Law100 Business Law | Distribution Assessment Answers

"Tax Consequences" Please respond to the following:

Discuss the various tax consequences of payments made to different types of retirement plans and recommend a retirement plan to your 50-year-old single client who earns $100,000 a year. Provide support for your recommendations.

Answer:

There are various types of retirement plans with different contribution and distribution rules as well as tax consequences. For instance, a 401 (k) is a defined contribution plan sponsored by the employer, and contributions are generally made with a pre-tax dollar amounts. This means that an individual does not pay taxes until he or she withdraws the funds. A traditional Individual Retirement Account (IRA) is another retirement plan that is usually established with a financial institution such as a brokerage or bank (Lurie, 2008). Money contributed may be deducted on an individual’s tax returns up to the limits of contributions. In this plan, contributions are generally made with pretax dollars and an individual only pays tax on withdrawal. However, in a Roth Individual Retirement Account (IRA), an individual is allowed to make contributions up to a specific amount but the contributions made are usually taxed as income and cannot be deducted. However, qualified distributions from this retirement plan are tax-free and are not considered part of taxable income (Power, 2008).

A Simplified Employee Pension (SEP) plan is another type of traditional Individual Retirement Plan that is owned by the employee. It is however set up by employers to enable their employees make contributions and receive the associated tax benefits. These contributions are usually made with tax-free deferrals of salary and earnings are not taxed unless distributions are made. Savings Incentive Match for Employees (SIMPLE) IRA is another retirement plan offered to employees working in small companies. In this plan, contributions are made from withdrawals of pre-tax paychecks, and the earnings are tax-deferred till employee’s retirement (Lurie, 2008).

For a 50-year-old single client earning $100,000 a year, participating in a retirement plan that has a catch-up contribution feature is an attractive choice. It is therefore recommended that the client should choose participating in a 401(k) plan since it would help him in adding significantly large amounts to his nest egg annually (Power, 2008).

References

Lurie, A. D. (2008). Bender's federal income taxation of retirement plans. Newark, NJ: LexisNexis.

Power, T. (2008). Superannuation: Planning your retirement for dummies. Milton, Qld: John Wiley & Sons.