Fundamentals of Taxation
Quiz 11 :
Retirement and Other Tax-Deferred Plans and Annuities C
Retirement Plan: In order to save money for retirement, an individual invests money in a plan which matures at the time of retirement. Such a plan of investing for retirement is known as retirement plan. Thus, retirement plans are categorized as Employer Sponsored Plans and Individual Sponsored Plans. Saving money for the retirement is the main goal of an individual. So an individual may decide to save a particular amount for retirement purpose and accordingly invest money in a retirement plan. However, if the amount so matured becomes taxable at the time of maturity, the individual may not achieve his goal of saving a particular amount. So as to encourage individuals to save money for retirement purpose, government provide tax benefits on retirement plans.
Taxability of Retirement Plan Distributions: Plan contributions and distributions are subject to various tax rules. Contributions are limited in amount and timing. Thus, distributions must be for specific purposes and are subject to rules that when they can be made and how they are taxed.Sometimes, taxability of distributions and the deductibility of contributions create confusion in minds of the individuals. So as to ease this confusion, the rule of thumb is to be kept in mind.The Rule of Thumb: The Rule of Thumb which should be kept in mind at the time of investing in a Retirement and Tax Deferred Plans is that: 1. If the investments made in retirement and tax deferred plans are in the form of untaxed dollars, the distributions available of such plans will be fully taxable in the hands of individual; 2. If the investments made in retirement and tax deferred plans are in the form of taxed dollars, the distributions available of such plans will not be taxable in the hands of individual. It is not necessary that this rule of thumb will be always true, but most of the time the rule is applicable to the plans.
All tax-deferred plans have an accumulation period and distribution period. These terms are explained as below: Accumulation Period: The time period for which a donor contributes cash to the tax deferred plan, is known as accumulation period.Making contribution to the tax-deferred plan is similar to making deposits in a saving account. Contributions are made monthly or annually over an accumulation period.Distribution Period: The period in which a trustee distributes or pays accumulated cash in the tax deferred plan to the plan beneficiary which would be used for the purpose for which the plan was established, is known as distribution period.