Retirement Plans
Qualified vs non-qualified, ERISA's rulebook, defined contribution vs defined benefit, the salary-reduction trio (401(k)/403(b)/457), small-employer plans, IRAs, rollovers, and education savings.
Take a shot at these. Being wrong here is the point — it primes you for the answers, which are all in this lesson.
A 401(k) plan is called a 'cash or deferred arrangement' because:
A Keogh (HR-10) plan may be established by:
Ken, 45, earns $90,000 and is covered by his employer's 401(k). Which statement about his traditional IRA is TRUE?
One idea organizes this whole chapter: qualified plans trade rules for tax favors. Meet the federal requirements (ERISA's participation, coverage, vesting, and nondiscrimination standards) and you get deductible contributions, no current tax to the employee, and tax-deferred growth. Refuse the rules — as deferred comp and other executive plans deliberately do — and you keep the freedom to discriminate but lose the tax candy. From there it's matching: which plan fits which employer (401(k)/403(b)/457, Keogh/SEP/SIMPLE), who bears the investment risk (defined benefit = employer, defined contribution = employee), and how money gets in and out of IRAs without the IRS taking a bite.
Qualified vs Non-Qualified & the ERISA Rulebook
[2–3.1]A qualified plan meets federal requirements → employer deducts contributions, employees aren't currently taxed, earnings defer. A non-qualified plan skips the rules (legally discriminating in favor of key people) and gets no tax favors; it may be funded (trust/escrow) or unfunded (an unsecured promise). ERISA is the price of qualification: written plan, exclusive benefit, age 21 + 1 year participation, nondiscrimination (with top-heavy fixes when key employees hold >60%), survivor benefits, segregated assets, Form 5500 reporting — and minimum vesting: 100% at 5 years or 20%-at-3 → 100%-by-7, with your own contributions always fully yours. Church, governmental, and collectively bargained plans are exempt.
A 42-year-old opens a bank savings account, deposits $150 a month, and vows not to touch it until 65. For tax purposes his 'retirement plan' is:
The primary purpose of ERISA is to:
Defined Contribution vs Defined Benefit
[4–5]A defined contribution plan fixes the input; the benefit floats with the market and the EMPLOYEE bears the risk. Four flavors: the money purchase plan (employer MUST contribute a fixed % of salary yearly), the profit-sharing plan (contributions optional but must be 'recurring and substantial'), the stock bonus plan (benefits in company stock, not profit-based), and the ESOP (shares held in trust until separation). A defined benefit plan — the classic 'pension' — fixes the OUTPUT by formula (service × salary, for life) and the EMPLOYER bears the risk of funding it.
B Corporation's pension formula pays 1.5% × years of service × final average salary, for life. Maria retires with 30 years and an $80,000 final average salary. This is an example of a:
Which plan REQUIRES the employer to contribute a fixed percentage of each employee's salary every year, regardless of profits?
Salary Reduction Plans: 401(k) · 403(b) · 457
[6]Three cousins, sorted by employer. The 401(k) (private employers) is a cash-or-deferred arrangement: take pay as cash or defer it pre-tax, usually with a match, IRS limits, and age-50 catch-ups. The 403(b) tax-sheltered annuity serves 501(c)(3) nonprofits, public schools, and religious organizations only. The Section 457 plan covers state and local government employees (and some nonprofits), with 401(k)-like limits and life insurance/annuities as authorized investments.
A 401(k) plan is called a 'cash or deferred arrangement' because:
A city water department employee wants to defer part of her salary without current taxation. Which plan is designed for her?
Small Employer & Self-Employed Plans
[7]The Keogh (HR-10) serves the self-employed and unincorporated businesses — the owner participates as an 'employee' only if staff are covered, and modern law gives Keoghs parity with corporate plan limits and rules. The SEP strips out the admin burden: employees own IRAs, the employer funds them (with far higher limits than personal IRAs). The SIMPLE is for employers with ≤100 employees (earning $5,000+) and NO other qualified plan — IRA or 401(k) format, minimal filing, and all contributions immediately 100% vested.
In a Simplified Employee Pension (SEP), the employer's contributions are made to:
Which requirement must an employer meet to establish a SIMPLE plan?
Traditional & Roth IRAs (+ Spousal)
[8–8.3]The traditional IRA: anyone of any age with earned income may contribute (limit or 100% of compensation, whichever is less; catch-up at 50+); growth defers; deductibility shrinks with income IF an employer plan covers you. The Roth IRA flips the timing: after-tax in, tax-free out — if the withdrawal is qualified (5-year clock AND 59½/death/disability/first home); contributions always return tax-free, and high earners are phased out of contributing at all. A spousal IRA lets a worker fund a full IRA for a non-working spouse. RMDs hit traditional IRAs at 73 (25% excise for misses, 10% if fixed in two years); Roths have none during the owner's life. Early traditional withdrawals cost 10% unless a penalty exception applies (death, disability, medical, education, first home, health premiums while unemployed).
Ron, 38, opened his Roth IRA seven years ago. He withdraws his entire balance to pay off credit cards. The tax result is:
Which concept does this describe? Tina (52, working) + Mark (54, retired): $8,600 into her IRA + $8,600 into his ___ = $17,200 for the year.
Rollovers, Transfers & Education Plans
[8.4–9]Rollovers keep retirement money tax-sheltered while it moves: reinvest within 60 days, unlimited amounts — but if the owner touches the funds, 20% is withheld (make it up out of pocket or it's taxed). A direct trustee-to-trustee transfer avoids the withholding entirely. One IRA rollover per 12 months (aggregated across all IRAs); trustee-to-trustee transfers, Roth conversions, and plan↔IRA moves don't count against it; RMDs and excess contributions can never roll. A surviving spouse is the only inheritor who can roll into their own IRA. For education: the Coverdell ESA covers K-12 AND college (roll leftovers to family before the beneficiary turns 30); Section 529 plans are state-run — savings type (any college) or prepaid type (lock in-state tuition) — with Roth-style tax-free qualified withdrawals.
A married couple wants to lock in today's tuition rates at their state's public university for their newborn. Which vehicle does this?
Larry receives a $100,000 lump-sum distribution from his former employer's plan and wants to roll it to an IRA himself. If the check is paid to Larry personally, the plan must:
Close your eyes for a moment, then write everything you remember from this chapter — rules, numbers, traps. Recalling first is worth more than rereading.
Recall captured. Compare it against the summary below.
What this chapter covered
- Qualified vs Non-Qualified & the ERISA Rulebook'Which plan may legally discriminate in favor of highly paid employees?' → a NON-qualified plan. That single sentence answers several exam questions.
- Defined Contribution vs Defined BenefitMaria's formula (1.5% × 30 yrs × $80,000 = $36,000/yr for life) is the defined-benefit fingerprint: a guaranteed, formula-set benefit regardless of markets.
- Salary Reduction Plans: 401(k) · 403(b) · 457Memorize the mapping cold: 401(k) = business · 403(b) = school/nonprofit · 457 = government. The question is usually just 'which employer?' wearing a costume.
- Small Employer & Self-Employed PlansThree tells: 'self-employed/unincorporated' → Keogh · 'employer contributes to employees' IRAs' → SEP · '100 employees or fewer + immediate vesting' → SIMPLE.
- Traditional & Roth IRAs (+ Spousal)The #1 IRA trap: deductibility ≠ eligibility. Employer-plan coverage and high income kill the DEDUCTION, never the right to CONTRIBUTE.
- Rollovers, Transfers & Education Plans60 days is the deadline; DIRECT is how you dodge the 20% withholding. Two different rules — the exam loves blending them into one question.
Lesson complete — every check passed from memory. Your pretest answers above are now revealed.