Retirement Plan Taxation: IRAs, 401(k)s, and Pensions for the CPA REG Exam

Retirement Plan Taxation for CPA Candidates

Retirement plan taxation is one of the most heavily tested topics on the CPA REG exam. The tax treatment of contributions, earnings, and distributions varies significantly depending on the type of plan, and the penalty provisions for early withdrawals and failure to take required distributions add additional complexity. CPA candidates must understand the rules for traditional IRAs, Roth IRAs, employer-sponsored defined contribution plans (such as 401(k) plans), and the general framework for defined benefit pension plans.

Traditional IRAs

Contributions

For 2024, the maximum annual IRA contribution is $7,000 ($8,000 for taxpayers age 50 or older). Contributions may be deductible depending on whether the taxpayer (or spouse) is an active participant in an employer-sponsored plan and the taxpayer's modified AGI. If neither the taxpayer nor the spouse is an active participant, the full contribution is deductible regardless of income. If the taxpayer is an active participant, the deduction phases out at specified income levels.

For active participants filing single, the 2024 phase-out range is $77,000 to $87,000. For married filing jointly where the contributing spouse is an active participant, the range is $123,000 to $143,000. For a non-participant spouse, the range is $230,000 to $240,000.

Distributions

Distributions from traditional IRAs are generally taxed as ordinary income. If the IRA contains nondeductible contributions, the pro-rata rule applies: each distribution is treated as consisting partly of taxable earnings and deductible contributions and partly of nontaxable nondeductible contributions. The ratio of nondeductible contributions to total IRA balances (across all traditional IRAs) determines the nontaxable portion.

Roth IRAs

Contributions

Roth IRA contributions are never deductible. The 2024 contribution limit is the same as for traditional IRAs ($7,000 or $8,000 for those 50+), and the total combined contribution to traditional and Roth IRAs cannot exceed these limits. The ability to contribute phases out at modified AGI of $146,000 to $161,000 for single filers and $230,000 to $240,000 for married filing jointly.

Qualified Distributions

Qualified distributions from Roth IRAs are entirely tax-free and penalty-free. A distribution is "qualified" if it is made after the five-taxable-year period beginning with the first year a Roth contribution was made, and it meets one of these conditions: the account owner is age 59-1/2 or older, the distribution is due to disability, the distribution is made to a beneficiary after the owner's death, or the distribution is for first-time homebuyer expenses (up to $10,000 lifetime).

Ordering Rules for Non-Qualified Distributions

Non-qualified Roth distributions follow a specific ordering: first from regular contributions (tax-free and penalty-free), then from conversion contributions (tax-free but potentially subject to penalty if within five years), and finally from earnings (taxable and potentially subject to penalty).

401(k) Plans

Employee Deferrals

For 2024, the maximum employee elective deferral to a 401(k) plan is $23,000 ($30,500 for employees age 50 or older with the catch-up contribution). Deferrals reduce the employee's taxable income in the year of contribution. The overall limit on annual additions (employee deferrals plus employer contributions) is the lesser of $69,000 or 100% of compensation.

Employer Matching and Profit-Sharing Contributions

Employer contributions are deductible by the employer and not included in the employee's income until distributed. Employer matching contributions may be subject to a vesting schedule; unvested amounts are forfeited if the employee leaves before becoming fully vested.

Roth 401(k) Option

Many employers now offer a Roth 401(k) option. Contributions are made on an after-tax basis (no current deduction), but qualified distributions are tax-free, similar to Roth IRA distributions. The same contribution limits apply, and the five-year holding period is determined separately from Roth IRAs.

Required Minimum Distributions (RMDs)

Under the SECURE 2.0 Act, RMDs from traditional IRAs and employer-sponsored plans must begin by April 1 of the year following the year the account owner reaches age 73 (increasing to age 75 starting in 2033). The RMD amount is calculated by dividing the account balance as of December 31 of the prior year by the applicable life expectancy factor from IRS tables. Failure to take the required distribution results in a 25% excise tax on the shortfall (reduced to 10% if corrected within the correction window). Roth IRAs are not subject to RMDs during the owner's lifetime.

Early Distribution Penalty

Distributions before age 59-1/2 are generally subject to a 10% early withdrawal penalty in addition to regular income tax. Exceptions to the penalty include: death or disability, substantially equal periodic payments (Section 72(t) payments), medical expenses exceeding 7.5% of AGI, qualified first-time homebuyer expenses (IRAs only, up to $10,000), higher education expenses (IRAs only), health insurance premiums during unemployment (IRAs only), birth or adoption expenses (up to $5,000), and separation from service after age 55 (employer plans only, not IRAs).

Rollovers

Tax-free rollovers are permitted between most types of retirement accounts. A direct rollover (trustee-to-trustee transfer) avoids mandatory 20% withholding. An indirect rollover (distribution to the taxpayer who then redeposits within 60 days) is subject to withholding and must be completed within the 60-day window. Taxpayers are limited to one indirect IRA-to-IRA rollover per 12-month period. Rollovers from traditional accounts to Roth accounts (conversions) are permitted but trigger income recognition on the converted amount.

CPA Exam Tips

• Know the contribution limits, phase-out ranges, and catch-up provisions for each plan type.
• Traditional IRA deductibility depends on active participant status and income level.
• Roth qualified distributions require the five-year period plus a triggering event.
• RMDs begin at age 73 (75 after 2033); 25% penalty for missed RMDs.
• Early withdrawal penalty exceptions differ between IRAs and employer plans.
• The pro-rata rule applies to traditional IRA distributions with nondeductible contributions.