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

Qualified Plans, IRAs, and Retirement

Retirement plans split into two camps the exam constantly contrasts: qualified plans (IRS-approved, tax-advantaged, with strict rules) and non-qualified plans (more flexible, fewer tax breaks). A producer must know the contribution rules, taxation, distribution penalties, and the alphabet of plan types — IRA, Roth, SEP, SIMPLE, 401(k), 403(b), and Keogh.

Qualified vs Non-Qualified Plans

Qualified plans trade flexibility for big up-front tax breaks; non-qualified plans (like deferred comp) let employers reward select executives.

Traditional vs Roth IRAs

• Traditional IRA: contributions may be tax-deductible; growth is tax-deferred; distributions are fully taxable. RMDs (required minimum distributions) must begin at age 73. A 10% penalty applies to withdrawals before 59½ (exceptions: death, disability, first home up to $10,000, qualified education, certain medical).
• Roth IRA: contributions are after-tax (never deductible); qualified distributions are entirely tax-free (account open 5+ years and age 59½+); no RMDs during the owner's lifetime.
• 2024–2025 contribution limit: $7,000 ($8,000 if age 50+ catch-up). Roth eligibility phases out at higher incomes.

Employer Plans: SEP, SIMPLE, 401(k), 403(b), Keogh

• SEP IRA (Simplified Employee Pension): employer funds IRAs for employees; high limit (up to 25% of comp / IRS dollar cap). Popular with self-employed and small firms.
• SIMPLE IRA: for employers with ≤100 employees; employee defers salary, employer matches.
• 401(k): employee salary-deferral plan; pre-tax (or Roth) deferrals; common employer match; defined-contribution.
• 403(b) / TSA: tax-sheltered annuity for public schools and 501(c)(3) nonprofits — the same idea as a 401(k) for tax-exempt employers.
• Keogh (HR-10): qualified plan for self-employed individuals and unincorporated businesses.

TEFRA, ERISA, and Key Rules

• TEFRA (Tax Equity and Fiscal Responsibility Act, 1982) tightened qualified-plan rules, set top-heavy testing, and established the LIFO taxation order for pre-annuitization annuity withdrawals.
• ERISA (1974) governs qualified plans: minimum participation/eligibility (generally age 21 and 1 year of service), vesting schedules, fiduciary duties, and reporting/disclosure.
• RMDs at 73 force distributions; failure triggers an excise penalty on the shortfall.
• A direct trustee-to-trustee rollover avoids the mandatory 20% withholding that applies to a 60-day indirect rollover of an eligible plan distribution.

Worked Distribution Example and Common Traps

Example: A 50-year-old takes a $20,000 early withdrawal from a Traditional IRA funded entirely with deductible (pre-tax) contributions.

• All $20,000 is ordinary taxable income (no basis, since contributions were deductible).
• Plus a 10% penalty = $2,000 (under 59½, no exception applies).

Traps to memorize:

1. Roth contributions (basis) can be withdrawn anytime tax- and penalty-free; only earnings face the 5-year/59½ test.
2. RMD age is 73, not 70½ (changed by SECURE Act updates).
3. A 60-day indirect rollover suffers 20% mandatory withholding; use a direct rollover to avoid it.

Contribution Limits and the SECURE Act Rules

The exam expects familiarity with the mechanics more than current-year dollar figures, but anchor a few: traditional and Roth IRAs share a single annual contribution limit (with a catch-up addition at age 50+); 401(k)/403(b) elective deferrals are far higher; and SIMPLE IRAs sit between IRAs and 401(k)s. The SECURE Act 2.0 moved the RMD age to 73 and eliminated the age cap on traditional-IRA contributions for those with earned income.

Distribution Taxation and Rollovers

Distributions from traditional/qualified plans are fully taxable as ordinary income; Roth qualified distributions (account open 5 years and age 59½) are entirely tax-free. Early distributions before 59½ generally carry a 10% penalty with exceptions (death, disability, first-home up to $10,000 for IRAs, qualified education, substantially equal payments).

Worked rollover trap: An employee takes a direct (trustee-to-trustee) rollover of a $50,000 401(k) to an IRA — no withholding, no tax. If instead she takes an indirect (60-day) rollover, the plan must withhold 20% ($10,000); she has 60 days to deposit the full $50,000 (replacing the withheld $10,000 from other funds) or the shortfall is taxed and penalized. The 20% mandatory withholding on indirect rollovers is a top exam fact.

ERISA Fiduciary and Reporting Duties

ERISA governs private employer retirement and welfare plans. The exam tests its core protections: a fiduciary standard (acting solely in participants' interest), vesting schedules (employer contributions must vest under statutory limits), reporting and disclosure (the Summary Plan Description must be furnished to participants), and nondiscrimination rules preventing plans from favoring highly compensated employees. Government and church plans are generally exempt from ERISA.

Qualified Plan Requirements and Tax Mechanics

A qualified plan earns its tax advantages — employer deductible contributions, tax-deferred growth, and pre-tax employee deferrals — by meeting IRS conditions: it must be in writing, for the exclusive benefit of employees, nondiscriminatory, and have a defined vesting schedule. Distributions are fully taxable as ordinary income and subject to the 10% pre-59½ penalty absent an exception.

Worked SIMPLE vs. SEP distinction: A SEP-IRA is funded only by employer contributions (up to 25% of compensation), ideal for self-employed and small employers. A SIMPLE IRA allows employee salary deferrals plus a mandatory employer match (typically up to 3%), suited to firms with up to 100 employees. Mixing up "who contributes" between SEP (employer-only) and SIMPLE (both) is a recurring exam trap.