Chapter 13: Retirement Savings & Deferred Compensation

What is a defined benefit plan?

A retirement plan where the employer promises a specific monthly benefit at retirement based on salary and years of service

What is a defined contribution plan?

A retirement plan where the employer specifies upfront contributions, but the final benefit depends on investment performance

Who bears the investment risk in a defined benefit plan?

The employer

Who bears the investment risk in a defined contribution plan?

The employee

What is vesting?

The process of gaining legal ownership or entitlement to retirement benefits

In a 3-year cliff vesting schedule, when does an employee become 100% vested?

At the end of year 3

True or False: Employee contributions to a 401(k) are always immediately 100% vested.

True

What percentage is an employee vested after 4 years under a 6-year graded vesting schedule?

60%

What is the 2025 employee contribution limit for a 401(k) plan?

$23,500

What is the catch-up contribution amount for 401(k) participants aged 50-59 in 2025?

$7,500

What is the special catch-up contribution for 401(k) participants aged 60-63 in 2025?

$11,250

What is the maximum total contribution limit (employee + employer) for a 401(k) in 2025 for someone under 50?

$70,000

True or False: A 403(b) plan is offered by for-profit companies.

False (403(b) plans are for non-profit organizations, schools, and hospitals)

What does "leaving money on the table" mean in retirement planning?

Not contributing enough to receive the full employer match, essentially refusing free money

If an employer matches 50% of employee contributions up to 6% of salary, and you earn $100,000, what is the maximum employer match?

$3,000 (50% × 6% × $100,000)

At what age do Required Minimum Distributions (RMDs) currently begin?

Age 73

What is the penalty for failing to take a Required Minimum Distribution?

25% of the amount that should have been withdrawn

True or False: You must take your first RMD by December 31 of the year you turn 73.

False (You can delay the first RMD until April 1 of the following year, but subsequent RMDs must be taken by December 31)

How are distributions from a traditional 401(k) taxed?

As ordinary income

What is the early withdrawal penalty for taking a distribution before age 59½?

10% additional tax on top of ordinary income tax

At what age can you take penalty-free distributions from a 401(k) if you are separated from service?

Age 55

Which of the following is NOT an exception to the 10% early withdrawal penalty? A) Medical expenses B) Vacation expenses C) First home purchase D) Childbirth or adoption

B) Vacation expenses

Are contributions to a traditional 401(k) made with pre-tax or after-tax dollars?

Pre-tax dollars (tax deductible)

Are contributions to a Roth 401(k) made with pre-tax or after-tax dollars?

After-tax dollars (not tax deductible)

True or False: Qualified distributions from a Roth 401(k) are tax-free.

True

What two conditions must be met for a Roth 401(k) distribution to be qualified (tax-free)?

1) Account open for 5 taxable years AND 2) Age 59½ or older (or death, disability, or first home purchase)

If you contribute $7,000 to a traditional IRA and your marginal tax rate is 24%, what is your after-tax cost?

$5,320 ($7,000 - ($7,000 × 0.24))

What is the 2025 annual contribution limit for both traditional and Roth IRAs?

$7,000

What is the catch-up contribution for IRAs for individuals aged 50 or older?

$1,000

True or False: You can contribute to an IRA without having earned income.

False (You must have earned income to contribute)

What is the deadline for making an IRA contribution for the 2025 tax year?

April 15, 2026

Can you deduct traditional IRA contributions if you are covered by an employer retirement plan?

Only if your income is below certain thresholds (phase-out applies)

True or False: Roth IRA contributions are tax deductible.

False

What is a major advantage of a Roth IRA over a traditional IRA?

No Required Minimum Distributions (RMDs)

What is a "backdoor" Roth IRA contribution?

Contributing to a traditional IRA (non-deductible) and immediately converting it to a Roth IRA

Can a non-working spouse contribute to an IRA?

Yes, through a spousal IRA, based on the working spouse's earned income

What is a non-qualified deferred compensation plan?

A retirement arrangement for executives/highly compensated employees that is not subject to qualified plan rules and has no contribution limits

True or False: Non-qualified deferred compensation plans can discriminate in favor of highly compensated employees.

True

What is the main risk to employees participating in non-qualified deferred compensation plans?

The deferred compensation remains the employer's asset; if the company goes bankrupt, the employee could lose it

When does the employer deduct contributions to a non-qualified deferred compensation plan?

When paid to the employee (not when earned)

What is a Qualified Charitable Distribution (QCD)?

A direct distribution from an IRA to a qualified charity that is excluded from income

What is the minimum age to make a Qualified Charitable Distribution?

70½ years old

What is the maximum annual amount for a Qualified Charitable Distribution (2024)?

$105,000

True or False: A QCD counts toward your Required Minimum Distribution.

True

Why is a QCD especially valuable for retirees who don't itemize deductions?

The distribution is excluded from income (not just a deduction), providing tax savings even without itemizing

What is a SEP IRA?

Simplified Employee Pension IRA - a retirement plan for self-employed individuals and small business owners

What is the 2025 contribution limit for a SEP IRA?

Lesser of $70,000 OR 20% × (Net Schedule C income - Self-employment tax deduction)

True or False: If you have employees, you must provide a SEP IRA to them if you have one for yourself.

True

What is an Individual 401(k)?

A 401(k) plan designed for self-employed individuals with no employees (except spouse), allowing contributions as both employer and employee

Which allows higher contributions for self-employed individuals: SEP IRA or Individual 401(k)?

Individual 401(k)

For an Individual 401(k), what is the employer contribution limit?

20% × (Net Schedule C income - Self-employment tax deduction)

For an Individual 401(k), what is the employee contribution limit in 2025?

$23,500 (plus catch-up if applicable)

If a self-employed person has adjusted net income of $46,468 and is age 64, what is the maximum Individual 401(k) contribution?

$40,294 [($46,468 × 20%) + $23,500 + $7,500 catch-up]

True or False: Employer matching contributions to a Roth 401(k) must also be designated as Roth contributions.

False (Employer contributions go to traditional 401(k) unless fully vested, then they can go to Roth)

When might a Roth 401(k) be better than a traditional 401(k)?

When you expect to be in a higher tax bracket in retirement or when you're young and in a lower tax bracket now

For a non-qualified Roth 401(k) distribution, which portion is never taxed?

The contribution portion (you already paid tax on it)

How do you calculate the non-taxable portion of a non-qualified Roth distribution?

(Total contributions ÷ Account balance) × Distribution amount

True or False: Required Minimum Distributions apply to both traditional and Roth 401(k) accounts.

True

What happens if you withdraw from a traditional 401(k) at age 45 while still employed?

The distribution is taxed as ordinary income PLUS a 10% early withdrawal penalty

Which type of employer-provided retirement plan was dominant in the 1950s-1970s?

Defined benefit plans

Why have defined contribution plans become more popular than defined benefit plans?

They are less costly for employers to maintain and transfer investment risk to employees

True or False: In a defined contribution plan, each employee has a separately maintained account.

True

Who typically chooses how retirement funds are invested in a defined contribution plan?

The employee

What does a 2-for-1 employer match up to 5% of salary mean?

For every dollar you contribute (up to 5% of salary), the employer contributes two dollars

If you earn $100,000 and your employer matches 100% up to 3% of salary, what is the maximum employer match?

$3,000 (100% × 3% × $100,000)

True or False: Catch-up contributions for certain high earners must be treated as Roth 401(k) contributions.

True

What is the self-employment tax rate used in calculating the SEP IRA contribution limit?

15.3% (with 0.9235 multiplier)

If Schedule C net income is $50,000, what is the approximate self-employment tax deduction?

$3,532 ($50,000 × 0.9235 × 15.3% × 50%)

For SEP IRA calculations, what percentage of adjusted income is used?

20%

True or False: You can make both traditional and Roth contributions to an Individual 401(k).

True

What is the maximum total IRA contribution for a married couple where one spouse doesn't work (both under 50)?

$14,000 ($7,000 each through spousal IRA)

Can you contribute to both a 401(k) and an IRA in the same year?

Yes

True or False: Roth IRA contributions can be withdrawn at any time without tax or penalty.

True (contributions only, not earnings)

What is the 5-year rule for Roth accounts?

The account must be open for 5 taxable years before qualified distributions can be taken

At what age can you avoid the 10% early withdrawal penalty from an IRA for any reason?

59½

Which retirement account has NO required minimum distributions?

Roth IRA

True or False: You can convert a traditional IRA to a Roth IRA at any income level.

True

What do you pay when converting a traditional IRA to a Roth IRA?

Ordinary income tax on the amount converted (but no 10% penalty)

What is the contribution deadline for SEP IRA and Individual 401(k) plans?

The tax return deadline (including extensions)

True or False: A Qualified Charitable Distribution can be made to any charity, including private foundations.

False (must be made to a qualified public charity; private foundations generally don't qualify)

If your RMD is $40,000 and you make a $15,000 QCD, how much must you include in income?

$25,000 (the QCD is excluded from income and counts toward the RMD)

What form is used to report non-deductible IRA contributions?

Form 8606

True or False: Earnings in a traditional IRA grow tax-free.

False (they grow tax-deferred, not tax-free; you pay taxes upon withdrawal)

True or False: Earnings in a Roth IRA grow tax-free.

True

Which provides more tax benefit to someone in the 32% tax bracket now who expects to be in the 12% bracket in retirement: traditional or Roth 401(k)?

Traditional 401(k) (save 32% now, pay 12% later)

What is "earned income" for IRA contribution purposes?

Wages, salaries, tips, self-employment income, and alimony (if divorce finalized before 2019)

True or False: Investment income (interest, dividends, capital gains) counts as earned income for IRA purposes.

False

Can you contribute to an IRA after age 73?

Yes, if you have earned income (no age limit)

What is the penalty for excess contributions to an IRA?

6% per year until the excess is withdrawn

True or False: You can take a loan from your IRA.

False (IRAs do not allow loans)

Can you take a loan from a 401(k)?

Yes, many 401(k) plans allow loans (typically up to 50% of vested balance or $50,000, whichever is less)

What happens to your 401(k) when you leave your employer?

You can: 1) Leave it with former employer, 2) Roll it to new employer's plan, 3) Roll it to an IRA, or 4) Cash it out (taxable event)

True or False: Rolling a 401(k) to an IRA is a taxable event.

False (if done correctly as a direct rollover)

What is a direct rollover?

When retirement funds move directly from one account to another without you receiving the money

What is the 60-day rollover rule?

If you receive retirement funds, you have 60 days to deposit them into another retirement account to avoid taxes and penalties

If you do an indirect rollover from a 401(k), what percentage is withheld for taxes?

20%

True or False: You can roll a traditional 401(k) into a Roth IRA.

True (but you must pay taxes on the amount converted)

What is the benefit of a "mega backdoor Roth"?

Allows high earners to contribute after-tax dollars to a 401(k) and convert to Roth, potentially adding much more than the standard Roth IRA limit

Which retirement account typically has more investment options: 401(k) or IRA?

IRA (typically offers more investment choices)

True or False: 401(k) accounts have creditor protection in all states.

True (federally protected under ERISA)