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401ks & Qualified Plans

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PLEASE DO NOW…

On Socrative, please answer the following

question:

1.Name all of the possible sources of your

retirement income you will receive in the

future.

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TODAY’S GOALS

• What is a Qualified Plan?

• Why should we establish a 401k plan?

• How do we contribute to a 401k plan?

• What is an ESOP?

• What is Matching & Vesting?

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INVESTMENT MANAGEMENT STANDARD(S)

Achievement Standard: Evaluate savings and investment options to meet short and long-term goals.

Achievement Standard: Evaluate services provided by financial deposit institutions to transfer funds.

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DEFINITIONS TO KNOW

• Vesting

• Matching

• 401k Plan

• Defined Benefit Plan

• Defined Contribution Plan

• Distributions

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WHAT IS A QUALIFIED PLAN?

A retirement account established by the employer for the benefit of the employee.

Allows the employer a tax deduction for contributing to the plan.

Employees make contributions on a pre-tax basis and earnings are invested and grow tax-deferred.

Employees cannot take distributions (withdrawals) until he or she reaches age 59 ½.

Employees are required to take distributions at age 70 ½ (Required Minimum Distributions or RMDs).

There are 2 types of qualified plans:

1.Defined Benefit - Employer makes contributions, benefits guaranteed (e.g., PENSION PLAN).

2.Defined Contribution - Employee makes contributions, employer can make contributions, no guarantees (e.g., 401k Plan).

401k PLAN EXAMPLE

Here is an example of contributing on a pre-tax basis:Assume you earn $40,000 per year and pay 25% in income taxes. If you contribute $6,000 of that to your 401k, you won’t have to pay tax on the $6,000. CONTRIBUTE TO 401k DO NOT CONTRIBUTE TO 401k

Gross Salary $40,000

Gross Salary $40,000

401k Contributions -$6,000

401k Contributions - 0

Taxable Income $34,000

Taxable Income $40,000

Income Tax Rate x 25%

Income Tax Rate x 25%

Income Tax Paid $8,500

Income Tax Paid $10,000

To provide retirement income for ourselves and our families.

To defer paying taxes.

401ks allow you to take a loan from your account (NOT A SMART MOVE)

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WHY SHOULD WE ESTABLISH A 401k PLAN?

Your contributions simply come out of your paycheck, on a pre-tax basis.

Example: Patty earns $80,000 a year working for Microsoft as a computer programmer. She contributes 13% of her salary to her 401k plan. How much, in dollars, does she contribute each MONTH to her 401k plan?

Monthly Contributions to 401k= (Salary * % Contribution)/12

Monthly Contributions to 401k= ($80,000 * 13%)/12

Monthly Contributions to 401k= $866.67 per month

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HOW DO WE CONTRIBUTE TO A 401k PLAN?

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WHAT IS AN ESOP?

Employee Stock Ownership Plan

A defined contribution plan by which the investments are primarily in the employer’s stock.

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WHAT IS MATCHING & VESTING?

Matching is a type of contribution an employer chooses to make to an

employee’s 401k plan.

•The employee’s maximum contribution in 2013 = $17,500•On average, employers MATCH between 0-6% of the employee’s salary.•The combined contribution amount cannot exceed $51,000.

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WHAT IS MATCHING & VESTING?

For Example:CONTRIBUTE TO 401k DO NOT CONTRIBUTE TO 401k

Gross Salary $50,000

Gross Salary $50,000

401k Contributions $6,000

401k Contributions $0

Employer Match $3,000 50% Match or 6% of salary

Employer Match +$0

Total Contributions $9,000

Total Contributions $0

$3,000 in FREE Money that you can invest!!

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WHAT IS MATCHING & VESTING? (Cont’d)

VESTING is the process by which the employee earns a non-forfeitable right to benefits funded

by employer contributions.

Employees are always 100% vested in their own contributions.

Employees are usually 100% vested in employer contributions after 3+ years.

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LET’S PRACTICE…

Mike is 40% vested in his 401k plan. The employer’s contribution represents $10,500 of the total value of the plan. His contributions represent $50,000 of the total value of the plan. What is the total VESTED value of his 401k ? Solution:

Vested Value of 401(k) = (% vested * employer contribution) + Total value of employee contributions

Vested Value of 401(k) = (40% * $10,500) + $50,000

Vested Value of 401(k) = $54,200

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A LOOK AHEAD……

SEP Plans

Case Study #4

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QUESTIONS???