 Hello and welcome to the session in which we will discuss various retirement plans now the US Congress has Implemented various incentives to encourage individuals people like you and I to say for retirement Through some sort of a retirement plans. What type of incentives can the US Congress give tax incentive? You say we're gonna give you some if you say for your retirement. We're gonna give you some tax incentive Now this tax incentive Well, they'll give it to the employee to save as well as for the employer and simply put if you're self-employed as well So what I'm gonna start with just discussing some basic concept some basic terms You need to be familiar with that applies to all retirement plans such as tax deferred account when we say tax Deferred account. What does that mean? It means that the money to be taxed later? It means it's gonna grow tax-free. So you put this money now in your Retirement account and it's gonna grow. It's gonna earn interest. It's gonna earn dividend. It's gonna have capital appreciation tax-free Sometimes the amount invested is not taxed simply put the amount that you invest today the original amount That you're putting away today That amount is not taxed. So it's called pre-taxed amount and That amount since it's a pre-taxed you did not pay taxes on it You're gonna get some sort of a savings today so if you put if you earn the $3,000 and That money and you put this money in a savings account not savings Let's call it retirement account. Whatever that let's assume 401k Which is a form of a retirement account if this money is not taxed Let's assume your tax rate is 30% Immediately you saved $900 on your taxes So you have to understand sometimes the money that you invest in those retirement plan is not taxed It means you have a savings today Sometimes the money invested is already taxed. So let's assume you earned $3,000 Here's what's gonna happen. You're gonna pay $900 in taxes. What's left is? 2100 this 2100 then you put this money in your in your in some sort of a retirement account I'm not gonna call it 401k because when it comes to 401k the assumption is it's a pre-taxed You put this money in a retirement plan. This money is already taxed. So the 2100 is already taxed. This is called post-taxed money. So you have no savings for today So you have to be careful whether the money is Not taxed or pre-taxed money or not pre-taxed money. If it's not taxed It means it's a pre-taxed. It hasn't been taxed yet. If it's taxed. Let's call it post-taxed Now what's gonna happen? That's gonna make a difference when you get this money out Here's what's gonna happen rule of thumb usually generally speaking Money invested and earnings under option one, which is it's already been The money was pre-taxed. It wasn't taxed It's fully taxable. So if you invested money and that money is not taxed before So let's assume go back to that $3,000 that you put it away and you save $900 a day because it was not taxed When you get that money out That that $3,000 plus any earnings and the earnings on that three thousand maybe this three thousand became a million I don't know. You made a good investment. It's fully taxable Money invested under tax to Under option to not tax to it means it's a post-tax money Generally speaking You you get it out tax-free why because the original money was taxed and the earnings if you meet certain Qualification it's gonna be tax-free The earning it depends. So if it's a Roth IRA, which we'll talk about that later If you invest this money in a Roth IRA and you qualify everything is tax-free Okay Otherwise it's gonna be mostly taxable. So the point is if the money is already taxed the original money is already taxed That's fine. You already pay taxes on it when you get it out. It's tax-free the original amount Sorting under certain plans You're gonna have the money already taxed and sometimes the money taxed and the earnings. They're both tax-free But it's it's all gonna depend but keep that in mind as we are gonna be discussing the various retirement plans Before we proceed any further. I have a public announcement about my company far hat lectures calm Farhat accounting lectures is a supplemental educational tool That's gonna help you with your CPA exam preparation as well as your accounting courses My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of Lectures multiple choice questions through false questions as well as exercises. Go ahead start your free trial today There are many types of retirement plans and basically we they can be broken down into employer sponsored plan What does that mean? It means the company. It's a sponsored by the company and this include people who are self-employed Self-employed they are the company themselves and we have individual sponsored plans like IRA Individual retirement account which we'll talk about in the next session in this session We're gonna be focusing on the employer sponsored plan and those include Qualified pension or simply pension, you know it by pension profit-sharing plan 401k or 403b. We'll talk about those KF plan SEP and simple plan. So basically, you know, you know, if you follow my lectures once I have a list That means I'm gonna go over each item on this list starting with qualified pension What is a qualified pension when you think of qualified pension? It's a good thing Like if you really can get it can get into a pension. It's a good thing Actually, I have a funny story about pension because I was enrolled into a pension without even me knowing I Was enrolled into a pension. So I'll tell you the story since I mentioned that I was not planning to do so So, you know as a as a as a university instructor, you will teach at different universities as adjuncts sometime So one time I was teaching at a state university in Pennsylvania state university. I was just teaching I believe one or two courses It doesn't matter. No, I believe it was two courses And as a result if you teach at that university two courses or more you will be enrolled automatically in their pension Now as an adjunct you sign a lot of papers at the beginning. Okay, you are enrolled in our retirement plan I did not really pay any attention to it because it's an adjunct position That's I don't get my benefit from my adjunct position my part-time position So I signed my paperwork and I forgot about it two to three years later I was hired by a community college in Pennsylvania and well Philadelphia the community College of Philadelphia and And they asked me to fill out my paperwork now. I have to be very careful. This is my full-time job So I gotta make sure I know what I'm I read what I'm signing So they had a 401 403 B to be more specific. They don't and we're gonna talk about what does that mean? They don't have 401k for educators and they had a pension And guess what I said, well, they told me Yes, we have a pension, but it's only for people who been in the in the system for a long period of time So the pension has been discontinued So that's it that's fine So I filled out my paper for 403 B or 401k, which is the equivalent of 401k two days later I got a phone called from the school saying you do have a pension. I was like that's not possible I don't have a pension and I just started working at your community college. Oh, yes You were enrolled in the state system when you work at that other university and they enrolled you and you are a grandfather into the system So it's a great. So now I have a pension This is how I got a pension without even me knowing I had a pension, which is good. Simply put if you're a new high re You don't get a pension unless you are grandfathered into another state pension plan So simply put the community college of Philadelphia used to be part of the state pension plan And I happened to be lucky that I would I taught those two classes at East Strasburg University and they enrolled me and I didn't pay attention because you know I thought it's a small amount anyway, but it gave me a benefit. So that's good So simply put when I retire if I if I stayed into the into the state system and meet order requirement I will have a guarantee income once I retire. So once I vest Who gets those qualified pension like if you're a police officer fire fighters usually government employees? What happened is they don't make a lot of money now So they make it, you know, they make a living salaries, but they don't make a lot of money like if you work in a corporation where you get bonuses and Raises you don't make a lot of money, but you are enrolled in a pension as a result when you retire You are guaranteed a certain amount. What about the other people? We'll talk about the other people in corporations Now back in the old days most companies had pension but pensions are very expensive because you have to set money away For your employees into the future. So you have to set that money with a trustee You don't hold the money. Now, why would you set this money with the trustee? Think about it? Well, yeah, the company could go could go out of business and when they go out of business, you know Then they cannot pay the retirees that work for them Or if they get sued, you don't want the person that sued the company have access to that to that fund Therefore the government require companies to set to set that money with a trustee. Now, how much will you get? Well, it all depends on how many years you put in for example at my community college If you serve 10 years, you have what's called half a pension if you serve 20 years, you have a full pension So this but each company is different each plan is different And what was your salary the last three or five or seven years other factors play a role as well But this is basically what a pension is so but the pension has to meet Strict requirements the company that's having a pension has to meet strict requirement. What are those requirements now? When I say qualified pension must meet strict requirement for most the other plans They also have to meet those requirements. I'm not gonna go I'm gonna I'm not gonna be repeating myself, but I'm gonna give you the gist the idea here first The pension plan cannot highly favored compensated employees So simply put you cannot have a pension plan for the top-notch Individual and the other employees low-level employees don't get to participate You cannot form the pen the benefit to only Benefit certain group of people for example the owners of the company and their families you can't do that Okay, for example 5% or more of the owners cannot have special benefit from this qualified pension plan You have to have a vesting period you have to tell your employees after two five seven wherever years you vest You are fully vested and the plan must benefit at least 70% of those employees who are not highly compensated so the low-level employees it has to benefit at least 70% of them If not all of them at least 70% has to participate. So it's a qualified pension Now why do you want it to be a qualified pension plan? Well because it's gonna give you tax benefit actually for both employers and employees for the company It's gonna give them immediate tax benefits for the contribution you make a contribution you get you get a tax deduction Not bad expenses are good in taxes The employer contribution are not wages. That's also good for employers simply put They are compensating you for the future nevertheless, but they don't have to worry about Social security tax. They don't have to worry about Medicare tax They don't have to worry about food and soda for those wages in quote wages simply put They're putting money away for you into the future. They can give it to you now But guess what they decide you know what to to incite you to work for us We're gonna have what's called the pension plan. Okay, and and earnings are tax deferred. So for you It's a good thing because if you get the money, you're gonna be taxed on it So the earnings are you remember the third? It means they're gonna be taxed later earnings are tax deferred tax later And it's not taxable until I take them out and when I take them out when I take the money out when I'm 59 and a half then I have the ability to pay so no no problem. I'll have to pay the money Okay, so this is why it's important that you have you qualify under a pension plan And the qualified pension plan they could be con non contributory or contributory. What does that mean? Contributory means you the employee myself. I contribute and for example my pension plan I do contribute our pension plan is contributory. I have to pay a certain amount They pay they will pay the rest but my outcome is guaranteed and this is important or some pension plan their non Contributory for example my wife work with at J&J Johnson and Johnson They also have a pension plan, but their pension plan is non contributory. She doesn't have to put money away in her plan They they fund the company finance. They put money away on your behalf You don't have to put any money from your paycheck Also, the qualified plan might be either at the fine Contribution the fine contribution means, you know what you are contributing But you don't know what you are receiving. Okay, so Certain clients who are gonna put this much away, but we don't know what the outcome will be and we're gonna see what what those plans are in a moment Other plans the traditional Pension plans are defined benefit. So the benefit are defined the benefit are spelled out for example my pension plan I don't know the details of it because as my salary changes the benefit will change But they will tell you they will specifically tell you The amount of the money you're gonna be getting down the road So they are less risky plans less risky plans now the profit sharing plan is basically a define Contribution, okay, so which is the fine contribution plan a defined contribution plan So it's a form of pension plan, but it's a defined contribution. So first of all, it's profit sharing Think about it. Well, we're gonna put money away from the profit. So what happened if we don't make a profit? Well, we can put money away. So first thing you need to know it is Discretionary by the company. Okay, the company decide whether they want to contribute at the plan or not contribute at the plan For example, it's if we have no profit We're not gonna contribute and these these type of pension plan are good for small companies But it gives them some flexibility. They're not under the obligation to put money away every year So the employee performance of the company what happened is now you tie the employee performance to the company You encourage the employee to work hard. Okay, it's a form of the fine Contribution the profit because you were maybe you were thinking a minute ago. What does he mean by the fine contribution? It means We know how much you're putting but you really don't know what's coming out because it's gonna fluctuate You don't know how much you're putting every year. Okay, an employee. Don't make any contribution because it's from the profit That's the idea of it. So some companies what they do they would say you have two options If you don't want to participate, you'll get your money now. What's called the cash out? Guess what? If you get your cash out, it's taxable But you get your money now or you can put your money away and what happened if you leave the company you can roll it over into an IRA don't worry about this term will discuss that roll over in the next session simply put you can transfer it But you need to know the rules for that will discuss it. Okay, and companies what they would do They would have some companies most companies will have a 401k on the side because of you know The profit sharing plan what happened if the company is not making profit. Well, you can you can participate in the 401k Well, what is 401k then? Well, that's another retirement plan The reason it's called 401k because of the IRS section the it's under that section Internal Revenue Code section 401k. It's a qualified technically profit sharing because you can take your money now If you don't want to participate or you can put your money away for retirement to grow tax-free the contribution for the 401k is Pre-tax dollar, which is good It means if you contribute $10,000 per year and your tax rate is 20% you shielded $10,000 from taxes. Those are not taxed if you put them away as a result you saved $2,000 in taxes This is your savings. So you save $2,000 today and you're gonna put $10,000. That's gonna grow tax-free So any money you earn any Income or profit you earn on this money. It's tax-free until you take it out when you retire How much can you contribute the changes per year? 2020 was nineteen thousand four hundred now if you are over 65 over 50 you will get 6,500 not over 65 or 65 you're gonna be taken the money out Okay, so here the employer can contribute and the employee will contribute usually it is the employee mostly the employee But the employer can contribute. So for example, you put 10% they will match 5 or 6% of it For example, my wife's company. I believe they match match up to 5% Okay, but remember this number and it might change from year to year. There's always a max contribution So for both employee and employer, so remember the employee said let's assume you're under under the age of 50 you contribute. I believe they're gonna change it this year to 20,000 2021 But let's we're working with 2020 so you can contribute nineteen thousand five hundred Let's assume your company contribute the maximum your company can contribute is an amount That together they cannot exceed 57. Okay, they make them. They don't usually contribute They don't match you 100% but let's assume they want to match some employees and pay them more the maximum is 57,000 Okay, any access contribution must be the returns. Let's assume you contributed more Must be returned to the employee by April 15 the following year or be included in gross income Okay, and you must meet all the qualification rule established for the pension and profit sharing plan Which is non-discriminatory cannot favor one group so on and so forth. Okay. Now 403 B I have I keep saying I have you know if I want to participate in my company's and CCP retirement We don't have 401 we have 403 B Usually they are for educational educational organization and tax exempt organization same concept different name. That's fine Okay, a little bit more about 401k. Let's assume an individual is making 80,000 elected to contribute 3% Well, they contribute a 2400 now. What happened is this they shielded this money. This money is not Not Taxed now the 2400 is not taxed. Okay, but if you take it out prematurely it's subject to taxation No, and your W2 here's what happened for this individual Their wages and compensation which is box one. It's gonna be 77,600 Okay, however, the Social Security and Medicare will be 80,000 the full amount is subject to Social Security and Medicare And they will have 2,400 reported in box 12 as retirement as a retirement Distribute retirement contribution not distribution. Okay now again You cannot take this money out. You're subject to a penalty. Don't worry. We're gonna have a whole session about distribution Unless, you know, the plan terminated You separated from your service you can transfer it and there's a certain way you have to do it that or disability Reaches obviously 59 and a half. We need to talk about this or you experience hardship There are many reasons for this hardship and this hardship changes from year to year like when we go through a recession Like when we go through the housing crisis in 2007 2008, they gave people the right to take some money out During COVID the same concept. So the hardship could be for many many reasons. Okay, there are special rules Cough key off or Cough plan. Okay, these are for self-employed individual. Remember if you work for a company, you might have a pension Or you might have a 401k and remember under a pension You can could be profit sharing plan and under 401k it could be 403b, but that's not the point What what happened if you're self-employed? You're the company. Well You're subject to the same contribution and benefit limitation at the as as a pension or profit sharing So the same rules apply to you. You can contribute the look you can contribute the lower of 57,000 maximum is 57,000 Remember, you're the employee and the employer or 25% of your of your earned income again It cannot it cannot you cannot contribute more than 57 all in all. Okay the lower of these two Okay, the purpose of the calculation earned income cannot exceed 285,000 so if it exceeds 285,000 that's that's your maximum You're gonna see the computation in a moment Earned income from self-employment is determined after deduction one half of self-employment taxes So you do when when we are making this determination of the 25% your earned income times 25% We have to deduct self-employment taxes And and after the amount of key contribution you're gonna see in a formula in a moment Actually, let's work an example same a self-employed is earning before the deduction But after one half of self-employment. So after they paid the self-employment. They are left with 60,000. How do we can how do we? Compute the amount that they can deduct. Okay. Well here here we go. We're gonna take the This amount after one half of self-employment minus 25 25 is the maximum percentage minus 25% of x. We don't know how much you're contributing So it's whatever you have now after so the amount after you deduct your This is So the 60,000 Oops the 60,000 is the amount Highlight in yellow There we go so This is after the deduction of one one half of self-employment So they're giving us this number that you now you're gonna deduct your 25% of the amount after that Which is you don't know the amount after the after the contribution. Therefore, we call it x. We're gonna see what's the maximum So it just basically you solve for x and x is 48,000 Therefore Sam is entitled to 57,000 the maximum or 25% of the amount after The contributions in the amount after the contribution is 40 48 25% of 48 is 12,000 so they can obviously The lower of these two the maximum they can contribute is 12,000 which is 20 simply put what what does the 12,000 represent? What does the 12,000 represent? 12,000 represent the amount 25% of the amount after After self-employment tax and after the maximum contribution the maximum contribution is 12,000 therefore 60,000 is the amount after self-employment tax the maximum contribution is the maximum contribution is 12,000 we'll come back to 48,000 48,000 times 25% will give us back to 12,000. So this is how it works Now why 285,000 why 285,000? So let's assume your earnings after your earnings after taxes is Your earning after self-employment tax is 285,000. So let's do this quick calculation to show you this So this is your this is your yellow number. Just let me highlight it in yellow This is your yellow number and let's see what's gonna happen now if we take 285,000 minus 0.25x equal to your x equal to your contribution and if you solve this formula, it's gonna be 285,000 equal to 1.25x we add You know 0.25x on each side now. We're gonna look for x. We're gonna divide by 1.25 285,000 divided by 1.25 I divided both sides by 1.25 and that's gonna give me 228,000 now if you take 228,000 Multiplied by the maximum amount that's gonna give you 57. So this is how the number 57 come along comes comes about comes about So 285, you know, you're gonna come back after you do after you do this computation The maximum contribution is 57. Therefore the lower of 57 and 57 is 57. So that's the maximum you can contribute Okay, 57. Okay. So, you know, what's the maximum now? We have two other plan that are kind of similar. So I'm gonna put them side by side They're also for self-employed individual one is called not self-employed small companies Actually, sorry, but could be for self-employed set could be for self-employed one of them called simplified employee pension And the other one called simple. Although it's called simple. It stands, you know, although it doesn't work quite good The abbreviation savings and incentive match plan for employees simple simple plan. So the simple plan versus SAP SAP is for small business the Simple plan is specifically for 100 Companies with fewer than 100 employee that does and does not qualify for pension or profit sharing plan. Okay here SAP the company will set up IRA account for each employee. So if you want to have a SAP plan, that's fine You're a small company. You don't want to pay, you know, all those pension here You can open either a 401k or an IRA Okay for the employees SAP you can have stocks bonds mutual fund. You can have stocks bonds mutual fund Okay, it's taxed like a 401k. What does that mean? It means The money is not taxable and it's good. It's funded with pre-tax money It's funded. So the money that you put now it's pre-tax and It grow tax-free until you're 59 and a half until your distribution Same thing for simple plan. They both they both work the same way. Okay here employer contribution only SAP plan only the employer Contribute it means the company contribute. You don't have to put money away They can contribute between 1 and 25% and they have to contribute to everyone. Okay The simple plan both the employee and the employer will contribute the employee can contribute up to 13,500 again, these numbers are for 2020 if you're listening to this recording in 2022 2023 pay attention to the limitation And if you are over 50 you can get in a kickoff an additional 3000 that's called catch up the employer have two options here the employer can contribute 2% or 3% what is that 2% and what's that 3% well, we call the 2% if they if they go with the 2% it's called non-elective It means ever they have to contribute 2% to all employees If they if they go with the 2% option if they go with the 3% option They only they would contribute only to the Employees that participated in the plan So if you don't participate in the plan the company has a 3% elect 3% elective They don't contribute anything to you. Whatever you want to contribute. They will open an IRA account for you That's fine or 401k But they will not finance it you'll have to finance it if they go with the three if they go with the If they go with the three would they go with the 3% they only finance it if you participate if the sorry Yes, if they go with the 3% if you don't participate, you don't get the 3% Okay, so simply put if a company has ten employees seven active and three not active Guess what if they go with the 2% all Employees will get 2% if they go with the 3% plan only the seven active employees will Will will get that additional money in the retirement account? Okay? For the simplified employee plan the employee has to work three of the last five years and earn at least six hundred dollars They want to make it easy for employees to to participate Okay, and when you do this come the computation you'll deduct yourself employment tax out of net earnings So it's the earnings again. You're back to the limit of fifty seven thousand any way you Any way you dice it, okay? Here you have to be under the simple plan age 21 earn five thousand in the last two years and expect to earn Five thousand in the current year to be able to participate in participate this way It's worth it for the company to set up the account for you. Okay, again, as we said the max is 57,000 max 57,000 and a lot of Lot of self-employed individual they create a set plan for themselves. For example, I know my brother. He's a self-employed He has his own company. He has his own. He has his own set plan. Okay, that's fine You're the employee and you're the employer and he's the only person in the company and For simple plan just one small rule is you have to be in the plan for two years before you can take money out Without penalty, so let's assume you started with the company at age 58 and a half And guess what you're not going to be able to take any money until 60 and a half So you have to be two years into the system Although the general rule is 59 and a half small trick for this you have to be two years into the system At the end of this recording if you like this recording, please like it share it Share it with others and if you are studying for the CPA exam I strongly encourage you to visit my website for hat lectures calm I don't replace your CPA review course. I can help you make the material easier Easier to understand so you can understand your CPA review course better. You can pass your exam. Good luck study hard and stay safe