Unit 11: Practice Exam

All of the following are true concerning a Section 529 prepaid tuition plan EXCEPT: A) monies distributed from the plan can only be used in a state-funded higher education institution. B) eligibility to participate is specific to the state which regulates the plan. C) the plan is used to lock in future tuition costs at current rates. D) prepaid tuition plans can be used to cover qualified tuition and room and board costs for the beneficiary of the plan.

The correct answer was A. 529 prepaid tuition plans are used to lock in higher education costs at current tuition rates. Eligibility for the plans is state specific. Monies distributed from the plan may be used to pay for tuition in a state funded institution in that state or you can use those monies to pay for a portion of an in-state private school or any out of state school. In these instances the amount available for use in tuition payments will be determined by the tuition that an in-state publicly funded college would charge.

If an employee makes a withdrawal from her IRA at age 52, she pays no penalty tax if she: A) is disabled. B) has retired. C) had no earned income that year. D) used the funds for her nephew's college tuition.

The correct answer was A. An employee may withdraw from an IRA before the age of 59½ without a penalty tax in the case of death or disability. Funds may be withdrawn without penalty for qualified education expenses for immediate family members, but that does not include nieces and nephews.

Your customer has a Coverdell Education Savings Account for each of four preteen daughters. What is the maximum amount of *pretax* contributions that he can make to each ESA? A) 0. B) 2000. C) 8000. D) 500.

Your answer, 2000., was incorrect. The correct answer was: 0. Pretax contributions cannot be made to Coverdell ESAs. The customer is allowed to make a $2,000 after-tax contribution annually for each student until their 18th birthday. Reference: 11.2.5.1 in the License Exam Manual.

A married couple in their late 50s (both employed) but neither covered under an employer sponsored retirement plan wish to open traditional IRAs and make the maximum tax-deductible contribution. If their combined income is $78,000 which of the following would apply? A) Each is eligible to make a catch-up contribution. B) One IRA must be designated as a spousal IRA. C) Neither is eligible to make a tax-deductible contribution. D) Neither is eligible to contribute to a traditional IRA.

The correct answer was A. Because both spouses are employed and not covered by other retirement plans, they are eligible for traditional IRAs with tax-deductible contributions up to specified limits. Each being older than age 50 is eligible to make a catch-up contribution. Spousal IRAs are for a non-working spouse and therefore neither is eligible in this instance.

Which statements are TRUE regarding funding for education? Distributions from a Coverdell ESA may be used for college only. Distributions from a Coverdell ESA may be used for both college and secondary education. Distributions from a Section 529 plan may be used for college only. Distributions from a Section 529 plan may be used for both college and secondary education. A) II and III. B) I and III. C) I and IV. D) II and IV.

The correct answer was A. Under Coverdell rules, an eligible educational institution includes colleges as well as elementary or secondary schools. Distributions from Section 529 plans are limited to higher education only.

To avoid penalty, a rollover of an IRA may occur no more frequently than: A) semiannually. B) every 5 years. C) annually. D) quarterly.

Your answer, annually., was correct!. Securities or funds may be rolled over by the account holder from one IRA to another only once every year. Direct transfers from one account to another, where the account holder does not receive the funds during the transfer, are not restricted in frequency. Reference: 11.2.3.1 in the License Exam Manual.

A member firm's customer is requesting that IRA contributions converted from a traditional IRA to a Roth IRA now be moved back to a traditional IRA. This is A) called a re-characterization and is allowed by the IRS so long as certain requirements are met B) called a rollover and allowed by the IRS as long all requirements are met C) never allowed under any circumstances D) called a re-characterization and is permitted under all circumstances and within any time frame

Your answer, called a re-characterization and is allowed by the IRS so long as certain requirements are met, was correct!. The IRS allows an individual to re-characterize contributions made to one type of IRA as if they had been made to another type of IRA as long as the requirements as to when the re-characterization can occur have been met. Reference: 11.2.4.1 in the License Exam Manual.

*A corporate profit-sharing plan must be set up under a(n):* A) beneficial ownership. B) administrator. C) trust. D) conservatorship.

Your answer, trust., was correct!. All corporate pension and profit-sharing plans must be set up under trust agreements. A plan's trustee assumes fiduciary responsibility for the plan. Reference: 11.5.2.1 in the License Exam Manual.

*Sally is the named beneficiary of her grandmother's IRA. After the death of her grandmother who was 80 years old, what would Sally's options be regarding the IRA?* A) Take minimum required distributions based on Sally's life expectancy. B) Wait until age 59½ to begin taking distributions, to avoid the 10% tax penalty. C) Wait until age 70½, to maximize tax deferral, and then begin required minimum distributions. D) Roll over her grandmother's money into Sally's own IRA.

The correct answer was A. Before age 80, Sally's grandmother would have already begun mandatory distributions. *When someone inherits an IRA for which the initial owner has begun mandatory distributions, payout must continue but is now based on the life expectancy of the new owner.*

IRAs and Keogh plans are similar in each of the following ways EXCEPT: A) the maximum allowable cash contribution is the same. B) taxes on earnings are deferred. C) distributions without penalty may begin as early as age 59-½. D) rollovers are allowed once every 12 months and must be completed within 60 days.

The correct answer was A. Both IRAs and Keogh plans have maximum annual allowable contribution limits but they are significantly higher in a Keogh Plan.

Which of the following statements CORRECTLY describe a Roth IRA? The maximum annual contribution is 100% of earned income or a maximum allowable dollar limit, whichever is greater. The maximum annual contribution is 100% of earned income or a maximum allowable dollar limit, whichever is less. Contributions are tax deductible. Contributions are not tax deductible. A) II and IV. B) I and III. C) I and IV. D) II and III.

The correct answer was A. The maximum annual contribution to a Roth IRA is 100% of earned income, not to exceed a maximum allowable dollar limit. Contributions are made with after-tax dollars.

Which of the following would make an employee ineligible to participate in a company's qualified retirement plan? A) He is only 20 years old. B) He works only 1,200 hours a year for the company. C) He has been with the company for only 2 years. D) He is not a member of the company's management team.

The correct answer was A. Under the Employee Retirement Income Security Act, anyone over the age of 21, management or not, who has been with the company for at least 1 year, and who works 1,000 or more hours per year for the company, must be allowed to participate in the company's qualified plan.

A married couple in their late 50s (both employed) but neither covered under an employer sponsored retirement plan wish to open traditional IRAs and make the maximum tax-deductible contribution. If their combined income is $78,000 which of the following would apply? A) Each is eligible to make a catch-up contribution. B) One IRA must be designated as a spousal IRA. C) Neither is eligible to contribute to a traditional IRA. D) Neither is eligible to make a tax-deductible contribution.

Your answer, Each is eligible to make a catch-up contribution., was correct!. Because both spouses are employed and not covered by other retirement plans, they are eligible for traditional IRAs with tax-deductible contributions up to specified limits. Each being older than age 50 is eligible to make a catch-up contribution. Spousal IRAs are for a non-working spouse and therefore neither is eligible in this instance. Reference: 11.2.1 in the License Exam Manual.

*A 52-year-old dentist has a balance of $150,000 in his Keogh plan, composed of $100,000 of contributions and $50,000 of earnings. If the dentist withdrew $100,000 from the Keogh plan, which of the following statements are TRUE?* The entire withdrawal is taxable. The entire withdrawal is not taxable. The entire withdrawal is subject to a 10% penalty tax. A portion of the withdrawal is taxable. A) III and IV. B) I and III. C) I and II. D) II and III.

Your answer, I and III., was correct!. Contributions to qualified plans are made with pretax dollars and earnings grow on a tax-deferred basis, so the cost basis is zero. Therefore, any distributions will be taxed as ordinary income. In addition, there is a 10% penalty on withdrawals made prior to reaching age 59-½. Reference: 11.3.1 in the License Exam Manual.

*Your client wishes to convert a 401k plan administered by your broker/dealer into a Roth 401k plan. Which of the following statements regarding a 401k conversion is TRUE?* A) Taxes are due on the funds rolled over when distributions from the new Roth 401k are made. B) All taxes are waived by the IRS at the time of conversion. C) In the new Roth 401k the funds will grow tax deferred. D) Taxes will be due on the funds when the rollover takes place.

Your answer, Taxes will be due on the funds when the rollover takes place., was correct!. Like a traditional IRA to Roth IRA conversion, 401(k) account holders pay the taxes on the funds when they are rolled over into the Roth 401(k). There is no waiver from the IRS. In the Roth 401(k), the funds now grow tax free and they can be withdrawn without tax liability in the future. Reference: 11.5.2.3.3 in the License Exam Manual.

Your customer opens a Coverdell ESA for his niece. In order to meet qualified education expenses of $9,000, she takes a distribution of $10,000. The amount of the distribution in excess of her education expenses that represents earnings in the account will be A) taxable to the uncle, the donor to the plan B) automatically reinvested back into the plan C) taxable to the niece, the beneficiary of the plan D) nontaxable to either party

Your answer, taxable to the uncle, the donor to the plan, was incorrect. The correct answer was: taxable to the niece, the beneficiary of the plan Any excess distribution representing earnings that is not used to meet qualified education expenses is taxable to the beneficiary who took the distribution. Reference: 11.2.5.1 in the License Exam Manual.

If a self-employed attorney earns $110,000 per year and he has no other retirement plans and contributes $4,000 to his IRA, his contribution is: A) partially tax deductible. B) fully tax deductible. C) not tax deductible. D) not permitted.

Your answer, fully tax deductible., was correct!. IRA contributions are fully deductible, regardless of income, if the taxpayer is not covered by any other qualified plans. Reference: 11.2.1 in the License Exam Manual.

All of the following are true regarding Section 529 college savings plans EXCEPT: A) tax-deductible contributions at the federal level. B) not subject to income limitations. C) tax-free withdrawal at the federal level for qualified education expenses. D) high contribution limits.

Your answer, not subject to income limitations., was incorrect. The correct answer was: tax-deductible contributions at the federal level. Contributions are made with after-tax dollars and are not deductible. Reference: 11.2.5.2 in the License Exam Manual.

Your client wishes to convert a 401k plan administered by your broker/dealer into a Roth 401k plan. Which of the following statements regarding a 401k conversion is TRUE? A) Taxes will be due on the funds when the rollover takes place. B) In the new Roth 401k the funds will grow tax deferred. C) Taxes are due on the funds rolled over when distributions from the new Roth 401k are made. D) All taxes are waived by the IRS at the time of conversion.

The correct answer was A. Like a traditional IRA to Roth IRA conversion, 401(k) account holders pay the taxes on the funds when they are rolled over into the Roth 401(k). There is no waiver from the IRS. In the Roth 401(k), the funds now grow tax free and they can be withdrawn without tax liability in the future. Reference: 11.5.2.3.3 in the License Exam Manual.

One of your customers set up a Section 529 plan for a child of one of his neighbors and contributed to it for some years. When the child reached age 17, it was obvious that he had no plans to pursue higher education and your customer decided to redesignate the account. Which of the following would be a permissible new beneficiary? A) The original beneficiary's younger sister. B) One of the donor's own grandchildren. C) One of the children of another of your customer's neighbors. D) The winner of an informal essay contest to be held among high-school aged children in the neighborhood.

The correct answer was A. There are few restrictions on who may be the first beneficiary of a Section 529 plan. However, if the beneficiary is redesignated, the new beneficiary must be a close family member of the first.

Which of the following investments is the least appropriate for a qualified pension or profit sharing plan? A) Municipal bonds. B) Treasury bonds. C) Zero-coupon bonds. D) Corporate AAA bonds.

The correct answer was A. When advising qualified plans, it is not a good investment practice to buy tax-free income. The yield on municipal bonds is typically lower than that on other bonds of comparable quality due to the tax-exempt status of their income payments. Any assets in the retirement plan are free of current taxation so the usual municipal security benefit is lost, and the portfolio contains assets that produce less income. A second problem arises because as participants in the plan begin withdrawing assets, the withdrawal is usually 100% taxable, thus turning what is inherently tax free into something taxable. It makes more sense to buy higher yielding taxable income and to shelter the income within the tax-exempt plan trust.

*An individual, age 40, at a median income level and covered by an employer sponsored retirement plan wants to save more for retirement. Which of the following is the most suitable recommendation?* A) An investment account utilizing only tax-free municipal bond mutual funds B) A Roth IRA, as long as the individual's income level does not exceed the maximum allowed to make a contribution (phase-out schedule) C) A hedge fund utilizing high risk, high potential yield strategies D) A traditional IRA as there will be no limit to the amount of the contribution that can be deducted

Your answer, A Roth IRA, as long as the individual's income level does not exceed the maximum allowed to make a contribution (phase-out schedule), was correct!. Given the limited information the Roth IRA is the most suitable as long as the investor's income level does not limit via the phase-out schedule what can be contributed to the IRA. Dollars invested will grow and distributions will be tax free as long as the dollars have been in the account for five years once the IRA owner has reached age 59 1/2. Because the individual is covered by an employer-sponsored plan we know that the contribution to a traditional IRA may not be fully tax-deductible if at all and the earnings would be taxable when distributed. Growth in an investment account would be taxable and and the utilization of tax-free municipal bonds with low yields are unlikely to accommodate saving for retirement. Hedge funds utilizing high risk investment strategies are inappropriate for retirement saving. Reference: 11.2.4 in the License Exam Manual.

A 45-year-old employment counselor has a Keogh plan for himself and three full-time employees who have been working for him for the past 4 years. If he earns $150,000 this year and contributes the maximum amount allowed to his Keogh plan, how much may he invest in an IRA? A) He may invest any amount up to 100% of his earned income. B) He may have an IRA but may not make a contribution for this year. C) He may contribute 100% of earned income or the maximum allowable IRA limit, whichever is less. D) He may not have an IRA.

Your answer, He may contribute 100% of earned income or the maximum allowable IRA limit, whichever is less., was correct!. Regardless of how much is invested in a Keogh plan, an investor may still invest in an IRA if he has earned income. The maximum contribution to an IRA is 100% of earned income or the maximum allowable limit, whichever is less. In this individual's case, however, the contribution would probably be nondeductible. Reference: 11.2.1 in the License Exam Manual.

A married couple are both employed by firms that cover them under the company pension plans, and each earns approximately $150,000 annually. If they both open a traditional IRA and make the maximum contribution, how much of their contribution could they deduct? A) They are ineligible to deduct any contribution made. B) Neither is eligible to make a contribution in any amount (deductible or not). C) Both may deduct the entire contribution. D) One spouse only is eligible to deduct their entire contribution.

Your answer, They are ineligible to deduct any contribution made., was correct!. While each are eligible to make the maximum contribution, at this income level, neither spouse, both covered under employer sponsored plans, would be eligible to deduct their contributions to their respective IRAs. Reference: 11.2.1 in the License Exam Manual.

*A businessowner pays himself a salary of $80,000 per year. He employs his spouse and pays her $45,000 per year. What is the maximum contribution that they may make to their traditional IRAs?* A) No traditional IRA contributions can be made by businessowners or their spouses. B) They can each contribute 100% of earned income or the maximum allowable limit, whichever is less, to their individual IRAs. C) They can contribute 100% of the lower income to one IRA only. D) They cannot make contributions, because their joint incomes are too high.

Your answer, They can each contribute 100% of earned income or the maximum allowable limit, whichever is less, to their individual IRAs., was correct!. They both may make annual contributions of 100% of earned income up to the maximum allowable limit, whichever is less, to their own respective IRAs. Reference: 11.2 in the License Exam Manual.

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

Your answer, be taxed at ordinary income rates., was correct!. The distribution described here would be taxed as ordinary income. A 10% penalty would apply if the individual were under age 59½. Reference: 11.3.1 in the License Exam Manual.

All of the following must meet the nondiscrimination provisions of the Employee Retirement Income Security Act (ERISA) EXCEPT: A) Keogh plans. B) profit-sharing plans. C) 401(k) plans. D) deferred compensation plans.

Your answer, deferred compensation plans., was correct!. Deferred compensation plans are nonqualified and therefore do not have to meet the nondiscrimination provisions of ERISA. Reference: 11.6 in the License Exam Manual.

All of the following are true regarding nonqualified deferred compensation plans EXCEPT: A) employees may use accumulated funds as collateral for a bank loan. B) income taxes on compensation are not due until constructive receipt. C) the plans need not be offered to all employees. D) IRS approval is not needed for deferred compensation plans.

Your answer, employees may use accumulated funds as collateral for a bank loan., was correct!. Deferred compensation is a promise made by an employer to defer a certain amount of an employee's salary upon retirement. The employee has no rights to the money until retirement, death, or disability, and thus cannot use it as collateral. Reference: 11.1.2.1 in the License Exam Manual.

Your customer, a resident of New York, wants to open up a Section 529 plan for his 10-year-old son. Because his son wants to attend Notre Dame, your customer wants to start a plan sponsored by the state of Indiana. You should: A) open the plan as instructed by your customer. B) not open the plan. C) explain that the potential state tax benefits available to residents of New York may not be available when opening an out-of-state plan. D) explain that the potential federal tax benefits available to residents of New York may not be available when opening out-of-state plans.

Your answer, explain that the potential state tax benefits available to residents of New York may not be available when opening an out-of-state plan., was correct!. Many states offer tax benefits to residents who open 529 plans in their home state. These benefits are generally not available when opening out-of-state plans. Federal tax benefits are available regardless of the state where the plan is opened. Reference: 11.2.5.2 in the License Exam Manual.

One of your customers, age 45, estimates that his annual earnings will be below the Roth IRA contribution ceiling limit and makes his Roth contribution early in the year. To his pleasant surprise, he receives a year-end bonus in December of that year, but, unfortunately, it puts his earnings over the Roth IRA earnings limit for allowing contributions. As the customer's registered representative, and given these circumstances, you could suggest that the customer A) roll over the Roth into a traditional IRA B) take out the contribution in the form of a withdrawal C) re-characterize the Roth contribution made into a traditional IRA D) leave the contribution in the Roth because a bonus does not impact the allowable earnings limit for making contributions to a Roth IRA

Your answer, re-characterize the Roth contribution made into a traditional IRA, was correct!. Given the circumstances, the best suggestion would be to re-characterize the contribution to a traditional IRA so that the rules for contributing to a Roth IRA will not have been broken, as earnings applicable would include bonuses. Taking the money out in the form of a withdrawal would not have allowed the amount to be there for the required 5 years nor would the customer have reached the age of 59 ½ yet; therefore, the withdrawal would be taxable. A rollover allows retirement money to move from one qualified plan to another but does not address re-characterizing the contributions made. Reference: 11.2.4.1 in the License Exam Manual.

*A distribution has been made from a Coverdell Education Savings account in the amount of $12,000 when the educational expenses were only $10,000. The amount distributed beyond the educational expenses will be:* *A) taxable to the beneficiary on any portion of the excess representing earnings.* B) a tax-free distribution. C) taxable to the donor on any portion of the excess representing earnings. D) completely taxable to the donor.

Your answer, taxable to the donor on any portion of the excess representing earnings., was incorrect. The correct answer was: taxable to the beneficiary on any portion of the excess representing earnings. If a distribution exceeds education expenses, a portion representing earnings will be taxable to the beneficiary and may be subject to an additional 10% penalty tax. Reference: 11.2.5.1 in the License Exam Manual.