Unit 23 - Qualified Plans

Who benefits most from a defined contribution plan? A) Younger employees B) Older employees C) All benefit the same D) Employees with fewer years left to work

Who benefits most from a defined contribution plan? A) Younger employees Explanation Younger employees have more time for the money to grow.

Defined Contribution Plan

A defined contribution (DC) plan is a retirement plan that's typically tax-deferred, like a 401(k) or a 403(b), in which employees contribute a fixed amount or a percentage of their paychecks to an account that is intended to fund their retirements. The sponsor company will, at times, match a portion of employee contributions as an added benefit.

A 72-year-old customer has a $30,000 required minimum distribution (RMD) calculated to be taken from an IRA. If the customer is in the 20% income tax bracket and only withdraws $25,000 from the account, how much in taxes and penalties will be owed? A) $8,500 B) $5,000 C) $10,000 D) $12,500

A) $8,500 Explanation Failure to meet the required minimum distribution (RMD) results in a 50% penalty tax on the shortfall. In this case, taking only $25,000 when $30,000 should have been taken leaves $5,000 exposed to the 50% penalty tax. $5,000 × 50% equals $2,500. Note that the IRS will force the distribution of the RMD shortfall ($5,000). In addition to the penalty, the ordinary income tax on the amount withdrawn must also be paid (20% × $30,000 = $6,000). Total tax liability on this withdrawal equals $8,500 ($2,500 penalty tax plus $6,000 ordinary income tax).

Test Q1 Individual retirement accounts allow a catch-up contribution of $1,000 to be made into the account for those who are A) 50 years old or over. B) over 50 years old. C) 59½ years old or over. D) over 72 years old.

A) 50 years old or over. Explanation Catch-up contributions are for those ages 50 and over (not over 50).

What is the penalty, if any, for overcontribution to an IRA? A) 6% B) 10% C) No penalty D) 50%

A) 6% Explanation There is a 10% penalty is for early withdrawal. There is a 50% penalty is for failure to make the minimum required distribution for the year. Contribution of more than the maximum amount in a year carries a 6% penalty.

Which of the following are true of nonqualified plans but not true of qualified plans? I Contributions are not tax deductible II Contributions are tax deductible III Plan needs IRS approval IV Plan does not need IRS approval A) I and IV B) II and IV C) I and III D) II and III

A) I and IV Explanation Qualified plans require IRS approval and the contributions are tax deductible. Because nonqualified plans' contributions are not deductible they do not require IRS approval.

In a defined contribution plan I the benefit amount is fixed. II the benefit amount is variable. III the contribution amount is fixed. IV the contribution amount can vary. A) II and III B) I and IV C) I and III D) II and IV

A) II and III Explanation In a defined contribution plan, the amount that the employer is depositing is fixed by the employer, but the employee chooses the investments, so the benefit varies.

Who benefits most from a defined benefit plan? A) Older employees B) Younger employees C) All benefit the same D) Employees with more years until retirement

A) Older employees Explanation Because the older employee has fewer years left to work, the contribution made by the company will be higher.

Who is responsible for meeting the desired returns on a defined benefit plan? A) The sponsor B) The custodian C) The employee D) The Pension Benefit Guaranty Corporation

A) The sponsor Explanation The sponsor is the employer who has promised the defined benefit plan to the employee.

A 73-year old client in the 25% income tax bracket withdraws $20,000 from her traditional IRA. Based on her life expectancy, the withdrawal should have been $30,000. How much tax will she owe? A) $10,000 B) $12,500 C) $5,000 D) $7,500

B) $12,500 Explanation Failure to meet the required minimum distribution results in a 50% penalty on the shortfall. In this case, she took $20,000 when she should have taken $30,000 so there will be a 50% tax on the $10,000 difference ($5,000 penalty). In addition to that $5,000 penalty, the ordinary income tax on the total amount that should have been withdrawn must also be paid (25% × $30,000 = $7,500). Total tax liability on the withdrawal equals $12,500 ($5,000 penalty tax plus $7,500 ordinary income tax).

Andrea recently began working for the Seabird Coffee Company as a barista. She tells you that her company has two retirement plans she can participate in. In one plan, she contributes a portion of her salary into an account where she can choose from a set of investments. The contributions reduce her taxable income. The money grows and when she retires, or leaves the company, she can take the balance. In the other program, she does not contribute to the plan; the company pays into the plan and invests the money. When she retires, and if she qualifies, she will receive a retirement income for life from the plan based on her working income. You explain that Seabird Coffee has A) two different defined contribution plans. B) a defined contribution and a defined benefit plan. C) two different defined benefit plans. D) a defined benefit and a nonqualified-deferred compensation plan.

B) a defined contribution and a defined benefit plan. Explanation The plan she contributes into on a pretax basis is a defined contribution plan. The other plan promises an income for and is a defined benefit plan. Both are types of qualified plans.

Another term for a defined benefit plan is A) a defined withdrawal plan. B) a pension plan. C) a traditional term plan. D) an annuity.

B) a pension plan. Explanation Though an annuity acts much like a defined benefit plan, it does not require sponsorship by an employer. The other two responses are just made up.

All of the following are true of Roth IRAs except A) Contributions are made after tax B) Withdrawals are not required at age 72 C) Contributions may be deductible depending on income limits D) Contributions may be able to be made after 72

C) Contributions may be deductible depending on income limits Explanation Contributions are not deductible. They are made with after-tax dollars and may continue past age 72 if still working. Roths are not subject to RMDs.

Which of these features does the Roth IRA include? I There are no minimum required distributions after age 72 with a Roth IRA. II There are higher contribution limits to a Roth IRA than to a traditional IRA. III Withdrawal of earnings in the Roth IRA may be made without any taxation as long as a Roth IRA has been open for a minimum of one year and the participant is age 59. IV There is the ability to contribute to both a Roth IRA and a traditional IRA. A) II and III B) I and III C) I and IV D) II and I

C) I and IV Explanation One of the primary benefits to the Roth IRA is that reaching age 72 does not trigger the required minimum distributions found in other retirement plans. Probably the biggest benefit is that all earnings grow tax deferred, and may be withdrawn free of any tax, as long as there has been an open Roth IRA for at least 5 years AND the participant is at least 59½. One may contribute to both types of IRA, but the combined contribution may not exceed that annual maximum (6K) for a single plan.

Which of the following are true of qualified plans but not true of nonqualified plans? I Contributions are not tax deductible II Contributions are tax deductible III Plan needs IRS approval IV Plan does not need IRS approval A) II and IV B) I and III C) II and III D) I and IV

C) II and III Explanation Qualified plans require IRS approval, and the contributions are tax deductible. Because nonqualified plans' contributions are not deductible, they do not require IRS approval.

Which of the following retirement plans does not require minimum distributions once the participant has reached age 72? A) 403(b) B) Traditional IRA C) Roth IRA D) 401(k)

C) Roth IRA Explanation The Roth IRA has no specific requirement that the participant receive distributions. In all of the other plans, generally, upon reaching age 72, minimum distributions must commence no later than the following April 1.

Who is responsible for meeting the desired returns on a defined contribution plan? A) The custodian B) The sponsor C) The employee D) The Pension Benefit Guaranty Corporation

C) The employee Explanation The employee chooses how the money is invested, so the employee takes responsibility for the returns.

All of the following are true of Roth IRAs except A) anyone with earned income under a certain limit may contribute. B) distributions are not required after reaching 72. C) distributions are required after reaching 72. D) contributions are not deductible.

C) distributions are required after reaching 72. Explanation Because distributions are not taxable on Roth IRAs, there are no required distributions. Roth IRAs have income limits and contributions to Roth IRAs are not deductible.

A 72-year-old customer has a $30,000 required minimum distribution (RMD) calculated to be taken from an IRA. If the customer is in the 20% income tax bracket and only withdraws $25,000 from the account, how much in taxes and penalties will be owed? A) $5,000 B) $12,500 C) $10,000 D) $8,500

D) $8,500 Explanation Failure to meet the required minimum distribution (RMD) results in a 50% penalty tax on the shortfall. In this case, taking only $25,000 when $30,000 should have been taken leaves $5,000 exposed to the 50% penalty tax. $5,000 × 50% equals $2,500. Note that the IRS will force the distribution of the RMD shortfall ($5,000). In addition to the penalty, the ordinary income tax on the amount withdrawn must also be paid (20% × $30,000 = $6,000). Total tax liability on this withdrawal equals $8,500 ($2,500 penalty tax plus $6,000 ordinary income tax).

Which of the following is an acceptable investment for an IRA? A) Gold coins minted in Switzerland but sold in the U.S. B) A collection of medieval manuscripts and art C) A universal variable life insurance contract D) A mutual fund specializing in speculative bonds

D) A mutual fund specializing in speculative bonds Explanation Investments in an IRA are limited to cash and securities. This would include gold coins if they are from a U.S. mint. Collectibles and insurance are not acceptable IRA investments.

Contributions to an IRA can be made up to which of the following dates? A) The extension deadline, October 15th of the year following the year the contribution is for B) December 31st of the year the contribution is for C) April 15th of the year the contribution is for D) April 15th of the year following the year the contribution is for

D) April 15th of the year following the year the contribution is for Explanation A contribution for tax year 2019 could be made until the tax filing deadline for the year, which would be April 15, 2020. No extensions are available for contributions even if an extension is granted for filing the taxes.

Which of the following are true of Roth IRAs but not Traditional IRAs? A) Anyone with income may contribute. B) Contributions are typically deductible. C) Distributions are required after reaching 72. D) Distributions are not required after reaching 72.

D) Distributions are not required after reaching 72. Explanation Because distributions are not taxable on Roth IRAs, there are no required distributions. Roth IRAs have income limits and contributions to Roth IRAs are not deductible. Contributions to IRAs must come from earned income.

Which of the following are true of both qualified plans and nonqualified plans? A) Contributions are not tax deductible B) Contributions are tax deductible C) Tax on interest and dividends are deferred, but not on capital gains D) The accounts grow tax deferred

D) The accounts grow tax deferred Explanation With qualified plans, deposits go in before taxes and grow tax deferred. All withdrawals are taxable. With nonqualified plans, deposits are made after tax, and distributions above the cost basis are taxable.

Distributions from IRAs are taxed at A) long-term capital gains rate on the full amount of the distribution. B) long-term capital gains rate on the amount of the distribution that exceeds the amount contributed. C) ordinary income tax rates on the amount of the distribution that exceeds the amount contributed. D) ordinary income tax rates on the full amount of the distribution.

D) ordinary income tax rates on the full amount of the distribution. Explanation Because no taxes were paid on the amount deposited, the full amount is taxable at distribution, and even though some of the distribution is from capital gains, the whole amount is taxed at the ordinary income tax rate.

Each of the following investments and practices are deemed ineligible for an IRA or any other retirement plan except A) margin account trading. B) life insurance. C) collectible fine art. D) variable annuities.

D) variable annuities. Explanation Annuities are eligible for IRAs. However, FINRA deems them generally unsuitable. The tax-deferred nature of a variable annuity comes with some cost. Placing this tax-deferred vehicle inside a tax-deferred account (like an IRA) will be hard to justify.

Defined Benefit Plan (Pension Plan) -Who contributes, employee or employeer?

Plan that promises employee a retirement benefit amount based on a formula Formula is based on years of service, age, and salary. -Employer contribute; required to make the payments as defined in the plan. Places investment risk on the company