Table of contents
Chapter 13 - Retirement Savings and Deferred CompensationChapter
13Retirement Savings and Deferred Compensation
SOLUTIONS MANUAL Discussion Questions
1. [LO 1, 2] How are defined benefit plans different from
defined contribution plans? How are they similar?As the name
suggests, defined benefit plans spell out the specific benefit the
employee will receive on retirement. In contrast, defined
contribution plans specify the maximum annual contributions that
employers and employees may contribute to the plan. Defined benefit
plans are funded by the employer while defined contribution plans
are funded by the employee. Both plans are generally classified as
employer-provided qualified retirement plans and have similar rules
for vesting (although the vesting rules are slightly more favorable
for defined contribution plans than defined benefit plans) and
required distributions.
2. [LO 1] Describe how an employees benefit under a defined
benefit plan is computed.Defined benefit plans provide standard
retirement benefits to employees based on a fixed formula. The
formula to determine the standard retirement benefit is usually a
function of years of service and employees compensation as they
near retirement. Employees usually receive a fixed benefit for each
full year of service for the employer. For example, the formula may
provide a benefit of 2% for each year of service, up to a maximum
of 50% (25 years of service), of the average of the employees three
highest years of salary. The maximum annual benefit an employee can
receive is the lesser of 100% of the average of three highest years
of compensation or $205,000 for employees who separate from service
(retire) in 2013.
3. [LO 1, 2] What does it mean to vest in a defined benefit or
defined contribution plan?Vesting means that one obtains the legal
right to something. An employee vests in (legally obtains the right
to receive) her benefits of a defined benefit or contribution plan
by meeting certain requirements set forth by her employerusually
the requirement is based on years of service.
4. [LO 1, 2] Compare and contrast the minimum vesting
requirements for defined benefit plans and defined contribution
plans? The minimum vesting requirements for a defined benefit plan
are a five-year cliff or a seven-year graded schedule. These enable
the employee to fully vest in her benefits after five years or over
the course of seven years, respectively. The minimum vesting
requirements for a defined contribution plan are a three-year cliff
or a six-year graded
schedule. Under these schedules, an employee fully vests after
three years of service or over the course of six years,
respectively.
5. [LO 1, 2] What are the nontax advantages and disadvantages of
defined benefit plans relative to defined contribution plans?For an
employee the advantage of a defined benefit plan is knowing what
the payout will be at retirement given a certain amount of years of
service. Thus a defined benefit plan shifts investment risk (the
risk of how an investment will perform) to the employer. However,
if the employer is not able to fund or pay for the benefits, the
employee may not ever receive the retirement benefits from a
defined benefit plan.
Many of the disadvantages of defined benefit plans are faced by
the employer. Employers are required to fund (pay for) the plans.
The contributions required to fund a plan are dependent upon
actuarial and management estimates. This process can become very
cumbersome and expensive for the employer. Also, because the
employer is required to provide a certain benefit for the employee,
the employer must bear the investment risk.
Many employers are now moving towards defined contribution plans
due to the significant nontax advantages. Employers are not
required to make costly estimates to fund a contribution planthey
simply make the contribution they have committed to make. Also,
employers do not bear the investment risk of the investments.
For defined contribution plans, employees generally have some
direction over the way in which contributions are invested and also
reap all the benefits of positive market conditions or good
investments. But employees also bear the investment risk associated
with defined contribution plans.
6. [LO 1] Describe the maximum annual benefit that taxpayers may
receive under defined benefit plans. The maximum annual benefit an
employee who retires in the year 2013 can receive from a defined
benefit plan is the lesser of 100% of the average of the three
highest years of compensation paid to the employee or $205,000.
7. [LO 1] Describe the distribution or payout options available
to taxpayers participating in qualified defined benefit plans. How
are defined benefit plan distributions to recipients taxed?Once
vested employees are able to receive distributions from a defined
benefit plan according to the plans provisions. These distributions
are taxable as ordinary income in the year received. These
distributions are subject to penalties if both minimum and early
distribution requirements are not met. These penalties are usually
of little concern since most defined benefit plans are structured
to avoid them.
Distributions from a defined benefit plan are taxed as ordinary
income when they are received.
8. [LO 1, 2] Describe the minimum distribution requirements for
defined benefit plans. Are these requirements typically an item of
concern for taxpayers?An employee must receive distributions by the
later of April 1st of the year after the year in which the employee
turns 70 or when she actually retires, if later. While the
requirement necessitates that she receive a distribution for the
year in which she turns 70 , she can defer receipt of the first
payment until April 1 of the year after which she turns 70 .
Distribution requirements for defined benefit plans are rarely a
concern since the plans are typically structured to avoid them.
9. [LO 1, 2] Compare and contrast the employers responsibilities
for providing a defined benefit plan to employees relative to
providing a defined contribution plan.Employers providing a defined
benefit plan to employees are required to make annual contributions
to fund the plan. The employer carries the responsibility of making
investments and creating sufficient funds to cover the cost of
distributions to retired employees. Thus, the employer bears the
investment risk associated with the investments.
Employers providing defined contribution plans to employees are
responsible to make up-front contributions. Separate accounts are
maintained for each employee and employees are often allowed to
make contributions as well. Employers do not bear the market risk
of investments.
10. [LO 2] Describe how an employees benefit under a defined
contribution plan is determined.Contributions are invested and
accumulate earnings until they are distributed to the employee.
Upon distribution the benefit is taxed as ordinary income. The
ultimate benefit depends on the amount of employer contributions,
employee contributions, and the earnings on the contributions.
11. [LO 2] Is there a limit to how much an employer and/or
employee may contribute to an employees defined contribution
account(s) for the year? If so, describe the limit.Yes, there is a
limit to how much an employer and/or employee may contribute to an
employees defined contribution account(s) for the year. The
combined contributions to an employees defined contribution plan(s)
made by both the employer and employee are limited to the lesser of
$51,000 or 100% of the employees compensation for the year ($56,500
for employees 50 years old by year end). The employees contribution
is limited to $17,500 for 401(k) and 403(b) plans ($23,000 for
employees who are at least 50 years old at the end of the
year).
12. [LO 2] Cami (age 52 and married) was recently let go as part
of her employers reduction in force program. Camis annual AGI was
usually around $50,000. Shortly
after Camis employment was terminated, her employer distributed
the balance of her employer-sponsored 401(k) account to her. What
could Cami do to avoid being assessed the 10 percent early
distribution penalty? Cami could roll over (contribute) the full
401(k) proceeds to an individually managed retirement plan such as
an IRA or a Roth IRA. Because she is under age 55, if she does not
roll over the proceeds she will be taxed on the full distribution
amount and she will be required to pay a 10% penalty on the full
proceeds.
13. [LO 2] When may employees begin to receive defined
contribution plan distributions without penalty?Employees may begin
to receive distributions when they reach the age of 59 or 55 if
they are retired from service.
14. [LO 2] Describe the circumstances under which distributions
from defined contribution plans are penalized. What are the
penalties?If an employee receives a distribution too early or too
late the employee is penalized. A distribution is considered to be
received too early if it is received before the individual reaches
59 years of age or 55 if retired from service. The penalty on an
early distribution is 10% of the entire distribution amount.
A distribution is subject to penalty if it is received too late
or is insufficient in amount. A minimum distribution penalty
applies when taxpayers dont receive the required minimum
distribution for a particular year. The required minimum
distribution is based on the age of the taxpayer and tables
provided by the IRS. The minimum distributions must be received by
later of April 1 of the year after the year in which the employee
turns 70 or when the employee actually retires. When an employee
fails to receive the minimum distribution, the employee is taxed at
50% on the difference between the required distribution and the
amount actually distributed.
15. [LO 2] {Research} Brady Corporation has a profit sharing
plan that allocates 10 percent of all after-tax income to
employees. The profit sharing is allocated to individual employees
based on relative employee compensation. The profit sharing
contributions vest to employees under a six-year graded plan. If an
employee terminates his or her employment before fully vesting, the
plan allocates the forfeited amounts among the remaining
participants according to their account balances. Is this
forfeiture allocation policy discriminatory, and will it cause the
plan to lose its qualified status? Use Rev. Rul. 81-10 to help
formulate your answer. 401(a)(4) dictates that a profit sharing
plan will not qualify if it discriminates in favor of officers, or
highly compensated employees. The issue addressed is whether or not
the above profit sharing plan is discriminatory. Rev. Rul. 81-10
explains that a profit sharing plan will not be disqualified merely
because it provides for the allocation of forfeitures arising from
termination of service among the remaining participants on the
basis of their account
balances. It appears that this profit sharing will not cause the
plan to lose its qualified status.
16. [LO 2] What does it mean if an employer matches employee
contributions to 401(k) plans?When an employer matches an employees
contribution, the employer contributes to the employees plan based
on how much the employee contributes. The matching policy is
frequently described as a multiple of what the employee contributes
to the plan. If for example, an employee contributes $1,000 to a
401(k) plan the employer may offer to match this contribution 2 to
1 for a $2,000 contribution from the employer. In this case, the
employer and employee contributions sum to $3,000.
17. [LO 2] {Planning} What nontax factor(s) should an employee
consider when deciding whether and to what extent to participate in
an employers 401(k) plan?Nontax factors to be considered in the
decision to participate in an employers 401(k) plan include any
matching programs the employer may have in place, when an employee
may need funds distributed, and how funds contributed to the 401(k)
will be invested.
18. [LO 2] What are the differences between a traditional 401(k)
and Roth 401(k) plan?Taxpayers contribute to Roth 401(k) accounts
after-tax dollars. That is their contributions are not deductible.
However, distributions from Roth 401(k) plans are not taxable. In
contrast, employees contribute before-tax dollars to traditional
401(k) plans. That is, these contributions are deductible.
19. [LO 2] Can employers match employee contributions to Roth
401(k) plans? Explain.Employers are not allowed to contribute to an
employees Roth 401(k) plan. They must contribute to the employees
traditional 401(k) plan.
20. [LO 2] Describe the annual limitation on employer and
employee contributions to traditional 401(k) and Roth 401(k)
plans.The combined contributions made by an employer and employee
to an employees 401(k) plan (Roth or traditional) is limited to the
lesser of $51,000 or 100% of the employees compensation for the
year. The employees contribution is limited to $17,500 ($23,000 if
age 50 by the end of the year). Thus, if an employee contributes
$17,500 to her 401(k) plan (Roth or traditional), the employers
contribution the employees traditional 401(k) plan is limited to
$33,500 ($51,000 - $17,500).
21. [LO 2, 3] When a company is limited by the tax laws in the
amount it can contribute to an employees 401(k) plan, what will it
generally do to make the employee whole? Is this likely an issue
for rank-and-file employees? Why or why not?
Employers offering matching opportunities for employee
contributions to 401(k) plans are often unable to make a full match
for highly compensated employees due to the $51,000 limitation (the
combined total contribution made by an employee and the employer is
limited to $51,000). In order to make these employees whole,
companies offer supplemental nonqualified deferred compensation
plans. This issue is not likely to matter for rank and file
employees because employers are less likely to be constrained by
the $51,000 limit on matching employee contributions to 401(k)
plans.
22. [LO 2] {Planning} From a tax perspective, how would a
taxpayer determine whether they should contribute to a traditional
401(k) or a Roth 401(k)?Roth 401(k) plans always generate after-tax
rates of return equal to before-tax rates of return. Thus,
traditional 401(k) plans only generate better rates of return when
the employees tax rate is higher at the time of contribution than
at the time of distribution. If the employees tax rate at the time
of contribution and distribution are the same, the after tax rates
of return of the Roth 401(k) and the traditional 401(k) will be the
same.
In other words, as a general rule traditional plans are
typically better if an employees tax rate will decrease upon
retirement and Roth plans are typically better if an employees tax
rate will increase upon retirement.
23. [LO 2] Could a taxpayer contributing to a traditional 401(k)
plan earn an after-tax return greater than the before-tax return?
Explain.If an individual contributes to a traditional 401(k) plan
and later receives a distribution when she is paying tax at a lower
marginal tax rate, she can earn an after-tax rate of return greater
than the before-tax rate of return. This occurs because
contributions are deductible and provide a tax benefit at a high
tax rate and distributions are taxable but provide a tax cost at a
low rate.
24. [LO 2, 3] Explain the tax similarities and differences
between qualified defined contribution plans and nonqualified
deferred compensation plans from an employers
perspective.Similarities Employers: Employers deduct amounts they
pay for qualified and nonqualified plans. Both plans provide
deferred compensation or benefits to the employee.
Dissimilarities Employers: Nonqualified plans are not subject to
the same restrictive requirements pertaining to qualified plans, so
employers may discriminate in terms of who they allow to
participate in the plan. In fact, employers generally restrict
participation in nonqualified plans to more highly compensated
employees. Also, employers are not required to fund nonqualified
plans. That is, employers are not required to formally set aside
and accumulate funds specifically to pay the deferred compensation
obligation when it comes due. Rather, employers typically retain
funds deferred by employees under the
plan, use the funds for business operations, and pay the
deferred compensation out of their general funds when it comes
due.
25. [LO 2, 3] Explain the tax similarities and differences
between qualified defined contribution plans and nonqualified
deferred compensation plans from an employees
perspective.Similarities Employees: Just as with defined
contribution plans, employee contributions to nonqualified deferred
compensation plans (NQDC) reduce an employees taxable income in the
year of contribution. Also, just as with qualified plans, employees
are not taxed on the balance in their account until they receive
distributions. Finally, like distributions from qualified plans,
distributions from nonqualified deferred compensation plans are
taxed as ordinary income.
Dissimilarities Employees: Unlike qualified defined contribution
plans, there is no legal limitation on the amount employees can put
into a nonqualified deferred compensation account. Also, the
penalty provisions for taking early (or late) distributions of
qualified defined contribution plans is different -than penalty
provisions that may apply to nonqualified deferred compensation
plan distributions.
26. [LO 2, 3] Explain the nontax similarities and differences
between qualified defined contribution plans and nonqualified
deferred compensation plans from an employers perspective.Qualified
plans are similar to nonqualified plans in that they both provide
compensation to employees in years after they earn it. Employers
may discriminate in terms of who they allow to participate in a
nonqualified deferred plan but they may not discriminate when they
provide a qualified plan. The employer typically makes annual
contributions to the defined contribution plan but is not required
to fund nonqualified plans.
27. [LO 2, 3] Explain the nontax similarities and differences
between qualified defined contribution plans and nonqualified
deferred compensation plans from an employees perspective.The two
types of plans are similar in that they invest (or defer receiving)
compensation for a future return. However, the future return is
frequently based on deemed, rather than actual, investment choices
and the employee becomes an unsecured creditor of the employer. If
the employer doesnt have the funds, the employee may not receive
benefit from a nonqualified plan. Because the funds in a defined
contribution plan are set aside for the taxpayer in a separate
account outside the control or ownership of the employer, the
employee is not an unsecured creditor of the company.
28. [LO 3] {Planning} From a tax perspective, what issues does
an employee need to consider in deciding whether to defer
compensation under a nonqualified deferred compensation plan or to
receive it immediately?
An employee should take into account projected tax rates at the
time of contribution (deferral) and at the time of receipt of
payments from an NQDC. The after-tax rate of return will be
dependent upon the marginal tax rate. As discussed in the chapter,
assuming equal before-tax rates of return, if the taxpayers
marginal tax rates are equal at the time of deferral and at the
time the employee receives the deferred compensation, the after-tax
rate of return will equal the before-tax rate of return. If the tax
rate is higher at the time of contribution than at the time of
distribution, then the after-tax rate of return will exceed the
before-tax rate of return. Finally, if the tax rate at the time of
contribution is lower than at the time of distribution, then the
after-tax rate of return will be lower than the before-tax rate of
return.
29. [LO 3] {Planning} From a nontax perspective, what issues
does an employee need to consider in deciding whether to defer
compensation under a nonqualified deferred compensation plan or to
receive it immediately?Employees should consider whether or not the
benefits to be received from the nonqualified deferred compensation
plan are adequate to meet their expected costs upon retirement.
They should also consider whether they can afford to defer current
salary and the expected rate of return of the deferred salary and
the rate of return they would receive if they were to receive the
salary now and invest it. Finally, employees should consider the
financial stability of their employer because employers are not
required to fund nonqualified plans.
30. [LO 3] What are reasons why companies provide nonqualified
deferred compensation plans for certain employees?Employers may
provide nonqualified deferred compensation as part of a
compensation package to attract prospective executives and other
employees. They may provide plans because they can earn more on the
deferred compensation than they are required to pay to employees.
They may also provide plans to make highly compensated employees
whole in terms of matching contributions to qualified retirement
plans (because employers may not be able to contribute the full
matching percentage to the highly compensated employees due to tax
law limitations on contributions).
31. [LO 3] {Planning} How can companies use deferred
compensation to avoid the 162(m) limitation on salary
deductibility?Section 162(m) limits the amount of compensation paid
to officers of publicly traded corporations that can be deducted by
corporations to $1,000,000. Providing a nonqualified deferred
compensation plan is a way to avoid this limitation by deferring
compensation to a later period. However, if upon distribution the
individual is still an employee, the deferred compensation paid is
still subject to the $1 million deduction limit.
32. [LO 3] Are companies allowed to decide who can and who
cannot participate in nonqualified deferred compensation plans?
Briefly explain.
Companies are allowed to decide who can and cannot participate
in a nonqualified deferred compensation plan. In fact, NQDCs are
typically used to discriminate in favor of highly compensated
employees because employers are often unable to match contributions
made to defined contribution plans due to the contribution
limitations.
33. [LO 1, 2, 3] How might the ultimate benefits to an employee
who participates in a qualified retirement plan of a company differ
from an employee who participates in a nonqualified deferred
compensation plan of the company if the company experiences
bankruptcy before the employee is scheduled to receive the
benefits?Employers are required to carry a separate account for
each employee participating in a defined contribution plan. Amounts
contributed to an employees account and all gains or losses
attributable to the account belong to the employee. Employers are
not required to fund nonqualified deferred compensation plans. As a
result, if an employer falls into bankruptcy before an employee
receives distributions from a nonqualified deferred compensation
plan, the employee is unlikely to recover the amount of the
deferred salary.
34. [LO 4] What are the primary tax differences between
traditional IRAs and Roth IRAs? Traditional IRA contributions are
deductible and distributions when received are taxable. Roth IRA
contributions are not deductible and distributions when received
are not taxable.
35. [LO 4] {Planning} Describe the circumstances in which it
would be more favorable for a taxpayer to contribute to a
traditional IRA rather than a Roth IRA and vice-versa.In general, a
traditional IRA will typically provide a better after-tax rate of
return when tax rates are expected to decline in the future. A Roth
IRA will generally provide a better after-tax rate of return when
tax rates are expected to increase in the future. If the tax rates
are expected to remain the same, the after-tax rate of return will
be the same for both types of IRAs.
36. [LO 4] What are the requirements for a taxpayer to make a
deductible contribution to a traditional IRA? Why do the tax laws
impose these restrictions?To make a deductible contribution to a
traditional IRA the taxpayer must (1) not be a participant in an
employer-sponsored retirement plan or (2) if they are participating
in an employee-sponsored retirement plan, they must have income
below a certain threshold. IRAs are meant to help persons that are
unable to participate in an employer-sponsored program or that have
relatively low levels of income.
37. [LO 4] What is the limitation on a deductible IRA
contribution for 2013? For those not already participating in an
employer-sponsored retirement plan, deductible contributions to an
IRA are limited to $5,500 a year or earned income if it is less.
Taxpayers who have reached the age of 50 are able to contribute an
additional $1,000. A taxpayer already participating in an
employer-sponsored program may also make
deductible contributions of the same amount if her AGI falls
below a certain threshold. The $5,500 (or $6,500) deductible amount
is phased out for taxpayers whose AGI exceeds the threshold
amount.
38. [LO 4] Compare the minimum distribution requirements for
traditional IRAs to those of Roth IRAs.In regards to traditional
IRAs, taxpayers are subject to the same minimum distribution
requirements as traditional 401(k) plans. They must begin receiving
distribution by the later of April 1 of the year after the year in
which the taxpayer turns 70 or when she retires. The minimum amount
of the distribution is determined by using a table provided by the
IRS and is based upon the taxpayers age and account balance.
Taxpayers are not ever required to make minimum distributions
from Roth IRAs.39. [LO 4] How are qualified distributions from Roth
IRAs taxed? How are nonqualified distributions taxed?Qualifying
distributions from a Roth IRA are not taxable. Nonqualified
distributions are taxed and penalized to the extent that they are
made from the earnings of the IRA. Contributions to a Roth IRA are
from after-tax dollars (non-deductible) and can always be recovered
tax free. Nonqualified distributions are considered to first come
from contributions and then earnings.
40. [LO 4] Explain when a taxpayer will be subject to the 10
percent penalty when receiving distributions from a Roth IRA? Only
nonqualified distributions made from the earnings of a Roth IRA are
subject to ordinary taxes and a 10% penalty. Nonqualified
distributions are any distributions if the taxpayer has not had the
Roth IRA account open for at least five years.[footnoteRef:1] If
the Roth account has been open for five years, all distributions
other than distributions (1) made on or after the date the taxpayer
reaches 59 years of age, (2) made to a beneficiary (or to the
estate of the taxpayer) on or after the death of the taxpayer, (3)
attributable to the taxpayer being disabled, or (4) used to pay
qualified acquisition costs for first-time homebuyers (limited to
$10,000) are considered to be disqualified distributions. [1: The
five year period starts on January 1 of the year in which the
contribution was made and ends on the last day of the fifth taxable
year.]
41. [LO 4] Is a taxpayer who contributed to a traditional IRA
able to transfer or roll over the money into a Roth IRA? If yes,
explain the tax consequences of the transfer.Taxpayers are able to
roll over (transfer) funds from a traditional IRA to a Roth IRA.
The entire amount taken from the traditional IRA is taxed at
ordinary rates but is not subject to the 10% penalty so long as the
taxpayer contributes the full amount taken out of the traditional
IRA to a Roth IRA within 60 days of taking it out of the
traditional IRA.
42. [LO 4] Assume a taxpayer makes a nondeductible contribution
to a traditional IRA. How does the taxpayer determine the
taxability of distributions from the IRA on reaching retirement?
When a taxpayer receives a partial distribution from an IRA
containing both deductible and nondeductible contributions, the
nontaxable portion of the distribution is determined by multiplying
the ratio of the nondeductible contribution over the entire balance
in the account (nondeductible contributions / entire account
balance) by the amount of the distribution.
43. [LO 4] When a taxpayer takes a nonqualified distribution
from a Roth IRA, is the entire amount of the distribution treated
as taxable income?Only the portion of a nonqualified distribution
attributable to the earnings from contributions is taxable (this
portion is also penalized at a 10% rate). Distributions are
considered to come first from contributions and then from
earnings.
44. [LO 5] What types of retirement plans are available to
self-employed taxpayers?Two of the more common plans for the
self-employed are the SEP IRA and individual (or self-employed)
401(k). Other plans such as Simple IRA plans are also available to
self-employed taxpayers although we dont discuss details of these
plans in the chapter.
45. [LO 5] Compare and contrast the annual limitations on
deductible contributions for self-employed taxpayers to SEP IRAs,
and individual 401(k) accounts? The contribution limitation on a
SEP IRA for 2013 is the lesser of $51,000 or 20% of the sole
proprietors net earnings from self employment.
The contribution limitation on individual 401(k) accounts is the
lesser of $51,000 or 20% of the sole proprietors net earnings from
self employment (the employers contribution) plus $17,500 (the
employees contribution). Taxpayers 50 years old and older may
contribute an additional $5,500 catch up contribution above and
beyond these limitations (the catch up is not available for SEP
IRAs). The contribution may not exceed net earnings from
self-employment.46. [LO 5] {Planning} What are the nontax
considerations for self-employed taxpayers deciding whether to set
up a SEP IRA or an individual 401(k)?Sole proprietors with
employees providing a SEP IRA must contribute to the employees SEP
IRA accounts based on their overall compensation from the business.
This can be a heavy burden for a sole proprietor and should be
considered before setting up a SEP IRA.
The individual 401(k) is not available for sole proprietors with
employees, so providing benefits to employees under the plan is not
a concern. However, the administrative burden of establishing,
operating, and maintaining a plan is much higher for a 401(k) plan
than the other self-employed plans such as SEP IRAs.
47. [LO 6] What is the savers credit and who is eligible to
receive it?The savers credit is a credit provided for an
individuals elective contributions of up to $2,000 to any qualified
retirement plan multiplied by a percentage provided by the IRS and
dependent upon AGI. The credit is in addition to any deduction the
taxpayer may have been able to take as a result of the
contribution. The credit is only available for taxpayers who are 18
years of age or older, not full-time students during the year
(full-time student during five calendar months during taxpayers tax
year), and not claimed as dependents on another taxpayer's
return.
48. [LO 6] What is the maximum savers credit available to
taxpayers? What taxpayer characteristics are relevant to the
determination?The maximum savers credit available to taxpayers is
$1,000. It is calculated by multiplying the taxpayers contribution,
up to a maximum of $2,000, by the applicable percentage depending
on the taxpayers filing status and AGI. Also, the credit is
restricted to individuals who are 18 years of age or older and who
are not full-time students or claimed as dependents on another
taxpayers return. The savers credit is nonrefundable.
49. [LO 6] How is the savers credit computed?The savers credit
is calculated by multiplying the taxpayers contribution (only up to
$2,000) by an applicable percentage provided by the IRS and based
on the taxpayers filing status and AGI. Also, the credit is
restricted to individuals who are 18 years of age or older and who
are not full-time students (full-time students during at least five
calendar months during taxpayers tax year) or claimed as dependents
on another taxpayers return.
Problems
50. [LO 1] Javier recently graduated and started his career with
DNL Inc. DNL provides a defined benefit plan to all employees.
According to the terms of the plan, for each full year of service
working for the employer, employees receive a benefit of 1.5
percent of their average salary over their highest three years of
compensation from the company. Employees may accrue only 30 years
of benefit under the plan (45 percent). Determine Javiers annual
benefit on retirement, before taxes, under each of the following
scenarios:a. Javier works for DNL for three years and three months
before he leaves for another job. Javiers annual salary was
$55,000, $65,000, $70,000, and $72,000 for years 1, 2, 3, and 4
respectively. DNL uses a five-year cliff vesting schedule.b. Javier
works for DNL for three years and three months before he leaves for
another job. Javiers annual salary was $55,000, $65,000, $70,000,
and $72,000 for years 1, 2, 3, and 4 respectively. DNL uses a
seven-year graded vesting schedule.
c. Javier works for DNL for six years and three months before he
leaves for another job. Javiers annual salary was $75,000, $85,000,
$90,000, and $95,000 for years 4, 5, 6, and 7 respectively. DNL
uses a five-year cliff vesting schedule.d. Javier works for DNL for
six years and three months before he leaves for another job.
Javiers annual salary was $75,000, $85,000, $90,000, and $95,000
for years 4, 5, 6, and 7 respectively. DNL uses a seven-year graded
vesting schedule.e. Javier works for DNL for 32 years and three
months before retiring. Javiers annual salary was $175,000,
$185,000, and $190,000 for his final three years of employment.
a. Only the three full years Javier worked for DNL count toward
his retirement benefit. Because DNL uses a five-year cliff vesting
schedule and because Javier worked for DNL for less than five full
years, Javier does not vest in any of his retirement benefit. So,
his before-tax annual benefit from DNL on retirement is $0.
b. Only the three full years Javier worked for DNL count toward
his retirement benefit. Because DNL used a seven-year graded
schedule, Javier has vested in 20% of his total benefit. Javier has
worked three full years and is eligible to receive 4.5% (3 1.5%) of
the average of his three highest years of compensation. The average
of his three highest years of salary is $63,333
[(55,000+65,000+70,000) / 3]. His annual before-tax benefit is $570
($63,333 4.5% 20%).
c. Javier is eligible to count six full years of service towards
his retirement benefit. Because DNL uses a 5-year cliff schedule
and Javier has worked more than five years, he has vested 100% in
his total retirement benefit. He will receive 9% (6 1.5%) of
$83,333, the average of his three highest years of salary
[(75,000+85,000+90,000)/3]. (he only earned one-fourth of his
salary in year 7). His annual before-tax benefit will be $7,500 (9%
$83,333).
d. Javier may count six full years of service with DNL towards
determining his retirement benefit with DNL. Because DNL uses a
seven-year graded vesting schedule, Javier has vested in 80% of his
total benefit. His total benefit is 1.5% a year of the average of
his three highest years of compensation. Because Javier has worked
for six full years, he is eligible for 9% of his average salary for
his three highest years of compensation. In this case, his highest
salary came in years 4 6 (he only earned one-fourth of his $95,000
salary in year 7). His average salary over this period is $83,333
[(75,000 + 85,000 + 90,000) / 3]. So his annual before tax benefit
from DNL is $6,000 (i.e., $83,333 9% 80%).
e. Javier has vested 100% in his total retirement benefit and is
eligible for the maximum 45% (1.5% x 30 years) benefit of the
average of his three highest years of salary. The average of his
three highest years of salary is $183,333
[(175,000+185,000+190,000) / 3]. Javiers before-tax benefit is
$82,500 ($183,333 45%).
51. [LO 1] Alicia has been working for JMM Corp. for 32 years.
Alicia participates in JMMs defined benefit plan. Under the plan,
for every year of service for JMM she is to receive 2 percent of
the average salary of her three highest years of compensation from
JMM. She retired on January 1, 2013. Before retirement, her annual
salary was $570,000, $600,000, and $630,000 for 2010, 2011, and
2012. What is the maximum benefit Alicia can receive in 2013?Before
considering any benefit limitation, Alicia is entitled to receive
64% (32 years 2% per year) of her average salary for her three
highest years of compensation. The average of Alicias three highest
years of compensation is $600,000 [($570,000+$600,000+$630,000)/3]
so she is entitled to receive $384,000 ($600,000 64%) from JMM
(before considering the limitation). However, for employees
retiring in 2013, the tax law limits the maximum benefit that can
be paid to an employee under a defined benefit plan to the lesser
of (1) the employees average compensation of their three highest
years of salary ($600,000 in Alicias case) or (2) $205,000.
Consequently, the maximum benefit Alicia can receive in 2013 is
$205,000.
52. [LO 2] Kim has worked for one employer her entire career.
While she was working, she participated in the employers defined
contribution plan [traditional 401(k)]. At the end of 2013, Kim
retires and the balance in her defined contribution plan was
$2,000,000 at the end of 2012.a. What is Kims minimum required
distribution for 2013 in 2014 if she is 68 years old at the end of
2013?b. What is Kims minimum required distribution for 2013 if she
turns 70 during 2013 and she has not turned 71 years old by the end
of the 2013? When must she receive this distribution?c. What is
Kims minimum required distribution for 2013 in 2014 if she is 73
years old at the end of 2013?d. Assuming that Kim is 75 years old
at the end of 2013 and that her marginal tax rate in 2013 is 33
percent, what will she have remaining after taxes if she receives
only a distribution of $50,000 for 2013?e. {Forms}. Complete Form
5329, page 2 to report the minimum distribution penalty in part d.
Use 2012 forms if 2013 forms are unavailable.
a. $0. The minimum distribution requirements for defined
contribution plans require employees to begin receiving
distributions from the plan by the later of (1) April 1 of the year
after the year in which the employee reaches 70 years of age or (2)
the year after the
year in which the employee actually retires. In this situation,
Kim has not yet reached 70 years of age so she is not required to
receive any distributions from the plan for 2013 in 2014. That is,
her minimum required distribution for 2013 is $0.
b. $73,000. Because she turns 70.5 during 2013, Kim is required
to receive a minimum distribution for 2013. Kims minimum
distribution for 2013 is based on the balance of her 401(k) account
at the end of 2012 ($2,000,000) multiplied by the applicable
percentage in the IRS Uniform Lifetime Table. Because she is 70
years old at the end of 2013, the applicable percentage is 3.65%.
Consequently, Kims minimum distribution for 2013 is $73,000
($2,000,000 3.65%). Note that even though this is a required
distribution for 2013, Kim is not required to receive this
distribution until April 1, 2014.
c. $81,000. The minimum distribution requirements for defined
contribution plans require employees to begin receiving
distributions from the plan by the later of (1) April 1 of the year
after the year in which the employee reaches 70 years of age or (2)
April 1 of the year after the year in which the employee retires.
In this case (2) applies to Kim. Because Kim retired at the end of
2013, she must receive a minimum distribution (for 2013) in 2014.
The amount of the distribution is calculated using the IRS Uniform
Lifetime Table. Because Kim is 73 at the end of 2013, the table
indicates that she must receive a distribution for 2013 of 4.05% of
her account balance at the end of 2012. Her account balance at the
end of 2012 was $2,000,000. Thus Kims minimum distribution for 2013
is $81,000 ($2,000,000 4.05%). Kim must receive the distribution by
April 1, 2014 to avoid penalty. This distribution is taxed as
ordinary income to Kim.
d. $14,800. The minimum distribution requirements for defined
contribution plans require employees to begin receiving
distributions from the plan by the later of (1) April 1 of the year
after the year in which the employee reaches 70 years of age or (2)
April 1 of the year after the year in which the employee retires.
In this situation, (2) applies to Kim. The amount of the
distribution is calculated using the IRS Uniform Lifetime Table.
Because Kim is 75 at the end of 2013, the table indicates that she
must receive a distribution for 2013 of 4.37% of her account
balance at the end of 2012. Her account balance at the end of 2012
was $2,000,000. Thus Kims minimum distribution for 2013 is $87,400
($2,000,000 4.37%). However, her actual distribution for 2013 was
only $50,000. Consequently, she must pay a 50% penalty tax on
$37,400 ($87,400 - $50,000); the amount she was required to receive
and did not. So, Kim must pay income tax of $16,500 on the $50,000
distribution she did receive ($50,000 33%) and an $18,700 penalty
tax on the amount she did not receive ($37,400 50%). In total, Kim
must pay $35,200 in taxes ($16,500 + $18,700) on a $50,000
distribution. This leaves her with $14,800 after taxes ($50,000 -
$35,200). Thus, this distribution would be effectively taxed at a
marginal tax rate of 70.4% or 70% ($35,200/50,000). This is a
strong incentive to receive the required minimum distributions.
e.
53. [LO 2] Matthew (48 at year-end) develops cutting-edge
technology for SV, Inc. located in Silicon Valley. In 2013, Matthew
participates in SVs money purchase pension plan (a defined
contribution plan) and in his companys 401(k) plan. Under the money
purchase pension plan, SV contributes 15 percent of an employees
salary to a retirement account for the employee up to the amount
limited by the tax code. Because it provides the money purchase
pension plan, SV does not contribute to the employees 401(k) plan.
Matthew would like to maximize his contribution to his 401(k)
account after SVs contribution to the money purchase plan.a.
Assuming Matthews annual salary is $400,000, what amount will SV
contribute to Matthews money purchase plan? What can Matthew
contribute to his 401(k) account in 2013?b. Assuming Matthews
annual salary is $240,000, what amount will SV contribute to
Matthews money purchase plan? What can Matthew contribute to his
401(k) account in 2013?c. Assuming Matthews annual salary is
$60,000, what amount will SV contribute to Matthews money purchase
plan? What amount can Matthew contribute to his 401(k) account in
2013? d. Assume the same facts as c. except that Matthew is 54
years old at the end of 2013. What amount can Matthew contribute to
his 401(k) account in 2013?a. For 2013, the sum of employer and
employee contributions that can be made to an employees defined
contribution plan(s) is the lesser of $51,000 or 100% of the
employees compensation for the year. Here, 100% of Matthews
compensation for the year is $400,000. So contributions to Matthews
defined contribution accounts for 2013 are limited to $51,000.
Under its plan, SV would contribute $60,000 to Matthews money
purchase pension plan ($400,000 15%). However, the tax code limits
the contribution to $51,000. So SV will contribute $51,000 to
Matthews money purchase pension plan. Because the limit on
contributions to Matthews defined contribution plans has been
reached by SVs $51,000 contribution, Matthew is not allowed to
contribute anything to his 401(k) account in 2013.
b. For 2013, the sum of employer and employee contributions that
can be made to an employees defined contribution plan(s) is the
lesser of $51,000 or 100% of the employees compensation for the
year. Here, 100% of Matthews compensation for the year is $240,000.
So contributions to Matthews defined contribution accounts for 2013
are limited to $51,000. Under its plan, SV contributes $36,000 to
Matthews money purchase pension plan ($240,000 15%). Because the
limit on overall contributions to Matthews defined contribution
plans is $51,000 and because the limit on contributions by an
employee to a 401(k) plan is $17,500, Mathew may still contribute
$15,000 to his 401(k) account in 2013 ($51,000 limit minus $36,000
contribution to money purchase plan).
c. $26,000. For 2013, the sum of employer and employee
contributions that can be made to an employees defined
contributions plan(s) is the lesser of $51,000 or 100% of the
employees compensation for the year. Here, 100% of Matthews
compensation for the year is $60,000, thus, contributions to his
defined contribution accounts for the year are limited to $51,000.
Under its plan SV contributes $9,000 (15% $60,000). Employees are
limited to contributing $17,500 for 2013, thus, Matthew is allowed
to contribute an additional $17,500 for a total contribution of
$26,500 (17,500 + 9,000).
d. Because Matthew is 50 years old or older at the end of the
year, he is allowed to contribute an additional $5,500 to his
401(k) account above and beyond the limitations described in c. So,
Matthew can contribute $23,000 to his 401(k) plan in 2013. Matthews
$23,000 contribution plus SVs $9,000 contribution adds up to a
total of $32,000 in contributions to Matthews 401(k) account for
the year.
54. [LO 2] In 2013, Maggy (34 years old) is an employee of YBU
Corp. YBU provides a 401(k) plan for all its employees. According
to the terms of the plan, YBU contributes 50 cents for every dollar
the employee contributes. The maximum employer contribution under
the plan is 15 percent of the employees salary (if allowed, YBU
contributes until the employee has contributed 30 percent of her
salary). a. Maggy has worked for YBU corporation for 3 years before
deciding to leave. Maggys annual salary during this time was for
$45,000, $52,000, $55,000, and $60,000 (she only received half of
her final years salary). Assuming Maggy contributed 8 percent of
her salary (including her 2013 salary) to her 401(k) account, what
is Maggys vested account balance when she leaves YBU (exclusive of
account earnings)? Assume YBU uses three-year cliff vesting.b. Same
question as a. except YBU uses six-year graded vesting.c.
{Planning} Maggy wants to maximize YBUs contribution to her 401(k)
account in 2013. How much should Maggy contribute to her 401(k)
account assuming her annual salary is $100,000 (she works for YBU
for the entire year)? d. {Planning} Same question as c., except
Maggy is 55 years old rather than 34 years old at the end of the
year?a. At the time Maggy leaves YBU, she has contributed $14,560 [
($45,000 + $52,000 + $55,000 + 50% (half year) $60,000) 8%)]. Maggy
automatically vests in her own contributions (and the earnings on
those contributions) no matter how long she works for YBU.
Because YBU contributes 50 cents for every dollar contributed by
the employee, YBU contributes $7,280 to Maggys plan ($14,560 .5).
Because YBU uses 3-year cliff vesting, and Maggy has worked for YBU
for more than three years, Maggy is fully vested in YBUs
contributions (and the earnings on those contributions). Since
Maggy is fully vested in all of the contributions to her 401(k)
account, she is fully vested in the entire balance in her 401(k)
account $21,840 ($14,560 + $7,280 + earnings on the account) when
she leaves YBU.
b. At the time Maggy leaves YBU, she has contributed $14,560
[($45,000 + $52,000 + $55,000 + 50% (half year) $60,000) 8%)].
Maggy automatically vests in her own contributions no matter how
long she works for YBU.
Because YBU contributes 50 cents for every dollar contributed by
the employee, YBU contributes $7,280 to Maggys plan ($14,560 .5).
Assuming YBU uses six-year graded vesting and Maggy has worked for
YBU for three full years, Maggys vesting percentage in YBUs
contributions is 40%. Thus Maggys vested benefit in YBU
contributions is $2,912 ( $7,280 40%) and her vested benefit in the
earnings on YBUs contributions is also 40%.
To summarize, Maggy is fully vested in her $14,560 contributions
and on the earnings on those contributions. She is also vested in
$2,912 of YBUs contributions and she is vested in 40% of the
earnings on those contributions. In total, she is vested in $17,472
of the $21,840 contributed to her 401(k) account.
c. YBU contributes 50 cents per dollar contributed by an
employee to her 401(k) plan up to 15% of an employees salary (if
allowed, YBU contributes until an employee contributes 30% of her
salary). However, for 2013, employees are limited to contributing
$17,500 to defined contribution plans. In this instance Maggy
should contribute the entire 17,500 and receive a contribution from
her employer of $8,750 for a total contribution to her 401(k) of
$26,250 .
d. Just as in c. to maximize the contributions to her 401(k)
account, Maggy should contribute a total of $23,000 ($17,500 plus
the $5,500 catch up adjustment for taxpayers age 50 years and older
at the end of the year). YBU would contribute an additional $11,500
to her account ($23,000 .5). For the year, $34,600 ($23.000 +
$11,500) would be contributed to her account.
55. [LO 2] In 2013, Nina contributes 10 percent of her $100,000
annual salary to her 401(k) account. She expects to earn a 7
percent before-tax rate of return. Assuming she leaves this (and
any employer contributions) in the account until she retires in 25
years, what is Ninas after-tax accumulation from her 2013
contributions to her 401(k) account?a. Assume Ninas marginal tax
rate at retirement is 30 percent.b. Assume Ninas marginal tax rate
at retirement 20 percent.c. Assume Ninas marginal tax rate at
retirement is 40 percent.
a. $37,992, computed as follows:
Before-tax contribution$10,000
Times future value factor 1.07257% annual rate for 25 years
Future value of contribution$54,274
Minus: taxes payable on distribution(16,282)(54,274 30% tax
rate)
After tax proceeds from distribution$37,992Value of account
minus taxes payable
b. $43,419Before-tax contribution$10,000
Times future value factor 1.07257% annual rate of return for 25
years
Future value of contribution$54,274
Minus: taxes payable on distribution(10,855)(54,274 20% tax
rate)
After tax proceeds from distribution$43,419Value of account
minus taxes payable
c. $32,564.Before-tax contribution$10,000
Times future value factor 1.07257% annual rate of return for 25
years
Future value of contribution$54,274
Minus: taxes payable on distribution(21,710)(54,274 40% tax
rate)
After tax proceeds from distribution$32,564Value of account
minus taxes payable
56. [LO 2] In 2013, Nitai contributes 10 percent of his $100,000
annual salary to a Roth 401(k) account sponsored by his employer,
AY, Inc. AY, Inc., matches employee contributions dollar for dollar
up to 10 percent of the employees salary to the employees
traditional 401(k) account. Nitai expects to earn a 7 percent
before-tax rate of return. Assuming he leaves his contributions in
the Roth 401(k) and traditional 401(k) accounts until he retires in
25 years, what are Nitais after-tax proceeds from the Roth 401(k)
and traditional 401(k) accounts after he receives the distributions
assuming his marginal tax rate at retirement is 30%? Because
distributions from a Roth 401(k) are not taxable, Nitais
accumulation on his 2013 contribution to his Roth 401(k) plan
is
Roth 401(k): $10,000 1.0725 = $54,274. His marginal tax rate
when he retires does not affect the after-tax proceeds of the
distribution because distributions at retirement from Roth 401(k)
plans are not taxable.
(Note that Nitai was not able to deduct his Roth 401(k)
contribution.)
Traditional 401(k)Nitai did not contribute to his traditional
401(k) plan during 2013. However, his employer, AY Inc.,
contributed one dollar for every dollar that Nitai contributed to
his Roth 401(k) account. Consequently, AY Inc. contributed $10,000
to his traditional 401(k) account. Because distributions from a
traditional 401(k) account are fully taxable to the recipient as
ordinary income in the year of distribution and Nitais marginal
rate at that time is 30%, Nitais after-tax accumulation from his
traditional 401(k) plan is as follows:
$10,000 1.0725 (1 30%) = $37,992
57. [LO 3] {Planning} Marissa participates in her employers
nonqualified deferred compensation plan. For 2013, she is deferring
10 percent of her $320,000 annual salary. Assuming this is her only
source of income and her marginal income tax rate is 30 percent,
how much tax does Marissa save in 2013 by deferring this income
(ignore payroll taxes)?$9,600. Because Marissa is not required to
pay tax on the $32,000 deferred salary ($320,000 10%), she will
save $9,600 ($32,000 30% marginal tax rate) in taxes.
58. [LO 3] Paris participates in her employers nonqualified
deferred compensation plan. For 2013, she is deferring 10 percent
of her $320,000 annual salary. Assuming this is her only source of
income and her marginal income tax rate is 30 percent, how much
does deferring Paris income save her employer (after-taxes) in
2013? Pariss employers marginal tax rate is 35 percent (ignore
payroll taxes).
$20,800. 10% of Paris compensation is $32,000. By not paying
this to Paris currently, Pariss employer saves $20,800 [$32,000 (1
- .35)] which is its after tax cost of her salary.
59. [LO 3] Leslie participates in IBOs nonqualified deferred
compensation plan. For 2013, she is deferring 10 percent of her
$300,000 annual salary. Based on her deemed investment choice,
Leslie expects to earn a 7 percent before-tax rate of return on her
deferred compensation, which she plans to receive in 10 years.
Leslies marginal tax
rate in 2013 is 30 percent. IBOs marginal tax rate is 35
percent. Ignore payroll taxes in your analysis.a. Assuming Leslies
marginal tax rate in 10 years when she receives the distribution is
33 percent, what is Leslies after-tax accumulation on the deferred
compensation?b. Assuming Leslies marginal tax rate in 10 years when
she receives the distribution is 20 percent, what is Leslies
after-tax accumulation on the deferred compensation?c. {Planning}
Assuming IBOs cost of capital is 8 percent after taxes, how much
deferred compensation should IBO be willing to pay Leslie that
would make it indifferent between paying 10 percent of Leslies
current salary or deferring it for 10 years? a. Leslies after-tax
accumulation is as follows:
$30,000 (1.07)10 (1 - .33) = $39,540
Her initial contribution of $30,000 grows at 7% for 10 years and
then is all taxed at 33% when she receives it.
b. Leslies after-tax accumulation is as follows:$30,000 x
(1.07)10 (1 - .2) =$47,212
Her initial contribution of $30,000 grows at 7% for 10 years and
then is all taxed at 20% when she receives it.
c $64,768. IBOs after-tax cost of providing Leslie with $30,000
of current compensation is $19,500 [$30,000 (1 - .35)]. IBO should
be indifferent between paying her current salary at an after-tax
cost of $19,500 and paying her in 10 years the amount (after-taxes)
that this would grow to if IBO were to invest this amount and earn
8% after-taxes.
In 10 years the $19,500 would grow to $42,099 [ $19,500 (1.08)10
]. IBO should be indifferent between paying current salary and
paying some amount of deferred compensation (DC) that would cost it
$42,099 after taxes in 10 years. To determine the amount of
deferred compensation we need to solve for DC in the following
equation:
$42,099 = DC (1-.35)DC = $64,768.
60. [LO 3] {Planning} XYZ Corporation has a deferred
compensation plan under which it allows certain employees to defer
up to 40 percent of their salary for five years. (For purposes of
this problem, ignore payroll taxes in your computations).a. Assume
XYZ has a marginal tax rate of 35 percent for the foreseeable
future and earns an after-tax rate of return of 8 percent on its
assets. Joel Johnson,
XYZs VP of finance, is attempting to determine what amount of
deferred compensation XYZ should be willing to pay in five years
that would make XYZ indifferent between paying current salary of
$10,000 and paying the deferred compensation. What amount of
deferred compensation would accomplish this objective?b. Assume
Julie, an XYZ employee, has the option of participating in XYZs
deferred compensation plan. Julies marginal tax rate is 40 percent
and she expects the rate to remain constant over the next five
years. Julie is trying to decide how much deferred compensation she
will need to receive from XYZ in five years to make her indifferent
between receiving current salary of $10,000 and receiving the
deferred compensation payment. If Julie takes the salary, she will
invest it in a taxable corporate bond paying interest at 5 percent
annually (after taxes). What amount of deferred compensation would
accomplish this objective?a. $14,694If XYZ were to pay $10,000, its
after tax cost would be $6,500 ($10,000 (1-.35)). If it defers the
compensation it would save $6,500 after-taxes. This is equivalent
to $9,551 after-taxes in 5 years ($6,500 1.085). So, XYZ should be
indifferent between paying Joel $6,500 after-taxes now or $9,551
after taxes in 5 years. Assuming XYZs marginal tax rate remains at
35%, $9,551 after-taxes is $14,694 before-taxes [$9,551/(1-.35)].b.
$11,592. If Julie were to take the salary now she would receive
$6,000 after tax (10,000 x (1 - .4)). She would then invest this
amount in taxable corporate bonds. The bonds generate a before tax
rate of return of 5% and an after tax rate of return of 3% [5% (1-
.4)]. After five years Julie would have accumulated $6,956 after
taxes by taking the salary and investing it herself [(6,000 1.035].
Thus, in order to be indifferent after five years between the
salary and deferred compensation, she must receive enough deferred
compensation that provides her with $6,956 after she pays tax at
her 40% marginal tax rate. If she receives $11,592, she will have
$6,956 after taxes [$11,592 (1-.4)].
61. [LO 4] John (age 51 and single) has earned income of $3,000.
He has $30,000 of unearned (capital gain) income. a. If he does not
participate in an employer-sponsored plan, what is the maximum
deductible IRA contribution John can make in 2013?b. If he does
participate in an employer-sponsored plan, what is the maximum
deductible IRA contribution John can make in 2013?c. If he does not
participate in an employer-sponsored plan, what is the maximum
deductible IRA contribution John can make in 2013 if he has earned
income of $10,000?a. $3,000. Deductible contributions to an IRA
account are limited to the lesser of $5,500 or earned income. If
the individual is at least 50 years old by the end of the year,
he/she may make a contribution of up to the lesser of $6,500 or
earned income. In this case, Johns deductible contribution is the
lesser of (1) his earned income of $3,000 or (2) the maximum
deductible amount of $6,500. So his deductible contribution is
$3,000.
b. $3,000. Taxpayers who are participants in an
employer-sponsored retirement plan are allowed to make deductible
contributions to an IRA account as long as they meet certain AGI
restrictions. In 2013, the deductibility of IRA contributions is
phased-out proportionally for AGI between $59,000 and $69,000.
Johns AGI of $33,000 (3,000 earned income + 30,000 capital gain)
falls below the $59,000 AGI phase-out threshold. Thus, John is
allowed to make a contribution equal to the lesser of $6,500 or
earned income (The $6,500 = $5,500 standard limit + $1,000 catch-up
contribution for taxpayers age 50 and over). So, he is allowed to
deduct $3,000.
c. $6,500. Deductible contributions are limited to the lesser of
$5,500 or earned income. The $5,500 limit is increased to $6,500
for taxpayers who have reached the age of 50 by the end of the year
(taxpayers age 50 or older at the end of the year are allowed to
make an additional $1,000 catch-up contribution). Thus, John may
make a total deductible contribution equal to the lesser of $6,500
(5,500 + 1,000) or earned income ($10,000). So, he is allowed to
deduct $6,500. 62. [LO 4] William is a single writer (age 35) who
recently decided that he needs to save more for retirement. His
2013 AGI is $61,000 (all earned income).a. If he does not
participate in an employer-sponsored plan, what is the maximum
deductible IRA contribution William can make in 2013?b. If he does
participate in an employer-sponsored plan, what is the maximum
deductible IRA contribution William can make in 2013?c. Assuming
the same facts as in b. except Williams AGI is $75,000, what is the
maximum deductible IRA contribution William can make in 2013?a.
$5,500. Because William is not covered by an employer provided
retirement plan, his deductible contribution is not limited by AGI.
Also, because he is under 50 years of age at the end of the year,
his maximum deductible IRA contribution for the year is $5,500. b.
$4,400. Because William is under 50 years of age at the end of the
year, his maximum deductible contribution (before phase-out) is
$5,500. However, because he is covered by an employer sponsored
plan as a single taxpayer, Williams maximum deductible contribution
is phased out proportionally for AGI between $59,000 and $69,000.
Williams AGI of $61,000 is 20% of the way through the $10,000
phase-out range [($61,000 - $59,000)/($69,000 - $59,000)] so he is
not allowed to deduct 20% of the $5,500 maximum deductible
contribution. But he is allowed to deduct 80% of his maximum
deductible contribution of $5,500 which is $4,400.
c. The maximum deductible IRA contribution that William can
contribute in 2013 is $0. Because he is covered by an employer
provided plan, the maximum deductible contribution for unmarried
taxpayers phases out between $59,000 and $69,000. Because Williams
AGI exceeds $69,000, he cannot make a deductible IRA
contribution.
63. [LO 4] In 2013, Susan (44 years old) is a highly successful
architect and is covered by an employee-sponsored plan. Her
husband, Dan (47 years old), however, is a Ph.D. student and is
unemployed. Compute the maximum deductible IRA contribution for
each spouse in the following alternative situations.a. Susans
salary and the couples AGI is $190,000. The couple files a joint
tax return.b. Susans salary and the couples AGI is $120,000. The
couple files a joint tax return.c. Susans salary and the couples
AGI is $80,000. The couple files a joint tax return.d. Susans
salary and her AGI is $80,000. Dan reports $5,000 of AGI and earned
income. The couple files separate tax returns.a. Susans maximum
deductible contribution is $0. Dans maximum deductible contribution
is also $0. Susans maximum deductible contribution is $0 because
she is an active participant in an employers retirement plan and
the AGI on the couples joint return exceeds $115,000 so her
deductible contribution is entirely phased out. Dans maximum
deductible contribution is also $0 even though he is not an active
participant in an employers plan. Because Susan is an active
participant and the couples AGI exceeds $188,000 Dans deductible
contribution is fully phased out.b. Susans maximum deductible
contribution is $0. Because she is an active participant in an
employers plan and the couples AGI exceeds $115,000 her deductible
contribution is entirely phased out. Dans maximum deductible
contribution is $5,500. This is the lesser of (1) $5,500 or (2) the
couples earned income of $120,000 (reduced by nondeductible IRA
contributions or Roth IRA contributions by Susanhere we assume
none). Dan is able to contribute $5,500 even though he doesnt have
any earned income because the couple has earned income and the
couples AGI is less than $178,000.c. Susans maximum deductible
contribution is $5,500 and Dans maximum deductible contribution is
$5,500. Even though Susan is an active participant in an employers
retirement plan she is able to make a deductible contribution
because the couples AGI is less than $95,000. Dan is able to make a
$5,500 deductible contribution which is the lesser of (1) $5,500 or
(2) $74,500 ($80,000 minus $5,500) which is the couples AGI minus
Susans deductible contribution.d. Susans maximum deductible
contribution is $0 because she is filing separately and her AGI
exceeds $10,000. Dan is able to make a $2,500 deductible
contribution. His maximum deductible contribution before phase out
is $5,500. Because he is filing a separate return, his maximum
contribution phases out proportionally between $0 and $10,000 of
AGI. Here his $5,000 AGI is 50% of the way through the phase out
range so he loses 50% of his otherwise deductible contribution.
64. [LO 4] In 2013, Rashaun (62 years old) retired and planned
on immediately receiving distributions (making withdrawals) from
his traditional IRA account. The balance of his IRA account is
$160,000 (before reducing it for withdrawals/distributions
described below). Over the years, Rashaun has contributed $40,000
to the IRA. Of his $40,000 contributions, $30,000 was nondeductible
and $10,000 was deductible. Assume Rashaun did not make any
contributions to the account in 2013.a. If Rashaun currently
withdraws $20,000 from the IRA, how much tax will he be required to
pay on the withdrawal if his marginal tax rate is 25 percent?b. If
Rashaun currently withdraws $70,000 from the IRA, how much tax will
he be required to pay on the withdrawal if his marginal tax rate is
28 percent?c. {Forms} Using the information provided in part b,
complete Form 8606, Part I to report the taxable portion of the
$70,000 distribution (withdrawal). Use 2012 forms if 2013 forms are
unavailable.a. Because Rashaun has made both deductible and
nondeductible contributions to his IRA, he needs to allocate the
distribution between taxable amounts and amounts that are a return
of his nondeductible contribution. To do this, he first has to
determine the ratio of nondeductible contributions to the value of
the IRA at the time of the distribution. In this case the ratio is
$30,000/$160,000 or 18.75%. Consequently, $3,750 (20,000 18.75%) is
not taxable and the remaining $16,250 is taxed at Rashauns marginal
tax rate of 25%. Thus, Rashaun must pay $4,062.5 in taxes and the
overall amount he receives after taxes is $15,937.5 [3,750 +
(16,250 (1- .25)].
b. Again, because Rashaun has made both deductible and
nondeductible contributions, he needs to allocate the distribution
between taxable amounts and amounts that are a return of his
nondeductible contributions. His ratio of nondeductible
contributions to the value of the IRA is 30,000/160,000 or 18.75%.
Consequently, $13,125 (70,000 18.75%) is not taxable and the
remaining $56,875 (70,000 13,125) is taxed at his marginal tax rate
of 28% for taxes of $15,925 ($56,875 28%). After taxes Rashaun
receives $$54,075 [13,125 + (56,875 15,925]).
c.
65. [LO 4] Brooklyn has been contributing to a traditional IRA
for seven years (all deductible contributions) and has a total of
$30,000 in the account. In 2013, she is 39 years old and has
decided that she wants to get a new car. She withdraws $20,000 from
the IRA to help pay for the car. She is currently in the 25 percent
marginal tax bracket. What amount of the withdrawal, after tax
considerations, will Brooklyn have available to purchase the
car?Brooklyn will be taxed at 25% on the $20,000 withdrawal.
Consequently, she will pay $5,000 in taxes (20,000 25%). In
addition, she must pay a 10% early distribution penalty on the
$20,000 withdrawal ($20,000 10% = $2,000 penalty). This leaves her
with $13,000 after taxes ($20,000 5,000 taxes 2,000 penalties) to
purchase the car.
66. [LO 4] Jackson and Ashley Turner (both 45 years old) are
married and want to contribute to a Roth IRA for Ashley. In 2013,
their AGI is $182,000. Jackson and Ashley each earned half of the
income. a. How much can Ashley contribute to her Roth IRA if they
file a joint return?b. How much can Ashley contribute if she files
a separate return?c. Assume that Ashley earned all of the couples
income. What amount can be contributed to Jacksons Roth IRA?a.
Individuals are allowed to contribute to a Roth IRA as long as
their AGI falls below certain threshold limits. The AGI threshold
limits for married individuals filing jointly is between $178,000
and $188,000. Because Jackson and Ashleys AGI is 40% of the way
between $178,000 and $188,000 [($182,000 178,000)/($188,000
178,000)], Ashleys maximum contribution is phased out by 40%. That
is, of the $5,500 maximum contribution, Ashley may contribute
$3,300 [$5,500 60% (100% - 40% phased-out percentage)].
b. The AGI threshold limits for married individuals filing
separately is between $0 and $10,000. Thus, if they filed
separately, Ashley would not be able to contribute to a Roth
IRA.
c. $3,300. Because Jackson is the lesser earning spouse, the
starting point for determining the amount he can contribute is the
lesser of $5,500 or $178,700 [total earned income of both spouses
of $182,000 reduced by the $3,300 contribution to Ashleys account
(see answer to part a)]. However, because the couples AGI of
$182,000 exceeds $178,000, 40% of Jacksons contribution limit is
phased out [($182,000 178,000)/($188,000 178,000)]. That is, of the
$5,500 maximum contribution, only $3,300 [$5,500 60% (100% - 40%
phased-out percentage)] may be contributed to Jacksons Roth
IRA.67.[LO 4] Harriet and Harry Combs (both 37 years old) are
married and both want to contribute to a Roth IRA. In 2013, their
AGI is $50,000. Harriet earned $46,000 and Harry earned $3,000.a.
How much can Harriet contribute to her Roth IRA if they file a
joint return?b. How much can Harriet contribute if she files a
separate return?
c. How much can Harry contribute to his Roth IRA if they file
separately?a. Individuals are allowed to contribute to a Roth IRA
as long as their AGI falls below certain threshold limits. The AGI
threshold limits for married individuals filing jointly is between
$178,000 and $188,000. Because Harriet and Harrys AGI is below
these threshold limits, Harriet can contribute $5,500, the maximum
contribution for taxpayers under age 50 at the end of the year. b.
The AGI threshold limits for married individuals filing separately
is between $0 and $10,000. Thus, if Harriet files separately, she
would not be allowed to contribute to Roth IRA because her AGI is
$46,000.c. $3,850 ($5,500 70%). Since Harrys AGI is 40% of the way
between $0 and $10,000 [($3,000 0)/(10,000 0)], Harry is only
allowed to contribute 70% (100% - 30% disallowed percentage) of the
$5,500 maximum contribution for tax payers under 50 years of age at
year end.68. Michael is single and 35 years old. He is a
participant in his employers sponsored retirement plan. How much
can Michael contribute to a Roth IRA in each of the following
alternative situations?
a. Michaels AGI is $50,000 after he contributed $3,000 to a
traditional IRA.
b. Michaels AGI is $80,000 before any IRA contributions.
c. Michaels AGI is $135,000 before any IRA contributions.
a. $2,500. Michael has contributed $3,000 to a traditional IRA.
Because his AGI was below the phase-out threshold, he was able to
deduct all $3,000 of that contribution. Because a taxpayers
contributions to traditional and Roth IRAs may not exceed $5,500
(taxpayers under 50 years of age) and because his AGI is below the
Roth IRA phase-out threshold, he may contribute $2,500 to the Roth
($5,500 total minus $3,000 contribution to traditional
IRA).raditional R
b. $5,500. Michaels AGI is too high to contribute to a
deductible IRA. So, Michael has the option of contributing to
nondeductible traditional IRA and/or a Roth IRA. In total, he can
contribute $5,500. So, he can contribute $5,500 to a Roth IRA.
Because the Roth IRA is superior to a nondeductible traditional
IRA, Michael should contribute to the Roth not the nondeductible
IRA.c. $0. Michaels AGI is too high to contribute to a Roth IRA. It
is also too high to contribute to a deductible IRA. In this case,
Michaels only option for contributing to an IRA is that he can
contribute $5,500 to a nondeductible IRA.
69.[LO 4] George (age 42 at year-end) has been contributing to a
traditional IRA for years (all deductible contributions) and his
IRA is now worth $25,000. He is planning on
transferring (or rolling over) the entire balance into a Roth
IRA account. Georges marginal tax rate is 25 percent.a. What are
the tax consequences to George if he takes $25,000 out of the
traditional IRA and puts the entire amount into a Roth IRA?b. What
are the tax consequences to George if he takes $25,000 out of the
traditional IRA, pays the taxes due from the traditional IRA
distribution, and contributes the remaining distribution to the
Roth IRA?c. What are the tax consequences to George if he takes
$25,000 out of the traditional IRA, keeps $10,000 to pay taxes and
to make a down payment on a new car, and contributes the remaining
distribution to the Roth IRA?a. George will have to pay taxes of
$6,250 (25% 25,000) for taking the $25,000 out of the IRA. However,
he will not have to pay the 10% penalty tax because he deposited
the entire $25,000 (the entire amount of the withdrawal) into a
Roth IRA within 60 days of taking it out of the traditional
IRA.
b. George will have to pay taxes of $6,250 for taking the
$25,000 out of the IRA. After taxes, this leaves $18,750 ($25,000
6,250) for George to contribute to the Roth IRA. However, because
he doesnt contribute (roll over) $25,000 (the full amount that was
withdrawn from the traditional IRA), he will also have to pay the
10% penalty tax on the $6,250 that he did not contribute or roll
over. Therefore, he will have to pay a penalty of $625 ($6,250 x
10%). In total he will pay taxes of $6,875 ($6,250 + 625) on the
transaction.
c. George will have to pay taxes of $6,250 for taking the
$25,000 out of the IRA. After taxes, this leaves him with $18,750
($25,000 6,250). Because George only contributes $15,000 to the
Roth IRA he must pay a 10% penalty tax on the $10,000 that he took
out of the traditional IRA and did not contribute or roll over to a
Roth IRA. Consequently, he pays a $1,000 penalty ($10,000 10%). In
total, George must pay $7,250 ($1,000 penalty + $6,250 tax) in
taxes on the distribution.
70. (LO4) Jimmer has contributed $15,000 to his Roth IRA and the
balance in the account is $18,000. In the current year, Jimmer
withdrew $17,000 from the Roth IRA to pay for a new car. If Jimmers
marginal ordinary income tax rate is 25 percent, what amount of tax
and penalty, if any, is Jimmer required to pay on the withdrawal in
each of the following alternative situations?
a. Jimmer opened the Roth account 44 months before he withdrew
the $17,000 and Jimmer is 62 years of age.b. Jimmer opened the Roth
account 44 months before he withdrew the $17,000 and Jimmer is age
53.c. Jimmer opened the Roth account 76 months before he withdrew
the $17,000 and Jimmer is age 62.
d. Jimmer opened the Roth account 76 months before he withdrew
the $17,000 and Jimmer is age 53.
a. $500 tax and $200 penalty. Because the Roth account has not
been open for five years at the time of the distribution), this is
a nonqualified distribution. Because Jimmer contributed $15,000, he
is allowed to receive $15,000 in distributions from the account
without paying tax or penalty. However, because it is a
nonqualified distribution, he must pay tax ($2,000 25%) and penalty
($2,000 10%) on the $2,000 earnings that Jimmer received in the
distribution.b. $500 tax and $200 penalty. Because the Roth account
has not been open for five years (and Jimmer has not reached age 59
by the time of the distribution), this is a nonqualified
distribution. Because Jimmer contributed $15,000, he is allowed to
receive $15,000 in distributions from the account without paying
tax or penalty. However, because it is a nonqualified distribution,
he must pay tax ($2,000 25%) and penalty ($2,000 10%) on the $2,000
earnings that Jimmer received in the distribution.c. $0 tax and $0
penalty. Because this is a qualified distribution (distribution is
after Jimmer has attained 59 years of age and the Roth account has
been open for more than five years) the distribution is not subject
to tax or penalty.d. $500 tax and $200 penalty. Because Jimmer has
not reached age 59 by the time of the distribution, this is a
nonqualified distribution. Because Jimmer contributed $15,000, he
is allowed to receive $15,000 in distributions from the account
without paying tax or penalty. However, because it is a
nonqualified distribution, he must pay tax ($2,000 25%) and penalty
($2,000 10%) on the $2,000 earnings that Jimmer received in the
distribution.
71.[LO 4] {Planning} John is trying to decide whether to
contribute to a Roth IRA or traditional IRA. He plans on making the
maximum $5,000 contribution to whichever plan he decides to fund.
He currently pays tax at a 30 percent marginal income tax rate but
he believes that his marginal tax rate in the future will be 28
percent. He intends to leave the money in the Roth IRA or
traditional IRA accounts for 30 years and he expects to earn a 6
percent before-tax rate of return on the account. a. How much will
John accumulate after taxes if he contributes to a Roth IRA
(consider only the funds contributed to the Roth IRA)? b. How much
will John accumulate after taxes if he contributes to a traditional
IRA (consider only the funds contributed to the traditional IRA)?
c. Without doing any computations, explain whether the traditional
IRA or the Roth IRA will generate a greater after-tax rate of
return.a. $28,718, calculated as follows: $5,000 (1.06)30 =
$28,718. Johns contribution grows tax free at 6% per year for 30
years and it is not taxed on withdrawal.
b. $20,677, calculated as follows: $5,000 (1.06)30 (1 28%) =
$20,677. Johns contribution grows tax free at 6% for 30 years.
However, because his initial contribution was deductible [this
saved him $1,500 in taxes ($5,000 30% MTR)] the entire distribution
is taxable. Because his marginal tax rate was 28% when he received
the distribution he must pay 28% of the total distribution in
taxes.
c. The traditional IRA. The rate of return on the Roth IRA is
the 6% before tax rate of return (the contribution is not
deductible and the distribution is not taxable so no effect of
taxes). However, the rate of return on the traditional IRA exceeds
6% because the contribution was deductible and saved taxes at 30%;
the distribution was fully taxable but it only cost taxes at 28%
(higher tax rate for deduction than for income generates higher
than before tax rate of return). Note that the traditional IRA
provides a lower accumulation than the Roth because the initial
contribution of after-tax dollars was less for the traditional IRA.
That is, the after-tax contribution to the Roth was $5,000 but the
after tax contribution to the traditional IRA was $3,500 ($5,000
contribution minus $1,500 tax savings from deduction).
72. [LO 4] Over the past three years, Sherry has contributed a
total of $12,000 to a Roth IRA account ($4,000 a year). The current
value of the Roth IRA is $16,300. In the current year, Sherry
withdraws $14,000 of the account balance to purchase a car.
Assuming Sherry is in a 25 percent marginal tax bracket, how much
of the $14,000 withdrawal will she retain after taxes to fund her
car purchase?Because Sherry has made a withdrawal from her Roth IRA
within five years of opening it, she has received a nonqualified
distribution. Nonqualified distributions are non-taxable to the
extent they are attributable to contributions; the earnings made on
such contributions are taxed as ordinary income and subject to a
10% penalty. In this instance, Sherry has withdrawn $2,000 of
earnings (14,000 withdrawal 12,000 contributions) and will pay
taxes of $500 (25% 2,000) and a penalty of $200 (10% 2,000). Of the
$14,000 withdrawn, Sherry will retain after-taxes $13,300 ($14,000
withdrawal 500 taxes 200 penalty).
73. [LO 4] Seven years ago, Halle (currently age 41) contributed
$4,000 to a Roth IRA account. The current value of the Roth IRA is
$9,000. In the current, year Halle withdraws $8,000 of the account
balance to use as a down payment on her first home. Assuming Halle
is in a 25 percent marginal tax bracket, how much of the $8,000
withdrawal will she retain after taxes to fund her house down
payment?All $8,000. Because Halle has had her Roth IRA open for at
least five years and she used the distribution proceeds as a down
payment on her first home, the entire distribution is considered a
qualified distribution and is not taxable.
74. (LO4) {Planning} {Research} Yuki (age 45 at year-end) has
been contributing to a traditional IRA for years (all deductible
contributions) and her IRA is now worth $50,000. She is trying to
decide whether she should roll over her traditional IRA into a Roth
IRA. Her current marginal tax rate is 25%. She plans to withdraw
the entire balance of the
account in 20 years and she expects to earn a before-tax rate of
return of 5% on her retirement accounts and a 4% after-tax rate of
return on all investments outside of her retirement accounts. For
each of the following alternative scenarios indicate how much more
or less Yuki will accumulate after taxes in 20 years if she rolls
over her traditional IRA into a Roth IRA. Be sure to include the
opportunity cost of having to pay taxes on the rollover.
a. When she withdraws the retirement funds in 20 years, she
expects her marginal tax rate to be 35%.
$19,044 greater accumulation if she rolls over traditional IRA
into Roth IRA. See calculations below:
Accumulation if she keeps funds in traditional IRA: $86,232
[$50,000 1.0520 (1 - .35)]
Accumulation if she rolls funds into Roth IRA: $105,276 $50,000
1.0520 = $132,665 total accumulation (before considering
opportunity cost of tax cost of rolling over) ($12,500) 1.0420 =
($27,389) opportunity cost for having to pay tax on rollover (by
rolling over traditional IRA, Yuki will have to pay $12,500 in
taxes ($50,000 25%). Because she pays $12,500 in taxes with funds
that are outside her retirement accounts, she will miss the
opportunity of generating a 4% after-tax rate of return on the
$12,500 for 20 years. Accumulation of Roth IRA net of opportunity
cost associated with taxes paid on rollover = $105,276 ($132,665 -
$27,389). Roth IRA accumulation $105,276 minus traditional IRA
accumulation $86,232 = $19,044 greater accumulation if she rolls
over traditional into Roth IRA.
b. When she withdraws the retirement funds in 20 years, she
expects her marginal tax rate to be 20%.
$856 lower accumulation if she rolls over traditional IRA into
Roth IRA (greater accumulation if she does not rollover). See
calculations below:
Accumulation if she keeps funds in traditional IRA: $106,132
[$50,000 1.0520 (1 - .2)]
Accumulation if she rolls funds into Roth IRA: $105,276 $50,000
1.0520 = $132,665 total accumulation (before considering
opportunity cost of tax cost of rolling over) ($12,500) 1.0420 =
($27,389) opportunity cost for having to pay tax on rollover (by
rolling over traditional IRA, Yuki will have to pay $12,500 in
taxes ($50,000 25%). Because she pays $12,500 in taxes with funds
outside her retirement account, she will miss the opportunity of
generating a 4% after-tax rate of return on the $12,500 for 20
years.
Accumulation of Roth IRA net of opportunity cost associated with
taxes paid on rollover = $105,276 ($132,665 - $27,389). Roth IRA
accumulation $105,276 minus traditional IRA accumulation $106,132 =
($856) smaller accumulation if she rolls over traditional into Roth
IRA. That is, she will accumulate $856 more if she does not roll
over traditional IRA into Roth.
c. Assume the same facts as in b. except that she earns a 3%
after-tax rate of return on investments outside of the retirement
accounts?
$3,957 greater accumulation if she rolls over traditional IRA
into Roth IRA. See calculations below:
Accumulation if she keeps funds in traditional IRA: $106,132
[$50,000 1.0520 (1 - .2)]
Accumulation if she rolls funds into Roth IRA: $110,089 $50,000
1.0520 = $132,665 total accumulation (before considering
opportunity cost of tax cost of rolling over) ($12,500) 1.0320 =
($22,576) opportunity cost for having to pay tax on rollover (by
rolling over traditional IRA, Yuki will have to pay $12,500 in
taxes ($50,000 25%). Because she pays $12,500 in taxes with funds
outside her retirement account, she will miss the opportunity of
generating a 3% after-tax rate of return on the $12,500 for 20
years. Accumulation of Roth IRA net of opportunity cost associated
with taxes paid on rollover = $110,089 ($132,665 - $22,576). Roth
IRA accumulation $110,089 minus traditional IRA accumulation
$106,132 = $3,957 greater accumulation if she rolls over
traditional into Roth IRA.
d. In general terms, reconcile your answer from part b. with
your answer to part c.
In both parts b and c, the taxpayers marginal tax rate is higher
in the year of the rollover than 20 years later when the taxpayer
withdraws the funds. In part b. the non-rollover option provides a
larger accumulation. In part c., the rollover option provides a
greater accumulation. The difference between part b and part c is
the after-tax rate of return on the investments outside the
retirement accounts (she must pay taxes with funds outside the
retirement account because she rolled the entire amount in the
traditional IRA into the Roth IRA). The low after-tax rate of
return in part c reduces the opportunity cost of paying current
taxes under the rollover option to the point where it more than
offsets the decrease in the taxpayers marginal tax rate from the
current year to year 20.
75. [LO 4] {Research} Sarah was contemplating making a
contribution to her traditional individual retirement account for
2013. She determined that she would contribute $5,500 to her IRA
and she deducted $5,500 for the contribution when she completed and
filed her 2013 tax return on February 15, 2014. Two months later,
on April 15, Sarah realized that she had not yet actually
contributed the funds to her IRA. On April 15, she went to the
post
office and mailed a $5,500 check to the bank holding her IRA.
The bank received the payment on April 17. In which year is Sarahs
$5,500 contribution deductible?
Sarah is allowed to deduct $5,500 in 2013.According to Rev. Rul.
84-18, an individual may deduct a contribution to an IRA (under
219) even though the contribution is made after the individuals tax
return is filed, as long as the contribution is made before the due
date of the return. The next issue is whether Sarahs contribution
was made by the due date of her return (April 15, 2014). According
to IRS Letter Ruling 8536085, June 14, 1985, contributions mailed
by a taxpayer on or before the tax return deadline are considered
as though they were timely made.
76. [LO 5] {Planning} Elvira is a self-employed taxpayer who
turns 42 years old at the end of the year (2013). In 2013, her net
Schedule C income was $120,000. This was her only source of income.
This year, Elvira is considering setting up a retirement plan. What
is the maximum amount Elvira may contribute to the self-employed
plan in each of the following situations?a. She sets up a SEP
IRA.b. She sets up an individual 401(k).a. $22,304. Elviras SEP IRA
contribution is limited to the lesser of (1) $51,000, or (2) 20% of
her net schedule C income (minus the deduction for self-employment
taxes paid). The second limitation is computed as follows: Elviras
net Schedule C income was $120,000. Her deduction for her
self-employment taxes paid is $8,478, computed as follows: $120,000
.9235 = $110,820. The social security limit for 2013 is $113,700.
Consequently, her self-employment tax is $16,955 ($110,820 .153).
Elvira can deduct 50% of the self-employment taxes she paid. In
this situation, Elviras self-employment tax deduction is $8,478
($16,955 50%). Thus the second limit for her SEP IRA contribution
is $