA contribution of $6667 (assuming a 25% tax rate at both contribution and withdrawal). In 2008 you cannot contribute $6667 to a traditional IRA due to the contribution limit, so the post-tax Roth contribution may be larger.
On estates large enough to be subject to estate taxes, a Roth IRA can reduce estate taxes since tax dollars have already been subtracted. A traditional IRA is valued at the pre-tax level for estate tax purposes.
[edit] DisadvantagesContributions to a Roth IRA are not tax deductible. By contrast, contributions to a traditional IRA are tax deductible (within income limits). Therefore, someone who contributes to a traditional IRA instead of a Roth IRA gets an immediate tax savings equal to the amount of the contribution multiplied by their marginal tax rate while someone who contributes to a Roth IRA does not realize this immediate tax reduction. Also, by contrast, contributions to most employer sponsored retirement plans (such as a 401(k), 403(b), SIMPLE IRA or SEP IRA) are tax deductible with no income limits because they reduce a taxpayer's adjusted gross income.
Eligibility to contribute to a Roth IRA phases out at certain income limits. By contrast, contributions to most tax deductible employer sponsored retirement plans have no income limit.
Contributions to a Roth IRA do not reduce a taxpayer's adjusted gross income (AGI). By contrast, contributions to a traditional IRA or most employer sponsored retirement plans reduce a taxpayer's AGI. One of the key benefits of reducing one's AGI (aside from the obvious benefit of reducing taxable income) is that a taxpayer who is close to the threshold income of qualifying for some tax credits or tax deductions may be able to reduce their AGI below the threshold at which he or she may become eligible to claim certain tax credits or tax deductions that may otherwise be phased out at the higher AGI had the taxpayer instead contributed to a Roth IRA. Likewise, the amount of those tax credits or tax deductions may be increased as the taxpayer slides down the phaseout scale. Examples include the child tax credit, or the earned income credit, or the student loan interest deduction.
A taxpayer who chooses to make a Roth IRA contribution (instead of a traditional IRA contribution or tax deductible retirement account contribution) while in a moderate or high tax bracket will likely pay more income taxes on the earnings used to make the Roth IRA contribution as compared to the income taxes that would have been due to be paid on the funds that would have been later withdrawn from the traditional IRA, had the taxpayer made a traditional IRA contribution. This is because contributions to traditional IRAs or employer sponsored tax deductible retirement plans result in an immediate tax savings equal to the taxpayer's current marginal tax bracket multiplied by the amount of the contribution. It has been shown that many people have a lower income in retirement than during their working years, and thus end up in a lower tax bracket in retirement, and this is another reason why withdrawals from a traditional IRA or tax deferred retirement plan in retirement are likely to result in a lower tax bill. The higher the taxpayer's marginal tax rate, the greater the disadvantage.
A taxpayer who pays state income taxes and who contributes to a Roth IRA (instead of a traditional IRA or a tax deductible employer sponsored retirement plan) will have to pay state income taxes on the amount contributed to the Roth IRA in the year the money is earned. However, if the taxpayer retires to a state with a lower income tax rate, or no income taxes, then the taxpayer will have given up the opportunity to avoid paying state income taxes altogether on the amount of the Roth IRA contribution by instead contributing to a traditional IRA or a tax deductible employer sponsored retirement plan, because when the contributions are withdrawn from the traditional IRA or tax deductible plan in retirement, the taxpayer will then be a resident of the low or no income tax state, and will have avoided paying the state income tax altogether as a result of moving to a different state before the income tax became due.
The perceived tax benefit may never be realized, i.e., one might not live to retirement or much beyond, in which case, the tax structure of a Roth only serves to reduce an estate that may not have been subject to tax. One must live until one's Roth IRA contributions have been withdrawn and exhausted to fully realize the tax benefit. Whereas, with a traditional IRA, tax might never be collected at all, i.e., if one dies prior to retirement with an estate below the tax threshold, or goes into retirement with income below the tax threshold (To benefit from this exemption, the beneficiary must be named in the appropriate IRA beneficiary form. A beneficiary inheriting the IRA solely through a will will not be eligible for the estate tax exemption. Additionally, the beneficiary will be subject to income tax unless the inheritance is a Roth IRA). Heirs will have to pay taxes on withdrawals from traditional IRA assets they inherit, and must continue to take mandatory distributions (although it will be based on their life expectancy). It is also possible that tax laws may change by the time one reaches retirement age.
Congress may change the rules that currently allow for tax free withdrawal of Roth IRA contributions. Therefore, someone who contributes to a traditional IRA is guaranteed to realize an immediate tax benefit, whereas someone who contributes to a Roth IRA must wait for a number of years before realizing the tax benefit, and that person assumes the risk that the rules might be changed during the interim. On the other hand, taxing earnings on an account which were promised to be untaxed may be seen as a violation of contract – individuals contributing to a Roth IRA now may in fact be saving themselves from new, possibly higher income tax obligations in the future.
[edit] Double taxationDouble taxation may still occur within these tax sheltered investment plans. For example, foreign dividends may be taxed at their point of origin, and the IRS does not recognize this tax as a creditable deduction. There is some controversy over whether this violates existing Joint Tax Treaties, such as the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital.

For Canadians with US Roth IRAs: A new rule (2008) provides that Roth IRAs (as defined in section 408A of the U.S. Internal Revenue Code) and similar plans are considered to be pensions. Accordingly, distributions from a Roth IRA (as well as other similar plans) to a resident of Canada will generally be exempt from Canadian tax to the extent that they would have been exempt from U.S. tax if paid to a resident of the U.S. Additionally, a resident of Canada may elect to defer any taxation in Canada with respect to income accrued in a Roth IRA but not distributed by the Roth IRA, until and to the extent that a distribution is made from the Roth IRA or any plan substituted therefor. The effect of these rules is that, in most cases, no portion of the Roth IRA will be subject to taxation in Canada.

However, where an individual makes a contribution to a Roth IRA while they are a resident of Canada (other than rollover contributions from another Roth IRA), the Roth IRA will lose its status as a "pension" for purposes of the Treaty with respect to the accretions from the time such contribution is made. Income accretions from such time will be subject to tax in Canada in the year of accrual. In effect, the Roth IRA will be bifurcated into a "frozen" pension that will continue to enjoy the benefit of the exemption for pensions and a non-pension (essentially a savings account) that will not.

[edit] Eligibility[edit] Income limitsCongress has limited who can contribute to a Roth IRA based upon income. A taxpayer can contribute the maximum amount listed at the top of the page only if their Modified Adjusted Gross Income (MAGI) is below a certain level (the bottom of the range shown below)[citation needed]. Otherwise, a phase-out of allowed contributions runs proportionally throughout the MAGI ranges shown below. Once MAGI hits the top of the range, no contribution is allowed at all; however, a minimum of $200 may be contributed as long as MAGI is below the top of the range (e.g. A single 40 year old with MAGI $119,999 may still contribute $200 to a Roth IRA vs. $30). Excess Roth IRA contributions may be recharacterized into Traditional IRA contributions as long as the combined contributions do not exceed that tax year's limit. The Roth IRA MAGI phase out ranges for 2010 are:

Single filers: Up to $105,000 (to qualify for a full contribution); $105,000–$120,000 (to be eligible for a partial contribution)[4]
Joint filers: Up to $169,000 (to qualify for a full contribution); $169,000–$179,000 (to be eligible for a partial contribution)[4]
Married filing separately (if the couple lived together for any part of the year): $0 (to qualify for a full contribution); $0–$10,000 (to be eligible for a partial contribution).
The lower number represents the point at which the taxpayer is no longer allowed to contribute the maximum yearly contribution. The upper number is the point as of which the taxpayer is no longer allowed to contribute at all. Note that people who are married and living together, but who file separately, are only allowed to contribute a relatively small amount.

However, once a Roth IRA is established, the balance in the plan remains tax-sheltered, even if the taxpayer's income rises above the threshold. (The thresholds are just for annual eligibility to contribute, not for eligibility to maintain a Roth IRA.) This would be a wise move for retired people who have a comfortable asset base to pay the taxes.

To be eligible, you must meet the earned income minimum requirement. In order to make a contribution, you must have taxable compensation (not taxable income from investments). If you make only $2,000 in taxable compensation, your maximum IRA contribution is $2,000.

[edit] Contribution LimitsContributions to both a Roth IRA and a traditional IRA are limited to the total amount allowed for either ($5,000 for tax year 2010 -- $6,000 if over 50 years of age). Contributions may be further limited if you participate in either a SEP or SIMPLE IRA plan. [5]

[edit] Conversion limitThrough 2009 only taxpayers with MAGI of less than $100,000 in the year of conversion and not married filing separately were allowed to convert from a traditional IRA to a Roth IRA (the converted amount is not included in MAGI). TIPRA 2005 eliminated the MAGI limit and filing status restriction on conversions starting in 2010. Thus regardless of income, contributions can have been made to a traditional IRA in previous years, and then rolled over in 2010 and beyond.

[edit] DistributionsDirect contributions may be withdrawn at any time.[1] Eligible (tax and penalty free) distributions of earnings must fulfill two requirements. First, the seasoning period of five years must have elapsed, and secondly a justification must exist such as retirement or disability. The simplest justification is reaching 59.5 years of age, at which point qualified withdrawals may be made in any amount on any schedule. Becoming disabled or being a "first time" home buyer can provide justification for limited qualified withdrawals. Finally, although one can take distributions from a Roth IRA under the substantially equal periodic payments (SEPP) rule without paying a 10% penalty,[6] any interest[vague] earned in the IRA will be subject to tax[7]—a substantial penalty which forfeits the primary tax benefits of the Roth IRA.

401(k) PlanWhat Does 401(k) Plan Mean?
A qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis. Employers offering a 401(k) plan may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.
Watch: Introduction in 401(k)

401(k) Plan
Caps placed by the plan and/or IRS regulations usually limit the percentage of salary deferral contributions. There are also restrictions on how and when employees can withdraw these assets, and penalties may apply if the amount is withdrawn while an employee is under the retirement age as defined by the plan. Plans that allow participants to direct their own investments provide a core group of investment products from which participants may choose. Otherwise, professionals hired by the employer direct and manage the employees' investments.

401(k)From Wikipedia, the free encyclopediaJump to: navigation, search
A 401(k) is a type of retirement savings account in the United States, which takes its name from subsection 401(k) of the Internal Revenue Code (Title 26 of the United States Code). A contributor can begin to withdraw funds after reaching the age of 59 1/2 years. (See subsection "Withdrawal of funds" below for restrictions before that age.) 401(k)s were first widely adopted as retirement plans for American workers, beginning in the 1980s. The 401(k) emerged as an alternative to the traditional retirement pension, which was paid by employers. Employer contributions with the 401(k) can vary, but in general the 401(k) had the effect of shifting the burden for retirement savings to workers themselves. In 2011, about 60% of American households nearing retirement age have 401(k)-type accounts.[1]

The first cohort of workers to widely adopt this style of retirement plan is beginning to retire, and the plans now appear to generally be falling short. According to a Feb 19, 2011 article in the Wall Street Journal, "the median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain its standard of living in retirement." This according to a study commissioned by the Journal, and conducted by the Center for Retirement Research at Boston College.[1]

Employers can help their employees save for retirement while reducing taxable income under this provision, and workers can choose to deposit part of their earnings into a 401(k) account and not pay income tax on it until the money is later withdrawn in retirement. Interest earned on money in a 401(k) account is never taxed before funds are withdrawn. Employers may choose to, and often do, match contributions that workers make. The 401(k) account is typically administered by the employer, while in the usual "participant-directed" plan, the employee may select from different kinds of investment options. Employees choose where their savings will be invested, usually, between a selection of mutual funds that emphasize stocks, bonds, money market investments, or some mix of the above. Many companies' 401(k) plans also offer the option to purchase the company's stock. The employee can generally re-allocate money among these investment choices at any time. In the less common trustee-directed 401(k) plans, the employer appoints trustees who decide how the plan's assets will be invested.

Since 2006, another type of 401(k) plan has been available. Participants in 401(k) plans that have the proper amendments can allocate some or all of their contributions to a separately-designated Roth account, commonly known as a Roth 401(k). These "Roth" contributions will be collected and treated as after-tax dollars; that is, income tax is paid or withheld in the year contributed. Qualified distributions from a designated Roth 401(k) account, including all income, are tax-free. (A traditional 401(k) account is funded with pre-tax dollars and, in general, tax must be paid when the original contribution and earnings are withdrawn.) All employer matching funds are deposited into the account on a pretax basis, even if the employee's contributions are all Roth contributions. Employer contributions may be subject to vesting rules set by the plan documents requiring the employee to reach a certain number of years of service before they are entitled to keep the matching funds.

For non-profit organizations the corresponding plan is found in 26 USC 403(b) and for government entities it is 26 U.S.C. § 457, although older plans were established under 457(g).

Contents [hide]
1 Tax consequences
2 Withdrawal of funds
2.1 Required Minimum Distributions (RMD)
2.2 Force-out
3 Technical details
3.1 Contribution limits
3.2 Contribution deadline
3.3 Highly compensated employees (HCE)
3.4 Automatic enrollment
4 Plans for certain small businesses or sole proprietorships
4.1 Rollovers as Business Start-Ups (ROBS)
5 Other countries
6 See also
7 References
8 External links

[edit] Tax consequencesDepending on whether the plan allows, employees can make contributions to the 401k on a pre-tax or post tax basis. With either pre-tax or after-tax contributions, earnings from investments in a 401(k) account (in the form of interest, dividends, or capital gains) are tax deferred. The resulting compounding interest with delayed taxation is a major benefit of the 401(k) plan when held over long periods of time. Starting in the 2006 tax year, employees can also elect to designate contributions as a Roth 401(k) deduction. Similar to the provisions of a Roth IRA these contributions are made on an after-tax basis and all earnings on these funds not only are tax deferred but could be tax free upon a qualified distribution. However, to do so, the plan sponsor must amend the plan to make those options available.

For pre-tax contributions, the employee does not pay federal income tax on the amount of current income that he or she defers to a 401(k) account. For example, a worker who earns $50,000 in a particular year and defers $3,000 into a 401(k) account that year only recognizes $47,000 in income on that year's tax return. Currently this would represent a near term $750 savings in taxes for a single worker, assuming the worker remained in the 25% marginal tax bracket and there were no other adjustments (e.g., deductions). The employee ultimately pays taxes on the money as he or she withdraws the funds, generally during retirement. The character of any gains (including tax favored capital gains) are transformed into "ordinary income" at the time the money is withdrawn.

If the employee made after-tax contributions to the non-Roth 401k account, these amounts are comingled with the pre-tax funds and simply add to the non-Roth 401(k) basis. When distributions are made the taxable portion of the distribution will be calculated as the ratio of the non-Roth contributions to the total 401(k) basis. The remainder of the distribution is tax free and not included in gross income for the year.

For accumulated after-tax contributions and earnings in a designated Roth account (Roth 401(k)), "qualified distributions" can be made tax free. To qualify, distributions must be made more than 5 years after the first designated Roth contributions and not before the year in which the account owner turns age 59 and a half, unless an exception applies as detailed in IRS code section 72(t). In the case of designated Roth contributions, the contributions being made on an after-tax basis means that the taxable income in the year of contribution is not decreased as it is with pre-tax contributions. Roth contributions are irrevocable and cannot be converted to pre-tax contributions at a later date. Administratively Roth contributions must be made to a separate account, and records must be kept that distinguish the amount of contribution and the corresponding earnings that are to receive Roth treatment.

Unlike the Roth IRA, there is no upper income limit capping eligibility for ROTH 401k contributions. An individual who finds themselves disqualified from a Roth IRA may contribute to their Roth 401(k). Individuals, who qualify for both, can contribute the maximum statutory amounts into both plans (including both catch-up contributions if applicable).

[edit] Withdrawal of fundsVirtually all employers impose severe restrictions on withdrawals while a person remains in service with the company and is under the age of 59½. Any withdrawal that is permitted before the age of 59½ is subject to an excise tax equal to ten percent of the amount distributed, including withdrawals to pay expenses due to a hardship, except to the extent the distribution does not exceed the amount allowable as a deduction under Internal Revenue Code section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).

In any event any amounts are subject to normal taxation as ordinary income. Some employers may disallow one, several, or all of the previous hardship causes. Someone wishing to withdraw from such a 401(k) plan would have to resign from their employer. To maintain the tax advantage for income deferred into a 401(k), the law stipulates the restriction that unless an exception applies, money must be kept in the plan or an equivalent tax deferred plan until the employee reaches 59½ years of age. Money that is withdrawn prior to the age of 59½ typically incurs a 10% penalty tax unless a further exception applies.[2] This penalty is on top of the "ordinary income" tax that has to be paid on such a withdrawal. The exceptions to the 10% penalty include: the employee's death, the employee's total and permanent disability, separation from service in or after the year the employee reached age 55, substantially equal periodic payments under section 72(t), a qualified domestic relations order, and for deductible medical expenses (exceeding the 7.5% floor). This does not apply to the similar 457 plan.

Many plans also allow employees to take loans from their 401(k) to be repaid with after-tax funds at pre-defined interest rates. The interest proceeds then become part of the 401(k) balance. The loan itself is not taxable income nor subject to the 10% penalty as long as it is paid back in accordance with section 72(p) of the Internal Revenue Code. This section requires, among other things, that the loan be for a term no longer than 5 years (except for the purchase of a primary residence), that a "reasonable" rate of interest be charged, and that substantially equal payments (with payments made at least every calendar quarter) be made over the life of the loan. Employers, of course, have the option to make their plan's loan provisions more restrictive. When an employee does not make payments in accordance with the plan or IRS regulations, the outstanding loan balance will be declared in "default". A defaulted loan, and possibly accrued interest on the loan balance, becomes a taxable distribution to the employee in the year of default with all the same tax penalties and implications of a withdrawal.

These loans have been described as tax-disadvantaged, on the theory that the 401(k) contains before-tax dollars, but the loan is repaid with after-tax dollars. While this is precisely correct, the analysis is fundamentally flawed with regard to the loan principal amounts. Some will argue that the loan is repaid with after-tax dollars, but the loan itself is not a taxable event, so the "income" from the loan is tax-free, but the "fact" that you get taxed a second time when you do retire and get your final distribution is a red herring. From your perspective as the borrower, this is identical to a standard loan where you are not taxed when you get the loan, but you have to pay it back with taxed dollars. However, the interest portion of the loan repayments, which are essentially additional contributions to the 401k, are made with after-tax funds but they do not increase the after-tax basis in the 401k. Therefore, upon distribution/conversion of those funds the owner will have to pay taxes on those funds a second time.

[edit] Required Minimum Distributions (RMD)An account owner must begin making distributions from their accounts by April 1 of the calendar year after turning age 70½ or April 1 of the calendar year after retiring, whichever is later. The amount of distributions is based on life expectancy according to the relevant factors from the appropriate IRS tables. The only exception to minimum distribution are for people still working once they reach that age, and the exception only applies to the current plan they are participating in. Required minimum distributions apply to both pre-tax and after-tax Roth contributions. Only a Roth IRA is not subject to minimum distribution rules. Other than the exception for continuing to work after age 70½ differs from the rules for IRA minimum distributions. The same penalty applies to the failure to make the minimum distribution. The penalty is 50% of the amount that should have been distributed, one of the most severe penalties the IRS applies. In response to the economic crisis, Congress suspended the RMD requirement for 2009.

[edit] Force-outFormer employees ("terminated participants") can have their 401(k) plans closed if the balance is low; such a provision in the plan is referred to as a "force-out" provision. Almost 90% of plans have a force-out provision.[3] As of March 2005, the limit for force-out provisions is a balance of $1,000—a participant whose balance is over $1,000 cannot have their plan terminated. Before March 2005, the limit was $5,000.

Closing the plan requires that the participant either roll-over the funds to an IRA, another 401(k) plan or take a distribution ("cash out"). 85% of those with balances of under $1,000 cash out, either voluntarily or due to a force-out provision.[4]

[edit] Technical details[edit] Contribution limitsThere is a maximum limit on the total yearly employee pre-tax or ROTH salary deferral into the plan. This limit, known as the "401(k) limit", was $15,500 for the year 2008 and $16,500 for 2009, 2010, and 2011.[5] [6] [7] For future years, the limit may be indexed for inflation, increasing in increments of $500. Employees who are 50 years old or over at any time during the year are now allowed additional pre-tax "catch up" contributions of up to $5,000 for 2008 and $5,500 for 2009, 2010, and 2011. The limit for future "catch up" contributions may also be adjusted for inflation in increments of $500. In eligible plans, employees can elect to contribute on a pre-tax basis or as a Roth 401(k) contribution, or a combination of the two, but the total of those two contributions amounts must not exceed the contribution limit in a single calendar year. This limit does not apply to post-tax non-ROTH elections.

If the employee contributes more than the maximum pre-tax/Roth limit to 401(k) accounts in a given year, the excess as well as the deemed earnings for those contributions must be withdrawn or corrected by April 15 of the following year. This violation most commonly occurs when a person switches employers mid-year and the latest employer does not know to enforce the contribution limits on behalf of their employee. If this violation is noticed too late, the employee will not only be required to pay tax on the excess contribution amount the year was earned, the tax will effectively be doubled as the late corrective distribution is required to be reported again as income along with the earnings on such excess in the year the late correction is made.

Plans which are set up under section 401(k) can also have employer contributions that cannot exceed other regulatory limits. Employer matching contributions can be made on behalf of designated Roth contributions, but the employer match must be made on a pre-tax basis.[8]

Some plans also have a profit-sharing provision where employers make additional contributions to the account and may or may not require matching contributions by the employee. These additional contribution may or may not require a matching employee contribution to earn them. These profit-sharing contributions plus the matching contributions both cannot exceed 25% of the employee's pre-tax compensation. As with the matching funds, these contributions are also made on a pre-tax basis.

There is also a maximum 401k contribution limit that applies to all employee and employer 401k contributions in a calendar year. This limit is the section 415 limit, which is the lesser of 100% of the employee's total pre-tax compensation or $44,000 for 2006, $45,000 for 2007, $46,000 for 2008, and $49,000 for 2009. For employees over 50, the catch-up contribution limit is also added to the 415 limit.

Governmental employers in the US (that is, federal, state, county, and city governments) are currently barred from offering 401(k) plans unless they were established before May 1986. Governmental organizations instead can set up a section 457(b).

[edit] Contribution deadlineFor a corporation, or LLC taxed as a corporation, contributions must be made by the end of a calendar year. For a sole proprietorship, partnership, or an LLC taxed as a sole proprietorship, the deadline for depositing contributions is generally the personal tax filing deadline April 15 (or September 15 if an extension was filed).

[edit] Highly compensated employees (HCE)To help ensure that companies extend their 401(k) plans to low-paid employees, an IRS rule limits the maximum deferral by the company's "highly compensated" employees, based on the average deferral by the company's non-highly compensated employees. If the less compensated employees are allowed to save more for retirement, then the executives are allowed to save more for retirement. This provision is enforced via "non-discrimination testing". Non-discrimination testing takes the deferral rates of "highly compensated employees" (HCEs) and compares them to non-highly compensated employees (NHCEs). An HCE in 2008 is defined as an employee with compensation of greater than $100,000 in 2007 or an employee that owned more than 5% of the business at any time during the year or the preceding year.[9] In addition to the $100,000 limit for determining HCEs, employers can elect to limit the top-paid group of employees to the top 20% of employees ranked by compensation.[9] That is for plans whose first day of the plan year is in calendar year 2007, we look to each employee's prior year gross compensation (also known as 'Medicare wages') and those who earned more than $100,000 are HCEs. Most testing done now in 2009 will be for the 2008 plan year and compare employees' 2007 plan year gross compensation to the $100,000 threshold for 2007 to determine who is HCE and who is a NHCE.

The average deferral percentage (ADP) of all HCEs, as a group, can be no more than 2 percentage points greater (or 125% of, whichever is more) than the NHCEs, as a group. This is known as the ADP test. When a plan fails the ADP test, it essentially has two options to come into compliance. It can have a return of excess done to the HCEs to bring their ADP to a lower, passing, level. Or it can process a "qualified non-elective contribution" (QNEC) to some or all of the NHCEs to raise their ADP to a passing level. The return of excess requires the plan to send a taxable distribution to the HCEs (or reclassify regular contributions as catch-up contributions subject to the annual catch-up limit for those HCEs over 50) by March 15 of the year following the failed test. A QNEC must be an immediately vested contribution.

The annual contribution percentage (ACP) test is similarly performed but also includes employer matching and employee after-tax contributions. ACPs do not use the simple 2% threshold, and include other provisions which can allow the plan to "shift" excess passing rates from the ADP over to the ACP. A failed ACP test is likewise addressed through return of excess, or a QNEC or qualified match (QMAC).

There are a number of "safe harbor" provisions that can allow a company to be exempted from the ADP test. This includes making a "safe harbor" employer contribution to employees' accounts. Safe harbor contributions can take the form of a match (generally totalling 4% of pay) or a non-elective profit sharing (totalling 3% of pay). Safe harbor 401(k) contributions must be 100% vested at all times with immediate eligibility for employees. There are other administrative requirements within the safe harbor, such as requiring the employer to notify all eligible employees of the opportunity to participate in the plan, and restricting the employer from suspending participants for any reason other than due to a hardship withdrawal.

[edit] Automatic enrollmentEmployers are allowed to automatically enroll their employees in 401(k) plans, requiring employees to actively opt-out if they did not want to participate. (Traditionally 401(k)s required employees to opt-in.) Companies offering such automatic 401(k)s must choose a default investment fund and savings rate. Employees who are enrolled automatically will become investors in the default fund at the default rate, although they may select different funds and rates if they choose, or even opt out completely.[10]

Automatic 401(k)s are designed to encourage high participation rates among employees. Therefore, employers can attempt to enroll non-participants as often as once per year, requiring those non-participants to opt out each time if they do not want to participate. Employers can also choose to escalate participants' default contribution rate, encouraging them to save more.[11]

The Pension Protection Act of 2006 made automatic enrollment a safer option for employers. Prior to the Pension Protection Act, employers were held responsible for investment losses as a result of such automatic enrollments. The Pension Protection Act established a safe harbor for employers in the form of a “Qualified Default Investment Alternative,” an investment plan that, if chosen by the employer as the default plan for automatically enrolled participants, relieves the employer of financial liability. Under Department of Labor regulations, three main types of investments qualify as QDIAs: lifecycle funds, balanced funds, and managed accounts. QDIAs provide sponsors with fiduciary relief similar to the relief that applies when participants affirmatively elect their investments.[12]

[edit] Plans for certain small businesses or sole proprietorshipsMany self-employed persons felt (and financial advisors agreed) that 401(k) plans did not meet their needs due to the high costs, difficult administration, and low contribution limits. But the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made 401(k) plans more beneficial to the self-employed. The two key changes enacted related to the allowable "Employer" deductible contribution, and the "Individual" IRC-415 contribution limit.

Prior to EGTRRA, the maximum tax-deductible contribution to a 401(k) plan was 15% of eligible pay (reduced by the amount of salary deferrals). Without EGTRRA, an incorporated business person taking $100,000 in salary would have been limited in Y2004 to a maximum contribution of $15,000. EGTRRA raised the deductible limit to 25% of eligible pay without reduction for salary deferrals. Therefore, that same businessperson in Y2008 can make an "elective deferral" of $15,500 plus a profit sharing contribution of $25,000 (i.e. 25%), and—if this person is over age 50—make a catch-up contribution of $5,000 for a total of $45,500. For those eligible to make "catch-up" contribution, and with salary of $122,000 or higher, the maximum possible total contribution in 2008 would be $51,000. To take advantage of these higher contributions, many vendors now offer Solo-401(k) plans or Individual(k) plans, which can be administered as a Self-Directed 401(k), allowing for investment into real estate, mortgage notes, tax liens, private companies, and virtually any other investment.

Note: an unincorporated business person is subject to slightly different calculation. The government mandates calculation of profit sharing contribution as 25% of net self employment (Schedule C) income. Thus on $100,000 of self employment income, the contribution would be 20% of the gross self employment income, 25% of the net after the contribution of $20,000.

[edit] Rollovers as Business Start-Ups (ROBS)ROBS is an arrangement in which prospective business owners use their 401 k retirement funds to pay for new business start-up costs.[13] ROBS is an acronym from the United States Internal Revenue Service for the IRS ROBS Rollovers as Business Start-Ups Compliance Project.

ROBS plans, while not considered an abusive tax avoidance transaction, are questionable because they may solely benefit one individual – the individual who rolls over his or her existing retirement 401k withdrawal funds to the ROBS plan in a tax-free transaction. The ROBS plan then uses the rollover assets to purchase the stock of the new business. A C corporation must be set up in order to roll the 401K withdrawal.

[edit] Other countriesThe term "401(k)" has no intrinsic meaning; it is a reference to a specific provision of the U.S. Internal Revenue Code section 401. However the term has become so well-known that some other nations use it as a generic term to describe analogous legislation. For example, in October 2001, Japan adopted legislation allowing the creation of "Japan-version 401(k)" accounts even though no provision of the relevant Japanese codes is in fact called "section 401(k)."

403(b) PlanWhat Does 403(b) Plan Mean?

A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers.

Generally, retirement income accounts can invest in either annuities or mutual funds.

Also known as a "tax-sheltered annuity (TSA) plan".
Investopedia explains 403(b) Plan
The features of a 403(b) plan are very similar to those of a 401(k) plan. Employees may make salary deferral contributions that are usually limited by regulatory caps. Individual accounts in a 403(b) plan can be any of the following types:

- An annuity contract, which is provided through an insurance company
- A custodial account, which is invested in mutual funds
- A retirement income account set up for church employees

403(b)From Wikipedia, the free encyclopediaJump to: navigation, search
This article needs additional citations for verification.
Please help improve this article by adding reliable references. Unsourced material may be challenged and removed. (November 2008)

A 403(b) plan is a tax-advantaged retirement savings plan available for public education organizations, some non-profit employers (only Internal Revenue Code 501(c)(3) organizations), cooperative hospital service organizations, and self-employed ministers in the United States. It has tax treatment similar to a 401(k) plan, especially after the Economic Growth and Tax Relief Reconciliation Act of 2001. Simply put, employee salary deferrals into a 403(b) plan are made before income tax is paid and allowed to grow tax-deferred until the money is taxed as income when withdrawn from the plan. Beginning in 2006, 403(b) and 401(k) plans may also include designated Roth contributions, i.e., after-tax contributions, which, if certain requirements are met, will allow tax-free withdrawals. Primarily, the designated Roth contributions have to be in the plan for at least five taxable years.

This article's factual accuracy may be compromised because of out-of-date information. Please help improve the article by updating it. There may be additional information on the talk page. (November 2010)

The Employee Retirement Income Security Act (ERISA) does not require 403(b) plans to be technically "qualified" plans, i.e., plans governed by US Tax Code 401(a), but have the same general appearance as qualified plans. While the option is available it is not known how prevalent or if any 403(b) plan has been started or amended to be ERISA-qualified. This is because the main advantage of ERISA plans for participants has been in the event of bankruptcy of the account holder, but this advantage ceased to exist after the October 2007 Bankruptcy Abuse Prevention and Consumer Protection Act extended bankruptcy protection to 403b plans. While they are different in some fundamental ways qualified and unqualified plans appear almost the same to the participant and the options available are very similar. The only important differences for the participant are some additional ways that they can withdraw employer money, not salary-deferral money, before the typical 59½ age restriction, but only if the plan is funded with annuities and not mutual funds. The federal government wants to eliminate this difference in proposed regulations expected to be finalized in 2007.

From a plan administration standpoint, 403(b) plans do not have many of the same technical difficulties that 401(k)s do, such as discrimination testing, especially if the plan is not an ERISA plan. If the plan is an ERISA plan (the employer makes contributions to employee accounts) there are additional restrictions and administrative issues applicable to those employer contributions, but not if a plan of a government employer which is not subject to discrimination testing.

Salary-deferral contributions are not subject to complicated discrimination testing. 403(b) plans are instead subject to universal availability which, briefly and in general, means all employees must be permitted to make salary-deferral contributions. 403(b) plans also have simpler and less costly annual reporting requirements on Internal Revenue Service (IRS) Form 5500, including not having the independent auditor requirement applicable to qualified plans with more than 100 plan participants.

Contents [hide]
1 Staying Compliant with 403(b) Plans
2 Bankruptcy protection before 2005
3 See also
4 External links

[edit] Staying Compliant with 403(b) PlansOn December 9, 2008 the IRS gave 403(b) plan sponsors a one-year reprieve for adopting a written plan document. A 403(b) plan, also known as a tax-sheltered annuity plan, is a retirement plan for employees of specific tax-exempt organizations such as health care organizations and colleges and universities. While the relief provisions from the IRS give 403(b) a full year to adopt a written plan document, the plans still must operate in compliance with 403(b) plan requirements. If somebody has taken 403(b) plan and his age is less than 59 1/2 then he can not initiate withdrawal from annuity. If he wants to initiate then he has to show triggering event like i.e. financial hardship, disability, separation from service. The IRS also charges a mandatory 20% as federal taxes on an early withdrawal before it is additionally taxed as ordinary income.

[edit] Bankruptcy protection before 2005Before the passage of the bankruptcy reform act in 2005, a 403(b) that was not an ERISA plan was not accorded protected status as property that could be claimed as exempt by the debtor under the U.S. Bankruptcy Code. In In re Barnes, 264 B.R. 415 (Bankr. E.D. Mich. 2001) Judge Spector held that the fixed-income annuity was not such a trust and could be reached by creditors. The variable account was held to fall within 541(c)(2) and was thus protected. Under the revised bankruptcy laws, 403(b) accounts, IRAs, and other retirement accounts are, in general, protected from creditors in bankruptcy.

For this reason, having an ERISA anti-alienation clause[1] was protective of pensions before the bankruptcy law revisions, giving those pensions the same protection as a spendthrift trust. Some critics argued that this is disparate treatment of similar pension schemes and that more consistent protection was called for. The United States Congress took this argument to heart in the 2005 bankruptcy reform.

457 PlanWhat Does 457 Plan Mean?
A non-qualified, deferred compensation plan established by state and local governments and tax-exempt governments and tax-exempt employers. Eligible employees are allowed to make salary deferral contributions to the 457 plan. Earnings grow on a tax-deferred basis and contributions are not taxed until the assets are distributed from the plan. Investopedia explains 457 Plan
Employees are allowed to defer up to 100% of compensation not exceeding the applicable dollar limit for the year. If the plan does not meet statutory requirements, the assets may be subject to different rules.

457 planFrom Wikipedia, the free encyclopediaJump to: navigation, search
The 457 plan is a type of non-qualified tax advantaged deferred-compensation retirement plan that is available for governmental and certain non-governmental employers in the United States. The employer provides the plan and the employee defers compensation into it on a pre-tax basis. For the most part the plan operates similarly to a 401(k) or 403(b) plan most people are familiar with in the US. The key difference is unlike a 401(k) plan, there is no 10% penalty for withdrawal before the age of 59½ (although the withdrawal is subject to ordinary income taxation). Another difference is that 457 plan participant cannot make designated Roth contributions as participants in appropriately amended 401(k) and 403(b) plans can. Also 457 plans (both governmental and non governmental) can allow independent contractors to participate in the plan where 401(k) and 403(b) plans cannot.[1]

Contents [hide]
1 Changes within The Small Business Jobs Act of 2010
2 Changes with EGTRRA 2001
2.1 Catch-up provisions
3 Governmental and non-governmental plans
3.1 Non-governmental plans
3.1.1 457(f) (ineligible) plans
4 Notes
5 External links and references

[edit] Changes within The Small Business Jobs Act of 2010Participants in section 457 plans are allowed to treat elective deferrals as Roth contributions.

[edit] Changes with EGTRRA 2001The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made a number of changes in how governmental 457 plans are treated, the most notable of which is that the coordination of benefits limitation was removed. This allows a person whose employer has a 401(k) or 403(b) and a 457 to defer the maximum contribution amounts to both plans instead of coordinating the total and only being able to meet a single limit amount. Thus a participant can contribute the maximum $16,500 for 2009 into their 401(k) and also the maximum $16,500 into their 457 plan. If that person's age is at least 50 at the end of the current tax year, they can contribute the additional catch up amount into each plan also, meaning an additional $5,500 into the 401(k) and another $5,500 into their governmental 457 (catch-up contributions are not provided for non-governmental 457 plans). The total would then be $44,000 deferred instead of the $22,000 that would have been allowed if the coordination of benefits provision had not been repealed in regard to the governmental 457 plan. As a result, many governmental employers have now set up 457 and 401(k) plans for their employees, and non-profit employers have set up 403(b) and 457 plans each allowing their employees to invest in both. Some state universities and school districts have access to all three tax-deferred plans. However, the total combined annual contribution to 401(k) and 403(b) plans is subject to the $16,500 limit and $5,500 catchup limit.

Other notable changes made in the EGTRRA legislation were increasing the maximum deferral amount from the approximately $8,500 that was previously allowed to the same maximum elective deferral amount that 401(k) plans and now 403(b) plans allow, and easing restrictions on some plan rollovers. Governmental 457 plans may be rolled into other types of retirement plans with few restrictions beyond the normal ones for any other type of employer provided plan, which includes separation of service or disability. This includes other 401(k) and 403(b) plans and also IRA's. IRA's have much greater flexibility in withdrawal and conversion privileges. In contrast, non-governmental 457 plans can only be rolled into another non-governmental 457 plan.

[edit] Catch-up provisionsThe 457 plan allows for two types of catch-up provisions. The first is similar to other defined contribution plans and amounts to an additional $5,500 that can be contributed as noted above. This option for making catch-up contributions is only available under governmental 457 plans. The second option is much more complicated and is available under both governmental and non-governmental plans. It can be elected by an employee who is within 3 years of normal retirement age (and perhaps eligible retirement at any age). This second catch-up option is equal to the full employee deferral limit or another $16,500 for 2009. Thus, a person over 50 within 3 years of retirement and who has both a 457 and a 401(k) could defer a total of $52,500 into their retirement plans by utilizing all of their catch-up provisions. The second type of catch-up provision is limited to unused deferral limits from previous years. An employee that had deferred the maximum amount of money into the 457 plan every year they were employed previously would not be able to utilize this extra catch-up.

[edit] Governmental and non-governmental plansThere are two primary types of the plans, governmental and non-governmental. Some governmental plans were under 457(g) but those plans may no longer be created. Most governmental and non-governmental plans are 457(b) plans.

[edit] Non-governmental plansNon-governmental plans can now be set up by non-profit organizations in addition to their 403(b) plans. They may either be "eligible" plans set up under section 457(b) or "ineligible" plans set up under section 457(f). ERISA legislation has said that non-governmental plans must be limited to some group of higher compensation employees. The level of compensation required is not specified by ERISA, but it must be according to some ascertainable standard that the employer sets. The same highly compensated limit ($100,000 a year for 2006) in place for 401(k) discrimination testing would likely be acceptable, as would restricting the plan to some class of employees such as directors or officers. Because of this limitation to higher-compensation employees, 457(b) plans are often referred to as "top hat" plans.

Non-governmental 457 plans have a number of restrictions that governmental ones do not. Money deferred into non-governmental 457 plans may not be rolled into any other type of tax-deferred retirement plan. It may be rolled only into another non-governmental 457 plan. Also, money deferred into non-governmental plans is not set aside in a trust for the exclusive benefit of the employee making the deferral. The Internal Revenue Code requires that money in a non-governmental 457 plan remains the property of the employer and is thus available to general creditors of the employer in legal or bankruptcy proceedings.

[edit] 457(f) (ineligible) plansIRS code section 457(f) allows for non-governmental, non-profit organizations to set up a plan that can be tax deferred and exceed the normal defined contribution employee deferral limit. Ineligible 457 plans are made available because non-profit organizations are not allowed to have another kind of non-qualified deferred compensation plan.

Generally, these deferred amounts would be currently taxable under Section 83 of the Code, unless the employee faces a "substantial risk of forfeiture" which has been clarified by the IRS to mean that in addition to the money remaining available to general creditors of the organization or subject to not vesting if the employee does not stay with the employer for the full vesting period. When the risk of forfeiture is gone, the value of the property given to the employee ceases to be deferred from taxation and is included in current ordinary gross income.

Another plan design, the rabbi trust, gives the employee deferred money in a trust and is funded, but must be available to creditors. This is to make the employer junior to general creditors so that the employee can avoid current inclusion into income.

These general deferral of current income conditions of Section 83 (as explained in Revenue Ruling 60-31) would give the 457(f) plan the deferral of tax desired.

In 2004 Congress passed a tax act which added Section 409A to the tax code and applies to deferred nonqualified compensation which also covers some 457(f) plans. This was in response to the executive bonus plans given to key employees at Enron which allowed them early access to their deferred compensation if financial conditions of the employer deteriorated (i.e., if Enron got into trouble).

Pension Fund What Does Pension Fund Mean?
A fund established by an employer to facilitate and organize the investment of employees' retirement funds contributed by the employer and employees. The pension fund is a common asset pool meant to generate stable growth over the long term, and provide pensions for employees when they reach the end of their working years and commence retirement. Investopedia explains Pension Fund
Pension funds are commonly run by some sort of financial intermediary for the company and its employees, although some larger corporations operate their pension funds in-house. Pension funds control relatively large amounts of capital and represent the largest institutional investors in many nations.

PensionFrom Wikipedia, the free encyclopediaJump to: navigation, search
This article is about the retirement income arrangement. For the type of lodging, see Pension (lodging). For the mortgage repayment scheme, see Mortgage loan.
It has been suggested that Pension Administration be merged into this article or section. (Discuss) Proposed since May 2009.
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In general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment.[1] Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.

The terms retirement plan or superannuation refer to a pension granted upon retirement.[2] Retirement plans may be set up by employers, insurance companies, the government or other institutions such as employer associations or trade unions. Called retirement plans in the United States, they are commonly known as pension schemes in the United Kingdom and Ireland and superannuation plans or super[3] in Australia and New Zealand. Retirement pensions are typically in the form of a guaranteed life annuity, thus insuring against the risk of longevity.

A pension created by an employer for the benefit of an employee is commonly referred to as an occupational or employer pension. Labor unions, the government, or other organizations may also fund pensions. Occupational pensions are a form of deferred compensation, usually advantageous to employee and employer for tax reasons. Many pensions also contain an additional insurance aspect, since they often will pay benefits to survivors or disabled beneficiaries. Other vehicles (certain lottery payouts, for example, or an annuity) may provide a similar stream of payments.

The common use of the term pension is to describe the payments a person receives upon retirement, usually under pre-determined legal and/or contractual terms. A recipient of a retirement pension is known as a pensioner or retiree.

Contents [hide]
1 Types of pensions
1.1 Employment-based pensions (retirement plans)
1.2 Social and state pensions
1.3 Disability pensions
2 Benefits
2.1 Defined benefit plans
2.1.1 Funding
2.1.2 Criticisms
2.1.3 Examples
2.2 Defined contribution plans
2.2.1 Examples
2.3 Hybrid and cash balance plans
2.4 Contrasting types of retirement plans
3 Financing
4 History
4.1 Germany
4.2 United States
5 Current challenges
6 Pensions by country
7 Famous examples of pension systems
8 Market structure
9 See also
10 Notes
11 References

[edit] Types of pensions[edit] Employment-based pensions (retirement plans)A retirement plan is an arrangement to provide people with an income during retirement when they are no longer earning a steady income from employment. Often retirement plans require both the employer and employee to contribute money to a fund during their employment in order to receive defined benefits upon retirement. It is a tax deferred savings vehicle that allows for the tax-free accumulation of a fund for later use as a retirement income. Funding can be provided in other ways, such as from labor unions, government agencies, or self-funded schemes. Pension plans are therefore a form of "deferred compensation". A SSAS is a type of employment-based Pension in the UK.

[edit] Social and state pensionsMany countries have created funds for their citizens and residents to provide income when they retire (or in some cases become disabled). Typically this requires payments throughout the citizen's working life in order to qualify for benefits later on. A basic state pension is a "contribution based" benefit, and depends on an individual's contribution history.

For examples, see National Insurance in the UK, or Social Security in the USA.

Many countries have also put in place a "social pension". These are regular, tax-funded non-contributory cash transfers paid to older people. Over 80 countries have social pensions.[4] Examples are the Old Age Grant in South Africa and the Universal Superannuation scheme in New Zealand.

[edit] Disability pensionsSome pension plans will provide for members in the event they suffer a disability. This may take the form of early entry into a retirement plan for a disabled member below the normal retirement age.

[edit] BenefitsRetirement plans may be classified as defined benefit or defined contribution according to how the benefits are determined.[5] A defined benefit plan guarantees a certain payout at retirement, according to a fixed formula which usually depends on the member's salary and the number of years' membership in the plan. A defined contribution plan will provide a payout at retirement that is dependent upon the amount of money contributed and the performance of the investment vehicles utilized.

Some types of retirement plans, such as cash balance plans, combine features of both defined benefit and defined contribution plans. They are often referred to as hybrid plans. Such plan designs have become increasingly popular in the US since the 1990s. Examples include Cash Balance and Pension Equity plans.

[edit] Defined benefit plansMain article: Defined benefit pension plan
A traditional defined benefit (DB) plan is a plan in which the benefit on retirement is determined by a set formula, rather than depending on investment returns. In the US, 26 U.S.C. § 414(j) specifies a defined benefit plan to be any pension plan that is not a defined contribution plan (see below) where a defined contribution plan is any plan with individual accounts. A traditional pension plan that defines a benefit for an employee upon that employee's retirement is a defined benefit plan.

Traditionally, retirement plans have been administered by institutions which exist specifically for that purpose, by large businesses, or, for government workers, by the government itself. A traditional form of defined benefit plan is the final salary plan, under which the pension paid is equal to the number of years worked, multiplied by the member's salary at retirement, multiplied by a factor known as the accrual rate. The final accrued amount is available as a monthly pension or a lump sum, but usually monthly.

The benefit in a defined benefit pension plan is determined by a formula that can incorporate the employee's pay, years of employment, age at retirement, and other factors. A simple example is a Dollars Times Service plan design that provides a certain amount per month based on the time an employee works for a company. For example, a plan offering $100 a month per year of service would provide $3,000 per month to a retiree with 30 years of service. While this type of plan is popular among unionized workers, Final Average Pay (FAP) remains the most common type of defined benefit plan offered in the United States. In FAP plans, the average salary over the final years of an employee's career determines the benefit amount.

Averaging salary over a number of years means that the calculation is averaging different dollars. For example, if salary is averaged over five years, and retirement is in 2009, then salary in 2004 in 2004 dollars is averaged with salary in 2005 dollars, etc., with 2004 dollars being worth more than the dollars of succeeding years. The pension is then paid in first year of retirement dollars, in this example 2009 dollars, with the lowest value of any dollars in the calculation. Thus inflation in the salary averaging years has a considerable impact on purchasing power and cost, both being reduced equally by inflation

This effect of inflation can be eliminated by converting salaries in the averaging years to first year of retirement dollars, and then averaging.

In the United Kingdom, benefits are typically indexed for inflation (known as Retail Prices Index (RPI)) as required by law for registered pension plans.[6] Inflation during an employee's retirement affects the purchasing power of the pension; the higher the inflation rate, the lower the purchasing power of a fixed annual pension. This effect can be mitigated by providing annual increases to the pension at the rate of inflation (usually capped, for instance at 5% in any given year). This method is advantageous for the employee since it stabilizes the purchasing power of pensions to some extent.

If the pension plan allows for early retirement, payments are often reduced to recognize that the retirees will receive the payouts for longer periods of time. In the United States, under the Employee Retirement Income Security Act of 1974, any reduction factor less than or equal to the actuarial early retirement reduction factor is acceptable.[7]

Many DB plans include early retirement provisions to encourage employees to retire early, before the attainment of normal retirement age (usually age 65). Companies would rather hire younger employees at lower wages. Some of those provisions come in the form of additional temporary or supplemental benefits, which are payable to a certain age, usually before attaining normal retirement age.[8]

[edit] FundingDefined benefit plans may be either funded or unfunded.

In an unfunded defined benefit pension, no assets are set aside and the benefits are paid for by the employer or other pension sponsor as and when they are paid. Pension arrangements provided by the state in most countries in the world are unfunded, with benefits paid directly from current workers' contributions and taxes. This method of financing is known as Pay-as-you-go (PAYGO or PAYG).[9] The social security systems of many European countries are unfunded[citation needed], having benefits paid directly out of current taxes and social security contributions, although several countries have hybrid systems which are partially funded. Spain set up the Social Security Reserve Fund and France set up the Pensions Reserve Fund; in Canada the wage-based retirement plan (CPP) is funded, with assets managed by the CPP Investment Board while the U.S. Social Security system is funded by investment in special U.S. Treasury Bonds.

In a funded plan, contributions from the employer, and sometimes also from plan members, are invested in a fund towards meeting the benefits. The future returns on the investments, and the future benefits to be paid, are not known in advance, so there is no guarantee that a given level of contributions will be enough to meet the benefits. Typically, the contributions to be paid are regularly reviewed in a valuation of the plan's assets and liabilities, carried out by an actuary to ensure that the pension fund will meet future payment obligations. This means that in a defined benefit pension, investment risk and investment rewards are typically assumed by the sponsor/employer and not by the individual. If a plan is not well-funded, the plan sponsor may not have the financial resources to continue funding the plan. In many countries, such as the USA, the UK and Australia, most private defined benefit plans are funded[citation needed], because governments there provide tax incentives to funded plans (in Australia they are mandatory). In the United States, non-church-based private employers must pay an insurance-type premium to the Pension Benefit Guaranty Corporation, a government agency whose role is to encourage the continuation and maintenance of voluntary private pension plans and provide timely and uninterrupted payment of pension benefits.

[edit] Criticisms This section does not cite any references or sources.
Please help improve this section by adding citations to reliable sources. Unsourced material may be challenged and removed. (March 2010)

Traditional defined benefit plan designs (because of their typically flat accrual rate and the decreasing time for interest discounting as people get closer to retirement age) tend to exhibit a J-shaped accrual pattern of benefits, where the present value of benefits grows quite slowly early in an employee's career and accelerates significantly in mid-career: in other words it costs more to fund the pension for older employees than for younger ones (an "age bias"). Defined benefit pensions tend to be less portable than defined contribution plans, even if the plan allows a lump sum cash benefit at termination. Most plans, however, pay their benefits as an annuity, so retirees do not bear the risk of low investment returns on contributions or of outliving their retirement income. The open-ended nature of these risks to the employer is the reason given by many employers for switching from defined benefit to defined contribution plans over recent years. The risks to the employer can sometimes be mitigated by discretionary elements in the benefit structure, for instance in the rate of increase granted on accrued pensions, both before and after retirement.

The age bias, reduced portability and open ended risk make defined benefit plans better suited to large employers with less mobile workforces, such as the public sector (which has open-ended support from taxpayers). This coupled with a lack of foresight on the employers part means a large proportion of the workforce are kept in the dark over future investment schemes.

Defined benefit plans are sometimes criticized as being paternalistic as they enable employers or plan trustees to make decisions about the type of benefits and family structures and lifestyles of their employees. However they are typically more valuable than defined contribution plans in most circumstances and for most employees (mainly because the employer tends to pay higher contributions than under defined contribution plans), so such criticism is rarely harsh.

The "cost" of a defined benefit plan is not easily calculated, and requires an actuary or actuarial software. However, even with the best of tools, the cost of a defined benefit plan will always be an estimate based on economic and financial assumptions. These assumptions include the average retirement age and lifespan of the employees, the returns to be earned by the pension plan's investments and any additional taxes or levies, such as those required by the Pension Benefit Guaranty Corporation in the U.S. So, for this arrangement, the benefit is relatively secure but the contribution is uncertain even when estimated by a professional.

[edit] ExamplesMany countries offer state-sponsored retirement benefits, beyond those provided by employers, which are funded by payroll or other taxes. The United States Social Security system is similar to a defined benefit pension arrangement, albeit one that is constructed differently than a pension offered by a private employer.

Individuals that have worked in the UK and have paid certain levels of national insurance deductions can expect an income from the state pension scheme after their normal retirement. The state pension is currently divided into two parts: the basic state pension, State Second [tier] Pension scheme called S2P. Individuals will qualify for the basic state pension if they have completed sufficient years contribution to their national insurance record. The S2P pension scheme is earnings related and depends on earnings in each year as to how much an individual can expect to receive. It is possible for an individual to forgo the S2P payment from the state, in lieu of a payment made to an appropriate pension scheme of their choice, during their working life. For more details see UK pension provision.

[edit] Defined contribution plansMain article: Defined contribution plan
In a defined contribution plan, contributions are paid into an individual account for each member. The contributions are invested, for example in the stock market, and the returns on the investment (which may be positive or negative) are credited to the individual's account. On retirement, the member's account is used to provide retirement benefits, sometimes through the purchase of an annuity which then provides a regular income. Defined contribution plans have become widespread all over the world in recent years, and are now the dominant form of plan in the private sector in many countries. For example, the number of defined benefit plans in the US has been steadily declining, as more and more employers see pension contributions as a large expense avoidable by disbanding the defined benefit plan and instead offering a defined contribution plan.

Money contributed can either be from employee salary deferral or from employer contributions. The portability of defined contribution pensions is legally no different from the portability of defined benefit plans. However, because of the cost of administration and ease of determining the plan sponsor's liability for defined contribution plans (you do not need to pay an actuary to calculate the lump sum equivalent that you do for defined benefit plans) in practice, defined contribution plans have become generally portable.

In a defined contribution plan, investment risk and investment rewards are assumed by each individual/employee/retiree and not by the sponsor/employer. In addition, participants do not necessarily purchase annuities with their savings upon retirement, and bear the risk of outliving their assets. (In the United Kingdom, for instance, it is a legal requirement to use the bulk of the fund to purchase an annuity.)

The "cost" of a defined contribution plan is readily calculated, but the benefit from a defined contribution plan depends upon the account balance at the time an employee is looking to use the assets. So, for this arrangement, the contribution is known but the benefit is unknown (until calculated).

Despite the fact that the participant in a defined contribution plan typically has control over investment decisions, the plan sponsor retains a significant degree of fiduciary responsibility over investment of plan assets, including the selection of investment options and administrative providers.

[edit] ExamplesIn the United States, the legal definition of a defined contribution plan is a plan providing for an individual account for each participant, and for benefits based solely on the amount contributed to the account, plus or minus income, gains, expenses and losses allocated to the account (see 26 U.S.C. § 414(i)). Examples of defined contribution plans in the United States include Individual Retirement Accounts (IRAs) and 401(k) plans. In such plans, the employee is responsible, to one degree or another, for selecting the types of investments toward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined mutual funds to selecting individual stocks or other securities. Most self-directed retirement plans are characterized by certain tax advantages, and some provide for a portion of the employee's contributions to be matched by the employer. In exchange, the funds in such plans may not be withdrawn by the investor prior to reaching a certain age—typically the year the employee reaches 59.5 years old-- (with a small number of exceptions) without incurring a substantial penalty.

In the US, defined contribution plans are subject to IRS limits on how much can be contributed, known as the section 415 limit. In 2009, the total deferral amount, including employee contribution plus employer contribution, was limited to $49,000 or 100% of compensation, whichever is less. The employee-only limit in 2009 is $16,500 with a $5,500 catch-up. These numbers may increase each year and are indexed to compensate for the effects of inflation.

[edit] Hybrid and cash balance plansHybrid plan designs combine the features of defined benefit and defined contribution plan designs.

A cash balance plan is a defined benefit plan made by the employer, with the help of consulting actuaries (like Kwasha Lipton, who it is said created the cash balance plan) to appear as if they were defined contribution plans. They have notional balances in hypothetical accounts where, typically, each year the plan administrator will contribute an amount equal to a certain percentage of each participant's salary; a second contribution, called interest credit, is made as well. These are not actual contributions and further discussion is beyond the scope of this entry suffice it to say that there is currently much controversy. In general, they are usually treated as defined benefit plans for tax, accounting and regulatory purposes. As with defined benefit plans, investment risk in hybrid designs is largely borne by the plan sponsor. As with defined contribution designs, plan benefits are expressed in the terms of a notional account balance, and are usually paid as cash balances upon termination of employment. These features make them more portable than traditional defined benefit plans and perhaps more attractive to a more highly mobile workforce.

Target benefit plans are defined contribution plans made to match (or resemble) defined benefit plans.

[edit] Contrasting types of retirement plansAdvocates of defined contribution plans point out that each employee has the ability to tailor the investment portfolio to his or her individual needs and financial situation, including the choice of how much to contribute, if anything at all. However, others state that these apparent advantages could also hinder some workers who might not possess the financial savvy to choose the correct investment vehicles or have the discipline to voluntarily contribute money to retirement accounts. This debate parallels the discussion currently going on in the U.S., where many Republican leaders favor transforming the Social Security system, at least in part, to a self-directed investment plan.

[edit] FinancingThere are various ways in which a pension may be financed.

This section requires expansion.

Defined contribution pensions, by definition, are funded, as the "guarantee" made to employees is that specified (defined) contributions will be made during an individual's working life.

[edit] History This section requires expansion.

[edit] GermanyAs part of Otto von Bismarck's social legislation, the Old Age and Disability Insurance Bill was enacted in 1889. The Old Age Pension program, financed by a tax on workers, was originally designed to provide a pension annuity for workers who reached the age of 70 years, though this was lowered to 65 years in 1916. It is sometimes claimed that at the time life expectancy for the average Prussian was 45 years; in fact this figure ignores the very high infant mortality and high maternal death rate from childbirth of this era. In fact, an adult entering into insurance under the scheme would on average live to 70 years of age, a figure used in the actuarial assumptions included in the legislation.

[edit] United StatesPublic pensions got their start with various 'promises', informal and legislated, made to veterans of the Revolutionary War and, more extensively, the Civil War. They were expanded greatly, and began to be offered by a number of state and local governments during the early Progressive Era in the late nineteenth century.[citation needed]

Federal civilian pensions were offered under the Civil Service Retirement System (CSRS), formed in 1920. CSRS provided retirement, disability and survivor benefits for most civilian employees in the US Federal government, until the creation of a new Federal agency, the Federal Employees Retirement System (FERS), in 1987.

Pension plans became popular in the United States during World War II, when wage freezes prohibited outright increases in workers' pay. The defined benefit plan had been the most popular and common type of retirement plan in the United States through the 1980s; since that time, defined contribution plans have become the more common type of retirement plan in the United States and many other western countries.

[edit] Current challengesA growing challenge for many nations is population ageing. As birth rates drop and life expectancy increases an ever-larger portion of the population is elderly. This leaves fewer workers for each retired person. In almost all developed countries this means that government and public sector pensions could collapse their economies unless pension systems are reformed or taxes are increased. One method of reforming the pension system is to increase the retirement age. Two exceptions are Australia and Canada, where the pension system is forecast to be solvent for the foreseeable future. In Canada, for instance, the annual payments were increased by some 70% in 1998 to achieve this. These two nations also have an advantage from their relative openness to immigration. However, their populations are not growing as fast as the U.S., which supplements a high immigration rate with one of the highest birthrates among Western countries. Thus, the population in the U.S. is not aging to the extent as those in Europe, Australia, or Canada.

Another growing challenge is the recent trend of states and businesses in the United States purposely under-funding their pension schemes in order to push the costs onto the federal government. For example, in 2009, the majority of states have unfunded pension liabilities exceeding all reported state debt. Bradley Belt, former executive director of the PBGC (the Pension Benefit Guaranty Corporation, the federal agency that insures private-sector defined-benefit pension plans in the event of bankrupment), testified before a congressional hearing in October 2004, “I am particularly concerned with the temptation, and indeed, growing tendency, to use the pension insurance fund as a means to obtain an interest-free and risk-free loan to enable companies to restructure. Unfortunately, the current calculation appears to be that shifting pension liabilities onto other premium payers or potentially taxpayers is the path of least resistance rather than a last resort.”

Challenges have further been increased by the credit crunch. Total funding of the nation's 100 largest corporate pension plans fell by $303bn in 2008, going from a $86bn surplus at the end of 2007 to a $217bn deficit at the end of 2008.[10]