Chapter 21

Question 1

Retirement Annuity

Answer 1

Stream of level cash flows available for consumption during one’s retirement years.

Question 2

Defined Benefit Plan

Answer 2

A pension fund that promises a specified level of income to vested retired employees.

Question 3

401K Plans

Answer 3

Defined contribution pension plans wherein the employer matches the employee’s contribution up to a set percentage.

Question 4

Traditional Retirement Account or Traditional IRA

Answer 4

Contributions to the account and investment earnings are tax sheltered until retirement.

Question 5

Roth IRA

Answer 5

Contributions are not tax sheltered, but investment earnings are tax free.

Question 6

Average Tax Rate (Effective Tax Rate)

Answer 6

• Total Amount of income tax paid divided by total income.

- Person’s average tax rate is always lower than or equal to his or her marginal tax rate.

Question 7

Marginal Tax Rate (MTR)

Answer 7

• Rate at which incremental income is taxed

- Only relevant rate for investment decision making purposes

Question 8

Cost Basis

Answer 8

Purchase price of asset, plus any commissions paid to acquire it

Question 9

Selling Price

Answer 9

Proceeds from sale of asset, less any commissions paid to sell it

Question 10

How are Short-Term Capital Gains Taxed?

Answer 10

Ordinary Income

Question 11

How is a Long-Term Capital Gain Taxed?

Answer 11

• If MTR is 10% or 15%, then taxed at 0%
• If MTR is 25%, 28%, 33%, or 35%, then taxed at 15%
rate
• If MTR is 39.6%, then taxed at 20% rate

Question 12

How are ST and LT Capital Losses Treated?

Answer 12

First, offset capital gains, then can deduct $3,000 per year and carry unused portion forward

Question 13

Tax-Loss Harvesting

Answer 13

-Recognize at least up to $3,000 in capital
losses each year if have them
• Savings on income taxes
• Allows recognition of some capital gains without
a tax bill, and/or
• Opportunity to rebalance portfolio

Question 14

Taxation of Qualified Dividends

Answer 14

If MTR is 10% or 15%, then taxed at 0%
• If MTR is 25%, 28%, 33%, or 35%, then taxed
at 15% rate
• If MTR is 39.6%, then taxed at 20% rate
• Minimum 60-day holding period

Question 15

Taxation of Ordinary Dividends

Answer 15

Taxed as ordinary income

Question 16

ETFs

Answer 16

Traded in secondary market like a stock
• Pay short or long-term capital gains
• Only taxed when sold
• No capital gains distributions
• Dividends taxed like a regular fund
• Hard to beat in taxable accounts
• Mutual funds may be better in sheltered