 Hello and welcome to the session in which we would look at retirement plans from a tax perspective. Now the U.S. Congress wants to encourage us, wants to encourage the taxpayers, the citizens, to save money away for retirement. So you work during your lifetime, you want to keep some money for later on. So what do they do? How do they encourage you to save? Well, they're going to give you tax incentive. And specifically, if you might be working for a company or you might be self-employed, now we're going to be looking at both type of situation. But simply put, what's going to happen is if you put money away in a retirement plan, what are going to be any specific now, we're going to call it retirement plan, you will get it, you will get a tax deduction and adjustment on part two of schedule one, form 1040, basically self-employed SEP, simple and qualified plans, we would look at those in the session, but basically they're giving you a tax deduction. And this is what we're going to be discussing in this session. Now this topic is covered on the CPA exam as well as your accounting course. If you are studying for the CPA exam, I'm pretty sure you should have a CPA review course. That's good. I don't replace your CPA review course. I can be a useful addition. I can explain the material differently. I can give you an alternative explanation. I can supplement your material. So this way you will understand it better, do better on your review course and do better on the exam. Your risk is one month of subscription. If you don't like it after a month canceled, your potential gain is passing the exam. And if not for anything, take a look at my website to find out how well is your university doing on the CPA exam. I do have resources for other accounting courses as well. Also connect with me on LinkedIn. If you haven't done so, check my LinkedIn recommendation, like this recording, subscribe to my channel, connect with me on Instagram, Facebook, Reddit, and Twitter. So before we start discussing the retirement plan, we want to make sure you understand basic terminology. And that's one of the basic terminology that confuse students is tax deferred account. What does it mean when we refer to this retirement plan as tax deferred? Well, think about the word deferred. Deferred means later. So here's what's going to happen now. In a retirement plan, you're going to put some money today away for the future. So this money is put away for the future. Here's what's going to happen sometime. Well, this money is pre-tax. Pre-tax means you did not pay any taxes on it. Then this money is going to be invested and grow for the future. Now, as it grows, it's tax-free. So you did not pay taxes on it now. It grow tax-free. Guess what? In the future, you'll pay your taxes. When do you pay your taxes when you take this money out when you are retiring? So this is what we mean by tax deferred. Now, sometime you put tax money, post tax, after you pay taxes on it. But it doesn't matter. The idea of tax deferred account, it means it's going to grow without paying any taxes. It will grow without paying any taxes. So it's very important to understand this. So the benefit is you will get a tax savings today because the money is not taxed. The money will grow tax-free. Also, you don't pay taxes. You only pay taxes when you are retired. So that's a good thing. It's tax deferred. The distribution. A rule of thumb is this. And hopefully, this makes sense. If the plan is funded, if you put money away with a dollar that has not been taxed, okay, guess what? When you distribute it, when you take this money out, it's going to be fully taxed. Makes sense. You have to pay tax on your earnings. If you don't pay it now, you're going to pay it later. It's as simple as that. If the plan, if the retirement plan is funded with already taxable dollar, some or all the distribution will not be taxed. And you're going to see why some or we have different rules, whether it's a Roth IRA versus regular IRA. We'll talk about this. But the idea is, if you already pay taxes on your money, you're not going to pay taxes on that amount, on the principal amount. Again, in the future, you might have to pay taxes on the earnings. You may not have to pay taxes even on the earnings if you meet certain requirement. So this is a general rule. This is a concept. This is not everything. Okay. But you have to understand this concept because it makes sense. And I hope it makes sense. Okay. There are many types of retirement plans. And basically, they can be broken down into employer sponsored plan. What does that mean? It means the company. It's 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 going to be focusing on the employer sponsored plan. And those include qualified pension or simply pension, you know, by pension, profit sharing plan, 401k or 403b. We'll talk about those. Chaos plan, SEP and simple plan. So basically, you know, if you follow my lectures, once I have a list, it means I'm going to 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 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 university instructor, you will teach at different universities as adjuncts sometimes. 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 they asked me to fill out my paperwork. Now I have to be very careful. This is my full-time job. So I got to make sure, I know what I'm, I read what I'm signing. So they had a 401-403B to be more specific. They don't, and we're going to 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've been in the system for a long period of time. So the pension has been discontinued. So that's fine. So I filled out my paper for 403B or 401K, which is the equivalent of 401K. Two days later, I got a phone call 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 and, oh, yes, you were enrolled in the state system when you work at that other university and they enrolled you and you are grandfather into the system. So it's 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 a grandfather 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 Strasbourg 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 stayed 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, firefighters, usually government employees, what happens 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, the company could go, 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 required 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. 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 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. So I'm not going to go, I'm going to, I'm not going to be repeating myself, but I'm going to give you the, just 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 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, whatever 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 going to give you tax benefit actually for both employers and employees. For the company, it's going to give them immediate tax benefits for the contribution. You make a contribution, 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 incite you to work for us, we're going to have what's called the pension plan. And earnings are tax deferred. So for you, it's a good thing, because if you get the money, you're going to be taxed on it. So the earnings are, you remember the third, it means they're going to 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 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 will pay the rest. But my outcome is guaranteed and this is important. Or some pension plan, they're non contributory. For example, my wife worked with at J&J, Johnson & 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 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 a 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 are going to put this much away, but we don't know what the outcome will be. And we're going to see 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 going to be getting down the road. So they are less risky plans, less risky plans. Now, the profit sharing plan is basically a defined 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 going to put money away from the profit. So what happened if we don't make a profit? Well, we can't 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 to the plan or not contribute to the plan. For example, it's if we have no profit, we're not going to 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 defined contribution, the profit because you were, maybe you were thinking a minute ago, what does he mean by defined contribution? It means we know how much you're putting, but you really don't know what's coming out because it's going to fluctuate. You don't know how much you're putting every year. Okay. And 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 a 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. We'll discuss that roll over in the next session. Simply put, you can transfer it, but you need to know the rules for that. We'll 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. That 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 going to put $10,000 that's going to 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're retired. How much can you contribute? It changes per year. 2020 was $19,400. Now, if you are over 65, over 50, you will get $6,500. Not over 65. Over 65, you're going to be taking 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 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 the age of 50, you contribute. I believe they're going to change it this year to 20,000, 2021, but let's, we're working with 2020. So you can contribute $19,500. Let's assume your company contribute. The maximum your company can contribute is an amount to gather. They cannot exceed 57. Okay. They may, they don't usually contribute. They don't match 100%. But let's assume they want to match some employees and pay them more. The maximum is 57,000. Okay. Any excess 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. You cannot favor one group, so on and so forth. Okay. Now, 403B. 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 403B. 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 at 2,400. Now, what happened is this. They shielded this money. This money is not, not taxed. Now, the 2,400 is not taxed. Okay. But if you take it out prematurely, it's subject to taxation. Now, on your W2, here's what happened for this individual. The wages and compensation, which is box one, it's going to 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 distribution, retirement contribution, not distribution. Okay. Now, again, you cannot take this money out. You're subject to a penalty. Don't worry, we're going to have a whole session about distribution. Unless, you know, the plan terminated, you separate it from your service, you can transfer it. And there's a certain way you have to do it, debt 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, kiosk or cough plan. Okay. These are for self-employed individuals. Remember, if you work for a company, you might have a pension or you might have a 401k. And remember, under a pension, you could be profit sharing plan and under 401k, it could be 403b. But that's not the point. What happened if you're self-employed? You're the company. Well, you're subject to the same contribution and benefit limitation as a pension or profit sharing. So the same rules apply to you. You can contribute the lower of 57,000. Maximum is 57,000. Remember, you're the employee and the employer or 25% of your earned income. Again, 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 your maximum. You're going to see the computation in a moment. Earned income from self-employment is determined after deduction, one half of self-employment taxes. So what you do when we are making this determination of the 25%, your earned income times 25%, we have to deduct self-employment taxes and after the amount of key contribution. You're going to see in a formula in a moment. Actually, let's work an example. Same as 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 compute the amount that they can deduct? Okay. Well, here we go. We're going to take 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 highlighted in yellow. Let me highlight it in yellow. So the 60,000 is the amount highlighted in yellow. There we go. So this is after the deduction of one half of self-employment. So they're giving us this number. Then now you're going to deduct your 25% of the amount after that, which is you don't know the amount after the contribution. Therefore, we call it X. We're going to see what's the maximum. So just basically, you solve for X and X is 48,000. Therefore, SEM is entitled to 57,000, the maximum, or 25% of the amount after the contribution. So the amount after the contribution is 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 does the 12,000 represent? What does the 12,000 represent? 12,000 represent the amount, 25% of the amount 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 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 taxes is your earning after self-employment taxes, 285,000. So let's do this quick calculation to show you this. So this is your yellow number. Just let me highlight it in yellow. This is your yellow number. And let's see what's going to 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 going to be 285,000 equal to 1.25x. We add 0.25x on each side. Now we're going to look for x. We're going to divide by 1.25, 285,000 divided by 1.25. I divided both sides by 1.25. And that's going to give me 228,000. Now if you take 228,000 multiplied by the maximum amount, that's going to give you 57. So this is how the number 57 comes about. So 285, you know, you're going to come back 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 plans that are kind of similar. So I'm going to put them side by side. They're also for self-employed individuals. One is called not self-employed small companies, actually, sorry, but could be for self-employed SAP 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 employees 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 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 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 one 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 a kick off an additional 3,000 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 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, if they go with the 3%, they only finance it if you participate, 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 10 employees, 7 active and 3 not active, guess what? If they go with the 2%, all employees will get 2%. If they go with the 3% plan, only the 7 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 $600. They want to make it easy for employees to to participate. Okay. And when you do this, 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 $57,000, any way you, any way you dice it. Okay. Here you have to be under the simple plan, age 21, earn $5,000 in the last two years, and expect to earn $5,000 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. The max is $57,000. And a lot of, a lot of self-employed individuals, 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, 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 with others. And if you are studying for the CPA exam, I strongly encourage you to visit my website, farhatlectures.com. 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.