Other Retirement Plans: Keogh, 401(k), SEP, and SIMPLE IRAs
Learning Objective
Know when deposits to other retirement accounts (Keogh, 401(k), SIMPLE, and others) are deductible.
Individual Retirement Accounts are savings plans created by individual taxpayers. Self-employed taxpayers have a variety of plans they can establish for themselves and their employees to help save for retirement. The retirement plan area is a complex area of the tax law. The coverage in this text provides a simple overview of several common options available.
Keogh (H.R. 10) Plans and Simplified Employee Pensions. Keogh plans (also called H.R. 10 plans)Keough or H.R. 10Retirement plan that can be used by unincorporated businesses. are the unincorporated business’s equivalent of the qualified retirement plans and contributions can be made for the owner and employees. For 2008, contributions to Keogh plans by self-employed taxpayers are generally limited to the lesser of 20% of their net earned income (before the Keogh deduction) or a maximum deduction of $46,000. A taxpayer’s net earned income includes profits from a business if a material part of the profits from the business are from the taxpayer’s personal services and the income has been reduced by self-employment taxes and the Keogh deduction.
Example
Phyllis is a self-employed financial planner, and the net earned income from her practice is $155,000. Under the terms of her Keogh plan, Phyllis contributes 20% of net earned income (up to the maximum allowable) to the plan. Phyllis’s maximum contribution to the plan, and deduction for AGI is $31,000, since this amount is the lesser of 20% of $155,000 ($31,000) or $46,000.
Simplified Employee Pensions, or SEPsSEPSimplified employee pension, usually established as a SEP-IRA., are one of the most popular retirement plans for self-employed taxpayers. The contribution limits for 2008 are the same as the limits for Keogh plans discussed above. The contributions are made into “SEP-IRAs,” which are special IRA accounts with the higher funding limits. Participants in both SEPs and Keogh plans must meet requirements for minimum age and years of service for the participants. An employer must cover employees if the employees meet the requirements for coverage.
Self-employed taxpayers can also adopt “SIMPLE” IRASIMPLE IRASelf-employed taxpayer retirement plan with higher contribution limits. plans. A SIMPLE retirement plan allows employees to make elective contributions to an IRA. Employee contributions must be expressed as a percentage of the employee’s compensation and can’t exceed $10,500 ($13,000 if age 50 or older) for 2008. To qualify for a SIMPLE plan, employers must satisfy one of two contribution calculation formulas. The standard matching contribution formula generally requires employers to match the employees’ elective contributions on a dollar-for-dollar basis up to 3% of the employees’ compensation. An alternative contribution formula allows employers to elect to contribute 2% of compensation for each employee earning more than $5,000 for the year, whether or not employees are contributing a percentage of salary.
Example
A small employer maintains a SIMPLE IRA plan for his employees. One of the employees, Ray, elects to contribute 5% of his salary. Ray is paid $40,000 for the 2008 tax year. The employer must withhold $2,000 (5% × $40,000) from Ray’s paychecks, match it with $1,200 (3% × $40,000) and contribute a total of $3,200 to an IRA established for Ray. Note that Ray would not have a deduction on his tax return as the W-2 would reflect salary net of his contribution of $38,000 ($40,000 − 2,000) subject to income tax this year.
To avoid penalties, taxpayers generally may not receive distributions from a Keogh Plan or SEP prior to age 59½ and must start drawing amounts by the age of 70½.
Questions and Problems
Which of the following statements with respect to a Keogh Plan is not accurate?
Employees of self-employed individuals are eligible to be members of a Keogh Retirement Plan.
Contributions to Keogh Plans are limited to 20% of the taxpayer’s net earned income or $46,000, whichever is greater.
In some cases, “earned income” includes profits from the taxpayer’s business.
Taxpayers must begin receiving distributions from a Keogh plan by the age of 70½.
None of the above statements are accurate
Carl’s employer makes a $2,000 contribution to a qualified retirement plan for Carl in the current year. Carl is only 50 years old and does not expect to retire until age 65, fifteen years from now. What is the proper tax treatment of the $2,000 contribution for Carl’s employer?
The $2,000 is never deductible.
The $2,000 is deductible in the current year.
The $2,000 is deductible in the year Carl retires.
Only one-fifteenth ($133.33) is deductible in the current year.
None of the above
When taxpayers receive distributions from individual retirement plans, how much time is allowed to rollover the amount received into a new plan to avoid paying taxes on the distribution in the current year, assuming there are no unusual events?
60 days
90 days
180 days
One year
There is no time limit
Chris quits his job with $130,000 in his employer’s qualified retirement plan. Since he is broke, Chris instructs the plan trustee to pay him the balance in his retirement account. How much will Chris receive when he gets his check from the retirement plan?
$130,000
$104,000
$100,000
$26,000
Some other amount
What is the maximum amount that can be contributed to a SIMPLE plan by an employee under age 50 for 2008?
$7,800
$8,000
$9,000
$10,500
A SIMPLE plan can be adopted by employers who have no other employer sponsored retirement plan and have no more than how many employees who earn $5,000 or more during the preceding tax year?
50
100
500
1,000
A small employer maintains a SIMPLE IRA plan for his employees. One of the employees, Christel, elects to contribute 5% of her salary to this SIMPLE plan. Christel is paid $40,000 for the tax year and her employer uses the standard matching contribution formula. What is the total amount (including the employer matching) of Christel’s contribution?
$1,200
$2,000
$2,400
$3,200
Some other amount
During the year, Erika, age 30, participated in a Section 401(k) plan, which provides for employee contributions of up to 10%. Erika’s salary was $80,000 for the year. She elects to make the maximum contribution. What is Erika’s tax-deferred contribution to the plan for the year? $__________
Inge is a self-employed esthetician and her net earned income is $56,000. Inge’s Keogh Plan, a defined contribution plan, states that she will contribute the maximum amount allowable. Calculate Inge’s contribution. $__________
