From Danko Quizzes (4+) Flashcards
- Scott Harding died recently (at age 74), with a taxable estate of roughly $8 million. Some years
ago he had seen an estate tax attorney and completed an extensive estate plan with a variety of
trusts. Among his assets is a stone-constructed New England farm house having a current fair
market value of $2 million. Scott’s will bequeathed the home to Clarisse who, due to authoring a
best-selling mystery novel, is worth approximately $20 million in her own right. Nevertheless,
when Scott died, Clarisse, (under the guidance of her tax advisor), did not want to own the
home outright, fearing it would become part of her already substantial gross estate. However,
she wishes to live in the home where she can continue to write and enjoy her grandchildren for
the rest of her life. The home had been in the Harding family since its arrival in America in 1789.
At the time of his death it was owned fee simple by Scott. There is great sentiment associated
with the home: Scott and his wife, Clarisse (age 66) were married in the home and raised their
two children Rebecca and Jonah (now adults) there. What technique, if any, will accomplish
Clarisse’s goals?
A. Clarisse cannot have her cake and eat it too: If she disclaims ownership of the home, she
may not live there without paying fair market rent.
B. With a proper provision in Scott’s will, if Clarisse disclaims ownership of the home, it can be
transferred to a disclaimer trust, the terms of which permit Clarisse to live in the home for
her lifetime. This would be a family trust.
C. With a proper provision in Scott’s will, if Clarisse disclaims ownership of the home, it can be
transferred to a disclaimer trust, the terms of which permit Clarisse to live in the home for
her lifetime. This would be a marital trust because Clarisse has a life interest in the home.
D. A qualified personal residence trust (QPRT) should accomplish Clarisse’s dual goals of not
including Scott’s home in her gross estate and the right to live in the home for her entire
lifetime.
B. Many well written wills include disclaimer trust provisions which give the surviving spouse the
ability to put specific disclaimed assets into the trust by disclaiming ownership of a portion of
the estate. Disclaimed property interests are transferred to the trust, without being taxed.
Provisions can be written into the trust that provide for regular payouts from the trust to
support survivors, or in the case of the Hardings, the right to occupy (but not own) property.
The trust can also be written so that surviving minor children can also be provided for, as long as
the surviving spouse elects to disclaim inherited assets, passing them on to the trust. To keep
the assets from being included in Clarisse’s estate, the trust would have to be a family trust
rather than a marital trust.
If a disclaimer trust is used, the full extent of the tax planning occurs upon the death of the first
spouse. At that point, the surviving spouse can either accept the trust assets or disclaim them. I
f he or she disclaims them into the disclaimer trust, the trust will function like a credit shelter
trust that will shelter the assets from inclusion in the surviving spouse’s estate. But if there is no
tax reason to use credit shelter planning, the spouse can simply receive the assets outright. This
allows tax-planning flexibility without creating unnecessary complication.
Using answer D will mean for the life of the QPRT it could be brought back into her estate. It is
not a bad answer. With Answer B, the house uses the exemption. Suggestion: The questions
are not too long to read. I would recommend reading it first.
Your client, Martha, requested a meeting with you. Martha is married to Glen. Glen is a
workaholic. You only met him once to set up their joint account. Martha always makes all the
investment decisions. Glen makes a lot of money, but Martha saves a majority of it through
frugal living. As the meeting starts, Martha is quite blunt. Glen has taken up with one of the
girls at the plant. Cash flow to Martha from Glen has ceased. He set up a separate bank
account in his name. She wants your advice on how to handle the assets in the investment
account.
A. Tell her to break the joint tenancy account and retitle as tenants in common.
B. Tell her you need to secure statements from both her and Glen to proceed with any
changes.
C. Tell her to see a divorce attorney before you can proceed to change the account into her
name.
D. Call up Glen and ask him to come into your office.
B. The account is in joint names, both are clients. She never says she wants to divorce him.
Also, to do Answer C, she has to get a divorce before you can proceed with the account titling.
Do you have enough of a relationship with Glen to select Answer D? Doubtful.
Answer A depends on Answer B
Mrs. Lucy, age 80, is in reasonable health. Five years ago, her husband died leaving her $3
million and placing $3.5 million in a bypass trust for her benefit. In addition, their home was in
JTWROS. The home, FMV value $500,000 and the $4 million of investments has a high basis of
$3.5 million. Mrs. Lucy has two married children and 5 grandchildren to keep her estate under
$5 million. What type of asset do you recommend she give and to whom?
A. Low basis, high dividend paying investments to both children and grandchildren.
B. High basis, high dividend paying investments to both children and grandchildren.
C. Low basis, growth investments to children and high basis, growth investments to
grandchildren.
D. High basis, growth investments to children and low basis, growth investments to
grandchildren.
B. Think ages. The grandchildren have to be age 30 maybe age 40. With high basis, they can sell
the investment with little or no tax or keep it and get big dividends. They could be taxed a 0% or
at most 15%. Low basis investments would be subject to capital gains. If she keeps the low
basis stocks until death, her estate will get a full step-up in basis. She does not have an estate
tax situation.
- Sid Thomas works for TTI, Inc. Sid makes $120,000 per year. TTI contracted with a disability
insurance company to buy long-term disability for its key employees. The carrier agreed to
insure up to 50% of salary. In Sid’s case, that is up to $5,000 per month. However, TTI only
agreed to pay for 60% of the $5,000 per month coverage with the provision that Sid could elect
to pay for the remaining 40%. Which of the following statements is/are true?
I. If Sid elects not to pay for the additional coverage, the disability benefits ($3,000) will be
taxable as income.
II. If Sid elects to pay for the additional coverage, 60% of the disability benefits are taxable
as income, and 40% are tax-free.
III. If Sid elects not to pay for the coverage, the disability benefits ($5,000) will be taxable as
income.
IV. If Sid elects to pay for the coverage, the disability benefits ($5,000) will be tax -free.
A. I, II B. I C. II D. III E. IV
A. 60% of the benefits are taxable as income (the company-paid portion of the premium), and
40% of the benefits are tax-free (if Sid pays the premium). The question says Sid could pay, not
had to pay which makes Answer I correct.
An existing client calls you, a CFP® professional, with a question about a topic you aren’t very
familiar with. She tells you her husband served in the military decades ago and is now receiving
care in a nursing home. She read a brochure at this new facility about a VA benefit called Aid
and Attendance that could pay her around $1,200 per month as the spouse of a serviceman who
is receiving skilled nursing care. She would like you to help her qualify for the benefit.
You tell her that you will do some homework and arrange a meeting with her the following week
to discuss their situation further. After doing some research, you discover that there are very
stringent income and asset restrictions to qualify for benefits. Since they have been clients for
years, you know they have a net worth of around four million dollars. In your meeting you
should:
A. Explain the income and asset thresholds that are well lower than their current situation.
Help her understand that this benefit is not intended for people in their financial position
and recommend they not pursue the benefit further.
B. Tell your client you aren’t an expert in this matter and put her in touch with an attorney
with whom you have worked the past whom you know to be a military veteran.
C. Review options for how the client may effectively reduce income and gift assets to qualify
for the benefit.
D. Recommend she purchase long term care insurance and review their current retirement and
investment objectives for other options to meet their needs.
. C. In D, you never address her objective and discuss options on how to qualify; you only give
recommendations apart from it. A is a good answer however you should let her determine if
she is willing to go to lengths to qualify, you shouldn’t be making the decision for her by
dismissing the option. B would be a great answer, but it is unclear if the attorney is competent
in the subject. In this meeting, you should review the client’s options as she requested, answer
C. Once that is done you may then decide to advise a more suitable solution (Answer D).
Subjective. If you answered B, I am not saying you are wrong. This is a practice question.
Alex and Susan Halton have been married for 5 years and each has children from a prior
marriage. Alex is self-employed as a homebuilding consultant with earnings after all expenses of
$150,000/yr. and plans to work 5 more years, while Susan is retiring from Verizon this year with
pension income of $60,000/yr., where her salary was 89,000/yr. Susan exercised 50 incentive
stock options this year with an option price of $20, when the stock was trading for $40 per
share. Also, Allan purchased 3 business use vehicles for his consulting practice in January for
$45,000 each and plans to forfeit any “special depreciation allowance” or section 179 expense,
and instead depreciate them using 5yr MACRS. Alex and Susan want to invest some of their
liquid assets totaling $50,000 into investments for income and have asked for your help. They
already have saved significant qualified retirement plan assets in excess of one million dollars in
well diversified mutual fund portfolios. What should you recommend? Hint: The CFP Board gives
you income tax charts. Are they in the 10-12% bracket? Are they in a 37% bracket? You have to
make decisions on this exam.
A. Recommend investment grade corporate bonds currently yielding 6%.
B. Recommend investment grade AMT private activity municipal bonds for several of the states
power companies currently yielding 4.5%.
C. Recommend state general obligation public purpose municipal bonds yielding 4.6%.
D. Recommend Verizon common stock, currently trading at $44 per share, since you know
Susan will love that idea based on her tenure with her lifelong employer, and because she
mentioned that Verizon pays a good dividend of $2.06 per share annually.
C. The correct answer is C because it has the highest yield for their tax situation and is an
income investment. There is no mention of maturity dates, so that should not be a factor to
consider. There is no mention of risk tolerance, so no judgment can be made on that. The
questions states investments for income not growth and income, so stocks would not be
suitable based on the client request.
A. Corporate bonds at 6% would yield an approximate after-tax income of 4.56% (24% tax)
which is lower than the tax-free yield of 4.6%
B. AMT could be triggered based on the ISOs exercised by Susan and the MACRS depreciation
for Alex, therefore, a private activity AMT bonds would not be suitable for them, as they would
end up paying AMT tax of around 26% on it bringing the yield to about 3.33%.
C. The taxable equivalent yield of the 4.6% municipal bonds should be approximately 6.05%
(24% tax) by dividing by the factor of .76 and is the best income for them.
D. Just because you know a client will like an idea, does not make it ethical. A common stock
should not be thought of as an income investment because of the growth component, and the
added volatility from equity investments. Even though, the yield ($2.06/$44) or 4.68% for a
qualified dividend would still be lower than the G.O. muni bond. (At a 15% cap gain rate the
after-tax income is 3.98%)
When dealing with a client’s estimated unequal cash flows from a potential investment, what is
the major difficulty that you, as a financial planner, may encounter?
A. Whether to use time value of money B. What discount rate to use C. Whether the investment under consideration should be rejected if the NPV is a negative number D. How the IRR will be reinvested
B. Answer C is a good answer. The difficulty is in determining what discount rate (client’s
required rate of return) to use for the investment.
What is the major difference between a red herring and a prospectus?
HINT: Think simple if you do not know. The question is quite easy if you eliminate the wrong
answers.
A. A red herring is a communist stock.
B. A red herring omits the selling price and the size of the issue.
C. If the front page of the prospectus is printed in red, then it is a red herring.
D. The SEC does not have to approve a red herring.
B. Although Answer C is true, the major difference is Answer B. The SEC has to approve a red
herring. Yes, questions come from material not covered.
Mr. Lukes owns a convenience store. After a storm hit his city, he donated $1,000 worth of food
to the American Red Cross. He feels he could have sold the food for $2,000. Normally, the
expenses associated with selling the food consume 50% of his profit. What amount of
charitable deduction can he take?
A. No contribution deduction is allowed.
B. 50% of his AGI
C. $1,000
D. $2,000
C. For self-employed individuals, partnerships, and Subchapter S corporations, the contribution
amount for inventory must be reduced by the amount, which would have been recognized as
gain if the property had been sold by the donor at its fair market value at the time of its
contribution to the charitable organization. In other words, the charitable contribution of
inventory is limited to its cost.
- What is a SERP?
I. It is a supplemental executive retirement plan.
II. It is an informally funded plan to provide benefits that greatly exceed those provided by a
normal retirement plan.
III. It is also called a “top hat” plan.
IV. It must cover all employees for supplemental benefits.
A. All of the above
B. I, II, III
C. I, II, IV
B. SERPs can only be provided for management or HCEs. This is where top hat comes from.
. Diane is a great photographer. She wants to donate one of her photos to the local art museum.
Her cost for film developing, printing, mounting, and framing is $250. The art museum curator
feels the photo is worth $3,000. If her AGI is $100,000, how much can she deduct for her gift to
the museum?
A. $0 – It is personal property.
B. $250
C. $1,500
D. $3,000
E. 50% of AGI
B. The tax deduction for a work of art created by the taxpayer is limited to basis. Please review
the income tax deductions for gifts to charity created by the taxpayer.
Harry Potter bought a $25,000 single premium deferred annuity 30 years ago at age 30. Now
approaching retirement, he is trying to decide if he should take the cash value ($110,000) as a
lump sum or annuitize the policy over a 20 year single life expectancy of $725 per month. When
he enters his retirement years his tax bracket will drop to 12% and he is concerned about
income. What would you recommend if he feels he can invest the lump sum and achieve a 6%
after-tax return?
A. He should take a lump sum and pay the tax
B. If he takes a lump sum, he will have to pay the tax plus a 10% penalty (annuity rules), he
should annuitize.
C. He should annuitize the contract.
D. He should take a lump sum because all he will get is 20 years of payments
C. Well, if he takes a lump sum Answer A he will pay 12% on $85,000 ($110,000 - 25,000 basis)
or $10,200. ($110,000 -10,200) x 6% = $5,988/year. $725 x (1 - 12.00%) = $638.00, $638.00 x 12
= $7,656/year
Answer C has a higher net of tax payout. Answer B is wrong. He is over 59½ so there is no 10%
penalty. Answer D is wrong as the payments continue after 20 years but are 100% taxable.
Tommy Todd died this year. He was an employee of a large company. The company owned a
group life policy covering him for $50,000 and the company also had a company benefit of
paying a $5,000 death benefit outright. If both death benefits were paid to Tommy’s wife, how
much would be subject to income tax?
A. $0
B. $5,000
C. $50,000
D. $55,000
B. A group life policy is normally owned by the company. The company pays the premium, but
the benefits (up to $50,000) are tax-free. The $5,000 death benefit paid the company used to
be tax-free (a De Minimis fringe benefit) but is now taxable.
Arthur is in a 35% income tax bracket. He has decided to buy a $40,000 car with cash. He needs
to sell an investment to raise cash. Which one of the following assets would generate the least
amount of tax liability if sold?
NOTE: LTCGs rate is 15%.
A. An annuity worth $30,000 with a basis of $28,000
B. A stock bought 6 months ago for $27,500, now worth $30,000
C. A stock bought 13 months ago for $24,000, now worth $30,000
D. A baseball card bought 2 years ago for $26,000, now worth $30,000
B. In regards to the annuity, you cannot assume he is over age 59½. The question must tell you
the person is over 59 1/2. You must assume it is a deferred annuity because it is worth more
than he bought it for originally. It cannot be an immediate annuity.
The tax is calculated as follows for each answer.
A. $2,000 ordinary income at 35%, plus 10% penalty on $2,000 = $900 (under 59 1/2)
B. $2,500 STCG at 35% = $875
C. $6,000 LTCG at 15% = $900
D. $4,000 at 28% = $1,120
Tammy is getting a divorce. As part of a property settlement, she is getting 50% ($250,000) of
her husband’s IRA ($500,000). Out of the settlement, she needs to buy a car ($20,000) with
cash. What should she do if her AGI is less than $100,000 this year (single)?
A. Take a distribution for $20,000 and roll over $230,000 into her own IRA. The $20,000 will be
subject to ordinary income tax but no 10% penalty (QDRO exception).
B. Roll the $250,000 into her own IRA. If she pledges $20,000 of the IRA to make the car loan,
only the loan interest would not be deductible (consumer interest).
C. Roll the $250,000 into a Roth IRA and then withdraw $20,000 to buy the car. Only the
$20,000 would be subject to ordinary income tax.
D. Take a 60-day distribution for the whole $250,000 and buy the car. Then, before the 60 days
are up, she could roll all available funds into her IRA and pay ordinary income tax and a 10%
penalty on the non-rollover money.
D. Answer A is wrong because this isn’t qualified plan money. QDROs only apply to qualified
plan distributions. Answer B is wrong because pledging the IRA to make a loan makes the IRA
subject to income tax and a 10% penalty. Doing Answer C would make the whole $250,000
subject to income tax and the $20,000 subject to a 10% penalty. I think Answer D is the best
answer. During the 60 days, she might find a cheaper car or find more liquid assets to reduce
the taxable event. This is the only possible answer.
Mr. Smart is shorting calls (at-the-money calls). What is his greatest risk? A. Time running out B. Market interest rates increasing C. The upside risk is unlimited. D. A flat market
C. Naked call writing is also called shorting calls. The maximum profit is the premium income.
Since the upside potential of a stock’s price is unlimited, the potential loss to the writer is
unlimited. A shorter defined is someone who believes that the price of the underlying stock will
drop or at worse will not rise (a flat market). Mr. Smart will be able to keep the premium
income (reference Live Review Investments page 21).
Sally Single works as an employee for a large company. The company has recently reduced
health benefits and increased deductibles in the company health insurance plan. Sally wants to
know what kinds of medical care costs not covered by her insurance are deductible subject to
7.5% of AGI.
I. Dental x-rays II. Athletic club expenses III. Bottled water bought to avoid drinking fluoridated city water IV. Divorced spouse's medical bills V. Eyeglasses
A. All of the above B. I, III, IV, V C. I, V D. III, IV, V E. IV
C. Medical expenses include the cost of diagnosis, cure, mitigation, treatment, or prevention of
disease or any treatment that affects a part or function of your body
While on a trip, Sandra’s wedding ring disappeared. The ring was worth $10,000. She has an
HO-3 policy. Which one of the following statements is true?
A. The coverage on the ring is limited to $1,000.
B. The coverage on the ring is limited to dollar amount ($1,000 - 1,500) if the loss is due to
theft.
C. If she has more than $10,000 personal property coverage, the ring is covered for its full
value.
D. The ring is not covered.
B. The ring is only covered if its disappearance is due to theft. The dollar amount shown is not
important. See Insurance pre-study lesson 3. It is a concept question (theft). There is no
coverage unless a theft occurred. The theft must be reported to the police. It is a
commonsense question/answer. Some policies cover jewelry up to $5,000.
Which of the following organizations would be considered public charities (50% organizations)?
I. Education organizations with regular faculty and curriculum & regularly enrolled students
II. Hospitals
III. The Rotary Club (a not-for-profit), which raises money for public causes
IV. The United Way
V. Public libraries
A. All of the above B. I, II, III, IV C. I, II, IV, V D. II, IV E. III, V
C. Rotary is a non-profit (Not-for-profit). It isn’t a public or private charity. The Rotary Club
would have to obtain IRS approval to receive tax deductible contributions.
Larry is disabled due to a job-related injury. He is being paid benefits under workers
compensation, Social Security, and his private disability plan (employer paid). Which of the
disability benefits could be taxable?
I. Workers compensation disability benefits
II. Social Security disability benefits
III. Private disability plan benefits
A. All of the above B. I, II C. I, III D. II, III E. II
D. If his MAGI is above certain levels, the Social Security benefits could be taxable. The private
disability plan benefits are taxable because the employer paid the premiums. It does not say it
was a taxable bonus. If the question said Larry paid the premiums on the private disability plan,
then what would be the answer? Answer E
Monica is age 13. She will not turn 14 until next year. She has an UTMA account set up by her
grandfather. (His tax bracket is 24%.) He invests her money for her. This year the UTMA had
the following income.
Municipal bond income of $500
LTCG of $600
Qualified dividends of $1,200
If her parents are in a 35% tax bracket, how much is her income tax? A. $0 B. $42.50 C. $70.00 D. $134.00 E. $145.00
A. Her taxable income is $1,800 ($600 plus $1,200). Her tax bracket is 10%, but the LTCGs and
dividends in the 10% bracket are subject to a 0% tax. Age 14 did not matter. She is not subject
to the kiddie tax as it starts at $2,200 ($1,100 free and $1,100 at 10%) Municipal bond income is
tax-free income. That is why $1,800 is taxable.
Which statements regarding a health FSA are correct?
I. It may receive contributions from an eligible person.
II. Allowable contributions are not subject to FICA.
III. Allowed contributions are not included in income.
IV. Reimbursements from the health FSA used for expenses are not taxed.
A. I, III B. I, II, IV C. I, II, III D. II, IV E. III, IV
C. Statement IV is wrong because it does not specify qualified medical expenses.
Patricia Cox owns a condo in Florida. Due to a hurricane, the condo roof was damaged. She has
an HO-6 unit owner’s policy. Does she have coverage if the condo owners association assesses
her for the deductible under the association policy?
A. She has no benefits under Coverage A.
B. She has named-perils benefits under Coverage A (limited).
C. She has 10% of Coverage C benefits for Coverage A.
D. She has benefits under Coverage C
B. According to one textbook, the HO-6 policy does provide $5,000 for Coverage A on a named perils basis. Most HO-6 policies have a $1,000 payment for loss assessment (also under
coverage A). This is the best choice. The other answers are wrong.
Your client, Susan bought a deluxe refrigerator 10 years ago. It cost Susan $1,200 when new. A
current model of the same refrigerator would now cost $1,500. The appliance was expected to
last 15 years. However, it was destroyed by a grease fire that started in Susan’s kitchen. How
much would the insurance carrier pay if Susan’s policy provided for used actual cash value
coverage?
A. $500
B. $1,000
C. $1,200
D. $1,500
A. Actual cash value is the current replacement value of $1,500 less depreciation of 10/15 of the
current replacement value of $1,500 ($1,000) or $500.
The executor of the late Farmer Brown’s estate heard that a special election may be available
with the potential to reduce both the gross estate and federal estate tax in Farmer Brown’s
estate. Which of the following requirements for an estate to elect special use valuation under
IRC Section 2032(a) could be accurately described to Farmer Brown’s executor?
A. The maximum amount by which the gross estate can be reduced is based on the total FMV
of the real property used for business purposes by the decedent.
B. The election is available to the estates of any and all decedents as long as the property for
which special use valuation is elected is located in the United States.
C. The election generally allows an executor to elect to value a farm for federal estate tax
purposes based on actual current use, as opposed to the fair market value of the property if
it was sold for development purposes.
D. To make the election, the property must pass to a qualifying heir. A qualifying heir can be a
non-family member if the property remains in qualified use for at least ten years.
C. The applicable base amount is $750,000. It is indexed for inflation. It is over $1 million
currently. The decedent must have been a U.S. citizen or resident. The qualified heir must be a
lineal descendent.
Arthur Smith regularly made elective deferrals into his employer’s 401(k) plan because his
employer provided generous matching contributions. Arthur’s 401(k) plan account had no
specified beneficiary. At the time his account was established, he was divorced so he named his
estate as the beneficiary. Five years later he married Pamela. He is now retired and has been
taking distributions for three years. If Arthur dies, what can Pamela do?
A. Take distributions at least as rapidly as the schedule in effect up to the date on which Arthur
died.
B. Roll over the remaining account balance in Arthur’s 401(k) account into her own IRA
C. Take distributions beginning over her life expectancy by December 31st of the year in which
Arthur died.
D. Distribute the account to herself within 10 years of Arthur’s death
E. Understand that her rights in Arthur’s 401(k) account will be determined under the probate
process.
E. There is no named beneficiary. The proceeds will be paid to the executor of his estate. They
will be subject to the probate process. It never says anything about his will other than he
named his estate the beneficiary. Remember this is a profit-sharing plan, not a pension plan. It
is not subject to OJSA. Whether he was required to name her as a beneficiary or not is
immaterial. You must answer the question as written. All she can do is petition the probate
court. The court will decide.
Melissa purchased some Treasury Inflation-indexed securities (TIPS). She asks you, her financial
planner, about the tax ramifications of the securities. Which one of the following statements is
incorrect?
A. The interest is subject to federal taxation when received.
B. The inflation adjustment to principal is also subject to federal taxation in the year the
adjustment is made.
C. The interest and inflation adjustment may be deferred until the bond is redeemed or
maturity occurs in 30 years.
D. The deflation adjustment to principal is also subject to federal tax deduction in the year
the adjustment is made.
C. Answer C is referring to I bonds. Tax reporting is similar to EE bonds. TIPS are adjusted for
deflation as well as inflation. In deflation, the principal is adjusted downward and interest
payments are less than they would be. This answer, as written, came from Treasury direct
website.
Jim Harrison, President of Harrison Office Supply and Furniture, Inc. wants to establish a profitsharing 401(k) plan. He would like to exclude some of the sales staff but is uncertain if qualified
plan rules permit this. Jim would like to cover all W-2 (salaried) employees. The office staff
consists of 17 W-2 employees (4 are classified as highly compensated and 3 are key employees).
The warehouse staff consists of 38 W-2 employees, none of whom are highly compensated. The
sales department consists of 6 1099 commissioned salespeople (all on straight commission and
all have complete control over their schedule and duties.) and 1 W-2 employee. Charles Porter,
the sales manager is a highly compensated key employee. Porter receives a salary, bonuses, and
commissions on his own sales. Which of the following statements are correct regarding
permissible coverage and includable compensation that would generally apply to the 401(k)
plan that Jim is considering?
I. If the salespeople are deemed to be common-law employees, the plan may exclude
them provided either the ratio percentage test or the average benefit test are passed to
indicate that the plan is not discriminatory.
II. If the salespeople are independent contractors, their participation they could cause
the plan to be disqualified.
III. Commissions may be excluded from includable compensation for elective and
employer contribution purposes.
IV. Bonuses may be excluded from includable compensation for elective deferral and
employer contribution purposes.
A. I, II
B. I, II, III
C. I, III, IV
D. All the above
D. Participation eligibility in a qualified plan is contingent on employee status (Sole-proprietors
and partners may establish their own qualified plan). An Independent contractor may
participate in his own qualified plan but may not participate in another entity’s qualified plan
unless he is also deemed to be a regular or common law employee of that entity. It is possible
to exclude commissions and bonuses from includable compensation provided that doing so does
not discriminate against a non-highly compensated participant.
For example, if commissions are not counted as includable compensation and the key
employees never receive commissions, the non-key employees have been discriminated against
because their includable compensation is being reduced (by the amount of commissions earned)
while the key employees compensation is not reduced at all. Very involved question and
answer
. Dr. Walters, who is age 64, wants to retire next year. He has asked you, a CFP® practitioner, for
a retirement income analysis. Given his current assets and risk tolerance, he is asking for an
impossible retirement income payout. In order to meet his projections, you would have to
factor very high return assumptions into your analysis. What should you do?
A. Decline him as a client.
B. Run the projections using only your normal return assumptions and explain why the client’s
assumptions are not realistic.
C. Run the projections using both your normal return assumptions and assumptions necessary
to meet his required retirement income payout.
D. Refer him to your colleague CFP®.
B. I think this is the best answer. Remember, this is a financial planners test. Answer B is being a
financial planner and educating the client.
Harry Stonewall owns HS, Inc. HS is a small manufacturer of perforated metal products sold to
larger manufacturers. The cash flow of HS, Inc. varies from month-to-month. Harvey feels that
he can train an employee to run a piece of equipment in an hour so. At times, Harvey fires
employees for various legitimate reasons. Most employees stay with HS, Inc. a month or two as
a result of firing and layoffs. Harvey is considering the installation of a retirement plan for his
company. What would you recommend?
A. A defined benefit pension plan B. A profit-sharing plan C. A SEP D. A SIMPLE E. A SIMPLE 401(k)
C. Without knowing Harry’s age or salary the SEP makes the most sense. ERISA only requires
1,000 hours to count as a year of service. But SEP also says 3 out of the 5 years. No employee
will ever make it to 3 years. SIMPLE (answers D and E) are too restrictive and require a match.
Mr. Todd hired you to create a financial plan for him. He is married. Before you present your
plan, he asks you to meet him for drinks after work. By the time you arrive, he is half sloshed.
During the conversation, he tells you he has a girlfriend on the side and her financial well-being
is one of his most important objectives. What should you do?
A. Decline Mr. Todd and his wife as clients
B. Consider the financial interests of the girlfriend as you analyze data and create the plan
C. Tell Mr. Todd’s wife.
D. Hope that Mr. Todd was too drunk to remember that he told you about his girlfriend.
. B. I know many of you do not like this answer, but Answer A is not correct. If Answer A said to
decline him only, then it could be a right answer. However, his wife is not a client. Only he is
the client. This is not a moral issue; it is a client issue. The only possible answer is Answer B.
NOTE: These are practice exam questions - this might be one that you do not agree with me.
Move on.
Mr. and Mrs. Boone are considering an investment program to fund for their seven-year-old
son’s college education. They expect to need the money in about 10-years when their AGI will
be approximately $175,000. They want to invest at least part of the funds in a tax-exempt
account. Identify which investment(s) could be tax-exempt if the proceeds were used to finance
their son’s secondary and postsecondary education in the current year.
I. EE bonds owned by Mr. and Mrs. Boone II. Coverdell Education Savings plan III. Municipal bond in a UTMA account IV. Zero coupon Treasury bonds in a UTMA account V. Qualified tuition program
A. I, II, IV B. I, III, IV C. II, IV, V D. III, V E. II, III, V
E. The question is asking about secondary (high school). Answers II, III and IV are correct.
Coverdell plans are tax-free for elementary, secondary, and postsecondary school expenses.
Expenses are fees, tuition, tutoring, books, supplies, room and board, uniforms, and certain
equipment. The municipal bond (UTMA) would be tax-free. The other answers are for
postsecondary expenses (college) or will be taxable.
Mr. and Mrs. Boone are considering an investment program to fund for their seven-year-old
son’s college education. They expect to need the money in about 10-years when their AGI will
be approximately $175,000. They want to invest at least part of the funds in a tax-exempt
account. Identify which investment(s) could be tax-exempt if the proceeds were used to finance
their son’s secondary and postsecondary education in the current year.
I. EE bonds owned by Mr. and Mrs. Boone II. Coverdell Education Savings plan III. Municipal bond in a UTMA account IV. Zero coupon Treasury bonds in a UTMA account V. Qualified tuition program
A. I, II, IV B. I, III, IV C. II, IV, V D. III, V E. II, III, V
E. The question is asking about secondary (high school). Answers II, III and IV are correct.
Coverdell plans are tax-free for elementary, secondary, and postsecondary school expenses.
Expenses are fees, tuition, tutoring, books, supplies, room and board, uniforms, and certain
equipment. The municipal bond (UTMA) would be tax-free. The other answers are for
postsecondary expenses (college) or will be taxable.
Iris works for XYZ, Inc. She is a participant in her company’s 401(k) plan. She defers $1,000 at
the end of each month, and the company provides a 50% match on her elective deferral. She
already has a balance of $10,000 in her 401(k) account. Presuming none of the facts change and
if the account can grow by an annual rate of 6%, how much will Iris have in the 401(k) in 20
years?
A. -$659,959
B. $693,061
C. $726,163
D. $729,629
C. Yes, the payment must go in as a negative. This is cash flow out. If you inputted the payment
as a positive you got answer D. Pretty hard to retire on a negative FV.
