tax deferred annuity chapter 25 employee benefit & retirement planning copyright 2009, the...

Copyright 2009, The National Underwriter Company 1

Tax Deferred Annuity Chapter 25Employee Benefit & Retirement Planning

What is it?

Tax deferred employee retirement plan that can only be adopted by certain

- tax exempt organizations

- public school systems

Benefits

- contribution not taxed currently

- account balances accumulate tax-free

- defer tax on contributions and earnings



When is it indicated?

1. Eligible employer

- tax exempt organization

- public school or college

2. employer wants low-cost tax deferred retirement plan




3. employees

- want choice regarding level of savings

- are young with time to retirement

- willing to accept some investment risk

4. employer wants “savings-type” supplement to defined benefit or other qualified plan




5. Other considerations

- non-governmental, tax-exempt employers can also offer Sec 401(k) plans

- tax-exempt employers and governmental entities can maintain SIMPLE IRA plan



What is a tax-exempt organization?

Meets qualifications of IRC Code Sec. 501(c)(3)

– organized and operated exclusively for religious, charitable, scientific, testing for public safely, literary, or educational purposes, or to foster national or international amateur sport competition or for the prevention of cruelty to children or animals

– must benefit public, not individual or private shareholder

– refrain from political campaigning or propaganda intended to influence legislation



What is an educational organization?

An educational organization has a• regular faculty and curriculum

• regularly enrolled student body in attendance that is operated by a state or municipal agency

Can also adopt a TDA plan for certain employees outside of the schools who perform services involving the

operation or direction of the public school education program



Advantages

1. Tax deferred retirement savings

2. Employees have choice about amount to save

3. Can fund plan entirely through salary reduction

4. In-service withdrawals are permitted



Disadvantages

1. Plan balance may be inadequate for employees entering plan when older

2. Employee annual salary reduction subject to elective deferral limit

3. Plan can be costly and complex to administer

4. Employees bear investment risk



Design Features: Salary Reductions

• Employees elect salary reductions before compensation earned

• Employer can also provide annual ‘bonus’ that employees can receive in cash or contribute to plan



Plan contributions have per employee limit applied to total contributed to:

– Sec. 401(k)– salary reduction SEPs – if established before 1997– SIMPLE IRAs– Section 403(b) TDA plans

However, “double-dip” opportunity exists with Sec. 457 plans



Total of all elective deferrals must not exceed:

2009 $16,500

Index in $500 increments



Employees reaching age 50 during plan year can make additional ‘catch-up’ contributions in plans using elective deferrals:

$5,500 in 2009 *

* $500 increments



Design Features: The TDA Salary ReductionCatch-Up

TDA plans have unique, additional catch-up features

IF employee has 15 years of service and employer is

– educational organization– hospital– home health care agency– health and welfare service agency– church, synagogue, or related organization



Design Features: The TDA Salary Reduction Catch-Up

If previous conditions met, the elective deferral limit is increased by an additional sum equal to the LEAST of

– $3,000;

– $15,000, reduced by the sum of (1) prior use of catch-up provision, and (2) the aggregate amount of designated Roth 403(b) contributions for prior tax years; or

– $5,000 times years of service with employer less all prior salary reductions with employer



Design Features: Employer Contributions

TDA plans allow employer contributions

– can use to encourage or augment employee contributions

– typically use formula matching contributions

– with employer contributions, complex nondiscrimination requirements must be met



Design Features: Section 415 Limits

employer contributionsemployee contributions

+ forfeiture from other participant accountsannual additions

Annual additions to each participant's account cannot exceed LESSER of:

- 100% compensation- $49,000 (2009, indexed)



Design Features: Nondiscrimination Requirements

With some exceptions, under current regulations TDA plans must satisfy rules similar to nondiscrimination rules that apply to regular qualified plans

– Rules relating to nondiscrimination in contributions and benefits (IRC Section 401(a)(4))




– Can consider only first $245,000 (2009) of each participant’s compensation in plan contribution formula

– Minimum coverage of non-highly compensated employees (Sec. 410(b))

– Rules aggregating related employers for nondiscrimination testing purposes




“Universal Availability”

All employees must be permitted to make elective deferrals if any employee may do so

• employer can require minimum salary reduction up to $200 to participate



Design Features: Vesting

• Employee always 100% vested in contributions made via salary reduction and earnings on those amounts

• Employer contributions can require vesting

– must follow rules for top-heavy plans• 3 year cliff or

• 2-6 year gradual vesting



Design Features: Plan Investments

Can be in either or both:

– annuity contracts purchase by the employer from an insurance company

OR

– mutual fund shares held in custodial accounts



Design Features: Plan Distributions

• Follow qualified plan distribution rules

• In-service withdrawals permitted, but unless withdrawal qualifies for an exception, it is subject to 10% early withdrawal penalty

• All withdrawals subject to income tax

• Many TDA plans allow plan loans



Tax Implications

1. Employees defer tax on salary reductions and employer contributions if amount under limit

2. Salary reductions (but not employer contributions) subject to Social Security (FICA) and federal unemployment (FUTA) payroll taxes

3. Limited nonrefundable tax credit available to certain lower income taxpayers making salary deferral to TDA



Tax Implications

4. Amounts contributed by employer to ‘deemed IRA’ reduce limit for contribution to traditional or Roth IRA

5. Can exclude from current income trustee to trustee transfer of funds from TDA to governmental defined benefit plan

6. Plan distributions must follow qualified plan distribution rules

7. Plan distributions subject to income tax; 10 year averaging not available



ERISA Requirements

ERISA rules generally apply to TDA plans to same extent that ERISA applies to qualified plans

Possible ERISA exemptions

– TDAs of governmental and church organizations

– plans with minimal employer involvement



How to Install a Plan

• Written plan document now required for all plans under final regulations

• Salary reduction forms must be completed before plan’s effective date

• Effective communication with employees essential if employer objectives and nondiscrimination tests are to be met



True or False?

1. As an educational organization, a private university can adopt a TDA plan.

2. TDA plans are not effective if an employer cannot afford to match employee contributions.

3. Employers bear the investment risk in TDAs.

4. TDA plans allow employees to make in-service withdrawals.

5. TDA plans can be complex and costly to administer.



True or False?

6. Janet, age 47, earned $75,000 in 2009. She is covered under a TDA plan funded exclusively through employee salary reductions. The maximum she may contribute to the TDA plan in 2009 is $16,500.

7. An employer can require a minimum salary reduction as a condition for TDA plan participation.

8. TDA plan participants are always 100% vested in all plan contributions.



True or False?

9. “Incidental life insurance” protection under annuity contracts is not permitted in a TDA plan.

10. A TDA plan subject to ERISA must provide a qualified joint and survivor annuity or provide that at participant’s death, 100% of nonforfeitable benefit be paid to the surviving spouse.



Discussion Question

Since a 501(c)(3) organization can sponsor both Section 401(k) plans and TDA plans, what are the considerations in choosing between the two?

tax deferred annuity chapter 25 employee benefit & retirement planning copyright 2009, the...

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