Investment Suitability Chapter

Question 1

What is a General Partnership?

Answer 1

Similar to a sole proprietorship but with multiple owners
Not a separate legal entity from its owners
Partners have unlimited liability
No double taxation
Each partner reports his or her distributive share of profits and losses on their own personal tax return

Question 2

What is a Limited Partnership?

Answer 2

Similar to a general partnership but has classification of partners
2 kinds of partners: General Partner and Limited Partners
All income and expenses flow through to the partners on their personal tax returns

Question 3

What is a general partner?

Answer 3

the person in a partnership that operates the business and assumes unlimited liability

Question 4

What is a limited partner?

Answer 4

a person in a partnership that is a passive or silent investor- they don’t have any control or operational power and have limited liability

Question 5

What is a C Corporation?

Answer 5

A business entity that is a separate legal entity from the individual owners
Double taxation for the business entity and individual shareholders
Shareholders are NOT personally liable for actions of the corporation
Shareholders’ only risk is their own personal investment in the company’s shares
Company does NOT cease to exist upon death of owners- has unlimited life and can run into perpetuity

Question 6

What is an S Corporation?

Answer 6

elects to pass corporate income, losses, deductions, and credit through to their shareholders to federal tax purposes
cannot be more than 100 shareholders
Shareholders report income and losses on their personal tax returns & are assessed at their individual income tax rates
No double taxation
Shareholders are taxed like sole proprietorships or partnerships

Question 7

What is a Limited Liability Company?

Answer 7

an entity that is taxed like a sole proprietorship but has the same liability protection of the corporate structure - owners are NOT personally liable
has higher administrative costs and regulations are more complex

Question 8

What is a will?

Answer 8

legal documentation that governs how an individual’s assets are to be distributed after their death

Question 9

What is a trust?

Answer 9

A legal entity that owns the property and assets placed in it
These do NOT go through probate

Question 10

What is a grantor/settlor?

Answer 10

The person creating the trust

May or may not also be the beneficiary

Question 11

What is a trust company?

Answer 11

The organization that acts as the fiduciary and administers the trust

Question 12

What is a trustee?

Answer 12

A person that acts as the fiduciary for a trust

Question 13

What is a revocable trust/grantor’s trust?

Answer 13

where the grantor is allowed to modify the trust or reclaim and use the assets

Question 14

What is an irrevocable trust?

Answer 14

when the trust cannot be modified or terminated without authorization from the beneficiary

Question 15

What is a simple trust?

Answer 15

trust where all income earned from the assets in the trust must be distributed in the year earned or the trust will convert to a complex trust

Question 16

What is a complex trust?

Answer 16

trust that may accumulate income OR distribute it to the named beneficiary
Capital gains are considered to be part of the distributed income unless they are reinvested

Question 17

What is a defined benefit plan?

Answer 17

type of qualified retirement plan where the employee’s retirement benefit is defined based on a formula which includes salary and years of service
the employer must contribute annually to the plan for each employee
employer assumes the investment risk
Returns are uncertain but the benefit is guaranteed

Question 18

What is a defined contribution plan?

Answer 18

type of qualified retirement plan where the employee contributes through a payroll deduction
Employer often matches the employee’s contribution up to a certain percentage
employee assumes the investment risk
contribution and growth are tax deferred
more popular as they are more flexible and less expensive for employers

Question 19

What is a qualified retirement plan?

Answer 19

retirement plan approved by the IRS for special tax benefits:

• employer contributions are tax-deductible and are not taxed as income to the employee
• the earnings in the plan accumulate tax deferred
• lump sum distributions to employees are eligible for favorable tax treatment

distributions prior to age 59 1/2 get a 10% penalty in addition to income taxes

Question 20

At what age can you begin receiving distributions from a qualified retirement plan without receiving a penalty?

Answer 20

59 1/2

If you take out distributions before then, you will receive a 10% penalty in addition to income taxes

Question 21

What is a 401(k) plan?

Answer 21

qualified retirement plan
allows the employees to take a reduction in their current salaries by deferring amounts into a retirement plan
employer can match the employee’s payroll contribution- either dollar for dollar or as a percentage
employer’s contribution is tax deductible to the employer

Question 22

What is a 403(b) plan?

Answer 22

Tax-deferred Annuity or Tax-Sheltered Annuity
a qualified retirement plan available to employees at certain nonprofit organizations under Section 501(c)(3)
not governed by ERISA
contributions can be made by the employer or by the employee through salary reduction - either case the contributions are excluded from the employee’s current income

Question 23

What is a 457(b) plan?

Answer 23

a retirement plan available to employees of public institutions - like state and local governments and to private, non-governmental, tax-exempt organizations like hospitals
employees set aside current compensation into the account on a pre-tax basis through a salary deferral agreement
money grows tax-deferred until withdrawn at retirement or when employee terminates employment
employee’s cost basis is zero

Question 24

What is a nonqualified retirement plan?

Answer 24

type of benefit plan that does NOT meet ERISA’s requirements for favorable tax treatment of deductions and contributions
does not need to be filed with the IRS
may discriminate in selecting plan participants
contributions are NOT tax deductible

Question 25

What is a Coverdell Account?

Answer 25

trust or custodial account created for the purpose of paying the qualified education expenses of the designated beneficiary
contributions are generally made after tax- aka not tax deductible
above certain income limits- contributions are not allowed
taxpayers may deposit up to $2,000 TOTAL per year for a child younger than 18 years old
amounts deposited grow tax-deferred until distributed
can be used to cover K-12 education and college costs

Question 26

What is a 529 savings plan?

Answer 26

a state-sponsored, tax-advantaged education savings plan
contributions are made with after-tax dollars - grow tax-deferred - withdrawals are tax-free when used for qualified educations expenses
nonqualified withdrawals are subject to a 10% penalty and ordinary income taxes on gains
no age limits on the beneficiary
the amount of money that is contributed is not limited, but the contribution is considered a gift and is subject to gift tax rules

Question 27

What is the Uniform Gifts to Minors Act (UGMA)?

Answer 27

gifts made to the minor are irrevocable
the account must include the custodian’s name and the name & SSN of the minor
all securities are registered in the name of the custodian for the benefit of the minor

Question 28

What is a Health Savings Account (HSA)?

Answer 28

accounts designed to help individuals save for qualified health expenses that they, their spouse, or their dependents incur
individual who is covered by a high deductible health plan can make a tax-deductible contribution and use it to pay for out-of-pocket medical expenses

Question 29

What is a qualified domestic relations order?

Answer 29

a court order that gives an individual the rights to a portion of a participant’s retirement funds in the case of a divorce

Question 30

What is a Joint Tenants with Rights of Survivorship (JTWROS)?

Answer 30

commonly used by married couples
must have at least 2 owners
if one owner dies, the survivor inherits the entire account and continues to authorize trades and withdraw funds
bypasses probate but NOT estate taxes
must be equal interest

Question 31

What is a tenants in common account?

Answer 31

joint account that allows for unequal ownership
when one owner dies, the ownership interest passes to the owner’s estate & ultimately the beneficiary’s
ownership is governed by the decedent’s will or state law

Question 32

What is Tenancy by the Entirety?

Answer 32

joint account that allows individuals who are married to own property as a single entity
each spouse owns an undivided interest in the property
upon the death of either spouse, the property would go to the living spouse and avoid probate

Question 33

What is a Transfer on Death (TOD)?

Answer 33

this type of account bypasses probate and transfers directly to the deceased owner’s designated beneficiary
Always an individual account

Question 34

What are the main provisions under the Employee Retirement Income Security Act (ERISA)?

Answer 34

all eligible employees must be allowed to participate in the plan (anyone over age 21 that works full-time and has been there for 1 year or more)
Participants can name their own beneficiaries
plan must communicate financial information to the participants as well as file reports annually with the Department of Labor