Final answer:
Traditional IRAs work more like qualified retirement plans, allowing pretax contributions to grow tax-deferred until withdrawal. Like 401(k)s and 403(b)s, these contributions are not taxed until distribution, benefitting retirees by deferring taxes and reducing the impact of inflation on retirement savings.
Step-by-step explanation:
A traditional Individual Retirement Account (IRA) works more like a qualified retirement plan rather than a non-qualified plan. The key characteristics of a traditional IRA include directing pretax income towards investments that can grow tax-deferred, where the capital gains or dividends are not taxed until withdrawal, which usually occurs after retirement.
Similar to 401(k)s and 403(b)s, which are also classified as qualified plans, funds contributed to a traditional IRA are not taxed until they are withdrawn, effectively deferring taxes and potentially providing a higher rate of return on savings by postponing tax payments until retirement.
Defined contribution plans like 401(k)s and 403(b)s are often employer-sponsored and involve both employer and employee contributions. These contributions are invested in a range of investment vehicles and enjoy tax-deferred status, making them portable and beneficial as they can be transferred if an individual changes employers.
Both these plans and traditional IRAs aim to mitigate the inflation costs for retirees by ensuring that the investments made within these accounts grow without being taxed immediately.