8.4 Qualified Plans, IRAs, and Retirement (TEFRA/SEP/401k)

What Makes a Retirement Plan "Qualified"

A qualified plan meets the requirements of IRC Section 401(a) and the Employee Retirement Income Security Act (ERISA), earning it favorable tax treatment. The defining tax features tested on the exam are:

• Employer contributions are tax-deductible to the business in the year made.
• Earnings accumulate tax-deferred inside the plan.
• Employee contributions are made with pre-tax dollars (traditional design), reducing current taxable income.
• Distributions are fully taxable as ordinary income when received in retirement.

To remain qualified, a plan must satisfy IRS rules on nondiscrimination (it cannot favor highly compensated employees or owners), eligibility, vesting, and funding. A plan that meets these standards is qualified; a plan that does not (e.g., an executive bonus or split-dollar arrangement) is nonqualified and loses the upfront deduction symmetry.

The exam draws a sharp line between qualified and nonqualified plans. Qualified plans must cover a broad, nondiscriminatory base of employees and follow strict vesting and funding schedules, but in exchange the employer deducts contributions immediately and employees defer tax until retirement. Nonqualified plans, by contrast, can be selectively offered to a few key executives and need not pass nondiscrimination tests — but the employer generally cannot deduct the contribution until the executive actually receives and reports the income. This deduction timing is the core trade-off producers must explain to business clients.

Defined Benefit vs. Defined Contribution; SEP and SIMPLE

Qualified plans split into two families:

401(k) plans are the dominant DC plan: employees defer salary pre-tax (or Roth after-tax), often with an employer match, subject to annual IRS deferral limits.

Employer plans designed for small business include:

• SEP (Simplified Employee Pension): the employer contributes to each eligible employee's IRA. Contributions are employer-funded, flexible year to year, and immediately 100% vested.
• SIMPLE plans: for employers with 100 or fewer employees; allow employee salary deferrals plus a required employer match or nonelective contribution.
• 403(b) / TSA: tax-sheltered annuities for public schools and 501(c)(3) nonprofits.
• 412(i) / 412(e)(3): fully insured DB plans funded with life insurance and annuities.

TEFRA and the History of Contribution Limits

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) is a frequent exam term. TEFRA tightened the rules governing retirement plan contributions and reduced the contribution and benefit limits for qualified plans, and it established parity between corporate plans and Keogh (HR-10) plans for the self-employed — ending the historical advantage corporations had over unincorporated business owners. Practically, remember TEFRA as the law that equalized self-employed Keogh plans with corporate plans and capped contribution limits.

Related landmark laws the exam may reference:

• ERISA (1974): the foundational federal law governing employer-sponsored plans — fiduciary duty, vesting, reporting, and disclosure.
• TEFRA (1982): contribution-limit reductions and corporate/Keogh parity.
• A self-employed person may use a Keogh (HR-10) plan, a SEP, or a solo 401(k) to shelter business income for retirement.

Know why these laws matter to a producer. ERISA protects employees by requiring that promised benefits actually vest and that fiduciaries manage plan assets prudently and solely in participants' interest. TEFRA matters because it leveled the playing field so a self-employed dentist or consultant can shelter as much income as the owner of an incorporated practice.

When a small-business client asks which plan to choose, the producer weighs how much the owner wants to contribute, how predictable cash flow is, and how many employees must be covered. SEPs reward flexibility, defined benefit plans reward older owners who want to contribute large amounts in a short window, and 401(k)s reward employee participation through deferrals and matching.

IRAs: Traditional vs. Roth

Individual Retirement Accounts (IRAs) let individuals save for retirement outside an employer plan. The two core types are tested as a contrast:

Penalty and Distribution Rules

• Premature distribution penalty: a 10% penalty applies to taxable amounts withdrawn before age 59½, with exceptions (death, disability, first-home up to $10,000, qualified education, certain medical).
• Required Minimum Distributions (RMDs): traditional IRAs and qualified plans require withdrawals beginning at the applicable RMD age; failure to take an RMD historically triggered a steep excise tax.
• Excess contributions above the annual limit are subject to a 6% excise tax each year they remain.

Worked Example

A 50-year-old withdraws $20,000 from a traditional IRA funded entirely with deductible contributions. Because all of it is pre-tax, the full $20,000 is taxable as ordinary income, plus a 10% penalty = $2,000, because she is under 59½ and no exception applies. Contrast a qualified Roth withdrawal, which would be entirely tax-free and penalty-free.