Primerica Life Producer Practice Test

What is a key tax advantage of a qualified retirement plan?

1. The plan allows for immediate tax deductions

2. Withdrawals are tax-free

3. The earnings in the plan accumulate tax deferred

4. Contributions are taxed at a lower rate

The correct answer is: The earnings in the plan accumulate tax deferred

A key tax advantage of a qualified retirement plan is that the earnings within the plan accumulate on a tax-deferred basis. This means that any interest, dividends, or capital gains generated within the account are not taxed in the current year. Instead, taxes on these earnings are deferred until the money is withdrawn, typically during retirement. This can be beneficial because many individuals are in a lower tax bracket during retirement than they are during their working years, allowing them to keep more of their savings invested for a longer period of time. This tax deferral can significantly enhance the growth potential of the retirement savings, as the individual can benefit from compound interest over time without the immediate impact of taxation. The ability to grow investments without the drag of taxes can lead to a much larger retirement nest egg. In contrast, the immediate tax deduction benefits and contributions being taxed at a lower rate do not fully capture the ongoing benefits of tax-deferred accumulation. Withdrawals being tax-free applies to specific types of accounts (like Roth IRAs) but is not a feature typical of qualified plans, which usually tax withdrawals during retirement. Thus, the accumulation of earnings on a tax-deferred basis stands out as a major advantage of qualified retirement plans.