3.c Flashcards
(9 cards)
What are the two main categories of retirement plans?
- Qualified Plans
- Nonqualified Plans
Are contributions to a qualified plan made with pre-tax or after-tax dollars?
Pre-tax, which means they are tax-deductible.
This lowers your taxable income for the year you make the contribution.
Are contributions to a nonqualified plan made with pre-tax or after-tax dollars?
After-tax.
The contributions are not tax-deductible.
How is the money inside both qualified and nonqualified plans taxed as it grows?
The earnings in both types of plans grow tax-deferred.
This means you don’t pay taxes on the interest, dividends, or capital gains each year.
How are withdrawals from a qualified plan taxed?
All withdrawals are taxed as ordinary income.
Since you never paid taxes on the contributions or the growth, the entire amount you take out is taxable.
How are withdrawals from a nonqualified plan taxed?
Only the growth (earnings) is taxed as ordinary income.
The portion of the withdrawal that came from your after-tax contributions (your cost basis) is returned to you tax-free.
Do qualified and nonqualified plans need IRS approval, and can they discriminate (choose who participates)?
Qualified Plans:
* Must be approved by the IRS.
* Cannot discriminate (must be offered to all eligible employees).
Nonqualified Plans:
* Do not need IRS approval.
* Can discriminate (often used for key executives).
What is the difference between a self-sponsored and an employer-sponsored plan?
- Self-sponsored: An individual can establish this type of account on their own (e.g., an IRA).
- Employer-sponsored: The employer must establish the plan for its employees (e.g., a 401(k)).
Quickly summarize the key differences between qualified and nonqualified plans.
Feature | Qualified Plan | Nonqualified Plan |
| :— | :— | :— |
| Contributions | Pre-tax (deductible) | After-tax (not deductible) |
| IRS Approval? | Yes | No |
| Discrimination? | No, cannot discriminate | Yes, can discriminate |
| Accumulation | Tax-deferred | Tax-deferred |
| Withdrawals | Fully Taxable | Earnings only are taxable |
