Missed Questions - 1st exam

Question 1

Given the following information:

Assume a risk-free rate of return of 1.75% and an R2 of 0.55 with respect to the market. Which of the following statements is CORRECT?

1. Portfolio A
   
   1. Standard deviation = 12%
   2. Beta = 2.05
   3. Actual return = 4.5%
   4. Expected return = 7%
2. Portfolio B
   
   1. Standard deviation = 8.5%
   2. Beta = 1.45
   3. Actual return = 8%
   4. Expected return = 7.5%

A)

Portfolio B has a higher Jensen’s alpha than Portfolio A indicating that Portfolio B outperformed Portfolio A.

B)

Portfolio B has a higher Treynor ratio than Portfolio A indicating that Portfolio B outperformed Portfolio A on a risk-adjusted basis.

C)

Portfolio B has a higher Sharpe ratio than Portfolio A indicating that Portfolio B outperformed Portfolio A on a risk-adjusted basis.

D)

Portfolio A has a higher Sharpe ratio than Portfolio B indicating that Portfolio A outperformed Portfolio B on a risk-adjusted basis.

Answer 1

Due to the low R2, the Sharpe ratio must be used to compare the risk-adjusted performance of the portfolios.

RULES TO REMEMBER

1. Low R Squared means you should select the fund with the highest Sharpe number
2. If R Squared is above 60-70, select the fund with the highest Treynor number whe Jensen/alpha is not an available answer!

RELATIONSHIP

1. Remember - Sharpe Ratio uses Standard Deviation
2. Remember - Treynor Ratio uses Beta
3. R Squared
   
   1. In investing, R-squared is generally interpreted as the percentage of a fund or security’s movements that can be explained by movements in a benchmark index. For example, an R-squared for a fixed-income security versus a bond index identifies the security’s proportion of price movement that is predictable based on a price movement of the index. The same can be applied to a stock versus the S&P 500 index, or any other relevant index.

Answer:C

Portfolio B has a higher Sharpe ratio than Portfolio A indicating that Portfolio B outperformed Portfolio A on a risk-adjusted basis.

Sharpe for Portfolio A = (0.045 − 0.0175) ÷ 0.12 = 0.2292
Sharpe for Portfolio B = (0.08 − 0.0175) ÷ 0.085 = 0.7353

The Sharpe ratio for Portfolio B is higher than Portfolio A indicating that Portfolio B outperformed Portfolio A on a risk-adjusted basis.

Question 2

Jamie, age 54, inherited $500,000 and she has an appointment with her CFP® professional, Oscar, this afternoon to discuss placing a portion of the proceeds in insurance-based investment vehicles. She currently manages the local grocery store and earns a $75,000 annual salary. Jamie is seeking a tax-deferred investment that will supplement her retirement income in 11 years. In addition, she wants the investment to to keep pace with inflation. Jamie considers herself a moderate risk taker and has a portfolio of individual stocks at her local brokerage office. Which of the following statements is(are) CORRECT and could be used within Oscar’s presentation?

1. Oscar can inform Jamie that she could achieve her goal of tax deferral with either a fixed or variable annuity.
2. Oscar should remind Jamie that if she chooses a fixed annuity for a portion of the inheritance, she will bear the investment risk.
3. Oscar should try to present annuities which are offered by insurance companies with a minimum A.M. Best rating of “E”.
4. Oscar could also mention that if Jamie chooses to invest in either a fixed or variable annuity, and decides that she would prefer a cash value life insurance policy in the future, she may utilize a Section 1035 exchange to move the funds from the annuity to the cash value life insurance policy.

A)

1 only

B)

2, 3, and 4

C)

1, 3, and 4

D)

1 and 2

Answer 2

1 ONLY - Oscar can inform Jamie that she could achieve her goal of tax deferral with either a fixed or variable annuity.

Explanation

• The insurer bears the investment risk with a fixed annuity.
• An A.M. Best rating of “E” means that the insurance company is under regulatory supervision and Oscar should not be presenting these companies as options for Jamie.
• A Section 1035 exchange will not allow an annuity with an unrealized gain to be moved into a cash value life insurance policy without incurring the tax consequences of the gain.
• A Section 1035 exchange allows a client to move an unrealized gain in a life insurance policy into an annuity on a tax-free basis and continue the tax-deferred treatment of the gain.

Question 3

The following exchanges of insurance contracts are considered tax-free by the IRS:

Answer 3

1. Replacing one annuity contract for another annuity contract with identical annuitants
2. Replacing one life insurance policy for another life insurance policy, endowment policy or annuity contract
3. Replacing one endowment policy for an identical endowment policy or an annuity contract

Any other variation from those acceptable exchanges listed above (annuity contract for life insurance) will not be considered a tax-free exchange. The IRS has provided strict guidelines that the owner, insured, and annuitant must be the same on the new contract as listed on the old in order to qualify for the tax-free treatment. The contract must also exchange directly between the insurance companies to retain the tax-free status. The IRS has ruled in several previous cases that if an owner cashes out of a current contract and immediately applies the proceeds to a new contract it will not be treated as a tax-free event or Section 1035 Exchange.

EXCEPTION

1. The tax code also says that you can make a tax-free exchange from: 1) a life insurance policy to another life insurance policy or 2) a life insurance policy to an annuity. You cannot, however, exchange an annuity contract for a life insurance policy

Question 4

Jim, recently retired, is 62 years old and expects to be in the maximum federal and state tax bracket. He plans to liquidate three of the investments listed below. Assume that each investment is worth $50,000 and has grown from an original investment of $25,000 over a period of more than 3 years. Liquidation of which three of the following investments, in order of priority, would result in the lowest tax liability for Jim? (CFP® Certification Examination, released 08/04)

1. 401(k) plan.
2. CD paying 4%.
3. U.S. savings bonds.
4. Traditional IRA (contributions were not deductible).
5. A blue chip stock.

A)

2, 5, 3.

B)

2, 3, 1.

C)

3, 5, 1.

D)

2, 5, 4.

Answer 4

2, 5, 3.

• CD paying 4%.
• A blue-chip stock.
• U.S. savings bonds.

The CD, blue-chip stock, and savings bonds (in that order) would result in the lowest tax liability upon liquidation.

• Because the interest on the CD was taxable each year, the basis in the CD would be equal to the value. Therefore, no federal or state income taxes would result upon liquidation. The appreciation of the blue-chip stock would be taxed, but at favorable capital gains rates. For U.S. savings bonds, the appreciation would be taxed at ordinary income tax rates for federal income tax purposes. However, savings bonds are not subject to state income taxes. For the traditional IRA, the appreciation only (client has basis for the contributions because they were nondeductible) would be taxed at both federal and state ordinary income tax rates. For the 401(k) plan, the entire amount would be taxed at both federal and state ordinary income tax rates.

Note: In the online version of Kaplan Schweser’s QBank, the letters preceding the answer choices that appear in the original CFP Board question have been eliminated. The answer choices may not be in the same order as in the original CFP Board released questions.

Question 5

Fred wants to transfer $50,000 of AAA rated corporate bonds to his 9-year-old daughter, Sarah. The bonds have a coupon rate of 3.5% and will mature in 10 years. He is interested in using a Uniform Gift to Minors Act (UGMA) account to hold the bonds. If he transfers the bonds to the UGMA account, which of the following statements is CORRECT?

A)

A portion of the interest income earned by the bonds within the UGMA account will be taxed at the trust and estate marginal income tax rate.

B)

UGMA account assets are not considered in determining financial aid.

C)

The interest income earned by the bonds within the UGMA account will be taxed at trust income tax rates.

D)

The interest income in the account will be income tax free if the account is used to fund Sarah’s college education.

Answer 5

Because Sarah is under age 19, a portion of the interest income will be taxed at the trust and estate tax rates.

UGMA account assets are considered an asset of the child and are considered in determining financial aid (student assets = 20% in the EFC calculation).

UGMA = The income from this type of account is not tax-free.

There are no IRS penalties on taking money out of a UGMA or UTMA account, but the investments purchased may have a surrender charge or exit fee if held less than a certain amount of time. Profits made on the liquidation of investments in a child’s UGMA or UTMA account are generally reported on the child’s tax return, but some or all might be included on the parent’s tax return, at the parent’s tax rate, depending on how the family files its federal taxes.

Question 6

Life Insurance - Unholy Trinity

Your client owns a whole-life insurance policy with a death benefit of $200,000 on the life of his spouse. The policy has a cash value of $13,500 of which the dividends are used to purchase additional paid-up life insurance. Their son is the named beneficiary. If the spouse were to die today, which of the following is true? (CFP® Certification Examination, released 12/96)

A)

The son must be at least 14 years old in order to collect the proceeds.

B)

A taxable gift of the life insurance proceeds has been made from the client to the son.

C)

The client continues to own the policy for the benefit of the son.

D)

The client receives an amount equal to the cash value, and the son receives the remainder of the life insurance proceeds tax-free.

Answer 6

If the insured does not own the life insurance policy, then a gift of the policy’s face value will be deemed made from the owner to the beneficiary upon the death of the insured. The person who makes the gift – the policy owner, not the beneficiary – is the one who could be subject to gift taxes.

Unholy Trinity - The three points of the triangle are as follows:

1. The policy owner – the person who bought the policy and pays the premiums.
2. The insured – the person whose life the policy covers.
3. The beneficiary – the person designated to receive the death benefit when the insured dies.

“You always want two points of the triangle to be the same person, company or charity,” Herrick says.

If there are three different people at the three points, then the death benefit could count as a taxable gift to the beneficiary.

Question 7

Wendy, age 73 and a recent widower, was referred to Frank, a CFP® professional, by her long-time friend, Janice. Wendy’s late husband handled most of the finances and Wendy has been overwhelmed with all the paperwork involved in settling her late husband’s estate. She had been skeptical in asking for assistance for fear of appearing uninformed about her finances. At a recent lunch, however, Janice offered Wendy reassurance and she ultimately decided to meet with Frank. After contacting his office, Frank instructed her to mail or fax her personal and financial information to expedite the process. In response Wendy indicated her uneasiness with providing confidential personal information via mail or fax. How should Frank proceed with the engagement?

A)

He should have his assistant contact her to answer any questions or concerns.

B)

He should disengage from the relationship.

C)

He should demand that she send in the paperwork before the meeting.

D)

He should set up a face-to-face meeting with Wendy to gather her personal financial information.

Answer 7

Frank should set up a face-to-face meeting with Wendy to collect the information, understand her concerns, and allay her fears. He should not disengage simply based on her resistance to mail or fax her information prior to the first meeting. Finally, he should not have an assistant contact her to persuade her to send in the information.

Question 8

Joel, a self-employed individual, has the following items related to his tax return in 2019:

1. Gross receipts from his business$50,000
2. Operating expenses for business$30,000
3. Self-employment tax paid$2,826
4. Medical insurance premiums$1,200
5. Mortgage interest$5,000

What is Joel’s adjusted gross income (AGI)?

A)

$17,630.

B)

$17,174.

C)

$17,387.

D)

$15,974.

Answer 8

50,000 - 30,000 - (2,826/2) - 1,200 =

17,387

REMEMBER = ONLY HALF OF THE SELF EMPLOYMENT TAX PAID IS DEDUCTIBLE FOR AGI

Question 9

Seven years before he died, Jake gifted commercial property with a fair market value of $1 million to his son, Dave. Jake used an annual exclusion of $11,000 and paid $250,000 in gift tax on the gift. The property was worth $5 million on the date of Jake’s death. In filing Jake’s federal estate tax return, Jake’s executor elected to use the alternate valuation date (AVD). Six months after Jake’s death, the property’s value had declined to $4.5 million.

In addition, Jake gifted lakefront residential property with a fair market value of $500,000 to Dave 2 years before he died. The annual exclusion was not available for this gift, and Jake paid $130,000 in gift tax. The property had a value of $750,000 on the date of Jake’s death and $700,000 on the alternate valuation date.

Which of the following statements regarding the amounts included on Jake’s federal estate tax return is(are) CORRECT?

1. Jake’s gross estate will include $380,000 in gift taxes paid.
2. The commercial property will be included in Jake’s taxable estate as an adjusted taxable gift (ATG) at a value of $989,000.
3. The commercial property will be included in Jake’s gross estate at a value of $4.5 million.
4. The lakefront property will be included in Jake’s gross estate at a value of $700,000.

Answer 9

Statement 1 is incorrect; only the gift taxes paid on gifts made within 3 years of death are included in the gross estate, so only $130,000 in gift tax is included in Jake’s gross estate.

Statement 2 is correct; adjusted taxable gifts are included in the taxable estate at their date-of-gift value minus any annual exclusion amount that was applied to the gift.

• $1,000,000 - $11,000 = $989,000

Statement 3 is incorrect; the commercial property will not be included in the gross estate. It will be included in the taxable estate as an adjusted taxable gift (ATG).

Statement 4 is incorrect because gifts made within 3 years of death are generally not included in the gross estate. The lakefront property will be included in Jake’s taxable estate as an adjusted taxable gift at its date-of-gift value.

Question 10

Which form of investment is most appropriate for a first-time real estate investor that is concerned about liquidity and diversification?

A)

Shares of a real estate investment trust

B)

Limited partnership

C)

Direct ownership of a suburban office building

D)

An undivided participation interest in a commercial mortgage

Answer 10

Of these investment choices, real estate investment trusts (REITs) are the most liquid because the shares are actively traded. Also, REITs provide quick and easy diversification across many properties.

Neither the direct investment nor the mortgage participation is liquid, and significant capital would be required to diversify the investments.

Question 11

Julie earns $40,000 per year and her employer provides a flexible spending account (FSA). Julie and her husband incur $5,000 in annual child-care expenses for their 2 children. Which of the following statements regarding Julie’s choices within her FSA is(are) CORRECT?

1. Julie’s maximum salary reduction for a dependent care FSA is $5,000.
2. Julie’s maximum salary reduction for dependent care FSA is $2,700.
3. Julie would be eligible for an FSA even if she were self-employed.
4. Julie’s contributions to her FSA are not subject to payroll taxes.

A)

1 and 3

B)

1 and 4

C)

2 only

D)

2 and 4

Answer 11

B)

1 and 4

Julie’s maximum salary reduction for a dependent care FSA is $5,000

Julie’s contributions to her FSA are not subject to payroll taxes.

Explanation

The maximum salary reduction for a dependent care FSA is $5,000. Excluded income not subject to FICA

The maximum amount available for reimbursement of incurred medical expenses of an employee (and dependents and other eligible beneficiaries) under the health FSA for a plan year (or other 12 month coverage period) cannot exceed $2,700 for 2019.

FSA benefits cannot be provided to self-employed persons or partners.

Question 12

Janice has owned her own company for 25 years. She is now 54 and wishes to retire at 64. She currently employs 5 people, all between the ages of 24 and 33. If Janice wanted to establish a retirement plan with the highest benefit for her, assuming the company has adequate cash flow, what is the most appropriate plan?

A)

Traditional defined benefit pension plan.

B)

Age-based profit-sharing plan.

C)

Cash balance pension plan.

D)

Money purchase pension plan.

Answer 12

Traditional Defined Benefit Pension Plan

A defined benefit pension plan is the best choice because a traditional defined benefit pension plan favors older participants and would allow the maximum contribution for Janice. This plan is especially appropriate because the company has adequate cash flow.

The other plans are incorrect because:

A cash balance pension plan does not favor older participants. Janice is age 54 and wants to retire in 10 years.

Money purchase pension plans do not favor older participants with larger annual contributions than a similarly compensated younger participant.

Although an age-based profit-sharing plan will favor older participants, it is still a defined contribution plan and would be subject to annual additions limits. A traditional defined benefit pension plan will allow for a larger contribution for Janice. An age-based profit-sharing plan would only be appropriate if the company had unstable cash flows.

Question 13

Grant, age 50, has a life insurance policy with a $500,000 face amount and a cash value of $200,000. The face amount will remain constant for Grant’s life, but no further premiums are due once Grant reaches age 65. This year, Grant receives a policy dividend of $100. What type of life insurance policy does Grant own?

A)

Term life to age 65

B)

Nonparticipating limited pay whole life

C)

Level term life insurance policy

D)

Participating limited pay whole life

Answer 13

D)

Participating limited pay whole life

Grant’s policy is a participating limited pay whole life policy. The fact that George received a policy dividend indicates he has a participating policy. The fact that no further premiums are due once he reaches age 65 indicates he has a limited pay whole life policy. The policy is not a term life insurance policy because it has a cash value.

Question 14

Which of the following statements most accurately describes one of the advantages of investing in real estate investment trusts (REITs)? REITs:

A)

lack of control.

B)

have lower price and return volatility than a comparable direct investment in properties.

C)

can pass on tax losses to their investors as deductions from their taxable income.

D)

limit investor liability to only the amount of the investor’s original capital investment.

Answer 14

REIT investors have no liability for the REITs in which they invest beyond the original amount invested. REITs usually cannot pass on tax losses to their investors as deductions from taxable income. Because REIT prices and returns are determined by the stock market, the value of a REIT is more volatile that its appraised net asset value.

Question 15

Dr. Argon is a dentist who operates as a sole proprietor. He bought a sterilization machine for $5,000. He used the MACRS 7-year percentages to recover the cost of the machine. Dr. Argon sold the machine in the current year for $3,000. He has claimed $1,200 of cost recovery deductions. How much will his gain or loss be in the current year?

A)

$800 ordinary loss.

B)

$1200 ordinary income.

C)

None of these.

D)

$0.

Answer 15

Dr. Argon calculates his gain or loss as follows:

1. Purchase price$5,000
2. Less: Depreciation taken− $1,200
3. Adjusted basis$3,800
4. Sales price$3,000
5. Less: Adjusted basis− $3,800
6. Realized loss($800)

If depreciated business property is sold at a gain, it falls under the Section 1245 rules. If it is disposed of at a loss, the loss is ordinary under Section 1231.

Question 16

Ken, age 23, a full-time student at a state university, is claimed as a dependent by his parents. He earned $1,600 from a summer job this year (2019). In addition, he received $1,350 of interest income from a savings account established with funds inherited from his grandmother. He had total itemized deductions of $150 in the current year. What is Ken’s taxable income this year?

A)

$1,000.

B)

$2,950.

C)

$2,000.

D)

$0.

Answer 16

Gross Income less Above the Line Deductions = AGI less Standard/Itemized = Taxable Income

A) $1,000.

$1,600 earned income + $1,350 interest income = $2,950 − $1,950 (the standard deduction is limited to earned income + $350). Therefore, taxable income is $1,000. The standard deduction for a dependent is limited to the greater of (1) $1,100, or (2) earned income plus $350 (limited to the regular standard deduction). Because Ken’s earned income is $1,600, he is entitled to claim a standard deduction of $1,950 ($1,600 + $350).

Question 17

The government is concerned about inflation and a possible recession. In an effort to curb these events, the Federal Reserve decides to sell government securities in the open market. Which of the following is NOT a consequence of this action?

A)

Less money will be circulating in the economy

B)

Banks will aggressively lend money to stimulate growth

C)

Consumer purchasing may decrease

D)

Interest rates will increase

Answer 17

B)

Banks will aggressively lend money to stimulate growth

Due to rising interest rates, banks will be forced to reduce to amount of money they can lend to borrowers. If consumers have less money available, this will further curb spending and may help to reduce inflationary pressures.

Question 18

In January 2019, Colleen gifted real estate valued at $10 million to her nephew, Greg. Her basis in the property was $4 million. The annual exclusion was not available, and she paid gift tax on the gift. In November 2019, Colleen dies unexpectedly in an automobile accident. On the date of her death, the real estate has a value of $11 million. Which of the following statements regarding the tax consequences of this gift is(are) CORRECT?

1. The gift tax paid on the gift of the real estate will be included in Colleen’s gross estate.
2. The real estate will be included in Colleen’s gross estate at a value of $11 million.
3. The real estate will be included in Colleen’s taxable estate as an adjusted taxable gift of $10 million.
4. Greg will receive a stepped-up basis of $11 million in the real estate as a result of Colleen’s death.

A)

1 only

B)

1, 3, and 4

C)

2 and 4

D)

1 and 3

Answer 18

D) 1 and 3

(1) The gift tax paid on the gift of the real estate will be included in Colleen’s gross estate.
(2) The real estate will be included in Colleen’s taxable estate as an adjusted taxable gift of $10 million.

Statement 1 is correct; because the gift was made within 3 years of Colleen’s death, the gift tax paid will be included in her gross estate.

Statement 2 is incorrect and Statement 3 is correct; the gifted real estate is not included in Colleen’s gross estate but is included in her taxable estate as an adjusted taxable gift of $10 million.

Statement 4 is incorrect; Greg received the real estate as a lifetime gift, so he receives a carryover basis-not a stepped-up basis-in the property.

Question 19

Samuel’s bond has a current market value of $1,056.78 and Macaulay duration of 7.9. If the bond’s yield-to-maturity (YTM) changes from 5.5% to 4.0%, what is the expected percent change in the market price of the bond?

A)

5.11%

B)

-14.20%

C)

11.23%

D)

1.50%

Answer 19

C) 11.23%

1. The formula for determining the percent change in the price of the bond:
2. ΔP/P = −D(Δy ÷ (1 + y))
3. ΔP/P = −7.9[(0.04 − 0.055) ÷ (1 + 0.055)]
4. ΔP/P = −7.9(−0.0142) = 0.1123, or 11.23%

General Rule

1. As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration. If a bond has a duration of five years and interest rates increase 1%, the bond’s price will drop by approximately 5% (1% X 5 years). Likewise, if interest rates fall by 1%, the same bond’s price will increase by about 5% (1% X 5 years).

Question 20

Dwayne and Maya are existing high net worth clients. In their recent annual financial plan review, the couple indicated that they are prepared to select an education savings account for their son, Robinson. Based on their income, the couple does not anticipate receiving any financial aid. Their primary concern is guaranteeing that the funds set aside for Robinson’s education are used specifically for that purpose. In addition, Dwayne and Maya prefer that the assets remain in their control after Robinson attains age 18. Select the college savings account(s) that best meet(s) the couples’ needs.

1. A parent-owned 529 account
2. An UTMA account
3. A CESA account
4. A trust with spendthrift provision

A)

2 and 4

B)

1 and 4

C)

1, 3, and 4

D)

1 only

Answer 20

A parent-owned 529 account & A trust with spendthrift provision

A parent-owned 529 account will remain under the control of Dwayne and Maya after their son is 18. To receive all of the tax advantages associated with 529 accounts, funds must be used on qualified education expenses.

With the guidance and assistance of an estate planning attorney, the couple may also design a trust that disburses funds for college expenses only and remains in the control of the trustee beyond the age of majority.

A CESAs assets are distributed to the beneficiary at age 30 if they are not used.

An UTMA is a custodial account in the child’s name. When the child reaches the age of majority (18 or 21, depending on state), they assume ownership of the account and are not required to use the funds for education

Question 21

Mrs. Chips taught elementary school for 30 years for a public school district that opted out of Social Security. Her monthly benefit from the State Teacher Retirement System is $2,400. Her husband was hired by the federal government in 1986. Both spouses have reached their full retirement age and are ready to start their Social Security benefits. Mr. Chips’ Social Security is $2,000/month. Mrs. Chips has 23 Social Security credits. What will her Social Security retirement benefits be while Mr. Chips is living?

A)

$0/month even though a spouse does not have to be fully insured to receive spousal retirement benefits.

B)

$1,000/month. Social Security spousal retirement benefits are 50% of the worker’s PIA.

C)

$0/month because she is not fully insured.

D)

$1,500/month. Social Security spousal retirement benefits are 75% of the worker’s PIA.

Answer 21

$0/month even though a spouse does not have to be fully insured to receive spousal retirement benefits.

• Mrs. Chips is subject to the Government Pension Offset.
• Since she receives a retirement from an employer at which she was not FICA taxed on the income, her spousal Social Security benefits are reduced by 2/3rds of her state and local government pension amount. In this case, she is receiving $2,400/month. $2,400 x .6667 = $1,600/month.
• So, Mrs. Chips loses $1,600 of spousal Social Security per month. Since her spousal Social Security retirement benefits are 50% of her husband’s PIA of $2,000, she is initially entitled to $1,000/month.
• The $1,000 is reduced by the $1,600 Government Pension Offset and she will get nothing currently. Most teachers find this most unsatisfactory. Financial planners who do not warn them about this would also be found most unsatisfactory.

Question 22

Which of the following types of property is(are) excluded from personal property coverage under Coverage C of a homeowners policy?

1. Pets
2. Property belonging to tenants who are not related to the insured
3. Credit cards
4. Cash

A)

2 only

B)

3 and 4

C)

1, 2, and 3

D)

1 only

Answer 22

C)

1, 2, and 3

Pets, property belonging to tenants who are not related to the insured, and credit cards are all excluded. Cash is not excluded but coverage is limited to $200.

Question 23

Andrew, age 79, wants to make a sizeable gift of most of his property to a local charity, but he would also like to retain an income interest from the property for the remainder of his life. He consults a CFP® professional for advice. After considering Andrew’s objectives and current financial status, the CFP® professional recommends that Andrew make a transfer to the charity’s pooled income fund. Assuming Andrew accepts this recommendation, which of the following steps are likely to be involved in implementing the recommendation?

1. The charity will establish a separate fund to hold Andrew’s donation.
2. Andrew will receive an annual income payment from the fund.
3. Andrew will claim an income tax charitable deduction.
4. The charity will invest Andrew’s donation in tax-free municipal bonds.

Answer 23

1. Andrew will receive an annual income payment from the fund.
2. Andrew will claim an income tax charitable deduction.

Statement 1 is incorrect because in a pooled income fund, a donor’s contribution is commingled with the property of other donors.

Statements 2 and 3 are correct.

Statement 4 is incorrect because a pooled income fund cannot invest in tax-free municipal bonds. (Domain 6-Implementing the Recommendation(s))

Question 24

In 2016, Nicole (age 40) converted her traditional IRA ($10,000) to a Roth IRA. She then contributed $2,000 to her Roth IRA for 2017 and $2,000 for 2018. Her total earnings to date in the Roth IRA have been $1,260. In 2019, the following events occurred.

1. In April, Nicole bought a new puppy. She withdrew $3,500 from her Roth IRA to cover this expense.
2. In July, Nicole took the CFP® Certification Examination and passed. To reward herself, she withdrew $4,000 from her Roth IRA to go on vacation in the Bahamas.
3. In September, Nicole decided to go back to school and get her master’s degree. She withdrew $7,000 for tuition expense.
4. In November, Nicole’s accountant sent her a letter along with a bill for $50 reminding her that the purpose of her Roth IRA was not to withdraw money but to put money in. Nicole promptly took out $50 from her Roth IRA and paid her accountant’s bill in full.

In which of these events would the 10% early withdrawal penalty apply to Nicole’s Roth IRA withdrawals?

A)

1 only.

B)

2, 3, and 4.

C)

2 and 4.

D)

4 only.

Answer 24

FIRST = Qualified Distributions?

1. None of the distributions is a qualified distribution because the Roth is only 4 years old in 2019. Thus, the very first test for a qualified distribution, the 5 year test, has failed.
2. NOTE - distributions for educational expenses

Distributions from a Roth IRA are ordered as follows:

1. From regular contributions (no tax, no penalty)
2. From conversions, FIFO (no tax, subject to penalty if attributed to conversion within 5 years)
3. Earnings (subject to income tax and the 10% early withdrawal penalty without a qualified distribution)

The first thing to do is to group the Roth account into three categories:

1. contributions
   
   1. 4,000
2. conversions
   
   1. 10,000
3. earnings
   
   1. 1,260

Contributions

1. Nicole’s first withdrawal of $3,500 is all attributed to regular contributions. This is a tax-free return of contributions. As such, she will not be subject to either income taxes or the early distribution penalty. The puppy withdrawal leaves her with $500 of contributions and the conversion and earnings categories are unchanged.
2. Her second distribution is attributed $500 to her contributions (and $3,500 below) and the$500 of contributions is totally tax-free and without penalty.

Conversions

1. $3,500 to the conversion from 2016.
2. The $3,500 from the vacation conversion had been subject to income tax in 2016, so it will not be income taxed again. If the conversion would have been at least five years old, there would not be any early distribution penalty either. However. the conversion was not five years old, so the $3,500 is subject to the 10% early distribution penalty of $350.
3. After the vacation withdrawal, she has $6,500 of conversions and $1,260 of earnings left. The third distribution starts out as subject to the penalty because it is within 5 years of the conversion, however, the funds were distributed to pay for higher education, so an exception to the penalty applies. After the tuition withdrawal, she only has earnings left in the Roth account.

Earnings

1. Her fourth withdrawal is attributed to earnings and is subject to both income tax and the early withdrawal penalty.

Question 25

Vince, age 53, recently lost his salaried job in which he earned $95,000 per year, due to his company downsizing the management team. He communicates to his CFP® professional that he is working with an executive placement agency to prepare a resume and search for another position within his field of expertise. In the meantime, he is concerned that he will not have enough liquidity to pay for his current expenses. Which of the following should the CFP® professional recommend to Vince to provide for his current needs?

A)

Take a loan from his Section 401(k) plan, with a balance of $350,000, and place this money into an interest-bearing money market deposit account.

B)

Elect a Section 72(t) distribution from his traditional IRA worth $73,500.

C)

Sell his collection of inherited artwork worth $40,000 at auction.

D)

Sell a portion of his ABC stock that he purchased five years ago for $25,000, which is currently worth $50,000.

Answer 25

D)

Sell a portion of his ABC stock that he purchased five years ago for $25,000, which is currently worth $50,000.

Selling the stock would be best choice because the stock is currently trading at a gain and the sale would be taxed at favorable long-term capital gains rates.

Because Vince has separated from service, any loan provision in the Section 401(k) plan will not be available.

Selling artwork at auction does not guarantee that he will receive full value. In addition, the auction house may take a commission on the sale.

Electing a Section 72(t) distribution from his traditional IRA may not provide the necessary funds based on his life expectancy and the impact of taxation.

Question 26

The following assets were used in John’s business:

1. Equipment with 4-year holding period and gain of $2,100
2. Truk with a 6-month holding period and a loss of $1,200
3. Common Stock (capital assets) with a 3-year holding period and a gain of $2,000

The equipment had an adjusted basis of zero and was purchased for $8,000. The truck was purchased for $3,000 and sold for $1,800. The stock was purchased for $3,000 and sold for $5,000. In the current year (the year of the sale), John should report what amount of net capital gain and net ordinary income?

A)

$800 long-term capital gain and $900 ordinary gain.

B)

$2,000 long-term capital gain and $900 ordinary gain.

C)

$2,100 long-term capital gain.

D)

$4,100 long-term capital gain and $1,200 ordinary loss.

Answer 26

B)

$2,000 long-term capital gain and $900 ordinary gain.

The equipment is fully depreciated, so the entire gain of $2,100 will be taxed as ordinary income because of Section 1245 depreciation recapture. The truck was held short term (not more than 1 year), and as a result, the entire $1,200 loss is treated as an ordinary, not capital, loss. The sale of the common stock is treated as a long-term capital gain.

Question 27

XY Trust is a complex trust with 2 beneficiaries, Kerri and Melody. In the current taxable year, the trust had distributable net income (DNI) of $50,000, $10,000 of which was nontaxable. The trustee made a $15,000 cash distribution to Kerri and a $20,000 cash distribution to Melody. What amount of taxable income from the trust should Kerri and Melody report, respectively?

Answer 27

$12,000

$16,000

The taxable portion of the distribution is based on the taxable portion of the distributable net income (DNI). Therefore, $12,000 [$15,000 distribution × ($40,000 taxable DNI ÷ $50,000 total DNI)] of the distribution will be taxable to Kerri, and $16,000 [$20,000 distribution × ($40,000 taxable DNI ÷ $50,000 total DNI)] of the distribution will be taxable to Melody.

Question 28

Harry purchased 6,000 shares of IBM common stock 18 years ago for $8.75 per share. The stock split 3 times and is now valued at $75.00 per share. The broker’s commission on the purchase was 3%. What is Harry’s adjusted basis?

A)

$54,075.

B)

$52,500.

C)

$3,601,575.

D)

$3,600,000.

Answer 28

The adjusted basis is calculated by starting with the original purchase price (6,000 shares × $8.75 = $52,500) and increasing it by certain allowable costs.

In this case, the only allowable cost that may be used to increase the basis is the broker’s commission ($52,500 × 0.03 = $1,575).

Harry’s adjusted basis is $52,500 + $1,575 = $54,075.

The LESSON IS…Stock Splits don’t affect basis

Question 29

The following details are available for the Prime Growth Fund, the S&P 500, and the U.S. T-bill rate (risk-free rate) for the past 5-year period.

Prime Growth:

1. Average Annual Rate of Return = 12.00%
2. Standard Deviation of Return = 22%
3. BETA =1.12
4. Sharpe Ratio = 0.41
5. Treynor Ratio = 0.080
6. Jensen’s Alpha = 0.017
7. R Squared = 0.29

S&P 500

1. Average Annual Rate of Return = 9.50%
2. Standard Deviation of Return = 14%
3. BETA =
4. Sharpe Ratio = 0.46
5. Treynor Ratio = 0.065

T-Bill

1. Average Annual Rate of Return = 3.00%

Based on the results, we can conclude that the Prime Growth Fund:

A)

under performed the market bases on a systematic risk-adjusted basis.

B)

seems to have under performed the market based on total risk basis but out performed the market based on a systematic risk-adjusted basis.

C)

contains virtually no unsystematic risk.

D)

out performed the market on a total risk-adjusted basis.

Answer 29

B)

seems to have under performed the market based on total risk basis but outperformed the market based on a systematic risk-adjusted basis.

Remember:

1. Risk-Adjusted Performance = Sharpe Ratio = Standard Deviation
2. Systematic Risk-Adjusted Performance = Jensen’s Alpha / Treynor Ratio = Beta
3. Low R Squared = Lot of Unsystematic Risk in Portfolio. Need to use Standard Deviation to measure Risk.

The Sharpe ratio for the Prime Growth Fund is lower than the S&P 500, hence the fund has underperformed the market on a total risk-adjusted basis.

Jensen’s alpha is positive and the Treynor ratio is higher for the Prime Growth Fund as compared to the S&P 500. Hence, Prime Growth outperformed the market on a systematic risk-adjusted basis.

Also, note that the fund has a low R2 value, meaning that the fund is not very well diversified and likely contains a significant amount of unsystematic risk.

Question 30

Which of the following individuals are highly compensated employees for qualified plan purposes for 2019? Assume the company made no relevant elections regarding the top 20% of employees.

1. Steve, a 6% owner of an incorporated law firm.
2. Mike whose salary was $180,000 last year and who was the company’s top-paid employee.
3. James, whose salary was the 10th highest of 40 people, and who earned $130,000 last year.
4. Donna, the corporate vice president of marketing, and an officer, whose salary last year was $85,000.

Answer 30

For 2019, an HCE is anyone who is:

1. a greater than 5% owner, or
2. anyone who received in excess of $125,000 in compensation during the previous year (2018).

Because the law includes a look-back provision, employees who earned more than $125,000 in 2018 are generally considered HCEs for 2019 plan year testing.

Steve is an HCE because of his ownership percentage, and Mike and James are HCEs because of income (either this year or last year in conjunction with the lack of the 20% election).

Question 31

Which of the following assets is NOT generally considered a capital asset?

A)

A personal auto.

B)

U.S. government securities held for investment.

C)

A computer used in a business.

D)

A personal residence.

Answer 31

The business computer is Section 1231 property, not a capital asset.

A capital asset is any asset that is not

1. copyright or creative work,
2. accounts or notes receivable,
3. depreciable property used in a trade or business or for production of income (such as a computer), or
4. inventory.

Section 1231 property is a type of property, defined by section 1231 of the U.S. Internal Revenue Code. Section 1231 property is real or depreciable business property held for more than one year.

Under old §1221(a)(3)

1. self-created copyrights were excluded from capital assets because, so the theory went, a self-created copyright represents the product of an individual’s labor much like inventory or services.
2. Gain from the sale of a copyright by the creator of the copyright was treated as ordinary income, just like selling inventory or services.
3. Besides copyrights, items such as literary, musical and artistic compositions were also ordinary.

As of January 1, under new §1221(a)(3)

1. patents, inventions, models or designs (whether or not patented), and secret formulas and processes that are created by a taxpayer’s “personal efforts” are all treated as ordinary.
2. This means that essentially all self-created software will be caught by this new rule. It also applies to self-created “models” and “secret processes” that includes many start-up business assets.

Question 32

Michael Jones is 71 years old (life expectancy 26.5 years based on the uniform distribution table) and must now begin receiving IRA required minimum distributions. As of December 31st of the previous year, his IRA accounts were valued as follows:

IRA 1:

1. $25,000

IRA 2:

1. $14,000

IRA 3:

1. $8,000

IRA 4:

1. $46,000

IRA 5:

1. $17,000

Answer 32

he aggregate total of Mr. Jones’ IRA accounts is $110,000. Therefore, $110,000 divided by 26.5 equals $4,151.

Question 33

Bailey and Jen, both age 28, are married and file a joint tax return. They have an AGI of $198,000 and have each contributed $3,000 to a Roth IRA during 2019. Bailey’s mother contributed $2,000 to a Coverdell Education Savings Account for each of their 2 children. Neither Bailey nor Jen is an active participant in employer sponsored retirement plan. What is the most that Bailey and Jen can contribute in total to a traditional IRA for 2019?

A)

$3,000.

B)

$6,000.

C)

$0.

D)

$10,000.

Answer 33

The maximum contribution to traditional and Roth IRAs is a total of $6,000 per person (who has not attained age 50) for 2019.

They have already contributed to a Roth IRA and they have an AGI in the phaseout range for 2019.

Thus, the first thing to check is whether they can keep their current Roth IRA contributions for this year.

1. Their maximum Roth contribution is phased out by 50% because their income exceeds the initial phase-out limit of $193,000.
2. The phase-out range for 2019 is $193,000 - $203,000.
   
   1. ($198,000 - $193,000)/$10,000 = .50 $6,000 x .50 = $3,000.
3. This is what they have each contributed to the Roth IRAs this year, so they may keep their current contributions, but they are not allowed any additional Roth IRA contributions this year.
4. However, they can still make a deductible contribution of $6,000 ($3,000 each) to a traditional IRA for 2019. This is because neither of them is an active participant. $6,000 is the combined contribution limit between Roth IRA and traditional IRA. The most Bailey and Jen may contribute to a traditional IRA is $3,000 each, and the contributions are deductible.

Question 34

Joel is a financial planner who uses the strategic management financial counseling process with his clients. Which of the following statements regarding Joel’s approach to financial counseling is(are) CORRECT?

1. Joel attempts to replace clients’ negative beliefs that lead to poor financial decisions with positive attitudes that lead to better results.
2. Joel conducts a SWOT analysis (identifying strengths, weaknesses, opportunities, and threats) early in the financial planning process.
3. Joel uses the clients’ goals and values to drive the client-planner relationship.

A)

1 and 2

B)

1 only

C)

2 and 3

D)

1, 2, and 3

Answer 34

Statements 2 and 3 are correct. Statement 1 is incorrect because it represents the cognitive-behavioral approach to financial counseling.

Question 35

Which of the following persons would be required to register with FINRA?

1. Jennifer, a CFP® professional, wants to market IRAs funded with mutual funds.
2. Louis, a CPA, is planning to add fixed insurance products to his portfolio of client offerings.
3. Jordan, an attorney, wants to provide private money management services, including securities trading, to his clients for a fee and/or commission.
4. Hannah, a life insurance agent, who wishes to sell variable universal life insurance policies.

A)

1, 2, and 3

B)

2 and 4

C)

1 and 2

D)

1, 3, and 4

Answer 35

A person must be registered with FINRA in order to sell securities. Therefore, Jennifer, Jordan, and Hannah need to register.

Variable Insurance needs it but fixed insurance won’t!

Question 36

Pauline wants to set up a trust that will pay a fixed annuity to her favorite charity for 15 years. At the end of the 15-year trust term, the assets remaining in the trust will pass to her 3 grandchildren equally. The grandchildren are currently 9, 12, and 15 years old. Pauline plans to contribute securities having a total fair market value of $10 million to the trust. Which of the following trusts is(are) suitable for meeting Pauline’s objectives?

1. CRAT
2. CLUT
3. CLAT
4. Section 2503(b) minor’s trust

Answer 36

Statement 3 is the only answer choice that is suitable for meeting Pauline’s needs.

A charitable lead annuity trust (CLAT) pays a fixed annuity to the charitable beneficiary for the term of the trust, with the remainder passing to noncharitable beneficiaries.

1. Statement 1 is incorrect because a CRAT pays a fixed annuity to noncharitable beneficiaries and the remainder to charity.
2. Statement 2 is incorrect because a CLUT pays a variable (not fixed) income interest to the charity, with the remainder to noncharitable beneficiaries.
3. Statement 4 is incorrect because with a Section 2503(b) trust, all trust income must be distributed annually for the benefit of the minor beneficiary.

Question 37

The XYZ Corporation is a C corporation with 4 shareholders. The total value of the corporation is $1 million. The shareholders want to ensure that if any of them dies, the corporation will redeem their shares. The corporation does not currently have enough cash to make the redemption, so the shareholders also want to provide a method of funding the agreement. Which of the following recommendations would best accomplish the shareholders’ objectives?

A)

Enter into an entity-purchase buy-sell agreement funded with 4 life insurance policies of $250,000 each.

B)

Enter into a cross-purchase buy-sell agreement funded with 4 life insurance policies of $250,000 each.

C)

Implement a self-canceling installment note (SCIN) between the corporation and each shareholder.

D)

Implement a corporate recapitalization.

Answer 37

The best recommendation is to enter into an entity-purchase buy-sell agreement funded with 4 life insurance policies of $250,000 each.

The corporation would own a $250,000 life insurance policy on each shareholder and would use the death proceeds to buy the shares of an owner who dies.

With a cross-purchase buy-sell agreement, the surviving shareholders would purchase the shares of a deceased shareholder.

A SCIN is typically used to sell an asset to a family member, with a provision that the note is automatically canceled upon the seller’s death.

A corporate recapitalization is an estate freeze technique used to gift a corporation to younger family members using valuation discounts.

Question 38

Derrick is involved in an automobile accident. The other driver is seriously injured and incurs medical expenses of $200,000. Following the accident, the other driver’s employer-provided health insurance covers $180,000 of these expenses. At the ensuing trial, the judge finds that Derrick’s negligence caused the accident and that he is responsible for the other driver’s injuries. Which of the following statements regarding the application of the collateral source rule to this situation is CORRECT?

A)

Derrick is not required to pay any damages because the other driver recovered from his own insurance company.

B)

Derrick must pay only $20,000 in damages because the other driver recovered $180,000 from a collateral source.

C)

Derrick must pay the entire $200,000 in damages even though the other driver’s insurance covered $180,000 of his medical expenses.

D)

Derrick must pay $10,000 in damages, representing 50% of the amount not paid by the other driver’s health insurance.

Answer 38

Derrick must pay the entire $200,000 in damages even though the other driver’s insurance covered $180,000 of his medical expenses.