ACC MISC: Chapter 7 Lecture.pdf

Chapter 7: Retirement Income and Other Income Types Chapter Description Upon completion of this chapter, students will be able to identify various types of retirement income. Students will be able to describe different kinds of pension plans and government benefit programs and the tax reporting required when a taxpayer receives income from any of these plans. Lastly, tax reporting requirements for these types of income will be explained. The following content is based on 2022 tax law for 2021 tax returns; however, discussions of prior year tax law will be addressed as applicable. 1) Recognize retirement income, including distinguishing between pensions and annuities. 2) Discuss specific types of pension plans, including SEP and SIMPLE plans, traditional and ROTH IRA’s, qualified plans, and federal civil service retirement, along with distributions from such plans which are reported on Form 1099-R (Form CSA 1099-R for federal civil service). 3) Discuss government retirement benefit programs; specifically, Social Security and railroad retirement and the applicable reporting forms (Forms SSA-1099, RRB-1099, and RRB- 1099-R). 4) Summarize where to report various types of income. • Annuity • Cost (of a retirement plan) • Disability Income • Distribution • Early Distribution • Employee Contribution • Excess Contributions • Individual Retirement Arrangement (IRA) • Lump-Sum Distribution • Nonqualified Employee Plan • Pension Plan • Qualified Employee Annuity • Qualified Employee Plan • Railroad Retirement Tier 1 • Railroad Retirement Tier 2 • Rollover • Tax-Sheltered Annuity (TSA) Plan • Transfer • Withdrawal Upon completion of service by an individual in performing normal work duties, that individual will enter the phase of his life that comes after work. That period will be considered retirement. Retired individuals will need a source of income for support after retirement. This support will often come in the form of a pension or annuity. Pensions are regular payments made to an individual after retirement. These payment amounts are determined by applying specific factors which are laid out in detail by the pension plan. The plan may specify several factors which will be used to determine the amount of these regular payments after retirement. Some examples of factors which may be used to determine the amount of these regular payments would be such things as age at retirement, years of service, level of compensation, and the age considered to be full retirement (where the employee will receive the full retirement amount specified by the plan). These are called defined benefit plans since the benefits (amount of each payment) will be calculated based upon factors specified in the plan. Pension plans may be set up by several different entities. An employer may set up an employment-based pension plan for the benefit of employees. This will be an employee benefit which is intended to provide employees with a reliable stream of income after they are no longer receiving a regular stream of income from employment. This type of plan may be entirely funded by the employer, or it may be partially funded by the employees. A shared funding arrangement between the employer and employees is common. Retirement income may also be provided by public pension funds (such as Social Security or railroad retirement benefits) or by certain disability payments (these may be provided by a pension plan for members who suffered a disability). Annuities may provide a similar series of payments to a retiree. Annuity plans are set up under a contract which provides for a stream of regular payments which will last for more than one year. These payments may be for a definite, constant amount (fixed), or they may be variable (not fixed). A life annuity will be similar to a pension since it insures against longevity by providing a stream of guaranteed payments for life. These annuity contracts may be purchased for the taxpayer, or by the taxpayer through another entity such as his employer or an advisor. A specific type of annuity, called a 403(b) plan, may be offered to employees by public schools, colleges, universities, churches, and tax-exempt charities. The employer will purchase annuity contracts for its participating employees. These are tax-sheltered, voluntary employee plans. Employees contribute some of their pretax salary to a 403(b) account and the contributions and earnings will be tax-deferred until distributions are made to the employee. Contributions by an employee to his individual account are flexible, but total contributions per year are limited. The private industry plan which is similar to the 403(b) is called a 401(k) plan. These are also individual accounts set up by the employer for employees and contributions are flexible. It should be noted that investment options are usually quite limited. Both 401(k) and 403(b) plans are defined contribution plans. In contrast to defined benefit plans, the benefits are not specified in the pension plan. The only known factor in a defined contribution plan is the level of contributions by each individual in the plan. The benefits (distributions) will depend on employee elections and on the successful investment of funds in the employee’s individual account. Many companies who offer pension plans have moved away from defined benefit plans over the last several years due to the complexity and expense of administering such plans. Defined contribution plans have become much more common than defined benefit plans due to the ease of administration. In such plans, only the contributions are specified. An account is set up for each employee to receive the contributions and nothing else is required except periodic account statements sent to each participant. SEP (Simplified Employee Pension) SEP plans allow an employer to make contributions to employees’ pension accounts. SEP plans are attractive to employers for a variety of reasons, including: • Administrative benefits – SEP-IRAs typically have lower administrative costs and less paperwork than traditional IRAs. • Flexibility – Employers are not required to make contributions every year. • Tax Deductibility - Employer contributions are tax deductible. • Employer Credits – Small employers may be eligible for certain tax credits related to startup costs. See “Practice Note” below. The employer contributions are made to a traditional IRA (SEP-IRA) account of each eligible participant in the plan. Each employee owns their own account and contributions will be made by or for an employee to the financial institution holding that employee’s SEP-IRA account. Each eligible employee must have a SEP-IRA account set up by or for them. Interest accumulates tax free until the participant begins to make withdrawals. A self-employed person is also eligible to participate in this plan. Their contribution limit is based on their net profit. Many financial institutions are available to help employers set up SEP plans. Employers must complete three steps to set up a SEP plan: 1. A formal written agreement. All eligible employees should receive benefits under the plan. Per IRS guidance, a formal written agreement may be established by signing one of these documents: o IRS Model SEP: Form 5305-SEP, Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement, may be used by an employer to establish an agreement to provide benefits to all eligible employees under a SEP. This form is not to be filed with the IRS; rather, the employer should keep the form in his or her records. o IRS-approved prototype SEP: If an employer is unable to use Form 5305-SEP, it may use a prototype document. These documents are usually provided by mutual funds, insurance companies, banks, or other qualified institutions. o Individually Designed SEP plan document: This is typically a document written by an attorney that is unique to the individual employer. 2. Provision of information to all eligible employees about the plan. This generally involves providing employees with a copy of Form 5305-SEP (or other plan document) and other information about the SEP plan, including plan terms and how to access accounts. 3. Account set-up for every eligible employee. Eligible employee