Unit 18: Retirement Plans
Which of the following permits the highest annual contributions? A) A SEP IRA B) A traditional nondeductible IRA C) A traditional spousal IRA for which the contribution has been deducted D) A Coverdell Education Savings Account
A) A SEP IRA Under most circumstances, the annual contribution to a SEP IRA will be higher than those allowed for ESAs or traditional or Roth IRAs.
As a rule, loans from a 401(k) plan must be repaid within how many years? A) 15 B) 20 C) 10 D) 5
D) 5 Most loans from a 401(k) plan are required to be repaid within 5 years. This rule does not apply to loans taken for a home purchase.
A 401(k) offering which of the following choices would be most likely to be in compliance with Section 404(c) of ERISA? A) Small-cap fund, large-cap stock ETF, money market fund B) Long-term bond fund, large-cap stock index fund, foreign equity fund C) Money market fund, intermediate-term municipal bond fund, large-cap stock index fund D) Money market fund, intermediate-term government bond fund, large-cap stock index fund
D) Money market fund, intermediate-term government bond fund, large-cap stock index fund The trustee of a 401(k) would be able to reduce her ERISA fiduciary exposure and meet the safe harbor provisions of 404(c) if the plan offered a broad index fund, a medium term government bond fund, and a cash equivalent fund. It isn't the number of funds that counts; it is the different asset classes available. In general, a municipal bond fund (or municipal bonds themselves) would be an inappropriate investment for a tax-qualified plan.
Which of the following employer-sponsored plans allows coverage to discriminate in favor of key employees? A) 401(k) plan B) 457 plan C) Defined benefit pension plan D) 403(b) plan
B) 457 plan Because the 457 plan is technically non-qualified, it does not come under the non-discrimination rules of ERISA.
Which of the following statements about plan fiduciaries under ERISA are true? Plan fiduciaries sometimes have conflicting obligations to plan participants and other parties in interest. Plan fiduciaries must ordinarily diversify plan investments. Plan fiduciaries are personally liable for fines if they violate their fiduciary duties. A) I, II, and III B) II and III C) I and II D) I and III
B) II and III Under ERISA, plan fiduciaries must act solely in the interests of plan participants and beneficiaries, and they may not place the interests of other interested parties above those of the plan participants and beneficiaries. They must diversify plan investments to minimize the risk of large losses, unless it would not be wise to do so. If they violate any of their fiduciary duties, they may be personally liable for large fines.
What is the tax penalty for the withdrawal of money from an IRA before age 59½? A) 10% B) 5% C) 50% D) 6%
A) 10% Early withdrawals from an IRA are subject to a tax penalty amounting to 10% of the taxable portion of the distribution.
Which of the following may not be used to fund an individual retirement account (IRA)? A) Stocks B) Mutual funds C) Life insurance D) Bank accounts
C) Life insurance There are many funding options available to investors who open an IRA. IRA contributions can be invested in stocks, mutual funds, bank accounts, and annuities. They cannot be invested in life insurance, however.
If a 41-year-old investor who earns $26,000 this year overcontributes to his IRA, how much will be subject to the 6% penalty? A) His original cost base B) His original cost base plus the contribution C) There will be no penalty D) The amount by which he over contributed
D) The amount by which he over contributed Any contribution in excess of the indexed maximum (and the earnings associated with the excess) is subject to a penalty of 6%.
Under which of the following circumstances would a premature distribution from a traditional IRA be exempt from the premature distribution penalty? A) When the distribution is paid in equal annual amounts over the owner's life B) When the account is fully funded with nondeductible contributions C) A distribution taken at age 55 if the owner is retired D) A distribution taken to satisfy the terms of a court-ordered property settlement
A) When the distribution is paid in equal annual amounts over the owner's life A distribution from an IRA taken in equal annual amounts over the owner's life is not subject to the 10% premature distribution penalty even if started before age 59½. This is one of the exceptions that apply to IRAs. The exception for qualified domestic relations orders (QDROs) and for retirement at age 55 apply to employer-sponsored plans but not to IRAs.
At the end of Maria's tax year, the unused funds in her HSA A) are automatically carried over to the new year B) revert to Maria's employer C) are distributed to Maria D) are distributed to the designated beneficiary or beneficiaries
A) are automatically carried over to the new year One of the major advantages of an HSA is that, unlike an FSA, unused funds belong to the employee and may be rolled over. Furthermore, as long as the funds are used for qualified medical expenses, they are non-taxable.
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 niece, the beneficiary of the plan B) nontaxable to either party C) taxable to the uncle, the donor to the plan D) automatically reinvested back into the plan
A) 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.
One of your clients has recently turned 73 and has questions about RMDs. The client has a traditional IRA, a rollover IRA, and 401(k) plans from two previous employers. When computing the RMDs, the RMD from each IRA is computed and may be made from one or both of them the RMD from each IRA is computed and must be paid from that IRA both 401(k)s are combined to compute the required distribution, which may be made from one or both of them the RMD from each 401(k) is computed and must be paid from that 401(k) A) I and III B) II and III C) II and IV D) I and IV
D) I and IV For RMD purposes, each IRA is figured separately and the distribution can be made from one or all of them. That is not the case with a 401(k) plan. Each account has an RMD that can only be paid from that account.
Minnie's Uncle Bob would like to contribute to his one-year-old niece's education expenses. He is able to contribute a maximum of $1,200 per year. There is no other family member in a position to make a contribution. If minimizing the taxes at withdrawal and low cost investing, such as index mutual funds, is the objective, which of the following would you recommend? A) Coverdell ESA B) Dollar cost averaging C) Section 529 plan D) UTMA
A) Coverdell ESA When you see contribution levels at $2,000 per year or less, that is a signal that Coverdell is the proper recommendation. Higher levels would be the 529 plan. There are no specific tax benefits to the UTMA. In fact, tax rates on unearned income can be rather high. Although Uncle Bob might dollar cost average by investing $100 per month, that does not specifically answer the question.
If the owner of a $1 million IRA leaves it to his daughter, which of the following best describes the income tax treatment to the daughter? A) She will pay income taxes on the full amount she withdraws each year. B) She will pay no income taxes because the estate taxes have already been paid. C) She will pay income taxes only on a portion of the withdrawals which exceed $1 million. D) She will pay income taxes on the full $1 million immediately.
A) She will pay income taxes on the full amount she withdraws each year. An inherited IRA will be subject to income taxes to the beneficiary at time of withdrawal, on the same terms as if it had been distributed to the original owner. How do we know that all of the contributions were made with pre-tax funds? We don't. What we do know is that we never read into a question to make it more complicated. If a portion of the IRA represented contributions that were not tax-deductible, the question would tell us that fact.
Mary teaches physics at the local high school and makes about $70,000 per year. She could maximize her annual retirement savings by participating in A) a 403(b) and a 457 plan. B) a 403(b) plan and an IRA. C) an employer-funded 401(k) plan. D) a 403(b) plan.
A) a 403(b) and a 457 plan. Employees of public schools can legally maintain both a 403(b) plan and a 457 plan. In 2023, if both plan limits are contributed, that can be $45,000 ($60,000 if Mary is 50 or older and uses the $7,500 catch-up provision available with both plans). Remember, the exact numbers are never tested on the exam; we are using them to show your the concept. A 401(k) plan is not generally available for public sector employees.
The main disadvantage of a contributory defined contribution pension plan is that A) the actual sum an employee will receive at retirement is unknown. B) the employees can choose the amount they wish to invest. C) the employer contributed toward the retirement planning of the employee. D) at retirement, the client might want to use the retirement fund to generate income in retirement, possibly by purchasing an annuity.
A) the actual sum an employee will receive at retirement is unknown. The liability of the employer in the defined contribution pension plan is an agreed contribution to the plan. The actual performance of the plan's investments will determine the final amount to be paid to the individual at retirement. In a contributory plan, the employee is also eligible to make contributions.
Why are ERISA Section 404(c) and the accompanying Department of Labor regulations important for an employer who sponsors a Section 401(k) retirement plan and who offers at least 3 diversified categories of investments with materially different risk and return characteristics? A) If followed, the employer is relieved of fiduciary liability for any unsatisfactory investment results experienced by the employee. B) Union-negotiated contracts are exempt from Department of Labor review under this safe harbor section. C) If followed, the employer need not provide a Summary Plan Description (SPD) to any employees participating in the plan. D) This section permits the employer to avoid certain coverage and participation rules that would otherwise apply to a qualified plan
A. If followed, the employer is relieved of fiduciary liability for any unsatisfactory investment results experienced by the employee. The importance of ERISA Section 404(c) to an employer sponsoring a Section 401(k) plan with self-directed investment or earmarking provisions is the relief from fiduciary responsibility for unsatisfactory investment results experienced by the employee.
A widower wants to fund a Section 529 plan for his daughter. What is the maximum amount he may initially contribute in 2023 without having to pay gift taxes? A) $15,000 B) $85,000 C) $160,000 D) An unlimited amount because a gift occurs only when he irrevocably changes the beneficiary
B) $85,000 A special rule under Section 529 allows the donor to load front-end load contributions and avoid paying gift taxes. Five years' worth may be used under this method (5 × $17,000 = $85,000). If he remarries, his wife may also consent to gift split, thereby doubling this amount to $170,000. Please note: The annual exclusion was increased to $17,000 effective January 1, 2023.
Which of the following securities is the least suitable recommendation for a qualified money purchase plan account? A) Large-cap common stock B) Investment-grade municipal bond C) A-rated corporate bond D) Treasury bond
B) Investment-grade municipal bond Investment-grade municipal bonds bear low yields that are federally tax exempt. Because money in a qualified retirement plan account grows tax deferred regardless of the investment instrument, tax-exempt securities are unsuitable. In addition, when the money is withdrawn, it is taxable as ordinary income, so in effect, tax-free income has been converted into taxable income. Although the interest on Treasury bonds is exempt from state income tax, that rate is invariably considerably less than the federal income tax rate.
All of the following statements regarding a Section 529 QTP are true EXCEPT A) the plan owner can rollover any unused funds to a member of the beneficiary's immediate family without incurring any tax liability as long as the rollover is completed within 60 days of the distribution. B) agents selling a Section 529 Plan must deliver a currently effective prospectus. C) the plan owner can rollover the assets into a different plan no more frequently than once every 12 months. D) a beneficiary may be covered under both a Coverdell ESA and a Section 529 QTP.
B) agents selling a Section 529 Plan must deliver a currently effective prospectus. Because Section 529 Plans are technically municipal fund securities, an official statement or offering circular is the document delivered, not a prospectus.
Under the UTMA, which of the following statements is not true? A) Once a gift is given to a minor, it cannot be reclaimed. B) Only an adult can make a gift to a minor. C) The maximum amount of money an adult can give to a minor in any one year is $17,000 D) An UTMA account may have only one custodian for only one minor.
C) The maximum amount of money an adult can give to a minor in any one year is $17,000 Any adult can give a gift to a minor in a custodial account. There is no limitation on the size of the gift. However, any gift in excess of $17,000 (or such higher number as indexing provides for) will possibly subject the donor to a gift tax liability.
A tax-advantaged medical savings account available to employees enrolled in a high-deductible health plan is A) an FSA. B) Medicare, Part C. C) an HSA. D) a Section 162 plan.
C) an HSA. One of the requirements for enrolling in an HSA is that the individual be covered under a health plan with a high deductible. No such requirement applies to a flexible spending account (FSA). Medicare Part C, sometimes known as Medicare Advantage, is government health coverage and does not generally apply to those who are covered by health insurance at a place of employment (and Medicare is not tested on the exam). A Section 162 plan is an executive bonus plan, generally involving life insurance and has never been covered on the exam.
One of your clients has told you that his employer has just instituted a Roth 401(k) plan. If the employer wishes to make matching contributions, A) the employee may choose whether he wants the matching contribution to be made to the Roth 401(k) or a regular 401(k) B) it may contribute a specified percentage of the employee's pay to the Roth 401(k) C) it may contribute a specified percentage of the employee's pay to a regular 401(k) D) current tax law does not permit matching contributions to be made on behalf of any employee participating in a Roth 401(k) plan
C) it may contribute a specified percentage of the employee's pay to a regular 401(k) In order to have matching contributions, participants in a Roth 401(k) plan must actually have 2 accounts—the Roth and a regular 401(k). The employer contributions are made on a tax-deductible basis to the regular 401(k) and are fully taxable upon withdrawal.
Although not required by DOL regulations, if a plan administrator prepared a written investment policy statement meeting ERISA requirements, you would expect to find all of the following except A) methods to be used for determining how the plan will meet future cash flow needs B) investment philosophy C) the identity of the specific securities to be chosen for the portfolio D) performance measurement parameters
C) the identity of the specific securities to be chosen for the portfolio Although not required by law, most qualified plans have an IPS. One thing not found in that statement is a listing of specific securities to be selected. The method for determining how they are selected will be there, but not the specific securities.
Which of the following statements regarding Coverdell ESAs and QTPs is not correct? A) QTPs are extremely useful tools that provide significant tax savings, allow for substantial investments for a child's education and provide a tool for avoidance of gift and estate taxes if used correctly. B) If a portion or all of the withdrawal (QTP) is spent on anything other than qualified higher education expenses, the distributee will be taxed at her own tax rate on the earnings portion of the withdrawal. C) Coverdell ESAs are designed to offer tax benefits to those individuals who wish to save money for a child/grandchild's higher education expenses. D) Coverdell ESAs currently permit up to $5,000 in annual contributions, whereas QTPs allow large contributions reaching as high as $500,000 and above.
D) Coverdell ESAs currently permit up to $5,000 in annual contributions, whereas QTPs allow large contributions reaching as high as $500,000 and above. Coverdell ESAs currently permit up to $2,000 in annual contributions, whereas QTPs (Section 529 Plans) allow large contributions reaching as high as $500,000, (each state sets its own limit) and above. When nonqualifying distributions are taken, any taxes are the responsibility of the distributee, defined by the IRS as the beneficiary (student) of the plan. Those who contribute to either of these are moving assets out of their estate and, in the case of the QTP, it may be front-loaded using the annual gift tax exclusion for up to 5 years. In both plans, distributions made for qualified expenses are tax-free.
A 45-year-old employment counselor has a Keogh plan for himself and 3 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 not have an IRA. D) He may contribute 100% of earned income or the maximum allowable IRA limit, whichever is less.
D) He may contribute 100% of earned income or the maximum allowable IRA limit, whichever is less. 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.
Nonqualified corporate retirement plans differ from qualified retirement plans because nonqualified plan contributions are not exempt from current income tax nonqualified plan earnings accumulate on a tax-deferred basis the corporation need not comply with nondiscrimination rules that apply to qualified plans the corporation must comply with ERISA requirements dealing with communications to plan participants A) II and IV B) I and II C) II and III D) I and III
D) I and III Two of the primary ways in which nonqualified corporate retirement plans differ from qualified retirement plans is that contributions are not exempt from current income tax and they need not comply with nondiscrimination rules that apply to qualified plans. Under most circumstances, the accounts do not provide for tax deferral on earnings because these plans are rarely funded. The ERISA communication requirements apply to qualified plans only.
You have a client who is not covered under an employer-sponsored retirement plan and has been contributing the maximum to her traditional IRA. She has just informed you that she won $1 million in the lottery, plans to continue working, and would like to continue to contribute to her IRA. Which of the following statements is correct? A) She may continue to contribute, but her contribution will not be tax deductible. B) Her income for the year exceeds the allowable limit for making a contribution. C) She may continue to contribute, but only a portion of her contribution will be tax deductible. D) She may continue to contribute and her contribution will be tax deductible.
D) She may continue to contribute and her contribution will be tax deductible. The only time that there is an earnings limit for tax deductibility is when the individual (or spouse) is covered under an employer-sponsored retirement plan. That is not the case here. It is important to note that the client intends to continue in her job because lottery winnings are not considered earned income for an IRA contribution.
A disadvantage of a defined benefit pension plan to the employee is that A) the individual is guaranteed a payout at the time of her retirement by her employer. B) the risk of fund performance is borne by the employer. C) the funds are an integral part of the retirement planning process. D) at retirement, the employee may not be earning as much as when she was at her peak earning power.
D) at retirement, the employee may not be earning as much as when she was at her peak earning power. In defined benefit pension plans, the retirement benefit is based on two factors: the final salary and the number of years of service. In some cases, earnings are reduced in those final years before retirement as the employee moves to a less stressful position. Because the benefit is defined, the employer bears the investment risk.
A client has made both tax-deductible and nondeductible contributions to a traditional IRA. When distributions are taken from the IRA, A) they are treated as being from the nondeductible portion first and the deductible portion last B) that portion derived from the nondeductible contributions is not subject to penalty if withdrawn before age 59½ C) they are treated as being from the tax-deductible portion first and the nondeductible last D) they are taxed on a pro rata basis
D) they are taxed on a pro rata basis The portion of the distribution that is nontaxable must be prorated with amounts that are taxable. For instance, if the individual contributed $2,000 in after-tax amounts and $8,000 in pre-tax amounts, a distribution of $5,000 would be prorated to include $1,000 after-tax and $4,000 in pre-tax assets.
