Retirement Plans Quiz #1

A tax deduction for a contribution to a Coverdell Education Savings Account is: A. permitted without limitation B. permitted only for persons earning below a statutory limit C. not permitted unless the monies remain in the account for at least 5 years D. not permitted

D. Contributions to Coverdell Education Savings Accounts are not tax deductible - no if's, and's, or but's!

To avoid penalties, funds cannot be withdrawn from tax qualified retirement plans before age: A. 59 1/2 B. 65 C. 70 1/2 D. 75

A. Before age 59 1/2, distributions from an IRA are subject to regular income tax plus a 10% penalty tax. Afterwards, withdrawals are subject to regular tax; but not to the 10% penalty tax.

Upon annuitization, a customer's insurer calculated the assumed interest rate (AIR) of his annuity as 5 percent. The account earned 6 percent after the first year. The customer's next payout amount will: A. increase B. decrease C. remain unchanged D. increase by the changes in the CPI

A. Payout amounts will change depending upon the actual earnings of the separate account assets. AIR - Assumed Interest Rate - is the assumed investment return needed to maintain a level monthly payment. If the actual investment return exceeds AIR (as in this example), then the monthly payment will increase. If actual investment return is less than the AIR, then the monthly payment will decrease.

A variable life policy will remain in force: A. for the stated term of the policy B. as long as the premium is paid C. if the policy has depleted its cash value D. for the life of the insured individual

B. An insurance policy remains "in force" as long as the premiums are paid. If the premiums are not paid, the policy will lapse and there is no more insurance! Because variable life is permanent insurance that build cash value, if the premium payment is not made, the insurance company will use the cash value (if any) to make the premium payment.

A single mother has 2 children, ages 5 and 9. She earns $150,000 per year and wishes to open Coverdell ESAs for each child to pay for qualified education expenses. Which statement is TRUE? A. She can open the account for each child and make an annual $2,000 tax-deductible contribution for each B. She can open the account for each child and make an annual $2,000 non tax-deductible contribution for each C. She is prohibited from opening an account for each child because she earns too much D. She is prohibited from opening an account for each child because Coverdell ESAs are only available to married couples with children

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 2019, the top end of the income phase out range for individuals is $110,000 and for couples it is $220,000.

Section 529 plans generally permit: I tax deductible contributions by the donor II non-tax deductible contributions by the donor III taxable distributions to the recipient to pay for higher education IV non-taxable distributions to the recipient to pay for higher education A. I and III B. I and IV C. II and III D. II and IV

D. Any adult can open a Section 529 account to pay for the higher education expenses of a beneficiary. Starting in 2018, up to $10,000 per year can be withdrawn to pay for education below the college level. There is no tax deduction for the contribution; earnings build tax-deferred; and distributions to pay qualified higher education expenses are not taxable.

In 2019, a customer earns $300,000 as a self-employed doctor, and contributes the maximum permitted amount to a Keogh plan. The doctor has a full time nurse earning $30,000 per year. The contribution to be made for the nurse is: A. $3,000 B. $3,750 C. $6,000 D. $7,500

D. If an employer earns $280,000 or more and contributes the maximum of $56,000 to a Keogh in 2019, then 25% of "after Keogh earnings" is used to compute the percentage to be contributed for employees. If the employer earns $300,000 and contributes $56,000 to the Keogh, the "after Keogh earnings" are based on the "cap" income amount of $280,000. $280,000 - $56,000 = $224,000 of "after Keogh deduction" income. $56,000/$224,000 = 25%. Thus, for the nurse, $30,000 of income x 25% = $7,500 contribution.

Distributions after age 59 ½ from tax qualified retirement plans are: A. 100% taxable B. partial tax free return of capital and partial taxable income C. 100% tax free D. 100% tax deferred

A. Contributions to tax qualified plans such as Keogh Plans are tax deductible. They are made with "before-tax" dollars, hence those funds were never taxed. Earnings accrue tax deferred. When distributions commence, since no tax was paid on the entire amount, the distribution is 100% taxable.

A customer that earns $300,000 per year wishes to set aside funds for his 12 year old daughter's future college expenses. Which statements are TRUE? I The customer can open a UTMA account for the daughter to deposit the funds II The customer cannot open a UTMA account for the daughter to deposit the funds III The customer can open a Coverdell ESA account for the daughter to deposit the funds IV The customer cannot open a Coverdell ESA account for the daughter to deposit the funds A. I and III B. I and IV C. II and III D. II and IV

B. Custodian accounts opened under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) can be opened by any adult for any minor, with no limitation on the income of the donor in determining whether the account can be opened. On the other hand, high earning individuals are prohibited from opening either a Roth IRA or a Coverdell Education Savings Account.

Individual Retirement Account contributions can be made with: I Cash II Exempt Securities III Non-Exempt Securities IV Money Market Fund Shares A. I only B. II only C. I and IV only D. II, III, IV only

A. Contributions to an IRA can only be made with cash. Once the cash is deposited, it can be used to purchase any type of qualified investments (bank certificates of deposit, securities, U.S. minted gold coins, and precious metals).

Which of the following statements are TRUE regarding contributions to 401(k) plans and the distributions from these plans after age 59 1/2? I Contributions are made with before tax dollars II Contributions are made with after tax dollars III Distributions are 100% taxable IV Distributions are tax free A. I and III B. I and IV C. II and III D. II and IV

A. Contributions to tax qualified plans such as 401(k) plans are tax deductible. They are made with "before-tax" dollars, hence those funds were never taxed. When distributions commence, since no tax was paid on the entire amount, the distribution is 100% taxable.

A 50 1/2 year old self-employed individual has a balance of $200,000 in his HR 10 plan. This balance is composed of $140,000 of contributions and $60,000 of earnings. The individual decides to withdraw $100,000 from the plan. Which statements are TRUE? I The entire withdrawal is taxed as ordinary income II Since half the account balance has been withdrawn, the withdrawal is taxed at 50% of ordinary rates III The entire withdrawal is subject to a 10% penalty tax IV Since half of the account has been withdrawn, the withdrawal is subject to half of the 10% penalty tax A. I and III B. I and IV C. II and III D. II and IV

A. Since this individual is younger than age 59 1/2, any distribution from the Keogh plan is subject to both ordinary income tax plus the 10% penalty tax. If the distribution is made after age 59 1/2, it is subject only to ordinary income tax - there is no penalty tax. Please note that 100% of all distributions from Keoghs are taxable - these are tax qualified plans where all of the investment dollars were never taxed. Once distributions commence, both the original investment (that was never taxed), and the tax deferred build-up, are now taxable in full.

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

B. 401(k) plans are corporate-sponsored salary reduction plans allow employees to contribute up to $19,000 in 2019 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. Note that the maximum contribution into an IRA is 2019 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 statements are TRUE about SEP IRAs? I The plan is established by the employer II The plan is established by each employee III The maximum annual contribution is the same as for a Traditional or Roth IRA IV The maximum annual contribution is significantly greater than for a Traditional or Roth IRA A. I and III B. I and IV C. II and III D. II and IV

B. A SEP IRA is a "Simplified Employee Pension" plan that must be set up by the employer, with deductible contributions made by the employer. They are easier to set up and administrate than regular pension plans and allow for a very large annual contribution (25% of income statutory rate; 20% effective rate, capped at $56,000 in 2019). The employer sets the actual contribution percentage, which must be the same for all employees. A major advantage of SEP IRAs is that there is flexibility regarding the annual contribution to be made - the employer can change the contribution percentage each year. So this plan is a good option for a small business that has variable cash flow. Also, any size business can establish a SEP IRA.

If a corporation has an unfunded pension liability which of the following statements are TRUE? I The expected payments from the retirement plan are in excess of the expected future assets in the plan II The expected payments from the retirement plan are lower than the expected future assets in the plan III The plan is in default and must be liquidated by the trustee IV The trustee must ensure that future funding is adequate A. I and III B. I and IV C. II and III D. II and IV

B. An unfunded pension liability means that expected payments from the retirement plan are in excess of the expected future assets in the plan. It is common for defined benefit pension plans to be underfunded, but the plan trustee is responsible to ensure that future funding is adequate as needed.

Which statement is TRUE about a non-qualified variable annuity? A. Contributions to the contract are tax-deductible B. Investments held in the separate account grow tax-deferred C. Withdrawals from the contract prior to retirement age are tax-free D. Withdrawals from the contract after retirement age are tax-free

B. Contributions to a non-qualified variable annuity contract are not deductible. The separate account grows tax-deferred (the main benefit of the contract), making Choice B true. Any distributions are taxable on amounts above that contributed to the contract. Furthermore, if a premature distribution is taken (prior to age 59 1/2), a 10% penalty tax is imposed as well.

When comparing Section 529 plans to Coverdell Education Savings Accounts, which statement is FALSE? A. The account may be opened by any adult B. Annual contributions are limited to $2,000 per beneficiary C. Earnings build in the account tax deferred D. Distributions to pay for higher education expenses are not taxable

B. There is a maximum $2,000 annual contribution into a Coverdell Education Savings Account; there is no maximum annual contribution into a Section 529 account - any contribution limits are set by the state (and are typically quite high). Any adult can open either type of account for a beneficiary; contributions to either are not tax deductible; earnings build tax-deferred in both; and distributions to pay for qualified higher education expenses are not taxable for both.

Which of the following statements are TRUE when describing a variable annuity separate account? I The separate account is part of the insurance company's general account holdings II The separate account is legally segregated from the insurance company's general account holdings III The separate account invests in shares of a designated mutual fund IV The separate account makes direct investments in shares of stock A. I and III B. I and IV C. II and III D. II and IV

C. An accumulation unit is an accounting measure used for valuing a variable annuity holder's interest in the separate account. The separate account buys shares of a designated mutual fund. The performance of the mutual fund determines the annuity amount to be paid. Direct investments in shares of stock cannot be made in the separate account; the account only buys shares of open-end management companies (mutual funds).

For an Individual Retirement Account contribution to be deductible from that year's tax return, the contribution must be made by no later than: A. April 15th of that year B. December 31st of that year C. April 15th of following year D. December 31st of the following year

C. IRA contributions must be made by April 15th of the following year - no extensions are permitted.

During the accumulation phase of a variable annuity: I funds can be distributed to unit holders II funds cannot be distributed to unit holders III as interest, dividends, and capital gains are received, the investor has the option of reinvesting in more shares IV as interest, dividends, and capital gains are received, these must be reinvested in more accumulation units A. I and III B. I and IV C. II and III D. II and IV

D. As interest, dividends, and capital gains are realized from the securities held in the separate account during the accumulation phase, these must be automatically reinvested to buy more accumulation units for the contract holder. These cannot be distributed to the unit holders until the contract is annuitized. Thus, the accumulation phase allows payments to be made into the plan; requires that all dividends and capital gains be reinvested in the plan; and does not allow distributions to be taken out of the plan.