Advanced Diploma of Financial Planning (ADFP) Practice Test

Which of the following statements is true about lump-sum distributions in tax-advantaged accounts?

1. They are always taxed at a higher rate

2. They can include employer securities

3. They are subject to no tax consequences

4. They are considered non-taxable income

The correct answer is: They can include employer securities

The statement that lump-sum distributions from tax-advantaged accounts can include employer securities is accurate. In the context of retirement plans, such as 401(k)s or pension plans, a lump-sum distribution refers to the withdrawal of all funds in a single payment rather than as an annuity or over time. When these distributions are taken, they can indeed include the value of employer securities held within the account. This is significant because when participants leave a job or retire, they often have the choice to cash out their retirement benefits, which may involve not only cash but also stocks or other securities issued by their employer. Including employer securities in the distribution allows individuals to make informed decisions about diversifying their investments or liquidating assets based on their specific financial situation. In contrast, lump-sum distributions are not necessarily always taxed at a higher rate, nor are they free from tax consequences. In fact, there are often tax implications associated with these distributions. Additionally, they cannot be classified as non-taxable income, as most distributions from tax-advantaged accounts are subject to income tax. Understanding these nuances is crucial for effective financial planning, particularly when strategizing to minimize tax liabilities associated with retirement distributions.