Series 7 Exam Question 135: Answer and Explanation

Question: 135

Regarding 401(k) plans, which TWO of the following are TRUE?

I. They are defined contribution plans.

II. They are defined benefit plans.

III. The amount withdrawn at retirement is partially taxable.

IV. The amount withdrawn at retirement is fully taxable.

• A. I and III
• B. I and IV
• C. II and III
• D. II and IV

Correct Answer: B

Explanation:

B. 401(k)s are corporate retirement plans. Employees decide the amount of their salary they want to contribute and typically, the employer will partially match the contribution up to a certain amount. As such, they are considered defined contribution plans. The amount contributed reduces the employees salary, so the employee's taxable income is reduced. Therefore, the employee never paid tax on the contribution or on the amount the account has appreciated in value, so withdrawals are fully taxed at the investor's tax bracket.