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Glossary of terms
Active participant
Any individual who is a participant in an employer-sponsored plan for any part of the tax year. These plans include qualified pension plans, 401(k), 403(b), SEP, SIMPLE, and 457(b) plans.
Actual deferral percentage (ADP), actual contribution percentage (ACP), and top-heavy safe harbors
If a 401(k) plan requires automatic enrollment for employee deferrals and requires automatic increases of those deferrals, the plan will be deemed to pass the ADP, ACP and top-heavy test and requirements. The ADP test is a nondiscrimination test that applies to salary deferral contributions. The ACP test is a nondiscrimination test that applies to matching or after-tax contributions. Plans are considered top-heavy if the assets of key employees exceed 60 percent of the assets in the accounts of all employees. Top-heavy plans are subject to special minimum contribution and vesting rules.
Adjusted gross income (AGI)
It is used to determine how much of your income is taxable. AGI is determined by subtracting your maximum allowable adjustments from your gross income.
Beneficiary
A person or entity entitled to receive the retirement proceeds when the plan participant/IRA holder dies.
Catch-up contributions
Individuals who attain the age of 50 or older before the close of the taxable year may contribute an amount in excess of the basic annual IRA contribution limit and the annual deferral amount in employer -sponsored plans. For 2008 the catch-up contribution maximum is $1,000 for IRAs and $5,000 for employer- sponsored plans.
Conduit IRA
An individual retirement account (IRA) that is established for the sole purpose of receiving a distribution from a qualified plan with the intent of rolling those funds into another qualified plan in the future.
The Economic Growth and Tax Reconciliation Relief Act increased portability of IRAs and employee-sponsored retirement plans. Individuals are now able to roll over after-tax assets held in a qualified retirement plan like a 401(k), a 403(b) plan as well as governmental 457(b) plan into a Traditional IRA. In addition, pre-tax assets held in a Traditional IRA may be rolled over into a qualified retirement plan.
In order to preserve capital gains and income averaging treatment for a qualified plan distribution that is rolled over, the rollover must be made to a conduit IRA and rolled back into a qualified plan.
Contributions, earnings and withdrawals
- Contributions describe the money you invest, whether on a (deductible) pre-tax basis or a (nondeductible) after-tax basis.
- Earnings are anything over and above contribution amounts,
including investment appreciation.
- Withdrawals – also called distributions – refers to any money that is taken out of an IRA, typically at retirement. Withdrawals can be composed of contributions, earnings or a combination of the two.
Conversion vs. rollover
Conversion describes the process of turning pretax Traditional IRA or 401(k)/403(b) assets into a Roth IRA and is, effectively, a kind of rollover. The term rollover, however, means moving retirement plan assets from one plan to another without creating a taxable event.
Deductibility
This term generally applies to individuals who are eligible to exclude current year contributions to a Traditional IRA from their taxable income. Certain criteria must be met before someone is eligible to take a deduction for any Traditional IRA contribution.
Defined benefit plan
A type of qualified plan in which a participant's benefits are based on a formula stated in the plan document. Generally, the benefit combines years of service and compensation in a way that would yield a monthly payment to a participant at retirement.
Defined contribution plan
A type of qualified plan in which a participant's benefits are based solely on the participant's account balance; the account balance depends on the level of employer and employee contributions and the earnings on those contributions.
Early (premature) withdrawal
A distribution from a qualified retirement plan or IRA prior to age 59½ is an early withdrawal, generally subject to a 10% penalty. Under certain conditions, premature distributions may not be subject to this penalty.
EGTRRA saver's tax credit
The saver's credit is a nonrefundable income tax credit for certain taxpayers with adjusted gross income that does not exceed $52,000 for 2008 (indexed annually). The credit is equal to a specific percentage of certain employee contributions made to employer-sponsored retirement plans and to IRAs.
Estate tax
An estate tax is an excise tax imposed on a decedent's estate for the privilege of transferring his or her property at death.
5500s
An annual report completed by certain qualified retirement plan sponsors and filed with the IRS summarizing qualified retirement plan activity. Certain employers are not required to file IRS Form 5500.
Income thresholds
If someone is an active participant in certain employer-sponsored retirement plans, modified adjusted gross income (MAGI) limits may apply in order for someone to take a deduction for a Traditional IRA contribution. These "income thresholds" may increase annually as they are tied to cost of living adjustments. Full Roth contributions can be made by single taxpayers with modified adjusted gross income (MAGI) up to $99,000 and married taxpayers filing a joint tax return with AGI up to $156,000.
Individual Retirement Account (IRA)
A tax-deferred trust or custodial account established by an individual who is under age 70½ and has earned income. Depending on an individual's active participant status in an employer-sponsored retirement plan, all or a portion of the individual's contribution may be deductible from taxable income (as an adjustment to adjusted gross income).
Modified adjusted gross income (MAGI)
This represents adjusted gross income before certain deductions or adjustments are taken. It is used to determine Roth IRA eligibility and Traditional IRA deductibility.
Penalty free vs. tax free
In general, withdrawals taken from retirement plans prior to attaining age 59½ are subject to an early withdrawal penalty of 10%. Depending on whether the withdrawals are qualified distributions from Roth IRAs or Roth accounts or distributions of pretax assets from Traditional IRAs or employer-sponsored retirement plans, penalty-free withdrawals still might be subject to ordinary income taxes.
Portability provisions
Eligible rollover distributions from employer-sponsored plans may be rolled over to an "eligible retirement plan." An eligible retirement plan includes;
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a Traditional IRA
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a qualified plan under IRC Sec. 401(a) (e.g., 401(k), profit sharing)
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a qualified annuity plan under IRC Sec. 403(a)
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a tax-sheltered annuity 403(b) plan
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a governmental 457(b) plan
Prohibited transaction exemption
Transactions, which would otherwise be considered prohibited are permitted under either a statutory or a Department of Labor issued exemption.
Qualified Roth contribution program
A program where a participant may elect to treat elective deferrals made to a 401(k) plan or a 403(b) as Roth (after-tax) contributions. Roth contributions (and earnings) may be distributed tax-free if the participant satisfies a five-year holding period and the distribution happens after the participant's death, disability or attainment of age 59½.
Required minimum distribution
Rules imposed by the Internal Revenue Service governing when distributions from all tax-deferred retirement plans must commence, how to determine the minimum amount to be distributed each year and the maximum time period over which benefit payments can be made. Generally, you must start to withdraw money by April 1 of the year after the year in which you attain age 70½, and you must continue to withdraw money at least annually. If you do not make any withdrawals, or if you do not withdraw enough, you may have to pay a 50% excise tax on the amount not withdrawn as required. Roth IRA owners do not have to take required minimum distributions. However, beneficiaries may be required to take distributions.
Rollover
A tax-free, reportable movement of cash or other assets from one eligible retirement plan to another eligible retirement plan. Generally, rollovers must be completed within 60 days to retain tax-favored status.
Roth IRA
An individual retirement account funded with after-tax contributions. Distributions of both investments and earnings may be withdrawn tax-free from Roth IRAs if certain criteria is met. Individuals are eligible to contribute to this type of IRA if they have earned income that falls within certain MAGI limits regardless of their age.
Substantially equal periodic payments
Generally, a 10% excise tax applies for distributions taken from Traditional IRAs and employer-sponsored retirement plans before age 59½. Retirement plan assets can be withdrawn from IRAs and most retirement plans prior to age 59½ without incurring the 10% premature distribution penalty if the withdrawal is part of a series of "substantially equal periodic payments" under Section 72(t) of the Internal Revenue Code. Generally, distributions must continue over a five-year period or until the individual reaches age 59½, whichever is longer.
Traditional Individual Retirement Account (IRA)
A retirement savings plan designed to provide individuals with a tax-advantaged means to invest for their future. Individuals under age 70½ and having earned income may contribute up to a maximum of $5,000 in 2008 ($6,000 if age 50 or older). Growth of investment earnings in the account is free from current taxation. Contributions to Traditional IRAs may be tax deductible if certain rules are followed.
Tax deferred vs. tax free
Tax deferred essentially means you delay the payment of ordinary income taxes to a later date. Tax free, of course, is just that – you don't owe taxes at all. The distinction between the two terms is the fundamental difference between Traditional IRAs and Roth IRAs: Distributions from a Traditional IRA are included in ordinary income the year distributed. Qualified distributions from a Roth IRA are not included in ordinary income the year distributed.
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