Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What is the typical cost basis for a participant in a qualified retirement plan?

1. Capital gains

2. Ordinary income

3. Investment returns

4. Tax-exempt income

The correct answer is: Ordinary income

The typical cost basis for a participant in a qualified retirement plan is considered to be ordinary income. This is because contributions made to qualified retirement plans, such as a 401(k) or traditional IRA, are typically made with pre-tax dollars, which means that individuals do not pay income tax on these contributions at the time they are made. Instead, they will pay taxes on the distributions they take from the plan during retirement. When funds are withdrawn from the qualified retirement plan, the amounts disbursed are treated as ordinary income, which is why the cost basis reflects ordinary income. The taxation occurs at the retiree's income tax rate during the period of withdrawal, which may differ from their rate during their working years. This understanding is crucial as it impacts the planning and tax implications of retirement income for participants. In contrast, capital gains, investment returns, and tax-exempt income do not typically represent the cost basis for contributions within a qualified plan. Capital gains are the profits from the sale of investments, which do not apply until assets are sold, while investment returns may refer to the earnings generated by the investment but are not the basis for contributions. Tax-exempt income relates to certain types of income that are not taxable, which also does not apply to