UNIT #24: Retirement Plans and Special Types of Accounts

Withdrawals during retirement from which of the following accounts would most likely be subject to the greatest amount of taxation? A) Nondeductible traditional IRA B) Roth IRA C) Qualified variable annuity D) Nonqualified variable annuity

C *The entire amount of the distribution from a qualified annuity will be subject to taxation at ordinary income rates. No tax is due on the Roth, and only the earnings on the nonqualified annuity or nondeductible IRA will be subject to tax.

A 401(k) offering which of the following choices would be most likely to be in compliance with Section 404(c) of ERISA? A) Long-term bond fund, large-cap stock index fund, foreign equity fund B) Small-cap fund, large-cap stock ETF, money market fund C) Money market fund, intermediate-term government bond fund, large-cap stock index fund D) Money market fund, intermediate-term municipal bond fund, large-cap stock index fund

C *The trustee of a 401(k) would be able to reduce her ERISA fiduciary exposure and meet the safe harbor provisions of 404(c) if the plan offered a broad index fund, a medium term government bond fund, and a cash equivalent fund. It isn't the number of funds that counts; it is the different asset classes available. In general, a municipal bond fund (or municipal bonds themselves) would be an inappropriate investment for a tax-qualified plan.

A single individual earning $250,000 a year may 1. open a Coverdell ESA 2. not open a Coverdell ESA 3. open a 529 college savings plan 4. not open a 529 college savings plan A) I and IV B) I and III C) II and III D) II and IV

C *There are income limits that apply to Coverdell ESAs. Single individuals earning more than $110,000 per year are not permitted to open a Coverdell account, and married couples lose the ability to contribute when earnings exceed $220,000. However, there are no income limits restricting who is eligible to open and contribute to a Section 529 college savings plan.

Which of the following is NOT an example of a non-qualified retirement plan? A) A deferred compensation plan B) A SERP C) A payroll deduction plan D) A SIMPLE plan

D *A Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) plan is a qualified retirement plan designed for small businesses (100 or fewer employees). The others are all non-qualified plans.

All of the following investments are eligible for a traditional IRA EXCEPT A) growth-oriented securities B) covered call writing C) bank CDs D) works of art

D *Gems, collectibles, and works of art are ineligible investments for an IRA. Covered call writing is allowed, but speculative options strategies are not. Bank CDs are permissible investments for an IRA. Growth-oriented securities and securities in general are appropriate investment vehicles for IRAs.

A 55-year-old investor makes a withdrawal from his qualified pension plan. Which of the following can he do to avoid tax liability? A) Transfer it as a gift to an UGMA account for his son B) Roll it over into a nonqualified annuity C) Use the withdrawal to pay his current year's taxes D) Roll over the funds into an IRA within 60 days

D *If withdrawals are made from qualified retirement programs with no extenuating circumstances, the participant can roll over the proceeds into an IRA within 60 days and have no tax liability.

Which of the following may be purchased in an UTMA, but not an UGMA? A) Mutual funds B) Individual stocks C) Bank CDs D) Real estate

D *UTMA has a wider range of investment opportunities than UGMA. One of the most often examples is the purchase of real estate.

All of the following statements regarding 529 plans are true EXCEPT A) the assets in the account are controlled by the account owner, not the child B) states impose very high overall contribution limits C) contributions to a 529 plan may be subject to gift taxation D) eligibility is affected by the income level of the contributor

D *Unlike Coverdell ESAs, the income level of the contributor will not affect eligibility to contribute to a Section 529 plan.

Under ERISA, which of the following activities may a fiduciary employ for a corporate retirement plan? A) Loan funds to the plan at favorable interest rates. B) Charge a reasonable commission for the purchase of interests in a real estate partnership that the fiduciary owns. C) Employ third-party pension consultants to advise the plan on the purchase of complex financial instruments. D) Lease office space to the plan.

C *Employing third-party consultants to advise the plan on complex financial instruments is permissible, but parties in interest cannot engage in self-dealing under ERISA.

Which of the following investments would be permitted in a client's IRA? A) Variable life insurance B) Art C) Term life insurance D) Municipal bonds

D *Although not generally recommended for a retirement plan, municipal bonds are permitted. The other choices are not.

Under the Uniform Gift to Minors Act, all of the following are permissible EXCEPT A) the donor and the custodian are the same person B) gifts of securities to a minor C) gifts of cash to a minor D) the purchase of securities on margin

D *UGMA accounts may never be opened as margin accounts.

Which of the following is the most suitable investment for the IRAs of a young couple with a combined annual income of $80,000? A) Partnership interests in an oil and gas drilling program B) Shares of a growth fund C) Options on large-cap common stock D) Initial public offerings of small companies

B *For this couple, the IRA should be established with an objective of long-term appreciation. DPPs, IPOs of small companies, and options on large-cap common stock are riskier investments and are generally considered imprudent for IRAs.

It would be incorrect to state that a lump-sum distribution from a 401(k) before retirement may be A) subject to ordinary income tax and penalty B) eligible to be rolled over into a traditional IRA C) eligible to be transferred to a Roth IRA D) tax free if the recipient is disabled

D *A distribution to someone who is disabled is free of the 10% penalty tax but is still subject to taxation as ordinary income. Distributions from a qualified retirement plan (e.g., a 401(k) plan) prior to retirement are subject to tax and possible penalty unless the funds are rolled over or transferred into a traditional IRA. If, instead, the move is made into a Roth IRA, there is no penalty, but tax would be due just the same as if one converted from a traditional to a Roth IRA.

Which of the following qualified retirement plans offer tax advantages to both the employer and the employee? 1. Individual retirement arrangements (IRAs) 2. 401(k) plans 3. Deferred compensation plans 4. Defined benefit plans A) II and IV B) I and IV C) II and III D) I and III

A *In both 401(k) plans and defined benefit plans, tax advantages accrue to both the employer and the employees. Employer contributions are deductible, and earnings growth is tax deferred to the employee. IRAs offer no benefit to the employer (note that the answer choice did not say "SEP IRA"), and deferred compensation plans are nonqualified.

In the administration of a qualified retirement plan, which of the following individuals is considered to be a fiduciary? A) A financial planner acting as a trustee over the plan assets B) The marketing director of the plan sponsor C) A highly-compensated employee who participates in the plan D) A CPA who prepares the plan's Form 5500 for an annual fee

A *An individual or business entity is considered a fiduciary under ERISA if that person renders investment advice or services to the plan for direct or indirect compensation. Clearly, the financial planner-investment trustee is within this definition. Completing an IRS form (5500) is not an investment-related activity.

Harry, age 52, is an unmarried individual currently earning $55,000 per year. He consults you about the possibility of establishing both a traditional IRA and a Roth IRA this year and making contributions to each. You have determined that Harry should make a $3,000 contribution to the traditional IRA for this year. What amount, if any, can Harry also contribute to the Roth IRA? A) $4,000 B) $2,500 C) $3,000 D) $0

A *Contribution amounts to the traditional and Roth IRA must be aggregated for purposes of determining a total amount. In addition, because Harry is over age 50, he is permitted a $1,000 catch-up contribution. Currently, his total allowable contribution is $7,000; Harry can contribute an additional $4,000 to the Roth IRA.

Which of the following statements regarding Coverdell ESAs and QTPs is NOT correct? A) Coverdell ESAs currently permit up to $5,000 in annual contributions, whereas QTPs allow large contributions reaching as high as $250,000 and above. B) Coverdell ESAs are designed to offer tax benefits to those individuals who wish to save money for a child/grandchild's higher-education expenses. C) QTPs are extremely useful tools that provide significant tax savings, allow for substantial investments for a child's education and provide a tool for avoidance of gift and estate taxes, if used correctly. D) If a portion or all of the withdrawal from a QTP is spent on anything other than qualified higher-education expenses, the the recipient of the money (the owner or the beneficiary) will be taxed at their own tax rate plus a 10% penalty on the earnings portion of the withdrawal.

A *Coverdell ESAs currently permit up to $2,000 in annual contributions, whereas QTPs (Section 529 plans) allow large contributions reaching as high as $250,000 and above.

In many cases, the exceptions from the early distribution tax penalty of 10% are the same for both IRAs and qualified plans. However, a specific exception granted to those with qualified plans that is not available to IRA owners is distributions A) under a QDRO B) for a first-time home purchase C) for certain medical expenses D) used for higher education expenses

A *Only in the case of a qualified (employer sponsored) plan are distributions from a qualified domestic relations order (QDRO) exempt from the 10% early distribution penalty. The home purchase and higher education exception applies only to IRAs, and certain medical expenses qualify for the exemption under both.

Which of the following could reduce the amount that an individual may contribute to a Traditional IRA? Roth IRA contributions made for the year High income level Participation in an employer-sponsored plan Marital status A) I only B) I, II, III and IV C) I, II and III D) I and II

A *The maximum annual contribution applies as a total among your Roth and your traditional IRA. So, if the maximum is $6,000 and you put $3,000 into your Roth, you could only put $3,000 into your traditional IRA. You could do a total of $7,000 if you were 50 or older. High income level and participation in an employer-sponsored plan will affect the amount you may deduct but not the amount you may contribute. Even though a married couple can have their own IRAs or set up a spousal IRA if one is nonworking, that doesn't reduce the amount that either spouse can contribute.

Martha passed away in November 2020 at the age of 87. Among the assets in her estate was an IRA with a value of $150,000. Martha's son, Jerome, a successful 52-year-old surgeon and a client of yours, was named as the beneficiary of the IRA. From a tax standpoint, which of the following options would you recommend to Jerome? A) Jerome should use the 10-year cash-out option. B) Jerome should take the cash now and use the money to fund a new IRA. C) Jerome should take the cash now and use a Section 1035 exchange into an annuity. D) Jerome should use the 5-year cash-out option.

A *When an IRA is inherited by a nonspouse individual, there are several options available. Unless something in the question told us that Jerome is disabled, at his age, the only practical choice is to withdraw the funds over a 10-year period. After the SECURE ACT of 2019, there is no longer a 5-year option. The Section 1035 exchange right does not apply when moving funds from an IRA, and inherited money is not considered earned income for purposes of funding an IAR. ** This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback

Which of the following is a benefit to an employee of a business offering a safe harbor 401(k) using a non-elective formula? A) It guarantees that highly compensated employees do not get more of an employer match than non-highly compensated employees. B) The employer is required to contribute on the employee's behalf even if the employee does not contribute to the plan. C) The employees are guaranteed the ability to consult an investment adviser D) The plan is free from the top-heavy testing requirements.

B *A safe harbor 401(k) with a non-elective formula is one in which the employer must contribute a minimum of 3% of each employee's earnings, whether or not the employee participates in the plan. Furthermore, those contributions are immediately vested. As a result, these plans offer a safe harbor from being tested for being top heavy, but this is a benefit for the employer, not the employee.

When Felicity died, she left her estate, including her IRA, to her daughter, Courtney. Because of her financial circumstances, Courtney decided to abjure the inheritance. This would lead to her A) contesting the estate B) disclaiming the IRA C) accepting the estate D) becoming the executrix of the estate

B *When one wishes to refuse the receipt of an IRA, the procedure is known as disclaiming the IRA.

Which one of the following statements regarding a characteristic or use of a Roth IRA is CORRECT? A) Like regular IRAs, Roth IRA contributions may not be made after the participant attains age 70½. B) Roth IRA withdrawals are tax-deferred in their entirety regardless of the participant's age at withdrawal. C) Roth IRAs are not subject to the minimum distribution rules until the death of the owner-participant of the plan. D) Like regular IRAs, Roth contribution eligibility is restricted by active participation in an employer's retirement plan.

C *Unlike the regular or traditional form of IRA, Roth IRAs are not subject to the minimum distribution rules upon the participant attaining age 70½. Rather, distributions need not be made until the death of the owner/participant. For a Roth IRA withdrawal to be entirely tax free, it must be made after a 5-year holding period and after the participant reaches age 59½.

Which of the following retirement plans is NOT legally required to establish vesting, funding, and eligibility requirements? A) Keogh plan B) Defined benefit pension plan C) Profit-sharing plan D) Payroll deduction plan

D *A payroll deduction plan is a retirement plan not subject to eligibility, vesting, or funding standards as required by ERISA plans. A payroll deduction plan is a nonqualified retirement plan. Profit-sharing, pension, and Keogh plans must have established standards.

In almost all states, the UGMA account has given way to the UTMA account. Although there are more similarities than differences between them, one of those differences is that A) the donor retains control over the investments with an UTMA account B) the account is in the name of the minor in an UTMA account C) there is more investment flexibility in the UGMA account D) transfer of ownership may be delayed to as late as age 25 in some states' UTMA accounts

D *In an UGMA account, ownership is transferred at the state's age of majority. In the case of an UTMA, some states permit delaying the transfer until as late as age 25. In both accounts, control is vested in the custodian, not the donor, and neither account is in the minor's name. The UTMA has greater flexibility, not the UGMA.

Suzy Stanton's wealthy Uncle Ray is a client of yours and is asking for some advice on funding a program to save for Suzy's college education with the lowest possible tax impact. Ray tells you that he set up an UGMA account for Suzy's older brother, Sammy; but, when Sammy turned 18, he took the money, bought a motorcycle, and joined a commune. Ray wants to avoid seeing something like that happen again. What would probably be the best suggestion to help Ray meet his objectives? A) A living trust B) An UTMA account C) A Roth IRA for Suzy with Ray's name as co-owner D) A Section 529 plan

D *The Section 529 plan will give the uncle both tax savings and, because in this plan the assets remain under the control of the donor, the ability to retain the funds if Suzy does not use them for higher education. There is no such thing as a co-owner for an IRA of any kind. Although in many states the age at which UTMA funds become available to the beneficiary is higher than with an UGMA account, there are no particular tax benefits, especially if the amount contributed is large and generates significant income. A living trust would be important for Ray's personal assets but wouldn't apply specifically to the needs described here.

Which of the following statements describes an advantage of a Roth IRA over a traditional IRA? A) Qualifying distributions are received free of income tax if a holding period and age requirement is met. B) There are no annual contribution limits once an individual attains age 59½. C) The required minimum distribution date rules do not apply if the distribution is made in the form of an annuity. D) The AGI limits for contributions are the same as those for traditional deductible IRA contributions.

A *A Roth IRA distribution is tax free if the distribution is made on or after the owner attains age 59½ (or other specified events), and a 5-year holding period requirement is met. The contribution limits are aggregated with that of a traditional IRA regardless of age; however, there are AGI limits with a Roth IRA but none with a traditional IRA.

Those individuals who are considered parties in interest due to handling the assets of a corporate retirement plans are A) not considered to have a fiduciary responsibility B) encouraged to use plan funds to assist the employer when there is a cash flow crisis C) not permitted to use those funds to acquire company assets in an amount beyond the allowable limits D) able to sell personal securities to the plan if that will benefit plan participants

A *ERISA does permit an employee benefit plan to acquire certain company assets subject to statutory limits, (generally, a maximum of 10% of the plan's assets).

What term is used to describe which employees will be covered by a pension plan? A) Funding B) Vesting C) Eligibility D) Party in interest

C *Pension plans must have a uniform nondiscriminatory eligibility program. All employees must be covered when they become eligible, which means reaching 1 year of service working full-time and age 21.

Two years after their wedding, Pam and Jim became the proud parents of child. Both grandparents want to help ensure educational funds for their new grandchild by using the Coverdell ESA. Assuming they are within the earnings limitations, which of the following would be permitted? A) $2,000 from Pam's parents and $2,000 from Jim's parents into a single ESA B) $2,000 from Pam's mother, $2,000 from Pam's father, $2,000 from Jim's mother, and $2,000 from Jim's father C) $2,000 from Pam's parents and $2,000 from Jim's parents into separate ESAs D) $1,000 from Pam's parents and $1,000 from Jim's parents into separate ESAs

D *Any individual whose modified adjusted gross income is under the limit set for a given tax year can make contributions. There's no limit to the number of accounts that can be established for a particular beneficiary; however, the total contribution to all accounts on behalf of a beneficiary in any year can't exceed $2,000.

All of the following permit investments into various securities, such as stocks, bonds, and mutual funds EXCEPT A) a Roth IRA. B) a traditional IRA. C) an HSA. D) an FSA.

D *Flexible spending accounts (FSAs) allow deductions from an employee's paycheck. That money is held by the company and is used to pay allowable claims by the employee. A health savings account (HSA) permits the employee to invest in a wide variety of securities. IRAs, traditional and Roth, have always permitted investment flexibility.

Which of the following has a "use it or lose" it provision? A) HSA B) IRA C) ESA D) FSA

D *The flexible spending account (FSA) offers employees the opportunity to use pre-tax money, primarily for medical expenses. If the money is not used, it is forfeited. HSA money remains and, in many cases, winds up being a supplemental retirement program. ESA funds can either be transferred to another family member, or if not used, withdrawn (although this will incur taxes and penalties).

Which of the following statements regarding loans from 401(k) plans is NOT correct? A) They must be made available to highly compensated employees in amounts greater than that made available to other employees. B) They must bear a reasonable rate of interest. C) They must be made in accordance with the loan provisions stipulated in the 401(k) plan. D) They must be adequately secured.

A *Loans must be repaid with interest, generally within 5 years. They must be secured and made in accordance with plan provisions. Loans may not be made available to highly compensated employees in amounts greater than that made available to other employees.

One benefit of a 457 plan that is not found in any other employer-sponsored tax-qualified plan is A) contributions are made on a pre-tax basis. B) penalty-free withdrawals at any age for any reason. C) earnings on the contributions are not taxed until the funds are withdrawn. D) the plan may allow for employer matching of contributions.

B *The 457 plan is unique in that it is the only tax-qualified retirement plan permitting withdrawals, for any reason, before reaching 59½ without penalty. All qualified plans have exceptions to the 10% penalty tax, but only the 457 allows the withdrawals for any reason. The other choices are found in almost all other employer-sponsored plans, such as 401(k) and (403(b) plans.

Which of the following retirement plans would be appropriate for a highly compensated government employee? A) IRA B) 401(k) C) 403(b) D) 457(b)

D *Section 457 of the Internal Revenue Code establishes 457(b) plans for, among others, employees of state and local governments. One can have both a 457 and a 401(k), or both a 457 and a 403(b), but it is the 457 that is specific to a governmental employee.

Which of the following offers the benefit of tax-deductible contributions? A) Health savings account (HSA) B) Roth IRA C) Coverdell Education Savings Account (ESA) D) Payroll deduction plan

A *An HSA permits eligible participants to claim a tax deduction for contributions made to the plan. In the ESA and Roth IRA, contributions are made with after-tax funds, but growth and, if qualified, ultimate distribution, are tax free.

ERISA regulation does not apply to public school district retirement plans publicly traded utility company retirement plans federal government employee retirement plans A) I, II, and III B) I and II only C) I only D) I and III only

D *ERISA rules only apply to private sector plans. Government or public sector plans are not subject to the Employees Retirement Income Security Act of 1974.

All of the following statements regarding 529 plans are true EXCEPT A) contributions are made with pretax dollars at the federal level B) earnings accumulate tax free if the money is used for qualified educational purposes C) anyone can make a contribution on behalf of a beneficiary D) a beneficiary of a 529 plan may also be the beneficiary of a Coverdell Education Savings Account

A *Contributions are made with after-tax dollars. Withdrawals are tax free at the federal level if used for qualified education expenses with a limit of $10,000 per year for K-12 tuition expenditures.

Under the minimum distribution rules, Jason is required to take a minimum distribution of $10,000 this year from his IRA. However, a distribution of only $8,000 has been made. What is the dollar amount of penalty that may be assessed in this situation? A) $1,000 B) $200 C) $2,000 D) $4,000

A *The penalty for failure to make the correct amount of required minimum distribution is 50% of the difference between the minimum required amount and the actual distribution. In this case, this would be 50% of $2,000 ($10,000 − $8,000) or $1,000.

To comply with the safe harbor requirements of Section 404(c) of ERISA, the trustee of a 401(k) plan must 1. offer plan participants at least three different investment alternatives 2. ensure that plan participants are insulated from control over their portfolios 3. allow plan participants to change their investment options no less frequently than quarterly 4. allow plan participants to purchase U.S. Treasury securities A) I and III B) II and IV C) II and III D) I and IV

A *The safe harbor requirements relieve the trustee of a 401(k) plan of liability if the plan participants have the ability to select from at least 3 different investments and are allowed to make selection changes no less frequently than quarterly.

For which of the following employer-sponsored qualified plans is it mandatory that annual contributions be made? A) Money purchase pension plan B) Deferred compensation plan C) Defined benefit plan D) Profit-sharing plan

A *When an employer sets up a type of defined contribution plan known as a money purchase pension plan, annual contributions are mandatory. Profit-sharing plan contributions are optional and largely depend on the company's profits. Deferred compensation plans carry no obligations. What about defined benefit plans? Because those are based on an actuarial computation, if the account over-performs expectations, it could result in a year when no contribution is necessary.

All of the following statements regarding qualified corporate retirement plans are true EXCEPT A) with defined benefit plans, the employee bears the investment risk B) all corporate pension and profit-sharing plans must be established under a trust agreement C) defined contribution plans have the same contribution limits as Keogh plans D) all qualified retirement plans are either defined contribution or defined benefit plans

A *With defined benefit plans, the employer (not the employee) bears the investment risk. The employer must fund the defined benefits, regardless of the investment performance of funds set aside for this purpose. The retiree receives a defined benefit regardless of investment performance. All corporate pension and profit sharing plans must be established under a trust agreement. All qualified retirement plans are either defined contribution or defined benefit plans. Defined contribution plans have the same contribution limits as Keogh plans.

Which of the following statements is TRUE regarding Section 529 plans? 1. Funds withdrawn for qualified education expenses are always free of federal income tax. 2. Funds withdrawn for qualified education expenses are always free of state income tax. 3. The maximum contribution limits are determined on a federal level. 4. The maximum contribution limits are determined on a state level. A) I and IV B) II and III C) I and III D) II and IV

A Section 529 plan withdrawals are exempt from federal income tax if used for the right expenses. In almost all cases, if the plan is one operated by your state of residence, it will be exempt from your state's income tax. But, if you elect to contribute to a plan operated by another state, more than likely, any withdrawals will be subject to your state's income tax. Because the plans are state operated, the maximum contribution limits are set by each state.

Tammy Jones is retiring from her company next month on her 62nd birthday. Her 401(k) has $300,000 and offers her 4 different mutual funds. After calculating what she will receive from Social Security, she concludes that she will need an additional $500 a month to retain her current lifestyle. Which of the following would be the most appropriate recommendation? A) Take a lump-sum distribution of the entire $300,000 B) Roll the money into a traditional IRA C) Leave the money in her current 401(k) account D) Roll the money into a mutual fund withdrawal plan

B *It would benefit Ms. Jones most to roll the money into a traditional IRA. By doing this she would defer paying taxes on the $300,000—something she could not avoid if she took the lump-sum distribution or rolled the money into a mutual fund withdrawal plan. Although the decision to roll over into a self-directed IRA or leave the funds in the 401(k), if permitted, is one worthy of consideration, with only 4 mutual funds being offered in Ms. Jones's 401(k) account, most would agree that the increased options available in the IRA make that the better choice.

Which of the following statements about plan fiduciaries under ERISA are TRUE? 1. Plan fiduciaries sometimes have conflicting obligations to plan participants and other parties in interest. 2. Plan fiduciaries must ordinarily diversify plan investments. 3. Plan fiduciaries are personally liable for fines if they violate their fiduciary duties. A) I and III B) II and III C) I and II D) I, II, and III

B *Under ERISA, plan fiduciaries must act solely in the interests of plan participants and beneficiaries, and they may not place the interests of other interested parties above those of the plan participants and beneficiaries. They must diversify plan investments to minimize the risk of large losses, unless it would not be wise to do so. If they violate any of their fiduciary duties, they may be personally liable for large fines.

Which of the following concerning a money purchase pension plan are TRUE? 1. All employees must contribute to the plan. 2. Voluntary employee contributions are optional. 3. Employer contributions are required. 4. Employer contributions are optional. A) II and IV B) I and IV C) II and III D) I and III

C *A money purchase pension plan is a defined contribution plan established by the employer, thereby making the contributions mandatory. Employee participation by making voluntary contributions to the plan is optional. Employees who contribute to the plan usually contribute a percentage of their income.

One of your clients asks about a Coverdell Education Savings Account for college savings. To avoid income taxation and penalties, your advice is that these funds must be used before the student reaches age A) 24. B) 32. C) 30. D) 25.

C *All funds within a CESA must be used before the student reaches 30 years of age. Any funds remaining must be distributed within 30 days of the birthday and earnings in the account are subject to ordinary income tax plus a 10% penalty. There is an exception for a special needs beneficiary and that would have to be mentioned in the question to apply.

An individual has a substantial vested interest in his 401(k) plan at work. Which of the following is NOT an exception to the premature distribution penalty tax? A) Distribution to pay certain medical expenses B) Distribution made pursuant to a qualified domestic relations order C) Distribution of up to $10,000 made to purchase a principal residence D) Distribution because of an employee's death or disability

C *Although individuals can make penalty-free withdrawals from an IRA to purchase a principal residence, this exception does not apply to withdrawals from a 401(k) plan. The penalty for withdrawals from a 401(k) plan taken before age 59½ is waived only in the cases of death, disability, qualified domestic relations orders (QDROs), certain medical expenses, certain period payments, and corrections of excess contributions.

Which of the following is not included in adjusted gross income on an individual's federal income tax return? A) Unemployment compensation B) Dividends paid on preferred stock C) Municipal bond interest D) Salary and commissions

C *Although tax-exempt interest is reported on the Form 1040 (line 8b), it is not included in adjusted gross income.

Which of the following is NOT true concerning a Coverdell Education Savings Account (ESA)? A) The beneficiary may be the contributor's child or grandchild or child of a friend of the contributor. B) The maximum contribution is $2,000 per beneficiary. C) In order for the withdrawal to be considered qualified, it may only be used for post-secondary education expenses. D) A beneficiary's unused balance may be rolled over to an ESA account for another child.

C *An ESA may be used to fund education at any level. The maximum contribution permitted for any beneficiary is $2,000 per year. The beneficiary need not be related to the contributor(s). ESAs may be rolled over to change investment vehicles or to change beneficiaries. Unlike the Section 529 plan, the contribution limits for an ESA are set by the federal government and are considerably less than those for 529 plans.

Assuming all withdrawals are equal, which of the following would subject a 60-year-old investor to the least amount of tax? A) Non-qualified variable annuity B) 403(b) plan C) Roth IRA D) Traditional IRA

C *As long as the Roth has been opened a minimum of 5 years, once the investor has reached 59 ½, withdrawals are free of any tax. Generally, the most tax would be with the traditional IRA (assuming it was funded exclusively with pretax funds) and the 403(b). Because the non-qualified VA is funded with post-tax funds, a portion of the amount withdrawn might be the original principal and there is no tax due on that.

Those individuals who are considered parties in interest due to handling the assets of a corporate retirement plans are A) not considered to have a fiduciary responsibility B) encouraged to use plan funds to assist the employer when there is a cash flow crisis C) not permitted to use those funds to acquire company assets in an amount beyond the allowable limits D) able to sell personal securities to the plan if that will benefit plan participants

C *ERISA does permit an employee benefit plan to acquire certain company assets subject to statutory limits, (generally, a maximum of 10% of the plan's assets).

Which of the following regarding a Roth IRA are TRUE? 1. The contributions are nondeductible. 2. One may not contribute to a Roth IRA if concurrently contributing to a traditional IRA. 3. The contributions are deductible. 4. Withdrawals after age 59½ may be tax free. A) I and II B) III and IV C) I and IV D) II and III

C *In a Roth IRA, contributions are not deductible from current income. Withdrawals after age 59½ are tax free, provided the account has been open for at least 5 years. One may maintain both a Roth and a traditional IRA concurrently. However, the maximum total contribution between both plans is $6,000 (or $7,000 for those age 50 or older).

Mrs. Jones, age 70, is retiring, and her employer has 3 investment options for her 401(k). You should advise her to A) leave the investments with her employer B) take a distribution of 100% of the funds in the account C) do a rollover to a traditional IRA D) do a rollover to a variable annuity under a Section 1035 exchange

C *Most advisers would agree that even when the employer's 401(k) plan permits retirees to continue to maintain their account, it is better for the client to move the assets to a self-directed IRA when the plan offers a limited number of investment choices. One cannot do a rollover into a variable annuity; Section 1035 only applies to insurance contract exchanges. Because of the immediate tax liability, it generally does not make sense to take a lump-sum distribution

A frequent concern of parents initiating a savings plan for the college education of their child is the lack of control over the assets, particularly if the child decides to forego higher education. When you have a client who shares this concern with you, it would be most appropriate to suggest A) an UTMA account. B) U.S. Treasury zero-coupon bonds. C) a Section 529 plan. D) opening a new account in the client's name for this purpose.

C *One of the features of the Section 529 plan is that the donor maintains control over the funds in the account. Therefore, should the child not go to college, the money can either be transferred to another family member or withdrawn by the donor (although that will incur taxation issues). With an UTMA account, once the child reaches the termination age set by the state, the money is now hers. The zero-coupon bonds would have to be purchased in a custodial account so the issue is the same. Yes, the client could open a separate account and consider its usefulness for the child's education, but there are no tax benefits, unlike with a 529 plan. Furthermore, there might be complications, such as those assets not being protected from creditors.

Jill's bank, where she has her traditional deductible contributory IRA, is recommending that she roll over her contributory IRA into a Roth IRA to benefit from the tax-free status of the withdrawals when she retires. (Jill is now 32 years old.) Which of the following is a consequence if Jill follows the bank's recommendations? A) No tax will occur, provided the rollover is completed within 60 days. B) Rolling over a traditional IRA to a Roth IRA will negate the tax-free status of future withdrawals. C) The amount attributable to growth must be declared as income. D) The entire amount rolled over must be declared as income.

D *A traditional IRA may be rolled over into a Roth IRA, and the 10% penalty may be avoided if the rollover is accomplished in 60 calendar days. However, there will be an immediate tax consequence regarding any sum that exceeds the participant's cost basis. Because Jill was taking deductions for her IRA contributions, she has a 0 basis, and the entire amount will be treated as taxable ordinary income in the year rolled over.

Under ERISA, all of the following retirement plans must set standards for vesting, eligibility, and funding EXCEPT A) corporate pension plans B) profit-sharing plans C) Keogh plans D) deferred compensation plans

D *Deferred compensation plans are not qualified plans and may be discriminatory. Keogh, profit-sharing, and corporate pension plans must meet set standards for vesting, eligibility, and funding under ERISA.

Your client who has not yet attained the age of 59 ½ wants to take a withdrawal from his traditional IRA. Not being disabled or meeting any other qualifying reason allowing for an early withdrawal you explain that the amount taken will be subject to a penalty of A) 6% B) 50% C) 15% D) 10%

D *Except in the case of death, disability, or certain other qualifying reasons, withdrawals made before the account owner reaches age 59½ are subject to a penalty of 10% of the gross amounts withdrawn in addition to ordinary income taxes.

An employer whose 401(k) plan complies with ERISA Section 404(c) is placing investment risk with A) the Internal Revenue Service B) the plan fiduciary C) the Securities and Exchange Commission. D) the plan participant

D *In a 401(k) plan, a plan sponsor can shift investment risk to the employee by complying with ERISA Section 404(c) rules

A 61-year-old wanting to take a lump-sum distribution from his Keogh will A) incur a 50% penalty tax B) incur a 10% penalty tax C) be taxed at long-term capital gains rates D) be taxed at ordinary income rates

D *The distribution described here would be taxed as ordinary income. A 10% penalty tax would apply if the individual were under age 59½.

If your customer works as a nurse in a public school and wants to know more about participating in the school's 403(b) plan, it would be accurate to make each of the following statements EXCEPT A) mutual funds and annuities are available investment vehicles B) contributions are made with pretax dollars C) distributions before age 59½ are normally subject to penalty D) she is not eligible to participate

D *The nurse must be informed that because she is employed by a public school system, she is eligible to participate in the tax-sheltered annuity plan. As in other retirement plans, a penalty is assessed on distributions taken before age 59½. A 403(b) plan may invest in various instruments, including mutual funds, and GICs in addition to annuity contracts.

One of your clients wishes to reallocate the assets in his 401(k) plan. Specifically, he plans to assist his parents in the purchase of a retirement home. He claims that it makes sense to have about 10% of his plan assets in real estate. A) This would only be permitted if the home were for his personal use. B) This is prohibited as qualified plans cannot own real estate. C) An asset allocation model would not have 10% in real estate. D) This is not permitted because a prohibited party will benefit.

D *There are two problems here. First of all, any investment in a qualified plan (or IRA), must be for future use (or else it would be considered a distribution subject to tax). Second, real estate may be used prior to your retirement, but not by "related" parties. These are defined as your spouse and lineal members of your family (ancestor or descendant or their spouse). So, because the parents will be using the property, they are considered prohibited persons.

A self-employed attorney has income of $110,000 per year. If he contributes $4,000 to his traditional IRA and has no other retirement plans, which of the following statements is true? A) The contribution is partially tax deductible. B) The contribution is not permitted. C) The contribution is not tax deductible. D) The contribution is fully tax deductible.

D *Traditional IRA contributions are fully deductible no matter how much income is earned if the taxpayer is not covered by any other qualified plan. Anyone with earned income can contribute to a traditional IRA.