Estate and Gift Tax Issues for Pension Plans Research Paper

Pages: 8 (2774 words)  ·  Bibliography Sources: 8  ·  File: .docx  ·  Level: Master's  ·  Topic: Economics

¶ … gift tax issues have been increasingly brought to the forefront. Part of the reason for this, is because these kinds of taxes are often considered to be unfair, by directly taxing the assets that someone has built up of the course of time. A good example of this can be seen with the contentious atmosphere surrounding the extension of the estate tax in 2010. Where, Congress was divided as to if: they should extend the various exemptions or allow them to expire. (Jacobs, 2010) This is problematic, because it means that many individuals have trouble determining how they can plan for the future. In the case of pension funds and retirement plans, this can be particularly challenging. As the money that is accumulated is required to remain in the account, until the individual begins to receive the various funds when they are retired. At which point, any kind of earnings would be taxed as ordinary income during the year that was received. This is troubling, because this kind of policy is discouraging people from investing for their retirement. As they do not have access to: the money when they need it and they will inevitably have to pay taxes on the money when their earnings power has declined (during retirement). As a result, various changes have been proposed to address these challenges facing a host of individuals. To fully understand the situation requires: examining various issues surrounding pension and retirement plans. This will be accomplished through: looking at the current regulations, how this is having an impact upon retirement planning and examining various ways that the different tax regulations can be reformed. Together, these different elements will provide the greatest insights, as to the overall scope of the problems surrounding the taxation of retirement plans.

The Current Regulations

Research Paper on Estate and Gift Tax Issues for Pension Plans Assignment

At the heart of all regulation surrounding any kind of pension plan is the Employee Retirement Income Security Act of 1974 (ERISA). This regulates how pension / retirement funds are created and administered. As the law is defining a number of different elements that must be included as a part of any plan such as: setting minimum deposit standards, allowing employees the opportunity to become a participant in the plan and letting the spouse of an employee have a right to a percentage of the plan (with the death of the participant). These different elements are important, because they would establish basic guidelines that all pension and retirement plans would embrace in the future. ("Frequently Asked Questions about Pension Plans," 2011)

As a result, a variety of pension and retirement plans would emerge, to offer employees a number of choices. The most notable include: defined benefit / contribution plans, simple employee pension plans (SEPs), 401Ks, profit sharing and employee stock ownership plans (ESOP). A defined benefit / contribution plan is when they are providing employees with specific benefits that they will receive in retirement. This can be in the form of: a stated amount of monthly income or based upon a predetermined formula. Simple employee pension plans are when employers will make contributions to individual retirement accounts that are held in their names. In general, these kinds of plans will often focus on investing in conservative tax free investments that can grow over a period of time. 401Ks are when the employee can contribute a certain percentage of their income into a company retirement plan. Their employer has the option of matching these contributions and establishing an investment policy strategy. A profit sharing plan is when an employer is sharing the profits that they are making with employees, by distributing a certain percentage of the profits every year into a retirement plan. Employee stock ownership plans are where the employer will make employee contributions through: the purchase of company stock. These different elements are important, because they are showing how the ERISA regulations, would create a number of programs that employees and employers could utilize to prepare for retirement. ("Frequently Asked Questions about Pension Plans," 2011)


There are two basic strategies that are utilized to account for how taxes will be applied (the qualified and non-qualified plans). A qualified plan is when someone is making contributions to their retirement account with pre-tax dollars. This is where they are depositing the money into the account before any kind of: income taxes are paid. Under this plan, the money that is deposited can be invested, as the earnings / capital gains will be protected from any of tax liabilities until they are withdrawn. The idea is to allow everyone the opportunity to save for retirement, without having to worry about the taxes when they are older. Once they are receiving the money (usually during retirement), is when their income tax bracket will be lower resulting in reduced tax liabilities. A non-qualified plan is when the money that is being invested, will not be taxed, based upon what was already paid for by the individual (in the form of ordinary income). This is commonly called after tax dollars. The idea is to prevent someone from being taxed twice on the money that they are investing into different retirement plans. This is important, because it shows how the taxes will be determined, based upon if they were already paid when the contribution is being made. (Gambone, 2010)

At the same time, there are a number of restrictions on how the funds can be used in different retirement plans the most notable are: that there is an age limit as to when these kinds of withdrawals can take place. Where, various regulations are setting the minimum age for distributions at 59 1/2 years old. Those who need the money before this time can be able to qualify for an early withdrawal under a host of different exemptions to include: if the money is used to pay for medical expenses, someone has become disabled and a person is buying a home for the first time. In the event that someone is withdrawing the funds without having any kind of exemption, they will be subject to: income tax on the funds that were withdrawn and a penalty of 10%. This is important, because it shows how various federal regulations are designed to prevent an individual from taking the money out of their pension / retirement plans early. (Gambone, 2010)


Annuities are a special situation when it comes to retirement plans. This is a product that is sold by insurance companies, to provide investors with periodic payments that they will receive in different intervals. The idea is to provide: retired individuals and those who are in need of certain amount of money, with the funds they require at a time when the will use it. ("Annuity," 2011) as far as tax liabilities are concerned, the individual will have to pay them in the year that the income was received. This is regardless if the annuity is held in: qualified or non-qualified plans. This is problematic, because it means that many investors (who are using this tool), will have greater tax liabilities down the road. While not being able to protect, the gains or income that was received with the annuity. (Gambone, 2010)

When you step back and analyze the various regulations surrounding pensions and retirement plans, it is clear that they are providing everyone with a basic guideline as to how taxes are accounted for. Yet, beneath the surface various disparities are increasing the overall liabilities that an individual will have. An annuity is a good example of this can be applied to any one of these plans, with most people assuming that it would fall under the same category of qualified / unqualified plans. However, the reality is that the full amount of taxes must be reported as ordinary income on the year that the distribution was received (regardless if it is in qualified or non-qualified plan). This is problematic, because it means that many investors will often purchase these products with the assumption that they will receive the same kind of tax treatment. Then, when they are taking the distributions, is when they find out that these regulations apply to them, resulting in a higher tax liability that an individual will have to pay. (Gambone, 2010)

How this is having an Impact upon Retirement Planning?

The conflicting tax regulations are having an impact upon the way retirement planning is taking place. Where, many individual are investing in annuities with the assumption that their tax rates will be lower when they are retired. However, there are a number of other expenses that are often included with the annuity on annual basis to such as: mortality and expense charges. This is problematic, because these kinds of expenses can eat away at the overall return that is being seen by investors. Once they begin to receive the various distributions, is when the taxes will hurt their overall return, by forcing individuals to pay more (when they could be most vulnerable). This is problematic, because this has often… [END OF PREVIEW] . . . READ MORE

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Estate and Gift Tax Issues for Pension Plans.  (2011, February 25).  Retrieved March 31, 2020, from

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