Question

part a

which two statements describe how saving $200 every month in her traditional 401(k) retirement account is different from saving $200 every month for her car?

select all the correct answers.

• isabels retirement savings are made with after-tax dollars.
• isabels retirement savings are made with pretax dollars.
• isabels retirement savings can be used for other purposes without penalty.
• isabels retirement savings have more liquidity than the money in her savings account.
• isabels retirement savings have no contribution limits.
• isabels retirement savings may include a contribution from her employer.

Explanation:

Analyze traditional 401(k) tax treatment

A traditional 401(k) is a retirement account funded with pre-tax dollars. This means contributions are deducted from gross income before taxes are calculated, reducing current taxable income. In contrast, saving for a car in a standard savings account is done using after-tax dollars. Therefore, the statement "Isabel's retirement savings are made with pretax dollars" is correct.

Evaluate liquidity and penalties

Retirement accounts like a 401(k) have strict rules regarding withdrawals. Early withdrawals before age \(59\frac{1}{2}\) generally incur a 10% penalty plus income taxes, meaning they have low liquidity. A standard savings account for a car is highly liquid and can be used at any time without penalty. Thus, statements claiming retirement savings have more liquidity or can be used without penalty are incorrect.

Evaluate contribution limits

Both 401(k) accounts and standard savings accounts have rules, but a 401(k) specifically has annual contribution limits set by the IRS. Therefore, the statement "Isabel's retirement savings have no contribution limits" is incorrect.

Analyze employer matching

Many employers offer matching contributions for employee 401(k) plans, which is free money added to the retirement account. Standard personal savings accounts for a car do not receive employer matches. Therefore, the statement "Isabel's retirement savings may include a contribution from her employer" is correct.

Answer:

• Isabel's retirement savings are made with after-tax dollars.
• Isabel's retirement savings are made with pretax dollars. (Correct answer)
• Isabel's retirement savings can be used for other purposes without penalty.
• Isabel's retirement savings have more liquidity than the money in her savings account.
• Isabel's retirement savings have no contribution limits.
• Isabel's retirement savings may include a contribution from her employer. (Correct answer)