Exam (elaborations)
CRPC Module 7
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- CRPC Sample Tests
Exam of 39 pages for the course CRPC Sample Tests at CRPC Sample Tests (CRPC Module 7)
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CRPC Module 7In-service withdrawals- Profit Sharing and 401(k) Plans - ANS-IRS guidelines generally
permit 401(k) and other profit sharing plans to offer in-service withdrawals. In-service
means you are still working for the employer sponsoring the plan. If a profit sharing plan
provides for in-service withdrawals, generally, no special emergency or hardship
conditions are required. The plan may, however, impose such restrictions. It may also
require attainment of age 59½ or a service requirement (usually two to five years), or
both. Plan provisions also specify the portions of the participant's account that may be
available for in-service withdrawal—usually, only the vested portion of the employer's
contributions (matching and nonelective contributions) prior to age 59½.
Taking advantage of an in-service withdrawal is not only a way of obtaining cash from a
plan, but it may also offer a good opportunity to expand the investment options available
to your client if choices are limited by their employer-sponsored plan. By doing a direct
or 60-day rollover of an in-service distribution to an IRA, an individual will typically find
that they have more funds to choose from, often with lower investment fees. They may
also have more freedom when naming beneficiaries and to create a customized income
plan at retirement.
In-Service Withdrawals- Pension Plans - ANS-Defined benefit, cash balance, money
purchase, or target plans generally can make distributions only upon death, disability,
separation from service, or after the attainment of age 62. (Separation from service
includes retirement of the participant.) Defined benefit plans are not likely to allow
in-service withdrawals due to the complex recordkeeping required. Typically, money
purchase or target plans include provisions for in-service withdrawals after the plan's
normal retirement age. This creates an option for the employee who elects to continue
working past the plan's retirement age but who would like to begin tapping their
retirement benefits.
in-service withdrawal - ANS-An in-service withdrawal occurs when an employee takes a
distribution from a qualified, employer-sponsored retirement plan,
Cautions with in-service withdrawals - ANS-Some companies impose penalties for
taking such a distribution. Penalties could include a suspension of plan contributions
and charges. If your client is considering rolling funds to an IRA, keep in mind that IRAs
do not have the same creditor protections as qualified plans and do not offer loans.
Also, 401(k) plans allow distributions after attainment of age 55 without penalty; with an
IRA your clients need to wait until 59½ to avoid the early withdrawal penalty. Finally, if
the distribution is not rolled over and is instead taken as cash, it could result in
,significant taxes and possible penalties. Because of these drawbacks, taking advantage
of a qualified plan's loan provision may be more advantageous (if available). Loans are
discussed in a following section.
Hardship Withdrawals - ANS-A 401(k) plan participant who demonstrates (1) "an
immediate and heavy financial need" and (2) lack of other "reasonably available"
resources may qualify for a hardship withdrawal. IRS regulations provide the following
examples of need that would be considered immediate and heavy:
-medical expenses for a parent, spouse, child, dependent, or any primary beneficiary
(defined below)
-purchase of a primary residence
-tuition payments for a parent, spouse, child, dependent, or any primary beneficiary
-payments to prevent eviction from one's primary residence
-funeral expenses for a parent, spouse, child, dependent, or any primary beneficiary
-repairs to principal residence that would qualify for a casualty loss income tax
deduction
My disastrously faulty emergency fund - ANS-"My" for Medical and funeral expenses
(unreimbursed). "Disastrously" for federally declared Disasters. "Faulty" for "First home
buying" in the sense of purchasing a primary residence. This is NOT the same definition
as a first-time home buyer for exceptions to the 10% early withdrawal penalty for IRAs.
Also hardship withdrawals can only be used for a primary/first residence—never a
second home. "Emergency" for Education (higher education) expenses. These higher
education expenses can be for the employee, the spouse, the employee's children, the
employee's dependents, or a beneficiary. The qualified educational expenses include
tuition and related educational fees plus room and board. These educational expenses
must occur within 12 months of the distribution. "Fund" for Foreclosure of the primary
home. Foreclosures on a second/vacation home do not count.
Hardship withdrawals can be thought of as "My disastrously faulty emergency fund"
because they should not be thought of as the emergency fund at all. However, hardship
withdrawals are often used when a true emergency fund had not been established.
Hardship withdrawals are not a proper emergency fund because they are taxed and
penalized. Worst still, the principal and the forgone earnings will not be available for
retirement.
How to Calculate the Maximum Allowed Withdrawal - ANS-Hardship withdrawals are
limited to the amount needed to pay the applicable expense plus the income taxes
(federal, state, and local) on the withdrawal.
Formula: ($ for Need ÷ (1.0 - Total Tax Rate) = Maximum Hardship Available
,Ex. $10,000 ÷ (1 - .40*) = $16,667 * (24% + 6% + 10% EWP)
$10,000 for the need. $4,000 for federal taxes. $1,000 for state taxes and $1,667 for
10% the EWP.
Taxes are really a hardship for Damar! It costs 2/3 of the hardship amount. Surely
Damar can find another source of funds. That is the exact point of the law. Hardship
withdrawals have a high tax penalty to incentive people to find another source of the
money. Maybe he can get some money elsewhere and only take the hardship
withdrawal for the rest. There are two other points:
Damar will think he only needs $10,000 for his current issue. However, if he only takes
$10,000 as a hardship withdrawal, he will have another crisis when he files his taxes.
Taking the money for the $10,000 crisis really only cuts his problem by a third. However,
he would have the rest of the year to increase his withholding. Still, he needs to know
that before taking the hardship withdrawal.
Damar will be focused on his current tax problem, but a hardship withdrawal now will
have a much larger long-term impact on his finances. If he withdraws $16,667 to clean
up his current financial problem, the money will not be able to compound into the future.
If this money stays in his retirement account for the 35 years until he is 65, it would grow
to around $128,000-$247,000 (if his average return is 6-8%). Thus, taking care of a
$10,000 problem at age 30 costs him between 12.8 and 24.7 times as much when he
reaches 65. A CRPC should be able to perform these calculations and present them to
their clients.
Qualified plan- Loans - ANS-1. The term of the loan must not exceed five years, except
if for the purchase of a primary residence, which may be for a longer period. Although
there is no legal restriction on how long a retirement plan loan can be when buying a
home, many plans choose to limit the repayment to 10 years.
2. Loans must be available to all participants and beneficiaries on a nondiscriminatory
basis. Hence, loans must not be available to highly compensated employees in greater
proportions (as a percentage of account balance) than to nonhighly compensated
employees.
3. Loan repayments must be made at least quarterly on a substantially level
amortization basis. Hence, "balloon payments" are not allowed. Repayments are
generally made through payroll, and if not repaid by termination of employment the loan
may be considered a taxable distribution.
4. The loan must be evidenced by a legally enforceable loan agreement or note
specifying the amount of the loan, the term, and the repayment schedule.
5. The amount of the loan typically may not exceed the lesser of $50,000 or one-half of
the vested balance.
6. A plan that offers loans must have a written loan policy in effect so that loans are
made in accordance with plan provisions, and the loan policy. When a loan is taken,
, securities are sold and funds are actually removed from the participant's account. The
amount repaid includes a "commercially reasonable interest rate"—typically prime.
Interest payable on a loan is considered a personal expense of the borrower and is not
deductible for income tax purposes.
7. The SECURE Act bans retirement plan loans from being offered using credit cards or
similar arrangements.
The rules to how much of a loan you can take out from qualified plan loan - ANS-The
exact rules are:
-If the vested balance is under $10,000, then the entire vested balance is available for a
loan.
-If the vested balance is between $10,000 and $20,000, then the available loan is
$10,000 (which is greater than 50% until $20,000).
-If the vested balance is $20,000-$100,000, then the maximum loan is half the vested
balance.
-The maximum retirement plan loan is usually $50,000, so having a vested balance
greater than $100,000 generally does not impact the available loan balance. The
exception to $50,000 being the maximum is for a qualified disaster loan. When a
retirement account loan is taken due to a federally declared disaster, the $50,000 loan
cap is replaced with $100,000.
-The maximum available loan balance is always reduced by the highest loan balance in
the previous 12 months. For example, if a person had a vested balance of $120,000,
their maximum loan would be $50,000. However, if they had a retirement plan loan with
the highest balance in the last 12 months of $5,000, then the maximum loan available
would be $45,000.
Deemed distribution - ANS-a plan loan fails to meet the five-year term requirement
a loan that did not involve purchasing, repairing, or remodeling the principal residence
was mistakenly made for seven years, the entire initial loan balance would be treated as
taxable income on day one. On the other hand, if a retirement plan loan fails to meet the
dollar limit, the amount in excess of the dollar limit is a deemed distribution.
What if payments for a qualified plan loan are not paid on a timely basis? - ANS-the
loan will usually be treated as a default and the entire balance outstanding will become
a deemed distribution. Loans treated as a distribution will be treated as any other
distribution from a qualified plan, and will be subject to ordinary income tax and
potentially a 10% early withdrawal penalty. In these situations, clients will probably focus
on the immediate tax implications. However, as bad as the current income tax situation
may be, the loss of the principal compounding until retirement is probably even worse.
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