FP515 Retirement Flashcards

Question 1

Q

Which of these is a type of defined contribution profit-sharing plan?

A) Cash balance pension plan

B) Employee stock ownership plan (ESOP)

C) Target benefit pension plan

D) Money purchase pension plan

Answer

A

B) Explanation
A cash balance pension plan is a type of defined benefit pension plan. An ESOP is a defined contribution profit-sharing plan.

LO 1.2.1

Question 2

Q

The maximum service requirement that a thrift plan may impose as a condition of participation is

A) two years.

B) one-and-a-half years.

C) six months.

D) one year.

Answer

A

A) Explanation
By law, the maximum service requirement that a thrift plan may impose is two years of service. An employee must become a participant in a thrift plan on the next plan entry date following the later of attainment of age 21 or the completion of two years of service. Of course, a more liberal participation requirement may be imposed. The maximum for a 401(k) is one year.

LO 1.3.1

Question 3

Q

Which of these is false regarding defined contribution plans?

A) The employer contribution limit is 25% of the participating employees’ payroll.

B) The retirement benefit is not certain; investment risk is borne by the participant.

C) Includible compensation is limited to the lesser of 100% of compensation or $230,000 in 2021.

D) The maximum allowable employee deferral amount for workers is $19,500 in 2021, not counting any catch ups.

Answer

A

C) Explanation
The maximum amount of includible compensation is $290,000, not $230,000. $230,00 is a maximum defined benefit test number in 2021.

LO 1.3.2

Question 4

Q

Question 4 of 20
Question ID: 1340519
Which of these statements regarding a top-heavy retirement plan is false?

A) Top-heavy plans favor key employees by providing more than 60% of the plan benefits to these employees.

B) Close scrutiny of the top-heavy rules is desirable from a planning standpoint because an understanding of these rules coupled with effective personnel decisions and plan design may enable the plan to escape top-heavy status.

C) Small-business owners are prone to shaping the organization’s retirement plan primarily to shelter taxes for themselves and key employees, thereby creating top-heavy plans.

D) Defined benefit pension plans can be top heavy; defined contribution plans cannot.

Answer

A

D) Explanation
Both defined benefit pension and defined contribution plans can be top heavy, but both must satisfy rules that apply to top-heavy plans.

LO 1.3.1

Question 5

Q

Benjamin Scott, age 42, earns $110,000 a year and wants to establish a profit-sharing plan. He employs four people whose combined salaries are $58,000 and who range in age from 24 to 30. The average employment period for all employees is three-and-a-half years. Which vesting schedule is best suited for Benjamin’s plan?

A) Three-to seven-year graded vesting

B) Five-year cliff vesting

C) Two-to-six-year graded vesting

D) Three-year cliff vesting

Answer

A

C) Explanation
The choices for vesting in a defined contribution plan are: (1) 100% full and immediate, (2) three-year cliff, or (3) two-to-six graded. Because of the average length of employment, the most suitable vesting schedule from Benjamin’s point of view (cash flow if termination occurs and reallocated forfeitures to Benjamin) is graded vesting. Five-year cliff vesting and three-to-seven-year graded vesting are not available to Benjamin’s company for a profit-sharing plan.

LO 1.3.1

Question 6

Q

Which of the following is CORRECT regarding IRS Form 5500?

A) A simplified version, Form 5500-EZ, is available for certain small employers.

B) The IRS 5500 is known as the employer’s annual return/report to the IRS of an employee benefit plan.

C) All of these statements are correct.

D) Filing an IRS 5500 is an ERISA requirement.

Answer

A

C) Explanation
All of these statements are correct regarding IRS Form 5500.

LO 1.4.1

Question 7

Q

If a qualified defined contribution retirement plan is found to meet the requirements under the Employee Retirement Income Security Act of 1974 (ERISA) and Internal Revenue Service (IRS) regulations, which of these statements is CORRECT?

A) The PBGC will provide coverage to the plan.

B) The participating employees must petition the IRS for acceptance of the plan.

C) The employer is permitted to require three years of service eligibility as long as employer contributions are immediately 100% vested to participants.

D) Employees are not taxed on plan contributions or earnings attributed to plan contributions as long as a plan distribution does not occur.

Answer

A

D) Explanation
Employees are not taxed on plan contributions or earnings attributed to plan contributions as long as a plan distribution does not occur. A two years of service eligibility requirement is permitted if 100% immediate vesting is also used. Employees do not petition the IRS for acceptance of the plan. No defined contribution plans are eligible for PBGC coverage.

LO 1.1.1

Question 8

Q

Which of the following describe differences between tax-advantaged retirement plans and qualified plans?

I. IRA-funded employer-sponsored tax-advantaged plans may not incorporate loan provisions.

II. Employer stock distributions from a tax-advantaged plan do not benefit from NUA tax treatment.

A) Both I and II

B) I only

C) II only

D) Neither I nor II

Answer

A

A) Explanation
Both statements are correct. IRA-funded employer-sponsored tax-advantaged plans are SEPs, SARSEPs, and SIMPLE IRAs.

LO 1.2.1

Question 9

Q

Which of the following are minimum coverage tests for qualified retirement plans?

I. Minimum allowed discrimination
II. Average benefits percentage test
III. Ratio test
IV. Maximum compensation test

A) II and III

B) II, III, and IV

C) I, II, and III

D) I and II

Answer

A

A) Explanation
The two minimum coverage tests for qualified retirement plans are the average benefits percentage test and the ratio test. To be qualified, a retirement plan must meet at least one of these tests if the plan does not meet the percentage (safe harbor) test.

LO 1.3.1

Question 10

Q

Which of the following are agencies that administer and ensure compliance with the federal laws that apply to qualified retirement plans?

I. Department of Labor (DOL)
II. Employee Retirement Income Security Agency (ERISA)
III. Internal Revenue Service (IRS)
IV. Pension Benefit Guaranty Corporation (PBGC)

A) I, II, and III

B) II and IV

C) I and III

D) I, III, and IV

Answer

A

D) Explanation
Under the reporting and disclosure requirements of the Employee Retirement Income Security Act of 1974 (ERISA), annual reports and summary plan descriptions are filed with the IRS (which provides copies to the DOL). An annual premium payment form is filed with the PBGC. If the defined benefit plan is not in compliance with funding requirements, the PBGC can terminate the plan. If the defined benefit plan is not in compliance with funding requirements, the PBGC can terminate the plan.

LO 1.1.1

Question 11

Q

Qualified retirement plans should do which of the following?

I. They must meet specific vesting requirements.
II. They have special tax advantages over nonqualified plans.
III. They must provide definitely determinable benefits.
IV. They require an annual profit to allow funding for the plan.

A) II and III

B) II, III, and IV

C) I, II, and III

D) I and II

Answer

A

C) Explanation
Qualified plans must meet specific vesting schedules. Qualified plans are preferred to nonqualified plans because of the special tax advantages enjoyed by qualified plans. Qualified retirement plans must offer definitely determinable benefits. An annual profit is not required for a qualified plan to be funded.

LO 1.2.1

Question 12

Q

Which of the following statements regarding nonqualified retirement plans is CORRECT?

A) Contributions are deductible by the employer when contributed to the plan.

B) Nonqualified plans do not have to meet the nondiscrimination requirements that apply to qualified plans.

C) Benefits are received by the employee income-tax-free.

D) Nonqualified plans are subject to the same Employee Retirement Income Security Act of 1974 (ERISA) requirements as qualified plans.

Answer

A

B) Explanation
Nonqualified plans do not have to meet the nondiscrimination requirements that apply to qualified plans. Nonqualified plans are not subject to all ERISA requirements applicable to qualified plans. Benefits are not deductible by the employer until paid and are includable in the employee’s taxable income at the time of receipt.

LO 1.2.1

Question 13

Q

Ryan, who is 50, is employed by Best Mutual Funds (BMF) and participates in its profit sharing Section 401(k) plan for 2021. The plan allocates contributions based on relative compensation and is not integrated with Social Security. Ryan’s current annual compensation is $80,000, and he has elected to defer 5% of compensation into the Section 401(k) plan. Including Ryan, 35 employees with a total covered payroll of $1.8 million participate in the plan and have elected to defer a total of $72,000 (4% of payroll). BMF’s matching contributions to the plan total $54,000 (3% of total covered payroll). What is the limit on annual additions to Ryan’s individual account?

A) $58,000

B) $13,500

C) $19,500

D) $26,000

Answer

A

A) Explanation
The limit on annual additions to Ryan’s account in 2021 is the lesser of 100% of compensation ($80,000) or $58,000.

LO 1.3.2

Question 14

Q

Which of the following statements regarding a top-heavy plan is CORRECT?

I. A top-heavy plan is one that provides more than 40% of its aggregate accrued benefits or account balances to key employees.

II. A top-heavy defined pension benefit plan must provide a minimum benefit accrual of 2% multiplied by the number of years of service (up to 20%).

III. For a top-heavy defined contribution plan, the employer must make a minimal contribution of 3% of annual covered compensation for each eligible non-key employee. If the contribution percentage for key employees is less than 3%, the contribution percentage to non-key employees can be equal to the key employees’ percentage.

IV. A top-heavy defined benefit pension plan must provide accelerated vesting.

A) I, II, and IV

B) II, III, and IV

C) I, II, III, and IV

D) I, II, and III

Answer

A

B) Explanation
Only Statement I is incorrect. A top-heavy plan is one that provides more than 60% of its aggregate accrued benefits or account balances to key employees.

LO 1.3.1

Question 15

Q

Velvet Lawns, Inc., employs 26 full-time workers and provides a money purchase pension plan for eligible employees. All 26 employees are plan participants this year. Jack, the owner of the company, has an account balance of $134,000. The total of the account balances of all plan participants amounts to $215,000.

Which of the following statements apply to this plan?

I. The plan would not pass the required coverage test and is therefore discriminatory.

II. The plan is top heavy.

III. ‘The plan may use either a five-year cliff or three- to seven-year graded vesting schedule.

IV. The plan must comply with requirements for minimum contributions to non-key employees.

A) I and III

B) II, III, and IV

C) I, II, and IV

D) II and IV

Answer

A

D) Explanation
If all 26 employees are participating in the plan, the coverage and nondiscrimination tests would be passed. The plan would, however, be top heavy (Jack’s $134,000 account balance is 62% of the $215,000 total of all account balances). Top-heavy plans must comply with minimum contribution requirements for non-key employees and use a top-heavy vesting schedule. All defined contribution plans are now required to vest no less rapidly than three-year cliff or two- to six-year graded.

LO 1.3.1

Question 16

Q

Which of the following are agencies that administer and ensure compliance with the federal laws that apply to qualified retirement plans?

I. Department of Labor (DOL)
II. Employee Retirement Income Security Agency (ERISA)
III. Internal Revenue Service (IRS)
IV. Pension Benefit Guaranty Corporation (PBGC)

A) I, II, and III

B) II and IV

C) I, III, and IV

D) I and III

Answer

A

C) Explanation
Under the reporting and disclosure requirements of the Employee Retirement Income Security Act of 1974 (ERISA), annual reports and summary plan descriptions are filed with the IRS (which provides copies to the DOL). An annual premium payment form is filed with the PBGC.

LO 1.1.1

Question 17

Q

In which situation(s) can the Pension Benefit Guaranty Corporation (PBGC) terminate a defined benefit pension plan?

I. The PBGC does not have the authority to terminate an employer’s defined benefit pension plan.

II. Joe’s Shoes Inc. has not met the minimum funding standards for the corporation’s defined benefit pension plan.

III. Ann has retired from her position and her former employer’s defined benefit pension plan cannot pay her retirement benefit because it lacks the funds.

IV. A professional service corporation with 15 active participants cannot meet the minimum funding standards of the defined benefit pension plan and has previously paid no PBGC premiums.

A) II, III, and IV

B) I only

C) II and III

D) III only

Answer

A

C) Explanation
Statements II and III are correct. The PBGC can terminate a defined benefit plan if:

minimum funding standards are not met;
benefits cannot be paid when due; and
the long-run liability of the company to the PBGC is expected to increase unreasonably.
A professional service corporation with 25 or fewer participants is not required to maintain PBGC coverage.

LO 1.1.1

Question 18

Q

Which of the following plans allow the excess method of permitted disparity?

I Money purchase pension plans
II. Defined benefit pension plans
III. Employee stock ownership plan (ESOP)
IV. Simplified employee pension (SEP)

A) I, II, and IV

B) II, III, and IV

C) I, III, and IV

D) I, II, and III

Answer

A

A) Explanation
All plans are allowed to integrate with Social Security except ESOPs, SIMPLEs, and SARSEPs. The excess method is allowed for all plans allowing integration, whereas the offset method is only allowed for defined benefit pension plans.

LO 1.3.3

Question 19

Q

Which of the following are included in the annual additions limit for defined contribution plans?

I. Investment gain
II. Employee elective deferral contributions
III. Employer contributions
IV. Forfeitures reallocated to the remaining participants in the plan

A) I, II, III, and IV

B) I and IV

C) II, III, and IV

D) II and III

Answer

A

C) Explanation
Only Statement I is incorrect. Investment gain is not considered in the calculation of annual additions.

LO 1.3.2

Question 20

Q

Which of the following are included in the annual additions limit for defined contribution plans?

I. Investment gain
II. Employee elective deferral contributions
III. Employer contributions
IV. Forfeitures reallocated to the remaining participants in the plan

A) I, II, III, and IV

B) I and IV

C) II, III, and IV

D) II and III

Answer

A

C) Explanation
Only Statement I is incorrect. Investment gain is not considered in the calculation of annual additions.

LO 1.3.2

Question 21

Q

ERISA requires reporting and disclosure of plan information to all of the following except

A) the Department of Labor (DOL).
B) plan participants.
C) plan sponsors.
D) the Internal Revenue Service (IRS).

Answer

A

C) Explanation
ERISA requires reporting and disclosure of plan information by plan sponsors to the IRS, DOL, Pension Benefit Guaranty Corporation (PBGC), and plan participants.

LO 1.1.1

Question 22

Q

Scott is the fiduciary of the BSB retirement plan. The entity responsible for monitoring his actions as a fiduciary is

A) the PBGC.
B) the DOL.
C) the SPD.
D) the ERISA.

Answer

A

B) Explanation
The Department of Labor (DOL) governs the actions of plan fiduciaries and ensures compliance with the ERISA plan reporting and disclosure requirements.

LO 1.1.1

Question 23

Q

Max is the finance director for Bland Foods, Inc. He is trying to implement a new qualified retirement plan for the company. There are numerous federal guidelines with which the company must comply. Which of the following federal agencies is tasked with supervising the creation of new, qualified retirement plans?

A) DOL
B) IRS
C) ERISA
D) PBGC

Answer

A

B) Explanation
The Internal Revenue Service (IRS) carries out the task of supervising the creation of new, qualified retirement plans.

LO 1.1.1

Question 24

Q

ERISA requirements for qualified plans include

A) participation and fiduciary requirements.
B) reporting and disclosure.
C) coverage and vesting.
D) all of these.

Answer

A

D) Explanation
All of these are ERISA requirements for qualified plans.

LO 1.1.1

Question 25

Q

Qualified retirement plans should do which of the following?

I. They must meet specific vesting requirements.
II. They have special tax advantages over nonqualified plans.
III. They must provide definitely determinable benefits.
IV. They require an annual profit to allow funding for the plan.

A) II and III
B) I, II, and III
C) I and IV
D) II, III, and IV

Answer

A

B) Explanation
Qualified plans must meet specific vesting schedules. Qualified plans are preferred to nonqualified plans because of the special tax advantages enjoyed by qualified plans. Qualified retirement plans must offer definitely determinable benefits. An annual profit is not required for a qualified plan to be funded.

LO 1.2.1

Question 26

Q

Qualified retirement plans are which of these?

I. They are subject to ERISA requirements.
II. They offer tax-deferred earnings to employees.
III. They can discriminate in favor of highly compensated employees.
IV. They provide a deferred tax deduction for employer funding.

A) I and II
B) I, II, and III
C) I, II, III, and IV
D) III and IV

Answer

A

A) Explanation
Statements I and II are correct. Qualified retirement plans are subject to ERISA requirements and provide tax deferral on investment earnings for employees. While qualified plans in general can provide different levels of benefits to different classes of employees, qualified plans cannot “discriminate in favor of highly compensated employees” in the sense that there is a legal limit to the amount of the difference. As long as the difference is inside the legal limits, the plan is not discriminatory (by definition). Qualified retirement plans provide an immediate tax deduction on employer contributions—not a deferred tax deduction, like a nonqualified deferred compensation plan.

LO 1.2.1

Question 27

Q

Which of the following describe differences between a tax-advantaged retirement plan and a qualified plan?

I. IRA-funded employer-sponsored tax-advantaged plans may not incorporate loan provisions.

II. Employer stock distributions from a tax-advantaged plan do not benefit from NUA tax treatment.

A) II only
B) Neither I nor II
C) I only
D) Both I and II

Answer

A

D) Explanation
Both statements are correct. IRA-funded employer-sponsored tax-advantaged plans are SEPs, SARSEPs, and SIMPLE IRAs.

LO 1.2.1

Question 28

Q

Jerry wants to establish a qualified plan for his business to provide employees of the company with the ability to save for retirement. Which of the following plans is a qualified plan?

I. Profit-sharing plan
II. Simplified employee pension (SEP) plan
III. SIMPLE IRA
IV. Section 457 plan

A) I, II, III, and IV
B) IV only
C) I only
D) II and III

Answer

A

C) Explanation
Of the plans listed, only the profit-sharing plan is a qualified plan. The SIMPLE IRA and the SEP plan are tax-advantaged plans, and the Section 457 plan is a nonqualified plan.

LO 1.2.1

Question 29

Q

Which of the following is an example of a qualified retirement plan?

A) Section 403(b) plan
B) Deferred compensation plan
C) Section 401(k) plan
D) SEP plan

Answer

A

C) Explanation
A Section 401(k) plan is a qualified plan. 403(b) plans and SEP plans are tax-advantaged plans, but are not ERISA-qualified retirement plans. A deferred compensation plan is a nonqualified plan. While tax-advantaged plans are very similar to qualified plans, there are some minor differences.

LO 1.2.1

Question 30

Q

Which of the following is NOT an example of a qualified retirement plan?

A) New comparability plan
B) Section 403(b) plan
C) Employee stock ownership plan (ESOP)
D) Section 401(k) plan

Answer

A

B) Explanation
A Section 403(b) plan is a tax-advantaged plan but not an ERISA-qualified retirement plan. While tax-advantaged plans are very similar to qualified plans, there are some minor differences. For example, a tax-advantaged plan is not allowed to have NUA treatment. NUA is covered later in the course. They are also not allowed to offer 10-year forward averaging or special pre-1974 capital gains treatment. Tax-advantaged plans also have less restrictive nondiscrimination rules. Otherwise, they are very similar to qualified plans.

LO 1.2.1

Question 31

Q

Which of these statements regarding top-heavy plans is CORRECT?

I. An accelerated vesting schedule is used when a defined benefit pension plan is top heavy.

II. A qualified plan is considered top heavy if it provides more than 50% of its aggregate accrued benefits or account balances to key employees.

III. Top-heavy defined benefit plans must provide a minimum benefit accrual of 2% per year of service for up to 10 years (20%) for all non-key employees.

IV. For a top-heavy plan, a key employee is an employee who owns more than 3% of the employer with compensation greater than $130,000 (2021).

A) I and II
B) II and III
C) II and IV
D) I and III

Answer

A

D) Explanation
An accelerated vesting schedule is used when a defined pension benefit plan is top heavy. A defined contribution plan always requires an accelerated vesting schedule. A qualified plan is considered top heavy if it provides more than 60% of its aggregate accrued benefits or account balances to key employees. A key employee is an employee who, at any time during the plan year, is the following: greater than a 5% owner; a greater than 1% owner with compensation greater than $150,000 (not indexed); or an officer of the employer with compensation greater than $185,000 in 2021.

LO 1.3.1

Question 32

Q

Which of the following are minimum coverage tests for qualified retirement plans?

I. Nondiscrimination test
II. Average benefits percentage test
III. Ratio test
IV. Maximum compensation test

A) II, III, and IV
B) I, II, and III
C) I and II
D) II and III

Answer

A

D) Explanation
The two minimum coverage tests for qualified retirement plans are the average benefits percentage test and the ratio test. To be qualified, a retirement plan must meet at least one of these tests if the plan does not meet the percentage (safe harbor) test.

LO 1.3.1

Question 33

Q

Nigel’s employer, Alpha, Inc., maintains a qualified defined benefit pension plan. There are 100 eligible employees working for Alpha, Inc. What is the minimum number of employees the retirement plan must cover to satisfy the 50/40 test?

A) 100
B) 80
C) 40
D) 50

Answer

A

C) Explanation
Under the 50/40 test, a defined benefit plan must cover the lesser of 50 employees or 40% of all eligible employees. In this case, the lesser of 50 employees or 40% of all eligible employees (100) is 40 employees. One way to remember the 50/40 test is the phrase people before percentages (50 people or 40%). Also, note that there are no qualifiers to the types of people. It is not 50 non-highly compensated people. It is just 50 individuals who work for the employer.

LO 1.3.1

Question 34

Q

Brad has been the sole owner and operator of Woodmasters, Inc., for the past 15 years. Brad is age 45, and his salary from the business is $130,000. Brad and his spouse, Laura, want to retire when Brad is age 65. Relevant information regarding the business is summarized as follows:

Financial performance fluctuated over the first 10 years.
Cash flow and profits have stabilized during the past five years and are expected to show modest but consistent growth in the future. Excess cash flow of approximately $150,000 is expected to be available this year. Future years should be about the same. Brad has expressed some concern about the company’s outdated equipment and is considering renovating the plant and replacing the outdated equipment over the next five years. The total cost should be about $300,000.
Total compensation for all employees (including Brad) is $245,000.
The four full-time rank-and-file employees range from age 19 to age 38, and have been with Woodmasters for periods ranging from four months to six years. Age and service information is shown as follows:
Employee Age Completed Years of Service Compensation
Brad 45 15 years $130,000
Beth 38 6 years $40,000
Todd 27 6 months $25,000
Carol 30 2 years $28,000
Jim 19 4 months $22,000
Which of the following statements can be made regarding any qualified plan that Brad installs at Woodmasters? (Assume that the plan admits any employee who is eligible under the ERISA age and one-year service requirements and that all eligible employees are participating.)

The plan passes the ratio percentage test.
Three employees (in addition to Brad) will be eligible to participate.
The plan passes the participation (50/40) test, although it may not be required to do so.
Information is insufficient to perform coverage and participation tests.
A) II and III
B) I and III
C) I, II, and III
D) II and IV

Answer

A

B) Explanation
Since the plan admits all ERISA-eligible employees, relevant percentages for the coverage and participation tests will be 100%; the plan will pass the ratio percentage test. Since the lesser of 50 participants or 40% of the ERISA-eligible employees is two and because three (100%) actually participate, the plan passes the 50/40 test. The 50/40 test only applies to defined benefit plans.

LO 1.3.1

Question 35

Q

Which of the following statements regarding a top-heavy plan is CORRECT?

I. A top-heavy plan is one that provides more than 50% of its aggregate accrued benefits or account balances to key employees.

II. A top-heavy defined pension benefit plan must provide a minimum benefit accrual of 2% multiplied by the number of years of service (up to 20%).

III. For a top-heavy defined contribution plan, the employer must make a minimal contribution of 3% of annual covered compensation for each eligible non-key employee. If the contribution percentage for key employees is less than 3%, the contribution percentage to non-key employees can be equal to the key employees’ percentage.

IV. A top-heavy defined benefit pension plan must provide accelerated vesting.

A) I, II, III, and IV
B) II and IV
C) II, III, and IV
D) I and III

Answer

A

C) Explanation
Only Statement I is incorrect. A top-heavy plan is one that provides more than 60% of its aggregate accrued benefits or account balances to key employees.

LO 1.3.1

Question 36

Q

The Jones Corporation has a profit-sharing plan with a 401(k) provision. The company matches dollar-for-dollar up to 5%. Pedro makes $150,000 and defers 5% into the 401(k) for 2021. The Jones Corporation has had a banner year and is considering a large contribution to the profit-sharing plan. What is the most that could be contributed to Pedro’s profit-sharing account this year?

A) $58,000
B) $43,000
C) $49,500
D) $19,500

Answer

A

B) Explanation
The maximum allowed contribution for 2021 is $43,000. The section annual additions limit for 2021 is $58,000. However, Pedro has already contributed $7,500, and this amount has been matched. Thus, $15,000 has already gone toward the $58,000 annual additions limit for 2021.

LO 1.3.2

Question 37

Q

Susan makes $400,000 working for Great Grapes, Inc. She defers 4% into the 401(k) and receives the 4% match. How much will go into her account in 2021?

A) $16,000
B) $32,000
C) $23,200
D) $19,500

Answer

A

Explanation
Only the first $290,000 of compensation may be used to determine contributions to qualified retirement plans in 2021. Thus, she contributes 4% of $290,000 in 2021. This amount is matched, so $290,000 × 0.08 = $23,200.

LO 1.3.2

Question 38

Q

In a Section 401(k) plan, which of these must be considered in complying with the maximum annual additions limit?

I. Employee contributions
II. Catch-up contributions for an employee age 50 or older
III. Dividends paid on employer stock held in the Section 401(k) plan
IV. Employer contributions

A) I and II
B) I and IV
C) II and IV
D) I, II, and V
Explanation

Answer

A

B) Statement I is correct. Employee contributions are counted against the annual additions limit. Statement II is incorrect. Catch-up contributions for an employee age 50 or older are not counted against the annual additions limit. Statement III is incorrect. Earnings on plan investments are not taken into account when computing the maximum annual additions limit. Statement IV is correct. For 2021, the annual additions limit is the lesser of 100% of the employee’s compensation, or $58,000.

LO 1.3.2

Question 39

Q

If a defined benefit pension plan is determined to be top heavy, what is one practical significance of this determination?

A) Different eligibility requirements come into effect.
B) One of two maximum contribution and benefit formulas must be used.
C) Different coverage requirements and nondiscrimination tests apply.
D) One of two accelerated vesting schedules must be used.

Answer

A

D) Explanation
If a defined benefit pension plan is top heavy, one of two accelerated vesting schedules must be used: either 100% vesting after three years of service or graded two- to six-year vesting. The same eligibility and nondiscrimination tests apply as for qualified plans that are not top heavy.

LO 1.3.1

Question 40

Q

Mac, age 39, works for the SLH Company. He has a salary of $28,000 and a 401(k) there. Mac also has another job with AKH, Inc., making $65,000. SLH and AKH are not related. Mac is deferring $9,500 into the 401(k) at SLH. How much can he defer into the 401(k) at AKH?

A) $58,000
B) $47,500
C) $10,000
D) $19,500

Answer

A

C) Explanation
Mac can defer $10,000 into his 401(k) at AKH, Inc. The total he can contribute to employer retirement plans in 2021 is $19,500. Since he is already doing $9,500 at one employer, he is limited to $10,000 at the other. The fact that the two employers are unrelated does not matter for how much a worker can defer into the two plans. However, when it comes to unrelated organizations, each would have an independent annual additions limit. In other words, the law expects workers to know how much they are contributing to various employer retirement plans and to stay below the limit. The same would be true for related employers. However, unrelated employers are not held responsible for the employee or employer contributions to the other employers.

LO 1.3.2

Question 41

Q

Window Washers, Inc., is establishing a profit-sharing plan using Social Security integration. The base contribution percentage for the profit-sharing plan will be 5%, and the owners have come to you with some questions about Social Security integration. Which one of the following statements is CORRECT?

A) The permitted disparity for the plan is 3%.
B) The permitted disparity for the plan is 5.7%.
C) The excess contribution percentage for the plan could be as high as 10%.
D) The excess contribution percentage for the plan could be as high as 26.25%.

Answer

A

C) Explanation
The excess contribution percentage for the plan could be as high as 10%. The excess contribution percentage is the base contribution percentage plus the permitted disparity. The permitted disparity for the defined contribution plan is the lesser of the base benefit percentage and 5.7%. Thus, in this case, the permitted disparity is 5% and the maximum the excess benefit percentage could be would be 10%.

LO 1.3.3

Question 42

Q

Jim, the president of East Dover Construction Company, has requested your advice in setting up a defined benefit pension plan for eligible employees in the company. Jim founded the company 17 years ago and now has 200 employees, most of whom are under 35 years of age. Due to the nature of the work and ongoing management difficulties, tenure among the employees has averaged under two years. Jim has just fired the managers who were creating problems, but turnover is likely to remain high due to ongoing morale problems. Jim’s current salary is $300,000, and he wants the plan to provide him with annual retirement income of $100,000 per year. He expects to retire in 13 years, at age 64.

Which of the following statements describes information you need to convey to Jim about factors that could affect the amount of his retirement benefit?

A) If the plan investments outperform expectations, he will receive the largest allocation of the excess earnings.

B) One method of increasing the retirement benefit paid to him is by integrating the plan using the offset method.

C) Using a flat benefit formula will always provide Jim a larger benefit than would a unit benefit formula.

D) The excess integration method could be used to increase the amount of his plan benefit in retirement.

Answer

A

D) Explanation
The excess integration method increases the retirement benefit for compensation above the integration level. The offset integration method reduces the retirement benefit due to the receipt of Social Security benefits. With a defined benefit plan, excess investment performance reduces the subsequent employer contributions. A flat benefit formula versus a unit benefit formula would depend on the details of the flat benefit versus the unit benefit formula, so more information would be required to determine which would give a larger benefit.

LO 1.3.3

Question 43

Q

Able Company is considering various types of qualified plans and seeks your advice. You are asked how a plan participant’s benefits at retirement are determined in a defined benefit plan with a flat benefit formula that uses the offset method of integration.

Which of these statements would best answer the company’s question?

A) The percentage of pay benefit specified by the plan is reduced by a specific percentage of the retired employee’s Social Security benefit.

B) The benefit paid from the employer plan is based only on employee compensation above the Social Security wage base.

C) The employee’s Social Security benefit is reduced by a specific percentage of the retired employee’s retirement plan benefit.

D) The benefit paid from the employer plan is reduced by the amount the employer pays into Social Security on behalf of the employee.

Answer

A

A) Explanation
The percentage of pay benefit specified by the plan is reduced by a specific percentage of the retired employee’s Social Security benefit. Offset integration reduces the defined benefit received due to the retiree also getting Social Security benefits.

LO 1.3.3

Question 44

Q

What is the permitted disparity for a defined contribution plan with a current base contribution percentage of 6%?

A) 12.0%
B) 11.7%
C) 5.7%
D) 6.0%

Answer

A

C) Explanation
The permitted disparity is the extra amount reached above the integration level. For an integrated defined contribution plan, the permitted disparity is the lesser of 5.7% and the base contribution percentage. Since the base benefit percentage is 6%, the permitted disparity is limited to 5.7%. That would mean the excess benefit percentage is 11.7% (6% + 5.7%).

LO 1.3.3

Question 45

Q

With an integrated defined contribution plan, what is the maximum permitted disparity?

A) The maximum permitted disparity is 25%, so if the base benefit percentage is greater than 25% then the permitted disparity would be capped at 25%.

B) In an integrated defined contribution plan, if the base contribution percentage is 5% then the permitted disparity is 5.7%.

C) The permitted disparity is 0.75% per year for up to 35 years.

D) For an integrated defined contribution plan, the permitted disparity is the lower of the base amount, or 5.7%.

Answer

A

D) Explanation
The permitted disparity is the lower of the base amount, or 5.7%. Thus, the maximum permitted disparity is 5.7% for integrated defined contribution plans. The number 5.7% is the percentage of an employee’s compensation that goes toward his Social Security retirement benefit for compensation below the taxable wage base ($142,800 in 2021).

LO 1.3.3

Question 46

Q

Which of these statements regarding prohibited transactions is false?

A) One category of prohibited transactions involves the sale, lease, or exchange of any property between the plan and a party in interest.

B) One category of prohibited transactions involves the investment in the sponsoring employer’s stock or real property.

C) One category of prohibited transactions bars a fiduciary from causing the plan to engage in a transaction if the fiduciary knows or should know that such a transaction constitutes a direct or indirect involvement between the plan and the parties in interest.

D) The lending of money or other extension of credit between the plan and a party in interest is a prohibited transaction exemption.

Answer

A

D) Explanation
Loans between the plan and a party in interest are prohibited transactions.

LO 1.4.1

Question 47

Q

Which of the following penalties apply to prohibited transactions?

I. A tax equal to 15% of the amount involved applies unless it can be demonstrated that the transaction satisfies ERISA’s fiduciary standards.

II. The transaction must be corrected and the plan placed in a financial position no worse than if the transaction had never occurred.

III. Plan participants who engage in prohibited transactions are subject to income tax on a judicially determined amount.

IV. Transactions that continue uncorrected into subsequent years are subject to additional penalties.

A) I and II
B) I, II, and IV
C) I and III
D) II and IV

Answer

A

D) Explanation
The law requires correction (i.e., undoing) of a prohibited transaction and restoring a plan to the position it would have been in, had the transaction never occurred. Ongoing transactions (e.g., loans, leases) create additional prohibited transactions in subsequent years (and additional penalties) until corrected.

Options I and III are incorrect for the following reasons. Once the prohibited transaction has taken place, the 15% penalty cannot be waived for extenuating circumstances. Income tax consequences may or may not apply depending on the nature of the underlying prohibited transaction. Usually, the IRS (not the courts) determines the amount of tax involved.

LO 1.4.1

Question 48

Q

Prohibited transactions are those that are not in the best interest of plan participants and include which of these?

I. A loan between the plan and any party in interest
The acquisition of employer securities or real property in excess of legal limits

II. A transfer of plan assets to or use of plan assets for the benefit of a party in interest

III. The sale, exchange, or lease of any property between the plan and a party in interest

A) I and II
B) I, II, and III
C) I, II, III, and IV
D) III and IV

Answer

A

C) Explanation
All of the statements are prohibited transactions. Self-dealing is also a prohibited transaction.

LO 1.4.1

Question 49

Q

Which of the following is the easiest type of retirement plan for an employer to adopt?

A) An individually designed plan
B) A Pension Benefit Guaranty Corporation (PBGC) plan
C) A prototype plan
D) A custom plan

Answer

A

C) Explanation
Master plans and prototype plans are easier to use than individually designed plans or custom plans because they are standardized plans approved as qualified in concept by the IRS. The PBGC is the governmental body that insures pension benefits; it is not a type of plan.

LO 1.4.1

Question 50

Q

In the administration of a qualified retirement plan, which of the following individuals is considered to be a fiduciary?

A) The marketing director of the plan sponsor
B) A financial planner handling the investment of plan assets
C) A CPA who prepares the plan’s Form 5500
D) A highly compensated employee who participates in the plan

Answer

A

B) Explanation
A person or corporation is considered a fiduciary under ERISA if that person or entity renders investment advice or services to the plan for direct or indirect compensation. Clearly, the financial planner-investment manager is within this definition.

LO 1.4.1

Question 51

Q

Which of the following is a characteristic of a target benefit pension plan?

A) Allows higher contribution levels for older plan participants

B) Allows the employee to select the amount of monthly benefit at retirement

C) Requires greater employee contributions for older employees

D) Has no limit on employee contributions

Answer

A

A) Explanation
Under such a defined contribution plan, the employer selects the target benefit. The employer contributes more for older employees. The fixed contribution formula is based on an initial actuarial determination of contributions required to meet a specific targeted benefit level.

LO 2.3.2

Question 52

Q

Which of these statements regarding target benefit pension plans are CORRECT?

I. The plans are covered by Pension Benefit Guaranty Corporation (PBGC) insurance.

II. Older participants who are new to the employer are favored in a target benefit pension plan.

III. Each employee has an individual account.

IV. Minimum funding standards apply.

A) I, II, III, and IV

B) I and III

C) II, III, and IV

D) II and IV

Answer

A

C) Explanation
Statements II, III, and IV are correct. Target benefit pension plans are a type of defined contribution plans and are not covered by PBGC insurance. Each plan participant has an individual account. Because target benefit plans are pension plans, minimum funding standards apply. Like defined benefit plans, the plans favor older participants in the sense that a new employee who is older than another employee and has the same compensation as the younger employee will get a larger target benefit contribution than the younger employee. This is true because both workers have the same target benefit, but the younger worker has more time for the balance to grow than an older worker.

LO 2.3.2

Question 53

Q

In a money purchase pension plan that utilizes plan forfeitures to reduce future employer plan contributions, which of the following components must be factored into the calculation of the maximum annual addition limit?

(CFP® Certification Examination, released 11/94)

I. Forfeitures that otherwise would have been reallocated

II. Annual earnings on all employer and employee contributions

III. Rollover contributions for the year

IV. Employer and employee contributions to all defined contribution plans

A) IV only

B) I, II, and III

C) I, II, III, and IV

D) I and III

Answer

A

A) Explanation
Because the forfeitures will be used to reduce future employer contributions, they will not count against the annual additions limit. Defined contribution plans do not consider earnings on investments when calculating contributions.

LO 2.3.1

Question 54

Q

Target benefit pension plans are defined contribution plans that do which of these?

I. They fund for a targeted benefit level.

II. They require a fixed contribution formula.

III. They provide a guaranteed retirement benefit.

IV. They adjust the contribution formula annually.

A) I and II

B) III and IV

C) II, III, and IV

D) I and III

Answer

A

A) Explanation
Statements I and II are correct. Target benefit pension plans have a fixed contribution formula that is based on an actuarial calculation and the participant’s age at plan inception or plan entrance. The plan allows higher contributions for older participants. Although the plan is technically a defined contribution plan, its intention is to fund for a targeted benefit at retirement, based on the participant’s age and number of years to retirement. The actual contributions may or may not achieve the targeted benefit; therefore, the retirement benefit is not guaranteed. The plan sponsor does not actuarially adjust the participant’s contribution percentage annually.

LO 2.3.2

Question 55

Q

Which of the following factors affect a target benefit plan participant’s retirement benefits?

I. The actuarial assumptions used to determine the contribution to the plan
II. The participant’s compensation for the plan year
III. The investment performance of the plan’s assets
IV. The age of the plan participant

A) I, II, III, and IV

B) II, III, and IV

C) I and III

D) I and II

Answer

A

A) Explanation
Options I, II, III, and IV are all correct. Actuarial assumptions about longevity and interest rates affect the amount contributed to a participant’s account. A participant’s compensation directly affects the size of her plan benefit. The value of a participant’s target benefit account balance (i.e., a separate account) depends, in part, on the investment performance (gains and losses) of the plan’s assets. Target benefit plans favor older employees who are closer to retirement.

LO 2.3.2

Question 56

Q

Which of the following is a basic provision of a money purchase pension plan?

A) Before-tax salary reductions or elective deferrals are subject to prescribed limitations on amounts.

B) Forfeitures from a nonvested participant’s account must be reallocated proportionately among remaining plan participants.

C) Forfeitures from a nonvested participant’s account must be applied to reduce the employer contribution to the plan.

D) In establishing such a plan, the employer typically agrees to make an annual contribution for each eligible employee as a fixed percentage of compensation.

Answer

A

D) Explanation
In establishing a money purchase pension plan, the employer agrees to make a fixed annual contribution, usually expressed as a percentage of compensation for each eligible employee.

LO 2.3.1

Question 57

Q

Which of the following statements regarding money purchase pension plans is CORRECT?

A) These plans typically favor younger employees.

B) They allow a maximum of 25% of employer stock.

C) The plan requires actuarial services.

D) Annual employer funding is optional.

Answer

A

A) Explanation
Money purchase plans favor younger employees. Money purchase pension plans have known funding costs, mandatory annual contributions, and limit the amount of company stock to a maximum of 10%.

LO 2.3.1

Question 58

Q

Which of the following are eligibility requirements that a defined benefit plan must satisfy to qualify for tax-favored status?

I. The plan must include employees who have attained 21 years of age.

II. The plan must include employees who have given one year of service to the employer during which they have worked a minimum of 1,000 hours.

III. If the employer uses the two-year 100% rule, participation requirements may be based on completion of two years of service.

IV. An employee’s service with a predecessor must count toward years of service in a successor’s plan.

A) I, II, and III

B) I, III, and IV

C) I, II, III, and IV

D) I, II, and IV

Answer

A

C) Explanation
All of these requirements must be met if the defined benefit plan is to qualify for tax-favored status.

LO 2.1.1

Question 59

Q

Which of the following statements regarding money purchase pension plans are CORRECT?

I. The employer makes annual mandatory contributions to each employee’s individual account.

II. The plan is relatively straightforward and easy to explain to participants.

III. Annual additions to each employee’s account are limited to the lesser of 100% of compensation, or $58,000 (for 2021).

IV. Generally, employer securities held by the plan cannot exceed 25% of the FMV of the plan assets at the times the securities are purchased.

A) I, II, III, and IV

B) I, II, and III

C) III and IV

D) I and II

Answer

A

B) Explanation
Only Statement IV is incorrect. Generally, employer securities held by the plan cannot exceed 10% of the FMV of the plan assets at the time the securities are purchased.

LO 2.3.1

Question 60

Q

Which of the following statements regarding fully insured Section 412(e)(3) plans is FALSE?

A) Section 412(e)(3) plans must meet minimum funding standards each plan year.

B) This type of plan is not required to be certified by an enrolled or licensed actuary.

C) A fully insured plan is inappropriate for an employer who cannot commit to regular premium payments.

D) A Section 412(e)(3) plan is a type of defined benefit pension plan.

Answer

A

A) Explanation
Section 412(e)(3) plans must only meet minimum funding standards if there is a loan outstanding against the insurance policy funding the plan.

LO 2.2.2

Question 61

Q

All of the following are characteristics of traditional defined benefit pension plans except

A) the employer is required to make annual contributions.

B) employees assume the risk of poor investment results.

C) they are complex to design and operate.

D) limited benefits are guaranteed by the Pension Benefit Guaranty Corporation (PBGC).

Answer

A

B) Explanation
A traditional defined benefit pension plan guarantees a specific benefit at retirement, and limited benefits are guaranteed by the PBGC. The employer assumes the risk of poor investment results in the plan. If investment results are poor, the employer may have to supply additional funding to assure that the guaranteed benefits are available.

LO 2.1.1

Question 62

Q

Which of the following statements is CORRECT in describing an accrued benefit?

A) The total benefit the participant has earned to date (amount is usually determined by multiplying the result of the participant’s years of service divided by the total potential years of service times the benefit formula in a flat percentage benefit plan)

B) The benefit that each employee receives when they leave the company

C) The dollar amount set aside in the defined benefit plan for the employee

D) The dollar amount distributed to the employee at termination of employment

Answer

A

A) Explanation
An accrued benefit is usually determined by multiplying the result of the participant’s years of service divided by the total potential years of service, times the benefit formula. The dollar amount to be distributed on termination is the “present value of the vested accrued benefit times the assumed annuity factor.”

LO 2.1.2

Question 63

Q

Which of the following statements is CORRECT in describing an accrued benefit?

A) The total benefit the participant has earned to date (amount is usually determined by multiplying the result of the participant’s years of service divided by the total potential years of service times the benefit formula in a flat percentage benefit plan)

B) The benefit that each employee receives when they leave the company

C) The dollar amount set aside in the defined benefit plan for the employee

D) The dollar amount distributed to the employee at termination of employment

Answer

A

A) Explanation
An accrued benefit is usually determined by multiplying the result of the participant’s years of service divided by the total potential years of service, times the benefit formula. The dollar amount to be distributed on termination is the “present value of the vested accrued benefit times the assumed annuity factor.”

LO 2.1.2

Question 64

Q

Which of the following statements regarding employer contributions to money purchase pension plans are CORRECT?

I. Aggregate employer deductible contributions may not exceed 25% of covered compensation.

II. Money purchase pension plans are not subject to a minimum funding standard.

III. Plan investment earnings and losses do not affect employer contributions.

IV. Forfeitures may be reallocated to remaining participants.

A) II and IV

B) I, III, and IV

C) II, III, and IV

D) I, II, and III

LO 2.3.1

Answer

A

B) Explanation
Money purchase pension plans require mandatory annual funding. Investment earnings and losses do not affect employer contributions. Most pension plans (like money purchase pension plans) are subject to minimum funding standards.

Answer 65

A

C) Explanation
Only two defined benefit pension plans (defined benefit and cash balance) have PBGC insurance.

LO 2.1.1

Answer 66

A

B) Explanation
Statement I is incorrect. Contributions to traditional defined benefit pension plans are not dependent on the profitability of a company. Statement II is incorrect because a unit benefit plan formula will not allow higher integration levels. Statement III is incorrect because a flat percentage formula favors workers without much longevity.

LO 2.1.2

Answer 67

A

D)
Explanation
The only qualified plans exempt from the minimum funding standard are profit sharing plans and stock bonus plans. Section 401(k) provisions are only permitted with profit sharing plans and stock bonus plans.

LO 2.3.2

Answer 68

A

A) Explanation
This plan is most likely a target benefit pension plan because of the individual account (DC) and projected (targeted) retirement benefit.

LO 2.3.2

Answer 69

A

A) Explanation
Defined benefit plans maintained by certain professional service employers with 26 or more employees must be covered by the PBGC.

LO 2.1.1

Answer 70

A

C) Explanation
Under Section 415 of the Tax Code, there is a limit on the projected annual benefit the plan can provide to the employee-participant at age 65. For 2021, this maximum benefit is the lesser of:

$230,000 of annual compensation; or
100% of the participant’s compensation averaged over his highest three consecutive years of earnings.
Bart’s last three years also contained his highest salaries, and averaged $266,667 [($255,000 + $260,000 + $285,000 maximum) ÷ 3], which is greater than the $230,000 maximum benefit allowed under Section 415. Compensation considered in any qualified plan benefit formula is capped at $290,000 (2021).

LO 2.1.2

Answer 71

A

B) Explanation
A defined benefit plan must meet an additional test to retain its qualified plan status. The 50/40 test states that the plan must benefit the lesser of 50 employees, or 40% of all eligible employees.

LO 2.1.1

Answer 72

A

C) Explanation
Only two defined benefit pension plans (defined benefit and cash balance) are covered by PBGC insurance.

LO 2.1.1

Answer 73

A

C) Explanation
The defined benefit pension plan favors older participants and generally allows larger contributions than other plans. Age-based profit-sharing plans and target benefit pension plans also favor older participants. However, age-based profit-sharing plans and target benefit pension plans are both defined contribution plans that are subject to the annual additions limit (for 2021 a maximum contribution of no more than the lesser of 100% of an employee’s compensation or $58,000).

LO 2.1.1

Answer 74

A

C) Explanation
Because defined benefit plans must apply forfeitures to reduce the employer contribution, an actuarial assumption of high turnover in a plan year will result in a lower required employer contribution.

LO 2.1.1

Answer 75

A

A) Explanation
Earnings on investment plans, which were lower than anticipated, will result in an increase to the required annual employer contributions to a defined benefit pension plan. The other factors noted may result in a decrease in plan contributions.

Answer 76

A

Explanation
An increase in employee life expectancies will increase the potential costs of the plan, so life expectancies have a direct impact on plan costs.

LO 2.1.1

Answer 77

A

B) Explanation

All of these statements are correct.

Answer 78

A

A) Explanation
The annual additions limit for the money purchase plan in 2021 is 100% of the participant’s compensation or $58,000, whichever is less. The participant’s benefit in the defined benefit plan is limited in 2021 to 100% of the participant’s compensation or $230,000, whichever is less. The Section 415 limits are applied separately for each plan.

LO 2.1.2

Answer 79

A

C) Explanation
Statement I is incorrect. Contributions to defined benefit pension plans are not dependent on the profitability of a company. Statement II is incorrect, because a unit benefit formula plan will not allow higher integration levels. Statement III is incorrect because a unit benefit formula favors workers with longevity. Employees hired in their 50s or 60s will not have significant years of service in the formula at retirement.

Answer 80

A

C) Explanation
Because this formula considers both compensation and years of service, the defined benefit plan is using a unit benefit formula. This type of formula is frequently used to reward continued service with the same employer.

LO 2.1.2

Answer 81

A

D) Explanation
The dollar percentage matrix formula does not exist.

LO 2.1.2

Answer 82

A

D) Explanation
One exception to the overall deduction limit is for defined benefit plans that are covered by the PBGC. Under current law, if a defined benefit plan is covered under the PBGC, then the defined benefit plan is not taken into account in applying the overall limit on employer deductions.

LO 2.1.2

Answer 83

A

C) Explanation
The plan described is a cash balance pension plan. Age-weighted plans allocate contributions to participants in such a way that when contributions are converted to equivalent benefit accruals (stated as a percentage of compensation), each participant receives the same rate of benefit accrual. Cross-tested plans are defined contribution plans that test whether the contribution formula discriminates in favor of the highly compensated employee by converting contributions made for each participant into equivalent benefit accruals. Target benefit pension plans are hybrid retirement plans that use a benefit formula like that of a defined benefit pension plan and the individual accounts like a defined contribution plan.

LO 2.2.1

Answer 84

A

D) Explanation
All contributions to the account-based cash balance plan come from the employer and must reflect a uniform allocation formula based on compensation.

LO 2.2.1

Answer 85

A

D) Explanation
Statements II and IV are disadvantages. Statements I and III are advantages of a cash balance pension plan.

LO 2.2.1

Answer 86

A

A) Explanation
Statements I and II are correct. Section 415(b) limits the benefits provided under the plan to the lesser of $230,000 per year (2021) or 100% of the participant’s highest consecutive three-year average compensation. Distributions from the plan must follow the rules for qualified plan distributions and may be subject to penalty for early distribution.

LO 2.2.1

Answer 87

A

A) Explanation
Statements I and III are advantages of a cash balance pension plan. Statements II and IV are disadvantages of a cash balance pension plan.

LO 2.2.1

Answer 88

A

D) Explanation
A fully insured Section 412(e)(3) pension plan is a type of traditional defined benefit pension plan. The other types of plans noted are defined contribution plans, including the money purchase pension plan.

LO 2.2.2

Answer 89

A

A) Explanation
Statements I, III, and IV are correct. Section 412(e)(3) plans are a type of defined benefit plan. This type of plan is not required to be certified by an enrolled or licensed actuary. A fully insured plan is inappropriate for an employer who cannot commit to regular premium payments. Statement II is incorrect. Fully insured Section 412(e)(3) plans must only meet minimum funding standards if there is a loan outstanding against the insurance policy funding the plan.

LO 2.2.2

Answer 90

A

A) Explanation
Statements II, III, and IV are correct. The first option states a requirement that applies to defined benefit pension plans but not to money purchase plans.

LO 2.3.1

Answer 91

A

D) Explanation
Options I and II describe a money purchase pension plan, while options III and IV do not. The employee bears the investment risk and there is no actuary needed for this plan.

LO 2.3.1

Answer 92

A

D) Explanation
Even if the company contribution is 25% of participant compensation, the current account balance and future contributions will not be adequate to meet his retirement income objective. Because of Joan’s age, the annual contributions into her account may be under 6%. Although she has time to accumulate savings, the level of the contribution will provide less retirement fund accumulation for her than a money purchase plan could.

LO 2.3.1

Answer 93

A

D) Explanation
In a money purchase pension plan, the employer typically contributes a fixed percentage of each participant’s compensation. The employer does receive a tax deduction for the amount of contribution to the plan. No guaranteed retirement benefit is provided in a defined contribution plan. The contribution is defined, not the benefit. Only defined benefit pension plans provide guaranteed retirement benefits.

LO 2.3.1

Answer 94

A

A) Explanation
The maximum annual contribution to the participant’s account under the plan is the lesser of 100% of the eligible employee’s compensation, or $58,000 (for 2021). The deduction for employer contributions to a defined contribution plan is limited to 25% of aggregate covered compensation.

LO 2.3.1

Answer 95

A

B) Explanation
A money purchase pension plan requires annual mandatory employer contributions to each employee’s account, does not require an actuary, and does not require PBGC insurance.

The other choices are incorrect:

A cash balance pension plan requires an actuary and PBGC insurance.
A target benefit pension plan requires an actuary at the inception of the plan, but not on an annual basis.
A traditional defined benefit pension plan requires the services of an actuary annually as well as PBGC insurance.
LO 2.3.1

Answer 96

A

B) Explanation
Statements III and IV are correct. PBGC insurance is not available for target benefit or money purchase pension plans. Also, the actual dollar retirement benefit is not guaranteed in either of these plans.

LO 2.3.2

Answer 97

A

D) Explanation
Statements II and IV are correct for the following reasons. Target benefit plans have benefit formulas similar to those of defined benefit plans, which favor employees who are significantly older and higher paid than the average employee of the employee group. Because target benefit plans use separate accounts, the participants bear the risk of the plan’s investment performance. Statement I is incorrect because amending a defined benefit plan into a target plan will result in termination of the defined benefit plan. Statement III is not true since a DC plan is limited to 25%, and a DB plan is not limited by a set percentage. Therefore, the DB plan will usually provide a greater tax deduction if an age-weighted plan works best. The key word to Statement III is “maximizing.”

LO 2.3.2

Answer 98

A

A) Explanation
A target benefit pension plan is similar to a traditional defined benefit plan in that they are both designed to benefit older employees. The employer bears the risk in the defined benefit plan only, and the employer contribution is not flexible in either plan. In a target benefit pension plan, the investment returns do affect the final benefit.

LO 2.3.2

Answer 99

A

A) Explanation
The plan described is a target benefit pension plan. The contribution is derived from an actuarially designed benefit formula in a target benefit pension plan, but once determined, the plan resembles a money purchase pension plan in all other ways. Cash balance pension plans are defined benefit pension plans that promise a benefit based on a hypothetical account balance versus a traditional defined benefit plan, which promises a monthly retirement benefit for life. Age-weighted profit-sharing plans are defined contribution plans that allocate contributions to participants in such a way that when contributions are converted to equivalent benefit accruals (stated as a percentage of compensation), each participant receives the same rate of benefit accrual. A money purchase pension plan does not use an actuarially designed benefit formula.

LO 2.3.2

Answer 100

A

A) Explanation
The question is describing a target benefit pension plan.

LO 2.3.2

Answer 101

A

C) Explanation
A target benefit pension plan is a type of defined contribution plan and, as in all other defined contribution plans, there is no guaranteed ultimate account balance. The plan favors older participants by making a larger contribution for an older plan entrant than for a younger plan entrant with exactly the same salary.

LO 2.3.2

Answer 102

A

A) Explanation
A profit-sharing plan would be most appropriate, as the owners could choose when to make contributions. Also, because the owners are young, they would have more time to receive contributions on their own behalf. A money purchase pension plan or target benefit pension plan would not be appropriate because this young company would not want to commit a large sum of money every year. The company probably would want the ability to reinvest the money in the firm if needed. The target benefit pension and age-weighted profit-sharing plans are also designed for older owner-employees.

LO 3.1.1

Answer 103

A

C) Explanation
The company has funding flexibility. Pension plans can invest only up to 10% of plan assets in employer stock. Profit-sharing plans have no restrictions regarding investment in employer stock. The employer may deduct a contribution limited to only 25% of participating employees’ covered compensation. They must make substantial and recurring employer contributions, or the IRS will remove the plan’s qualified status. The employee bears investment risk.

LO 3.1.1

Answer 104

A

D) Explanation
Profit-sharing plans are not required to make contributions each year.

LO 3.1.1

Answer 105

A

C) Explanation
Because a Section 401(k) plan is a qualified defined contribution plan, the employee is immediately vested (100%) in all elective deferrals and their accrued benefits. Such deferrals are, however, subject to FICA taxes. Vesting schedules may be used with employer-matching contributions.

LO 3.3.1

Answer 106

A

B) Explanation
Valerie earns $320,000 annually in 2021. The plan provides for a contribution of 25% of participants’ compensation. However, the maximum compensation that can be taken into consideration is $290,000. Twenty-five percent of $290,000 is $72,500. Finally, the maximum annual additions limit is $58,000, making the maximum company contribution for Valerie $58,000.

LO 3.1.1

Answer 107

A

D) Explanation
A profit-sharing plan does not require a mandatory, annual employer contribution. Therefore, they are best suited for companies that experience fluctuating cash flow and would like the flexibility of a discretionary (though substantial and recurring) contribution. The maximum tax-deductible contribution is 25% of covered payroll. Because there is less time to accrue a retirement benefit by retirement age, a profit-sharing plan is not the best choice for a plan with a great number older employee-participants.

LO 3.1.1

Answer 108

A

C) Explanation
All of the statements regarding hardship withdrawal requirements are correct.

LO 3.1.1

Answer 109

A

D) Explanation
A traditional profit-sharing plan may be appropriate when an employer’s profits, or cash flow, fluctuate from year to year;
an employer wishes to implement a qualified plan with an incentive feature by which an employee’s account balance increases with employer profits; or
most employees are young (under age 50) and have substantial time to accumulate retirement savings, and the employees are, most likely, willing to accept a degree of investment risk in their individual accounts.
Jack’s company is not eligible to implement a Section 403(b) plan, as it is not a nonprofit organization. A defined benefit plan is not appropriate for the company’s employee demographics, requires stable cash flows, and can be expensive to administer. Money purchase plans also require a mandatory contribution each year and do not provide the incentive feature regarding company profits.

LO 3.1.1

Answer 110

A

D) Explanation
A new comparability plan would allow the owners to divide the participants into two classes based on their compensation levels and allocate different contribution levels to the classes. An age-based profit-sharing plan wouldn’t meet their objectives because the owners’ ages are significantly different. Section 401(k) plans are subject to discrimination testing, and a self-employed Keogh plan is inappropriate because the owners aren’t self-employed.

LO 3.2.1

Answer 111

A

A) Explanation
Contribution formulas for both age-weighted profit-sharing plans and traditional defined benefit pension plans favor older employees. Retirement benefits are determined by the participant’s final account balance in defined contribution plans. Employer contributions can be flexible in an age-weighted profit-sharing plan, but not in a defined benefit pension plan. Vesting is not more liberal in these plans than in other types of plans.

LO LO 3.2.1

Answer 112

A

C) Explanation
Of the plans listed, the employer stock ownership plan and the stock bonus plans are not cross-tested plans. Only the new comparability plan and the age-based profit-sharing plan are cross-tested plans.

LO 3.2.1

Answer 113

A

D) Explanation
Of the plans listed, only the new comparability plan and the age-based profit-sharing plan are cross-tested plans. Cross-testing means a defined contribution plan is tested for nondiscrimination based on benefits rather than contributions.

LO LO 3.2.1

Answer 114

A

B). Explanation
Employees are not taxed on stock in an ESOP until the stock is distributed. Upon distribution, the employee must pay ordinary income taxes on the fair market value of the stock when it was contributed to the plan on his behalf. Any net unrealized appreciation (NUA) at that time can be deferred until the stock’s subsequent sale. Upon the sale, the NUA portion will be treated as long-term capital gain. Additionally, the growth of the stock subsequent to the distribution will receive long-term capital gain treatment because Bernie held the stock longer than one year after distribution. Therefore, the appropriate tax treatment available to Bernie upon sale of the stock is a $20,000 long-term capital gain.

LO 3.2.2

Answer 115

A

D) Explanation
An ESOP could help ABC meet all of these objectives.

LO 3.2.2

Answer 116

A

D) Explanation
All of these statements are ESOP advantages to the employer.

LO 3.2.2

Answer 117

A

B) Explanation
Options I and II correctly state the diversification rule and the rule that prohibits integrated ESOPs. There is no limit on amounts used to pay interest on ESOP debt. ESOP distributions of employer stock only are not subject to the 20% income tax withholding requirement.

LO 3.2.2

Answer 118

A

A) Explanation
Defined contribution plans limit employer contributions to 25% of covered payroll. With a leveraged ESOP, the employer may deduct both the principal (up to 25% of compensation paid to covered employee-participants) and additional amounts paid as interest as the loan is paid off. An ESOP is not a defined benefit plan.

LO 3.2.2

Answer 119

A

A) Explanation
Options II, III, and IV correctly describe the 25% employer deduction limitation, eligibility requirement, and potential sources of employee elective deferrals for Section 401(k) plans. Option I is incorrect because employee elective deferrals (i.e., salary deferrals) are subject to FICA and FUTA taxes. Option III is correct. There can be a two-year period of service requirement if the participants are 100% immediately vested for some other employer retirement plans. However, this does not apply for 401(k) plans.

LO 3.3.1

Answer 120

A

A) Explanation
Statements II and III are correct. Statement I is incorrect. Employee contributions and investment earnings are always 100% vested, not the employer contributions. Statement IV is incorrect. Elective deferrals in a CODA are subject to FICA and FUTA taxes.

LO 3.3.1

Answer 121

A

D) Explanation
The elective deferral limit for 2021 to a Section 401(k) is $19,500. The maximum annual additions limit is $58,000.

LO 3.3.1

Answer 122

A

D) Explanation
Statement II is incorrect. A Section 401(k) plan may allow in-service distributions before age 62.

LO 3.3.2

Answer 123

A

B) Explanation
Employee contributions and investment earnings are always 100% vested, not the employer contributions. The vesting of employer contributions depends on the type of employer contribution to the plan.

LO 3.3.1

Answer 124

A

A) Explanation
The maximum amount of elective deferrals possible in 2021 to a traditional profit-sharing Section 401(k) plan for an individual under age 50 is $19,500 (it is $26,000 for an individual age 50 or older). The lesser amount of $13,500 applies to the SIMPLE 401(k) form.

LO 3.3.1

Answer 125

A

D) Explanation
Hardship withdrawals are typically allowed for unreimbursed medical expenses, college tuition and fees, to purchase a principal residence, burial expenses for spouse or dependents, and to prevent eviction from one’s principal residence or foreclosure on the mortgage of such residence.

LO 3.1.1

Answer 126

A

D) Explanation
Employees must be immediately 100% vested in mandatory employer contributions that are made under the safe harbor provisions. The mandatory contributions can take the form of either a non-elective contribution to all eligible employees or matching contributions to participating non-highly compensated employees who participate in the plan.

LO 3.3.1

Answer 127

A

D) Explanation
All of these statements regarding Section 401(k) plan safe harbor rules are correct.

LO 3.3.1

Answer 128

A

B) Explanation
Under a SIMPLE 401(k), an employer does not have the option to change the percentage used for the matching contribution. A SIMPLE IRA would be able to move the match down to 1% for two out of five years. However, in this case the employer can use the 2% non-elective contribution instead of the 3% matching contribution. Under the scenario described, however, the savings would be minimal.

LO 3.3.3

Answer 129

A

D) Explanation
Although Grant took the distribution after five taxable years from the date of initial contribution, he did not meet one of the other requirements for a qualified distribution (it must be made after the individual attained age 59½, the individual must be disabled, or the distribution must be made to a beneficiary or estate of an individual on or after the individual’s death). In this case, the first $34,000 is counted against his contributions. Thus, there is no tax or penalty on $34,000. There are no conversions, so the rest of the distribution is earnings and thus subject to income tax and the 10% early distribution rules.

LO 3.3.3

Answer 130

A

B) Explanation
Statement I is incorrect. SIMPLE 401(k) plans are qualified plans and are subject to mandatory 20% income tax withholding for a distribution that is not a direct trustee-to-trustee transfer. When there is a direct transfer of a distribution from a qualified plan to an IRA, the mandatory 20% withholding rule does not apply.

LO 3.3.3

Answer 131

A

A) Vesting schedules are not permitted in SIMPLE 401(k)s. Employees are always 100% vested in employer contributions.

LO 3.3.3

Answer 132

A

D) Explanation
The ADP test applies only to traditional Section 401(k) plans. The test does not apply to SIMPLE 401(k)s or money purchase pension plans. The ADP deals with worker deferrals. A money purchase plan is essentially an employer contribution only plan.

LO 3.3.3

Answer 133

A

C) Explanation
The ADP test fails when too much is being saved or contributed on behalf of highly compensated employees. In order to bring the plan into compliance it would be necessary to make a corrective distribution to a portion of the highly compensated employee deferrals, not the nonhighly compensated employee deferrals. The other three options are stated correctly.

LO 3.3.2

Answer 134

A

D) Explanation
An age-weighted formula can be used by a profit-sharing plan. This arrangement will work best for a business with a fluctuating cash flow and key employees who are older than the other employees. Pension plans (i.e., cash balance plans and target plans) are subject to minimum funding requirements and may create a problem for a business with a fluctuating cash flow, even though they will maximize contributions for older employees. A service-based formula will favor employees who have many years of service with the business.

LO LO 3.2.1

Answer 135

A

C) Explanation
George should amend the profit-sharing plan, making it a LESOP. Then, as the LESOP trustee, he can borrow $3 million in the name of the LESOP from a bank familiar with LESOP loans. The LESOP will receive $3 million from the loan and it will use the proceeds to buy George’s $3 million worth of stock and become the owner of the company. George will receive the $3 million in cash and retire. Only a LESOP can borrow money. Borrowing $3 million doesn’t extract the value of his company for his benefit; it only creates debt and a nondeductible interest cost.

LO 3.2.2

Answer 136

A

B) Explanation
Total annual contributions to a participant’s account are limited in 2021 to the lesser of 100% of employee compensation, or $58,000, with only the first $290,000 of employee compensation considered in the contribution formula. The total contribution is made up of the worker contribution, the employer contribution, and reallocated forfeitures. The worker contribution alone is limited to $19,500 in 2021 for those 49 and younger.

LO 3.3.1

Answer 137

A

D) Explanation
Hardship withdrawals from profit sharing or stock bonus Section 401(k) plans require that hardship conditions (“immediate and heavy financial need” and other resources not “reasonably available”) be demonstrated. Only elective deferral amounts—not the associated earnings—are available for hardship withdrawals.

LO 3.3.1

Answer 138

A

C) Explanation
Because of the net unrealized appreciation rule, at distribution, Tina will be taxed only on $5,000, the original cost of the stock when it was contributed to the plan. Tina was taxed on the $5,000 basis in the stock when she received her distribution. Therefore, her capital gain will be $7,000 if she sells the stock for $12,000.

LO 3.2.2

Answer 139

A

A) Explanation
A new comparability plan would allow the owners to divide the participants into two classes based on their compensation levels, and to allocate different contribution levels to the classes. An age-based profit-sharing plan wouldn’t meet their objectives because the owners’ ages are significantly different. Section 401(k) plans are subject to discrimination testing, and a Keogh plan is inappropriate because the owners are not self-employed.

LO LO 3.2.1

Answer 140

A

A) Failed
Explanation
The ADP test looks at employee deferrals (ADP).

LO 3.3.2

Answer 141

A

Explanation
Both statements describe the tests that must be met to qualify for a hardship withdrawal.

LO 3.1.1

Answer 142

A

D) Explanation
An age-weighted profit-sharing plan is a qualified plan that would offer maximum benefits for the shareholders, who are older. An age-weighted profit-sharing plan would also offer flexible contributions and low administrative costs. A defined benefit pension plan would not have contribution flexibility or low administrative costs. Although a profit-sharing plan would offer contribution flexibility and low administrative costs, it would not allow maximum benefits for the principals. A SEP is not a qualified plan.

LO LO 3.2.1

Answer 143

A

C) Explanation
For amounts higher than 8%, the allowable spread between NHCEs and HCEs is 1.25 (125%). So for this question, 9% × 1.25 = 11.25%. Besides the 1.25 times test, the other test is the 200% rule with a maximum difference of 2%. In this case, 200% is 18%, but the maximum difference of 2% brings this test down to 11%. Since 11.25% is higher, that test decides how much highly compensated employees could contribute.

LO 3.3.2

Answer 144

A

B) Explanation
An age-weighted formula can be used by a profit-sharing plan. This arrangement will work best for a business with a fluctuating cash flow and key employees who are older than the other employees. Pension plans (i.e., cash balance plans and target plans) are subject to minimum funding requirements and may create a problem for a business with a fluctuating cash flow, even though they will maximize contributions for older employees. A service-based formula will favor employees who have many years of service with the business.

LO 3.2.1

Answer 145

A

D) Explanation
While the ACP test applies to TSA plans, both the ACP and the ADP tests apply to 401(k) plans.

LO 3.3.2

Answer 146

A

D) Explanation
Schedule C net income	$ 80,000
Less 7.65%	(6,120)
Self-employment income subject to self-employment taxes	$ 73,880
Times 15.3%	
Self-employment tax	$ 11,304

One-half of the self-employment tax is deductible as an adjustment to income. In this example, the deductible portion is $5,652 ($11,304 ÷ 2).

Determine the adjusted contribution percentage for the Albert, the business owner.

Maximum percentage contribution for participants

(employee %)

.25
Divided by (1 + employee %) 1.25
Equals adjusted contribution percentage for owner = .20

Schedule C net profit (business profit) $80,000
Less income tax deduction allowed (1/2 self-employment tax) ($5,652)
Net earnings from self-employment $74,348
Multiply by .20 =
Owner’s contribution $14,870

Note that $14,870 is 25% of $59,478 and $59,478 is the amount you get from taking the net earnings of $74,348 and subtracting $14,870. Thus, the IRS would argue that the self-employed owner is getting the same 25% contribution as the worker after all the accounting is factored in.

LO 3.3.3

Answer 147

A

C) Explanation
Although Roth IRAs have an additional reason for qualified distributions (up to $10,000 of first-time homebuyer expenses), a distribution from either type of Roth account after five years and over age 59½ would be a qualified distribution. No type of Roth contribution is deductible. Roth IRAs are not subject to RMDs while the original owner is alive, but employer Roth accounts for retirees are subject to the normal RMD rules. Roth IRAs are phased out for higher earners, but not for employer Roth accounts.

LO 3.3.3

Answer 148

A

A) Explanation
Assuming the participant elects NUA treatment, the unrealized gain in the value of the stock is not taxed until the stock is sold. Stock bonus and profit-sharing plans both have the flexible employer contribution characteristics. Participants have the option to take the employer’s stock under either. When the employer’s securities are not readily tradable on an established market, a participant who separates from service must be provided the right to have the employer—not the plan—repurchase the employer securities under a fair valuation formula (i.e., a put option). Although Social Security integration is allowed in stock bonus plans, it is not permitted in employee stock ownership plans (ESOPs).

LO 3.2.2

Answer 149

A

D) Explanation
Statements II and IV are correct. Both ESOPs and stock bonus plans give employees a stake in the company through stock ownership. They may increase company cash flow because employers make cashless contributions to the retirement plan and create a market for employer stock. In addition, they both limit the availability of retirement funds to employees if an employer’s stock falls drastically in value and create an administrative and cash-flow problem for employers by requiring them to offer a repurchase option (put option) if their stock is not readily tradable on an established market. Employees must pay income tax on the value of the stock contributed to the plan at the time of distribution. Gain on the stock before a lump-sum distribution is net unrealized appreciation and is not taxed until the employee-participant sells the stock.

LO 3.2.2

Answer 150

A

B) Explanation
Of the choices offered, only a Section 401(k) is a defined contribution profit-sharing plan. The other choices are pension plans.

LO 3.1.1

Answer 151

A

D) Explanation
For qualified plans, an ESOP or LESOP is unique in its ability to borrow money in the plan’s name without violating prohibited transaction rules.

LO 3.2.2

Answer 152

A

D) Explanation
The total of the employee and employer contributions that may be made to George’s account in 2021 is $24,000.

$13,500 employee contribution
+ $7,500 employer contribution ($250,000 × 0.03)
+ $3,000 employee age-50-and-over catch-up contribution
$24,000

LO 4.2.1

Answer 153

A

D) Explanation
A SEP plan is a very simple retirement plan that provides for flexible funding and allows employers to make contributions directly to participants’ individual IRAs and can be established by any type of employer. The percentage contributed by the employer can fluctuate each year as long as it is the same for every employee. Up to 25% of an employee’s covered compensation is allowable for the tax benefit, up to a maximum of $58,000 (2021).

LO 4.2.2

Answer 154

A

C) Explanation
A 403(b) plan is limited to investing in mutual funds and/or annuity contracts. Conversely, the Internal Revenue Code does not specify which instruments 401(k) funds can be invested in. A 403(b) plan is technically not a qualified plan under the Employee Retirement Income Security Act of 1974 (ERISA).

LO 4.3.1

Answer 155

A

D) Explanation
All of these organizations may establish a Section 457 plan. Deferrals are limited to the lesser of $19,500 in 2021, or 100% of compensation. Statement I is incorrect because the agreement must be executed before the first day of the month in which the services will be performed. The result will be a loss of the tax deferral for that month if the agreement is made during the month.

LO 4.3.2

Answer 156

A

A)Explanation
A SEP plan would not be appropriate because it would require coverage of Dorothy’s part-time employees. A traditional Section 401(k) is not appropriate because it would involve special nondiscrimination testing and annual filing of the Form 5500 series. A Section 457 plan is not appropriate because it is available only for certain, private tax-exempt organizations. A SIMPLE IRA would be the most appropriate plan because it involves little administrative costs and would meet Dorothy’s retirement planning goals.

LO 4.2.1

Answer 157

A

D) Explanation
All of the statements are correct.

LO 4.2.2

Answer 158

A

D) Explanation
The employee bears the investment risk under the plan, which is a disadvantage to the employee. All of the other choices are disadvantages of a SEP plan.

LO 4.2.2

Answer 159

A

C)Explanation
A participant in a governmental Section 457 plan may not use both the special catch-up allowance and the over-age-50 catch-up allowance in the same tax year.

LO 4.3.2

Answer 160

A

C) Explanation
A participant in a governmental Section 457 plan may not use both the special catch-up allowance and the over-age-50 catch-up allowance in the same tax year.

LO 4.3.2

Answer 161

A

B) Explanation
Tom’s goals describe attributes of a SIMPLE IRA. The SEP plan and the target benefit plan do not allow worker contributions. The age-weighted profit-sharing plan is not as easily understood. Also, the target benefit plan and the age-weighted profit-sharing plan favor older employees.

LO 4.2.1

Answer 162

A

B) Explanation
Because Section 457 plans are sponsored by tax-exempt entities, deductibility of plan contributions is not an issue.

LO 4.3.2

Answer 163

A

B) Explanation
Statements I and II are correct. An employer can make a 2% nonelective employer contribution in a SIMPLE IRA, where employees eligible to participate receive an employer contribution equal to 2% of their covered compensation (limited to $290,000 in 2021 and subject to cost-of-living adjustments for later years), regardless of whether they make their own contributions. Alternatively, an employer may make a dollar-for-dollar match up to 3% of compensation, where only the participating employees who have elected to make contributions will receive an employer-matching contribution. Each year, the employer can choose which contribution level it will use for the following year’s contributions. The company is required to communicate this information to employees before the beginning of the 60-day election period.

LO 4.2.1

Answer 164

A

C) Explanation
George will incur a $250 penalty tax on the $1,000 withdrawal. Premature withdrawals made from a SIMPLE IRA within two years of initial participation are subject to a penalty tax of 25%.

LO 4.2.1

Answer 165

A

D) D) Explanation
Only the employees of Bonnet Company who earned at least $5,000 in the prior year and expect to earn at least that amount in the current year are eligible to participate in the plan (40 employees). Employees may make an elective deferral into the SIMPLE IRA as a percentage of compensation of up to at least $13,500 in 2021. Those age 50 and above can add an additional $3,000. The unofficial, but mathematically set, effective covered compensation limit for SIMPLE IRAs for employees under age 50 is $450,000 in 2021 when the employer elects the 3% match ($13,500 divided by 0.03). The covered compensation limit is $290,000 if Bonnet Company decides on the 2% nonelective employer contribution.

LO 4.2.1

Answer 166

A

B) Explanation
Sharon can defer the basic $19,500 allowed in 2021, plus $6,500 for the age 50 catch-up and $3,000 for the long service catch-up (15 years of service or more).

LO 4.3.1

Answer 167

A

C) Explanation
The additional deferral amount is available only from prior unused deferrals and is to make up for those years when deferrals were less than the maximum allowed. The other catch-up is for those who have attained age 50. They can increase their deferrals by $6,500 (in 2021) in all but the last three years before retirement if they are using the final three-year catch-up.

LO 4.3.2

Answer 168

A

D) Explanation
A Section 457 plan is not a qualified plan. This plan is a deferred compensation plan that may be established by governmental units or agencies and non-church-controlled, tax-exempt organizations. Section 457 plans have special catch-up rules.

LO 6.3.1

Answer 169

A

C) Explanation
A top-hat plan would meet all of the company’s objectives. The other choices are all qualified plans and would be subject to the limitations on funding, contributions, and benefits.

LO 4.1.1

Answer 170

A

A) Explanation
SEPs and profit sharing plans are both subject to the 25% limit on deductible employer contributions, the controlled group rules, and nondiscrimination requirements. Eligibility requirements are different for a SEP.

LO 4.2.2

Answer 171

A

A) Explanation
Ex-March must make a nonelective contribution of $800 for Christopher. Though Christopher does not make a contribution this year, Ex-March must make a nonelective contribution of $800 (2% × $40,000) on his behalf. Under the employer contribution election Ex-March has selected, even if an eligible employee does not contribute to the SIMPLE IRA, that employee would still receive an employer nonelective contribution to his SIMPLE IRA equal to 2% of compensation.

LO 4.2.1

Answer 172

A

D) Explanation
All of these statements are reasons a small business might choose the SIMPLE over a Section 401(k) plan.

LO 4.2.1

Answer 173

A

E) Explanation
SIMPLE IRA plans are available to employers with 100 or fewer employees and with no other qualified retirement plan. The employer contribution requirement may be satisfied by either a 3% matching contribution formula or a 2% nonelective contribution for each employee with current-year compensation of $5,000 or more. IRA-funded employer-sponsored tax-advantaged plans may not incorporate loan provisions. These plans do not require ADP or ACP nondiscrimination tests.

LO 4.2.1

Answer 174

A

B) Explanation
Qualified plans require a significant amount of expense and paperwork. Because Tom’s business is small, a SEP or SIMPLE IRA is preferred. Tom can, however, defer more in a SIMPLE than in a SEP. Based on 2021 plan contribution limits, in the SIMPLE, he can defer $16,500 ($13,500 salary deferral, plus $3,000 as a catch-up contribution) plus receive a 3% match. In a SEP, he would be limited to $9,293 as follows:

$50,000 Schedule C income
− 3,533 deductible half of self-employment tax (SECA)
$46,467 net Schedule C SE income
× 20% (the 20% is calculated by 0.25 ÷ 1.25 = 20%)
$9,293
LO 4.2.1

Answer 175

A

A) Explanation
The employee bears the investment risk for all of these plans.

LO 4.2.1

Answer 176

A

C) Explanation
Gary will be 100% vested in his employer contributions to his account. He may defer up to $13,500 (2021) into the SIMPLE IRA if he is younger than age 50. An employer may only limit the matching contribution to 1% of employee compensation in no more than two out of every five years. Effective covered compensation for employees under age 50 is limited to $450,000 ($13,500 ÷ 0.03) for a SIMPLE IRA (2021) in which the employer elects to make 3% matching contributions. The covered compensation limit of $290,000 (2021) does not apply in this instance because there is a special rule for SIMPLE IRAs.

LO 4.2.1

Answer 177

A

B) Explanation
Premature withdrawals made from a SIMPLE IRA within two years of initial participation are subject to a penalty tax of 25%. Max’s penalty would be $250.

LO 4.2.1

Answer 178

A

B) Explanation
Neither a SIMPLE IRA nor a SIMPLE 401(k) requires ADP testing. A SIMPLE is not subject to top-heavy rules. Statement III is correct. The early withdrawal penalty is 25% for distributions taken within the first two years of participation in a SIMPLE IRA. The maximum elective deferral to a SIMPLE is $13,500 (2021). Employees who have attained age 50 by the end of the tax year will also be eligible for a catch-up contribution of $3,000.

LO 4.2.1

Answer 179

A

B) Explanation
Employers with more than 100 employees (who earn more than $5,000) may not offer a SIMPLE. In addition, the employer may not usually offer any other type of qualified retirement plan in conjunction with a SIMPLE. Union plans and governmental 457 plans are the exceptions to the employer having a second active plan. However, this is not to be applied to a test question unless specifically mentioned in the question. Basically, can a SIMPLE have a second active plan for its workers? No, because that is as far as the test is going. What about a union plan or a 457 for qualified state and local government employers? Well, okay, for those rare exceptions, but the question would have to bring up one of these rare exceptions. The point is that SIMPLEs were intended to be the only active plan for the small employer. Congress was afraid the employer would try to be discriminatory with the other retirement plan, so the rules was made that there could not be another retirement plan. Then governmental 457 plans and union plans snuck in, but these rare exceptions are not a part of the question unless specifically mentioned.

LO 4.2.1

Answer 180

A

A) Explanation
A SIMPLE IRA would be the most appropriate plan because it involves little administrative costs and would meet Margaret’s retirement plan goals. Notice the workers are making more than $650 and less than $5,000. If a SEP would be chosen, she would have to contribute for employees who made more than $650; are at least age 21; and who have worked for her for three of the preceding five years.

LO 4.2.1

Answer 181

A

D) Explanation
A 2% nonelective contribution formula on behalf of eligible employees is one of two formulas an employer may use in making contributions to a SIMPLE IRA. A 3% match is the other. For a SIMPLE IRA only, the 3% match can be lowered to 1% for two out of five years.

LO 4.2.1

Answer 182

A

A) Explanation
SEP contributions must be 100% vested (i.e., nonforfeitable). SEPs consist of individual IRAs; there is no trustee for a SEP plan. The contribution formula of a SEP is not required to be fixed. Employer contributions to a SEP are not subject to payroll taxes.

LO 4.2.2

Answer 183

A

C) Explanation
Statements I, III, and IV are disadvantages of a SEP plan to an employer. Statement II is false. The employee bears the investment risk under the plan.

LO 4.2.2

Answer 184

A

A) Explanation
Statements I, II, and III are correct. Employees who participate in a SEP plan are considered active participants in an employer retirement plan for the tax year in which an employer contribution is made. The deductibility of an active participant’s IRA contribution depends upon his MAGI and can be phased out or eliminated at certain income levels. SEP plan participation does not reduce or eliminate an employee’s ability to fund an IRA. The IRA can be funded, but not necessarily deducted from gross income.

LO 4.2.2

Answer 185

A

A) Explanation
Contributions are currently excludible from the employee’s gross income. Employer contributions to a SEP are not subject to FICA, FUTA, or income tax withholding. The SEP contribution limit for 2021 is the lesser of 25% of covered compensation or $58,000.

LO 4.2.2

Answer 186

A

B) Explanation
The requirement that contributions must be made for employees who earned at least $600 in the prior years identifies the plan as a SEP plan.

LO 4.2.2

Answer 187

A

A) Explanation
A SEP plan must cover any employee who is at least 21 years old and who worked for the employer, even on a part-time basis, for three of the preceding five years. In addition, contributions must be made on behalf of any eligible employee whose compensation for the year is at least $650 (2021). These provisions make most part-time employees eligible to participate.

LO 4.2.2

Answer 188

A

B) Explanation
A Section 403(b) plan/TSA (tax-sheltered annuity) is a tax-deferred employee retirement plan that is adopted only by certain tax-exempt organizations and certain public schools and colleges. Employees have individual accounts to which employers contribute (or employees contribute through salary reductions).

LO 4.3.1

Answer 189

A

D) Explanation
All of the statements are correct. The $29,000 maximum elective deferral for 2021 includes the $19,500 basic limit; the extra $3,000 per year for up to $15,000 lifetime for employees of not-for-profit health care, education, and church employers; and the $6,500 catch-up for those age 50 and older.

LO 4.3.1

Answer 190

A

D) Explanation
The special catch-up provision for eligible Section 403(b) participants allows a maximum additional $3,000 per year elective deferral until a lifetime maximum catch-up is reached. The ability to double the worker contribution in the last three years before the retirement plan document’s normal retirement age applies to governmental 457 plans.

LO 4.3.1

Answer 191

A

A) Explanation
Statement II is incorrect because distributions from a TSA are treated as ordinary income. Statement IV is incorrect. Only annuities and mutual funds are permitted investments in a TSA.

LO 4.3.1

Answer 192

A

B) Explanation
The Section 403(b) plan, like the Section 457 plan, can be used as an employee-deferred contribution plan. Certain tax-exempt employers can implement Section 403(b) plans. With a SEP plan or a profit-sharing plan, there are also employer contribution considerations. New SARSEP plans can no longer be established.

LO 4.3.1

Answer 193

A

C) Explanation
Statement I is incorrect. The special or additional catch-up provision requires at least 15 service years.

LO 4.3.1

Answer 194

A

C) Explanation
Investments in TSAs are limited to annuity contracts, either group or individual, and custodial accounts invested in mutual funds. Individual stocks and bonds are not permitted.

LO 4.3.1

Answer 195

A

A) Explanation
Ronald can separately defer the maximum of $19,500 (2021) into the Section 457 plan because Section 457 plan limits are not aggregated with the Section 403(b) plan limits.

LO 4.3.2

Answer 196

A

B) Explanation
To establish a SIMPLE, an employer cannot maintain another plan. However, a Section 457 plan is a nonqualified deferred compensation plan; therefore, it does not constitute a plan for purposes of establishing a SIMPLE.

LO 4.2.1

Answer 197

A

D) Explanation
To establish a SIMPLE (IRA or Section 401(k)), an employer cannot generally maintain another retirement plan. However, a plan bargained in good faith with a union is allowed because Congress is more worried about powerful businessowners using a retirement plan in a discriminatory manner.

LO 4.3.2

Answer 198

A

B) Explanation
Statements I and IV are correct. Statement II is incorrect because a Section 457 plan is a deferred compensation arrangement that will not cause a participant to be considered an active participant. Statement III is incorrect because net unrealized appreciation (NUA) tax treatment is not permitted for distributions from either plan.

LO 4.3.2

Answer 199

A

C) Explanation
The dollar limit applicable to Section 403(b), 457, and 401(k) plans is $19,500 in 2021.

LO 4.3.2

Answer 200

A

B) Explanation
State and local governments and organizations exempt from federal income tax are eligible to offer Section 457 deferred compensation plans, but churches and church-controlled organizations cannot. No for-profit organizations can offer either of these plans.

LO 4.3.2

Answer 201

A

B) Explanation
Employee elective deferrals are permitted in Section 401(k) plans, profit-sharing plans with Section 401(k) provisions, and SIMPLEs, but not in SEP plans.

LO 4.2.2

Answer 202

A

D) Explanation
The early distribution penalty does apply to certain nonqualified distributions from a Roth IRA. All other statements are correct.

LO 5.4.2

Answer 203

A

A) Explanation
Of those listed, only IRAs are not subject to 20% withholding (regardless of the type of rollover). In contrast, all qualified plan and Section 403(b) plan distributions require withholding in the absence of a direct trustee-to-trustee transfer. SEP plans, while not listed, are a type of IRA and thus do not require 20% withholding.

LO 5.3.1

Answer 204

A

A)Explanation
Based on IRS regulations, minimum distribution rules have been simplified by providing a uniform table that can be used by all participants (except when a spouse is more than 10 years younger) to determine the minimum distribution required during their lifetimes. This makes it easier to calculate the RMD because participants would neither need to determine their beneficiary by the required minimum distribution beginning date, nor would they have to decide whether to recalculate their life expectancies each year. The excise tax is 50%, not 10%. The required beginning date is April 1 of the year after the year the account owner turns age 72 for IRAs and qualified plan participant owners of 5% or more of the company. The required beginning date for Section 403(b) plans, Section 457 plans, and qualified plans is April 1 of the year after the employee retires. It is advisable for the owner of an IRA or qualified plan account to name an individual as beneficiary, but there is no requirement that such a beneficiary be determined before the owner attains age 72.

LO 5.4.2

Answer 205

A

B) Explanation
A person may always choose not to deduct her IRA contribution, regardless of AGI or whether or not the person is an active participant.

LO 5.1.2

Answer 206

A

C) Explanation
Any distribution must satisfy the five-year holding period that began in Year 1 with Clara’s first contribution to the Roth IRA to be tax free and penalty free. A nonspouse beneficiary cannot roll over the inherited Roth IRA into his own Roth IRA and forego the required distributions.

LO 5.4.2

Answer 207

A

D) Explanation
Once a year, an IRA owner may roll over his account to a new IRA within 60 days after distribution from the original IRA. Direct trustee-to-trustee transfers may be made as often as desired. The 20% withholding requirement does not apply to IRA distributions; the 20% mandatory withholding applies to eligible rollover distributions made directly to the plan participant from employer-sponsored qualified retirement plans or TSAs.

LO 5.2.1

Answer 208

A

C) Explanation
Money withdrawn to purchase an automobile would be subject to the 10% early withdrawal penalty. If a participant dies or becomes disabled, there is no penalty for an early withdrawal. Distributions for certain serious medical expenses allow the participant to avoid the 10% early withdrawal penalty. Generally, the expenses that avoid the penalty are those that exceed the threshold of 10% of a participant’s adjusted gross income for individuals who are under age 59½. A withdrawal for any medical or any other expenses for those over age 59½ would not be subject to the early withdrawal penalty because the person is over 59½ anyway.

LO 5.3.1

Answer 209

A

A) Explanation
Of the money Dorinda receives, only $3,600—the portion of the payments that can be attributed to alimony from a pre-2019 divorce settlement—qualifies as earned income for the purposes of a Roth IRA contribution. The definition for earned income is the same as for a traditional IRA. Please note that divorces finalized during and after 2019 will fall under the new rules, which will not include alimony as tax deductible to the payer and taxable to the receiver. As such, this will not be considered earned income. This divorce happened before this Tax Reform Act, and thus follows the old rules.

LO 5.4.1

Answer 210

A

A)Explanation
Since Ted is an “active participant” and their AGI falls within the phaseout range for married joint filers ($105,000–$125,000), their $12,000 IRA contribution will be only partially deductible. The upper AGI limit of $125,000 minus their AGI of $112,000 equals $13,000. $13,000 ÷ $20,000 = .65. And .65 × $6,000 (the maximum contribution) = $3,900 for Ted + $6,000 for Margaret’s spousal IRA. For test taking purposes, there is no need to actually calculate the number for this question. They are in the phaseout range for active participants, but only one spouse is an active participant. Thus

the nonactive participant spouse can deduct the full amount, but the active participant spouse cannot do the full amount; and
because of this, the answer must be higher than $6,000 and lower than $12,000 because they are both younger than 50 in 2021. There is only one answer in this range, so it must be the correct answer.
If there were two or more answers within the range, the exact number must be calculated.

Finally, if a person is not allowed to deduct an IRA contribution, the next option would be to contribute to a Roth IRA if income allows. Why would anyone want to make a nondeductible IRA contribution if they were eligible to make a Roth IRA contribution?

LO 5.1.2

Answer 211

A

B) Explanation
This type of distribution is subject to the 10% penalty for an IRA. However, the exemption from the premature distribution penalty does apply to qualified plan distributions.

LO 5.3.1

Answer 212

A

B) Explanation
An IRA may be rolled to another IRA, TSA, SEP, qualified plan, or governmental 457 plan that accounts for such rollovers separately. The reason a governmental 457 would need to account for an IRA rollover separately is that a 457 plan is not normally subject to the 10% EWP. However, a distribution of money from a 457 plan that came from an account that was subject to the 10% EWP would be subject to the EWP.

LO 5.2.1

Answer 213

A

A)
Explanation
Although Grant took the distribution after five taxable years from the date of initial contribution, he did not meet one of the other requirements for a qualified distribution (made after the individual attained age 59½, attributed to being disabled, made to a beneficiary or estate of an individual on or after the individual’s death, or used for a first-time home purchase). In this case, the first $34,000 is counted against his contributions. Thus, there is no tax or penalty on $34,000. There are no conversions, so the rest of the distribution is earnings and thus subject to income tax and the 10% early distribution rules.

LO 5.4.2

Answer 214

A

B) Explanation
The penalty for excess contributions to an IRA is 6%. The 10% penalty for distributions before age 59½ does not apply to withdrawals made for qualified higher education expenses or first-time home purchase ($10,000 lifetime max). The required beginning date for minimum distributions is April 1 of the following year following the year in which the account holder attains age 72, not December 31.

LO 5.3.1

Answer 215

A

B)Explanation
Only Statement IV is incorrect. A qualified distribution from a Roth IRA is a distribution after the five-year holding period has been met and the distribution satisfies one of the following four requirements: attainment of the age of 59½; death; disability; or first-time home purchase up to $10,000. College tuition is not a qualified special purpose distribution. However, it is an exception for the 10% early withdrawal penalty. Thus, with a Roth distribution for college costs, only the earnings would be subject to income tax after all contribution and conversion amounts were withdrawn.

LO 5.4.2

Answer 216

A

B) Explanation
The Roth IRA conversion is more appropriate when the income tax rate is the same or higher at the time of distribution than at the time of conversion.

LO 5.4.3

Answer 217

A

C) Explanation
A participant in a Section 457 plan is not considered an active participant for IRA tax deductibility purposes. Because Nicholas is not an active participant, he can make a fully deductible $6,000 contribution to a traditional IRA in 2021. If Nicholas were an active participant in a qualified plan, SEP, SARSEP, SIMPLE, or Section 403(b) plan, his deduction would be fully phased out at his MAGI level. However, his MAGI would still be low enough to allow contributions to a Roth IRA. Contributions to a Roth IRA begin to be phased out at $125,000 for unmarried individuals in 2021.

LO 5.1.2

Answer 218

A

A) Explanation
The client has already made a nondirect withdrawal (60-day rollover) this year; therefore, Statement I is incorrect, because he is not permitted to have another 60-day rollover during the same year. Statement II is a permitted alternative. Statement III is not permitted without the proceeds being included in taxable income.

LO 5.3.1

Answer 219

A

A) Explanation
In this case, the mandatory withholding requirement will not apply because the payment is made from an IRA, not an employer retirement plan. The distribution will be income tax free because it is less than her conversion contribution and she paid the tax at the time of conversion. However, she will be assessed a 10% early withdrawal penalty because the distribution is from a converted IRA, five years has not elapsed, and the withdrawal does not meet any of the exceptions to the early withdrawal penalty from an IRA.

LO 5.4.2

Answer 220

A

C) Explanation
The beneficiary can take a qualified distribution immediately. The five-taxable-year period is not restarted when the owner of a Roth IRA dies. Thus, the beneficiary of the Roth IRA would have to wait only until the end of the original five-taxable-year period for the distribution to be a qualified distribution. The five-year period was satisfied for this Roth IRA four years ago.

LO 5.4.2

Answer 221

A

C)Explanation
Only Statement I is correct. When a traditional IRA is converted to a Roth IRA, the converted amount is treated as a taxable distribution and is included in the owner’s gross income. The 10% penalty does not apply to the conversion amount when converted, regardless of the owner’s age. However, if the taxable portion of the converted amount is withdrawn within five years of the conversion, then the taxable portion of the conversion is treated as coming out first when the converted amount is withdrawn. This taxable amount would be subject to the early withdrawal rules and penalized 10% unless an exception applies. The point of this rule is to protect Roth conversions from being sham transactions intended to get around the 10% early withdrawal penalty.

The law treats withdrawals of converted amounts that are more than five years past the conversion date the same as contributions.

LO 5.4.2

Answer 222

A

C) Explanation
Active participation for purposes of determining deductibility of IRA contributions differs from being covered under a qualified plan. Specifically, an employee must be contributing to the plan, having employer contributions or forfeitures reallocated on his behalf, or accruing a defined benefit before he is considered an active participant in a qualified plan for IRA purposes. The participant in Statement I has begun to accrue a benefit in the pension plan. The participant in Statement II is considered an active participant because of the forfeiture relocation. The taxpayers in Statements III and IV are not considered active participants this year because no contributions were made on their behalf this year.

LO 5.1.1

Answer 223

A

B) Explanation
Statements I and II correctly describe prohibited transactions. Statement III is incorrect. Selling property to an IRA by a fiduciary or an individual owner of the IRA is a prohibited transaction. Statement IV is incorrect. The individual may have to pay the 10% additional tax on premature distributions.

LO 5.1.1

Answer 224

A

C) Explanation
Traditional IRAs cannot own S corporation stock, as an IRA is not a permissible shareholder under the S corporation rules. All of the other choices are permitted investments.

LO 5.1.1

Answer 225

A

D) Explanation
An individual is not denied a deduction for his IRA contribution simply because of the other spouse’s active participation, unless the couple’s combined AGI exceeds $208,000 (2021). Based on their AGI, Abby will be able to deduct a contribution of up to $6,000 to an IRA. Since their combined AGI is too high for Stewart to make a deductible IRA contribution, he should consider contributing to a Roth IRA.

LO 5.1.2

Answer 226

A

D) Explanation
Neither Scott nor Gayle is an active participant in an employer-sponsored retirement plan. Therefore, they can establish a traditional IRA for Scott and a spousal IRA for Gayle and contribute a deductible total of $12,000 ($6,000 each) to traditional IRAs for 2021.

LO 5.1.2

Answer 227

A

Explanation
Neither John nor Mary is an active participant in an employer-sponsored retirement plan, qualified retirement plan, SEP plan, SIMPLE, or Section 403(b) plan; therefore, they can contribute and deduct $12,000 ($6,000 each) to traditional IRAs for the current year (2021).

LO 5.1.2

Answer 228

A

D) Explanation
Each of these persons can make deductible contributions to an IRA for 2021.

LO 5.1.2

Answer 229

A

D) Explanation
The IRA rules allow an IRA deduction for individuals who are not active participants but whose spouses are, in some cases. However, that option is phased out if the couple’s AGI is between $198,000 and $208,000 in 2021. With a combined AGI of $201,000, George would be able to deduct $208,000 − $201,000 = $7,000; ($7,000 ÷ $10,000) × $6,000 = $4,200.

LO 5.1.2

Answer 230

A

A) Explanation
Only Statement II is correct. Required minimum distributions may not be rolled over. To decrease current taxation, Martha should execute a direct transfer to an inherited IRA. She, will, however, be required to begin required minimum distributions from the inherited IRA.

LO 5.2.1

Answer 231

A

D) Explanation
Statements I and II are correct. A nonspouse beneficiary (such as an adult child) may use a trustee-to-trustee transfer of the decedent’s balance from a qualified plan, Section 403(b) plan, governmental Section 457 plan, or IRA to her own inherited IRA. However, the nonspouse beneficiary must generally begin receiving the distributions from the deceased participant’s IRA immediately, whereas a surviving spouse beneficiary may continue to defer payouts until she attains age 72.

LO 5.2.1

Answer 232

A

B) Explanation
A stretch IRA is used to stretch the period of tax-deferred earnings on the IRA beyond the lifetime of the original owner. The goal is to delay the distribution of assets from the IRA for as long as possible.

LO 5.2.1

Answer 233

A

D) Explanation
If no beneficiary is named, the funds revert to the account owner’s estate and are distributed according to the will or the state’s intestacy laws. The spouse has the option of rolling over the IRA to the beneficiary-spouse’s own account, and a nonspouse beneficiary may use a direct trustee-to-trustee transfer of the IRA into an inherited IRA. A nonspouse named beneficiary is not required to distribute the entire IRA balance within five years.

LO 5.2.1

Answer 234

A

C) Explanation
Penalties are imposed upon distributions that commence before age 59½ or after April 1 following the year the account owner turns age 72.

LO 5.3.1

Answer 235

A

A) Explanation
IRA distributions are exempt from the early distribution penalty if made in payment of qualified higher education expenses. The other distributions are either exempt only if made from a qualified plan or not exempt, regardless of the source. The exception for a distribution paid as a series of substantially equal payments must extend over the greater of five years or age 59½.

LO 5.3.1

Answer 236

A

B) Explanation
For tax purposes, the account holder must be at least age 70-1/2 to make a qualified charitable distribution from an IRA. The other answer options are expressly exempt from the 10% early withdrawal penalty, regardless of the account holder’s age.

LO 5.3.1

Answer 237

A

Explanation
A distribution made after age 55 and separation from service with an employer is not a qualified IRA early distribution penalty exception.

LO 5.3.1

Answer 238

A

C) Explanation
All of these retirement accounts are subject to RMD requirements after the account owner/plan participant dies. However, RMD requirements do not apply to Roth IRAs while the owner is alive.

LO 5.4.1

Answer 239

A

B) Explanation
Roth IRAs offer no current deductions. Low-income wage earners needing current deductions are better served by traditional IRAs.

LO 5.4.1

Answer 240

A

A) Explanation
For 2021, the maximum combined contribution to traditional and Roth IRAs (for an owner younger than age 50) is $6,000 per person annually. Dotty has already contributed the maximum amount for her traditional IRA, but they can make a further contribution of $6,000 to a Roth IRA for Guy. The $2,000 Coverdell contribution is never relevant to any retirement account contribution. Their AGI is below the Roth IRA phaseout range for a married couple ($198,000–$208,000) in 2021.

LO 5.4.1

Answer 241

A

A) Explanation
Withdrawals of earnings from a Roth IRA are not penalized under these circumstances if the five-year holding period has been met.

LO 5.4.2

Answer 242

A

A) Explanation
Contributions to a Roth IRA are made with after-tax dollars. Distributions from a Roth IRA are income tax and penalty free if the owner has maintained the account for at least five years and the distribution is attributed to one of the following:

Death
Disability
First-time home purchase ($10,000 lifetime maximum)
Attainment of age 59½
LO 5.4.2

Answer 243

A

Explanation
The Roth IRA yields greater after-tax benefits than a traditional deductible IRA if the front-end tax due upon conversion is paid from funds outside the Roth IRA and an equivalent amount of funds is, thereby, available for investment.

LO 5.4.2

Answer 244

A

B) Explanation
Although the distribution is not a qualified distribution, it will not be taxable income because it is treated as a distribution from the Roth IRA regular contributions first. Because the $4,000 distribution is not includible in gross income, nor does it relate to a conversion within the last five years, the distribution is not subject to regular income tax or the 10% early withdrawal penalty.

LO 5.4.2

Answer 245

A

C) Explanation
A distribution from a Roth IRA is not subject to taxation if it is a qualified distribution or to the extent that it is a return of the owner’s contributions or conversions to the Roth IRA. A qualified distribution is one that meets both of the following tests:

The distribution was made after a five-year holding period.
The distribution was made for one of the following reasons:
Owner has attained age 59½
Distribution was made to a beneficiary or the estate of the owner on or after the date of the owner’s death
Distribution was attributable to the owner’s disability
Distribution was for a first-time homebuyer expense purchase
The 10% early withdrawal penalty only applies to a distribution from a Roth IRA that is includable in gross income. The 10% early withdrawal penalty also applies to a nonqualified distribution, even if it is not then includable in gross income, to the extent it is allocable to a conversion contribution made within the five-year period beginning with the first day of the individual’s taxable year in which the conversion contribution was made.

LO 5.4.2

Answer 246

A

C) Explanation
The conversion amounts were already included in Marian’s gross income when converted. Therefore, they will not be subject to income taxes again when withdrawn. The distribution allocable to the $10,000 conversion contribution made in 2019 (less than five taxable years ago) starts out as being subject to the early distribution penalty because it was withdrawn less than five years after the conversion. However, it is not subject to the 10% penalty tax under Section 72(t) in this case because Marian is over age 59½, which is one of the exceptions to the 10% penalty. The withdrawal of the conversion amount from the first conversion is not subject to the 10% early withdrawal penalty because the conversion is more than five years old. Thus, if the owner would have been younger than age 59½, the withdrawal of that money would not have been subject to the early withdrawal penalty.

LO 5.4.2

Answer 247

A

A) Explanation
When a traditional IRA is converted to a Roth IRA, the converted amount is treated as a taxable distribution to the extent the distribution does not represent a return of basis and is included in the owner’s gross income. A penalty does not apply for amounts converted from a traditional IRA to a Roth IRA, regardless of the owner’s age. However, the amount that was taxable at the conversion will be subject to the 10% early distribution penalty if it is withdrawn within five years of the conversion and the withdrawal does not qualify for an exception to the 10% early withdrawal penalty. This rule protects against people converting to a Roth and then taking a distribution as a way of escaping the 10% early withdrawal penalty.

LO 5.4.2

Answer 248

A

D) Explanation
There is no MAGI limit for a taxpayer in the year in which there is a conversion.

LO 5.4.2

Answer 249

A

D)Explanation
The clock started on January 1, 2016, so five years will have elapsed on January 1, 2021. A Roth IRA owner is required to hold the account for a minimum of five years to qualify for tax-free distributions. In addition, the owner must be at least age 59½, dead, disabled, or withdrawing up to $10,000 of Roth IRA earnings for qualified first-time homebuyer expenses.

LO 5.4.2

Answer 250

A

A) Explanation
The Roth IRA conversion is more appropriate when the income tax rate is the same or higher at the time of distribution than at the time of conversion.

LO 5.4.2

Answer 251

A

A) Explanation
Roth 401(k) accounts, just as with traditional 401(k) accounts, have RMD rules that apply, meaning that distributions must start in the year the participant reaches age 72 (unless they are still working). This can be avoided by rolling the Roth 401(k) over into a Roth IRA since there are no RMDs with Roth IRAs. There is a new clock that is started for a Roth 401(k) account, even if the participant already has a Roth IRA account. However, if a participant transfers the Roth 401(k) into a Roth IRA, then the Roth IRA clock will be the one that applies, not the Roth 401(k) clock.

LO 5.4.3

Answer 252

A

C) Explanation
$100,000 ÷ 25.6 = $3,906 (The first distribution year results in the same amount for each.)

LO 6.2.2

Answer 253

A

C) Explanation
Generally, an individual must receive his first minimum distribution by April 1 following the year the individual attains age 72. However, if the individual remains employed beyond age 72, he may defer minimum distributions until April 1 of the year following the year of retirement. This exception to the general rule only applies to the employer’s qualified plan (not IRAs). Therefore, the other choices are incorrect. Also, this exception is not available if the individual is a greater-than-5% owner of the company sponsoring the retirement plan.

LO 6.2.1

Answer 254

A

A) Explanation
Because they are married and their ages differ by more than 10 years, the joint life factor results in a longer life expectancy and smaller required distributions, so the joint life factor may be used. A joint distribution is calculated as follows: $360,000 ÷ 47.5 = $7,579.

LO 6.2.2

Answer 255

A

A) Explanation
The IRS requires the owner to take minimum distributions from a traditional IRA no later than April 1 of the year following the owner’s attaining age 72. If the amount distributed is less than the required minimum, a 50% excise tax is assessed on the amount of the shortage. The minimum distribution is determined by dividing the IRA account balance (or aggregate account balances) on December 31 of the prior year by the owner’s remaining life expectancy (or joint life expectancy of the owner and beneficiary) shown in the table. The required distribution may be taken from one IRA, but the calculation must be based on the totals in all IRAs.

LO 6.2.1

Answer 256

A

B). Explanation
SEPs and profit-sharing plans do not have to provide for preretirement or post-retirement joint and survivor annuities because they are not pension plans. In this case, a “pension plan” is a category, not a single type of plan. Pension plans require mandatory annual funding each and every year. The other category besides pension plans is called “profit-sharing plans.” In this usage, a profit-sharing plan is a plan that does not require mandatory annual contributions. You can remember the pension plans as the “Be my cashtarget plans”: “B” for benefit in defined benefit plans, “M” for money purchase plans, “Cash” for cash balance plans, and “Target” for target benefit plans. This mnemonic device not only separates the pension plans and profit-sharing plans, but it can be extremely helpful in selecting retirement plans for a business. For example, if a firm cannot commit to mandatory annual funding, then the “Be my cash target plans” are eliminated.

Profit-sharing plans pay nonforfeitable balances to surviving spouses as an alternative provision to preretirement and postretirement joint and survivor annuities. Qualified pension plans must provide QJSA and QPSA benefits.

LO 6.4.2

Answer 257

A

A) Explanation
Statement I is incorrect. Cindy will be required to pay income taxes on the distribution to the extent the distribution would have ordinarily been taxable. Statement II is correct. An early distribution from the plan that Cindy receives pursuant to the QDRO is exempt from the 10% early distribution penalty. Statement III is incorrect. Cindy becomes an alternate payee of the plan under the QDRO. Statement IV is correct. The QDRO may specify when Cindy may receive the plan benefit.

LO 6.5.1

Answer 258

A

C) Explanation
When an account owner dies prior to his required beginning date (RBD), a surviving spouse is not required to commence distributions in the year following the death of the owner. A spouse beneficiary may elect to treat the IRA as his own and defer distributions until attainment of age 72.

LO 6.4.1

Answer 259

A

A) Explanation
Non-owner participants in qualified plans, Section 403(b) plans, and governmental Section 457 plans may defer the required beginning date until April 1 following the year of retirement, if the participant continues to work after attaining age 72. However, if the employee-participant is a greater than 5% owner of the business sponsoring the retirement plan, the RMD may not be deferred, but must be taken by April 1 of the year after the employee attains age 72.

LO 6.2.1

Answer 260

A

D) Explanation
Susan, as the surviving spouse, can receive distributions over her remaining life expectancy. A spouse beneficiary can recalculate life expectancy each year, but distributions must begin no later than the year in which Sam would have reached age 72. Susan would also have the option of treating the IRA as her own and deferring distributions until she attains age 72. This means moving the money to an IRA in her own name as opposed to an inherited IRA. An inherited IRA has the deceased’s name in the title. For example, “Sam B Jones (deceased July 28, 2009) FBO Sally G Jones.”

LO 6.4.1

Answer 261

A

A) Explanation
Generally, loans from qualified plans must be repaid within 5 years, unless the loan is used to acquire a primary residence.

LO 6.3.2

Answer 262

A

B) Explanation
A distribution made after age 55 and separation from service with an employer is only a qualified retirement plan early distribution penalty exception.

LO 6.3.1

Answer 263

A

C) Explanation
Options I and II are correct. A surviving spouse who is named as the beneficiary may roll over the IRA to another IRA and retitle this account in his or her own name (option I). If the IRA owner dies before the required beginning date and if no designated beneficiary is named, the entire account must be distributed by the end of the fifth year following the year of the owner’s date of death (option II, the five-year rule). If the beneficiary is a spouse, that person can either begin taking distributions immediately or defer them until the end of the year in which the deceased would have been age 72, so option III is incorrect. Option IV is incorrect because a nonspouse beneficiary must use the Single Life Table (Table 1) for determining the first required minimum distribution; life expectancy is then reduced by one for each subsequent year.

LO 6.4.1

Answer 264

A

B) Explanation
Of these choices, a qualified plan distribution is exempt from the 10% premature distribution penalty if it is made as part of substantially equal periodic payments. The exception for qualified higher-education expenses applies only to IRA distributions. The separation from service exception only applies if the qualified plan participant is at least age 55 at the time of distribution. Hardship withdrawals are subject to the 10% early distribution rules. That is part of the hardship. It is also why a withdrawal from an IRA is better than a hardship withdrawal from an employer-provided retirement account to pay eligible college costs. The IRA withdrawal for qualified college expenses is not subject to the 10% early withdrawal penalty (EWP).

LO 6.1.1

Answer 265

A

C) Explanation
The stock has a basis to the trust of $95,000, and the basis is taxed as ordinary income in the year of the lump-sum distribution, which now becomes her basis in the stock. The NUA will be taxed at the long-term capital gains rate when the stock is subsequently sold. If Carrie keeps the stock until age 66 as planned, the subsequent growth after the lump-sum distribution will also be taxed as long-term capital gain. The holding period for any subsequent growth after the lump-sum distribution begins on the date of distribution.

LO 6.1.2

Answer 266

A

B) Explanation
The 10% premature distribution penalty does not apply to distributions on account of death or annuitized payments based on an individual’s remaining life expectancy. Substantially equal periodic payments can be thought of as the person doing their own annuity arrangement. Options I and II are incorrect. The law does not recognize a heavy and immediate financial need as an exception to the penalty. The age 55 exception does not apply to in-service distributions; i.e., the employee must have separated from the service of the employer on or after attaining age 55. That means the person must be 55 on December 31 of the year of separation. For example, Joe was laid off on March 27th. He turned 55 on December 25 of that year. He would qualify as having separated from service in the year he turned 55 and thus he would avoid the 10% penalty for withdrawals from his qualified plan or 403(b), but not from his IRA.

LO 6.3.1

Answer 267

A

A) Explanation
The amount is $10,287 ($456,743 ÷ 44.4 = $10,287). The factors in the RMD Single Life Table must be used to determine her life expectancy at age 38. According to the RMD Single Life Table, a person age 38 has a life expectancy factor of 44.4. Trudy is 38 in the year following the year of death when her distributions must begin. Some key elements in this question are that the owner died after his RBD and that he had already taken his RMD for the year of death.

LO 6.4.1

Answer 268

A

B) Explanation
All of these statements are correct. Note: SEP plans may only use the excess method (and not the offset method) of integration. Rollovers are limited to one per 12-month period.

LO 4.2.2

Answer 269

A

D) Explanation
The 20% mandatory withholding requirement does not apply to distributions from traditional IRAs, SIMPLE IRAs, or SEP IRAs.

LO 6.1.1

Answer 270

A

B) Explanation
Statement I is correct. Generally, loans are limited to half the vested account balance and cannot exceed $50,000. Note: When account balances are less than $20,000, however, loans up to $10,000 are available. Statement II is correct. The limit on the term of any loan is generally five years, unless the loan is for a principal residence. Loans for the purpose of buying a residence must be repaid over a reasonable period of time. Statement III is incorrect. A qualified plan loan may not be rolled over to an IRA. Any outstanding loan balance is treated as a distribution and thus is subject to income taxes and the early withdrawal penalty rules. However, he would have until the due date of his tax return for the year the loan defaulted (including extensions) to get as much of the loan back into his IRA or a qualified plan as he could. This would lower his income tax bill and reduce his 10% EWP. It would also help his eventual retirement situation. Statement IV is correct. Participant loans from qualified plans to sole proprietors, partners, shareholders in S corporations and C corporations are permitted.

LO 6.3.2

Answer 271

A

D) Explanation
For a preretirement distribution to escape the 10% penalty for early distribution, the distribution must be made after a separation from service for early retirement after age 55. This exception is not applicable to IRAs.

LO 6.3.1

Answer 272

A

A) Explanation
Statement I is incorrect because IRA distributions do not require 20% mandatory federal income tax withholding. Statement III is incorrect because a rollover is permitted from a qualified plan to a governmental Section 457 plan. Statement IV is incorrect because loans are not permitted from an IRA. If a person separates from service with an unpaid retirement plan loan balance, the person is allowed to move some or all of the unpaid balance into an IRA or another employer plan as a plan loan offset up to the due date of the tax return for the year the unpaid retirement plan loan was defaulted, as described in Module 3.

LO 6.1.1

Answer 273

A

B) Explanation
The answer is a 20% withholding tax applies in the event of the employee-participant’s physical possession of the amount rolled over. In a regular rollover, the recipient physically receives a check, made payable to the recipient, for the eligible rollover distribution from the plan trustee. Under this method of distribution, the issuer must withhold 20% of the proceeds for federal income tax. A rollover does not count against the annual contribution limit.

LO 6.1.1

Answer 274

A

D) Explanation
While Blake may not roll over the RMD distributions, if he has earned income, he may make contributions to a traditional or Roth IRA.

LO 6.1.1

Answer 275

A

A)

Explanation
The answer is II only. Statement I is incorrect. SIMPLE 401(k) plans are qualified plans and are subject to mandatory 20% income tax withholding for a distribution that is not a direct trustee-to-trustee transfer. When there is a direct transfer of a distribution from a qualified plan to an IRA, the mandatory 20% withholding rule does not apply.

LO 6.1.1

Answer 276

A

C) Explanation
The adjusted basis of the stock to the qualified plan trust is taxed as ordinary income to the participant in the year of the distribution.

LO 6.1.2

Answer 277

A

C) Because the distribution is a lump-sum distribution of employer stock, the net unrealized appreciation (NUA) rules apply. Under the NUA rules, the adjusted basis of the stock to the trust ($70,000) is included in Martin’s gross income in the year of the distribution and is treated as ordinary income.

LO 6.1.2

Answer 278

A

C) Explanation
The Uniform Lifetime Table must be used to calculate required minimum distributions (RMDs) under a qualified plan or IRA unless the designated beneficiary is the participant’s spouse and the spouse is more than 10 years younger than the participant.

LO 6.2.2

Answer 279

A

B) Explanation
Both statements are correct. IRA-funded employer-sponsored tax-advantaged plans are SEPs, SAR-SEPs, and SIMPLE IRAs.

LO 6.1.2

Answer 280

A

B) Explanation
A spouse beneficiary can roll the distribution over into an IRA and treat it as the spouse’s own; a nonspouse beneficiary can use a direct trustee-to-trustee transfer of the distribution into a specially titled inherited IRA.

LO 6.4.1

Answer 281

A

C) Explanation
Participants in qualified plans, Section 403(b) plans, and governmental Section 457 plans may defer the required beginning date until April 1 following the year of retirement, if the participant continues to work after attaining age 72. If the employee-participant owns more than 5% of the business sponsoring the retirement plan, the RMD may not be deferred but must be taken by April 1 of the year after the employee attains age 72.

LO 6.2.1

Answer 282

A

D) Explanation
The trustee should use the plan balance for December 31 of the year preceding the distribution year—in this case, December 31, 2020.

LO 6.2.2

Answer 283

A

C) Explanation
Generally, the first required minimum distribution (RMD) from a qualified plan must be taken by April 1 of the year following the year in which the participant reaches age 72, so she must complete her trigger year distribution by April 1, 2022. Even though all or part of the first RMD distribution could be taken in 2022, it is still the 2021 RMD (until April 2, 2022). Also, the 2021 RMD will be based on the account balance at the end of 2020.

LO 6.2.2

Answer 284

A

D) Explanation
The postponed 1st-year RMD is based on the participant’s plan or IRA account balance as of the end of the year preceding the first distribution year. Her first distribution year is 2021 because she turned 72 in 2021. The RMD for each year is based on the balance at the end of the previous year. Because the first distribution year is 2021, the balance for the 2021 RMD calculation is the account balance at the end of 2020. The second RMD, which will be for the year 2022, is based on the account balance at the end of 2021. This is the year in question.

LO 6.2.2

Answer 285

A

C)Explanation
Elaine’s required minimum distribution this year is $14,545, calculated as follows: $320,000 ÷ 22.0 = $14,545. She must calculate her required distribution using the Uniform Lifetime Table and not her actual life expectancy (nor by using the difference between projected and actual life expectancy as the applicable divisor). This is actually advantageous for the owner because the original owner’s RMD is usually based on the owner’s age and the age of someone 10 years younger than the owner. This is true even if the account owner is not married. The only time the assumed life expectancy in a RMD calculation for the original account owner is different than this is when the original owner is actually married to someone who is more than 10 years younger. In that case, the RMD is based on the actual ages of the married couple according to Table II.

LO 6.2.2

Answer 286

A

C) Explanation
The exception from the 10% early distribution penalty for distributions for higher-education costs only applies to IRA distributions.

LO 6.3.1

Answer 287

A

C) Explanation
Statement I is incorrect. Because David is over age 59½, he will not be subject to the early withdrawal penalty. Statement II is correct. If David does not begin taking minimum distributions by the required beginning date (typically April 1 following the year in which the participant attains age 72), he will be subject to the 50% minimum distribution penalty. Statement III is correct. If David contributes more than the permitted amount to an IRA, he will be subject to a 6% penalty on the excess contribution. Statement IV is incorrect. There is no penalty for excess withdrawals.

LO 6.3.1

Answer 288

A

B) Explanation
All of these statements are correct.

LO 6.3.1

Answer 289

A

D) Explanation
A distribution by a qualified retirement plan to an alternate payee who is a spouse or former spouse of the participant is taxable to the spouse, if it is made pursuant to a QDRO. The distribution to Barbara pursuant to a QDRO is not subject to the 10% penalty for early distribution. Barbara may roll over the distribution to an IRA.

LO 6.3.1

Answer 290

A

A) Explanation
A SEP plan is a type of IRA. A participant is not permitted to borrow from a SEP plan.

LO 6.3.2

Answer 291

A

D) Explanation
The 20% mandatory withholding requirement does not apply to distributions from traditional IRAs, SIMPLE IRAs, or SEP IRAs.

LO 6.1.1

Answer 292

A

C) Explanation
The NUA portion of the distribution is taxed at the capital gains rate when the stock is sold. The adjusted basis of the stock to the qualified plan trust is taxed as ordinary income to the participant in the year of the distribution.

LO 6.1.2

Answer 293

A

D) Explanation
Generally, the limit on loans from qualified plans is 50% of the vested account balance, up to a maximum loan of $50,000. The maximum loan must be reduced by any loan balance the participant had in the 1-year period preceding the loan. Geraldine’s maximum allowable loan is $49,000.

LO 6.3.2

Answer 294

A

C) Explanation
All of these statements are correct.

LO 6.4.1

Answer 295

A

D) Explanation
These are both potential disadvantages of naming one’s estate as beneficiary. The estate cannot be treated as a designated beneficiary for purposes of determining required minimum distributions, and the estate will begin paying income tax at the maximum rate at a much lower level than an individual beneficiary would.

LO 6.4.1

Answer 296

A

C) Explanation
For the trust beneficiaries to be treated as designated beneficiaries, the beneficiaries must be identifiable from the trust instrument.

LO 6.4.1

Answer 297

A

D) Explanation
The beneficiaries of the trust must be named (identified) in the trust instrument. Only the trust needs to be named as a beneficiary on the account.

LO 6.4.1

Answer 298

A

D) Explanation
The QJSA amount payable to the surviving spouse may not be less than 50% (nor greater than 100%) of the amount of the annuity payable during the life of the participant. The QJSA may be waived with written notarized consent of the participant’s spouse. A Section 401(k) plan may be subject to QJSA requirements unless certain requirements are met.

LO 6.4.2

Answer 299

A

D) Explanation
QPSA payments are not required to equal the benefit that would have been payable to the participant at retirement but must be the actuarial equivalent of not less than half of the participant’s vested account balance as of the date of the participant’s death.

LO 6.4.2

Answer 300

A

C) Explanation
Sara may rollover the distribution to her own qualified plan, Section 403(b) plan, Section 457 plan, or IRA.

LO 6.5.1

Answer 301

A

A) Explanation
All of these statements are correct.

LO 6.5.1

Answer 302

A

D) Explanation
The PIA is calculated from the AIME. The PIA is used for multiple Social Security benefits, not just the worker’s Social Security retirement benefit. The PIA is not reduced when someone takes early retirement. The retirement benefit is reduced. This is important for spousal and other Social Security benefits. Social Security is weighted so that the lower the income the higher the replacement ratio.

LO 7.2.1

Answer 303

A

C) Explanation
His income during the year before his attainment of FRA is irrelevant because he had no Social Security income. There is no reduction for earnings after attaining FRA.

LO 7.2.1

Answer 304

A

C) Explanation
The farmer is in a covered occupation and is over age 65. Thus, he or she would receive benefits if fully insured. The 55-year-old and 62-year-old individuals are in covered occupations, but they must be age 65 to be eligible for Medicare benefits. The trust fund recipient is age 65, but he or she is not in a covered occupation for Social Security purposes.

LO 7.2.1

Answer 305

A

B) Explanation
All persons, age 65 or older, who are eligible for Social Security cash benefits, qualify for Medicare.

LO 7.2.1

Answer 306

A

A) Explanation
Early retirees born in 1954 will have their retirement benefits reduced throughout the remainder of their lives.

LO 7.2.1

Answer 307

A

D) Explanation
The first thing to do is to determine Lisa’s FRA. She is four years younger than Gary, so she was born in 1964. FRA for someone born in 1960 or later is 67. She is entitled to 50% of Gary’s full benefit amount as her full spousal benefit at her FRA. By filing early, Lisa will receive a reduced benefit. If she files at age 63, she will be 4 years early. This is 48 months early. The reduction for the first 36 months is 25/36 of 1%, which equates to a 25% reduction. The remaining 12 months are reduced by 5/12 of 1% per month. This is an additional 5% (12 × 5/12% = 5%). Thus, the total reduction will be 30% for starting at age 63 (4 years early). So, her reduction will be 30% of Lisa’s spousal benefit of $1,000. $1,000 × 0.30 = $300. Thus her final spousal benefit for starting at 63 will be $700 ($1,000 ‒ $300).

LO 7.2.2

Answer 308

A

B) Explanation
She worked for four years, so she has 16 credits. To be fully insured at age 29 she needs 7 credits. This is one credit per year after she turned 21 (29 ‒ 22 = 7). Also, the minimum is 6 and the maximum is 40. Thus, she has plenty of credits to be fully insured. To be currently insured, she would need 6 of the last 13 credits. She only has 4 of the last 13 credits, so she is not currently insured. Not being currently insured would not hurt her as long as she is fully insured. The currently insured status is similar to life insurance in that it will only pay off if the person dies. It was added to Social Security to help the survivors of workers who have not yet earned enough credits to be fully insured.

LO 7.2.1

Answer 309

A

D) Explanation
Unearned income will never lower the amount of any Social Security benefit because Social Security is not means-tested. However, anything that increases adjusted gross income (AGI) can push provisional income to the point that a larger percentage of Social Security benefits will be taxable. On the other hand, once 85% of Social Security is taxable income, that process is completed. Thus, unearned income may have a bearing on the taxation of their Social Security benefits. COLAs are indexed annually.

LO 7.2.1

Answer 310

A

A) Explanation
People who are receiving Social Security disability become eligible for Medicare two years after they are entitled to Social Security disability. Most other people become eligible for Medicare at age 65.

LO 7.2.1

Answer 311

A

C) Explanation
Only Statement III is incorrect. Approximately 75% of state and local government employees are covered under the Social Security system.

LO 7.1.1

Answer 312

A

A) Explanation
COLA stands for cost-of-living adjustment. RMD stands for required minimum distribution. PIA stands for primary insurance amount. FRA stands for full retirement age.

LO 7.1.1

Answer 313

A

D) Explanation
Social Security disability-related benefits are only available if you have paid into the system (20 credits, at four per year maximum, over the last 10 years at Bill’s age). Medicare eligibility for people age 65 and older requires payment into the system for at least 10 years. Bill does not qualify for either set of benefits.

LO 7.2.2

Answer 314

A

C) Explanation
Because his earned income is below the $18,960 (2021) earnings cap for singles, he will not be impacted by the earned income benefit reduction.

LO 7.2.1

Answer 315

A

A) Explanation
Compensation for work received in the year you obtain FRA will be reduced $1 for every $3 earned above the earnings cap until the first of the month in which you will obtain your FRA.

LO 7.2.2

Answer 316

A

A) Explanation
The spouse, at his full retirement age (age 65 to age 67), will receive 50% of the worker’s PIA unless the spouse’s Social Security benefit is higher based on his own earnings.

LO 7.2.2

Answer 317

A

A) Explanation
There is a dollar-for-dollar reduction on up to two-thirds of the Social Security spousal benefit pension amount if their spouse is receiving a government pension.

LO 7.2.2

Answer 318

A

B) Explanation
The client’s earnings (earned income) are below the allowable limit for the current year ($18,960 for 2021). Remember that according to the work penalty rule, only earned income is counted toward the allowable limit.

LO 7.2.1

Answer 319

A

B) Explanation
The deductible employer share of payroll taxes for the self-employed is 7.65% (6.2% OASDI + 1.45% Medicare). This percentage is taken after a certain deduction is taken to calculate the net self-employment income. The point is that the employer’s share of Social Security taxation is 7.65% up to the taxable wage base.

LO 7.1.1

Answer 320

A

C) Explanation
Because Stanley’s modified adjusted gross income (MAGI) of $72,500 (AGI of $60,000 + 50% of his Social Security income [$12,500]) exceeds the second threshold amount for a single taxpayer by an amount greater than his Social Security benefit, up to 85% of his Social Security benefits will be taxable.

LO 7.2.2

Answer 321

A

B) Explanation
If provisional income exceeds the stated threshold, a maximum of 85% of the excess amount is taxable as ordinary income.

LO 7.2.1

Answer 322

A

C) Explanation
To qualify for most benefits under Social Security, an individual must be in fully insured status. This is defined as one credit per year since age 21 with a minimum of 6 and a maximum of 40 credits of covered employment, where an individual has earned above a specified dollar amount.

LO 7.2.1

Answer 323

A

B) Explanation
An individual who is only currently insured under Social Security (6 credits of coverage in preceding 13-quarter period) is entitled to a surviving child’s benefit. This is the case provided the child is under age 18, over age 18 and disabled by a disability that began before age 22, or under age 19 and a full-time elementary or secondary school student who is not married and was dependent on the deceased parent.

LO 7.1.1

Answer 324

A

D) Explanation
Disability, for the purpose of Social Security, means an individual is so severely physically or mentally disabled that the person cannot engage in any substantial, gainful activity, which must be expected to last at least 12 months or result in death.

LO 7.2.1

Answer 325

A

B) Explanation
For 2021, a worker receives 1 credit for each $1,470 in annual earnings on which Social Security taxes are withheld up to a maximum of 4 credits annually. All 4 credits may be earned in the same calendar quarter.

LO 7.2.1

Answer 326

A

D) Explanation
The PIA is used to determine a participant’s actual Social Security retirement benefit. The PIA is derived from the worker’s average indexed monthly earnings (AIME), which is based on lifetime earnings history.

LO 7.2.1

Answer 327

A

B) Explanation
Railroad workers covered under the federal Railroad Retirement Act are not covered by Social Security but are covered by Medicare if they meet those rules separately.

LO 7.1.1

Answer 328

A

B) Explanation
Employers must pay a combined Social Security (OASDI) and Medicare rate of 7.65%. Employers pay 6.2% for Social Security and 1.45% for Medicare. The Social Security portion is payable up to the Social Security wage base of $142,800 for 2021. The Medicare portion is paid without an income limit.

LO 7.1.1

Answer 329

A

C) Explanation
To qualify for Social Security disability benefits, a person must suffer an impairment that is expected to Medicare tax is assessed on an unlimited amount of compensation.

Answer 330

A

A) Explanation
The Social Security taxable wage base (TWB) in 2021 is $142,800.

LO 7.1.1

Answer 331

A

B) Explanation
This is the case regardless of your age or if you are still employed.

LO 7.2.2

Answer 332

A

C) Explanation
Dawn is too old under the rules, Maggie does not have a child under age 16 for whom she is caring, and Betty is not eligible because she is not age 62 or older. Only Bill is eligible to receive a dependent or surviving child’s benefit.

LO 7.2.1

Answer 333

A

A) Explanation
To qualify for the child’s benefit, the child must be under age 18, or a full-time student at an elementary or secondary school if under age 19. A child may also qualify if the child became disabled before reaching age 22. Joe qualifies for the father’s benefit, but that benefit is reduced by $1 for each $2 of earned income in excess of the limit for persons under full retirement age (FRA). Joe’s income would reduce the benefit to zero. At John’s age, he would only qualify for a benefit if he were disabled.

LO 7.2.1

Answer 334

A

C) Explanation
Delaying receipt of benefits will allow you to earn delayed retirement credits, and your future cost-of-living adjustments will be higher because they will be based on a higher base. Also, the increased base will ultimately be used to determine survivor benefits.

LO 7.2.1

Answer 335

A

D) Explanation
Provisional income = $47,500. This is over the $44,000 threshold, so 85% of their Social Security benefit will be subject to taxation.

LO 7.2.2

Answer 336

A

C) Explanation
The $600 spousal benefit stops, and Ralph will begin receiving 100% of Mary’s old-age Social Security benefit. This survivor benefit is not reduced because Ralph has reached his full retirement age (FRA) when his wife died.

LO 7.2.1

Answer 337

A

A) Explanation
Currently, the spouse of a Social Security recipient is entitled to 50% of the recipient’s primary insurance amount (PIA), subject to a family maximum, as long as the spouse is of full retirement age (FRA) or between age 62 and FRA for reduced benefits. The spouse will take the greater of either 100% of their own benefit or 50% of their spouse’s benefit.

LO 7.2.1

Answer 338

A

C) Explanation
Replacement rates, or the amount of one’s paycheck that is replaced by Social Security retirement benefits, favor lower-income earners by replacing about 90% of their (very low) earnings. Higher earners will see only a 26% replacement.

LO 7.2.1

Answer 339

A

C) Explanation
Survivor benefits are provided to a spouse caring for a child under 16 or disabled. Age 16 is not “sweet 16” for the surviving spouse because when the youngest child turns 16, the survivor benefits ceased for the widow(er) caring for the deceased’s child.

LO 7.2.1

Answer 340

A

B) Explanation
A worker who starts Social Security retirement benefits early (as early as age 62 is allowed) will receive a reduced benefit, which will continue for life. This reduced benefit will be adjusted for inflation each year.

LO 7.2.1

Answer 341

A

C) Explanation
$9,000 divided by the extra amount ($600) equals 15 years to equal the same benefit taking the larger amount the next year. ($9,000 ÷ $600 = 15 years)

LO 7.2.1

Answer 342

A

A) Explanation
The maximum family benefit limitation does not apply when both the husband and wife receive a retirement benefit based on their own (or each) employment record. It does apply to reduce total Social Security benefits payable in the other situations.

LO 7.2.1

Answer 343

A

A) Explanation
If someone has provisional income in excess of $32,000 for unmarried taxpayers and $44,000 for married taxpayers, up to 85% of Social Security benefits may be subject to income taxation. These numbers are not indexed. Also, the threshold is $0 for people who file their return as married filing separately (MFS) if they are not living apart.

LO 7.2.2

Answer 344

A

D) Explanation
A child under the age of 18 who is employed in the parent’s unincorporated business is not covered by Social Security.

LO 7.1.1

Answer 345

A

C) Explanation
Amy, Jeff, and Brad will receive benefits. Amy became disabled before age 22 and will receive a benefit, as will Jeff, who is now her caregiver. Brad will receive a benefit because he is an unmarried child under age 19 and still in high school. Because Lisa is not a dependent, she is not eligible for a benefit.

LO 7.2.1

Answer 346

A

B) Explanation
The FRA for individuals born in 1960 and later is 67.

LO 7.2.1

Answer 347

A

A) Explanation
Maryellen has not reached full retirement age, so she is subject to the retirement earnings test. Her Social Security benefits will be reduced by $1 for every $2 in earnings over the applicable limit.

LO 7.2.1

Answer 348

A

A) Explanation
The worker must be fully insured to qualify for retirement benefits based on her own work history. Reduced spousal retirement benefits are available as early as age 62. Reduced survivor benefits are available as early as age 60 unless the surviving spouse is disabled, then reduced survivor benefits are available as early as age 50.

LO 7.2.1

Answer 349

A

B) Explanation
Only Statement II is incorrect. Benefits paid to a former spouse of a covered worker are not considered in the application of the family maximum benefit limit.

LO 7.2.1

Answer 350

A

A) Explanation
The WEP does not apply simply if a worker is eligible for retirement benefits from multiple employers. It may apply to a worker who qualifies for a Social Security retirement or disability benefit but who also earns a pension from an employer who does not withhold Social Security taxes. An example of such an employer could be a state or local government agency that had opted out of the Social Security retirement system; a public school employee is some states; or an employer in a foreign country. Under this provision, the formula used to calculate a worker’s PIA is reduced, resulting in a lower benefit. Social Security benefits are designed to pay a higher percentage of career average earnings for lower-paid workers than are paid to higher earning workers. Statement III is incorrect because the WEP does not apply to spousal or survivors benefits under Social Security. The Government Pension Offset would apply to Social Security spousal or survivor benefits when the non-Social Security worker is the spouse or the survivor of a fully covered retired or deceased worker.

LO 7.2.2

Answer 351

A

B) Explanation
Each of these persons is eligible for survivor’s benefits.

LO 7.2.2

Answer 352

A

A) Explanation
Because the desired retirement age is so soon, the amount of retirement assets available may be insufficient to allow for retirement at age 62. Therefore, all of the alternatives should be considered.

LO 8.3.1

Answer 353

A

B)Explanation
Options II and III are correct. The investment of 40% of the plan’s assets in company stock violates the requirements for money purchase plan investments. A qualified retirement plan that invests in a limited partnership is considered to be engaged in the partnership’s business as if it were a general partner; hence, the UBTI rules apply.

Option I is incorrect because the short-term certificates of deposit do not pose an interest rate risk and therefore can be used to satisfy the plan’s liquidity requirements (like former employees rolling their accounts out of the plan). Option IV is incorrect because disproportionately large investments have been made in particular asset categories, such as employer securities, that do not minimize risk.

LO 8.2.1

Answer 354

A

A) Explanation
Defined benefit plans use the 100 times test for determining whether they comply with the incidental benefit rules. Under this test, the death benefit cannot exceed 100 times the participant’s projected monthly benefit (in this instance, $100,000).

LO 8.2.2

Answer 355

A

C) Explanation
SIMPLE IRA plans are available to employers with 100 or fewer employees and with no other qualified retirement plan. The employer contribution requirement may be satisfied by either a 3% matching contribution formula or a 2% nonelective contribution for each employee with current-year compensation of $5,000 or more.

LO 8.1.1

Answer 356

A

B)Explanation
Paul will need to make 10 level annual payments of $134,331.53 at the end of each year.

Step 1: What will it take to produce $75,000 of purchasing power in 10 years?

$75,000 PV 3, I

10, N

FV Answer: $100,793.7285

Step 2: How much do they need at retirement to pay a serial payment of $100,793.7285 at the beginning of each year for 20 years?

$100,793.7285, PMT 20, N

[(1.05 ÷ 1.03) – 1] × 100, I (This number is 1.9417)

0, FV

Shift Mar (To get into the Begin Mode) PV Answer is $1,689.607.5595

Step 3: How much needs to be saved as a level payment at the end of each year until retirement so the account will have

$1,689,607.5595?

$1,689,607.5595, FV 10, N

5, I O, PV

Shift, MAR (To change to the End Mode) PMT Answer $134,331.53

LO 8.3.2

Answer 357

A

A) Explanation
Money purchase pension plans (and other pension plans) allow only 10% contributions in employer securities. All of the other plans are types of profit-sharing plans and may invest 100% in securities.

LO 8.1.1

Answer 358

A

A) Explanation
The annual level end of year deposit required is $38,159, calculated as follows: In END mode

FV = $1,157,140

n = 16

i = 8

PMT = −38,158.8576

LO 8.3.2

Answer 359

A

A)
Explanation
An ESOP may not be integrated with Social Security.

LO 8.1.2

Answer 360

A

B) Explanation
A fully insured 412(e)(3) pension plan is funded exclusively by cash value life insurance or annuity contracts. Using insurance as a funding vehicle ensures the payment of a death benefit to plan beneficiaries.

LO 8.2.1

Answer 361

A

A).Explanation
A profit-sharing plan would accomplish all of Barry’s objectives and is appropriate for a business with unstable cash flow. Defined benefit pension plans and money purchase pension plans require annual mandatory funding, making them inappropriate for businesses with unstable cash flows.

LO 8.1.2

Answer 362

A

A) Explanation
The answer is the number of dependents a client will have at retirement. There are three primary assumptions that are made in any retirement needs analysis calculation. They are

the anticipated annual rate of inflation;
the projected rate of annual investment return; and
the client’s age at retirement and anticipated life expectancy.
LO 8.3.1

Answer 363

A

A) Explanation
First, the retirement income deficit is $30,000 (PV) in today’s dollars. This is determined by reducing their gross income need of $42,000 by the anticipated Social Security benefit, $12,000. This net figure is inflated at 4% (I) over the 14 years (N) until retirement (age 48 to age 62). Thus, the income deficit in the first year of retirement (FV) is $51,950.

To determine the $1,168,060 lump sum needed: 51,950 PMT, 35 N, 2.8846 I (using a 7% after-tax rate of return and a 4% inflation rate). Note that a retirement period of 35 years is used, which differs from the mortality tables referenced in the question text. Very small differences in these numbers come from how many decimal places are used. For example, calculating the inflation-adjusted interest rate and then pressing I/YR, actually enters the calculated interest rate to nine decimals even though the calculator only shows 4. Thus, if you write down 2.8846 and then enter that number for I/YR a very small difference will be calculated for the PV. This difference will not be enough to change an answer on the test.

The other choices are incorrect for the following reasons:

$1,017,211 is wrong because a retirement period of 28 years (27.8 years rounded up) was used. Note how the lump sum needed is reduced by assuming a shorter period of retirement.
$1,135,310 is wrong because the result was arrived at by calculating the present value of an ordinary annuity (End mode), not an annuity due (Begin mode).
$1,635,275 is wrong because the calculation was performed using a gross number of $42,000, not $30,000.
LO 8.3.2

Answer 364

A

A) Explanation
A profit-sharing plan would accomplish all of Barry’s objectives and is appropriate for a business with unstable cash flow. Defined benefit pension plans and money purchase pension plans require annual mandatory funding, making them inappropriate for businesses with unstable cash flows.

LO 8.1.2

Answer 365

A

A) Explanation
The answer is the number of dependents a client will have at retirement. There are three primary assumptions that are made in any retirement needs analysis calculation. They are

the anticipated annual rate of inflation;
the projected rate of annual investment return; and
the client’s age at retirement and anticipated life expectancy.
LO 8.3.1

Answer 366

A

A) Explanation
First, the retirement income deficit is $30,000 (PV) in today’s dollars. This is determined by reducing their gross income need of $42,000 by the anticipated Social Security benefit, $12,000. This net figure is inflated at 4% (I) over the 14 years (N) until retirement (age 48 to age 62). Thus, the income deficit in the first year of retirement (FV) is $51,950.

To determine the $1,168,060 lump sum needed: 51,950 PMT, 35 N, 2.8846 I (using a 7% after-tax rate of return and a 4% inflation rate). Note that a retirement period of 35 years is used, which differs from the mortality tables referenced in the question text. Very small differences in these numbers come from how many decimal places are used. For example, calculating the inflation-adjusted interest rate and then pressing I/YR, actually enters the calculated interest rate to nine decimals even though the calculator only shows 4. Thus, if you write down 2.8846 and then enter that number for I/YR a very small difference will be calculated for the PV. This difference will not be enough to change an answer on the test.

The other choices are incorrect for the following reasons:

$1,017,211 is wrong because a retirement period of 28 years (27.8 years rounded up) was used. Note how the lump sum needed is reduced by assuming a shorter period of retirement.
$1,135,310 is wrong because the result was arrived at by calculating the present value of an ordinary annuity (End mode), not an annuity due (Begin mode).
$1,635,275 is wrong because the calculation was performed using a gross number of $42,000, not $30,000.
LO 8.3.2

Answer 367

A

A) Explanation
A traditional profit-sharing plan would not allow the plan contributions to be skewed for the benefit of the older owner. All of the other plan choices listed would allow greater contributions for the older owner.

LO 8.1.2

Answer 368

A

B) Explanation
All defined benefit plans require mandatory annual funding. A defined benefit plan would not be appropriate for a businessowner who is uncomfortable with mandatory annual funding.

LO 8.1.2

Answer 369

A

B) Explanation
The answer is both I and II.

LO 8.3.1

Answer 370

A

D) Explanation
Carol’s total retirement fund needed to support her desired standard of living is $907,144, calculated as follows:

Carol’s first year retirement income need is $54,028.

PV = –$30,000

i = 4

n = 15

FV = $54,028

The total capital required to support this need for 20 years is $907,144.

In BEGIN mode (the client will make annual withdrawals at the beginning of each year)

PMT = $54,028

n = 20

i = 1.9231 [(1.06 ÷ 1.04) – 1] × 100

PVAD = –$907,144

LO 8.3.2

Answer 371

A

D) Explanation
A flat annual rate of return has the disadvantage of not taking into consideration the annual volatility of returns.

LO 8.3.1

Answer 372

A

B) Explanation
The business needs to be more profitable and established. Also the other choices either require mandatory annual funding (money purchase plan and cash balance plan) or stock (stock bonus plan). The business is not established enough to commit to mandatory annual funding and there is no stock with a sole proprietorship.

LO 8.1.1

Answer 373

A

A) Explanation
A qualified plan participant must include the pure protection cost of the life insurance as income, but this amount is treated as nontaxable basis once the participant begins receiving distributions from the plan.

LO 8.2.2

Answer 374

A

B) Explanation
IRAs and annuities are individual savings plan alternatives a client can implement to meet his retirement income goals. NQDC plans are employer-sponsored alternatives.

LO 8.3.1

Answer 375

A

C) Explanation
A businessowner (or a person planning for his own retirement) should accomplish all of these objectives before considering the adoption of a retirement plan.

LO 8.1.1

Answer 376

A

C) Explanation
A Section 457 plan can be adopted only by private, tax-exempt organizations and state and local government entities. Section 403(b) plans may be adopted by Section 501(c)(3) nonprofit organizations, and ESOPs and stock bonus plans may be adopted by corporations.

LO 8.1.1

Answer 377

A

A) Explanation
All of the factors listed should be considered in selecting a retirement plan for the business.

LO 8.1.1

Answer 378

A

A) Explanation
Employee elective deferrals are permitted in Section 401(k) plans, profit-sharing plans with a Section 401(k) provisions, and SIMPLEs, but not in SEP plans.

LO 8.1.1

Answer 379

A

C) Explanation
A defined benefit pension plan is not subject to the annual additions limit. Each of the other plans listed is a defined contribution plan which is subject to the annual additions limit.

LO 8.1.1

Answer 380

A

B) Explanation
Of the listed plans, only a traditional defined benefit pension plan is available to Bernie and Tim’s business. A Section 403(b) plan may only be adopted by a Section 501(c)(3) organization. An eligible Section 457 plan may only be adopted by a private, tax-exempt organization or a state or local governmental organization. A partnership cannot use a stock bonus plan because this form of business does not issue stock. Notice how subtlety the form of business was introduced in the question. The form of business is very important in selecting a retirement plan.

LO 8.1.2

Answer 381

A

D) Explanation
Only Statement III is incorrect. A qualified pension plan is subject to nondiscrimination rules and the client would not be able to cover only select participants.

LO 8.1.2

Answer 382

A

D) Explanation
Selecting a plan means selecting the best plan for the owner (i.e., the owner gets the desired or needed amount at the minimum cost for the other employees). Any retirement plan installed by the company would have to be affordable, considering the need for large cash outlays to update company equipment. The safe harbor 401(k) plan is the best choice since it not only fits within the contribution requirements with flexibility, but also meets the objective of minimizing cost. By increasing his compensation and using the increase as his deferral, Brad will get a disproportionate share of the contribution, and because of his much higher compensation, the nonelective contribution will be skewed in his favor. Thus, he can meet his personal contribution requirement while paying significantly less for the other participants.

A 401(k) safe harbor plan will allow Brad to defer $19,500 in 2021. The required matching contribution is dollar-for-dollar of the first 3% of deferral and $.50 on the dollar for the next 2%. Brad needs only 17% of his current compensation, so we would choose the safe harbor 401(k), and not a defined benefit plan, since we can achieve the desired savings with a contribution that is less than 25%. (This calculation is not required, but knowledge of the safe harbor plan is.)

LO 8.1.2

Answer 383

A

D) Explanation
A target benefit pension plan is likely most appropriate. It would permit Joe to favor older participants and allow for a vesting schedule. A cash balance pension plan does not favor older participants and provides employees with a guaranteed rate of return on investments (thus, not transferring the risk of investment performance to the employees). SEP plans and SIMPLE 401(k) plans both provide for 100% immediate vesting of employer contributions.

LO 8.1.2

Answer 384

A

D) Explanation
Traditional defined benefit pension plans do not permit employee contributions through elective deferrals. Section 403(b) plans are for 501(c)(3) tax-exempt organizations, and there is no indication that this is a tax-exempt organization. SIMPLE plans permit employee contributions through elective deferrals, matching, and immediate vesting.

LO 8.1.2

Answer 385

A

C) Explanation
Employees bear the investment risk in defined contribution plans, and employers bear the investment risk in defined benefit plans. Cash balance pension plans are defined benefit plans; all the other answer choices are defined contribution plans.

LO 8.2.1

Answer 386

A

B) Explanation
Money market instruments provide the low risk, safety, and liquidity Sharon is seeking for her IRA. Corporate bonds and stocks do not provide safety of principal.

LO 8.2.1

Answer 387

A

C) Explanation
Unrelated business taxable income (UBTI) is gross income generated by a qualified plan trust that is not related to the function that is the basis for the trust’s income tax exemption. In addition, the trust is generally prohibited from incurring debt. Therefore, dividends declared on common stock purchased on margin are treated as UBTI.

LO 8.2.1

Answer 388

A

D) Explanation
In determining the suitability of an asset class in a retirement plan portfolio, mutual funds provide diversification and provide a comparable historical rate of return to that of equities (of course, depending on the investment objective and composition of the particular fund).

LO 8.2.1

Answer 389

A

A) Explanation
A major factor to be considered in the asset allocation process of qualified plans is the type of plan (defined contribution or defined benefit) and who bears the investment risk (the employee or employer). Very broadly, a more conservative allocation is appropriate for a defined benefit plan than in the defined contribution approach.

LO 8.2.1

Answer 390

A

B) Explanation
The primary investment vehicles for Section 403(b) plans are annuities or mutual funds held in a custodial account, although funds can also be used to purchase life insurance. Section 403(b) accounts can be invested in annuities or mutual funds held in a custodial account. Funds also can be used to purchase life insurance. Neither stocks nor bonds can be used as an investment for a Section 403(b) plan.

LO 8.2.1

Answer 391

A

B) Explanation
The beneficiary receives the pure insurance element of the death benefit income tax free.

LO 8.2.2

Answer 392

A

C) Explanation
Life insurance cannot be held in any type of IRA, including SEPs. Qualified retirement plans and Section 403(b) plans can purchase life insurance if they comply with the incidental benefit rules.

LO 8.2.1

Answer 393

A

C) Explanation
The tax-exempt nature of qualified retirement plans must be considered in determining if a specific type of investment is appropriate. Municipal bonds are tax-free investments. Because a qualified plan is already tax exempt, there would be no reason to utilize them in plan assets.

LO 8.2.2

Answer 394

A

D) Explanation
Defined benefit pension plans use the 100 times test for determining whether they comply with the incidental benefit rules. Under this test, the death benefit cannot exceed 100 times the participant’s projected monthly benefit.

LO 8.2.2

Answer 395

A

B) Explanation
For defined contribution plans, no more than 25% of the employer contributions (not plan assets) can be used to purchase universal life or term insurance. No more than 50% of the employer contributions in a defined contribution plan can be used to purchase whole life insurance.

LO 8.2.2

Answer 396

A

B) Explanation
Before retirement, the planner may use a before-tax rate of return in the assumptions, particularly if tax-advantaged savings vehicles (such as a traditional or Roth IRA) are used in the planning process. However, at the time of either optional or required retirement plan distributions, the client’s anticipated effective income tax rate is very important. This rate should be a blend of the client’s federal and state marginal income tax rates but should be projected based only on current rates because precisely predicting future income tax rates is not feasible.

LO 8.3.1

Answer 397

A

B) Explanation
Most planners use a flat annual rate of return based on past performance. The Black-Scholes model is a stock option valuation model. The Consumer Price Index (CPI) measures inflation.

LO 8.3.1

Answer 398

A

B) Explanation
The retirement needs analysis should be recalculated any time there is a change in the client’s life such as marriage, divorce, births, deaths, employment and income, or health. Temporary changes in tax laws will not impact the retirement needs over the long term.

LO 8.3.1

Answer 399

A

C) Explanation
Using a before-tax rate of return to project investment performance is appropriate for tax-advantaged assets, such as qualified plans and IRAs, because the earnings on these assets are not taxed each year as they accumulate.

LO 8.3.1

Answer 400

A

D) Explanation
This is a future value calculation.

PV = –$350,000

i = 5 (after-tax rate of return)

n = 15 (years to retirement)

FV = $727,625

LO 8.3.2

Answer 401

A

A) Explanation
His total retirement fund needed to support his standard of living is $1,689,612, calculated as follows:

The client’s first-year retirement income need is $100,794.

PV = –$75,000

i = 3

n = 10

FV = $100,794

The total capital required to support this need for 20 years is $1,689,612. In BEGIN mode (the client will make annual withdrawals at the beginning of each year)

PMT = $100,794

n = 20

i = 1.9417 [(1.05 ÷ 1.03) – 1] × 100

PVAD = –$1,689,612

LO 8.3.2

Answer 402

A

A) Explanation
Under the serial payment approach, the first-year savings amount is computed and then increased each year by the inflation rate. In this example, the amount in the second year is $10,000 × 1.04, or $10,400.

LO 8.3.2

Answer 403

A

C) Explanation
Carol will need to make 15 level annual payments of $38,973.65 at the end of each year.

Here is how to work this problem using the regular TVM keystrokes.

What will it take to have $30,000 of today’s purchasing power in 15 years?

$30,000, +/-, PV

4, I

15, N

0, PMT

FV Answer: $54,028.3052

How much needs to be in the account at retirement to fund 20 years of serial payments at the first of each year?

+/-, +/-, PMT (Hitting the +/- button twice before PMT allows the entire FV of 54,028.3052 to be entered as the PMT quickly and to nine decimal places, The second +/- makes the value positive again)

Shift, MAR (To get into the Begin Mode)

0, FV

[(1.06 ÷ 1.04) -1] × 100 = 1.9231, I

20, N

PV Answer: -$907,149.5440

How much needs to be saved at the end of each year to have $907,149.5440?

+/-, $907,149.5440, FV (Hitting the +/- here allows the calculator to take the answer and turns the number positive)

15, N

6, I

0, PV

Shift MAR (To be in the End Mode.)

PMT Answer: $38,973.65

LO 8.3.2

Answer 404

A

B) Explanation
Paul will need to make a serial payment of $118,578.00.

Here is how to calculate this type of problem using the regular TVM keystrokes:

What will it take in ten years to have $75,000 of today’s purchasing power?

75,000, +/-, PV

3, I

10, N

FV Answer: $100,793.7285

What does Paul need to have in his account when he retires to produce a serial payment of $100,793.7285 at the beginning of the year for 20 years?

+/-, +/-, PMT (This enters $100,793.7285 into the PMT as a positive value. The first +/- allows the calculator to accept the number. The second +/- makes it a positive number.)

Shift, MAR (To get into the Begin mode.)

20, N

0, FV

[(1.05 ÷ 1.03) – 1] × 100 = 1.9417, I

PV Answer: $1,689,607.5595

What is $1,689,607.5595 in 10 years with inflation taken out of it? This step is critical because it prepares for the serial payment from today to retirement by removing the inflation from the dollar goal in 10 years. Serial payments account for inflation by adjusting the interest rate. Without expressing the FV in today’s dollars, inflation will be double counted for the investment period.

+/- $1,689,607.5595, FV (Only one +/- is needed here because the first +/- allows the calculator to accept the value and the PV was negative so after one +/- the new value will for FV will be positive.)

10, N

0, PMT

3, I

PV Answer: -$1,257,226.7036

What is the first serial payment required at the end of the first year to have $1,257,226.7036 in 10 years?

+/-, FV (This enters the result from aboe and changes the sing to positive $1,257,226.7036

Shift, MAR (To get in the End mode.)

[(1.05 ÷ 1.03) – 1] × 100 = 1.9417, I

0, PV

10, N

PMT Answer: $115,124.2738

This answer is in today’s dollars, but the first payment will be made in a year, so…

$115,124.27 × 1.03 = $118,578

LO 8.3.2

Answer 405

A

C) Explanation
SEP contributions for self-employed owners require two adjustments. First, her net self-employment income after deducting half of her self-employment income must be calculated. $50,000 − ($7,065 ÷ 2) = $46,467.50. Second, the contributions rate must be adjusted by dividing the rate by 1 + the contribution rate. The maximum rate for a SEP is 25%. Thus the adjusted contribution rate is 20% (.25 ÷ 1.25). Now the adjusted contribution rate is multiplied times the adjusted self-employment income. In this case, .20 × $46,467.50 = $9,293.50. This is rounded up to $9,294.

Answer 406

A

B) Explanation
Retirement account loans are generally 50% of the vested balance minus the highest loan amount in the previous 12 months. In this case there is no previous loan amount in the last 12 months, so they have access to $43,500 ($87,000 ÷ 2).

LO 9.1.1

Answer 407

A

B) Explanation
Kaitlyn’s Roth IRA will cause the least disruption to their current cash flow. The two employer retirement accounts will be subject to both income taxes and the 10% early withdrawal penalty. Neither IRA will be subject to the 10% penalty because qualified higher education expenses are an exception to the penalty. Thus, the answer would have to be one of the IRAs. There is no indication that the traditional IRA has ever received nondeductible contributions. Thus, all withdrawals from the traditional IRA will be taxable income. Withdrawals from the Roth IRA will first be accounted for as coming from contributions and then conversions. These withdrawals will not be subject to income tax. Thus, withdrawing the money from the Roth IRA will present a lower income tax bill. In fact, since she has contributed $35,000 to her Roth IRA over the years, there would be no income tax bill if she withdrew the $23,000 needed for the final college year. Pulling money from the Roth IRA might not be the best decision long-term, but it is the best option of the given choices to meet the client’s current goal.

LO 9.1.1

Answer 408

A

C) Explanation
Their MAGI of $120,000 is inside the phaseout range for active participants who are married filing jointly. Dillon is an active participant at work. Thus, he may only deduct $1,500 in 2021. [($125,000 − $120,000) ÷ $20,000] × $6,000 = $1,500. Kaitlyn is self-employed with no retirement plan and their MAGI is well below the $198,000 start of the phaseout range for those married filing jointly who are not active participants. Thus, she can deduct up to $6,000 of IRA contributions. That brings their total deductible IRA contributions to $7,500 for 2021.

LO 9.1.1

Answer 409

A

C) Explanation
An estate cannot be a designated beneficiary. Thus, each of their IRAs would have to take the entire balance by the end of the fifth year following the year of death. 2021 is the year of death. 2022 is the first year following the year of death. That makes 2026 the fifth year following the year of death.

LO 9.1.1

Answer 410

A

C) Explanation
The first step is to estimate their actual withdrawal for their first year of retirement. Their goal is $100,000 in today’s dollars, but Social Security is assumed to provide $46,000 in today’s dollars for their 30-year retirement. Thus, they need to fund $54,000/year in today’s dollars. With inflation averaging 3% for 19 years, this will take $94,689.33 to produce $54,000 of today’s purchasing power. The second step is determining how much principal would be required at retirement to produce a serial payment starting at $94,689.33 and lasting for 30 years assuming a 6% investment return and 3% inflation. The answer is $1,931,764. This is calculated using the following factors: 30 for N, 0 for the FV, 2.9126 for the inflation adjusted interest rate and $94,689.33 has the initial payment in the Begin Mode. $1,877,092 is the result in the End Mode. Small differences in these final numbers are the result of using differences in rounding. These numbers were computed using the full values produced at each step. The HP-10bII used nine decimal places when it calculates a number (even if fewer decimal places are shown). For example, the inflation-adjusted interest rate calculated using the formula shows 2.9126%. However, by pressing Shift, =, 9, you will see the actual interest rate used is 2.9126211359. On a test, these small differences will not change the answers.

LO 9.1.1

Answer 411

A

B) Explanation
$16,164. The FV is $1,100,000. N is 19 years. The inflation adjusted interest rate shows 4.8544% but if you use the formula and immediately press I/YR, it will enter 4.854368932. The PV is -$255,000. Pressing PMT in the end mode will give you $15,694. However, the payment will not be made for a year. Thus, you must multiply times 1.03 to account for the first year of inflation.

LO 9.1.1

Answer 412

A

C) Explanation
The maximum elective deferral into a 401(k) for someone under age 50 is $19,500 in 2021.

LO 9.1.1

Answer 413

A

C) Explanation
Although Roth IRAs have an additional reason for qualified distributions (up to $10,000 of first-time homebuyer expenses), a distribution from either type of Roth account after five years and over age 59½ would be a qualified distribution. No type of Roth contribution is deductible. Roth IRAs are not subject to RMDs while the original owner is alive, but employer Roth accounts for retirees are subject to the normal RMD rules. Roth IRAs are phased out for higher earners, but not for employer Roth accounts.

LO 9.1.1

Answer 414

A

C) Explanation
$1,907. Social Security retirement benefits for workers are reduced five-ninths of 1% for the first 36 months and five-twelfths of 1% for any months in excess of 36 months. Dillon would be starting 24 months early, so 5/9 x .01 x 24 = 13.333% reduction. Thus, he would be receiving 86.667% of $2,200.

LO 9.1.1

Answer 415

A

C) Explanation
The answer is rulings including prohibited transaction exemptions (PTEs). The Department of Labor issues advisory opinions and rulings (including prohibited transaction exemptions) similar to private-letter rulings, which are issued by the IRS. The DOL does not issue guaranty insurance. The summary plan description is required by the DOL, but the DOL does not approve plan documents. The IRS approves plan documents.

LO 1.1.1

Answer 416

A

B) Explanation
The answer is I only. Money purchase pension plans, profit-sharing plans, and target benefit pension plans do not require PBGC insurance because they are forms of defined contribution plans. Only defined benefit pension plans (traditional defined benefit plans and cash balance plans) require the payment of PBGC insurance premiums.

LO 1.1.1

Answer 417

A

A) Explanation
The answer is II only. ERISA does not guarantee plan benefits; the Pension Benefit Guaranty Corporation (PBGC) guarantees benefits in defined benefit pension plans. A qualified plan is a tax-efficient way to save for retirement. Qualified plans may be established for firms with as few as one employee. Qualified plans also benefit non-highly compensated employees.

LO 1.2.1

Answer 418

A

B) Explanation
The answer is I, II, and IV. A Section 403(b) plan is a tax-advantaged plan but not an ERISA-qualified retirement plan. While tax-advantaged plans are very similar to qualified plans, there are some minor differences. For example, a tax-advantaged plan is not allowed to have net unrealized appreciation (NUA) treatment. They are also not allowed to offer 10-year forward averaging or special pre-1974 capital gains treatment. Tax-advantaged plans also have less restrictive nondiscrimination rules. Otherwise they are very similar to qualified plans.

LO 1.2.1

Answer 419

A

A) Explanation
The answer is II and III. The two minimum coverage tests for qualified retirement plans are the average benefits percentage test and the ratio test. In order to be qualified, a retirement plan must meet at least one of these tests if the plan does not meet the percentage (safe harbor) test.

LO 1.3.1

Answer 420

A

C) Explanation
The answer is 40. Under the 50/40 test, a defined benefit plan must cover the lesser of 50 employees or 40% of all eligible employees. In this case, the lesser of 50 employees or 40% of all eligible employees (100) is 40 employees. One way to remember the 50/40 test is the phrase “people before percentages” (50 people or 40%). Also, note that there are no qualifiers to the types of people. It is not 50 non-highly compensated people. It is just 50 employees who work for Roderick Manufacturing.

LO 1.3.1

Answer 421

A

B) Explanation
The answer is II only. Statement I should list the third coverage test as the average benefit percentage test, not the average contribution percentage test.

LO 1.3.1

Answer 422

A

B) Explanation
The answer is III and IV. Defined benefit pension plan contributions decrease because of the events described in statements III and IV. Statements I and II are incorrect. Inflation would likely cause salaries and plan expenses to increase, thereby causing contributions to increase. Likewise, benefits that are adjusted for the cost of living would result in greater employer contributions, not less.

LO 1.3.2

Answer 423

A

A) Explanation
The answer is I and III. Statement I is incorrect because the excess method may only be used by a defined contribution plan. A defined benefit pension plan may use either the excess method or the offset method for Social Security integration. Statement III is incorrect because not all retirement plans may be integrated with Social Security.

LO 1.3.3

Answer 424

A

A) Explanation
The answer is I, II, III, and IV. All these plans may be integrated with Social Security. Employee stock ownership plans (ESOPs), savings incentive match plan for employees (SIMPLEs), and salary reduction SEPs (SARSEPs) are not permitted to use integration. Also, employee elective deferrals and employer matching contributions cannot be integrated.

LO 1.3.3

Answer 425

A

D) Explanation
The answer is II, III, and IV. Statement I is incorrect. The sale, exchange, lending, or leasing of any property between the plan’s assets and a party in interest is a prohibited transaction. A plan participant can take a retirement plan loan based on the participant’s balance, but the plan cannot make a loan of the general plan assets to a party in interest.

LO 1.4.1

Answer 426

A

C) Explanation
The answer is investment risk is borne by the employer in a defined benefit pension plan, whereas the employee bears the risk in a defined contribution plan. A defined benefit pension plan has a benefit limit, whereas a defined contribution plan has a contribution limit. Investment risk is borne by the employer in a defined benefit pension plan, whereas the employee bears the risk in a defined contribution plan.

Accounts are commingled in a defined benefit pension plan, and a defined contribution plan maintains separate accounts for each participant. A guaranteed retirement benefit is the goal of a defined benefit pension plan, while a guaranteed contribution is the focus of a defined contribution plan.

LO 2.1.1

Answer 427

A

D) Explanation
The answer is cash value life insurance or annuity contracts. A fully insured 412(e)(3) pension plan is funded exclusively by cash value life insurance or annuity contracts. Using insurance as a funding vehicle ensures the payment of a death benefit to plan beneficiaries.

LO 2.2.2

Answer 428

A

B) Explanation
The answer is the company has flexibility as to annual funding. Pension plans can invest up to 10% only of plan assets in employer stock. Profit-sharing plans have no restrictions regarding investment in employer stock. The employer may deduct a contribution limited to only 25% of participating employees’ covered compensation. The employer must make substantial and recurring employer contributions, or the IRS will remove the plan’s qualified status. The employee bears investment risk.

LO 3.3.1

Answer 429

A

D) Explanation
The answer is I, II, and IV. Statement III is incorrect. Section 412(e)(3) plans must only meet minimum funding standards if there is a loan outstanding against the insurance policy funding the plan.

LO 2.2.2

Answer 430

A

B) Explanation
The answer is I, II, and III. Forfeitures count against the remaining participants’ annual additions limits.

LO 2.3.1

Answer 431

A

B) Explanation
The answer is both I and II. Both of these statements are correct for money purchase pension plans.

LO 2.3.1

Answer 432

A

B) Explanation
The answer is IV only. Benefits depend on such plan’s account balances, and the final benefit amount is not guaranteed. Target benefit pension plans are funded by the employer, not through employee elective deferrals. Forfeitures in such plans are likely to be unequal as a result of unequal compensation.

LO 2.3.2

Answer 433

A

B) Explanation
The answer is an employee census showing young owners and young rank-and-file employees. A good candidate for a target benefit pension plan is a business that has an employee census showing older owners who are around 50 or older and younger rank-and-file employees. The other choices are additional characteristics that describe good candidates for target benefit pension plans.

LO 2.3.2

Answer 434

A

B) Explanation
The answer is IV only. Statements I, II, and III are incorrect. Profits are not required to be able to make a contribution to a profit-sharing plan. A current contribution may be made from retained earnings or current cash flow. Annual contributions are not required in a profit-sharing plan. Profit-sharing plans are suitable for companies with unstable earnings given that they have discretion over contributions.

LO 3.1.1

Answer 435

A

D) Explanation
The answer is I, II, III, and IV. All of these are considered profit-sharing plans. They don’t require fixed annual employer contributions and are not affected by the minimum funding standard requirements.

LO 3.1.1

Answer 436

A

D) Explanation
The answer is allocations to participants are made in proportion to the participant’s age-adjusted compensation. A participant’s compensation is age-adjusted by multiplying the participant’s actual compensation by a discount factor based on the participant’s age and the interest rate elected by the plan sponsor. As a result, older employees generally receive the greatest allocation under an age-based profit-sharing plan. Nondiscrimination rules are tested in accordance with benefits rather than contributions. The final retirement benefit is not guaranteed in any type of profit-sharing plan.

LO 3.2.1

Answer 437

A

D) Explanation
The answer is $30,000. A new comparability plan will only satisfy the nondiscrimination rules if the plan design satisfies one of either of these:

Each eligible non-highly compensated employee (HCE) must receive an allocation of at least 5% of compensation.
If the plan provides for an allocation rate of less than 5%, the minimum allocation rate for the non-HCEs is one-third of the highest allocation rate under the plan.
John can contribute a maximum $30,000 (20%) of his salary to the plan while limiting his other employees to as little as 5% of salary. In this example, the total compensation of the eligible employees is $226,000. A 5% contribution for this group totals $11,300, leaving $30,000 of the total $41,300 for John’s benefit.

LO 3.2.1

Answer 438

A

A) Explanation
The answer is I, II, III, and IV. All these statements regarding ESOPs are correct.

LO 3.2.2

Answer 439

A

C) Explanation
The answer is the lesser of 100% of compensation, or $58,000. Total annual contributions to a participant’s account are limited to the lesser of 100% of employee compensation, or $58,000 (2021) with only the first $290,000 (2021) of employee compensation considered in the contribution formula. The total contribution is made up of the worker contribution, the employer contribution and reallocated forfeitures. The worker contribution alone is limited to $19,500 in 2021 for those 49 and younger.

LO 3.3.1

Answer 440

A

D) Explanation
The answer is 6%. The maximum ADP for HCEs at the Ross Company is 6%. To satisfy the ADP test, a traditional 401(k) plan must meet one of the following two tests.

The ADP for eligible HCEs must not be more than the ADP of all other eligible employees multiplied by 1.25. In this case, the non-HCEs averaged 4%. (4% × 1.25 = 5%)

The ADP for eligible HCEs must not exceed the ADP for other eligible employees by more than 2% (4% + 2% = 6%), and the ADP for eligible HCEs must not be more than the ADP of all other eligible employees multiplied by 2 (4% × 2 = 8%). This second test is a lesser-than test. The lesser number is 6%. Thus, 6% is the second test answer.

Thus, the two test answers are 5% and 6%. The plan only must pass one of these tests, and the HCEs want to know how much they can contribute, so the higher number always wins. That is 6% in this case.

LO 3.3.2

Answer 441

A

C) Explanation
The answer is I, II, III, and IV. All statements are true.

LO 3.3.2

Answer 442

A

C) Explanation
The answer is 100 employees who earned at least $5,000 last year. An employer with 100 or fewer employees who earned $5,000 or more during the preceding year may adopt a SIMPLE 401(k).

LO 3.3.3

Answer 443

A

B) Explanation
The answer is employees cannot make after-tax contributions to the plan. Employee after-tax contributions are not allowed. All the other statements are incorrect:

Unlike SIMPLE IRAs, employers that sponsor SIMPLE 401(k)s cannot reduce the matching percentage to below 3%. Employer contributions to a SIMPLE 401(k) are 100% vested.

The 25% penalty applies only to SIMPLE IRAs.

LO 3.3.3

Answer 444

A

A) Explanation
The answer is there is a 25% penalty for early distributions from a participant’s account within two years of entry into the plan. Only early distributions from a SIMPLE IRA within the first two years of initial participation in the plan are subject to the 25% early withdrawal penalty tax.

LO 3.3.3

Answer 445

A

D) Explanation
The answer is I, II, and III. All IRA and qualified plan distributions are eligible for rollover treatment except distributions made to satisfy the minimum distribution rules and distributions made as part of a series of substantially equal periodic payments. Required minimum distributions are not eligible for rollover treatment. The law states a nontaxable portion of a qualified plan distribution must be made using a trustee-to-trustee transfer because that is the only reliable way to provide documentation that this money was actually nontaxable.

LO 6.1.1

Answer 446

A

D) Explanation
The answer is I only. Statement II is incorrect because participants must be fully and immediately vested in the contributions to SEPs and SIMPLEs. Qualified plans can include vesting schedules.

LO 4.2.2

Answer 447

A

C) Explanation
The answer is II and IV. Employees are 100% vested in their elective deferrals. Employers with fewer than 100 employees who earned $5,000 during any two preceding years and are reasonably expected to earn at least $5,000 during the current year must be allowed to participate. SIMPLE IRAs are not subject to the nondiscrimination rules generally applicable to qualified plans (including top-heavy rules). The employee is 100% vested in both his elective deferrals as well as any employer contributions.

LO 4.2.1

Answer 448

A

A) Explanation
The answer is the maximum contribution possible on behalf of an individual participant is $58,000 (2021). Both SEP plans and qualified plans can be funded as late as the due date of the return plus extensions. The maximum contribution possible on behalf of an individual participant is $58,000 (2021). Qualified plans are protected under ERISA and federal bankruptcy law. SEPs share this protection. Both types of plans have the same nondiscriminatory and top-heavy rules.

LO 4.2.2

Answer 449

A

D) Explanation
The answer is I, II, and III. Only statement IV is incorrect. A SEP plan is a retirement plan that uses an IRA as the receptacle for employer/employee contributions. The SEP plan is often a good choice for very small companies because of its low cost and ease of administration. All employer contributions to a SEP plan are discretionary.

LO 4.2.2

Answer 450

A

D) Explanation
The answer I and II. A Section 403(b) or TSA plan is subject to the annual additions limit of the lesser of 100% of compensation or $58,000 for 2021. Contributions must not discriminate in favor of highly compensated employees. Employer contributions are based on a maximum annual covered compensation of $230,000 and are not subject to FICA and FUTA payroll taxes (employee deferrals are subject to FICA and FUTA).

LO 4.3.1

Answer 451

A

D) Explanation
The answer is I and II. Section 403(b)/TSA plan investments are limited to mutual funds and annuities. Although the ADP test does not apply, Section 403(b)/TSA plans must comply with the ACP test for matching contributions. One way to remember that Section 403(b) plans must pass ACP testing and not ADP testing is that Section 403(b) plans are for 501(c)(3) organizations. The (c) in 501(c)(3) is like the “C” in ACP testing. Nondiscrimination testing causes Section 403(b)/TSA plans to be relatively costly and complex to administer. Account balances at retirement age may not be sufficient to provide adequate retirement amounts for employees who entered the plan at later ages.

LO 4.3.1

Answer 452

A

B) Explanation
The answer is II and IV. Statement I is incorrect. Deductibility of plan contributions is not a factor for employers choosing a Section 457 plan because these employers are tax-exempt. Statement II is correct. Earnings on assets in a Section 457 plan grow tax-deferred until withdrawn. Statement III is incorrect. Required minimum distribution rules apply. Statement IV is correct. A Section 457 plan is a nonqualified deferred compensation plan.

LO 4.3.2

Answer 453

A

A) Explanation
The answer is tax deductibility of employer contributions. Because Section 457 plans are sponsored by tax-exempt entities, deductibility of plan contributions is not an issue and would not be a reason to establish such a plan. A Section 457 plan is not a qualified plan and has no early withdrawal penalty on distributions.

LO 4.3.2

Answer 454

A

A) Explanation
The answer is $13,500. The maximum allowable elective deferral for 2021 is $19,500. If Sally contributes $6,000 to ABC’s plan, then she can only contribute up to $13,500 to XYZ’s plan ($19,500 − $6,000 = $13,500).

LO 4.4.1

Answer 455

A

C) Explanation
The answer is $7,000. Jack is not currently an active participant in a qualified plan, is age 50 or older, and has earned income in 2021. Jack may make a deductible IRA contribution of $7,000 (6,000 + $1,000 catch-up) for 2021.

LO 5.1.1

Answer 456

A

C) Explanation
The answer is both I and II. A traditional IRA is also suitable when a taxpayer wishes to accumulate assets for retirement or defer taxes on investment income.

LO 5.1.1

Answer 457

A

A) Explanation
The answer is $12,000. Because neither Thad nor Debra participates in an employer-sponsored retirement plan, they can contribute and deduct $6,000 each for 2021. While Debra has no earned income, a spousal IRA may be established and funded based on Thad’s compensation.

LO 5.1.2

Answer 458

A

C)

Explanation
The answer is II only. A person who participates in a qualified plan, SEP IRA, or Section 403(b) plan may not be able to make tax-deductible IRA contributions if the participant’s MAGI exceeds certain limits. Participation in a Section 457 plan does not subject a person to these limitations.

LO 5.1.2

Answer 459

A

A) Explanation
The answer is both I and II. A stretch IRA extends or stretches the period of tax-deferred earnings within an IRA beyond the lifetime of the original owner, possibly over a decade.

LO 5.2.1

Answer 460

A

Explanation
The answer is I and II. Statement III is incorrect. As a non-spouse beneficiary, Jack is required to receive distributions over a ten-year period, beginning with the year of the death of the previous owner.

LO 5.2.1

Answer 461

A

D) Explanation
The answer is III is only. The correct formula is:

nontaxable portion = [(nondeductible contributions prior to current year + all contributions for current year) ÷ (balances at end of current year + distributions received in current year)] × total distributions during current year

LO 5.3.1

Answer 462

A

B)Explanation
The answer is I and III. A distribution made after the owner is age 55 and after separation from service is only an exception for distributions from qualified plans, not from IRAs.

LO 5.3.1

Answer 463

A

B) Explanation
The answer is neither I nor II. The original owner of a Roth IRA is never subject to an RMD requirement during his lifetime and can continue making contributions after he reaches age 72.

Answer 464

A

A)Explanation
The answer is the IRA owner’s modified adjusted gross income (MAGI) cannot exceed $100,000 in the year of the conversion. There is no MAGI limit for a taxpayer in the year in which there is a conversion.

LO 5.4.2

Answer 465

A

C)Explanation
The answer is I only. When a traditional IRA is converted to a Roth IRA, the converted amount is treated as a taxable distribution and is included in the owner’s gross income. The 10% penalty does not apply to the conversion amount when converted, regardless of the owner’s age. However, if the taxable portion of the converted amount is withdrawn within five years of the conversion, then the taxable portion of the conversion is treated as coming out first when the converted amount is withdrawn. This taxable amount would be subject to the early withdrawal rules and penalized 10% unless an exception applies. The point of this rule is to protect Roth conversions from being sham transactions intended to get around the 10% early withdrawal penalty.

The law treats withdrawals of converted amounts that are more than five years past the conversion date the same as contributions.

LO 5.4.2

Answer 466

A

C)Explanation
The answer is neither I nor II. Although there is not an income limitation to participate in a pre-tax 401(k) plan, there are income limits for Roth IRAs (2021 – modified AGI: $208,000 married/$140,000 single). For Roth IRAs, there is no requirement to start taking distributions while the participant is living. For pre-tax 401(k) plans, distributions must begin no later than age 72, unless the participant is still working at the company and is not a 5% owner.

LO 5.4.3

Answer 467

A

B)Explanation
The answer is II, III, and IV. Pension plans (traditional defined benefit, cash balance, target benefit, or money purchase) generally do not allow in-service withdrawals to participants under the age of 62. All the others listed allow for in-service withdrawals if the plan document permits.

LO 6.1.1

Answer 468

A

A)Explanation
The answer is distributions made after a separation from service for early retirement after any age. For a preretirement distribution to escape the 10% penalty for early distribution, the distribution must be made after a separation from service in the year the worker turns age 55 or later. This exception is not applicable to IRAs.

Answer 469

A

C)Explanation
The answer is $80,000. Because the distribution is a lump-sum distribution of employer stock, the net unrealized appreciation (NUA) concept applies. Under the NUA rules, the adjusted basis of the stock to the plan trust ($80,000) is included in Steve’s gross income in the year of the distribution and is treated as ordinary income. When Steve later sells the stock, he will have an $80,000 basis in it.

LO 6.1.2

Answer 470

A

C) Explanation
The answer is II, III, and IV. Of the $300,000 Lauren received as a lump-sum distribution from the stock bonus plan, $100,000 is net unrealized appreciation (NUA) and will be taxed at the long-term capital gain rate. The remaining $200,000 is taxed at Lauren’s ordinary income tax rate in the year of the lump-sum distribution. Because Lauren sold the stock within six months of distribution, the $10,000 post-distribution appreciation is taxed as short-term capital gain.

LO 6.1.1

Answer 471

A

D)Explanation
The answer is I only. If Blake takes a distribution that is in addition to his RMD, he can pay the required income tax on this distribution and convert it to a Roth IRA. Because there are no required minimum distributions for Roth IRAs, Blake will have effectively reduced the amount of his pretax retirement plan account against which he must calculate subsequent RMD. Statement II is incorrect. A direct transfer or rollover may occur at any age.

Answer 472

A

C)Explanation
The answer is April 1 of the year following the year in which the IRA owner attains age 72. The Internal Revenue Code provides that minimum distributions from a traditional IRA must begin no later than April 1 of the year following the year in which the IRA owner attains age 72.

LO 6.2.2

Answer 473

A

A)Explanation
The answer is an in-service hardship distribution from a Section 401(k) plan to an employee-participant, age 55. Even if the distribution is a hardship withdrawal, the penalty applies unless the employee-participant has attained the age of 59½ (or one of the other 10% penalty exceptions applies).

LO 6.3.1

Answer 474

A

D)Explanation
The answer is II, III, and IV. A trustee may not be forced to distribute assets from a plan unless the plan document allows for it.

LO 6.5.1

Answer 475

A

A) Explanation
The answer is II, III, and IV. The dependent parent of a disabled worker is not eligible for benefits under the disabled worker’s employment record when the worker receives Social Security disability benefits.

LO 7.2.1

Answer 476

A

C) Explanation
The answer is II and III. Employers who sponsor defined benefit pension plans typically do not have highly predictable costs, because funding is subject to an annual actuarial determination. Highly paid employees receive a tax shelter with a defined benefit plan in the sense that their compensation includes large contributions to the defined benefit and they are not subject to current income tax on this compensation. The Pension Benefit Guaranty Corporation (PBGC) and the employer guarantee benefit levels. Defined benefit pension plans are complex to design and expensive to install and maintain.

LO 8.1.2

Answer 477

A

A) Explanation
The answer is traditional defined benefit pension plan. This type of plan is most appropriate for Larry and his business. The business has favorable cash flow and can commit to the annual contribution required by the defined benefit approach. Additionally, Larry’s savings need as a percentage of his compensation exceeds anything possible in a defined contribution plan. Finally, Larry is currently age 55 with only 10 years until retirement.

LO 8.1.2

Answer 478

A

A) Explanation
The answer is American Eagle gold coins are permitted IRA assets. Only permissible collectible that an IRA may invest in is certain U.S. coins, such as the American Eagle gold coin.

LO 8.2.1

Answer 479

A

D) Explanation
The answer is as an inflation hedge. The inclusion of real estate among a retirement plan’s investment portfolio is most suitable as a hedge against future inflation. Otherwise, it is generally nonliquid, is not stable enough to fund fixed obligations, and is not always considered a very low risk holding.

LO 8.2.1

Answer 480

A

D) Explanation
The answer is $100,000. Defined benefit plans use the 100 times test for determining whether they comply with the incidental benefit rules. Under this test, the death benefit cannot exceed 100 times the participant’s projected monthly benefit (in this instance, $100,000).

LO 8.2.2

Answer 481

A

D) Explanation
The answer is neither I nor II. Increasing the life expectancy of the retiree increases the amount of capital needed on the first day of retirement to support the assumed retirement income because the retiree will draw on the capital fund for a longer period. Statement II is incorrect because an 8% investment return and 4% inflation rate produces a lower inflation-adjusted rate of return, and thus increases the amount of capital needed on the first day of retirement to support the assumed retirement income.

[(1.06 ÷ 1.02) − 1] × 100 = 3.9216%; [(1.08 ÷ 1.04) − 1] × 100 = 3.8462%

LO 8.3.1

Answer 482

A

B) Explanation
The answer is $1,490,649.

Step 1: Determine the present value of capital needs:

Current income $75,000
Wage replacement ratio × 80%
Present value of capital needs $60,000
Step 2: Determine the future value of the capital needs in the first year of retirement:

PV of capital needs ($60,000)
n (number of years until retirement) 20
i (use inflation rate) 3
FV (required income in the first year of retirement) $108,366.6741
Step 3: Determine the amount of savings (capital) needed at retirement to fund expenses throughout remainder of life expectancy:

PMTAD(annuity due) ($108,366.6741)
n (retirement life expectancy) 25 (90 − 65)
i (use real rate of return) 5.8252 [(1.09 ÷ 1.03) − 1] × 100
PV (capital needed at retirement) $1,490,649
LO 8.3.2

Answer 483

A

B)Explanation
The answer is $1,663,516.

Step 1: Determine the present value of capital needs:

Current income $75,000
Wage replacement ratio × 80%
Present value of capital needs $60,000
Step 2: Determine the future value of the capital needs in the first year of retirement:

PV of capital needs ($60,000)
n (number of years until retirement) 20
i (use inflation rate) 3%
FV (required income in the first year of retirement) $108,366.6741
Step 3: Determine the amount of savings (capital) needed at retirement to fund expenses throughout remainder of life expectancy using a capital utilization approach:

PMTAD(annuity due)
($108,366.6741)

n (retirement life expectancy) 25 (90 − 65)
i (use real rate of return) 5.8252 [(1.09 ÷ 1.03) − 1] × 100
PV (capital needed at retirement) $1,490,649
Step 4: For capital preservation, calculate the additional capital needed at retirement to generate the desired retirement income and leave a balance at life expectancy equal to the original capital utilization value:

FV = $1,490,649

n = 25

i = 9

Solve PV = (172,867)

Add to previous step: $1,490,649 + $172,867 = $1,663,516

LO 8.3.2

Answer 484

A

A) Explanation
The answer is $12,000. The maximum deductible contribution for the Bernards to a traditional IRA for 2021 is $12,000 ($6,000 each). Chris is an active participant in a qualified plan, but his AGI is below the married filing jointly (MFJ) phaseout of $105,000. If Allison has no earned income in 2021, she can make an IRA contribution based on Chris’s earned income, and her AGI for these purposes is below the nonparticipant spouse AGI limit of $198,000.

LO 9.1.1

Answer 485

A

B) Explanation
The answer is $255. It is the total amount paid, regardless of the number of Social Security beneficiaries.

LO 9.1.1

Answer 486

A

B) Explanation
The answer is $53,800. Chris contributes 3% of his salary ($70,000 × 3% = $2,100) and the employer matches employee deferrals up to that amount. The maximum that can be contributed to Chris’s profit-sharing account is the lesser of 100% of his compensation, or $58,000. Because $2,100 is going in as an elective deferral from Chris’s salary and another $2,100 is the match, that leaves $53,800 the employer could contribute.

LO 9.1.2

Answer 487

A

C) Explanation
The answer is $1,388,038. The lump sum needed at the date of retirement to support Chris’s goal (without considering Social Security) is $1,388,038.

Step 1:

$70,000 × 80% = $56,000

$56,000 +/− PV

17 N

3 I/YR

Solve FV

$92,559

Step 2:

BEG mode

$92,559 PMT

25 N

[(1.08 ÷ 1.03) − 1 × 100] = 4.8544 I/YR

0 FV

Solve PV

−$1,388,038

LO 9.2.1

Answer 488

A

A) Explanation
The answer is II and III. No one can roll a retirement plan loan to an IRA and keep the payments and term the same. By using a plan loan offset, Chris could lower the amount of the defaulted loan by making payments into his new employer’s plan or an IRA up to the due date (including extensions) of his tax return for the year of the retirement plan loan default. The loan becomes fully taxable if not repaid and may be subject to an additional 10% excise penalty.

LO 9.2.2

Answer 489

A

C) Explanation
The answer is both I and II. According to the Code and Standards, “if the practitioner is unable to obtain sufficient and relevant quantitative information and documents to form a basis for recommendations, the practitioner shall either restrict the scope of the engagement to those matters for which sufficient information is available; or terminate the engagement.”

LO 9.3.2

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