Practice Exam 2

Question 1

Question 1 of 80

Use the information below about Lisa and Tom Stewart to answer the question that follows.

Lisa and Tom are both age 48 and are planning to retire at age 62.

They estimate that their annual income need at retirement will be $42,000 in today’s dollars.

They expect to receive $12,000 (in today’s dollars) annually from Social Security and they wish to include this amount in their retirement needs analysis.

Assume that Social Security benefits will be adjusted for inflation.

After discussions with their financial planner, they feel confident that they can earn a 7% after-tax return on their investments and would like to assume that inflation will average 4% over the long term.

Life expectancy tables are provided in IRS Regulations Section 1.401(a)(9)-9. RMD Single Life Table—Life Expectancy indicates a factor of 23.5 years at age 62. RMD Joint Life and Last Survivor Table—Life Expectancy indicates a factor of 29.0 years at age 62.

Due to a history of longevity in both their families, Lisa and Tom would like to assume a retirement period of 35 years.

What amount of assets will Lisa and Tom need at the beginning of their retirement period to fund an annual income need that increases annually with inflation—i.e., a growing annuity?

(LO 1–3)

a. $1,017,211 (+/– $20)
b. $1,135,304 (+/– $20)
c. $1,168,053 (+/– $20)
d. $1,635,275 (+/– $20)

Answer 1

c. $1,168,053 (+/– $20)

STEP 1
Begin
1 P/YR

N = 14
I = 4
PV = 30,000
PMT = 0
FV = ? 

FV = 51,950.2934

STEP 2
Begin
1 P/YR

N = 35
I = 2.8846
PV = ?
PMT = 51,950.2934
FV = 0 

PV = 1,168,062.4730

Question 2

Question 2 of 80

Use the information below about Kevin and Cindy Penny to answer the question that follows.

Kevin and Cindy are both age 38 and are planning to retire at age 65.

They estimate that they will need a lump sum of $2.4 million at retirement to provide the income stream required during their retirement years.

They project that their current assets will grow to a value of $1.9 million at the first year of retirement.

They feel they can earn a 6% after-tax return on their investments and would like to assume that inflation will average 4% over the long term.

They would like to increase their annual savings amount each year as their incomes increase.

They would like to assume a 30-year period of retirement.

They have no heirs and would like to assume the worst-case scenario: that they will use up all their assets during retirement.

They would like you, their financial planner, to determine the annual serial saving requirement needed to make up for their asset shortfall.

What is the first end-of-year savings payment, adjusted for inflation, that Kevin and Cindy must set aside?

(LO 1–3)

a. $5,060
b. $5,157
c. $7,849
d. $8,626
e. $14,871

Answer 2

b. $5,157

First, the capital utilization method is being used. Their asset shortfall is $500,000 ($2,400,000 – $1,900,000). This shortfall must be deflated at a 4% rate over the 27 years until retirement (age 38 to age 65). The deflated value of additional savings needed at retirement is $173,408.

STEP 1:
Begin
1P/YR

N = 27
I = 4
PV = ?
PMT = 0
FV = 500,000 

PV = 173,408.2851

STEP 2:
End
1P/YR

N = 27
I = 1.9231
PV = 0
PMT = ?
FV = 173,408.2851

PMT = 4,958.982

4,958.982 + 4% = 5,157.3413

Question 3

Question 3 of 80

Use the information below about Kent and Susan Olson to answer the question that follows.

Kent and Susan are both age 32 and are planning to retire at age 62.

They estimate that they will need a lump sum of $4.3 million at retirement to provide the inflation-adjusted income stream required during their retirement years.

They project that their current assets will grow to a value of $3.1 million by their first year of retirement.

They feel they can earn a 6% after-tax return on their investments and would like to assume that inflation will average 4% over the long term.

They want to fund their retirement by making level annual payments.

They would like to assume a 26-year period of retirement.

Using the capital utilization method, what annual end-of-year savings will the Olsons need to deposit during their preretirement years?

(LO 1–4)

$9,230

$9,419

$9,600

$15,179

$15,786

Answer 3

$15,179

The $15,179 level payment is determined by using the following variables: 30 years until retirement, 6% after-tax rate of return, and $1.2 million (FV) of additional savings needed at retirement. Then one solves for the payment to be made at the end of the year.

STEP 1:
End
1P/YR

N = 30
I = 6
PV = 0
PMT = ?
FV = 1,200,000 

PMT = 15,178.6938

Question 4

Question 4 of 80

Which one of the following is a correct statement about a Roth IRA?

a. An individual could contribute $5,500 to a regular IRA and $5,500 to a Roth IRA in 2016.
b. Withdrawals of up to $10,000 from a Roth IRA for the purchase of a first home are tax free and penalty free if the withdrawals are made at least five years after the first contribution to the Roth IRA.
c. If a non-qualifying distribution is made prior to age 59½, the principal is subject to the 10% penalty but is not considered taxable income.
d. As with conventional IRAs, distributions must begin from a Roth IRA by April 1 of the year following the year the participant reaches age 70½.

Answer 4

b. Withdrawals of up to $10,000 from a Roth IRA for the purchase of a first home are tax free and penalty free if the withdrawals are made at least five years after the first contribution to the Roth IRA.

Answer a. is incorrect because an individual is limited to contributing $5,500 to both IRAs—e.g., the contributions could be $2,750 to a Roth and $2,750 to a conventional IRA.

Answer c. is incorrect because if a non-qualified distribution is made, the tax and penalty apply only to the earnings of the Roth IRA.

Answer d. is incorrect because the minimum distribution rules that require distributions from IRAs beginning at age 701⁄2 do not apply to Roth IRAs, but the minimum distribution requirement for payments after the death of the participant does apply to Roth IRAs.

Question 5

Question 5 of 80

Mr. and Mrs. Dalloway file their taxes jointly. Mr. Dalloway has been out of work for over 18 months. He earned $1,746 this year doing odd jobs. Mrs. Dalloway earned $84,000 this year and is an active participant in the 401(k) plan at work. She contributed $2,700 to her IRA and the maximum to Mr. Dalloway’s IRA for this year.

How much can they deduct for their IRA contributions?

(LO 5–2)

$0

$5,500

$5,746

$8,200

$11,000

Answer 5

$8,200

The maximum contribution for spousal IRAs is $5,500. The combined contribution for the husband and wife, however, cannot exceed the total compensation of both spouses, and the deduction cannot exceed the contribution. She only contributed $2,700 to her IRA.

Question 6

Question 6 of 80

Harry Colvert is a full-time employee at Tops Roofing Materials Inc. (TRM); he does not own any stock in TRM. Harry also operates a part-time sole proprietorship consulting business, which is not related to TRM in any way. Last year, his part-time business generated $25,000 of net earnings from self-employment. He wants to maximize the contributions to the profit sharing Keogh plan that he has established for this business.

Which one of the following statements describes the limits that apply in Harry’s situation?

(LO 3–9)

a. He is not permitted to contribute any funds to his account in the Keogh plan this year.
b. He may contribute 20% of his net earnings from self-employment to his account in the Keogh plan.
c. He may contribute 25% of his net earnings from self-employment to his account in the Keogh plan.
d. A special calculation must be made that considers his aggregate compensation from TRM and the sole proprietorship.
e. He may contribute $25,000 (100% of his net earnings from self-employment) to the Keogh plan.

Answer 6

b. He may contribute 20% of his net earnings from self-employment to his account in the Keogh plan.

Harry’s contribution to his account in the Keogh plan cannot be the full 25% profit sharing contribution.

Due to his owner/employee status, the maximum contribution on his behalf is 20% of his net earnings from self-employment.

(Since the sole proprietorship and TRM are unrelated entities, he is not required to aggregate compensation or contributions.)

Question 7

Question 7 of 80

Which one of the following statements correctly describes a SIMPLE IRA?

(LO 5–6)

a. Employee deferrals are limited to $12,500, and employer contributions are limited to 15% of compensation.
b. SIMPLE IRAs may include loan provisions for participants who have satisfied a two-year participation period.
c. Withdrawals from a SIMPLE IRA during the first two years of participation would generally be subject to a 25% penalty tax.
d. To offer a SIMPLE IRA, an employer can have no more than 50 employees earning a minimum of $5,000.

Answer 7

c. Withdrawals from a SIMPLE IRA during the first two years of participation would generally be subject to a 25% penalty tax.

Answer a. is incorrect because employers’ contributions are limited to either a 3% matching or a 2% non-elective.

Answer b. is incorrect. SIMPLE IRAs cannot include a loan provision.

Answer d. is incorrect because employers with up to 100 employees earning a minimum of $5,000 can offer a SIMPLE IRA.

Question 8

Question 9 of 80

If a defined contribution plan is top-heavy, the required minimum employer contribution is equal to what percentage of each non-key participant’s compensation?

(LO 4–2)

2%

3%

4%

5%

Answer 8

3%

If a defined contribution plan is top-heavy, the minimum contribution to the plan is 3% per year.

Question 9

Question 10 of 80

Which one of the following rules governs how much life insurance may be provided by a qualified defined contribution plan?

(LO 6–6)

a. Any amount of permanent life insurance, accident insurance, or severance benefits may be included as part of the coverage.
b. The 25% incidental benefit cost rule is based on the portion of the premium allocated to the policy’s cash value.
c. An employer’s costs associated with the purchase of life insurance represent a nondeductible expense.
d. The cost of whole life insurance must be less than 50% of the total employer contribution allocated to a participant’s account.

Answer 9

d. The cost of whole life insurance must be less than 50% of the total employer contribution allocated to a participant’s account.

The IRS defines the term cost of a whole life insurance policy to be 50% of the premium.

A whole life insurance premium that is less than 50% of the contribution for a participant’s account will satisfy the 25% test since the term cost must necessarily be less than 25%.

Therefore, a defined contribution plan which provides that less than one-half the amount allocated annually to each participant’s account will be used to purchase whole life insurance meets the 25% test (i.e., total plan contributions used to purchase incidental benefits).

Answers a., b., and c. are incorrect for the following reasons. Incidental benefits do not include severance benefits. The 25% rule is applied to the portion of the premium used to provide term life insurance ( not cash value). Employer expenses for incidental benefits are deductible as plan contributions.

Question 10

Question 12 of 80

Which one of the following correctly states a characteristic of a type of executive benefit plan?

(LO 9–3)

a. Benefits received from a death-benefit-only (DBO) plan are subject to income tax.
b. A supplemental/salary continuation plan requires the employee to forgo current compensation.
c. Benefits payable by an excess benefit plan to an executive cannot exceed $1.5 million.
d. An excess benefit plan must be an unfunded plan.

Answer 10

a. Benefits received from a death-benefit-only (DBO) plan are subject to income tax.

DBO benefits constitute taxable income to the beneficiary.

Answer b. is incorrect because this type of plan does not require the employee to lose any current compensation.

Answer c. is wrong because there is no such limit.

Answer d. is wrong because an excess benefit plan may be funded or unfunded.

Question 11

Question 14 of 80

Which statement is true? A Medicare Part A patient must pay

(LO 1–8)

a. all costs for a hospital stay beyond 150 days.
b. the $360 annual deductible for doctor’s services in 2016.
c. all costs above the hospital deductible for a 30-day stay in a hospital.
d. the approved costs of care in a skilled nursing facility for the first 10 days.

Answer 11

a. all costs for a hospital stay beyond 150 days.

The patient must pay all costs related to a hospital stay beyond 150 days.

Answer b. is wrong because it describes the deductible for Medicare Part D coverage.

Answer c. is incorrect because it does not describe a gap; Medicare pays for the cost of the first 60 days in a hospital, but the patient must pay the Part A deductible.

Answer d. is wrong because Medicare will pay the approved charges for the first 20 days in a skilled nursing facility. The gap results from the cost of care that exceeds 20 days (the patient pays the per day copayment) or the need for custodial care.

Question 12

Question 15 of 80

James Erickson is age 56. He has worked for the Minntoe Homeless Relief Council for 18 years and received a salary of $142,000 this year. He plans to retire in nine years and participates in the tax-sheltered annuity (TSA) plan offered by his employer.

Which of the following statements apply to his contributions to the TSA?

I. He can contribute up to $18,000 in 2016, plus any catch-ups for which he may be eligible.

II. He can contribute an additional $6,000 this year under the age 50 catch-up.

III. He can take advantage of the long service catch-up provision and increase his salary deferral limit by $3,000 to make a total possible deferral of $27,000.

IV. He cannot take advantage of the long service catch-up, so his deferral is limited to $24,000.

(LO 6–2)

I and III only

I and IV only

II and III only

I, II, and IV only

I, III, and IV only

Answer 12

I, II, and IV only

The $18,000 salary reduction limit will apply plus the $6,000 age 50 catch-up, making the total $24,000.

James is not an employee of a health, education, or church organization, and therefore is not eligible for the long service catch-up.

He therefore cannot use the catch-up that allows $3,000 increases to the $18,000 limit in 2016.

Since James is 52, the age 50 catch-up allows him to increase his total deferral to $24,000 in 2016.

Question 13

Question 16 of 80

Which of the following correctly states the rules regarding distributions from an IRA plan?

I. The Section 72 annuity rules govern an IRA distribution that includes nondeductible and deductible contributions.

II. At the IRA owner’s death, the account balance exceeding the greater of $150,000 or $112,500, as indexed, is included in the decedent’s gross estate.

III. A distribution attributable to contributions to a Roth IRA is subject to the premature distribution penalty tax, if done prior to age 591⁄2.

IV. Distributions related to the death of the IRA owner are exempt from the premature distribution penalty tax.

(LO 5–3)

I and II only

I and IV only

I, II, and III only

I, III, and IV only

II, III, and IV only

Answer 13

I and IV only

Section 72 annuity rules relating to the recovery of the participant’s cost basis still apply to an IRA distribution consisting of deductible and nondeductible contributions.

(The Small Business Job Protection Act of 1996 provided a simplified method of cost basis recovery for qualified plans and TSA annuities; the provisions for IRAs were not affected, however.)

Death is an exception to the premature distribution penalty.

Option II is wrong because the total balance of an IRA will be included in the owner’s gross estate; however, if the spouse is the beneficiary, the marital deduction may be available.

Option III is wrong because this type of distribution is not subject to the premature distribution penalty (10%). With a Roth IRA, non-qualifying distribution amounts that exceed contributions or include earnings are subject to both income tax and the 10% penalty.

Question 14

Question 17 of 80

Which of the following types of qualified retirement plans are subject to the minimum funding requirements?

I.	defined benefit pension plans
II.	money purchase pension plans
III.	profit sharing plans
IV.	Section 401(k) plans
V.	target benefit plans

(LO 2–8, 3–11)

I, II, and III only

I, II, and V only

I, III, and IV only

II, III, and V only

I, II, III, IV, and V

Answer 14

I, II, and V only

The only qualified plans exempt from the minimum funding standard are profit sharing plans and stock bonus plans.

Section 401(k) provisions are only permitted with profit sharing plans and stock bonus plans.

Question 15

Question 18 of 80

A qualified plan must allow a 22-year-old employee who satisfies the plan’s one-year service requirement to commence participation in the plan no later than which two of the following events?

I. the first day of the plan year beginning after the date on which the employee satisfies such requirements

II. the last day of the plan year during which the employee satisfies such requirements

III. the date six months after the date on which the employee satisfies such requirements

IV. the first day of the plan year in which the employee satisfies such requirements

(LO 2–3)

I and II only

I and III only

I and IV only

II and III only

II and IV only

Answer 15

I and III only

A plan that contains an age 21 and one-year-of-service requirement must provide that an employee who meets the age and service requirements shall participate in the plan no later than the earlier of the first day of the first plan year beginning after the date on which the employee satisfies such requirements, or the date six months after the date by which the employee satisfies such requirements.

Question 16

Question 19 of 80

Which of the following are correct statements about defined contribution pension plans?

I. They use an indefinite allocation formula.

II. They provide a benefit that is based on the value of a participant’s account.

III. They require employer contributions to be made from business earnings.

IV. They require fixed employer contributions according to the terms of the plan.

(LO 3–2, 3–3)

I and II only

II and III only

II and IV only

I, II, and III only

II, III, and IV only

Answer 16

II and IV only

Employer contributions to a defined contribution pension plan must be fixed according to the terms of the plan; e.g., a plan could stipulate that the employer shall contribute an amount equal to 10% of the compensation of each participant.

The investment performance of a participant’s account balance determines the value of his or her benefit upon termination or retirement.

However, contributions must be made to fund a pension plan, even if an employer has no earnings or profits.

Furthermore, defined contribution plans must use a definite allocation formula; i.e., the annual employer contribution to an employee’s account must be fixed or definitely determinable.

Question 17

Question 20 of 80

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

I. the actuarial assumptions used to determine the contribution to the plan

II. the participant’s compensation for the plan year

III. the investment performance of the plan’s assets

IV. the age of the plan participant

(LO 3–3)

I and II only

I and III only

I, II, and III only

II, III, and IV only

I, II, III, and IV

Answer 17

I, II, III, and IV

Actuarial assumptions about longevity and interest rates affect the amount contributed to a participant’s account.

A participant’s compensation directly affects the size of his or her plan benefit.

The value of a participant’s target benefit account balance (i.e., a separate account) depends, in part, on the investment performance (gains and losses) of the plan’s assets.

Target benefit plans favor older employees who are closer to retirement.

Question 18

Question 22 of 80

Which of the following legal requirements apply to money purchase pension plans?

I. The normal retirement benefit must be specified in the plan.

II. The plan must provide a definite and non-discretionary employer contribution formula.

III. Forfeitures can be reallocated to the remaining participants’ accounts in a nondiscriminatory manner or be used to reduce employer contributions.

IV. A separate employer contribution account must be maintained for each participant.

(LO 3–2)

I and II only

II and III only

I, II, and III only

I, II, and IV only

II, III, and IV only

Answer 18

II, III, and IV only

Options II, III, and IV correctly state the employer contribution formula rule, the forfeiture reallocation rule, and the separate account rule for money purchase pension plans.

The first option states a requirement that applies to defined benefit pension plans but not to money purchase plans.

Question 19

Question 23 of 80

Under which of the following circumstances is a target benefit plan (also called age weighted plans) the most appropriate choice for small-business owners?

I. to simplify and reduce the cost of eliminating a defined benefit plan (without termination) by amending it into a target plan

II. where the employer wants to provide larger retirement benefits for key employees who are significantly older than the other employees

III. to meet the employer’s goal of maximizing deductible contributions to provide benefits for older, highly compensated employees

IV. where the employer is opposed to assuming the investment risk and prefers the simplicity of a separate account plan

(LO 3–3)

I and II only

I and III only

II and IV only

I, II, and IV only

II, III, and IV only

Answer 19

II and IV only

Options II and IV are correct for the following reasons.

Target benefit plans have benefit formulas similar to those of defined benefit plans, which favor employees who are significantly older and higher paid than the average employee of the employee group.

Because target benefit plans use separate accounts, the participants bear the risk of the plan’s investment performance.

Option I is incorrect because amending a defined benefit plan into a target plan will result in termination of the defined benefit plan.

Option III is not true since a DC plan is limited to 25% and a DB plan is not limited by a set percentage.

Therefore the DB plan will usually provide a greater tax deduction if an age-weighted plan works best. The key word to III is “maximize.”

Question 20

Question 24 of 80

Gwen Yang is 38 years old and hopes to retire at age 60.

She is president and 100% owner of BaseLine Economics Inc.

Gwen is paid $120,000 in salary plus bonuses by the corporation.

BaseLine Economics Inc. employs five rank-and-file employees with annual salaries ranging from $20,000 to $50,000.

Rank-and-file employees range in age from 28 to 56; turnover among these employees is low.

Cash flow for BaseLine Economics Inc. has been increasing for the past five years and is expected to increase in the future.

Gwen would like to implement a qualified plan that will maximize her retirement benefits and minimize corporate income taxes.

Which of the following are advantages of a profit sharing plan over other plans?

I. This plan offers maximum contribution flexibility.

II. As a percentage of her compensation, Gwen will benefit from the plan each year as much as the other employees from contributions and investment growth.

III. The plan can be integrated to give Gwen an even greater share.

IV. The appropriate plan will provide a maximum contribution equal to 25% of covered compensation.

I and III only

I and IV only

II and IV only

I, III, and IV only

I, II, III, and IV

Answer 20

I, II, III, and IV

This defined contribution plan will maximize benefits for Gwen and will also maximize deductions for the corporation and provide flexibility.

A defined benefit or target plan will not achieve the same benefit results because of Gwen’s age.

Forfeitures can be used to subsidize the cost of making plan contributions.

The contribution and the plan’s investment growth each year will benefit all the employees about the same as a percentage of compensation.

Question 21

Question 25 of 80

Gwen Yang is 38 years old and hopes to retire at age 60.

She is president and 100% owner of BaseLine Economics Inc.

Gwen is paid $120,000 in salary plus bonuses by the corporation.

BaseLine Economics Inc. employs five rank-and-file employees with annual salaries ranging from $20,000 to $50,000.

Rank-and-file employees range in age from 28 to 56; turnover among these employees is low.

Cash flow for BaseLine Economics Inc. has been increasing for the past five years and is expected to increase in the future.

Gwen would like to implement a qualified plan that will maximize her retirement benefits and minimize corporate income taxes.

Which of the following are advantages of adding a 401(k) provision to the profit sharing plan?

I. The 401(k) feature will permit the participants to save money pretax.

II. By maximizing her deferrals, Gwen can lower the amount of the profit sharing contribution allocated to other participants and still achieve her savings goal.

III. The 401(k) feature can be integrated to give Gwen an even greater deferral amount.

IV. If needed, a 401(k) plan will allow BaseLine Economics Inc. to make a contribution equal to 25% of covered compensation to maximize the plan deduction.

(LO 3–11, 4–1)

I and III only

I and IV only

II and IV only

I, II, and IV only

II, III, and IV only

Answer 21

I, II, and IV only

I. is true.

II. is true since she can save part of her savings goal through deferral and then lower the contribution percentage to the amount needed to make up the rest of the goal.

Deferrals and matching contributions may not be integrated.

IV. is true.

Question 22

Question 26 of 80

Frank Scott, your client, received a letter from his brother-in-law advising him about his 401(k) plan. The following sentences from that letter were sent to you by Frank. Which ones are true with respect to a profit sharing 401(k) plan?

I. Before non-elective employer contributions can be made, there must be profits.

II. Hardship withdrawals must come only from deferrals and cannot include matching contributions or earnings.

III. Salary reduction elections must be made before the compensation is earned.

IV. Special safe harbor provisions can be used to comply with the ADP tests.

(LO 4–1, 4–2)

I and II only

II and III only

I, II, and III only

I, II, and IV only

II, III, and IV only

Answer 22

II, III, and IV only

Options II, III, and IV correctly describe the restrictions on hardship withdrawals, the timing of salary reduction elections so as to avoid constructive receipt, and the availability of special provisions (“safe harbors”) to enable a 401(k) plan to comply with the ADP tests.

Option I is incorrect because contributions can be made to a profit sharing plan even if the employer does not have current or accumulated profits.

Question 23

Question 27 of 80

Frank’s letter from his brother-in-law also touched on his other retirement plan, a defined benefit plan, and he has forwarded to you the parts of the letter he doesn’t understand. Which of the following statements in the letter about the defined benefit plan are true?

I. A separate account must be maintained for each plan participant.

II. The maximum benefit permitted by law is reduced proportionately for each year of participation less than 10.

III. The services of an actuary are needed to demonstrate that the minimum funding standards are satisfied.

IV. A definitely determinable retirement benefit must be provided regardless of employer profits.

(LO 2–1, 2–5)

I and II only

II and III only

I, II, and III only

I, II, and IV only

II, III, and IV only

Answer 23

II, III, and IV only

Options II, III, and IV correctly state the rules concerning the 10-year participation requirement for the maximum benefit, the need for an actuary to demonstrate adequate funding, and the requirement that the plan’s benefit be definite.

A pension plan’s benefit cannot be conditional upon the employer’s earning profits.

Option I is incorrect because defined benefit plans do not maintain a separate account for each participant.

Question 24

Question 28 of 80

Frank’s brother-in-law also said that all actuarial assumptions cause a defined benefit plan’s costs to increase. Which of the following actuarial assumptions or methods increase the costs associated with funding a defined benefit plan?

I. use of a high interest rate assumption
II. use of a low turnover rate assumption
III. use of a high mortality assumption
IV. use of a salary scale assumption

(LO 2–5)

I and II only

I and III only

II and IV only

I, II, and IV only

II, III, and IV only

Answer 24

II and IV only

Options II and IV are correct for the following reasons.

A low turnover rate assumption requires greater funding because more participants are assumed to remain employed and receive benefits.

A salary scale assumption requires greater funding because salaries (and hence benefits) are assumed to increase.

The higher the interest rate assumption used, the lower the projected cost of funding the plan.

Also, the higher the mortality assumption used, the lower the projected cost of funding the plan.

Question 25

Question 29 of 80

Which of the following legal requirements apply to a salary reduction simplified employee pension plan (SARSEP)?

I. Lump-sum distributions from a SARSEP are eligible for 10-year forward-averaging treatment, assuming all other legal requirements are satisfied.

II. An existing (pre-1997) SARSEP may be maintained by a sole proprietorship, partnership, or corporation, under the provisions of prior law.

III. The actual deferral percentage for all highly compensated employees must not exceed the actual deferral percentage of all other eligible employees multiplied by 1.25.

IV. A new SARSEP may not be established after 1996.

(LO 4–5)

I and III only

I and IV only

II and IV only

I, III, and IV only

II, III, and IV only

Answer 25

II and IV only

Options II and IV are correct statements about SARSEPs because for-profit entities are permitted to maintain SARSEPs in existence at 12/31/96, under the terms of prior law; beginning in 1997, new SARSEPs may not be established.

Options I and III are incorrect because SARSEP distributions are not eligible for forward averaging, and the SARSEP deferral percentage for each highly compensated employee must not exceed the average deferral percentage for all nonhighly compensated employees multiplied by 1.25.

Question 26

Question 30 of 80

Which of the following are correct statements about Keogh plans?

I. Benefits provided by a defined benefit Keogh plan cannot exceed the lesser of $210,000 or 100% of a participant’s average compensation for his high three years.

II. Keogh plans are qualified plans established by any unincorporated business entity.

III. Keogh contributions for owner-employees are based on their gross salary.

IV. Keogh plans are permitted to make loans to common-law employee participants and owner-employees.

(LO 3–9)

I and II only

I and III only

II and IV only

I, II, and IV only

II, III, and IV only

Answer 26

I, II, and IV only

Options I, II, and IV are correct statements about defined benefit Keogh plan restrictions, business entities that adopt Keogh plans, and the availability of Keogh plan loans to common-law employee participants and owners.

Option III is incorrect because Keogh plan contributions for owner-employees are based on their net income, which is not the same for tax purposes as gross salary.

Question 27

Question 31 of 80

Which of the following statements correctly describe requirements that must be met for a plan to be considered a Section 457 plan?

I. Distributions from the plan are not permitted until age 701⁄2.

II. To avoid adverse income tax effects, the agreement must be executed during the same month as the participant’s services are provided.

III. Eligible participants include employees of agencies, instrumentalities, and subdivisions of a state as well as Section 501 tax-exempt organizations.

IV. The deferral limit is the lesser of $18,000 in 2016, or 100% of compensation.

(LO 6–7)

I and II only

I and III only

II and III only

II and IV only

III and IV only

Answer 27

III and IV only

All of these organizations may establish a Section 457 plan.

Deferrals are limited to the lesser of $18,000 in 2016 or 100% of compensation.

Option I is wrong because one could receive a distribution prior to age 701⁄2 if it was due to separation from service or an unforeseen emergency.

Option II is incorrect because the agreement must be executed before the first day of the month in which the services will be performed.

The result will be a loss of the tax deferral for that month if the agreement is made during the month.

Question 28

Question 32 of 80

Which of the following are correct statements about the top-heavy rules?

I. An employer’s minimum top-heavy contribution to a money purchase pension plan is the lesser of 3% of compensation per year for non-key employees or the highest contribution percentage made for a key employee if the highest contribution percentage is less than 3% of compensation.

II. An employer’s top-heavy contribution to a money purchase pension plan must be at least 3% of compensation per year for each employee.

III. For purposes of applying the 60% top-heavy test, benefits include any distributions made due to separation from service during the last year and any in-service distributions made during the last five years.

IV. Any employee with annual earnings from the employer in excess of $260,000 is considered a key employee.

(LO 2–3)

I and II only

I and III only

II and IV only

I, II, and IV only

II, III, and IV only

Answer 28

I and III only

Options I and III are correct statements about the minimum contribution to a top-heavy plan and the years taken into consideration for purposes of determining the top-heavy status of a plan.

Option II is incorrect because the required minimum top-heavy contribution must be made on behalf of each non-key employee.

Option IV is incorrect because a key employee is defined as a more-than-1% owner of the employer company, with annual compensation from the employer in excess of $150,000 or an officer of the employer whose annual compensation from the employer exceeds $170,000 in 2016, or a more-than-5% owner.

Question 29

Question 33 of 80

Which of the following individuals are “key employees” as defined by the Internal Revenue Code?

I. a more-than-5% owner of the employer company

II. an employee who received compensation of more than $120,000 from the employer (looking back to 2015)

III. an officer of the employer who received compensation of more than $170,000 in 2016

IV. a 1% owner of the employer with an annual compensation from the employer of more than $113,700

(LO 2–3)

I and II only

I and III only

II and IV only

II, III, and IV only

Answer 29

I and III only

Options I and III correctly define two situations where an individual is treated as a “key employee.”

Option II is one definition of a highly compensated employee.

Both options II and IV are incorrect because they do not fall within one of the following definitions of a key employee:

• an officer of the employer whose annual compensation from the employer exceeds $170,000 in 2016;
• a more-than-5% owner of the employer; or
• a more-than-1% owner of the employer having annual compensation from the employer in excess of $150,000.

Question 30

Question 34 of 80

Which of the following are correct statements about the overall limits on employer contributions to and deductions for qualified plan contributions?

I. An employer’s deduction for contributions to a money purchase pension plan and profit sharing plan cannot exceed 25% of the participants’ payroll.

II. If a company has a defined benefit plan and a defined contribution plan and no employee is covered by both plans, the overall deduction limit does not apply.

III. An employer’s deduction for contributions to a defined benefit pension plan and profit sharing plan cannot exceed the lesser of the amount necessary to satisfy the minimum funding standards or 25% of the participants’ payroll.

IV. A plan may lose its qualified status if the contribution for a participant exceeds IRC Section 415 limits.

(LO 6–5)

I and II only

I and III only

II and IV only

I, II, and IV only

Answer 30

I, II, and IV only

Options I, II, and IV accurately state the following rules:

the deduction limitation for defined contribution pension and profit sharing plans;

one of the rules governing the contribution limit for an employer who maintains both a defined benefit and a defined contribution plan;

and the possible loss of qualified status if the contribution for a plan participant exceeds the Section 415 limits.

Option III is incorrect because if the overall deduction limit applies, the deduction for a combination defined benefit plan and profit sharing plan cannot exceed the greater of the amount necessary to meet the minimum funding requirements or 25% of the participants’ payroll.

Question 31

Question 35 of 80

Which of the following requirements must be satisfied by a leasing organization’s qualified plan before the “leased employees” can be excluded from participation by the lessee employer’s qualified plan?

I. The plan must provide for profit sharing.

II. The plan must state that employees shall be immediately eligible to participate.

III. The plan must provide a contribution equal to at least 15% of each participant’s compensation.

IV. The plan must require 100% full and immediate vesting.

(LO 6–6)

I and II only

I and III only

II and IV only

II, III, and IV only

Answer 31

II and IV only

Options II and IV are correct for the following reasons: An employer may disregard “leased employees” if

(a) they do not make up more than 20% of the employer’s non-highly compensated employees, and
(b) they are covered by the leasing organization’s money purchase pension plan.

The plan must provide for an employer contribution of at least 10%, immediate participation, and 100% immediate vesting.

Options I and III are incorrect.

The leasing organization must sponsor a money purchase pension plan; any other type of plan (e.g., a profit sharing plan) will not meet the requirements of the law.

The money purchase pension plan must provide for an employer contribution of at least 10%.

Question 32

Question 36 of 80

Which of the following are correct statements about the permitted disparity (Social Security integration) rules for defined benefit plans?

I. A plan that provides a benefit for wages up to the integration level, plus a higher benefit for wages that exceed the integration level, is an integrated defined benefit excess plan.

II. A plan that provides that an employee’s benefit otherwise computed under the plan formula is reduced by a fixed amount or formula amount is an integrated defined benefit offset plan.

III. Covered compensation is the average of the participant’s compensation not in excess of the taxable wage base for the three-consecutive-year period ending with or within the plan year.

IV. The base benefit percentage is determined by calculating the benefits provided by the plan based on compensation below the integration level, and expressing these benefits as a percentage of compensation below the integration level.

(LO 2–4)

I and II only

I and III only

II and IV only

I, II, and IV only

II, III, and IV only

Answer 32

I, II, and IV only

Options I, II, and IV are correct statements about the definition of integrated defined benefit excess plans, the definition of integrated defined benefit offset plans, and how to determine the base benefit percentage.

Option III is incorrect because covered compensation means the average Social Security wage base over the 35 years prior to Social Security retirement age.

Question 33

Question 37 of 80

Which of the following are correct statements about the permitted disparity (Social Security integration) rules for qualified plans?

I. An integration level for a defined contribution plan that exceeds the current year’s taxable wage base may be selected.

II. The permitted disparity level in a defined benefit plan must be reduced for early retirement.

III. It is no longer possible to have a defined benefit formula in which lower-paid employees receive no benefit.

IV. The permitted disparity under a defined benefit plan, using covered compensation as the integration point, is the Social Security wage base averaged over a maximum of 35 service years.

(LO 2–4, 3–10)

I and II only

I and III only

II and IV only

I, III, and IV only

II, III, and IV only

Answer 33

II, III, and IV only

Options II, III, and IV correctly state the following integration rules.

The permitted disparity level must be reduced if a participant retires early.

It is no longer possible to have an “integrated excess” plan that does not provide any benefits (or contributions) to employees with wages below the integration level.

This was permitted under prior law.

The excess benefit percentage is calculated on a per year of service basis (over a maximum of 35 years).

Option I is incorrect because the integration level selected cannot exceed the current year’s taxable wage base; however, it may be less.

Question 34

Question 38 of 80

Which of the following transactions by a qualified plan’s trust are subject to the unrelated business taxable income (UBTI) rules?

I. A trust obtains a low-interest loan from an insurance policy it owns and reinvests the proceeds in a certificate of deposit paying a higher rate of interest.

II. A trust constructs a residential apartment building and receives rent from the tenants.

III. A trust owns vending machines located on the employer-plan sponsor’s premises.

IV. A trust owns raw land that it rents to an oil and gas developer.

(LO 6–6)

I and II only

I and III only

II and IV only

I, II, and IV only

II, III, and IV only

Answer 34

I and III only

Options I and III are subject to the UBTI rules for the following reasons.

Income from any type of property will be taxable as UBTI if the property has been acquired with borrowed funds (e.g., a life insurance policy loan).

Income from the operation of a business (e.g., vending machines) is subject to UBTI treatment.

Options II and IV are not subject to the UBTI rules for the following reasons.

Real property rents are statutorily exempt from UBTI.

Hence, the rent from the building and raw land is not subject to UBTI treatment.

Question 35

Question 39 of 80

Bedford Enterprises Inc. is a closely held corporation that manufactures computer software products. David Bedford owns 100% of the stock in the corporation. Bedford Enterprises Inc. sponsors a money purchase plan. Additional information about the corporation is presented below.

David is age 45 and hopes to retire at age 65.

The next-oldest employee expects to retire in 22 years.

The corporation has been in business for 10 years and has a history of increasing profits.

The corporation employs 35 people, with 60% of the employees under age 40.

The average turnover rate among employees is high.

The owner’s risk tolerance level is medium.

The fair market value of the money purchase plan’s assets is $4 million.

As the financial planner for David, you have been asked to evaluate the money purchase plan’s investment portfolio, which is distributed as follows:

-10% invested in short-term certificates of deposit
with staggered maturity dates

-20% limited partnership interest in a private
commercial real estate project that generates a high
income yield

-40% invested in company stock

-30% in long-term government bonds with staggered
maturity dates

Which of the following statements best describe the appropriateness of the money purchase plan’s investment portfolio?

I. The investments in the short-term certificates of deposit have fixed maturity dates and therefore are not appropriate for liquidity reasons.

II. The investments in company stock exceed the 10% maximum allowed for a money purchase plan.

III. The investment in the limited partnership may be subject to unrelated business taxable income treatment and therefore is inappropriate.

IV. Overall, the types of investments selected by the plan are sufficiently diversified and therefore minimize investment risk.

(LO 3–2, 6–6)

I and II only

II and III only

I, II, and III only

I, II, and IV only

II, III, and IV only

Answer 35

II and III only

Options II and III are correct for the following reasons.

The investment of 40% of the plan’s assets in company stock violates the requirements for money purchase plan investments.

A qualified retirement plan that invests in a limited partnership is considered to be engaged in the partnership’s business as if it were a general partner. Hence, the UBTI rules apply.

Option I is incorrect because the short-term certificates of deposit do not pose an interest rate risk and therefore can be used to satisfy the plan’s liquidity requirements.

Option IV is incorrect because disproportionately large investments have been made in particular asset categories, such as employer securities, that do not minimize risk.

Question 36

Question 40 of 80

Which of the following transactions between a qualified plan and a disqualified person are “prohibited transactions” as defined by ERISA?

I. the employer’s purchase of a mortgage note in default from the plan for more than fair market value

II. the sale of undeveloped land to a qualified plan for a bargain price

III. the acquisition of employer stock by a profit sharing plan for full and adequate consideration

IV. a loan to a 100% shareholder-participant in an amount proportionate to the amounts available to other plan participants, as specified in the plan documents

(LO 6–4)

I and II only

II and III only

I, II, and III only

I, II, and IV only

II, III, and IV only

Answer 36

I and II only

Options I and II, respectively, are prohibited transactions for the following reasons.

The sale or exchange of property (i.e., a mortgage note in this situation) between a plan and a disqualified person results in a prohibited transaction.

The sale of the undeveloped land is a prohibited transaction for the same reason.

The federal courts have held that an in-kind contribution of employer-owned property to a plan in satisfaction of the employer’s funding obligation is a prohibited transaction; i.e., a sale or exchange.

Options III and IV are not prohibited transactions.

ERISA specifically exempts the acquisition or sale of qualifying employer securities by an individual account plan (such as a profit sharing plan) from prohibited transaction treatment.

Loans in accordance with plan provisions are available to shareholder-participants who are disqualified persons.

Question 37

Question 41 of 80

Which of the following penalties apply to prohibited transactions?

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

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

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

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

(LO 6–4)

I and II only

I and III only

II and IV only

I, II, and IV only

II, III, and IV only

Answer 37

II and IV only

Options II and IV are correct statements concerning prohibited transaction penalties.

The law requires correction (i.e., undoing) of a prohibited transaction and restoring a plan to the position it would have been in had the transaction never occurred.

Ongoing transactions (e.g., loans, leases) create additional prohibited transactions in subsequent years (and additional penalties) until corrected.

Options I and III are incorrect for the following reasons.

Once the prohibited transaction has taken place, the 15% penalty cannot be waived for extenuating circumstances.

Income tax consequences may or may not apply depending on the nature of the underlying prohibited transaction.

Usually, the IRS ( not the courts) determines the amount of tax involved.

Question 38

Question 42 of 80

Which of the following are correct statements about the legal requirements for pension plans that are subject to Pension Benefit Guaranty Corporation (PBGC) coverage?

I. The PBGC may initiate a standard termination proceeding if the pension plan is unable to pay benefits when due.

II. PBGC-guaranteed benefits exclude medical insurance benefits, benefits in excess of the PBGC limit, and lump-sum benefit payments.

III. The amendment of a defined benefit pension plan into a money purchase pension plan will result in termination of the defined benefit plan.

IV. Pension plans are required to pay premiums to the PBGC.

(LO 2–6)

I and II only

II and III only

I, II, and III only

I, II, and IV only

II, III, and IV only

Answer 38

II and III only

Options II and III are correct statements.

Option I is incorrect because the PBGC may initiate an involuntary distress termination proceeding if a pension plan is unable to pay pension benefits when they become due.

Option IV is incorrect because only defined benefit plans are generally required to pay PBGC premiums; “pension” plans include some defined contribution plans.

Question 39

Question 43 of 80

Which of the following qualified plans are required to provide a qualified joint and survivor annuity (QJSA)?

I. cash balance plan
II. certain ESOPs
III. target benefit plan
IV. thrift plan

(LO 2–1, 2–7)

I and II only

I and III only

III and IV only

I, II, and IV only

II, III, and IV only

Answer 39

I and III only

Options I and III are the correct answers for the following reasons.

Pension plans are required to provide married participants with a QJSA option.

Cash balance plans and target benefit plans are both pension plans.

However, defined contribution plans that are not subject to minimum funding standards (profit sharing plans and ESOPs) are exempt if the plan provides payment of the participant’s nonforfeitable accrued benefit in full to the surviving spouse, the participant does not elect a life annuity benefit form, and the plan is not a transferee of another plan that is subject to survivor annuity requirements.

Question 40

Question 44 of 80

Which of the following are exempt from the 10% penalty on qualified plan distributions made before age 591⁄2?

I. distributions made to an employee because of “immediate and heavy” financial need

II. in-service distributions made to an employee age 55 or older

III. distributions made to a beneficiary after the participant’s death

IV. substantially equal periodic payments made to a participant following separation from service, based on the participant’s remaining life expectancy

(LO 7–2)

I and II only

III and IV only

I, II, and III only

I, II, and IV only

II, III, and IV only

Answer 40

III and IV only

The 10% premature distribution penalty does not apply to distributions on account of death or annuitized payments based on an individual’s remaining life expectancy. Options I and II are incorrect.

The law does not recognize heavy and immediate financial need as an exception to the penalty.

The age 55 exception does not apply to in-service distributions; i.e., the employee must have separated from the service of the employer.

Question 41

Question 45 of 80

Assume that a retirement plan participant dies before retirement and that there is a cost basis associated with his or her account. Which of the following correctly state the beneficiary’s income tax liability due to death benefits paid from a qualified plan as either life income or installment payments?

I. When the benefits are from life insurance, the cash value portion is taxed under the annuity rules.

II. If the benefits are not related to life insurance, the employee’s cost basis becomes the cost basis for the beneficiary.

III. If the benefits are not related to life insurance, the includible amount is taxed as ordinary income.

IV. When the benefits are from life insurance, the amount deemed to be pure insurance is excludible from gross income.

V. If the benefits are not related to life insurance, the beneficiary’s cost basis is reduced by the policy’s cash value.

I, II, and III only

II, IV, and V only

I, II, III, and IV only

II, III, IV, and V only

I, II, III, IV, and V

Answer 41

I, II, III, and IV only

The annuity rules govern the taxation of the cash value portion of the benefits.

The beneficiary assumes the employee’s tax basis if the death benefits are not from life insurance.

The beneficiary’s cost basis is used to determine the taxable portion of a distribution that does not come from life insurance.

Pure insurance death benefits are received income tax free.

Option V is wrong because the cash value has no effect on cost basis.

Question 42

Question 46 of 80

Yvonne Lindeman is single and age 65.

She has decided to separate from service with her employer and retire next month.

She is eligible for retirement benefits from her employer’s qualified money purchase plan.

She has been a plan participant for four years.

The money purchase plan has two distribution options: the life-only annuity and a lump-sum distribution.

The balance to the credit of her account is $155,000.

Assume that if a lump-sum distribution is made, it will be made in one taxable year.

Her cost basis in the account is $25,000.

There is no net unrealized appreciation in the account.

Which of the following are correct statements about Yvonne’s distribution options?

I. If Yvonne elects the life-only option, a portion of each payment will be tax free.

II. If she makes a direct transfer of the total lump-sum distribution to an IRA and then takes a distribution of $60,000 from the IRA, she will not be subject to the 20% withholding tax.

III. If she makes a direct rollover of the total lump-sum distribution to an IRA and then takes a distribution of $60,000 from the IRA, she will pay ordinary income tax and the 10% premature distribution penalty.

IV. If Yvonne decides to take the $155,000 in a lump sum and not roll it over to an IRA, she will pay ordinary income tax on the full amount and be subject to both the 10% early withdrawal penalty and the 20% withholding requirement.

(LO 7–2)

I and II only

I and III only

II and IV only

III and IV only

Answer 42

I and II only

The simplified annuity rules govern the taxation of an annuity-type distribution from a qualified plan.

Since Yvonne has a cost basis of $25,000 in the account, a portion of each payment will be received tax free based on the number of anticipated payments indicated for her age level:

$25,000
÷ 310 payments
= $80.65 (the portion of each annuity payment that represents nontaxable recovery of basis).

The 20% withholding tax related to distributions does not apply to distributions from an IRA.

Option III is wrong because a distribution from an IRA prior to age 591⁄2 is subject to this tax, but she is 65.

Option IV is wrong because the 10% penalty does not apply at age 65; however, Yvonne would be taxed on the distribution less her cost basis and be subject to the 20% withholding.

Question 43

Question 47 of 80

Which of the following are correct statements about the rules governing IRA distributions if an IRA owner dies before his or her required beginning date?

I. A spouse who is named as the beneficiary may roll the IRA over into another IRA titled in his or her own name.

II. If a designated beneficiary isn’t named, the entire account must be distributed within five years after the death of the IRA owner.

III. If the beneficiary is a spouse, that person must begin taking distributions no later than December 31st of the year following the year in which the deceased died.

IV. A non-spouse beneficiary may take distributions based upon the uniform table.

(LOs 7-4 and 7-5)

I and II only

II and III only

III and IV only

I, II, III, and IV

Answer 43

I and II only

A surviving spouse who is named as the beneficiary may roll over the IRA to another IRA and re-title this account in his or her own name (option I).

If the IRA owner dies before the required beginning date and if no designated beneficiary is named, the entire account must be distributed by the end of the fifth year following the year of the owner’s date of death (option II, the five-year rule).

If the beneficiary is a spouse, that person can either begin taking distributions immediately or defer them until the end of the year in which the deceased would have been age 70½, so option III is incorrect.

Option IV is incorrect because a non-spouse beneficiary must use the Single Life Table for determining required minimum distributions; life expectancy is reduced by one for each subsequent year.

Question 44

Question 48 of 80

Which of the following correctly describe characteristics of group universal life insurance?

I. The contract is usually implemented by a master group policy.

II. The employer usually pays all of the policy premiums.

III. Often the expenses are lower than for an individual universal life policy.

IV. Universal life policies offer the potential for higher returns than whole life policies.

V. The coverage is based on a combination of decreasing units of group term and accumulating units of single premium whole life.

(LO 9–1)

I and II only

III and IV only

IV and V only

I, II, and III only

III, IV, and V only

Answer 44

III and IV only

Often, expenses (administrative, marketing, commissions) for group universal are lower than for individual universal policies.

Universal policies may offer higher returns than whole life policies.

Option I is wrong: this form of group insurance is made up of individual contracts.

Option II is incorrect because the employee generally pays the premiums.

Option V is wrong because it describes group paid up, which is seldom used due to its unfavorable income tax treatment.

Question 45

Question 49 of 80

Which of the following correctly state criteria that must be met for a group term life insurance policy to be considered nondiscriminatory?

I. At least 85% of participants are not key employees.

II. At least 80% of all employees must benefit from the plan.

III. The plan must benefit a nondiscriminatory class of employees.

IV. At least 85% of the participants must not be highly compensated employees.

V. If benefits are part of a cafeteria plan, then the plan must comply with the nondiscrimination rules of Internal Revenue Code Section 125.

(LO 9–2)

I and III only

I, III, and V only

II, IV, and V only

I, II, III, and IV only

I, II, III, IV, and V

Answer 45

I, III, and V only

Options I, III, and V describe three of the four criteria that can be met for a group term life insurance plan to be considered nondiscriminatory.

Note: The plan can satisfy any one of the four criteria and still be considered nondiscriminatory.

Option II is wrong because at least 70% of all employees must benefit from the plan.

Option IV is incorrect because 85% of participants should not be key employees.

Question 46

Question 53 of 80

Which of the following describe characteristics of benefits generally available from employer-provided short-term or long-term disability coverage?

I. Long-term disability benefits are commonly paid to the worker for life.

II. The waiting period on a long-term disability policy generally ranges from 20 to 80 days.

III. Benefits from short-term disability coverage start on the first day when the disability is related to an illness.

IV. Generally, short-term disability coverage will start after sick pay benefits have been provided to a covered employee.

V. Generally, total disability under short-term disability coverage is defined as the inability to perform the normal responsibilities of one’s position.

(LO 9–5)

I and II only

I and IV only

II and V only

III and IV only

IV and V only

Answer 46

IV and V only

Sick pay plans cover employees for short periods of injury or sickness, and if the condition continues, then short-term disability provides further income.

Generally, the definition of total disability is the inability to perform the normal duties of one’s position.

Option I is wrong because benefits are commonly paid until age 65.

Option II is incorrect because the most common waiting periods range from 60 to 180 days.

Option III is wrong because benefits will start on the first day if the disability is related to an accident and on the eighth day if related to sickness.

Question 47

Question 54 of 80

Which of the following correctly describe tax implications of a non-qualified deferred compensation arrangement?

I. Benefits payable to the survivor of a participant in a deferred compensation plan are excludible from the employee’s gross estate if he/she had at the time of death a vested lifetime right to the future benefits.

II. Per Revenue Ruling 60-31, a participant in an unfunded SERP plan will not be taxed currently if the promise of benefits by the employer is unsecured and the agreement is executed prior to the earning of compensation.

III. If a partnership establishes a funded plan and the benefit payments are nonforfeitable, then contributions are deemed partnership income, and each partner must include his or her share of the contribution in his or her current income.

IV. Assuming that an employee becomes vested in part of a funded plan that contains provisions establishing a “substantial risk of forfeiture,” such benefits are deemed to be constructively received and will be taxed to the employee in that year.

(LO 8–2)

I and IV only

II and III only

I, II, and III only

II, III, and IV only

Answer 47

II, III, and IV only

Revenue Ruling 60-31 relates to the issue of constructive receipt.

If the agreement is made prior to the performance of services and fund assets are subject to creditors, there is no constructive receipt, and benefits are not currently taxable to the employee.

If a partner’s benefits are vested, contributions are considered income to the partnership and thus are currently taxable to the partner.

A participant in a funded plan will be in constructive receipt of the benefits in the year in which his or her rights change from forfeitable to vested.

Thus, he or she will be taxed on those benefits.

Option I is wrong since such benefits would be includible in the gross estate because they were vested at time of death.

Question 48

Question 55 of 80

Which of the following correctly identify characteristics of methods of informally funding a private non-qualified deferred compensation plan?

I. With a phantom (shadow) stock plan, at retirement the employee always receives actual shares of stock plus accumulated dividends and must include the total value in income.

II. With a deferred stock plan, at distribution the employee is taxed on the fair market value of the shares, and the employer deducts the original cost basis in the stock.

III. When using a variable annuity, the employing corporation (contract owner) will be taxed annually on the increase in cash surrender value.

IV. The disability premium waiver allows the funds otherwise used to pay life insurance premiums to be paid to the disabled employee and such amounts to be deducted by the employer.

(LO 8–3)

I and II only

III and IV only

I, II, and III only

I, III, and IV only

Answer 48

III and IV only

If using corporate-owned annuities (COAs), the corporation is taxed annually on the accumulating earnings.

If the disability premium waiver on a life insurance policy on the life of an employee is selected, the employer will not pay policy premiums during the employee’s disability.

The premium dollars saved are used to pay disability benefits to the employee and can be deducted by the employer.

Option I is wrong because a distribution from a phantom (shadow) stock plan generally does not involve actual shares of stock. The stock is used as a valuing device, and distributions are generally in cash. At retirement, the value of the stock plus dividends will be taxed.

Option II is incorrect because the employer deducts the same amount the employee includes in income—i.e., the fair market value of the share, not just the original cost basis.

Question 49

Question 56 of 80

Which of the following individuals would be eligible for Social Security retirement benefits? Assume each has held the same position for 11 years.

I. a 65-year-old owner/employee of a professional corporation

II. a 60-year-old officer/employee of an S corporation

III. a 65-year-old federal government employee who was hired in 1983

IV. a 67-year-old self-employed consultant who works as an independent contractor

V. a 61-year-old employee of a Section 501(c)(3) nonprofit educational organization

(LO 1–6)

I and II only

I and IV only

III and V only

IV and V only

Answer 49

I and IV only

Option I is correct because this is a covered occupation, and the person meets the current normal retirement age of 65. Thus, benefits would be received because he or she is fully insured—i.e., has worked more than 40 quarters.

Option IV is a covered occupation, and a person over age 62 is eligible for benefits because he or she is fully insured.

Option II is wrong since this person works in an occupation that is covered by Social Security but is not eligible for benefits until age 62. Benefits at age 62 will be 80% of his or her PIA.

Option III is incorrect since although this person is normal retirement age, federal workers hired before 1984 are not covered by OASDI.

Option V is wrong because although this is a covered occupation, the employee has not yet reached the minimum age of 62.

Question 50

Question 57 of 80

Which of the following are correct statements about unemployment insurance?

I. In most states, individuals can receive unemployment benefits for 52 weeks.

II. The amount of unemployment benefits is based on an employee’s previous earnings.

III. To be eligible to receive benefits, the worker must be willing and able to work.

IV. To be eligible to receive benefits, the worker must have had unemployment taxes paid on his or her behalf.

V. To be eligible to receive benefits, the worker must have earned a minimum income during a base period.

(LO 9–10)

II, III, and IV only

III, IV, and V only

I, II, III, and IV only

II, III, IV, and V only

I, II, III, IV, and V

Answer 50

II, III, IV, and V only

The previous earnings of the employee determine the benefits.

To receive benefits, a worker must have participated in “covered” employment, earned a minimum income during a base period, and have a continued “attachment” to the workforce.

Option I is wrong since benefits are generally payable for 26 weeks and sometimes are extended for 13 additional weeks during periods of high unemployment.

Question 51

Question 58 of 80

Which one of the following employee benefits is not currently deductible by a C corporation?

(LO 9–2, 9–4, 9–5, 9–8)

a. qualified employee discounts
b. group term life insurance of $100,000
c. group legal services
d. health and accident insurance

Answer 51

a. qualified employee discounts

Items that are currently deductible by a C corporation include group term life insurance, group legal services, and health and accident insurance.

Qualified employee discounts do not generate a deduction for the corporation; the discounts merely result in less sales revenue for the organization.

Question 52

Question 59 of 80

Grady Hamilton is employed by Danson Industries. Danson offers 200 shares of its stock to Grady as a performance incentive. Under the terms of the agreement, Grady will pay $.10 per share and the company is given the right to buy the shares back at $.10 per share if Grady should leave the company within four years or fail to meet the specified performance requirement at the end of four years. After Grady purchases the stock, it will be held in an escrow account at a local bank subject to the terms of the performance agreement. (The stock’s value at the time of the sale to him was $50 per share.)

Which one of the following correctly describes the tax implication to Grady of this transfer?

(LO 8–2, 8–6)

a. Grady will recognize income immediately.
b. Grady will recognize income at the end of four years.
c. Grady will recognize income immediately for alternative minimum tax purposes only.
d. Grady will recognize income at the end of four years for alternative minimum tax purposes only.

Answer 52

b. Grady will recognize income at the end of four years.

Because this is a performance share program, income will be recognized by Grady for regular tax purposes when a substantial risk of forfeiture no longer exists, which will be at the end of the four-year term.

This will be the point in time at which the transfer becomes completely irrevocable.

Question 53

Question 60 of 80

Total Talent Inc., a publicly held company, wants to offer an employee benefit to its chief executive officer, Bill Furman, that will provide an incentive to him but will postpone vesting of the benefit. The company is considering an arrangement whereby Bill would be allowed a current right to purchase newly-issued, non-voting shares of the company at a specified price. Under this plan, the shares could later be converted into actual shares of the company’s stock. Bill is in a high marginal income tax bracket and would like to minimize the income taxes he must pay as a result of this benefit.

What is the most appropriate form of compensation plan for Bill?

(LO 8–3, 8–4, 8–5, 8–6)

a. a rabbi trust
b. a stock appreciation right
c. an incentive stock option
d. a Section 83 transfer
e. a junior stock plan

Answer 53

e. a junior stock plan

A junior stock plan would be most effective in deferring any taxation and providing a significant performance incentive to Bill.

This plan would be structured so that Bill could purchase junior shares of newly-issued, non-voting company stock at a price considerably lower than that of the regular stock of the company.

The shares could be converted into regular stock after the agreed-upon performance incentives are reached.

Question 54

Question 61 of 80

Custom Plywood is a closely held corporation. Frank Roberts is Custom Plywood’s sales director. During the last five years that Frank has been in this position, Custom Plywood has experienced tremendous growth in earnings and sales. Custom Plywood would like to provide Frank with the opportunity to share in the future growth of the company, while not diluting the ownership interests of the present shareholders.

What is the most appropriate form of compensation plan that could be offered by Custom Plywood to Frank?

(LO 8–1, 8–5, 8–6)

a. a non-qualified stock option
b. a rabbi trust
c. an incentive stock option
d. stock appreciation rights
e. a junior stock plan

Answer 54

d. stock appreciation rights

Stock appreciation rights would be the best choice because there would be no dilution of ownership, and Frank would still be compensated for his efforts in increasing the value of the company.

Since Frank would not own actual stock, no dilution would occur; however, Frank would benefit directly from any increase in the value of the stock.

Question 55

Question 62 of 80

Of the following employee benefits, which are nontaxable to the employee?

I. qualified employee discounts
II. group term life insurance of $100,000
III. group legal services
IV. health and accident insurance

(LO 9–2, 9–4, 9–6, 9–8)

I and II only

I and III only

I and IV only

II and III only

III and IV only

Answer 55

I and IV only

Qualified employee discounts and health and accident insurance are the only listed employee benefits that are nontaxable to the employee.

Group term life insurance in excess of $50,000 is partially taxable to the employee, as are the premiums on group legal services.

Question 56

Question 63 of 80

Which of the following are characteristics of a rabbi trust as used in the funding of a deferred compensation plan?

I. It is a trust set aside for the benefit of the employee.

II. The trust property is subject to the claims of the employer’s creditors.

III. The trust property must consist of cash or liquid investments.

IV. Contributions to the trust are not taxable currently to the employee.

(LO 8–1, 8–3)

I only

I and III only

II and III only

I, II, and III only

I, II, and IV only

Answer 56

I, II, and IV only

All options describe characteristics of a rabbi trust except the one requiring that trust property consist of liquid assets.

The property contributed to a rabbi trust is often illiquid assets, usually stock in the employer’s company.

Question 57

Question 64 of 80

Which of the following are reasons why a recipient of Section 83(b) property might make a Section 83(b) election?

I. The employee wants to defer current income tax liability.

II. The employee wants to avoid the risk of an increase in value being included later in taxable income.

III. The employee wants to obtain preferential treatment of capital gain income.

(LO 8–4)

I and II only

I and III only

II and III only

I, II, and III

Answer 57

II and III only

A Section 83(b) election will result in current taxation, so option I is invalid.

Avoiding the risk of greater future taxable income and the ability to treat all future gain as capital gain are advantages to using a Section 83(b) election.

Question 58

Question 65 of 80

Sandy’s Shades is a closely held corporation. Alma Jones is the company’s top sales person. During the last eight years Alma has created a significant growth in sales and earnings. The company would like to provide her with the opportunity to share in the future growth of the company, while not diluting the ownership interests of the present shareholders.

What is the most appropriate form of compensation plan that could be offered by Sandy’s Shades to Alma?

(LO 8–1, 8–5, 8–6)

a. non-qualified stock option
b. rabbi trust
c. incentive stock option
d. stock appreciation rights

Answer 58

d. stock appreciation rights

Stock appreciation rights do not involve actual stock shares.

Rather, they use the price of the stock to determine the amount of the benefit. Thus, SARs do not dilute ownership.

Question 59

Question 66 of 80

Jim Spencer has a non-qualified deferred compensation plan through his employer. Assume that Jim’s employer grants him an option to purchase the company’s stock at its market value on the date of the grant. The option may be exercised at the end of four years, provided that Jim is still employed by the company at that time. Jim is the only employee to whom this offer was made.

Assume that the option does not have a readily ascertainable market value.

Which one of the following is an income tax implication of the option given to Jim to purchase the employer’s stock at a reduced price?

(LO 8–6)

a. There will be current taxation to Jim because this option was granted solely to Jim.
b. There will be no current taxation to Jim because a substantial risk of forfeiture is present.
c. There will be current taxation on the difference between the fair market value of the stock and the option price of the stock.
d. There will be no taxation until Jim exercises the stock option.

Answer 59

d. There will be no taxation until Jim exercises the stock option.

There will be no taxation at the time of the grant because the value of the stock option is not readily ascertainable on the date of the grant.

The bargain element at time of exercise will be taxed as ordinary income.

If there were a discount in the exercise price from the fair market value of the stock at the time of grant, the plan would fall under Section 409A and its tax results, ordinary income, interest charges from the time of grant, and a 20% penalty on the taxable income when the substantial risk of forfeiture lapses.

Question 60

Question 67 of 80

Great Benx Corporation provides both a defined benefit and a money purchase plan for its employees. The defined benefit plan is covered by the PBGC. All employees participate in each plan. If the Section 415 limits apply, how do they apply?

(LO 6–5)

a. Under the Section 415 limits, the total contributions to both accounts of a participant are limited to 25% of the participant’s compensation.
b. Each participant could receive a maximum contribution of 25% of the participant’s compensation for the money purchase plan and a maximum contribution of 100% of the participant’s compensation for the defined benefit plan.
c. The Section 415 limits are applied separately for each plan. The annual additions limit for the money purchase plan in 2016 is 100% of the participant’s compensation or $53,000, whichever is less. The participant’s benefit in the defined benefit plan is limited in 2016 to 100% of the participant’s compensation or $210,000, whichever is less.
d. The Section 415 limits no longer apply. These limits were repealed by EGTRRA for qualified plan application.

Answer 60

c. The Section 415 limits are applied separately for each plan. The annual additions limit for the money purchase plan in 2016 is 100% of the participant’s compensation or $53,000, whichever is less. The participant’s benefit in the defined benefit plan is limited in 2016 to 100% of the participant’s compensation or $210,000, whichever is less.

The Section 415 limits are applied separately for each plan.

Question 61

Question 68 of 80

Great Benx Corporation provides both a defined benefit and a money purchase plan for its employees. The defined benefit plan is covered by the PBGC. All employees participate in each plan. Great Benx Corporation’s contribution deduction is limited on the combined contribution to its two plans. What is the limit?

I. If the defined benefit plan is not covered by PBGC, the defined contribution plan cannot receive more than 6% in employer contributions.

II. The company’s maximum contribution for both plans is the lesser of 25% of participants’ compensation or the amount required to satisfy the minimum funding standard for the defined benefit plan.

III. If a single employer plan is insured by the PBGC, then the plan is not considered when applying the overall combined plan deduction limit.

(LO 6–5)

I only

III only

I and III only

I, II, and III

Answer 61

I and III only

If the defined benefit plan is not covered by PBGC, the defined contribution plan cannot receive more than 6% in employer contributions.

If a single employer plan is insured by the PBGC, then the plan is not considered when applying the overall combined plan deduction limit.

Question 62

Question 69 of 80

John Tyree will turn 66, his full retirement age (FRA), on August 2nd of this year and begin drawing $1,475 per month in Social Security. He earns $4,160 per month and plans to continue working as long as he is able. He has asked his advisor about the reduction in Social Security since his older brother told him his benefit will be reduced if he continues working. Does a benefit reduction apply to him? If so, how does it apply?

(LO 1–5, 1–6)

a. No. There is no benefit reduction for those who continue to work after attaining full retirement age (FRA).
b. Yes, his benefit will be reduced $1 for every $2 he earns over $15,720 (in 2016).
c. No. His benefit will not be reduced because his earnings are below the threshold.
d. Yes. His benefit will be reduced. His income for the year will be $49,920, or $8,040 more than the $41,880, indexed (in 2016), reduction threshold.

Answer 62

a. No. There is no benefit reduction for those who continue to work after attaining full retirement age (FRA).

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

Question 63

Question 70 of 80

George Cobb owns a construction company, Cobb Construction Inc., which is worth $3 million with an annual payroll of $1.3 million. George receives a salary of $300,000. The company initiated a profit sharing plan last year and makes contributions at year-end. The plan has about $120,000 in assets. George’s account has a balance of $28,000. He is 60 and wants to retire this year and sell his company. His problem is that the construction industry is very slow this year, and the major companies are retrenching, not expanding. George’s company is very profitable from year to year, earning a profit of $550,000 to $650,000 each year. George has an excellent management team in place that he has carefully built and trained over the years. His bank approached him recently, offering to loan him almost any amount, up to the value of his company, at 8%. Typically such loans are amortized over no more than 10 years.

How can George use a qualified plan to accomplish his goal?

(LO 3–6)

a. George should amend the company profit sharing plan and make it an ESOP and have the ESOP buy his stock.
b. George should have the company profit sharing plan borrow $3 million and buy his stock.
c. George should amend the company profit sharing plan and make it a LESOP, then have the plan borrow $3 million and buy his stock.
d. George should borrow $3 million from the bank and retire.

Answer 63

c. George should amend the company profit sharing plan and make it a LESOP, then have the plan borrow $3 million and buy his stock.

George should amend the profit sharing plan, making it a LESOP.

Then, as the LESOP trustee, he can borrow $3 million in the name of the LESOP from a bank familiar with LESOP loans.

The LESOP will receive $3 million from the loan and it will use the proceeds to buy George’s $3 million worth of stock and become the owner of the company.

George will receive the $3 million in cash and retire. Options a and b are wrong because only a LESOP can borrow money.

Option d is wrong because borrowing $3 million doesn’t extract the value of his company for his benefit; it only creates debt and a nondeductible interest cost.

Question 64

Question 73 of 80

On June 18th of last year, Robert Gatsbough was granted 1,000 NSOs on the company stock with an exercise price of $12 per share. The price of the stock on that date was $34 per share. He exercised the NSOs in August of this year when the price was $78 per share. At the time of grant there were no other requirements or limitations. How is Robert taxed at the time of grant, exercise and sale?

(LO 8–6)

a. No tax at grant or exercise, capital gain on sale—violates Section 409A
b. No tax at grant, AMT adjustment at exercise, and capital gain on sale
c. No tax at grant, bargain element taxed as wages at exercise, and capital gain on sale
d. Fully taxed at grant, no tax on exercise and capital gain on sale—violates Section 409A

Answer 64

d. Fully taxed at grant, no tax on exercise and capital gain on sale—violates Section 409A

Robert’s NSO grant was in violation of Section 409A of the American Jobs Creation Act 2004 because the exercise price was less than market value at the time of grant, the 409A requirements were not met, and there was no substantial risk of forfeiture provision.

These failures cause the imposition of the rules of Section 409A on the NSO and the bargain element becomes subject to tax and with a 20% penalty on the income subject to tax. Interest would be assessed from the date of the grant.

The assessment of tax and penalty would be at the time of exercise since the value of the options at grant was not ascertainable.

Question 65

Question 74 of 80

Tom and Jenny Calliese need to accumulate $260,000 (in day-one of retirement dollars) in 24 years to meet their retirement income goal. Assume inflation will be 3% and they can earn 7% after tax during the applicable time period. They are planning to deposit $3,380, adjusted for inflation, into each of their two investment accounts at the end of each year. If they do so will they achieve their desired goal?

(LO 1–3)

Yes, they will accumulate $130,141.

No, they will accumulate $130,141.

No, they will accumulate $196,637.

Yes, they will accumulate $260,281.

Yes, they will accumulate $264,198.

Answer 65

Yes, they will accumulate $260,281.

N = 24
I = 3.8835
PV = 0
Pmt = 6760
FV = ?

FV = $260,281

Question 66

Question 76 of 80

Mac Starr has taught math across the hall from Shirley for 13 years, and he’s been in the school district for 28 years. He plans to retire in five years at age 60. He has a salary of $58,000 and a TSA. He has not always contributed the maximum amount to his TSA. Mac also has a part-time job with Learn Well Learning Systems Inc. (he owns no company stock) where he sells teaching materials in his four state territory and works full time each summer. Learn Well has a profit sharing plan and will make a 20% contribution to the plan for 2016. Mac will earn $152,000 at Learn Well this year. He will also defer the maximum to his TSA for 2016. What is the combined contribution for Mac’s two plans?

(LO 4–1, 6–5)

$47,400

$53,000

$56,500

$57,400

Answer 66

$57,400

Mac can defer $26,000:

$18,000
+ $3,000
+ $6,000
= $26,00

to his TSA and also receive the full 20% contribution from Learn Well:

.20
× $152,000
= $30,400

because he is not a controlling owner of the business.
Because of this fact, the contributions are not combined when measuring for Section 415 limit compliance.

Question 67

Question 77 of 80

Bill Rogers is a salesman for Titan Chemical Inc. His base salary is $3,500 per month. His total compensation (salary plus commissions) has averaged $89,552 per year for the last three years, and he has deferred $1,350 per month to the 401(k) plan and $300 per month to his FSA for the past three years. Titan Chemical also pays $1,200 to provide Bill with long-term disability coverage that will pay 50% of his base salary should he become disabled. Bill has increased this benefit to provide 67% of his base salary by making a $600 after-tax payroll deduction.

Assume Bill is disabled. What is the amount of his disability benefit?

$1,750 per month

$2,345 per month

$3,500 per month

$3,567 per month

Answer 67

$2,345 per month

His benefit is 67% of his base salary.

$3,500
× .67
= $2,345

Question 68

Question 78 of 80

Bill Rogers is a salesman for Titan Chemical Inc. His base salary is $3,500 per month. His total compensation (salary plus commissions) has averaged $89,552 per year for the last three years, and he has deferred $1,350 per month to the 401(k) plan and $300 per month to his FSA for the past three years. Titan Chemical also pays $1,200 to provide Bill with long-term disability coverage that will pay 50% of his base salary should he become disabled. Bill has increased this benefit to provide 67% of his base salary by making a $600 after-tax payroll deduction.

Assume Bill is disabled. What part of his disability benefit is taxable?

$0

$1,155

$1,571 per month

$2,390 per month

$3,333 per month

Answer 68

$1,571 per month

The benefit paid by the employer is taxable.

Total premiums paid equal $1,800.

The employer paid $1,200 or 67% of the premium.

67% of the benefits received of $2,345 equals $1,571.

Question 69

Question 80 of 80

Russ Owens, age 42, and Ralph Jones, age 54, are each 50% owners of the Light Emporium. They both make $150,000 per year. Business has been steadily growing for the past five years, and Russ and Ralph believe that now is the time to set up a qualified retirement plan for their business. Russ and Ralph both want to take care of their eight full-time employees, and don’t mind making a commitment to fund their retirement accounts. However, they are also concerned about their own retirement, and want to make sure that enough is set aside for them while having some flexibility over how much has to be contributed each year. Since they are equal owners they would like for an equal amount to be contributed on their behalf if possible. Which of the following plans would best suit their requirements?

(LO 3–4, 3–7, 3–8)

a. money purchase
b. SIMPLE IRA
c. age-weighted profit sharing
d. cross-tested profit sharing

Answer 69

d. cross-tested profit sharing

The cross-tested plan would work best for Russ and Ralph.

They could maximize the contributions for themselves, and it would be an equal amount since they each earn $150,000.

They also want to take care of their full-time employees, so contributing 5% for each of them would accomplish this.

Russ and Ralph want to install a qualified plan, which eliminates the SIMPLE IRA.

The age-weighted profit sharing plan would provide a much larger contribution to Ralph, and the owners want an equal contribution.

The money purchase is possible, but since it is a pension plan it would have a mandatory funding requirement that the cross-tested profit sharing plan does not have—meaning that there is more flexibility with the cross-tested plan.