7 February, 2007

Important Thoughts, Financial and Economic Advice

Posted by alex in Financial Column, George Lenz at 5:47 pm | Permanent Link

By George Lenz

Recently I am getting more and more questions on withdrawals of various pension schemes, so I decided to start a series dedicated to this. In particular, I will cover the common pension schemes available, the optimal ways of withdrawing money from them and ways of minimizing tax penalties that would otherwise apply.

Today I will cover most common pension schemes available, their peculiar characteristics and general tax treatment. A qualified pension scheme or pension plan is a savings plan that lasts up to a retirement of a beneficiary and is a subject to certain tax benefits as defined in section 401 U. S. Tax Code. The condition of receiving this tax benefits is that the money saved would be used chiefly to pay for retirement, and one must therefore follow complicated distribution rules in order to use the money saved or to loose part or all tax advantages associated with the plan.

There are four broad categories of pension plans:

1) qualified plans, set by an employer;

2) qualified plans set by an employee, also called IRAs;

3) plans that offer some but not all benefits of qualified plans;

4) plans that do not offer benefits associated with qualified plans.

The first group encompasses plans that an employer sets up for an employee and that fulfill all the requirements of article 401 and, therefore, carry all tax benefits, mentioned therein (inter alia contributions to such plans are tax deductible before withdrawal). There are nine common types of such plans:

1) Profit-sharing plan – a profit-sharing plan allows employees to share in the company profits, and to use their share to save for retirement. A company can contribute no more than 25% of an employee’s salary, but no more than 42 000 USD, and an employee is not expected to contribute anything;

2) 401(k) plan – is a type of profit-sharing plan, under which both an employee and an employer can contribute matching contributions. The ceiling for 401(k) plan is the same that for a general profit-sharing plan;

3) Roth 401(k) plan – is a type of 401(k) plan, with significant differences however. Contributions to such a plan are no longer tax deductibles, but withdrawals are, provided that an employee is at least 59 ½ years old and has owned the plan for at least 5 years;

4) Stock bonus plan – similar to profit-sharing plan, the difference being that contributions are made by an employer in form of a company’s stock;

5) Money purchase pension plan – similar to profit-sharing plan, but employer’s contributions are mandatory, not discretionary;

6) ESOPs – similar to stock bonus plan, only employer’s contributions are mandatory. This plan has been successfully used many times to create an employee’s ownership of the company stocks;

7) Defined benefit plan – a plan that promises fixed regular payments after retirement. The benefit in such plans depends mainly on length of employment and the salary of an employee;

8) Target benefit plan – similar to money purchase pension plan, the only difference being that an employer aims at (but not promises) fixed regular payments after retirement for each employee, and not a lump sum;

9) Keogh plan – any of the above mentioned types of plans set up by a self employed people; those are regulated by a separate act of law.

The second group encompasses plans, to which an employee contributes by himself, often called IRAs. IRAs are deposit accounts that can be established with a bank, brokerage, insurance company or other financial institution and to which an employee can contribute tax free. There are five main types of such plans:

1) Traditional contributory IRAs. These are deposit accounts that can be established with a bank, brokerage, insurance company or other financial institution and to which an employee can contribute tax free, if not covered by an employer’s pension plan; and wholly, partially or not tax free depending on employee’s gross income, if covered. The tax-free limit changes every year, and can be obtained by calling at 800-829-3676, by visiting the agency’s website

at www.irs.gov, or by visiting your local IRS office;

2) Rollover IRAs. Rollover IRAs are IRAs that receive distributions from other qualified pension plans. Currently their tax treatment is similar to IRAs;

3) Simplified employee pensions. These are new IRAs that can be established by an employer or a self-employed employee. They are easy to set up and administer, with no complicated accounting or actuary work required, and tax-deductible contributions to them are much higher, up to 25% of a salary or 42 000 USD, whichever is higher.

4) Simple IRAs. These are IRAs set up by employers, to which they can contribute at their discretion but no more than a pre-set limit, as in case of traditional contributory IRA. Employees, however, are obliged either to match employees’ contribution up to 3% of their annual compensation, or to pay 2% of employees’ annual compensation irrespective of employees’ contributions.

5) Roth IRAs. These are IRAs, where contributions are not tax free, but distributions starting from a certain age are. One cannot, however, contribute to Roth IRAs when his annual gross income exceeds 150 000 USD.

The third group of pension plans offers some, although not all, tax benefits provided in section 401: they are generally covered by section 403 of the U. S. tax code. There are two types of such plans:

1) Qualified annuity plans. Section 403(a) allows employees to use pension contributions to purchase annuities; it has been done to avoid significant expenses that were associated with administering qualified plans. The rules that cover purchase of such annuities are similar to those covering qualified pension plans as well as most tax benefits.

2) Tax deferred annuities (TDAs). These pension schemes are generally used by educational institutions or charities, purchasing annuities that pay up fixed monthly amount after an employee’s retirements. Most tax benefits do not apply to TDAs, but they are still subject to the distribution rules, common to all qualified plans.

In this three groups pension plans assets are exempt and protected in case of bankruptcy of an employer or employee.

The fourth group encompasses the non-qualified pension plans: those that do not satisfy the section 401 or 403 requirements, and therefore are not subject to its distribution rules. They are mostly incentives, offered to key managers and specialists, come in various shapes and forms, and are not exempt and protected in case of bankruptcy. Thus, one of the first things an employee should do is to clear what types of pension plans are available at the company he works for.

More questions are coming on Liberty Dollars: what are these, and how are they different from Aryan Dollars. Basically the answer is simple: Liberty Dollars cost on average twice as much as the metal in them, Aryan Dollars cost the price of physical metal and 5% seniorage. I put a show, explaining the details of the Liberty Dollar scheme here: http://mihd.net/t4iq3r.

I am looking into INTL, as a target for 3-6 month short selling. The company is overvalued (22.9 current market value vs. 17.1 intrinsic value under optimistic scenario and 13.0 intrinsic value under pessimistic scenario), so are its product line and spare capacity in microchips is high. My recommendation is 3-6 month sell.

  • One Response to “Important Thoughts, Financial and Economic Advice”

    1. Olde Dutch Says:

      Another really nice savings/retirement vehicle is the Treasury “I” Bond.

      “I” Bonds are available at most banks, or you can buy them direct over your computer from the Treasury.

      “I” Bonds pay a base rate plus an inflation rate adjusted every 6 months. The inflation rate is based on the CPI-U, the urban inflation rate.

      “I” Bonds are tax defered, and you only pay federal taxes when you cash them in—you pay no state or local income tax on them at all!

      Check ’em out in depth: