Unit 18

The type of tax-favored retirement plan that is available to nonprofit entities such as schools and hospitals and that is sometimes called a tax-sheltered annuity is A) a SIMPLE retirement plan B) a 403(b) plan C) a 401(k) plan D) a simplified employee pension (SEP)

A 403(b) plan is a special type of tax-favored retirement plan allowed for nonprofit entities. Amounts contributed to 403(b) plans are often invested in annuity contracts, so these plans are sometimes referred to as tax-sheltered annuities. LO 18.d B

An investment policy statement would likely include expected returns of the recommended strategy and the expected range of these returns recommended allocations among differing asset classes strategies used for selecting specific stocks in the equity portion of the portfolio disclosure of the fees that the adviser will earn for implementing the recommended strategy A) II, III, and IV B) I only C) I and II D) I, II, and III

An investment policy statement prepared for clients delineates the allocation percentages for each asset class and the expected returns from each class, and outlines strategies that may be used for timing the market and choosing specific investments within each class, but fees the adviser may earn are not included in the policy statement; they are disclosed separately. LO 18.g D

Distributions from which of the following can be rolled over into an IRA? Another IRA Corporate pension plan Corporate profit-sharing plan Keogh plan A) I and IV B) I, II, III, and IV C) III and IV D) II and III

Assets from any qualified corporate plan or from another IRA may be rolled over into an IRA. LO 18.b B

The employer does not get a current tax deduction when offering which of the following retirement plans? A) Deferred compensation plan B) Money purchase plan C) Defined benefit plan D) SIMPLE plan

Because there is no constructive receipt of income until the deferral period is over, the employing company does not get a current tax deduction. Of course, the employee doesn't report taxable income until then. In the other plans, all qualified, any contributions made by the employer represent a current business expense and are deductible from the company's income. LO 18.e A

Which of the following employer-sponsored plans would never be covered by ERISA? A) 403(b) B) Deferred compensation C) 401(k) D) Defined benefit pension

Deferred compensation plans are never ERISA-covered plans; that is what gives them greater flexibility than a covered plan. Depending on the employer, some 403(b) plans are covered under ERISA while others are not. LO 18.g B

For purposes of the maximum allowable annual contribution, an individual would have to aggregate contributions made to A) a 401(k) and a 457. B) a 403(b) and a 457. C) a 401(k) and a Roth IRA. D) a 401(k) and a 403(b).

Disregarding the catch-up provision for those age 50 and older, the maximum annual contribution in 2023 for the employer-sponsored plans is $22,500 (never tested). An individual covered by a 401(k) or a 403(b) may contribute that plus another $22,500 to the 457. Likewise, contributing to an employer-sponsored plan does not affect the Roth IRA limit. What is tested is knowing that maintaining a 401(k) and a 403(b) is similar to maintaining a Traditional and Roth IRA. The maximum is not doubled; it is aggregated. LO 18.d D

What is the tax penalty for the withdrawal of money from an IRA before age 59½? A) 50% B) 5% C) 10% D) 6%

Early withdrawals from an IRA are subject to a tax penalty amounting to 10% of the taxable portion of the distribution. LO 18.b C

All of the following permit investments into various securities, such as stocks, bonds, and mutual funds except A) an FSA. B) a traditional IRA. C) a Roth IRA. D) an HSA.

Flexible spending accounts (FSAs) allow deductions from an employee's paycheck. That money is held by the company and is used to pay allowable claims by the employee. A health savings account (HSA) permits the employee to invest in a wide variety of securities. IRAs, traditional and Roth, have always permitted investment flexibility. LO 18.j A

Under Keogh plan provisions, a full-time employee is defined as one working at least how many hours per year? A) 1,000 B) 2,000 C) 500 D) 100

Full-time employment is defined as 1,000 hours or more per year, regardless of the number of days, weeks, or months worked. LO 18.c A

Which of the following statements is true regarding Section 529 plans? Funds withdrawn for qualified education expenses are always free of federal income tax. Funds withdrawn for qualified education expenses are always free of state income tax. The maximum contribution limits are determined on a federal level. The maximum contribution limits are determined on a state level. A) II and III B) I and III C) I and IV D) II and IV

Section 529 plan withdrawals are exempt from federal income tax if used for the right expenses. In almost all cases, if the plan is one operated by your state of residence, it will be exempt from your state's income tax. But, if you elect to contribute to a plan operated by another state, more than likely, any withdrawals will be subject to your state's income tax. Because the plans are state operated, the maximum contribution limits are set by each state. LO 18.h C

Which of the following investment activities are acceptable for a fiduciary acting under the prudent expert rule? Purchasing AAA-rated debentures Purchasing a growth mutual fund Purchasing new issues of a AAA-rated issuer Writing covered calls on dividend-paying stocks A) II and IV B) I and II C) II and III D) I, II, III, and IV

The prudent expert rule permits a fiduciary to invest in securities that a prudent expert might buy. These investments are nonspeculative, low to moderate risk, and likely to be considered prudent if they are used in a way consistent with modern portfolio theory (MPT). LO 18.g D

An employer-sponsored retirement plan that pays a specific benefit to participants at their normal retirement age is A) a defined contribution plan B) a supplemental employee retirement plan C) a defined benefit plan D) a section 401(k) plan

A traditional defined benefit plan promises to pay a specific benefit to a participant at his normal retirement age as specified by the plan document. LO 18.c C

Two years after their wedding, Pam and Jim became the proud parents of child. Both grandparents want to help ensure educational funds for their new grandchild by using the Coverdell ESA. Assuming they are within the earnings limitations, which of the following would be permitted? A) $2,000 from Pam's parents and $2,000 from Jim's parents into a single ESA B) $2,000 from Pam's parents and $2,000 from Jim's parents into separate ESAs C) $1,000 from Pam's parents and $1,000 from Jim's parents into separate ESAs D) $2,000 from Pam's mother, $2,000 from Pam's father, $2,000 from Jim's mother, and $2,000 from Jim's father

Any individual whose modified adjusted gross income is under the limit set for a given tax year can make contributions. There's no limit to the number of accounts that can be established for a particular beneficiary; however, the total contribution to all accounts on behalf of a beneficiary in any year can't exceed $2,000. LO 18.h C

A single individual earning $250,000 a year may open a Coverdell ESA not open a Coverdell ESA open a 529 college savings plan not open a 529 college savings plan A) II and III B) II and IV C) I and III D) I and IV

There are income limits that apply to Coverdell ESAs. Single individuals earning more than $110,000 per year are not permitted to open a Coverdell account, and married couples lose the ability to contribute when earnings exceed $220,000. However, there are no income limits restricting who is eligible to open and contribute to a Section 529 college savings plan. LO 18.h A

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

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. LO 18.a C

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) $160,000 B) An unlimited amount because a gift occurs only when he irrevocably changes the beneficiary C) $85,000 D) $15,000

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. LO 18.h C

Which of the following statements regarding a qualified profit-sharing plan is true? A) It must define a specific contribution amount. B) It can permit regular direct cash payouts to participants before retirement. C) Contributions are required annually. D) It must be established under a trust agreement.

All qualified retirement plans must be established under a trust agreement. Contributions with this type of plan are not required annually, nor can the plan make direct cash payouts to participants before retirement. LO 18.c D

In the administration of a qualified retirement plan, which of the following individuals is considered to be a fiduciary? A) A highly-compensated employee who participates in the plan B) A CPA who prepares the plan's Form 5500 for an annual fee C) The marketing director of the plan sponsor D) A financial planner acting as a trustee over the plan assets

An individual or business entity is considered a fiduciary under ERISA if that person renders investment advice or services to the plan for direct or indirect compensation. Clearly, the financial planner-investment trustee is within this definition. Completing an IRS form (5500) is not an investment-related activity. LO 18.g D

Which of the following statements regarding Roth IRAs is not true? A) There is no age limit on making contributions to Roth IRAs. B) Roth IRAs have higher contribution limits than traditional IRAs. C) Distributions prior to age 59½ may be subject to penalty. D) Roth IRAs do not have required distributions.

An individual with earned income may choose to have either or both a traditional and a Roth IRA (as long as he falls within the Roth's income limitations). The maximum contribution under current regulations is $6,500 (+ $1,000 catch-up for those age 50 or older) and can be split however desired so long as no more than a total of $6,500 ($7,500 with catch-up) is contributed. LO 18.a B

Your married client has an AGI of $105,000 per year and is covered by his employer's defined benefit pension plan. When inquiring about opening a Roth IRA, you would respond that A) the client's earnings exceed the Roth limits so the plan could not be opened B) the client could open the Roth IRA without any restriction C) the client could open a Roth but, depending on future earnings, might not be able to deduct all of the annual contribution D) one cannot be a participant in a qualified plan and a Roth IRA at the same time

As long as a married couple's AGI does not exceed $228,000 (for 2023, but this is never tested), a Roth IRA can be opened without any restrictions. Contributions are never deductible. LO 18.a B

Terry Bolton employs his two sons in the family gardening business. Josh is 12 years old and was paid $2,000 for the year. Drake is 14 years old and was paid $3,000 for the year. Which of the following are correct statements regarding the taxation of the income? Josh's income is taxed at his tax rate. Drake's income is taxed at his tax rate. Josh's income is taxed at his parents' marginal rate. Drake's income is taxed at his parents' marginal rate. A) I and IV B) II and III C) I and II D) III and IV

Because the money paid is earned income, it is not subject to the child tax rules, regardless of age. If, however, there is unearned income, anything over $2,500 in 2023 (an amount that isn't tested) is taxed at the parents' marginal (top) tax rate. LO 18.i C

Employee contributions to a 401(k) plan are subject to Social Security taxes federal unemployment taxes federal income tax withholding state income tax withholding A) I and III B) II and IV C) III and IV D) I and II

Employee contributions are excluded from taxable income at the time of contributions, which exempts them from income tax, but not from payroll taxes such as social security and FUTA (federal unemployment tax). LO 18.f D

​In terms of being considered compensation for determining the allowable contribution to an IRA, receipt of which of the following would be included? A) Taxable interest income B) Alimony received as part of a divorce decree signed in 2018 C) Child support D) Deferred compensation

For divorce decrees entered into before January 1,2019, court-ordered alimony is taxable to the payee (and tax deductible to the payor). Therefore, receiving it is considered compensation for purposes of an IRA contribution. Please note: Effective January 1, 2019, there are changes to the tax treatment of alimony for all divorce agreements entered on and after that date (no changes to those already in existence). LO 18.a B

Health savings accounts (HSAs) offer the opportunity for employees to use pretax funds to pay for a wide range of medical expenses. Medical expenses included are all of the following except A) long-term care insurance premiums. B) health insurance coverage under COBRA. C) long-term disability insurance premiums. D) Medicare premiums for those age 65 or older.

If an HSA may be used to pay long-term care (LTC) premiums, why can't it be used for long-term disability premiums? The answer is in the first word of the name: health. Disability insurance is not health insurance. It is used to replace the income lost when one is unable to perform the labor required for their occupation. LO 18.j C

Which of the following statements are true about both an individual Roth IRA and a Roth 401(k) plan? Contributions are made with after-tax dollars. One must have AGI below a certain level in order to maintain either Roth. If all the conditions are met, withdrawals are tax free. There are no RMDs at age 73. A) II and IV B) I and II C) I and III D) III and IV

In any Roth plan, contributions are made with after-tax dollars, and assuming all conditions are met, withdrawals are tax-free. However, unlike the individual Roth IRA, there are no earnings restrictions on participants in a Roth 401(k) plan and RMDs must begin at age 73. LO 18.f C

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) at retirement, the employee may not be earning as much as when she was at her peak earning power. D) the funds are an integral part of the retirement planning process.

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. LO 18.c C

When a participant in a 401(k) plan dies before retirement, the proceeds are distributed A) to the designated beneficiary without going through probate. B) to the designated beneficiary after going through probate. C) according to the terms of the will after going through probate. D) according to the terms of the will without going through probate.

Most qualified retirement plans require naming a designated beneficiary (or beneficiaries). Upon the death of the participant, the account proceeds are distributed without going through the probate process. This is done without regards to the terms of the will, similar to the beneficiary of a life insurance policy. LO 18.c A

Gaston is a police officer and wishes to contribute to a retirement plan sponsored by the city. Gaston wants the flexibility of being able to have unfettered penalty-free access to his funds before reaching age 59½. This can only be accomplished if Gaston contributes to A) a 401(k) plan. B) a SEP-IRA. C) a 457 plan. D) a 403(b).

The 457 plan is unique in that it is the only tax-qualified retirement plan permitting withdrawals, for any reason, before reaching 59½ without penalty. All qualified plans have exceptions to the 10% penalty tax, but only the 457 allows the withdrawals for any reason. LO 18.d C

Which of the following securities is the least suitable recommendation for a qualified money purchase plan account? A) Investment-grade municipal bond B) Treasury bond C) Large-cap common stock D) A-rated corporate 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. LO 18.g A

Marv teaches literature at the local high school and makes about $60,000 per year. He could maximize his annual retirement savings by participating in A) a SEP-IRA B) a Roth IRA. C) a 401(k) plan D) a 403(b) plan.

When you see public school, you know the question is generally asking about a 403(b) plan. The other two employer plans are not available to school teachers and the contribution limits on a Roth IRA are far less than the 403(b). LO 18.d D

Which of the following is not included in adjusted gross income on an individual's federal income tax return? A) Unemployment compensation B) Municipal bond interest C) Dividends paid on preferred stock D) Salary and commissions

Although tax-exempt interest is reported on the Form 1040 (line 8b), it is not included in adjusted gross income. LO 18.a B

Which of the following individuals is clearly eligible to make a catch-up contribution? A) Hannah, who is 55 years old B) Roger, who has completed 1 year of service C) Sam, who has completed 15 years of service D) Emily, who is fully vested

Catch-up contributions are allowed to participants who are age 50 and over. LO 18.a A

Each of these would be considered an advantage of using a 529 plan rather than a Coverdell ESA to fund a child's future education except A) the 529 plan has no earnings limitation on the donor. B) the 529 plan allows for higher contribution levels. C) the 529 plan is counted at a lower percentage of assets when applying for financial aid. D) the 529 plan has no age limits.

Funds in both plans are counted as assets of parents at 5.64% if owner is a parent or dependent student, so there is no difference. The 529 plan allows for far greater contribution levels and there is no income limitation on the donor as exists with the Coverdell ESA. The funds in the ESA must be used by the time the beneficiary is 30; no such age restrictions apply to the 529 plan. LO 18.h C

A QDRO is a judgment, decree, or order for a qualified retirement plan to pay child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of a participant. The QDRO must contain certain specific information as stated in whose regulations? A) NASAA B) DOL C) ERISA D) IRS

It is the IRS who states the QDRO must contain certain specific information, such as: the participant and each alternate payee's name and last known mailing address, and the amount or percentage of the participant's benefits to be paid to each alternate payee. This is not part of ERISA or the Department of Labor and, least of all, NASAA. LO 18.f D

Which of the following investments could be found in an UTMA but not an UGMA? A) Bonds B) Sector mutual fund C) Real estate D) Preferred stock

The Uniform Transfer to Minors Act (UTMA) allows virtually any kind of asset, including real estate, to be transferred to a minor. UGMA accounts, on the other hand, are limited to gifts of cash, securities (such as stocks, bonds, or mutual funds), and insurance policies. LO 18.i C

Becky Biggins has an executive position with a large corporation that covers her under its defined benefit pension plan. This year, Becky's salary will top $435,000. Becky has no dependents and wishes to maximize funds that she can accumulate for her retirement. Becky could not contribute to a traditional IRA contribute to a traditional IRA but would not be able to deduct her contributions contribute to her Roth IRA not contribute to her Roth IRA A) II and III B) I and IV C) II and IV D) I and III

Anyone with earned income can open a traditional IRA. Deductibility of contributions may be disallowed if the individual is covered under a corporate plan and has earnings in excess of a certain level. Becky's salary exceeds the maximum permitted for a single person so her contributions would be made with after-tax dollars. In the case of a Roth, nothing is deductible, so it doesn't matter if you are covered at work. However, Becky's salary is far in excess of the maximum permitted for a single person to contribute to a Roth IRA. LO 18.a C

One of your clients has reached his company's mandatory retirement age of 67. He has been a participant in his employer's 401(k) plan and his account is valued at $400,000. The account is funded with mutual funds and company stock. The cost basis of the company stock is $25,000 and it is currently worth $125,000. If he were to rollover the entire account into an IRA, the tax treatment would be A) current tax at ordinary income rates on the unrealized appreciation of the company stock, ordinary income rates on the balance when withdrawals are taken B) no current tax on the portion applicable to the mutual funds; ordinary income on the cost basis of the company stock; and long-term capital gains on the unrealized appreciation of the company stock when it is sold C) no current tax, but any withdrawals would be taxed as ordinary income D) no current tax, but any withdrawals representing the gain on the company stock would be taxed as long-term capital gains

As with any rollover from a qualified plan to an IRA, there is no current tax, but withdrawals are taxed at ordinary income tax rates. This client would have saved had he taken advantage of the NUA (net unrealized appreciation) approach. In that case, taking the company stock and putting it into a taxable account would have resulted in ordinary income tax on the $25,000 cost basis, and long-term capital gain rates on the appreciation whenever the stock was sold. LO 18.f C

A participant in an ERISA qualified retirement plan is studying the investment policy statement (IPS) prepared by the plan's fiduciary. The contents of the IPS would not include A) specific security selection B) investment philosophy including asset allocation style C) methods for monitoring procedures and performance D) determination for meeting future cash flow needs

One thing that could never be in an IPS is a listing of the securities that will be purchased in the future. Types of securities, yes, but not the specific ones. LO 18.g A

Which of the following statements regarding Roth IRAs is true? A) Like traditional IRAs, Roth IRA contributions may not be made after the participant reaches age 73. B) Like traditional IRAs, Roth contribution eligibility is restricted by active participation in an employer's retirement plan. C) Roth IRA withdrawals are tax free in their entirety regardless of the participant's age at withdrawal. D) Roth IRAs are not subject to the minimum distribution rules until the death of the owner/participant of the plan.

Unlike traditional IRAs, Roth IRAs are not subject to the minimum distribution rules regarding a participant's age (73). Rather, distributions need not be made until the death of the owner/participant. For a Roth IRA withdrawal to be entirely tax free, it must be made following a 5-year holding period after the first contribution and after the participant reaches age 59½. Effective with the SECURE Act, there are no age limitations for contributions for any retirement plan. LO 18.b D

A prospective client has been interviewing a number of investment advisers and wishes to see your firm's investment policy statement. Your IPS would probably include which of the following headings? Investment objectives Investment philosophy Investment selection criteria Monitoring procedures A) I, II, III, and IV B) I and II C) I, III, and IV D) II and IV

Although there are no rules requiring that an IA develop an investment policy statement, it is a recommended procedure. Each of these 4 items would be found in a typical IPS. Please note that the IPS would include the criteria for selecting investments, but not the listing of the actual investments themselves. LO 18.g A

One of your clients is discussing various options for funding his IRA. Current tax law would permit investing in which of the following vehicles? Collectible stamps issued by the U.S. Postal Service Gold or silver coins minted by the U.S. Treasury Department Fixed annuities REITs A) II, III, and IV B) I and III C) I, II, III, and IV D) II and IV

In general, investments in collectibles are not permitted in IRAs. The one major exception is U.S. gold and silver coins minted by the Treasury Department. Although some might object to placing an annuity into a tax-deferred plan because it is already tax deferred, there could be a good reason for its inclusion and, more important for this question, it is permitted. LO 18.a A

A grandparent wishes to contribute funds to an account for the benefit of the college education of a grandchild. In which of the following does the donor have the greatest amount of control over the assets in the account? A) An UTMA account B) A Coverdell ESA C) An UGMA account D) A Section 529 plan

It is the Section 529 plan that offers the greatest amount of control to the donor. In the case of the ESA, on the IRS form used to open the account, it states: "The 'responsible individual"' named by the depositor shall be a parent or guardian of the designated beneficiary." Unless we are told that the grandparent has been appointed as legal guardian, there is a lack of control. And, even then, one thing the "responsible individual" cannot do that the donor to a 529 plan can is take the money back. Although the grandparent could be named the custodian of the UGMA or UTMA account, the only authority there is to make the investment decisions and disbursements until the termination age of the account. LO 18.h D

A client has made both tax-deductible and nondeductible contributions to a traditional IRA. When distributions are taken from the IRA, A) they are taxed on a pro rata basis B) they are treated as being from the nondeductible portion first and the deductible portion last C) they are treated as being from the tax-deductible portion first and the nondeductible last D) that portion derived from the nondeductible contributions is not subject to penalty if withdrawn before age 59½

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. LO 18.b A

Which factor is least important when assessing a defined benefit pension? A) Expected amount payable B) Investment performance of the fund C) Age at which benefits can be taken D) Lump sum available at retirement

Under a defined benefit plan, the pension payable is related to the length of service and usually expressed as a proportion of final earnings. The investment performance of the fund is therefore the least important factor to consider. LO 18.c B

Which of the following statements regarding a QDRO is correct? A) A QDRO must comply with ERISA to be effective. B) A QDRO applies to assets in a qualified employer plan and a traditional IRA. C) A QDRO applies only to assets in a traditional IRA. D) A QDRO applies only to assets in a qualified employer plan.

A QDRO applies only to assets in a qualified employer plan; it would not be applicable to an IRA or a SEP. Under IRS regulations, early distributions that are taken pursuant to a qualified domestic relations order, or QDRO, are exempt from the 10% penalty. A QDRO is a court-issued order that gives someone the right to an individual's qualified plan assets, typically an ex- (or soon-to-be-ex-) spouse, and the QDRO is usually issued in the course of divorce proceedings or to satisfy child support obligations. LO 18.f D

Which of the following would be permitted to contribute to an IRA? An individual whose sole income consists of dividends and capital gains A divorced mother whose sole income is alimony and child support under the terms of a divorce agreement signed on October 31, 2018 A self-employed attorney who has a Keogh plan A corporate officer covered by 401(k) A) I, II, III, and IV B) II, III, and IV C) I and II D) III and IV

An IRA contribution can only be made by someone who has earned or otherwise eligible income. Earned income is defined as salary, wages, commissions, and tips. Alimony (but not child support) is considered eligible income for an IRA as long as the divorce decree was signed prior to January 1, 2019. Individuals can contribute to an IRA even if they are covered by a corporate pension plan or Keogh plan. Although a contribution can be made, it may or may not be deductible depending on the individual's income. Dividends and capital gains are not considered earned income. LO 18.a B

A fiduciary of an ERISA plan is preparing an investment policy statement. Included would probably be specific security selection methods of performance measurement determination for meeting future cash flow needs the Summary Plan Description A) II and IV B) III and IV C) I, II, and III D) II and III

The IPS will include methods of performance measurement (if it is meeting objectives) and a way to determine how future cash flow needs will be met (based on expected numbers of retirees). It will not include the specific securities to be purchased, but will include the types that may be placed in the portfolio. The Summary Plan Description (SPD) is a Department of Labor (DOL)-required document that gives employees a summary of the plan and its features. It has nothing to do with determining how the money is invested. LO 18.g D

Which of the following statements regarding IRAs are correct? One may have both a Roth IRA and a traditional IRA, contributing the maximum to each one. One may have both a Roth IRA and a Roth 401(k) contributing the maximum to each one. Both traditional IRAs and Roth 401(k) plans have RMDs at age 73. If one is a participant in a Roth 401(k) plan, the earnings limits are waived for opening a Roth IRA. A) I and II B) I and IV C) III and IV D) II and III

A Roth IRA and Roth 401(k) are two separate items, and maximum allowable contributions may be made to both. This is unlike the IRAs, where one can maintain both but the total contribution is the annual limit (currently $6,500 with a $1,000 catch-up). One of the things about a Roth 401(k) that is different from the Roth IRA is that RMDs must start at the same time as with traditional IRAs. Although one may participate in a Roth 401(k) without regard to AGI limits, that is not so with the Roth IRA. LO 18.c D

All of the following statements concerning IRA contributions are true except A) contributions can be paid into this year's IRA from January 1 of this year until April 15 of next year B) contributions for the past year may be made after April 15, provided an extension has been filed on a timely basis C) between January 1 and April 15, contributions may be made for the current year, the past year, or both D) if you pay your tax on January 15, you can still deduct your IRA contribution, even if not made until April 15

Contributions can be made to an IRA only until the first tax filing deadline (April 15), regardless of having filed an extension. LO 18.a B

A nonqualified, single premium variable annuity differs from a Keogh plan in that A) earnings are tax deferred B) it is open to self-employed persons C) both are subject to early withdrawal penalties D) all payouts are fully taxable in a Keogh plan

Earnings on investments made in both a Keogh plan and nonqualified annuity grow on a tax-deferred basis; they are not taxed until withdrawn. The cost basis in a Keogh plan is zero because contributions are tax deductible, but distributions are fully taxable upon receipt. However, in a nonqualified annuity, the cost basis is equal to the amount invested because the contributions are nondeductible; only the earnings portion of the distributions is taxable. LO 18.c D

Saving for higher education using which of the following tools will generally result in the worst outcome when filing the FAFSA form? A) UTMA B) Coverdell ESA C) Cash value in the parent's insurance policy D) Section 529 plan

One of the negatives of using UTMA (or UGMA) to save for a child's education is that those funds are counted at a far higher percentage of the child's assets than are funds in a Coverdell ESA or 529 plan. Cash value in the parent's life insurance policy is not counted at all. LO 18.i A

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) Dollar cost averaging B) Section 529 plan C) UTMA D) 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. LO 18.h D

All of the following statements regarding qualified corporate retirement plans are true except A) all corporate pension and profit-sharing plans must be established under a trust agreement B) with defined benefit plans, the employee bears the investment risk C) they are covered under ERISA D) all qualified retirement plans are either defined contribution or defined benefit plans

With defined benefit plans, the employer (not the employee) bears the investment risk. The employer must fund the defined benefits, regardless of the investment performance of funds set aside for this purpose. The retiree receives a defined benefit regardless of investment performance. All corporate pension and profit-sharing plans must be established under a trust agreement. All qualified retirement plans are either defined contribution or defined benefit plans. LO 18.c B

Under UTMA, which of the following are allowable distributions for the benefit of the minor? A) Clothing expense for a child who has gone through a growth spurt B) The cost to attend a summer camp C) A percentage of housing expenses, such as the utilities for his bedroom D) A percentage of food expense

You cannot use UTMA (or UGMA) money for the basics: food, clothing, and shelter; those are the responsibility of the parent. An optional expense, such as summer camp, vacation, and sports league registration, would be permitted. LO 18.i B

Among the benefits of an HSA is A) the amount that may be contributed is based on the number of dependents. B) up to $10,000 per year may be accumulated. C) funds not used for health expenses may be invested in mutual funds and other securities. D) funds may be used for various medical expenses once the low deductible has been met.

Unlike an FSA (flexible spending account), employee contributions to a health savings account (HSA) not used for medical expenses may be invested in a wide variety of securities. Although mutual funds are the most common, many providers offer the opportunity to invest in stocks and bonds. Remember, one of the eligibility requirements for an HSA is a high, not low, deductible. In 2023, the maximum contribution is $3,850 for an individual or $7,750 if family coverage, regardless of the number of dependents covered. These numbers are never tested and are included so that students get an idea of what a "high-deductible" plan means. LO 18.j C

Where would you be most likely to find an IPS? A) IRA B) Defined benefit plan C) SPD D) GRAT

The investment policy statement (IPS), although not required under Department of Labor (DOL) rules, is generally found in corporate qualified plans, such as the defined benefit or defined contribution plan. Because the investor manages the IRA, there is no need to prepare an IPS for participants to review. LO 18.g B

For which of the following employer-sponsored qualified plans is it mandatory that annual contributions be made? A) Deferred compensation plan B) Profit-sharing plan C) Defined benefit plan D) Money purchase pension plan

When an employer sets up a type of defined contribution plan known as a money purchase pension plan, annual contributions are mandatory. Profit-sharing plan contributions are optional and largely depend on the company's profits. Deferred compensation plans carry no obligations. What about defined benefit plans? Because those are based on an actuarial computation, if the account over-performs expectations, it could result in a year when no contribution is necessary. LO 18.a D

The child of one of your clients is headed off for a year of graduate study at the University of Oxford in England. The Section 529 plan used to fund the child's undergraduate study still has about $20,000 in the account. Because Oxford is on the U.S. Department of Education's list of approved institutions, qualified expenses would include which of the following? A) The full cost of an off-campus luxury apartment B) The full cost of tuition and required fees C) Textbooks used to supplement the required reading assignments D) Dues to sports clubs or societies

The list of qualified expenses is rather small and includes mandatory tuition and fees, as well as room and board on campus. If off-campus, the qualified portion is limited to basically the amount that would be charge for on-campus accommodations. Although required textbooks are qualified, any texts purchased to supplement one's study are not. LO 18.h B

To protect the benefits of plan participants and beneficiaries, ERISA prescribes standards for the execution of the plan fiduciary's duties and responsibilities. Which of the following CORRECTLY describes those standards? The standard of prudence applies to responsibilities relating to the investment of the plan assets but not to the responsibilities relating to the administration and management of the plan. Participants must be offered a broad range of investment options. The rules prohibit transactions between the plan and persons who have conflicts of interest with the plan even though a particular transaction may benefit the plan participants. ERISA requires the plan fiduciaries to adopt and adhere to an investment policy that must be communicated in writing to all participants. A) III and IV. B) I and IV. C) II and III. D) I and II.

The fiduciary standards of ERISA require that plan participants be offered a broad range of investment options in order to obtain the benefit of broad diversification. Under no circumstance, even when benefiting plan participants, are fiduciaries permitted to engage in prohibited transactions such as lending money to the plan. The standards of prudence apply to the administration of the plan, as well as to the investment decisions, and the investment policy, although a good thing to have, is not required under ERISA. LO 18.g C

Which of the following does not benefit both the employee and the employer? A) SEP-IRA B) Traditional IRA C) Defined benefit plan D) SERP

There is no employee/employer relationship in a traditional (or Roth) IRA. A SEP-IRA is different in that the employer makes the contribution, gets the tax deduction, and the employee's account is enriched by that contribution. The same is true for the defined benefit plan and the SERP. A supplemental executive retirement plan is a nonqualified plan designed to provide additional retirement benefits limited to a select group of management or highly-compensated employees. LO 18.e B

Which of the following statements regarding a traditional IRA is true? A) Because contributions to a traditional IRA are not currently tax deductible, all qualifying withdrawals are tax free. B) Distributions before age of 59½ are subject to a 10% penalty in lieu of income taxes. C) The income and capital gains earned in the account are tax deferred until the funds are withdrawn. D) Distributions without penalty may begin after the age of 59½ and must begin by April 1 of the year before an individual turns 73.

The income and capital gains earned in the account are tax deferred until the funds are withdrawn. It is the Roth IRA that can have tax-free withdrawals. Distributions must begin by April 1 of the year after an individual turns 73, not before. If a distribution is taken before reaching age 59 1/2, it is subject to income tax plus a 10% penalty, not instead of (in lieu of) the taxes. If the question does not indicate an exception to the penalty, such as death or disability, there isn't one. LO 18.b C

Which of the following is an allowable early withdrawal from a traditional IRA without penalty? A) A wealthy individual withdraws $10,000 from his IRA to purchase his first principal residence. B) A single parent supplements a home equity loan with $5,000 from her IRA to pay for an additional home (a vacation home). C) A single parent withdraws funds from her IRA to pay for the education of a nephew. D) A person withdraws funds from his IRA to buy a principal residence after he sold his first home as a result of medical expenses.

Any individual withdrawing $10,000 from his IRA to purchase his first principal residence would have the penalty waived. The wealth of the individual is not relevant. The purchase must be a first-time purchase as well as the primary residence. A single parent who withdraws funds from her IRA to pay for the education of a nephew will pay a 10% tax penalty. Educational withdrawals are limited to the taxpayer or a spouse, child, or grandchild. A single parent who supplements a home equity loan with funds from her IRA to pay for an additional home will pay a penalty because only a primary residence can be purchased with early withdrawal funds. A person who withdraws funds from his IRA to buy a principal residence after he sold his first home as a result of medical expenses will pay a penalty because the purchase is not for his first principal residence. LO 18.b A

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) This section permits the employer to avoid certain coverage and participation rules that would otherwise apply to a qualified plan. B) Union-negotiated contracts are exempt from Department of Labor review under this safe harbor section. C) If followed, the employer is relieved of fiduciary liability for any unsatisfactory investment results experienced by the employee. D) If followed, the employer need not provide a Summary Plan Description (SPD) to any employees participating in the plan.

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. LO 18.g C

One of your clients wishes to reallocate the assets in his 401(k) plan. Specifically, he plans to assist his parents in the purchase of a retirement home. He claims that it makes sense to have about 10% of his plan assets in real estate. A) This is prohibited as qualified plans cannot own real estate. B) This is not permitted because a prohibited party will benefit. C) This would only be permitted if the home were for his personal use. D) An asset allocation model would not have 10% in real estate.

There are two problems here. First of all, any investment in a qualified plan (or IRA), must be for future use (or else it would be considered a distribution subject to tax). Second, real estate may be used prior to your retirement, but not by "related" parties. These are defined as your spouse and lineal members of your family (ancestor or descendant or their spouse). So, because the parents will be using the property, they are considered prohibited persons. LO 18.a B

Hal and Amy are covered by a pension plan at Benson Industries, Inc., where they are both employed as executives. Their incomes total $300,000 per year, and they file a joint tax return. Which of the following best describes what they can do in a regular IRA program for the year 2023? A) They may contribute $6,500 each, but they cannot take a deduction. B) They cannot have an IRA because they are covered by a pension plan. C) They may make an $13,000 deductible contribution. D) They may each make a $6,500 deductible contribution.

They may each contribute to their own IRA and enjoy tax-deferred growth within their IRAs, but neither may take the $6,500 annual contribution as a deduction to taxable income on a tax return. For married couples covered by retirement plans at work, the phaseout begins at a joint MAGI (modified adjusted gross income) of $116,000 and is complete at $136,000. These numbers will never be tested because the amounts change yearly. Also, don't ask yourself, "What if one or both are age 50 or older?" You can safely assume that if a contributor can qualify for the catch-up provision, age will be given in the question. For 2023, the IRA limit is increased to $6,500. LO 18.a A