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401(k), IRA, and other Qualified Plans

Any traditional qualified retirement plan offers the participant the opportunity to contribute money toward retirement and take the amount contributed off his taxable income for that year. In addition, any investment growth of the funds will be sheltered from income tax while building up inside the plan. Thus, there is a great opportunity for an individual to grow his money leading up to retirement much quicker than if the funds were taxed.

At retirement, distributions from the account are taxed as ordinary income. These payments must not begin until age 59 1/2  or else be subject to a 10% federal excise tax (with certain exceptions). Also, payments cannot be deferred past age 70 1/2 without penalty. Starting at age 70 1/2, the minimum amount of taxable distribution each year  (the Required Minimum Distribution, or RMD) grows as one gets older and is expressed as an increasing percentage of the remaining account assets.

The amount that one can contribute to a qualified plan in any given year is also restricted. Defined contribution plans, which are the most common, usually limit annual contributions to between $6,000 and $20,500 depending on the circumstances. A solo 401(k) allows up to $53,000 - twice that if combined with a spouse.

Investment of the assets in a qualified plan can be varied, but most commonly are placed in mutual funds, index funds, or fixed income vehicles. It is not typical for these plans to invest in hedged investments that protect against investment loss. Safety is usually sought in buying fixed income, especially U. S. government bonds.

A variation on most qualified plans is the Roth IRA, Roth 401(k), etc. Here the contributions are not deducted from current income, but retirement distributions come out tax-free after age 59 1/2. With a Roth IRA - not so with a Roth 401(k) - there are also no Required Minimum Distributions, so funds withdrawal can be deferred as long as desired. For a person looking to leave the largest possible legacy to his heirs, this provision is huge. Funds in a Roth Solo 401(k) can be transferred into a Roth IRA anytime prior to age 70 1/2 so as to avoid RMDs as well.

There are defined contribution plans (as discussed so far), and then there are defined benefit plans.  Defined benefit plans may allow larger contributions for a given participant since the plan works toward a specifically defined retirement income goal. Tax treatment is similar to that of traditional defined contribution plans.

Any future retiree or business owner should consider each type of qualified plan alongside some of thenon-qualified alternatives, such asindexed universal life. (Back to IUL Table of Contents)


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