Certified Plan Sponsor Professional (CPSP) Practice Exam

What is the tax treatment of Roth contributions?

1. Contributions are tax-deductible.

2. No federal, state, or local taxes apply.

3. Applicable federal, state, and local taxes are withheld for the contribution amount.

4. Taxes are only due upon withdrawal.

The correct answer is: Applicable federal, state, and local taxes are withheld for the contribution amount.

Roth contributions are unique in their tax treatment compared to traditional retirement contributions. When an individual makes Roth contributions, they do so with after-tax dollars. This means that the contributions are made from income that has already been taxed. As a result, there is no tax deduction available for these contributions, which differentiates them from traditional pre-tax contributions. As the contributions are made after taxes have been deducted, it means that when funds are withdrawn from the Roth account in retirement, provided certain conditions are met (such as reaching age 59½ and the account being held for at least five years), those withdrawals—including both contributions and earnings—are tax-free. This is one of the main advantages of Roth accounts. In terms of federal, state, or local taxes affecting the contributions themselves, while they do receive favorable tax treatment upon qualified withdrawal, taxes are not withheld at the time of contribution. This makes the characterization of contributions being tax-deductible incorrect, as well as the idea that no taxes apply at all or that they are withheld at the time of contribution. The nature of Roth contributions is fundamentally about paying taxes upfront, which sets the stage for tax-free withdrawals later. Thus, while taxes are not withheld at the time of contribution, it's crucial to