401(k) Plan

Owen leaves his job and instructs his 401(k) plan to send his entire balance DIRECTLY to the custodian of his new IRA. This move is:

1. A.An indirect rollover, which he must complete within 60 days to avoid taxation.An indirect rollover happens when the participant receives the funds personally. Here they never pass through his hands.
2. B.A taxable distribution, because leaving the employer ends the plan tax deferral.Separating from service permits a distribution but does not force taxation. A properly executed rollover keeps the deferral intact.
3. C.A direct rollover, because the money goes from the plan straight to the IRA custodian and Owen never takes possession of it.Correct. Custodian-to-custodian movement is the defining feature of a direct rollover.
4. D.A Roth conversion, because moving money between account types is always a conversion.A conversion means moving pre-tax money into a Roth account and paying tax now. Moving a 401(k) into a traditional IRA is not that.

Why: When the plan sends the money straight to another custodian, Owen never has possession or use of the funds. That is a direct rollover, and because there is no distribution to the participant, none of the complications that attach to receiving a check personally apply. Review rollovers and transfers in the retirement accounts topic.

An adviser is asked to serve as a fiduciary to the 401(k) plan of Kestrel Manufacturing, a privately held company with 300 employees. ERISA primarily governs:

1. A.Private-sector employer retirement plansCorrect - ERISA covers private plans.
2. B.Government employee plansGovernment and public-school plans are expressly exempt from ERISA's coverage and are governed instead by state law and their own federal provisions. ERISA was enacted to protect workers in the private sector.
3. C.Municipal bondsMunicipal securities are regulated under the securities laws by the MSRB and SEC. ERISA is employee benefits legislation and does not regulate any class of security.
4. D.Only IRAsIRAs borrow some ERISA concepts and enjoy certain protections, which makes this partly plausible. IRAs are individual accounts created under the tax code, while ERISA's core subject is the employer-sponsored plan.

Why: ERISA sets standards for private-sector employer-sponsored retirement plans.

Yolanda Berrios, 38, participates in her employer 401(k) plan, and her modified adjusted gross income for the year is well above the phase-out range for deducting a traditional IRA contribution. Assume she has enough earned income to contribute the full annual limit. Which statement is correct?

1. A.She is prohibited from contributing to a traditional IRA at all because she is covered by an employer plan.Incorrect. Employer plan participation never blocks a traditional IRA contribution; it only affects deductibility.
2. B.Her contribution is fully deductible, because participation in an employer plan has no bearing on IRA deductibility.Incorrect. Active participation combined with income above the phase-out range is exactly what eliminates the deduction.
3. C.She may make a full traditional IRA contribution, but none of it is deductible; the nondeductible amount becomes after-tax basis reported to the IRS.Correct. High income plus active participation removes the deduction, not the right to contribute, and the contribution creates basis.
4. D.She may contribute, and the contribution is deductible only if she makes a Roth IRA contribution of the same amount.Incorrect. No such pairing rule exists, and the two account types share one annual contribution limit.

Why: Being an active participant in an employer plan does not bar anyone from contributing to a traditional IRA; it only affects whether the contribution is DEDUCTIBLE. Above the phase-out range, an active participant may still contribute the full allowable amount, but gets no deduction for it. The nondeductible amount becomes after-tax basis in the IRA, reported to the IRS each year, so that when distributions eventually begin that basis is recovered tax free rather than taxed a second time.

A 401(k) plan is best described as:

1. A.An individual account funded only with after-tax contributionsDescribes an IRA-style arrangement, not an employer-sponsored deferral plan.
2. B.A plan available exclusively to public school employeesThat describes a 403(b); 401(k) plans are used by for-profit employers.
3. C.An employer-sponsored defined contribution plan funded by employee salary deferrals, often with an employer matchCorrect. Employees elect to defer salary and the employer may match.
4. D.A defined benefit plan promising a fixed monthly payment in retirementDescribes a traditional pension, where the benefit rather than the contribution is defined.

Why: A 401(k) is an employer-sponsored defined contribution plan in which employees elect to defer part of their salary into the plan, often with an employer matching contribution.