Retirement Planning: Investment Considerations for Retirement Plans (Module 6)

Which of the following types of funding vehicles is not approved for 403(b) plans? a. Cash value life insurance b. Mutual fund c. Unit investment trust d. Variable annuity contract

C Cash value life insurance must be an incidental benefit. Only open-end mutual funds are allowed, not UITs, closed-end funds, or individual securities.

If the amount of insurance meets either of the following tests, it is considered incidental insurance. What are the tests?

- The participant's insured death benefit must be no more than 100 times the expected monthly benefit (100 times limit), or - The aggregate premiums paid (premiums paid over the entire life of the plan) for a participant's issued death benefit are at all times less than the following percentages of the plan cost for that participant (percentage limits): -- Ordinary life insurance - 50% -- Term insurance - 25% -- Universal life insurance - 25%

In the event of a death, how is the death benefit from a qualified plan taxed to the beneficiary?

- pure life insurance element is tax free - the remained is taxed as a qualified plan distribution

The Secretary of Labor may not grant an exemption under subsection 1108 unless he finds that such an exemption is which of the following? 1. in the interest of the plan and of its participants and beneficiaries 2. protective of the rights of participants and beneficiaries of such plan 3. administratively feasible 4. protective of the rights of the fiduciary of the plan

1, 2, 3 The secretary of labor may not grant an exemption under subsection 1108 unless he finds that such an exemption is: administratively feasible, in the interest of the plan and of its participants and beneficiaries, and protective of the rights of participants and beneficiaries of such plan

Mr. and Mrs. Yelson have been married 40 years. They live in the same town they grew up in. They attend the same church they got married in 40 years ago. Mr. Yelson has worked at the GM plant in town since he graduated from high school and is now a supervisor at the plant. Which of the following issues do you think Mr. and Mrs. Yelson discuss? 1. Their children 2. Retirement goals 3. GM 4. Their grandchildren 5. Moving to Florida

1, 3, 4 Various surveys concluded that couples are not discussing their retirement goals. 62% do not even agree on what the expected retirement age should be. The husbands seemed to be more involved with money. This is a very subjective behavioral finance type question. All of the above is not an impossible answer.

Which of the following statements is true regarding fully insured pension plans? 1. there is a trusteed side fund 2. fully insured plans may solve the problem of "overfunded" plans 3. Funded exclusively by life insurance or annuity contracts 4. fully insured plans are very popular

2, 3 A fully insured pension plan is one that is funded exclusively by life insurance or annuity contracts. There is not trusteed side fund. Such plans were once common, but the high interest rates of the late 1970s lured many pension investors away from traditional insured pension products

Who are the fiduciary's main concerns? 1. the retirement plan 2. the fiduciary's company 3. participant 4. beneficairies

3, 4

Which of the following investment vehicles may not be used to fund a TSA? a. U.S. operating company stock (cannot be passive) b. Mutual funds c. Open-end investment management companies d. Annuities with incidental life insurance

A "Open-end investment management companies" is a different name for Mutual funds. Any type of annuity is an acceptable investment. Incidental life insurance within the annuity is also acceptable. A TSA cannot be funded with common stock.

Which of the following characteristics is not included in a profit-sharing plan? a. It cannot invest the plan's assets in the sponsoring company's stock. b. The employer can deduct up to 25% of the compensation of all eligible participants. c. It can allow for in-service distributions. d. The employee assumes the risk of preretirement inflation, investment performance, and adequacy of retirement income.

A A plan subject to ERISA may not acquire or hold qualifying securities if the total fair market value of such assets exceeds 10% of the plan's portfolio at the time of acquisition. The plan can invest up to 100% of the plan's assets in the sponsoring company's stock if, and only if, the plan document allows it.

Fully insured pension plan

A fully insured pension plan is one that is funded exclusively by life insurance or annuity contracts. There is not trusteed side fund. Such plans were once common, but the high interest rates of the late 1970s lured many pension investors away from traditional insured pension products

Envelope Funding Approach

At the opposite pole from the combination plan, where the entire plan is structured around the insurance policies, is the envelope funding approach, where insurance policies are simply considered as plan assets like any other assets.

Mr. Adams, age 68, had just been considering retiring. He had discussed his retirement options with his wife before he died. A participant in a profit sharing 401(k) plan, he had accumulated $1.5 million. Mr. and Mrs. Adams had very little invested outside the plan except their home and personal property. He had not taken Social Security benefits. Mrs. Adams, age 65, also had not taken Social Security benefits. Mrs. Adams has no investment knowledge and has trouble making basic decisions. If she applies for benefits under Social Security, what do you suggest she do with his retirement plan? a. Roll it into an IRA in her name and hire a good money manager. b. Roll it into an IRA and take a guaranteed lifetime income option. c. Leave it in his 401(k) account until she needs the income. d. Roll it into a Roth IRA in her name and use the money manager who was handling the 401(k).

B His Social Security benefits may not be enough to support her lifestyle. While living, Mr. Adams never saved any money. By taking the guaranteed lifetime income, she will not be forced to make a decision. Hiring a money manager or leaving in the 401(k) does not address her needs for money now. Rolling into a Roth IRA and using the same money manager who handles the 401(k) would be subject to income tax.

What is the ideal employer to use a combination pension?

Combination plans are very appropriate for funding smaller pension plans, fewer than about 25 employees, but can be administratively costly for larger plans due to the number of insurance policies necessary for funding.

Larry and Kristi select a joint and survivor annuity with a 100 percent survivor benefit. What are the disadvantages to them of selecting a 100 percent survivor benefit versus a 50 percent survivor benefit? A. The initial benefit will be less B. If Larry dies, Kristi will not receive a benefit C. If Kristi dies, Larry will receive a lump sum distribution D. If Kristi dies, Larry will not receive a benefit

Correct Answer: A. The initial benefit will be less Explanation: The disadvantage of a joint survivor annuity with a 100 percent survivor benefit is that the initial benefit received will be less because there is a guarantee that the survivor will receive the same payout. A joint and survivor annuity with a 50 percent payout will pay a higher initial benefit due to the fact that only 50 percent of the benefit will be paid upon one of the annuitants' deaths.

Ted has purchased an annuity for $20,000 that is expected to pay him $300 per month for the rest of his life. Ted's life expectancy is 20 years. How much of each payment is taxable to Ted? A. $ 83.33 B. $ 216.67 C. $ 300 D. None

Correct Answer: B. $ 216.67 Explanation: Taxable = Exclusion Ratio (Payment) = 1-(Investment in contract/Expected payout) x payment = 1-($20,000/$72,000) x $300 = 216.67

Jack is looking for an annuity that will guarantee a rate of return and provide payments for his lifetime. What type of annuity and payout option should he choose? A. Variable annuity with single life payout B. Fixed annuity with single life payout C. Variable annuity with certain period payout D. Fixed annuity with certain period payout

Correct Answer: B. Fixed annuity with single life payout Explanation: A fixed annuity guarantees a rate of return because it puts the funds in the general account. With a single payout option, the annuitant will receive payments as long as he or she lives whether that is 1 year or 50 years.

Bill, a fiduciary of the CAP pension plan, took $10,000 of the pension plan and invested it in his own account. The $10,000 grew to $15,000 and then Bill's breach was discovered. What will Bill be responsible for? A. He has no liability for the $10,000. B. He must return the $10,000 to the plan. C. He must return the $10,000 and the $5,000 profits to the plan. D. He must return the $5,000 earning to the plan only.

Correct Answer: C. He must return the $10,000 and the $5,000 profits to the plan. Explanation: Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries shall be personally liable to make good to such plan any losses to the plan resulting from each breach. They will have to restore to such plan any profits of such fiduciary, which have been made through use of assets of the plan by the fiduciary.

John has a qualified plan that has $100,000 of life insurance on his life with his wife as the named beneficiary of his qualified plan and his children as the contingent beneficiaries. Who is the owner of the life insurance policy? A. John B. John's wife C. The plan trustee D. John's children

Correct Answer: C. The plan trustee Explanation: The plan trustee is the owner according to The Retirement Equity Act of 1984.

Jane is looking for annuity that may outpace inflation and will guarantee payments for at least 10 years. What type of annuity and payout option should she choose? A. Variable annuity with single life payout B. Fixed annuity with single life payout C. Variable annuity with certain period payout D. Fixed annuity with certain period payout

Correct Answer: C. Variable annuity with certain period payout Explanation: To outpace inflation, a variable annuity has a better opportunity to outpace inflation than a fixed annuity because of the investment in the separate account. To ensure that Jane receives payments for 10 years, she must select a certain period payout option. Jane could select a single life payout option. However, depending upon her death she may receive more or less than 10 years.

Which of the following are advantages of having life insurance in retirement plans? 1. It provides a safe investment for a qualified plan. 2. Policy expenses and commissions on life insurance products may be greater than for comparable investments. 3. It provides predictable plan costs for the employer. 4. A "pure insurance" portion of a qualified plan death benefit is subject to income tax.

Correct Answers: 1, 3 Explanation: Life insurance provides one of the safest available investments for a qualified plan. In addition, the use of appropriate life insurance products for funding a qualified plan can provide extremely predictable plan costs for the employer. Also, the "pure insurance" portion of a qualified plan death benefit is not subject to income tax. This makes it an effective means of transferring wealth.

Which of the following would be considered part of the Prudent Person Standard of Care? 1. Offering a variety of investment options from all the different asset classes. 2. Offering loan and withdrawal options in the plan. 3. Providing education material on the investment options in the plan. 4. Looking for plan administration that offers reasonable fees.

Correct Answers: 1, 3, 4 Explanation: A fiduciary must act with care, skill, prudence and diligence of a prudent person with the participant or beneficiary's best interests in mind. And they have an obligation to diversify the plan's assets to reduce the risk of loss.

What are the three common approaches in which life insurance can be used in defined benefit plans? 1. Combination Plan 2. Whole-life Plans 3. Envelope Funding 4. Fully Insured Pension Plans

Correct Answers: 1, 3, 4 Explanation: In a combination plan, retirement benefits are funded with a combination of whole life policies and separate assets in a separate trust fund called the "side fund" or "conversion fund". In the envelope funding approach, insurance policies are simply considered as plan assets like any other assets. A fully insured pension plan is one that is funded exclusively by life insurance or annuity contracts. There is no trusteed side fund.

In what ways can life insurance in all defined contribution plans be provided to employees? 1. The insurance is provided as an in-service distribution 2. Insurance purchases are voluntary by participants. 3. The insurance is provided automatically as a plan benefit. 4. The insurance is provided at the plan administrator's option.

Correct Answers: 2, 3, 4 Explanation: In defined contribution plans, a part of each participant's account is used to purchase insurance on the participant's life. This plan can provide (a) that insurance purchases are voluntary by participants (using a directed account or earmarking provision), (b) that the insurance is provided automatically as a plan benefit, or (c) that the insurance is provided at the plan administrator's option (on a nondiscriminatory basis).

Why is life insurance in a defined benefit plan more advantageous then a defined contribution plan?

Defined benefit plan allows you to put more away. In a defined contribution plan the life insurance premiums count towards your contribution limits

Employer contributions to the plan, including those used to purchase life insurance, are they deductible to the employer?

Employer contributions to the plan, including those used to purchase life insurance, are deductible if the amount of life insurance is within the incidental limits.

In which plans does ERISA not requires the employers to give the employees investment control?

Employers are not required by ERISA to provide investment control to participants in Profit Sharing, Money Purchase and Target Benefit plans. Despite the fact that the employees are subject to investment risk, the employer can elect to control the investment choices. However, the employer is held to the "Prudent Person" standard as a Fiduciary of the plan.

Jack purchases an annuity with a period certain of 10 years. Jack passes away 5 years into the 10 year period. His beneficiaries will receive payments for the rest of their lives. True or false? Why?

False If one dies before the end of the "certain period," which is generally either 10 or 20 years, payments will continue to their beneficiary until the end of that period

Insurance outside the plan is paid for entirely by after tax dollars, so the person is benefiting from tax deductibility. True or false? Why?

False Insurance outside the plan is paid for entirely with after tax dollars, so there is no tax deferral

A participant exercises control and makes an exchange in his account. The plan is liable if the exchange eventually causes a loss within the participant's account. True or false? Why?

False No person who is otherwise a fiduciary shall be liable for any loss, or by reason of any breach, which results from such participant's or beneficiary's exercise of control

Using the appropriate life insurance products in a qualified plan can provide unpredictable costs for the employer. True or false? Why?

False The use of the appropriate life insurance products for funding a qualified plan can provide extremely predictable plan costs for the employer

Life insurance can be used in defined benefit plans in many ways. Three common approaches are what?

the combination plan, the envelope funding approach and the fully insured plan.

Insurance coverage be conditioned on taking a _________ ____________

Medical exam

Are qualified plan death proceeds included in the decendents estate?

Qualified plan death benefits are, in general, included in a decedent's estate for federal tax purposes. However, it may be possible to exclude the insured portion of the death benefit if the decedent has no incidents of ownership in the policy.

How is the economic value of pure life insurance taxed?

The economic value of pure life insurance coverage on a participant's life is taxed annually to the participant at levels specified by the IRS.

How is the pure insurance portion of life insurance in a qualified plan taxed?

The pure insurance portion of a qualified plan death benefit (basically, the death proceeds less any policy cash value) is not subject to income tax. This makes it an effective means of transferring wealth.

Profit sharing plans use 100% of the employer contribution to purchase insurance of any type after it has been in the plan two years. True or false? Why?

True Any employer contribution that has been in the profit sharing plan for at least two years can be used up to 100% for insurance purchases of any type as long as the plan specifies that the insurance will be purchased only with such funds

Which of the following is NOT an investment option that is typically offered in a retirement plan? a. Bond b. Cash Equivalent c. Stock d. Series EE Bond

d Most plans offer stock, bond and cash equivalent options in their plan, which will cover the three investments alternatives that are required

Combination Plan

retirement benefits are funded with a combination of (1) whole life policies and (2) separate assets in a separate trust fund called the side fund or conversion fund. At each participant's retirement, the policies for that participant are cashed in. The participant's retirement benefit is then funded through a combination of the policy cash values and an amount withdrawn from the side fund. Since whole life policies have a relatively slow cash value buildup, the cash values alone are not usually adequate at age 65 to fund the retirement benefit. This is the reason for the side fund.

The Retirement Equity Act of 1984 requires that the owner and beneficiary of life insurance in a qualified plan must be the ___________

trustee