TCP CPA Practice Questions Explained: Roth IRAs and 401(k)s

Roth IRAs and 401(k)s

Share This...

In this video, we walk through 5 TCP practice questions teaching about Roth IRAs and 401(k)s. These questions are from TCP content area 1 on the AICPA CPA exam blueprints: Tax Compliance and Planning for Individuals and Personal Financial Planning.

The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.

Also be sure to watch one of our free webinars on the 6 “key ingredients” to an extremely effective & efficient CPA study process here…

Click here to watch the video on YouTube…

Roth IRAs and 401(k)s

Roth IRAs

How Roth IRAs Work: Roth IRAs are individual retirement accounts that offer tax-free growth and tax-free withdrawals in retirement. Contributions to Roth IRAs are made with after-tax dollars, meaning they are not deductible on your tax return. Because taxes are paid on the front end, all withdrawals made during retirement (after age 59½ and once the account has been open for at least five years) are completely tax-free. This includes both the initial contributions and any earnings accrued.

Example of Contributions and Earnings:

  • Contributions: If Alice contributes $5,000 annually to her Roth IRA for 10 years, she invests a total of $50,000 of after-tax money.
  • Earnings: If her investments grow at an average rate of 7% per year, her account may grow to about $71,000 after 10 years, where $21,000 represents earnings on her contributions.

Early Withdrawals: Withdrawals from a Roth IRA are taken in a specific order: contributions are withdrawn first, then conversion and rollover amounts, and lastly, earnings. Contributions can be withdrawn at any time without taxes or penalties. However, early withdrawals on earnings may incur a 10% penalty unless they qualify for an exemption like educational expenses, a first-time home purchase (up to $10,000), or unreimbursed medical expenses.

Example of Early Withdrawal:

  • If Alice withdraws $10,000 from her Roth IRA, and she has previously contributed $50,000, the entire withdrawal is classified under contributions and is thus penalty- and tax-free.

401(k)s

How 401(k)s Work: A 401(k) is an employer-sponsored retirement plan that allows employees to save and invest a portion of their paycheck before taxes are taken out. Contributions reduce their taxable income, and the funds grow tax-deferred until withdrawn in retirement. Some employers offer a Roth 401(k) option, where contributions are made with after-tax dollars and withdrawals are tax-free, similar to a Roth IRA.

Employer Matching: Many employers offer a match on contributions, which is essentially free money. For example, an employer may match 50% of employee contributions up to 6% of their salary.

Example of 401(k) Contributions:

  • Contributions: Bob contributes 10% of his $60,000 salary ($6,000) annually to his traditional 401(k).
  • Employer Match: His employer offers a 50% match up to 6% of his salary, contributing an additional $1,800 to Bob’s 401(k).

Early Withdrawals: Withdrawing funds from a 401(k) before age 59½ generally results in a 10% penalty in addition to being taxed as ordinary income. Exceptions include hardship withdrawals, such as certain medical expenses, which may still be subject to taxes.

Example of Early Withdrawal:

  • If Bob withdraws $10,000 from his traditional 401(k) for a non-qualified expense, he faces a 10% penalty ($1,000) and the withdrawal is taxed at his income rate.

Differences Between Roth IRAs and 401(k)s

  1. Tax Treatment: Roth IRAs use after-tax dollars for contributions and provide tax-free growth, while traditional 401(k)s use pre-tax dollars and defer taxes until withdrawal.
  2. Withdrawal Rules: Roth IRAs do not require RMDs (Required Minimum Distributions) during the owner’s lifetime, whereas 401(k)s do require RMDs starting at age 72.
  3. Contribution Limits: Roth IRA contribution limits are generally lower than those for 401(k)s. For example, in 2023 the limit for Roth IRAs was $6,500 ($7,500 for those 50 or older), while for 401(k)s it was $22,500 ($30,000 for those 50 or older).
  4. Employer Contributions: 401(k) plans may include employer contributions, but Roth IRAs are solely funded by the individual.

Other Posts You'll Like...

Want to Pass as Fast as Possible?

(and avoid failing sections?)

Watch one of our free "Study Hacks" trainings for a free walkthrough of the SuperfastCPA study methods that have helped so many candidates pass their sections faster and avoid failing scores...