Chapter 13 Retirement Savings and Deferred Compensation

1. [LO 1] Javier recently graduated and started his career with DNL Inc. DNL provides a defined benefit plan to all employees. According to the terms of the plan, for each full year of service working for the employer, employees receive a benefit of 1.5 percent of their average salary over their highest three years of compensation from the company. Employees may accrue only 30 years of benefit under the plan (45 percent). Determine Javier’s annual benefit on retirement, before taxes, under each of the following scenarios:

a. Javier works for DNL for three years and three months before he leaves for another job. Javier’s annual salary was $55,000, $65,000, $70,000, and $72,000 for years 1, 2, 3, and 4 respectively. DNL uses a five-year cliff vesting schedule.

b. Javier works for DNL for three years and three months before he leaves for another job. Javier’s annual salary was $55,000, $65,000, $70,000, and $72,000 for years 1, 2, 3, and 4 respectively. DNL uses a seven-year graded vesting schedule.

c. Javier works for DNL for six years and three months before he leaves for another job. Javier’s annual salary was $75,000, $85,000, $90,000, and $95,000 for years 4, 5, 6, and 7 respectively. DNL uses a five-year cliff vesting schedule.

d. Javier works for DNL for six years and three months before he leaves for another job. Javier’s annual salary was $75,000, $85,000, $90,000, and $95,000 for years 4, 5, 6, and 7 respectively. DNL uses a seven-year graded vesting schedule.

e. Javier works for DNL for 32 years and three months before retiring. Javier’s annual salary was $175,000, $185,000, and $190,000 for his final three years of employment.

2. [LO 1] Alicia has been working for JMM Corp. for 32 years. Alicia participates in JMM’s defined benefit plan. Under the plan, for every year of service for JMM she is to receive 2 percent of the average salary of her three highest years of compensation from JMM. She retired on January 1, 2014. Before retirement, her annual salary was $570,000, $600,000, and $630,000 for 2011, 2012, and 2013. What is the maximum benefit Alicia can receive in 2014?

3. [LO 2] Kim has worked for one employer her entire career. While she was working, she participated in the employer’s defined contribution plan [traditional 401(k)]. At the end of 2014, Kim retires and the balance in her defined contribution plan was $2,000,000 at the end of 2013.

a. What is Kim’s minimum required distribution for 2014 in 2015 if she is 68 years old at the end of 2015?

b. What is Kim’s minimum required distribution for 2014 if she turns 70½ during 2014 and she has not turned 71 years old by the end of the 2014? When must she receive this distribution?

c. What is Kim’s minimum required distribution for 2014 in 2015 if she is 73 years old at the end of 2014?

d. Assuming that Kim is 75 years old at the end of 2014 and that her marginal tax rate in 2014 is 33 percent, what will she have remaining after taxes if she receives only a distribution of $50,000 for 2014?

e. {Forms}. Complete Form 5329, page 2 to report the minimum distribution penalty in part d. Use the most recent form available.

4. [LO 2] Matthew (48 at year-end) develops cutting-edge technology for SV, Inc. located in Silicon Valley. In 2014, Matthew participates in SV’s money purchase pension plan (a defined contribution plan) and in his company’s 401(k) plan. Under the money purchase pension plan, SV contributes 15 percent of an employee’s salary to a retirement account for the employee up to the amount limited by the tax code. Because it provides the money purchase pension plan, SV does not contribute to the employee’s 401(k) plan. Matthew would like to maximize his contribution to his 401(k) account after SV’s contribution to the money purchase plan.

a. Assuming Matthew’s annual salary is $400,000, what amount will SV contribute to Matthew’s money purchase plan? What can Matthew contribute to his 401(k) account in 2014?

b. Assuming Matthew’s annual salary is $240,000, what amount will SV contribute to Matthew’s money purchase plan? What can Matthew contribute to his 401(k) account in 2014?

c. Assuming Matthew’s annual salary is $60,000, what amount will SV contribute to Matthew’s money purchase plan? What amount can Matthew contribute to his 401(k) account in 2014?

d. Assume the same facts as c. except that Matthew is 54 years old at the end of 2014. What amount can Matthew contribute to his 401(k) account in 2014?

5. [LO 2] In 2014, Maggy (34 years old) is an employee of YBU Corp. YBU provides a 401(k) plan for all its employees. According to the terms of the plan, YBU contributes 50 cents for every dollar the employee contributes. The maximum employer contribution under the plan is 15 percent of the employee’s salary (if allowed, YBU contributes until the employee has contributed 30 percent of her salary).

a. Maggy has worked for YBU corporation for 3 ½ years before deciding to leave. Maggy’s annual salary during this time was for $45,000, $52,000, $55,000, and $60,000 (she only received half of her final year’s salary). Assuming Maggy contributed 8 percent of her salary (including her 2014 salary) to her 401(k) account, what is Maggy’s vested account balance when she leaves YBU (exclusive of account earnings)? Assume YBU uses three-year cliff vesting.

b. Same question as a. except YBU uses six-year graded vesting.

c. {Planning} Maggy wants to maximize YBU’s contribution to her 401(k) account in 2014. How much should Maggy contribute to her 401(k) account assuming her annual salary is $100,000 (she works for YBU for the entire year)?

d. {Planning} Same question as c., except Maggy is 55 years old rather than 34 years old at the end of the year?

6. [LO 2] In 2014, Nina contributes 10 percent of her $100,000 annual salary to her 401(k) account. She expects to earn a 7 percent before-tax rate of return. Assuming she leaves this (and any employer contributions) in the account until she retires in 25 years, what is Nina’s after-tax accumulation from her 2014 contributions to her 401(k) account?

a. Assume Nina’s marginal tax rate at retirement is 30 percent.

b. Assume Nina’s marginal tax rate at retirement 20 percent.

c. Assume Nina’s marginal tax rate at retirement is 40 percent.

7. [LO 2] In 2014, Nitai contributes 10 percent of his $100,000 annual salary to a Roth 401(k) account sponsored by his employer, AY, Inc. AY, Inc., matches employee contributions dollar for dollar up to 10 percent of the employee’s salary to the employee’s traditional 401(k) account. Nitai expects to earn a 7 percent before-tax rate of return. Assuming he leaves his contributions in the Roth 401(k) and traditional 401(k) accounts until he retires in 25 years, what are Nitai’s after-tax proceeds from the Roth 401(k) and traditional 401(k) accounts after he receives the distributions assuming his marginal tax rate at retirement is 30%?

8. [LO 3] {Planning} Marissa participates in her employer’s nonqualified deferred compensation plan. For 2014, she is deferring 10 percent of her $320,000 annual salary. Assuming this is her only source of income and her marginal income tax rate is 30 percent, how much tax does Marissa save in 2014 by deferring this income (ignore payroll taxes)?

9. [LO 3] Paris participates in her employer’s nonqualified deferred compensation plan. For 2014, she is deferring 10 percent of her $320,000 annual salary. Assuming this is her only source of income and her marginal income tax rate is 30 percent, how much does deferring Paris’ income save her employer (after-taxes) in 2014? Paris’s employer’s marginal tax rate is 35 percent (ignore payroll taxes).

10. [LO 3] Leslie participates in IBO’s nonqualified deferred compensation plan. For 2014, she is deferring 10 percent of her $300,000 annual salary. Based on her deemed investment choice, Leslie expects to earn a 7 percent before-tax rate of return on her deferred compensation, which she plans to receive in 10 years. Leslie’s marginal tax rate in 2014 is 30 percent. IBO’s marginal tax rate is 35 percent. Ignore payroll taxes in your analysis.

a. Assuming Leslie’s marginal tax rate in 10 years when she receives the distribution is 33 percent, what is Leslie’s after-tax accumulation on the deferred compensation?

b. Assuming Leslie’s marginal tax rate in 10 years when she receives the distribution is 20 percent, what is Leslie’s after-tax accumulation on the deferred compensation?

c. {Planning} Assuming IBO’s cost of capital is 8 percent after taxes, how much deferred compensation should IBO be willing to pay Leslie that would make it indifferent between paying 10 percent of Leslie’s current salary or deferring it for 10 years?

11. [LO 3] {Planning} XYZ Corporation has a deferred compensation plan under which it allows certain employees to defer up to 40 percent of their salary for five years. (For purposes of this problem, ignore payroll taxes in your computations).

a. Assume XYZ has a marginal tax rate of 35 percent for the foreseeable future and earns an after-tax rate of return of 8 percent on its assets. Joel Johnson, XYZ’s VP of finance, is attempting to determine what amount of deferred compensation XYZ should be willing to pay in five years that would make XYZ indifferent between paying current salary of $10,000 and paying the deferred compensation. What amount of deferred compensation would accomplish this objective?

b. Assume Julie, an XYZ employee, has the option of participating in XYZ’s deferred compensation plan. Julie’s marginal tax rate is 40 percent and she expects the rate to remain constant over the next five years. Julie is trying to decide how much deferred compensation she will need to receive from XYZ in five years to make her indifferent between receiving current salary of $10,000 and receiving the deferred compensation payment. If Julie takes the salary, she will invest it in a taxable corporate bond paying interest at 5 percent annually (after taxes). What amount of deferred compensation would accomplish this objective?

12. [LO 4] John (age 51 and single) has earned income of $3,000. He has $30,000 of unearned (capital gain) income.

a. If he does not participate in an employer-sponsored plan, what is the maximum deductible IRA contribution John can make in 2014?

b. If he does participate in an employer-sponsored plan, what is the maximum deductible IRA contribution John can make in 2014?

c. If he does not participate in an employer-sponsored plan, what is the maximum deductible IRA contribution John can make in 2014 if he has earned income of $10,000?

13. [LO 4] William is a single writer (age 35) who recently decided that he needs to save more for retirement. His 2014 AGI is $61,000 (all earned income).

a. If he does not participate in an employer-sponsored plan, what is the maximum deductible IRA contribution William can make in 2014?

b. If he does participate in an employer-sponsored plan, what is the maximum deductible IRA contribution William can make in 2014?

c. Assuming the same facts as in b. except William’s AGI is $75,000, what is the maximum deductible IRA contribution William can make in 2014?

14. [LO 4] In 2014, Susan (44 years old) is a highly successful architect and is covered by an employee-sponsored plan. Her husband, Dan (47 years old), however, is a Ph.D. student and is unemployed. Compute the maximum deductible IRA contribution for each spouse in the following alternative situations.

a. Susan’s salary and the couple’s AGI is $190,000. The couple files a joint tax return.

b. Susan’s salary and the couple’s AGI is $120,000. The couple files a joint tax return.

c. Susan’s salary and the couple’s AGI is $80,000. The couple files a joint tax return.

d. Susan’s salary and her AGI is $80,000. Dan reports $5,000 of AGI and earned income. The couple files separate tax returns.

15. [LO 4] In 2014, Rashaun (62 years old) retired and planned on immediately receiving distributions (making withdrawals) from his traditional IRA account. The balance of his IRA account is $160,000 (before reducing it for withdrawals/distributions described below). Over the years, Rashaun has contributed $40,000 to the IRA. Of his $40,000 contributions, $30,000 was nondeductible and $10,000 was deductible. Assume Rashaun did not make any contributions to the account in 2014.

a. If Rashaun currently withdraws $20,000 from the IRA, how much tax will he be required to pay on the withdrawal if his marginal tax rate is 25 percent?

b. If Rashaun currently withdraws $70,000 from the IRA, how much tax will he be required to pay on the withdrawal if his marginal tax rate is 28 percent?

c. {Forms} Using the information provided in part b, complete Form 8606, Part I to report the taxable portion of the $70,000 distribution (withdrawal). Use 2013 forms if 2014 forms are unavailable.

16. [LO 4] Brooklyn has been contributing to a traditional IRA for seven years (all deductible contributions) and has a total of $30,000 in the account. In 2014, she is 39 years old and has decided that she wants to get a new car. She withdraws $20,000 from the IRA to help pay for the car. She is currently in the 25 percent marginal tax bracket. What amount of the withdrawal, after tax considerations, will Brooklyn have available to purchase the car?

17. [LO 4] Jackson and Ashley Turner (both 45 years old) are married and want to contribute to a Roth IRA for Ashley. In 2014, their AGI is $185,000. Jackson and Ashley each earned half of the income.

a. How much can Ashley contribute to her Roth IRA if they file a joint return?

b. How much can Ashley contribute if she files a separate return?

c. Assume that Ashley earned all of the couple’s income and that she contributed the maximum amount she is allowed to contribute to a Roth IRA. What amount can be contributed to Jackson’s Roth IRA?