A sponsor can fund a plan perfectly and still destroy it with one loan to the owner. Exam questions here split four ways: contributions, non-discrimination testing, reporting, and prohibited transactions.
What qualification buys. A qualified plan is a retirement plan that satisfies IRC 401(a) and holds its assets in a trust for the exclusive benefit of participants. Employers go to the trouble because that status delivers three tax results at once.
- The employer deducts contributions in the year it makes them, before any employee is taxed on them.
- The participant defers tax until the money is distributed, and the trust's earnings grow untaxed in the meantime.
- The assets get creditor protection. They are generally out of reach of the sponsor's creditors.
The price of qualification is following the rules on coverage, vesting, funding, and non-discrimination.
Deferral in a qualified plan doesn't last forever. Required minimum distributions, the amounts a participant must start withdrawing each year, begin at age 73 for a participant who turns 72 after 2022.
Common mistakes
- Multiplying by 0.9235 twice. The 0.9235 factor is used once, to compute SE tax. Running profit through 0.9235 again before the 20% step double-counts that adjustment and understates the contribution. On $120,000 it produces $22,164 instead of $22,304.
- Using 25% for a sole proprietor. The statutory 25% applies to W-2 compensation. A self-employed owner uses 20% of the base that remains after the deduction for one-half of SE tax.
- Misdating the HCE look-back. The pay test uses the look-back year's compensation and that year's threshold: for the 2025 plan year, 2024 compensation above $155,000 controls. A 5% owner is an HCE regardless of pay.
Bottom line
- Qualified plans give the employer an immediate deduction and the employee deferral; non-qualified plans defer the employer deduction until inclusion and stay creditor-reachable.
- 2025 limits: elective deferral $23,500, catch-up $7,500 ($11,250 at ages 60 to 63), 415(c) annual additions $70,000, compensation cap $350,000.
- SEP = employer-only, lesser of 25% of compensation or $70,000, uniform percentage, fundable through the extended due date.
- SIMPLE IRA = $16,500 ($17,600 at an employer with 25 or fewer employees), catch-up $3,500 or $3,850; employer must match 3% or give 2% nonelective; self-employed apply 20% to Schedule C profit minus one-half SE tax.
Exam shortcut
Read the stem for the employment status first. "Sole proprietor," "Schedule C," or "partner's self-employment income" means the answer uses profit × 0.1859 as a sanity check and never 25%. "Employee with W-2 wages" means a straight 25%. The distractor built on 0.9235-then-20% is in almost every self-employed contribution item; compute the real base and eliminate it.
The full lesson (about 4,129 words, 28 min read) adds 2 worked examples, all 7 common mistakes, a self-check, free in the app.
Learning objectives
- 3
Browse all free EA Part 2 lessons or jump into free EA Part 2 practice questions.