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Planning
Essentials of Retirement
Planning
A Holistic Review of Personal
Retirement Planning Issues
andEmployer-Sponsored Plans
Second Edition
Eric J. Robbins
Abstract
This book provides the quintessential information needed to understand
the financial side of the retirement planning coin. Youll begin by learning
about the various plan types employers may offer their employees. Topics
related to compliance testing as well as the strategies used to legally shift
benefits in favor of highly compensated employees will be thoroughly
discussed.
However, some employers do not sponsor a plan. In this instance,
retirement savers will need to understand the options available within
the world of individual retirement accounts. This book is not intended to
provide investment advice, but rather to show how different retirement
savings vehicles function and how they can be effectively deployed.
Many financial professionals find that their clients ask questions about
all aspects of their financial life. For this reason, this book also d
iscusses
noninvestment-related topics such as housing options, Social Security
planning, Medicare planning, and a few other basic insurance-based
issues faced by all retirees.
Keywords
employer-sponsored plans, medicare, social security, retirement plan
compliance testing, retirement planning
Contents
Prefaceix
Acknowledgmentsxi
Part I
viii Contents
Preface
I am an Eagle Scout. Why is that important? Well, the Boy Scout motto is
Be Prepared. And, when it comes to retirement, the sad reality is that most
people are not. Most people live their lives spending most of what they
earn and sometimes more than that. The state of retirement in America
for the majority of people is not what Hollywood portrays in movies, and
this worries me greatly.
How do we work toward a solution? Only through education, discipline, and a strategic rewrite of the status quo can we hope to reshape our
own futures and the futures of those that we, as financial professionals,
help. I have worked in private wealth management since 1998, and much
of that time has been spent helping those who did plan well. Individuals
in this category will need a trained financial professional.
It is imperative that the next generation of financial professionals
receives the highest level of training possible. It is also important that
they subscribe to a clear ethical standard, perhaps by becoming a Certified
Financial Planner or perhaps by becoming a Chartered Financial Analyst
charterholder. The industry desperately needs individuals who are willing
to leverage their training to benefit their clients first and foremost.
I wrote this book because I was asked to teach a course on Retirement
Planning at Penn State Erie, the Sam and Irene Black School of Business.
I was immediately impressed with the rigorous program in place and the
high quality of both the faculty and the students. The textbook being
used was Planning for Retirement Needs by Littell and Tacchino and it is
an excellent teaching tool for those students studying for the CFP exam
or for those who want a very in-depth review of retirement planning.
But some of my students were still considering their career paths and did
not require the full intensity of a CFP prep course. I chose to make this
book a thorough review of all of the major topical areas, but in a more
condensed format. My students appreciate this format and relish the fact
that the price of this textbook is so budget friendly.
x Preface
This book covers all of the core topics. It crosses the spectrum of
employer-sponsored plans, compliance testing concerns, individual
retirement accounts, Social Security, Medicare, and retirement distribution planning. There are discussion questions at the end of each chapter,
which I use myself in the classroom to get students thinking about the
core topics from the chapter. There are also online resources available on
the books webpage for interested educators.
Acknowledgments
I would like to thank my wife, Joy, and both of my kids, Hope and
Nathanael, for their patience and support as I finished this book.
I would like to thank my professional mentor, Dr. Greg Filbeck, for
without his guidance I would not have entered the wonderful world of
higher education.
CHAPTER 1
Crisis of Financial
Unawareness and
a 30,000-Foot View
Introduction
The reality is that most Americans are underprepared for retirement.
Thecurrent plan deployed by many is to spend what you make, save as
little as possible, and fall back on Social Security when it is time to retire.
This is a broken philosophy that is both wrong and approaching the end
of its potential realistic use. We need a new level of awareness. Further, we
need to understand the amazing benefits offered by tax-advantaged retirement savings opportunities. Some employers offer retirement b enefits,
and some employers do not. We will explore exactly why an employer
should consider offering a plan in this chapter.
Learning Goals
Understand the current state of an average Americans
retirement preparedness.
Identify why tax-advantaged retirement plans are beneficial.
Identify general characteristics of tax-advantaged plans.
Explain how employer-sponsored plans benefit large employers.
Explain how employer-sponsored plans benefit small business
owners.
will have stockpiled adequate savings for retirement, and 63 percent will
be completely reliant upon Social Security, friends, relatives, or charity
for their subsistence needs.1 According to the Federal Reserve Bank of
St. Louis (St. Louis Fed), Americans personal savings rate is almost at
its lowest point since 1959 when it began tracking the measurement.2
With this as a backdrop, it should not be too surprising that according
to the Harris Poll, 34 percent of Americans have nothing saved for retirement.3 This is partly because employer-sponsored plans are not offered by
all companies. According to the U.S. Bureau of Labor Statistics (BLS),
only 68percent of all workers have access to an employer-sponsored plan,
and of those who have access, only 54 percent participate.4 This same
annual report from the BLS shows that those least likely to have access
to a plan are service workers, part-time workers, and nonunion workers.
Ifthis information does not make your jaw drop, then you need to check
yourpulse.
We cannot blame the average American too much. We have been
programmed to spend, spend, and spend. We need a reboot, and we
need a plan because without proper retirement planning, the potential
of retirement security will remain as elusive as it is today. Throughout
this textbook, you will learn various facets in the retirement planning
process and about the different types of tax-advantaged plans available to
a business and the types available to individuals privately. You will learn
about specific regulations and limitations inherent in the system. You will
also learn about unique employer-sponsored plans like stock options and
employee stock discount programs.
To begin our correction of the crisis of financial unawareness, there
are two main categories of tax-advantaged retirement plans. The first
category is known as a qualified plan. A qualified plan meets certain government requirements to be tax deferred. Examples of qualified plans are
defined benefit (DB) plans, cash balance (CB) plans, money purchase
plans, target benefit (TB) plans, profit-sharing plans, 401(k)s, stock
bonus plans, and employee stock ownership plans (ESOPs). Some investors misuse the term qualified plan to include all tax-advantaged retirement savings accounts including individual retirement accounts (IRAs),
which are the primary retirement savings vehicle for those without an
employer-sponsored plan. Theterm qualified plan applies only to a very
DB plans
SEP plans
CB plans
SIMPLE plans
TB plans
403(b) plans
specific list of account types. The other account types fall into a second category, which does not have a fancy name, and so we will simply
call them other plans. Specifically excluded from qualified plan status
are IRAs, 403(b)s, SEP plans, and SIMPLE plans. You will learn about
SEPs, SIMPLEs, and 403(b)s in Chapter 6. Table 1.1 summarizes the
list of those employer-sponsored plans that are considered qualified and
those that are considered other.
Regular investment
account ($)
17,500.00
17,500.00
0.00
4,900.00
17,500.00
12,600.00
1,225.00
882.00
0.00
246.96
18,725.00**
13,235.04
From the employees perspective, taxes are deferred typically until money
is withdrawn from the account in retirement. This is a significant benefit
to employees as their marginal tax rate while they are working is almost
always reasonably higher than their marginal tax rate during retirement.
Because of this amazing tax deferral benefit, municipal bonds and other
tax-sheltered investments should not be held within an already tax-deferred
plan. Tax-sheltered investments usually have lower returns because the tax
benefit attracts investors, but someone with an IRA or a 401(k) would
already receive favorable tax treatment. They are free to look for higher
yielding investments since there is no benefit from double tax deferral.
Employees do not need to withdraw their entire account balance,
thus triggering a taxable event, when they retire. They have the option
of rolling their employer-sponsored plan into a different type of retirement account like an IRA. This step will further defer taxes beyond the
employees retirement date. We will also discuss this process in detail later
in this book.
An interesting and creative feature of qualified plans is that a life
insurance policy can be included as an investment within the plan. Again,
we will discuss details later, but for now, we must understand that the use
of life insurance is only available within qualified plans and not in the
other category.
Discussion Questions
1. What are the tax advantages common to all types of tax-advantaged
retirement savings plans?
2. Do tax-advantaged plans need to invest in tax-favorable investments
to remain tax advantaged?
3. What common requirements do all tax-advantaged retirement plans
share?
4. What are some nontax-related benefits of participating in an
employer-sponsored retirement plan?
5. There is a small smartphone supplier with mostly young e mployees.
The industry is highly competitive. How could offering an
employer-sponsored retirement plan help this company compete
better with its rivals?
Index
Accrued benefit, 80
Accumulation years, 186187
ACP. See Actual contribution
percentage
Active participants, 188191
Actual contribution percentage
(ACP), 46
Actual deferral percentage (ADP), 45
Actuarial cost method, 110
ADL. See Advanced determination
letter
Administrative exemptions, 131
Adoption agreement, 6768
ADP. See Actual deferral percentage
ADP 1.25 test, 46
ADP 2.0 test, 46
Adult daily living functions, 264
Adult day care, 263
Advanced determination letter (ADL),
148
Advance directives, 265266
Affiliated service groups, 74
After-tax contributions, 8687
Agency conflict, 174
Age-restricted housing, 258
Age-weighting, 8485
Aggregation rules, 7273
AIME. See Average index monthly
earnings
Alternative minimum taxes (AMT),
178
AMT. See Alternative minimum taxes
Annuity certain, 293
Anticutback rule, 81
Arbitration, 166
Assisted living, 263
Assumptions
inflation, 249250
investment, 251253
life expectancy, 245246
retirement age, 244245
382 Index
Controlled groups, 73
Corporate-owned life insurance
(COLI), 167168
Cost basis, 273274
Cost of living adjustment (COLA),
249
Coverage, eligibility, and participation
rules
affiliated service groups, 74
aggregation rules, 7273
21-and-1 rule, 72
family attribution, 74
leased employees, 7475
410(b) minimum coverage test, 68
planning opportunities, 7172
401(a)(26) testing, 7071
Crisis of financial unawareness
financial awareness, 35
individual retirement accounts, 12
nonqualified deferred
compensation, 78
tax-advantaged plan attributes, 56
tax-advantaged plan, general
requirements, 7
Cross testing, 8384
Currently insured worker, 228
Cushion amount, 111
Death planning
incidental death benefit rule,
103106
preretirement death planning,
102103
Deceased participant, 281282
Defense of Marriage Act (DOMA),
142
Deferred retirement, 98, 233234
Defined benefit (DB) plan
vs. DC plan, 2326
formulas, 3134
funding, 110112
in PPA, 14
selection reasons, 3031
special plan types, 3435
terminations, 149150
Defined contribution (DC) plan
401(k), 2223, 4145
403(b), 23, 6061
Index 383
Exemptions
administrative, 131
individual, 131
statutory, 130
Exercise price, 176177
Expense method, 249
FAC. See Final average compensation
Fact-finding process, 20
FADEA. See Federal Age
Discrimination in
Employment Act
Fair market value (FMV), 177
Family attribution, 74
Federal Age Discrimination in
Employment Act (FADEA),
98
Federal Insurance Contributions Act
(FICA), 161162, 226
Federal Reserve Bank of St. Louis, 4
FICA. See Federal Insurance
Contributions Act
Fiduciary bond, 132
Fiduciary responsibility, 115
collateral benefit, 125
conflict mitigation, 125127
disclosures and requirements,
127128
discretionary authority, 124
exclusive benefit rule, 125
exemptions, 130131
fiduciary duty, 124125
fiduciary-prohibited transactions,
129131
limiting fiduciary liability, 132133
participant-directed investing,
128129
plan assets, 125
self-dealing, 130
standard of prudence, 126
third-party administrators, 124
Fifth Third Bancorp vs. John
Dudenhoeffer, 51
Final average compensation (FAC), 32
Financial awareness, 35
Five-year rule, 195
Flat amount per year of service
method, 34
384 Index
Hardship, 41
Hardship withdrawal, 43
HCEs. See Highly compensated
employees
Highly compensated employees
(HCEs), 7, 40
Holistic view
drawbacks, 220222
employer-sponsored plan, 218219
financial professionals, 215216
retirement planning, 214215
retirement planning process steps,
216218
women and, 219220
Home healthcare, 263
Housing issues
alternative choices, 258259
overview of, 256257
relocation issues, 257258
100-1 rule, 104
ILIT. See Irrevocable life insurance
trust
Immediate vesting, 72
Incentive stock options (ISO),
178180
Incidental death benefit rule,
103106
Indemnity policy, 263
Indirect rollover, 193
Individual exemptions, 131
Individual retirement accounts (IRAs)
active participants, 188191
definition, 12
excess contributions, 195196
funding instruments, 199201
nonqualified deferred
compensation, 78
opportunities, 202204
overview of, 186187
prohibited investments, 202204
rollovers and roth conversions,
193195
Roth, 186187, 191193
self-directed, 201202
spousal, 187
traditional, 186188
Individual retirement annuity, 200
Ineligible plan, 171
Index 385
386 Index
Nontax-advantaged savings, 6
Normal retirement age (NRA), 33,
9697
Notice of intent to terminate, 149
NQSO. See Nonqualified stock
options
NRA. See Normal retirement age
NUA. See Net unrealized appreciation
Offering period, 180
One year of service, 72, 80
Overshadowing concept, 82
Parent-subsidiary-controlled group,
73
Partial termination, 152
Participant-directed investing effects,
128129
Patient Protection and Affordable
Care Act of 2010, 261262
PBGC. See Pension Benefit Guaranty
Corporation
PBO. See Projected benefit obligation
Pension Benefit Guaranty
Corporation (PBGC), 1617,
35
Pension Protection Act (PPA), 14
Pension-type plan vs. profit-sharingtype plan, 30
Percentage test, 69
Personally liable fiduciary, 132
Phantom stock, 181
Phaseout scenario, 190
PIA. See Primary insurance amount
Plan assets, 125
Plan installation
administration requirements,
140141
common errors, 141142
compliance issues, 142143
new plan, 138139
qualified domestic relations order,
141142
summary plan description, 139
Plan loans
ERISA, 9192
IRS, 92
Index 387
Qualified plan
definition, 4
examples of, 4
vs. other plans, 5
Qualified plan distribution options,
291292
Qualified preretirement survivor
annuity (QPSA), 102103
Qualified replacement plan, 150
Qualified termination administrator,
153
Rabbi trust, 169
Ratio test, 6970
RBD. See Required beginning date
Reallocation forfeiture, 95
Recharacterization, 196
Regulation
definition, 15
proposed, 15
Replacement ratio approach, 247
Required beginning date (RBD), 280
Required minimum distribution
(RMD), 279281
Restricted stock, 182
Retirement age assumptions, 244245
Retirement distribution planning
beneficiary rollovers, 277278
cost basis, recovery of, 273274
for deceased participant, 281282
general tax treatment, 270271
net unrealized appreciation rule,
278279
other issues, 282284
qualifying Roth IRA distribution,
274276
required minimum distribution,
279281
rollovers, 276277
72(t) special exception, 271272
Retirement income approach,
247249
Retirement landscape
Employee Retirement Income
Security Act, 1112
Pension Protection Act, 14
post-ERISA trends, 1314
388 Index
Index 389