Retirement Plan Contribution Limits and Withdrawal Requirements

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1 Manning & Napier Advisors, LLC Retirement Plan Contribution Limits and Withdrawal Requirements April 2011 Approved CAG-CM PUB030-R (10/11)

2 Introduction The following report provides general information regarding contribution limits for a variety of taxadvantaged savings vehicles, including defined contribution plans, defined benefit plans, Traditional IRAs, and Roth IRAs. In addition, the report discusses generally the implications of early and late withdrawals, required retirement plan distributions, converting Traditional IRAs to Roth IRAs, and allowable account rollovers. All of the information outlined below is for tax year This information is presented for general education purposes and does not include any opinions as to optimal tax-deferral strategies or retirement plan selections. Likewise, the information is not intended to serve as tax and/or legal advice. Therefore, individuals are encouraged to contact either a retirement planning specialist or an accountant to verify that the information provided applies to their unique personal situations. All of the information within this report is from the Internal Revenue Service website ( Defined Contribution Plan Contribution Limits Defined contribution plans are employer sponsored plans where retirement assets are accumulated via employer and/or employee deferrals into individual employee accounts (e.g., 401(k) and Profit Sharing Plans). The investment risk of defined contribution plans is fully borne by the employee. In general, the maximum that can be contributed to defined contribution plans in 2011 (including both employer and employee contributions) is the lesser of 100% of compensation or $49,000. In addition, contributions made solely by the employee are further limited. Employee contribution limits for several common defined contribution (DC) plans are outlined in Table I below: Table I: Contribution Limits for Select DC Retirement Plans in 2011 Retirement Plan: Employee Contribution Additional Employee Catch-Up Contribution 1 401(k) $16,500 $5, (b) $16,500 - $19,500 2 $5, (b) $16,500 $5,500 - $16,500 3 SIMPLE $11,500 $2,500 SEP $0 4 $0 SARSEP 5 $16,500 $5,500 Profit Sharing Plan $0 6 $0 1 Catch-up contributions are allowed for individuals over 50 and are not subject to the $49,000 limit. 2 Individuals that have participated in a 403(b) plan for over 15 years may contribute an additional $3,000 in During the final three years before retirement, rather than making a $5,500 catch-up contribution, individuals with 457 plans may elect to defer up to twice the dollar limit for the year (i.e., $33,000 in 2011) to 457(b) plans to the extent that they have unused deferrals from previous years. 4 Only employers may make contributions to SEP IRAs. In 2011, employers may contribute the lesser of 25% of compensation or $49,000 to employee s SEP IRAs. 5 New SARSEPs may not be set up. However, individuals that are employed at companies that offer SARSEPs (including new hires) may contribute part of their compensation to the plan (within the limits outlined above). 6 Only employers may contribute to Profit Sharing Plans. 1

3 The aggregate employee contribution to 401(k), 403(b), SIMPLE, and SARSEP plans in 2011 is $16,500. For example, individuals may defer up to $16,500 total to 401(k) and 403(b) plans in 2011 if their employer(s) offer multiple plans and if they are active participants in each plan. However, contributions to 457(b) plans are not included in this aggregation. For example, if an individual is an active participant in both a 457(b) and a 401(k) plan, then they may contribute up to $33,000 total in 2011, with up to $16,500 deferred to the 457(b) plan and up to $16,500 contributed to the 401(k) plan (not including any applicable catch-up contributions). Defined Benefit Plan Contribution Limits In contrast to defined contribution plans, where employees and employers make contributions to individual accounts and the employee bears the investment risk, defined benefit (DB) plans offer employees a determinable retirement benefit regardless of the performance of underlying investments (assuming the health of the plan isn t a mitigating factor). Complex DB plan formulas (based on factors such as years of service and percentages of compensation) are oftentimes used to determine the employee s exact retirement benefit. While individuals generally may not make contributions to defined benefit plans, they should be aware of how their defined benefit plan payout is calculated and estimate what payout to realistically expect from their defined benefit plan(s) when they retire. Understanding an expected benefit from a DB plan can lead to increased accuracy when planning for retirement and can help individuals set more realistic long-term retirement spending/budgeting goals. The maximum annual benefit from a DB plan in 2011 is the lesser of $195,000 or 100% of compensation, and a plan s benefit formula may take into account up to $245,000 of an employee s compensation. Traditional IRA and Roth IRA Contributions In addition to the qualified defined contribution plan limits listed on the previous page, there are limits that apply to annual contributions to Individual Retirement Accounts (IRAs). In 2011, individuals may contribute the lesser of their earned income for the year or $5,000 to their Traditional IRAs 7 and Roth IRAs (individuals age 50 and over may make an additional annual catch-up contribution of $1,000, subject to meeting the annual income requirement). Excess contributions over these limits are subject to a 6% penalty for each year the excess contribution is not corrected. Within these limits, contributions to Traditional IRAs are taxdeductible if an individual and their spouse (if married) are not active participants in a qualified employer plan (active participation is defined on the following page). However, if an individual is an active qualified retirement plan participant, IRA contributions are still tax-deductible if their Modified Adjusted Gross Income (AGI) falls under the limits listed in Table II on page 3 (with partial deductibility for active plan participants that fall within the phase-out ranges). Likewise, if an individual is not an active plan participant, but their spouse (with whom they file a joint tax return) is an active participant in a qualified retirement plan, the non-active participant spouse may make fully tax-deductible Traditional IRA contributions if their joint Modified AGI is under $169,000 (with partial deductibility up to $179,000). Individuals whose income is above these thresholds may make non-deductible contributions to their Traditional IRAs. While non-deductible Traditional IRA contributions do not provide a tax deduction, the earnings will grow tax-deferred, and when withdrawn, the portion of the withdrawal which is a return of non-deductible contributions is distributed income tax free. 7 Contributions to Traditional IRAs are permitted up until the year individuals reach 70½ (provided they meet the earned income requirements for contributions). 2

4 Table II: 2011 Modified AGI Phase-Out Ranges for Traditional IRA Deductibility for Active Retirement Plan Participants Tax Filing Status Phase-out Ranges in 2011 Single Taxpayer $56,000- $66,000 Married Taxpayers Filing Jointly $90,000 - $110,000 Non-Active Participant Whose Spouse is an Active Plan Participant $169,000 - $179,000 The definition of an active participant differs slightly for individuals whose employers offer defined contribution and defined benefit plans. When an employer offers a defined contribution plan, an employee is classified as an active participant if they make contributions to the plan, if the employer makes any contributions to their individual account, or if plan forfeitures are allocated to their account. Even if an employer offers a DC plan, the employee is considered inactive if the previous criteria are not met, resulting in the full amount of the IRA contribution being deductible. In contrast, if an employer offers a defined benefit plan, every employee to whom the plan is offered is classified as an active participant, even if they choose to waive participation. Several differences exist between Traditional and Roth IRAs, including the tax status of the accounts, the eligibility to contribute to the accounts, and the ability/requirement to take withdrawals from the accounts. For example, contributions to Traditional IRAs are generally made with pre-tax dollars (the exception being non-deductible contributions), while Roth IRA contributions are made with after-tax dollars (and earnings grow and are distributed tax free as long as certain criteria are met). Likewise, Roth IRA contributions can generally be made regardless of active participation status since the ability to contribute to Roth IRAs is primarily based on whether an individual s Modified AGI is under the limits listed in Table III below 8. Furthermore, while contributions to Traditional IRAs must cease in the tax year when individuals turn 70½, Roth IRA contributions may continue indefinitely, as long as the individual has earned income to contribute. Finally, while Traditional IRA distributions are penalty-free if the individual is over 59½ years old (along with additional exceptions outlined in the section on withdrawal requirements), portions of Roth IRA withdrawals are penalty-free only if the Roth account is at least five years old and if other criteria are met (The rules regarding Traditional IRA and Roth IRA withdrawals are outlined in the section on withdrawal requirements.). Table III: 2011 Modified AGI Phase-out Ranges for Roth IRA Contributions Tax Filing Status Phase-out Ranges in 2011 Single Taxpayer $107,000 - $122,000 Married Taxpayers Filing Jointly $169,000 - $179,000 8 Unlike Traditional IRAs, which individuals can make after-tax contributions to regardless of AGI, contributions to Roth IRAs are not permitted when above the phase-out ranges. 3

5 The Spousal IRA 9 While contributions to an IRA are intended to be made from an individual s income (i.e., a husband can contribute to his own IRA and a wife can contribute to her own IRA), spousal IRAs allow married joint-filing taxpayers to contribute to IRAs when one spouse has little-to-no income. Specifically, if a married couple has only one wage-earner, or if one wage-earner makes less than $5,000, the higher wage-earning spouse may make tax-deductible contributions to a spouse s IRA as long as they file a joint tax return and neither spouse is an active participant in an employer sponsored qualified plan. However, if one spouse is an active qualified plan participant (as defined previously), tax-deductible contributions to a Spousal IRA are permitted as long as their AGI is under the range listed in Table IV below. If their AGI is above the range, then the couple may still make contributions to a Spousal IRA, although the contributions will not be taxdeductible. Table IV: 2011 Spousal IRA Contribution AGI Phase-out Range Year Spousal IRA Phase-out Range 2011 $169,000 - $179,000 Withdrawal Requirements Rules exist regarding the distribution of assets from tax-deferred savings vehicles. Specifically, regulations exist that penalize individuals who withdraw assets either too early or too late. Except for specific exceptions, individuals are not permitted to withdraw assets from an IRA before they are 59½ years old, and individuals may not withdraw assets from qualified employer sponsored retirement plans until they are separated from service and are at least 55 years old. Early withdrawals will generally be subject to a 10% early withdrawal penalty in addition to the required income tax liability, although several exceptions to the 10% early withdrawal penalty exist. For example, early withdrawals because of death, disability, certain medical expenses (e.g., medical expenses in excess of 7.5% of AGI), a series of substantially equal periodic payments (i.e., 72(t) distributions) 10, and distributions as a result of a qualified domestic relations order (QDRO) are generally penalty-free from a qualified retirement plan or from an IRA. In addition to these options, individuals may take early distributions from either Traditional IRAs or Roth IRAs without penalty for a down payment on a house for first time home buyers (up to $10,000) or for qualified higher education expenses. As a reminder, penalty-free withdrawals from tax-deferred savings vehicles (e.g., 401(k)s, 403(b)s, and Traditional IRAs) are still subject to ordinary income tax. Table V on page 5 shows common exceptions to the 10% penalty for early withdrawals. 9 Spousal IRAs may be in the form of either Traditional IRAs or Roth IRAs (t) distributions from a 401(k) only are penalty-free only if the individual has separated from service. 4

6 Table V: Common Exceptions to the 10% Early Withdrawal Penalty Traditional and Roth IRAs 401(k) or 403(b) Death, disability, or attaining age 59½ Medical expenses in excess of 7.5% of AGI 72(t) distributions Qualified Education Expenses No First-time homebuyer (up to $10,000) No Distributions following separation of service after age 55 No Distributions under a Qualified Domestic Relations Order (QDRO) The tax consequences of taking early withdrawals from Roth IRAs are different than for Traditional IRAs. Since contributions to Roth IRAs are with after-tax dollars, withdrawals of contributed principal are permitted penalty-free and tax-free at any time. Likewise, withdrawals of converted assets are always taxfree. However, early withdrawals of earnings are only tax-free if they are qualified. Non-qualified withdrawals of converted assets and earnings may be assessed a 10% early withdrawal penalty if none of the criteria in the table above are met. For a withdrawal from a Roth IRA to be qualified, the account must have been established at least five years prior to the withdrawal 11 and at least one of the following criteria must be met (i.e., the individual is over 59½, death, disability, or for a first-time home buyer up to $10,000). Table VI below discusses the income tax liability and penalties for early withdrawals from Roth IRAs. Table VI: Taxation and Penalties of Roth IRA Distributions Qualified Distributions 12 Non-Qualified Distributions Contributions No tax or penalty No tax or penalty Conversions No tax or penalty No income tax but subject to 10% penalty* (if within 5 years of conversion) Earnings No tax or penalty Subject to income tax and 10% penalty* *Not subject to the 10% early withdrawal penalty if one of the exceptions in Table V applies. 11 The five year time period starts when the first contribution is made to the Roth IRA. 12 A distribution from a Roth IRA is qualified if the account was established at least five years prior to the withdrawal and if one of the other criteria is met (i.e., the individual is over 59½, death, disability, or for a first-time home buyer up to $10,000). 5

7 Furthermore, the government has limited the amount of time that accounts can experience the benefit of tax-deferred growth. Specifically, starting 13 at age 70½, individuals are generally required to begin taking distributions from their retirement accounts and must continue taking distributions annually over their lifetimes (Roth IRAs are exempt from this requirement). The Required Minimum Distribution (RMD) is determined by dividing the previous year s ending market value by the factor shown in the second column of Table VII below (the column on the right translates the Required Minimum Distribution factor to the approximate corresponding percentage withdrawal). The factors below generally apply to individuals and married couples and are based on the IRS Uniform Life Expectancy Table 14. Individuals may delay withdrawals beyond 70½ from qualified retirement plans only if they continue to work and are less than a 5% owner of the company. There is a 50% penalty in addition to income tax due for any required amount that is not withdrawn each year. Table VII: Required Minimum Distributions Age Factor Required Minimum Distribution % % % % % % % % % % % Converting Traditional IRAs to Roth IRAs Prior to 2010, the ability to convert Traditional IRA assets to a Roth IRA was limited to single filers and married couples filing joint tax returns with AGIs below $100,000. However, at this time, those who were unable to convert their Traditional IRA assets into Roth IRA assets due to the income limit are now able to convert. (Note: married individuals who file separate tax returns are still unable to convert their Traditional IRAs to Roth IRAs.) Though, even with the income hurdle lifted, individuals must weigh the positive and negative aspects of each tax-advantaged vehicle to determine if a conversion would be beneficial. For example, if Traditional IRAs are converted to Roth IRAs, the individual owes income tax on the converted portion at their current marginal income tax rate (after-tax contributions are exempt). In contrast, if a 13 The first withdrawal must be taken by April 1 st of the year following the year in which the individual turns 70½. For subsequent required distributions, the required withdrawal must be completed by December 31 of the year in which each age is attained. 14 When a married couple s ages are more than 10 years apart, the IRS Joint Life Table may be used to determine Required Minimum Distributions as long as the younger spouse is the sole beneficiary. Likewise, depending on the situation a different table may be appropriate. 6

8 Rollover From Traditional IRA is not converted, income tax remains deferred until the individual takes withdrawals from the account. Thus, a potential difference between an individual s current marginal tax rate and their expected future marginal tax rate (based on both differences in their current tax bracket and their expected future tax bracket, as well as changes in tax law) is a key factor in determining whether or not to convert. However, other factors also influence whether a conversion may be beneficial for any particular individual. For example, as stated above, individuals are required to take minimum distributions from Traditional IRAs beginning at 70½, while Roth accounts do not require individuals to take withdrawals. Thus, if an individual believes that they won t need to spend the Required Minimum Distributions starting at 70½, the tax-free growth of a Roth IRA beyond 70½ would likely be beneficial. Furthermore, if individuals are under 59½ and use Traditional IRA assets to pay the tax due on conversion, they will be most likely subject to a 10% early withdrawal penalty on the portion of the withdrawal used to pay the conversion tax (as this portion of the withdrawal is treated as an early withdrawal and not as a conversion). Finally, individuals should understand that there are other factors that come in to play when determining if a Roth conversion is appropriate. For example, Roth IRAs tend to be better multi-generational wealth transfer tools, as the decedent has prepaid the income tax liability for the beneficiary and effectively reducing his/her taxable estate. We encourage individuals interested in Roth Conversions to speak with their tax advisor prior to engaging in a conversion. Plan Rollovers Individuals may change employers and as a result may accumulate several retirement accounts. In order to simplify their investments, they may wish to combine their accounts into one larger, consolidated investment approach. Table VIII below lists the rollovers which are generally permitted, assuming that the individual is no longer an active participant in the account being rolled over. Rollovers from one plan to another must be completed within 60 days in order for the transaction to be classified as a rollover and not as a taxable distribution. Table VIII: Permitted Retirement Account Rollovers 15 Rollover To Permitted Rollovers? Traditional Roth 401(k), 401(k) 403(b) 457(b) Roth IRA SEP IRA SIMPLE IRA 403(b), or 457(b) 401(k) 4 2 No 5 403(b) 4 2 No 5 457(b) 2 No 5 Traditional IRA 2 No No Roth IRA No No No No No No No SEP IRA 4 2 No No SIMPLE 3 3 3,4 3 2,3 3 No Roth 401(k), 403(b), or 457(b) No No No No No No 1 1 If a direct Trustee-to-Trustee transfer. 2 Rollovers into Roth IRAs are permitted only if the converted assets are included as income during the current year. 3 Rollovers from SIMPLE plans are permitted only after two years of plan participation. 4 Assets may be rolled into 457(b) plans, but must be held in separate accounts within the plan. 5 Must be an in-plan rollover. 15 Rollovers into employer sponsored retirement plans may be subject to further limits and restrictions imposed by the plan document. 7

9 In addition to the 60-day limit, several rules exist regarding account rollovers. For example, when a rollover is made from a qualified profit sharing plan, 401(k), or 403(b) to an individual (not as a direct rollover to an IRA), the employer is required to withhold 20% 16 of the rollover amount unless the employee s entire balance is rolled over. Furthermore, while the 20% withholding requirement is not assessed on IRA to IRA rollovers, individuals are limited to one IRA-to-IRA rollover per IRA per year 17. Finally, if an individual is in the process of changing employers and anticipates more than 60 days of unemployment (which would result in the rollover being deemed a taxable distribution), they may be able to leave their assets in the old plan or they could consider rolling the assets from a retirement plan into a temporary Conduit IRA. A rollover into a Conduit IRA (rather than a Traditional IRA) will maintain the account s qualified plan status, allowing the individual to maintain ERISA protection, as well as to maintain certain benefits (e.g., loans from the account in the future 18 ). Conclusion The preceding report has provided a broad overview of contribution limits and withdrawal requirements for some of the most common retirement plans. Based on the intricacies of each of these plans, we recommend that individuals contact a tax or legal professional before setting up and/or making significant contributions to a given plan. Likewise, this information has been provided for general education purposes only and should not be construed as advice on whether one certain tax-deferral strategy is better than another in a given situation. Additional information on each of these plans as well as other retirement plans may be found on the IRS website at 16 While the 20% withholding requirement is returned to the individual with their tax return (as long as the plan is rolled over within 60 days), the participant must front the 20% when the assets are rolled over to avoid it being considered a distribution. 17 This includes rollovers of assets from one account to another, but does not include changes in investments. 18 For a rollover to qualify as a Conduit IRA, all assets rolled over must be contributions to and earnings on qualified plan assets. 8

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