Unit 18 Checkpoint Exam
All of the following statements regarding 529 plans are true except A) contributions are made with pretax dollars at the federal level. B) anyone can make a contribution on behalf of a beneficiary. C) earnings accumulate tax free if the money is used for qualified educational purposes. D) a beneficiary of a 529 plan may also be the beneficiary of a Coverdell Education Savings Account.
A) contributions are made with pretax dollars at the federal level. 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.
All of the following are advantages of a 401(k) plan except A) the employer may make unlimited contributions, which generate unlimited tax deductions for the business. B) the owner of the business may participate in the plan. C) employees and the business may reduce current taxes. D) tax deferral on the plan earnings is advantageous to employees.
A) the employer may make unlimited contributions, which generate unlimited tax deductions for the business. Contributions are deductible by the employer but are not unlimited because contributions to a 401(k) are subject to a number of limits. Tax deferral on plan earnings is advantageous to employees. The owner of the business may participate in the plan.
Which of the following retirement plans would be appropriate for a highly compensated government employee? A) 401(k) B) 403(b) C) 457(b) D) IRA
C) 457(b) 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.
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) 10%. B) 50%. C) 15%. D) 6%.
A) 10%. 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reasons, withdrawals made before the account owner reaches age 59½ are subject to a penalty of 10% of the gross amounts withdrawn in addition to ordinary income taxes.
Which of the following may be purchased in an UTMA, but not an UGMA? A) Individual stocks B) Real estate C) Bank CDs D) Mutual funds
B) Real estate UTMA has a wider range of investment opportunities than UGMA. One of the most often examples is the purchase of real estate.
All of these are reasons a corporation might choose to establish a nonqualified plan rather than a qualified plan except A) the corporation can exclude rank-and-file employees from a nonqualified plan. B) a nonqualified plan typically has lower administrative costs. C) a nonqualified plan has more design flexibility than a qualified plan. D) the employer can take a tax deduction at the time the contribution is made to the plan.
D) the employer can take a tax deduction at the time the contribution is made to the plan. Employers are not permitted to take a tax deduction until the assets are received by the executive as income after the deferral period.
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) she is not eligible to participate. B) mutual funds and annuities are available investment vehicles. C) distributions before age 59½ are normally subject to penalty. D) contributions are made with pretax dollars.
A) she is not eligible to participate. 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.
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) some states permit transfer of ownership in UTMA accounts to be delayed beyond the age of majority. C) there is more investment flexibility in the UGMA account. D) the account is in the name of the minor in an UTMA account.
B) some states permit transfer of ownership in UTMA accounts to be delayed beyond the age of majority. 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 (one state, not tested, allows to age 30). 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.
Those individuals who are considered parties in interest due to handling the assets of a corporate retirement plans are A) encouraged to use plan funds to assist the employer when there is a cash flow crisis. B) able to sell personal securities to the plan if that will benefit plan participants. C) not permitted to use those funds to acquire company assets in an amount beyond the allowable limits. D) not considered to have a fiduciary responsibility.
C) not permitted to use those funds to acquire company assets in an amount beyond the allowable limits. 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 has a use-it-or-lose-it provision? A) ESA B) HSA C) IRA D) FSA
D) FSA 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).
Under the Uniform Gift to Minors Act, all of the following are permissible except A) gifts of securities to a minor. B) gifts of cash to a minor. C) the donor and the custodian are the same person. D) the purchase of securities on margin.
D) the purchase of securities on margin. UGMA accounts may never be opened as margin accounts.
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 SIMPLE plan 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.
Withdrawals during retirement from which of the following accounts would most likely be subject to the greatest amount of taxation? A) Qualified variable annuity B) Nondeductible traditional IRA C) Nonqualified variable annuity D) Roth IRA
A) Qualified variable annuity 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.
Which of the following offers the benefit of tax-deductible contributions? A) Coverdell Education Savings Account (ESA) B) Health savings account (HSA) C) Payroll deduction plan D) Roth IRA
B) Health savings account (HSA) 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.
A 40-year-old teacher would find her retirement needs best served by contributing to A) a traditional IRA. B) a 401(k). C) a 403(b). D) a Roth IRA.
C) a 403(b). Employees of the public school system are eligible to participate in a 403(b) retirement plan. This plan offers the opportunity to contribute far more than could be contributed to an IRA.
Each of the following individuals is eligible to participate in a Keogh plan except A) an executive of a corporation who receives $5,000 in stock options from his company. B) a self-employed doctor in private practice. C) an engineer employed by a corporation who earns $5,000 making public speeches in her spare time. D) a securities analyst employed by a major research organization who makes $2,000 giving lectures in his spare time.
A) an executive of a corporation who receives $5,000 in stock options from his company. Individuals with income from self-employment may participate in Keogh plans. Stock options, capital gains, dividends, and interest are not considered income earned from self-employment.
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) used for higher education expenses. B) under a QDRO. C) for certain medical expenses. D) for a first-time home purchase.
B) under a QDRO. 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.
All of the following statements regarding 529 plans are true except A) contributions to a 529 plan may be subject to gift taxation. B) the assets in the account are controlled by the account owner, not the child. C) states impose very high overall contribution limits. D) eligibility is affected by the income level of the contributor.
D) eligibility is affected by the income level of the contributor. Unlike Coverdell ESAs, the income level of the contributor will not affect eligibility to contribute to a Section 529 plan.
Assuming all withdrawals are equal, which of the following would subject a 60-year-old investor to the least amount of tax? A) Traditional IRA B) Roth IRA C) Non-qualified variable annuity D) 403(b) plan
B) Roth IRA As long as the Roth has been opened a minimum of five 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.
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 because of an employee's death or disability B) Distribution of up to $10,000 made to purchase a principal residence C) Distribution to pay certain medical expenses D) Distribution made pursuant to a qualified domestic relations order
B) Distribution of up to $10,000 made to purchase a principal residence 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 true concerning a Coverdell Education Savings Account (ESA)? A) The maximum contribution is $2,000 per beneficiary. B) In order for the withdrawal to be considered qualified, it may only be used for post-secondary education expenses. C) A beneficiary's unused balance may be rolled over to an ESA account for another child. D) The beneficiary may be the contributor's child or grandchild or child of a friend of the contributor.
B) In order for the withdrawal to be considered qualified, it may only be used for post-secondary education expenses. 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 contributors. 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.
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) The employees are guaranteed the ability to consult an investment adviser B) The plan is free from the top-heavy testing requirements. C) It guarantees that highly compensated employees do not get more of an employer match than non-highly compensated employees. D) The employer is required to contribute on the employee's behalf even if the employee does not contribute to the plan.
D) The employer is required to contribute on the employee's behalf even if the employee does not contribute to the plan. 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.
If the administrator of a corporate 401(k) plan ensures that a wide variety of investment alternatives are available to employees along with the ability for the employees to monitor their accounts and make frequent changes as needed, ERISA A) might find the administrator to be shirking his fiduciary responsibility. B) shifts the responsibility for account performance to the employee. C) removes the requirement for top-heavy testing. D) removes the requirement for the plan to provide employees with quarterly reports.
B) shifts the responsibility for account performance to the employee. Under Section 404(c) of ERISA, when the employees have adequate control of their own investments and sufficient alternatives, the responsibility for account performance is shifted from the administrator to the employee.
When a corporation establishes a qualified money purchase plan, A) the corporation is obligated to make annual contributions at the rate stated in the plan. B) discrimination in favor of lower-compensated employees is encouraged. C) the employee is obligated to make annual contributions at the rate stated in the plan. D) the corporation can adjust the contribution rate based on company profits.
A) the corporation is obligated to make annual contributions at the rate stated in the plan. Money purchase plans have required contributions. The employer must make a contribution to the plan each year for the plan participants. With a money purchase plan, the plan states the contribution percentage that is required. For example, let's say that the money purchase plan has a contribution of 5% of each eligible employee's pay. The employer needs to make a contribution of 5% of each eligible employee's pay to each employee's account. A participant's benefit is based on the amount of contributions to her account and the gains or losses associated with the account at her retirement.
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 take the cash now and use a Section 1035 exchange into an annuity. B) Jerome should take the cash now and use the money to fund a new IRA. C) Jerome should use the five-year cash-out option. D) Jerome should use the 10-year cash-out option.
D) Jerome should use the 10-year cash-out option. 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 five-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
Jill's bank, where she has her traditional deductible contributory IRA, is recommending that she roll over her 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) The entire amount rolled over must be declared as income. B) No tax will occur, provided the rollover is completed within 60 days. C) Rolling over a traditional IRA to a Roth IRA will negate the tax-free status of future withdrawals. D) The amount attributable to growth must be declared as income.
A) The entire amount rolled over must be declared as income. 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.
One of your customers passed away recently. The customer had an IRA with you and had his sister listed as the beneficiary. Other assets included the home and furnishings and a brokerage account at another firm. The titling on that brokerage account was the customer and his son, JTWROS. The customer's will specified that 100% of his assets should pass to his daughter. Based on this information, the estate settlement will have A) the daughter getting the home and furnishings and the IRA, with the son getting the brokerage account. B) the daughter getting the home and furnishings, the son the brokerage account, and the sister the IRA. C) the daughter getting the home and furnishings and the brokerage account, with the sister getting the IRA. D) the daughter receiving everything as stated in the will.
B) the daughter getting the home and furnishings, the son the brokerage account, and the sister the IRA. A will can designate the disposition of an estate's assets only to the extent that they are not previously assigned. A JTWROS account specifies that the assets go to the survivor and that overrules any will. An IRA (or any qualified retirement plan) always has a designated beneficiary and that supersedes any will. Anything other than the assets in the JTWROS account or the IRA will go to the daughter.
All of the following statements regarding qualified corporate retirement plans are true except A) defined contribution plans have the same contribution limits as Keogh plans. B) with defined benefit plans, the employee bears the investment risk. C) all qualified retirement plans are either defined contribution or defined benefit plans. D) all corporate pension and profit-sharing plans must be established under a trust agreement.
B) with defined benefit plans, the employee bears the investment risk. 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.
