Types of Qualified Retirement Plans

Qualified retirement plans encourage saving for retirement by deferring income taxes on the earnings. These plans are one of the most common and important sources of retirement income for seniors in all three income groups.

Individual Retirement Accounts (IRAs)

IRAs provide working Americans with tax-advantaged means to save for retirement while self-directing the investments in their accounts. Only those with earned income from working may contribute to IRAs-individuals receiving income only from investments or trusts are ineligible to make IRA contributions.

An American having earned income or reportable alimony may make an annual contribution up to the lesser of 100 percent of compensation or $ 5,000 to a traditional, spousal, or Roth IRA. Further, an individual age 50 or older may make an annual additional catch-up contribution of $ 1,000 in 2009 (indexed for inflation, which means the contribution amount may change with inflation). For example, in 2009, a 60-year-old taxpayer could contribute $ 3,000 to a traditional IRA and an additional $ 3,000 to a Roth IRA, for a total of $ 6,000.

Contributions to IRAs may be made up to the tax filing date (typically, but not always April 15) for the year in which the IRA contribution is intended. Filing extensions do not extend the deadline for making an IRA contribution. Taxpayers can choose among several types of IRAs based on their needs and income: traditional, spousal, and Roth.

Traditional IRAs

Taxpayers who are not active participants in an employer-sponsored retirement plan may deduct an annual contribution up to the full amount they earn, or the maximum contribution amount, whichever is lower, to an IRA.

Alternatively, a taxpayer may wish to make a nondeductible IRA contribution to a Roth IRA or a contribution to a nondeductible traditional IRA because the money in the Roth accumulates tax-free.

For taxpayers who are active participants in an employer-sponsored retirement plan, the IRS determines whether the annual IRA contribution is tax deductible, and if so, in what amount based on the individual’s adjusted gross income (AGI).

The deductibility of traditional IRA contributions for a taxpayer actively participating in a workplace retirement plan is phased out on a pro rata basis over the specified phase-out range of AGI.

 Adjusted Gross Income Deductibility Phase-Out Ranges for IRAs

Tax Year

Joint Returns

Single Returns


$65,000 - $75,000

$ 45,000 - $55,000


$ 70,000 - $80,000

$ 50,000 - $ 60,000


$ 75,000 - $ 85,000

$ 50,000 - $ 60,000


$ 83,000 - $ 103,000

$ 52,000 - $ 62,000


$ 85,000 - $ 105,000

$ 53,000 - $ 63,000


$ 89,000 - $ 109,000

$ 55,000 - $ 65,000


As the chart shows, individuals who participate in an employer-sponsored retirement plan, and whose income is below the lower limit, may deduct their full contribution to an IRA. However, someone with income above the upper limit will not be allowed to make any deductible contribution. Taxpayers with income between the listed limits can make a partially deductible contribution that decrease as their income increases toward the upper limit.

Spousal IRAs

Married couples who file joint income tax returns may be able to take advantage of spousal IRA contributions even though one spouse earns less than the maximum contribution amount or has no earned income from working.

Presuming the income of the working spouse reaches or exceeds contribution amounts, a working spouse may contribute up to $ 5,000 ($6,000 if the working spouse is at least age 50) to an IRA established under the name of the nonworking spouse. Contribution amounts are scheduled to be indexed for inflation. This allows the working spouse to make a contribution on behalf of (Because limits are expected to change every year, you should advise your clients to check with their financial or tax planners when making contributions.)

Roth IRAs

As mentioned above, Roth IRAs permit nondeductible annual contributions up to the lesser of 100 percent of earned income in 2009 or $ 5,000, with catch-up contributions of up to $ 1,000 per year available for taxpayers age 50 and over (for a total annual contribution of $ 6,000). Contribution limits are scheduled to be indexed for inflation. Spousal Roth IRAs may also accept contributions of up to $ 5,000/$ 6,000 (because limits are expected to change every year, seniors should check with their financial or tax planners when making contributions).

Annual contribution limits to Roth and traditional IRAS are interrelated: as an individual may contribute more more than $ 5,000/$ 6,000 per year to the combination or both Roth and traditional accounts (i.e., $ 3,000 to the Roth and $ 3,000 to the traditional, for a total of $ 6,000 annually). No maximum age limits apply to Roth contributions, so seniors of any age (with earned income not exceeding the AGI limits) may contribute.

Income limitations apply to Roth contributions. Only taxpayers who annual adjusted gross income is within the limits listed may contribute to Roth IRAs.

Adjusted Gross Income Contribution Phase-Out Ranges for Roth IRAs in 2009

Filing Status

Adjusted Gross Income

Single Filers

$ 105,000 - $120,000

Joint Filers

$ 166,000 - $176,000


The maximum annual Roth contribution is phased out proportionally according to the thresholds shown in the table. This means that someone whose income is below the lower limit may be able to make up a full contribution (e.g., $5,000 or $6,000 with the catch-up allowance). Someone with income above the upper limit, however, will not be allowed to make any contribution to a Roth. Taxpayers with income between the listed limits can make a partial contribution that decreases as their income increases toward the upper limit.

As an example of partial contribution to a Roth IRA, suppose in tax year 2009, a widow, age 66, had a modified adjusted gross income (MAGI) of $ 112,500 (the midpoint of the phase-out range for unmarried individuals). She can contribute $3,000 to a Roth IRA. (Had she been under age 50, she could have contributed only $2,500.)

Employer-Sponsored Retirement Plans

A variety of retirement plans offer tax advantages to employers while potentially increasing employee morale, productivity, and loyalty. These include 401(k)s, defined-benefit pensions, money purchase pensions, and profit-sharing plans. Generally, employers may deduct their contributions to the plan-for example, matching funds up to a certain percentage of the employees’ contributions. Employees’ contributions are tax-deductible. The newer Roth 401(k) is not deductible by the employee, but qualified withdrawals of the employee’s account are tax free.

Retirement Plans for Corporations and Unincorporated Businesses

Tax-deferred retirement plans available to businesses regardless of whether they are corporations or other forms include SEP IRAs, SIMPLE IRAs, and retirement plans for only unincorporated organizations: Koegh (HR-10) plans for the self-employed and 403(b) tax-sheltered annuities for not-for-profit organizations and education employees.

Distributions from Qualified Retirement Plans

To encourage people to use the assets in their qualified plans plan for retirement income, the IRS established penalties on withdrawals made too early or too late. Withdrawals made between the ages of 59 ½ and 70 ½ are subject to ordinary income tax but no penalty.

Early Withdrawals

Early withdrawals are those taken before the taxpayer is age 59 ½. They are generally subject to a nondeductible 10 percent penalty, along with ordinary income tax at the taxpayer’s own bracket.

You may have clients who are not age 59 ½ but may qualify for and need to use an exception to the 10 percent early withdrawal penalty. For most retirement plans, the exceptions to the early withdrawal penalty are:

  • A direct transfer into another similar qualified plan by a worker who changes jobs-for example, from one 401(k) to another 401(k);
  • A rollover (transfer) or funds into a different form of qualified retirement plan-for example, from a 401(k) into a traditional IRA;
  • Purchase of a first home (available for IRAs but not employer-sponsored retirement plans);
  • Permanent total disability of the plan owner;
  • Payment of health insurance premiums while the plan owner is unemployed (available for IRAs but not employer-sponsored plans);
  • Compliance with a court order in conjunction with a divorce (available for employer plans but not IRAs);
  • Annuitized distributions-distributing substantially equal payments over the plans owner’s life expectancy (or the life expectancy of the plan owner and a designated beneficiary) for a continuous period of five years or until the recipient is age 59 ½, whichever occurs later.

Roth IRAs and Roth 401(k)s

After a five-year holding period from the date the owner first established a Roth IRA or Roth 401(k) account, withdrawals of any kind may be taken and not taxed when the owner is at least age 59 ½ or the distributions are:

  • Made at or after death (to an estate or a beneficiary);
  • Generated by the owner’s disability;
  • Used for a qualified first-time homeowner’s expenses.

These withdrawals may consist of one or several types of funds: after-tax contributions to the account, earnings, and funds converted from a traditional IRA. (The five-year holding period does not apply to withdrawals that consist of only contributions made by the IRA owner. Also, regular annual contributions are always returned tax-free.)

The five-year period starts with the first day of the tax year in which the owner first sets up and contributes to a Roth IRA. For example:

Emily, age 60, made her first contribution to a Roth IRA on October 1, 2003, for the 2003 tax year. The five-year holding period for all of Emily’s succeeding contributions to this Roth IRA account (that are not converted from a traditional IRA) begins on January 1, 2003.

Even if Emily were to die during this five-year holding period, it still applies to her heirs. They would also have to wait until January 2, 2008 to receive tax-free distributions of earnings from her Roth. A spouse, on the other hand, could use the five-year period of the decedent’s Roth or the five-year period of their own Roth to access the funds in the decedent’s Roth on a tax-free basis.

(Taxpayers often mistakenly believe that a separate five-year holding period applies to each year’s regular annual contribution.)

This five-year period that applies to a distribution from a conversion of a traditional IRA to a Roth IRA is determined separately for each conversion. It starts the first day of the tax year in which you make the conversion.

No withdrawal is required while the Roth IRA owner lives.

Required Beginning Date

For information on the required beginning dates for qualified retirement plans, refer, to Estate Planning.

Distribution Options after Retirement

Retirees may choose one of four options for taking required minimum distributions from their qualified retirement plans starting on their required beginning date:

  • Lump-sum payment
  • Rollover
  • Direct transfer
  • Annuitized payments

Lump Sum

The tax consequences of lump-sum distributions differ greatly from those for periodic annuity payments or Roth IRA distributions. Individuals who are considering taking a lump-sum distribution should first have a qualified financial or tax planning expert analyze the tax consequences of a lump-sum payout against other payout options.

Obviously, a potential disadvantage to a substantial lump-sum payout is the temptation to spend too much of it immediately, rather than to invest it to provide future retirement income. However, the advantages of a lump-sum option are that it offers retirees:

  • Maximum control over investments;
  • Financial resources for paying unforeseen expenses such as a major illness;
  • Flexibility for future investment decisions that offer more protection against inflation.

If the employee does not do a custodian-to-custodian transfer, then employers must withhold 20 percent of lump-sum distributions made from employer-sponsored retirement accounts (but not IRAs or Roth 401(k) s) as an advance on income taxes likely to be due on the distributed amount.


A retirement account owner who directly receives a lump-sum distribution from his or her employer’s retirement plan and rolls it over into an IRA or qualified plan within 60 days may receive a refund of the 20 percent mandatory withholding. This refund occurs when the employee files a tax return. Although the employee only receives 80 percent of the proceeds, and must wait until the next tax year to get the refund, the employee may take money from other personal savings to substitute for the 20 percent, and thus can roll over 100 percent of the distribution amount. This can all be avoided by doing a custodian-to-custodian transfer.

Roth 401(k)s, no matter the holding period or age of the owner, may be rolled over into a Roth IRA.

Direct Transfer

Direct transfer from one qualified plan to another, without passing through the plan owner’s hands, is the most effective way to avoid income or penalty taxes. Transfers and rollovers may involve all or only a portion of the distribution.

Annuitized Distributions

An annuity distributes the funds in the plan in fixed monthly amounts that are taxed as ordinary income, with the exception of nondeductible or after-tax contributions, which are tax-free. Payout options must be selected carefully; once on is chosen, it generally cannot be changed. The two payout options that are almost always available are:

  • Single life option: Pays a set monthly amount to the retiree. Payments stop when the retiree dies. The account balance remains with the financial institution that issued the annuity.
  • Joint and survivor option: Provides a smaller monthly payment, but a percentage of the payment amount will continue for a surviving spouse after the retiree dies. The survivor benefit may range between 50 and 100 percent of the joint payment.

With either option, a retiree can elect to receive a reduced monthly payment for life, in addition to a guaranteed minimum payment period of 5, 10, or 15 years to a beneficiary (a life income with period certain payout). Monthly payments under period certain or survivor arrangements are smaller than those made under single life options. Note, however, that annuitizing distributions may lock in the money at fixed rates of return, which over time could make them vulnerable to a loss of buying power.

Taxes on Distributions: Owners and Beneficiaries

Distributions from retirement plans have significant financial and tax consequences for the plan owner as well as the beneficiaries. These often irreversible decisions can affect whether money lasts through retirement or whether funds are available for a spouse or heirs at the owner’s death. Uninformed decisions may leave thousands of dollars in a plan at death and leave nothing for a surviving spouse or heirs.

For many, beneficiary designations on retirement plans were made when the plan was originally established and have not been reviewed since, in spite of inevitable changes in family structure-births, deaths, divorce, or remarriage.

Failure to monitor beneficiary designations may result in unanticipated consequences when a retiree dies. Remaining benefits may go to the IRS in unplanned estate taxes or bypass the current spouse and go to a previous spouse. Further, if beneficiary designations in a retirement plan are in conflict with the retiree’s current will, final distribution will be made according to the beneficiary designation-it takes precedence over the will. The estate should generally not be named as a beneficiary since this will subject the proceeds to probate. The tax consequences that follow naming a beneficiary or determining how to receive payments as a beneficiary are significant and demand consultation with a knowledgeable financial and tax professional.

The information above is reprinted from Working with Seniors: Health, Financial and Social Issues with permission from Society of Certified Senior Advisors® . Copyright © 2009. All rights reserved.