Ch 7 The foundation of savings

Up to what amount, the kiddie tax rules, partially or fully, shelter income on custodial accounts for the 2018 tax year?

$2100

Jerry is thinking about buying a U.S. savings bond. What is the minimum investment that he needs to make if he opens a Treasury Direct account and purchases the bond online?

$25

Barbara has a steady job earning of $39600 per year. She has looked at her fixed expenses and other financial obligations and determined that in the event of a major financial emergency she would need to replace approximately $24000 per year in income. Based on the 3-month emergency fund ratio rule, how much should Barbara have in an emergency fund today?

$6000

Which of the following is a warning sign of fraud?

An unsolicited phone call asking for personal information, promises of high returns with very low risk, and / or limited time offers that must be purchased now.

Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA)

Assets can be given, transferred, or owned by a minor using the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) custodial account, depending on individual state laws. UGMAs are used for bank accounts, investments, and insurance policies. UTMAs can be used to hold any type of property, including real estate.

Investment

Assets that you purchase to reach long-term goals.

For which of the following savings goals would a U.S. savings bond be most useful?

Building a child's education fund

The cost of going without an emergency fund can be:

Catastrophic

An emancipated minor may: I. buy property. II. sell property. III. not open a financial account until he or she turns 21years old.

I and II only

Which type of account can hold any type of investment or real estate property?

UTMA

Which of the following types of accounts could be subject to taxation?

UTMA, 529 plan, and/or Qualified Tuition Program.

Graham would prefer to own a U.S. savings bond directly, rather than through an account with Treasury Direct. What method should he use to make the purchase?

Using Form 8888 when he files his federal income tax return.

Which of the following is not a common financial emergency?

Vacation Travel

If you withdraw money from a CD prior to maturity, what can happen?

You can be penalized through the lost interest earned.

real rate of return

Your inflation-adjusted return is called your real rate of return. Real rates of return are rarely stated; you need to calculate them.

If you become a victim of identity theft, you should report the crime to:

Your local police office or sheriff's department

Earned Income

all the taxable income and wages you get from working

Which of the following bank products are insured by FDIC? I. Savings account. II. Certificate of deposit. III. Dedicated savings account.

all three

kiddie tax

allows only a small amount of unearned income to be taxed at a child's marginal tax bracket

phishing scheme

an unsolicited e-mail asking you to provide personal information (such as your Social Security number) or confirm the details of a credit account.

Earnings

are generated from the different types of investments within the account

college savings plan

are specific types of accounts set up by states that allow individuals to set money aside for a designated beneficiary's higher education expenses. College savings plans provide: Tax-deferred growth on earnings. Tax-free distributions if the money is used for qualified educational expenses such as tuition, fees, books, equipment, housing, meal plans, and other necessary expenses.

Which of the following benefits do U.S. savings bonds provide?

are very safe, are tax-advantaged, and do not require a bank account.

Identity Theft

as a crime in which someone wrongfully obtains and uses your personal data in some way that involves fraud or deception for his or her economic gain

Volatility

as the value of an asset fluctuating up and down, or the variability of returns over time

Money Market Savings Account

combines the benefits offered by savings and checking accounts, including FDIC and NCUSIF insurance protection up to $250,000 for individuals. MMSAs pay a higher interest rate on the money deposited as the amount in the account increases. Access to the money is easy but slightly more restrictive than a savings account. You are limited to the number of withdrawals you can make each month, but these withdrawals can be made using a check, an ATM, or in person at the bank or credit union.

After-Tax Basis

contributions do not lower taxable income

Pretax Basis

contributions to these accounts lower taxable income and, as long as the money remains in these accounts, the earnings grow tax-deferred

A Roth IRA can be established at a(n):

credit union, bank, and / or an investment company.

Traditional IRAs

do not provide the same flexibility in terms of withdrawals: Some or all future withdrawals from traditional IRAs will be fully taxable. Traditional IRAs are subject to early withdrawal penalties (see Helpful Hint). Exceptions to the penalty include withdrawals after age 59½, due to disability, on account of the owner's death, first-time home purchase (up to $10,000), qualified higher education expenses, or to purchase medical insurance if you are unemployed.

Custodial IRA accounts

either as a Roth or traditional IRA. Custodial IRA accounts have the same requirements as regular IRA accounts but simply allow minors to begin building their long-term savings

EE Bonds

have a fixed interest rate payable for up to 30 years

I Bonds

have a variable interest rate that adjusts semiannually based on inflation

Liquidity can be described as:

having access to your money whenever you need it.

Purchasing an asset designed to help you reach a long-term goal is a form of:

investing

Certificate of Deposit

is a savings product that is generally purchased with one lump-sum dollar amount. CDs are different from savings and checking accounts in that CDs restrict withdrawals from the account until some future date, referred to as the maturity date

Emergency Fund

needs to be very liquid, that is, immediately accessible for use in case of unexpected expenses (such as a major car repair) or lost income (reduced number of hours worked). A basic guideline is that you should have between 3 and 6 months of living expenses saved for emergencies.

Telemarketing Fraud

occurs when a product or service is misrepresented in an unsolicited phone call, e-mail, or text message. A common line is as follows: "I am calling to inform you that you have won a free gift." The reality is that no one ever gives away something for free. Always assume that there is a catch to the story. Usually, the catch is that you will lose money.

Inflation Risk

occurs when prices increase over time. This is often overlooked when making financial plans.

Compounding Interest

occurs when the interest earned begins to earn additional interest.

Liquidity Risk

occurs when you cannot sell something you own because of a weak market, meaning others aren't willing to buy what you are selling.

Fraud

occurs whenever someone attempts to deceive you with a promise of goods, services, money, or other benefits that really do not exist, were never intended to be provided, or were misrepresented

Qualifying Distributions

of earnings from a Roth IRA is tax-free if it meets the following two conditions: 1. You are at least 59½ years old, disabled, or use the funds to purchase a first home (up to $10,000). 2. The Roth IRA account has been open for at least 5 years.

A pure risk is one that results:

only in a financial loss

Roth IRA

therefore, is an individual retirement account that offers two significant advantages: Investments held in the account accumulate earnings on a tax-deferred basis. Money pulled from the account is tax-free if certain conditions are met

Adjusted Gross Income (AGI)

total income before subtracting any deductions or expenses

You can make tax-free withdrawals from Roth IRAs:

when you withdraw your principal, or after reaching age 59 ½ and the account has been open for 5 years

Monetary Assets

which includes cash, savings, and checking accounts.

Emergency Fund Ratio

which indicates whether you have sufficient resources in case of an emergency, such as losing your job or becoming seriously ill Emergency Fund Ratio= Monetary Assets/Monthly Living Expenses

Monthly Living Expenses

which is the minimum monthly dollar amount you would need to replace in case of an emergency by adding all your expenses and then subtracting nonessential expenses. Most fixed expenses—things like mortgage or rent, insurance, and loan payments—tend to fall into the emergency-need category. Other necessities would also be in this category, such as food, transportation, and utilities

Custodial Account

Account that is created for a minor, usually at a bank, brokerage firm, or mutual fund. Minors cannot make securities transactions without the approval of the custodian, who manages cash and other property gifted to minors under the UNIFORM GIFTS TO MINORS ACT or the Uniform Transfers to Minors Act.

Roth IRAs were created by:

Congress

Which of the following would be an appropriate tool, if necessary, for someone who has not yet accumulated any savings and is just starting to build an emergency fund?

Credit Cards

risk

Degree of uncertainty of return on an asset; in business, the likelihood of loss or reduced profit.

A Ponzi scheme represents:

Fraud Risk

credit freeze

Freezing your credit seals your credit reports so that no new accounts can be opened unless you unfreeze the account using a personal identification number (PIN)

Which of the following risk-return statements is true?

Higher returns mean greater risk.

nominal return

Interest rates and rates of return are stated as nominal returns.

Tammy is going on a 2-week vacation overseas. She is planning on taking two credit cards, and has notified her credit card issuers that she will be traveling with those credit cards. What should she do with her other credit cards while she is gone?

Keep them in a safe deposit box

Which of the following bank products provides high liquidity with a limited ability to make penalty free withdrawals?

Money market savings account.

Savings

Money you put aside for short-term goals.

A portfolio of securities that is professionally managed is known as a:

Mutual Fund

If a parent establishes a UGMA or UTMA to fund their child's college education and the child—now age 22—decides to forgo college, the parent can do what to ensure that the child does not use the money in the account for an unwise purchase?

Nothing, because the child is legally entitled to the assets held in the account.

Bernie Madoff ran the world's largest:

Ponzi Scheme

Who should consider buying an I bond today?

Someone who thinks inflation will be higher in the future.

Rick is petrified at the thought of flying. Whenever he thinks about getting on an airplane, he envisions a disaster. Rick's assessment of the risks associated with flying is most closely associated with his:

Subjective Risk Evaluation

Rule of 72

The number of years it takes for a certain amount to double in value is equal to 72 divided by its annual rate of interest.

FDIC (Federal Deposit Insurance Corporation)/ NCUSIF

These agencies provide individuals with automatic deposit insurance, which guarantees that depositors get their money back (up to certain limits, generally $250,000 for individuals) even if the financial institution goes bankrupt.

Investment Pyramid

This concept of a tradeoff is summarized by the investment pyramid shown in Illustration 7.1.4. Think of the pyramids like those in Egypt, which require a solid foundation before the top layers can be added. 3 Levels 1. Low Risk and Return 2. Medium Risk and Return 3. High Risk and Return

Pyramid Scheme

is a scam that is typically based on selling products or recruiting new members into an organization. Rather than promise a high rate of return like a Ponzi scheme, those who run pyramid schemes either promise high commissions on products sold or a sizable share of any money paid by new members to join the organization. The pitch is that you may not earn very much money selling products but if you can grow your network, you can earn substantial money based on fees paid by those in your network, as well as from commissions generated by your network. The whole premise of a pyramid scheme is to continually recruit new network members. Pyramid schemes are quite lucrative to those on the top of the pyramid, but like all scams, later investors or network members usually end up losing as it becomes difficult to find new network members. Once the number of new participants declines, the pyramid crumbles.

U.S. Savings Bond

is a way for nearly all Americans to lend money to the U.S. government. In exchange, the federal government agrees to pay you interest.

Savings account

is an interest-bearing asset that allows you, as the account owner, to earn a small return on your deposit. Banks and credit unions are the most common places to find savings accounts.

Pure Risk

is one that results only in an economic loss, such as needing to repair a car or replace a major appliance

Principal

is the amount that you deposit into the account

Interest Rate Risk

is the chance that general interest rates will increase, which will reduce the value of most investments

opportunity cost

is the loss of a benefit that you would have received by choosing another option.

Business Risk

is the possibility that a company in which you invest will be forced to close.

Objective Risk

is the ranking of risk using actual statistics. Objective risk is something that can be measured using probabilities.

Subjective Risk

is your perception of the riskiness associated with a behavior or decision. Subjective risk is based on your personally developed probabilities of potential losses based on expectations, fears, worries, and other factors. Subjective risk varies from one person to another.

An effective way to manage temptation and impulse spending involves:

managing your environment.

Tax-Deferred Earnings

mean that there is no tax assessed on the earnings in the account in the year that the earnings are received.

Consumer Price Index

measures the change in the price of consumer goods and services over time.

Traditional IRAs provide for:

pretax contributions and taxable distributions.

Ponzi scheme

promises investors and savers a low-risk, high rate of return, interest, or dividends

Visualization

techniques to imagine what the future will look like in real terms.

Liquidity

the ease with which an asset can be converted into cash

When someone says that they purchased something, but they could have bought something else, they are referring to:

the opportunity cost of their purchase.

return on investment

the percentage of the total cost of purchasing an investment and the profit made from selling that investment

Risk refers to:

the possibility of losing money

Dedicated Savings Account

the variation of CD is that these accounts allow you to contribute additional money to the CD until the maturity date. Like traditional CDs, the early withdrawal penalty helps stop the impulse to purchase unnecessary items using emergency funds while also providing access to the funds in the event you do experience an emergency. Dedicated savings accounts pay interest rates similar to traditional CDs.

Financial Risk Tolerance

then, is the extent of your willingness to engage in financial behavior that has the possibility of a loss.