Retirement Plans
A divorced woman with 2 young children has a small trust fund that gives her $2,500 a year in income. She collects another $2,500 per year in alimony payments. The woman wishes to make a contribution to an Individual Retirement Account this year. Which statement is TRUE? A No contribution can be made based on either the alimony payments or the trust fund income B A contribution can be made based only on the income received from the trust fund C A contribution can be made based only on the alimony payments received D A contribution can be made based on both the income received from the trust fund and the alimony payments received
The best answer is A. IRA contributions can only be made based on earned income - meaning income from one's work. Portfolio income does not count, since it is not earned income. Alimony and child support payments, starting in 2019, also do not count. (Of course, the big question here is: "If this person only has total income of $5,000 a year, how would she be able to make an IRA contribution since she doesn't even have enough money to eat?!")
In 2020, a self-employed person earning $100,000, who also has $100,000 of investment income, wishes to open a Keogh Plan. Their maximum permitted contribution is: A $20,000 B $40,000 C $57,000 D $67,000
The best answer is A. Keogh (HR10) contributions are based only on personal service income - not investment income. $100,000 of personal service income x 20% effective contribution rate = $20,000. Note that this is less than the maximum contribution allowed of $57,000 in 2020.
Which of the following statements are TRUE about variable annuities? I To sell variable annuities, salespersons must be registered with FINRA II To sell variable annuities, salespersons do not have to be registered with FINRA III To sell variable annuities, salespersons must be registered with the State Insurance Commission IV To sell variable annuities, salespersons do not have to be registered with the State Insurance Commission A I and III B I and IV C II and III D II and IV
The best answer is A. To sell a variable annuity, salespersons must be registered with FINRA with either a Series 6 (mutual funds and variable annuities only) license or Series 7 (general securities) license. In addition, the salesperson must be registered with the State Insurance Commission (since these products are sold by insurance companies; and insurance companies are regulated only at the state level).
Which statement is TRUE about 401(k) plans? A They are established by the corporate employee B Contributions are made with pre-tax dollars by the employee C The maximum contribution amount is lower than that permitted for an IRA D Distributions at retirement age are tax-free
The best answer is B. 401(k) plans are corporate-sponsored salary reduction plans allow employees to contribute up to $19,500 in 2020 as a salary reduction, so these are pre-tax dollars going into the plan. The account grows tax-deferred and all distributions at retirement age are 100% taxable. The cost basis in retirement plans only consists of after tax dollars. Therefore, the cost basis is "0" and when distributions commence at retirement age, they are 100% taxable at ordinary income tax rates (since none of the dollars were ever taxed). Note that the maximum contribution into an IRA is 2020 is $6,000 (plus an extra $1,000 catch up contribution for those 50 and older), so 401(k) accounts allow for a greater contribution amount.
Which of the following annuity payment options will continue payments for a specified time period if the annuitant dies prematurely? A Life Annuity B Life Annuity with Period Certain C Joint and Last Survivor Annuity D Unit Refund Annuity
The best answer is B. A life annuity-period certain pays for the annuitant's life, but if that person dies prematurely, the annuity will pay a designated beneficiary for a specified minimum time period (usually 10 years).
A 60-year old man wishes to receive an annuity payment for himself and his beneficiary for at least 15 years. The recommended payout option is: A life annuity B life annuity - period certain C life annuity - unit refund D installments for a designated amount
The best answer is B. A life annuity-period certain will pay for one's life, however if that person dies early, the annuity will still pay for a designated period. In this case, the period certain would be 15 years. A life annuity simply pays for one's life. Once that person dies, payments cease. A unit refund annuity pays the remaining balance as a lump sum if the annuitant dies "early". The annuity option that chooses installments for a designated amount allows the annuitant to choose the monthly amount to be received. Payments continue for that amount until the account is exhausted.
Which statement is TRUE about earnings limitations on the following plans? A A Coverdell ESA can be opened by a high-earning individual employed by a corporation B A 529 Plan can be opened by a high-earning individual employed by a corporation C A Roth IRA can be opened by a high-earning individual employed by a corporation D A Keogh Plan can be opened by a high-earning individual employed by a corporation
The best answer is B. Coverdell ESAs and Roth IRAs cannot be opened by high-earning individuals - there is an income phase out range. 529 Plans can be established by anyone, with no income limits. Keogh Plans do not have income limitations, but they can only be opened based on self-employment income.
Which statements are TRUE regarding Individual Retirement Accounts for an individual earning more than $75,000 in year 2020? I If the individual is covered by another plan, and has earned income, the IRA contribution is always tax deductible II If the individual is not covered by another plan, and has earned income, the IRA contribution is always tax deductible III If the individual is covered by another plan, and has earned income, an IRA contribution may always be made with "after tax" dollars IV If the individual is not covered by another plan, and has earned income, an IRA contribution may always be made with "after tax dollars" A I and IV only B II and III only C II and IV only D I, II, III, IV
The best answer is B. If an individual is not covered by another qualified pension plan, then, regardless of his or her income, a tax deductible contribution to an Individual Retirement Account may be made. This contribution is said to be made with "before tax" dollars. If an individual is covered by another qualified pension plan, and earns more than $75,000 in year 2020 ($124,000 for a couple filing jointly where both are covered by qualified plans), then a contribution may still be made, but is not tax deductible. This contribution is said to be made with "after tax" dollars.
Your customer, age 68, that has an IRA account at your firm valued at $500,000, passes away. The customer leaves the account to his son, age 38. He has no need for current income as he is still working, and wishes to know his best option to minimize taxes. He expects to retire in 22 years, at which time, he will need the funds to pay for annual living expenses. You should advise the son to: A roll the funds over into a new IRA in the son's name B transfer the IRA funds to a beneficiary distribution account C cash out the inherited IRA account D disclaim the inherited IRA account
The best answer is B. Since the son is the beneficiary, the most advantageous option, which is to roll over the account, is not available. Roll overs of inherited IRAs are only available to spouses. The best option is for the son to transfer the funds into a beneficiary distribution account. The tax rule is that the account must be depleted over 10 years - however distributions can be taken at any time during that 10-year window. Tax must be paid on each distribution, but there would be no 10% penalty tax, even though the son is under age 59 1/2, because the account is titled in both the decedent's name and the beneficiary's name and the account is considered to be the property of the estate of the decedent. Immediate cash out of the account would subject the entire proceeds to ordinary income tax that year - again, not meeting the customer's goal of minimizing taxes. Finally, the customer has stated that he will need the funds for retirement in 22 years, so disclaiming (giving away) the account makes no sense.
An individual owns a bicycle repair business as a sole proprietorship. He does not make a lot of money, but he does have $5,000 available for investment this year. The BEST recommendation for this individual is to make a $5,000 contribution to a(n): A Traditional IRA B Roth IRA C SEP IRA D SIMPLE IRA
The best answer is B. Since this individual does not make a lot of money, a tax-deductible Traditional IRA contribution would not produce significant tax savings. When distributions from the Traditional IRA are taken at retirement, they are taxable. A Roth IRA does not permit a deduction for the contribution, but when distributions are taken at retirement age, there is no tax due. Roth IRAs are a very good deal, but they are not available to high-earning individuals. This question states that the individual does not earn a lot of money, so this is not an issue. SEP IRAs are designed for small businesses. These are "Simplified Employee Pension" plans that do not have to comply with ERISA. The employer establishes the plan and makes deductible contributions for the employees. The employer has the flexibility to change the amount contributed each year. A sole proprietor would not use this type of plan. SIMPLE IRAs are also designed for small businesses and do not have to comply with ERISA. They are similar to 401(k) plans because the employee makes the contribution as a salary reduction. The employer must make a matching contribution (the "SIM" in SIMPLE stands for "Simplified Incentive Match") of either 2% of the salary of each employee or 3% of the salary of each employee who makes a salary-reduction contribution. Whether times are good or bad, the employer must make the match, so there is no flexibility as to the amount the employer contributes each year, as compared to a SEP IRA. Again, a sole proprietor would not use this type of plan.
In 2020, a self-employed person earning $300,000 wishes to open a Keogh Plan. The maximum yearly contribution is: A $6,000 B $57,000 C $60,000 D $75,000
The best answer is B. The maximum contribution to a Keogh is effectively 20% of income (prior to taking the Keogh "deduction") or $57,000 in 2020, whichever is less. 20% of $300,000 = $60,000. However, only the $57,000 maximum can be contributed in 2020. (Note that this amount is adjusted each year for inflation.)
Two years ago, a client of a representative rolled over his 401(k) into a Traditional IRA because he was terminated by his company at age 45. Since then, the customer has been upset by the fact that his permitted annual IRA contribution is so much lower than what he was able to contribute annually into the 401(k). He directs the representative to roll over his IRA into a variable annuity contract, which was completed by setting up an IRA account at the insurance company to hold the variable annuity. Now, a few months after all these transactions, the client is not happy with the variable annuity and wants to roll it back into another Traditional IRA account. What is the most important action for the representative to take? A This is viewed as a customer complaint and must be referred to a manager or principal to oversee its resolution BThe client should be told that he cannot take the assets out of the variable annuity until he reaches age 59 ½ C The client should be told that this would require cashing out the annuity, possibly subjecting the client to high surrender fees D The client should be told that this can be done without any negative consequence
The best answer is C. A client can roll the proceeds of a Traditional IRA into a variable annuity tax-free. The insurance company creates an IRA holding account that purchases the variable annuity. It is similar to moving IRA assets from one trustee to another. The cost basis in the separate account would be any non-deductible contributions that were made into the IRA. The IRS does not allow a "non-qualified" annuity to be rolled over into an IRA - only qualified plan assets can be rolled over into an IRA. However, in this case, the variable annuity is purchased within an IRA account established by the insurance company, so it can be rolled back into a Traditional IRA without penalty - it is treated as an IRA trustee-to-trustee transfer. The big issue is that the insurance company that sold the variable annuity usually imposes high surrender fees for early termination of the annuity. This is the most important thing to be explained to the client.
A husband and wife are self-employed and have 3 children, ages 4, 7, and 9. They have a combined income of $300,000. They wish to open Coverdell ESAs for each of their children to pay for qualified education expenses. Which statement is TRUE? A They can open the account for each child and make an annual $2,000 tax-deductible contribution for each B They can open the account for each child and make an annual $2,000 non tax-deductible contribution for each C They are prohibited from opening an account for each child because they earn too much D They are prohibited from opening an account for each child because Coverdell ESAs cannot be opened by self-employed individuals
The best answer is C. Both Roth IRAs and Coverdell ESAs are not available to high-earning individuals. There is an income phase-out range, above which contributions are prohibited to either of these. For 2020, the top end of the income phase out range for individuals is $110,000 and for couples it is $220,000.
Which statement is TRUE when a non-qualified variable annuity is annuitized prior to age 59 1/2 under the provisions of IRS Rule 72t? A 100% of each payment will be taxable at ordinary income rates B 100% of each payment will be non-taxable C Each payment received will be partially taxable but the 10% penalty tax will not be applied D Each payment received will be partially taxable and the 10% penalty tax will be applied
The best answer is C. Instead of taking a lump sum distribution, the owner of a variable annuity contract can "annuitize" and receive annuity payments for life. Each payment has 2 components - an earnings portion that is taxable and a return of capital portion (cost basis) that is not taxable. The non-taxable portion represents the return of the original investment that was made with "after tax" dollars. IRS Rule 72t gives a way for payments to be taken from the annuity prior to age 59 1/2 without the 10% penalty tax being applied. Rule 72t basically requires that annual payments deplete the account over that individual's expected life (the IRS has 3 approved methods for this). The rule also requires that a minimum of 5 annual "Substantially Equal Periodic Payments" (SEPPs) be taken, but that payments must continue until at least age 59 1/2.
A customer contributed $50,000 to a variable annuity contract. The account value has grown over the years and the NAV is now $70,000. The customer is now age 60, and takes a lump-sum distribution of $25,000 to pay for expenses. Which statement is TRUE? A The entire $25,000 distribution is not taxable B $5,000 of the distribution is taxable and $20,000 is not taxable C $20,000 of the distribution is taxable and $5,000 is not taxable D The entire $25,000 distribution is taxable
The best answer is C. Variable annuity contributions are not tax-deductible. Earnings in the account build tax-deferred. When distributions are taken, tax is due on the portion that represents the tax-deferred build-up. The portion that represents the original contribution (already taxed dollars) is returned without any further tax due. If a lump-sum distribution is taken, the IRS uses LIFO (Last-In; First-Out) accounting. The Last-In Dollars are the tax-deferred build-up, so these are the First-Out dollars and they are 100% taxable! Any distribution above and beyond the build-up amount is a tax-free return of original capital. In this example, the customer contributed $50,000 and this has grown, tax-deferred, to $70,000. If a lump sum distribution of $25,000 is taken, the first dollars out are the $20,000 of never taxed build-up and this amount is taxable. The remaining $5,000 is a partial tax-free return of the original $50,000 investment (which was not tax deductible).
Contributions to Individual Retirement Accounts must be made by: A December 31st of the calendar year in which the contribution may be claimed on that person's tax return B April 15th of the calendar year in which the contribution may be claimed on that person's tax return C December 31st of the calendar year after which the contribution may be claimed on that person's tax return D April 15th of the calendar year after which the contribution may be claimed on that person's tax return
The best answer is D. Contributions to Individual Retirement Accounts must be made by April 15th (tax filing date) of the year after the tax filing year. For example, a contribution for tax year 2020 must be made by April 15th, 2021.
Which statement is TRUE? A Contributions to a 529 plan are tax deductible while contributions to a Coverdell are not tax deductible B Contributions to a 529 plan are not tax deductible while contributions to a Coverdell are tax deductible C Contributions to both a 529 and Coverdell ESA are tax deductible D Contributions to both a 529 and Coverdell ESA are not tax deductible
The best answer is D. Contributions to both Coverdell ESAs and 529 plans are not tax deductible. Earnings build tax-deferred in both. Distributions from both, when used to pay for appropriate educational expenses, are not taxable. Coverdell ESA distributions can be used without limit to pay for all levels of education. 529 plan distributions can only be used without limit to pay for college and higher; distributions to pay for education below the college level are limited to $10,000 per year. High earning individuals cannot open a Coverdell; there is no similar restriction on a 529 plan. Coverdell ESA contributions are limited to $2,000 per child per year; 529 plan contribution limits are set by each state and are much higher.
Contributions to Keogh Plans must be made by: A December 31st of the calendar year in which the contribution may be claimed on that person's tax return B December 31st of the calendar year after which the contribution may be claimed on that person's tax return C April 15th tax filing date of the calendar year after which the contribution may be claimed on that person's tax return D August 15th tax filing date permitted under an automatic extension of the calendar year after which the contribution may be claimed on that person's tax return
The best answer is D. Contributions to qualified retirement plans (other than IRAs) must be made no later than the date the tax return is filed (even if it is filed with an extension). On the other hand, IRA contributions must be made no later than April 15th of the tax year after the year for which the deduction is claimed.
If an individual, aged 65, wishes to withdraw money from her variable annuity, which of the following statements are TRUE regarding the taxation of her withdrawal? I All of the withdrawal is subject to income tax II Part of the withdrawal is subject to income tax III The amount is subject to a 10% penalty tax for early withdrawal IV The amount is not subject to a 10% penalty tax for early withdrawal A I and III B I and IV C II and III D II and IV
The best answer is D. Since this person is above age 59 1/2, any withdrawals from the retirement plan are not subject to the 10% penalty tax for a premature distribution. Since the contribution amount in the non-tax qualified plan was not tax deductible (meaning the amount contributed was already taxed), this portion of the investment is returned without any tax consequence. Thus, only part of the monthly payment is taxable (the portion that represents the tax deferred build up). The portion that represents the original after-tax contribution of capital is not taxed.
All of the following statements are true about variable annuities EXCEPT variable annuities: A must be registered with the Securities and Exchange Commission B must be sold with a prospectus C are a participating unit investment trust form of investment company D are sold without a sales charge
The best answer is D. Variable annuities differ from other products sold by insurance companies in that the purchaser bears the investment risk; as opposed to the insurance company bearing the investment risk. For example, if an insurance company achieves poor investment results, this does not affect the amount of death benefit that one gets from a traditional insurance policy; if the separate investment account funding a variable annuity achieves poor investment results, the annuity payment will drop. Because the purchaser bears the investment risk in a variable annuity contract, these are defined by the SEC as a non-exempt security that must be registered and sold with a prospectus. Because these are structured as participating unit trusts, variable annuities are regulated under the Investment Company Act of 1940. Variable annuities are sold with a sales charge that must be "fair and reasonable" under FINRA rules.