Retirement & Employee Benefits Flashcards
1
Q
Bob Thornton received his NonQualified Stock Option (NQSO) from his company (publicly traded on the NYSE), one year ago last week, with an option exercise price and stock price of $30. He told you recently, as his trusted financial adviser, that he desperately needed cash, and so he exercised the options last week on the one year anniversary with the stock price at $40 per share, and he sold the stock as it climbed to $45 per share. What will the tax ramifications of these transactions be?
Bob will be taxed at capital gain rates only when the option is exercised and again for the difference when the stock is sold.
Bob will be taxed as W-2 income for the fair market value of the stock less the exercised price when it is exercised, and then he will be taxed at capital gain rates for the balance when the stock then subsequently sold (long or short term).
Bob will be taxed at ordinary income rates on the difference between the exercise price and the fair market value of the stock when the option is granted and then on capital gain rates when the stock is sold for the fair market value.
There are no consequences to this circumstance until Bob sells the stock with all proceeds being taxed at capital gains rates.
A
Solution: The correct answer is B.
He will be required to report the gain as W-2 income of $10 per share when the option is exercised and then another $5 capital gain (long or short) when sold as the question indicates.
2
Q
For tax determination purposes, the holding period of a nonqualified option is determined to begin by which of the following?
On the date the transferee becomes eligible for the grant.
On the date of sale.
On the date of the grant.
On the date of exercise.
A
Solution: The correct answer is D.
The security holding period in the case of a non-qualified options begins on the date the option is exercised.
3
Q
David is awarded an immediately vested, non-qualified stock option for 1,000 shares of company stock with an exercise price of $35 per share while the stock price is currently $33 per share. What are the tax ramifications, if any at the date of the grant?
$0
The gain between exercise and actual price of $2,000 is immediately taxable.
The awarded option price value of $33,000 will be immediately taxable.
Because these are unrealized gains, neither the option value nor the gain are taxable until the stock is finally sold.
A
Solution: The correct answer is A.
In the case of NQS Options, the option is not taxed at the grant if the exercise price is equal to or greater than the fair market value of the stock.
4
Q
Which of the following statements regarding ISOs and NQSOs is correct?
The tax treatment of a cashless exercise of an ISO is the same as the cashless exercise of a NQSO.
One of the disadvantages of an ISO is that the sale of the stock attributable to an ISO may result in the taxpayer paying alternative minimum tax.
IRC 409A provides harsh penalties when a company grants an ISO or NQSO with a strike price that exceeds the current FMV of the employer’s tax.
To the extent that the aggregate fair market value of stock with respect to which incentive stock options are exercisable for the 1st time by any individual during any calendar year exceeds $100,000, such options shall be treated as options which are not incentive stock options.
A
Solution: The correct answer is D.
Choice a is not correct as the tax treatment is not the same for a cashless exercise of an ISO and an NQSO. ISO is not subject to payroll tax, NQSO is subject to payroll tax. They will be the same for income tax; both ordinary income. Choice b is not correct. The sale of an ISO share of stock will generally have a negative adjustment for AMT, not positive, and therefore, it would not result in AMT. Choice c is not correct as 409A would apply if the strike price was less than the FMV on the date of grant.
5
Q
Eric works for Carpets, Inc. Carpets, Inc issued him both ISOs and NQSOs during the current year. Which of the following would be the most compelling reason why they might issue both ISOs and NQSOs?
They want to issue over $80,000 in options that are exercisable in the same year.
The NQSOs and ISOs are exercisable in different years.
The company wants to provide the NQSOs to assist the individual in purchasing the ISOs.
Since they are virtually the same there is no compelling reason to issue both in the same year.
A
Solution: The correct answer is C.
When both ISOs and NQSOs are available in the same year the individual can exercise and sell the unfavored NQSOs to generate enough cash to purchase and hold the favored ISOs. It would also be valuable to have both if they issued over $100,000 in options exercisable in the same year because there is a $100,000 limit on ISOs
6
Q
Bob Jones is a senior executive at Sys, a global outsourcing firm based in New York. The company has recently rolled out a new compensation program that includes non-qualified stock options. Bob has approached you, as his planner, with several questions about the tax impact involved in his nonqualified (non-statutory) stock options. His circumstance is as follows:
February 1st: he was granted an option when the company stock price was $30. His option exercise price was $30, but option value was not readily ascertainable.
August 1st: he exercised the option when the stock price was $50.
September 1st: with the price at $50 per share and seeming to have peaked, Bob is wondering if he should sell the stock.
Which of the following applies?
Bob will have ordinary income of $50 if he sells at a stock price of $50.
Bob will have ordinary income at exercise, based on the spread between the stock price and the exercise price of the option.
Bob will have long-term capital gain income of $20 if he sells the stock on September 1st at a price of $50.
Bob will have ordinary income of $30 when the option is awarded.
A
Solution: The correct answer is B.
Bob will not be taxed for gain upon the award of the option because of the lack of readily ascertainable value. He will be taxed at exercise on the spread between the stock price of $50 and exercise price of $30, and finally, upon sale of the stock for any additional amounts of gain.
7
Q
When would you advise a person not to wait to exercise a nonqualified stock option?
When long-term price appreciation is anticipated, but uncertainty regarding future stock price remains.
When the individual has had an excellent year resulting in much higher than expected income.
When the price of the stock in the market is out-of-the-money and not expected to enter or change any time soon.
When the stock price seems to have peaked and sale will immediately follow exercise.
A
Solution: The correct answer is D.
If all gain has been apparently made in a security, rather than lose the profit, and since there are no special advantages to holding non-qualifieds, it may be the time to exercise and to follow with an immediate sale. The rest of the options are actually reasons for holding the option without exercising it.
8
Q
Which of the following is true regarding qualified incentive stock options?
No taxable income will be recognized by the employee when the qualified option is granted or exercised.
The income from sale of the qualified option will always be taxed as capital gains when the stock is sold.
The income from sale of the qualified option will be taxed as ordinary income regardless of when the stock is sold.
The employer will not be able to deduct the bargain element of the option as an expense under any circumstance.
For favorable tax treatment the option must be held two years and the stock for one year after exercise.
II and IV only.
I and V only.
III only.
I, II and V only.
A
Solution: The correct answer is B.
In Statement “II,” be careful of “always”! In Statement “III,” if held longer than one year, they receive capital gains treatment. In Statement “IV,” under most circumstances, the bargain element is deductible. There are exceptions when certain qualifications have not been met for deductibility, such as time employed, time to exercise in excess of rules, etc.
9
Q
Which one of the following incidental benefit rules apply to life insurance coverage provided by a profit sharing plan?
Permanent life insurance, accident insurance, or severance benefits may be included as part of the coverage.
The 25% incidental benefit cost rule is based on the portion of the premium allocated to the policy’s cash value.
An employee’s costs associated with the purchase of life insurance represent a non-deductible expense.
The cost of whole life insurance must be not more than 50% of the total employer contribution allocated to a participant’s account.
A
Solution: The correct answer is D.
Only life insurance may be included in a qualified retirement plan - no accident, severance, or health benefits may be offered under the incidental benefit rules. To qualify under the incidental benefit rules, the entire premium for universal life cannot exceed 25% of the employer’s aggregate contributions, and 50% for whole life insurance. Any pension contributions used to purchase life insurance inside a qualified plan are deductible to the employer.
10
Q
In determining the allowable annual additions per participant to a defined contribution pension plan account for the current year, the maximum contribution is:
Contribution up to $57,000 (indexed).
Compensation up to $285,000.
Compensation not exceeding the defined benefit Section 404 plan limitations in effect for that year.
100% of all salary and bonuses at all income levels.
A
Solution: The correct answer is A.
Option “B” addresses maximum includable compensation, which is not what the question asks. Option “C” is incorrect in mentioning Section 404. The DC plan regulations are addressed in Section 415. Finally, Option “D” is incorrect because not “ALL” salary is included in allowable contributions. There is an annual additions cap of $57,000, making Option “A” the correct response.
11
Q
Which of the following characteristics are found in both a defined contribution plan and a defined benefit plan?
Individual accounts.
Actuarial assumptions required.
Retirement benefits based on account values.
Employer bears investment risk.
I only.
II and IV only.
I, III and IV only.
None of the above.
A
Solution: The correct answer is D.
Statements “I” and “III” apply to defined contribution plans. Statements “II” and “IV” apply to defined benefit plans. None apply to both defined benefit and defined contribution plans
12
Q
Which of the following is not a requirement for the owner of corporate stock who sells to an ESOP to qualify for the nonrecognition of gain treatment?
The ESOP must own at least 55% of the corporation’s stock immediately after the sale.
The owner must reinvest the proceeds from the sale into qualified replacement securities within 12 months after the sale.
The ESOP may not sell the stock within three years of the transaction unless the corporation is sold.
The owner must not receive any allocation of the stock through the ESOP.
A
Solution: The correct answer is A.
The ESOP must own at least 30% of the corporation’s stock immediately after the sale. All of the other statements are true.
13
Q
Cody is considering establishing a 401(k) for his company. He runs a successful video recording and editing company that employs both younger and older employees. He was told that he should set up a safe harbor type plan, but has read on the Internet that there is the safe harbor 401(k) plan and a 401(k) plan with a qualified automatic contribution arrangement. Which of the following statements accurately describes the similarities or differences between these types of plans?
The safe harbor 401(k) plan has more liberal (better for employees) vesting for employer matching contributions as compared to 401(k) plans with a qualified automatic contribution arrangement.
Both plans provide the same match percentage and the same non-elective contribution percentage.
Employees are required to participate in a 401(k) plan with a qualified automatic contribution arrangement.
Both types of plans eliminate the need for qualified matching contributions, but may require corrective distributions.
A
Solution: The correct answer is A.
Safe harbor plans require 100% vesting, while 401(k) plans with QACAs require two year 100% vesting. The matching contributions are different for the plans. Employees are not required to participate in either plan. Both plans eliminate the need for ADP testing, which means that they eliminate the need for qualified matching contributions and corrective distributions.
14
Q
Hiroko, age 54, works for Alpha Corporation and Delta Corporation. Alpha and Delta are both part of the same parent-subsidiary control group. Alpha and Delta both sponsor a 401(K) plan. If Hiroko earns $75,000 at Alpha and $30,000 at Delta what is the maximum employee elective deferral he can make to both plans in total?
$19,500
$26,000
$39,000
$57,000
A
Solution: The correct answer is B.
An individual can defer up to $19,500 (2020) plus an additional $6,500 (2020) catch up for all of their 401(K) and 403(b) plans combined. In this case he can defer the entire $26,000 between the two plans.
15
Q
Timothy is covered under his employer’s Defined Benefit Pension Plan. He earns $500,000 per year. The Defined Benefit Plan uses a funding formula of Years of Service × Average of Three Highest Years of Compensation × 2%. He has been with the employer for 25 years. What is the maximum contribution that can be made to the plan on his behalf?
$137,700
$230,000
$285,000
It is indeterminable from the information given.
A
Solution: The correct answer is D.
Read the question carefully. The question asks “what is the maximum contribution that can be made.” Remember that for a defined pension plan the contribution must be whatever the actuary determines needs to be made to the plan.
16
Q
Which of the following are basic provisions of an IRC Section 401(k) plan?
Employee elective deferrals are exempt from income tax withholding and FICA / FUTA taxes.
Employer’s deduction for a cash or deferred contribution to a Section 401(k) plan cannot exceed 25% of covered payroll reduced by employees’ elective deferrals.
A 401(k) plan cannot require, as a condition of participation, that an employee complete a period of service greater than one year.
Employee elective deferrals may be made from salary or bonuses.
I and III only.
I and IV only.
II and IV only.
II, III and IV only.
A
Solution: The correct answer is D.
Statement “I” is incorrect because all CODA plans, including 401(k) plans, subject the income to Social Security and Medicare tax even though Federal and state income tax is deferred by placing the income into the plan.
Statements “II”, “III” and “IV” are accurate.
Note: Statement III is true. A 401k cannot require 2 years of service before participation. The 2 years of service rule is for Qualified plans other than 401k. A 401k can require 2 years service for employer matching, not employee participation. All employees age 21 with 1 year of service can participate.
17
Q
In 2020, the Section 415 limit for defined contribution plans is:
$19,500
$57,000
$230,000
$285,000
A
Solution: The correct answer is B.
Answer “A” is employee contribution . Answer “C” is top-heavy key-employee maximum and Answer “D” is the annual compensation limit.
18
Q
Cash Balance and Money Purchase Pension Plans favor who?
A
Younger entrants.
19
Q
Defined Benefit and Target Benefit Pension Plans favor who?
A
Older age entrants with less time to accumulate, and therefore, require higher funding levels.
20
Q
Corey is covered under his employer’s Profit-Sharing Plan. He currently earns $500,000 per year. The plan is top heavy. The employer made a 5% contribution on behalf of all employees. What is the company’s contribution for him?
$14,250
$25,000
$57,000
$285,000
A
Solution: The correct answer is A.
For a profit sharing plan the contribution is limited to the lesser of $57,000 (2020) or covered compensation. In this case the contribution will be limited by the covered compensation limit of $285,000. $285,000 × 5% = 14,250 (the calculation without the compensation cap would have been 500,000 x 5% = 25,000). The fact that the plan is top heavy is irrelevant since all employees are receiving a contribution greater than 3%.
21
Q
Jeb, age 54, works for Gamma Corporation and Epsilon Corporation. Gamma and Epsilon are both part of the same parent-subsidiary control group. Gamma and Epsilon both sponsor a 25% money purchase plan. If Jeb earns $200,000 at Gamma and $30,000 at Epsilon what is the maximum employer contribution that can be made to both plans?
$57,000
$57,500
$63,500
$81,000
A
Solution: The correct answer is A.
Because the two companies are part of the same controlled group they will be required to aggregate both plans. Therefore, he will be limited to the defined contribution limit of $57,000. (25% of $230,000 is $57,500 but the single employer limit applies and is $57,000 (2020)). The employer does not contribute the catch-up amount, the taxpayer would that in a contributory plan, which a Money Purchase Plan is not.
22
Q
Matt is a participant in a profit sharing plan which is integrated with Social Security. The base benefit percentage is 6%. Which of the following statements is/are true?
The maximum permitted disparity is 100% of the base benefit level or 5.7%, whichever is lower.
The excess benefit percentage can range between 0% and 11.7%.
Elective deferrals may be increased in excess of the base income amount.
The plan is considered discriminatory because it gives greater contributions to the HCEs.
I and II only.
I, II and IV only.
II only.
I, II, III and IV.
A
Solution: The correct answer is A.
His base rate is 6% and the social security maximum disparity is 5.7% for 11.7% as the top of his range.
Statement “III” is incorrect because integration does not affect voluntary deferrals by employees. Statement “IV” is incorrect because, done properly, integration is NOT considered discriminatory.
23
Q
Hot Dog Moving Company (HDM) sponsors a 401(k) profit sharing plan. In the current year, HDM contributed 20% of each employee’s compensation to the profit sharing plan. The ADP of the 401(k) plan for the NHC is 2.5%. Alex, who is age 57, earns $177,778 and owns 7.5% of the company stock. What is the maximum amount that he may defer into the 401(k) plan for this year?
$6,500
$11,000
$14,500
$16,500
A
Solution: The correct answer is C.
Alex is highly compensated because he is more than a 5% owner, so the maximum that he can defer to satisfy the ADP Test requirements is 4.5% (2.5% + 2%) and because he is over 50, he can defer the additional $6,500 (2020) as a catch-up contribution. Alex can defer $8,000 (4.5% × $177,778) and $6,500 (the catch-up) for a total of $14,500.
24
Q
Paul is considering establishing a defined benefit plan for his company, Viking. He has a blend of highly compensated employees and rank and file employees, who have varying income levels. After doing some research, he wants to know which of the following formulas he is not permitted to use.
Base the benefit on the years of service and salary level of employees, while taking into consideration some of the benefits of Social Security.
Base the benefit retirees receive on a fixed percentage of every employee’s salary, limited to the annual compensation limit.
Define the benefit for retirees as a fixed dollar amount, regardless of income level.
He could use any of the above choices.
A
Solution: The correct answer is D.
All of the above are benefit formulas used by defined benefit plans.
25
Dr. Dylan James is a 55-year-old Doctor who just started his gastroenterologist practice and hired Nurse Nancy, who is age 25. Dr. DJ is expected to earn annual income of $350,000 that will increase at least at the rate of inflation. Inflation is expected to be 3 percent. Which of the following defined benefit plan formulas would you recommend if Dr. DJ wants to maximize his benefits in retirement, which is expected to occur at age 65?
Unit benefit (a.k.a. percentage-of-earnings-per-year-of-service) formula.
Flat-percentage formula.
Flat-amount formula.
New comparability formula.
Solution: The correct answer is B.
The unit credit formula rewards many years of service. The flat percentage formula will work well, as long as the Doctor has ten years of service. The maximum benefits under IRC 415(b) are reduced for participation less than 10 years. The flat amount would provide higher benefits for Nurse Nancy compared to Dr. DJ on comparative basis. A new comparability plan is a profit sharing plan.
26
Which of the following are legal requirements for 401(k) plans?
Employer contributions do not have to be made from profits.
Employee elective deferral elections must be made before the compensation is earned.
Hardship rules allow in-service withdrawals which are not subject to the 10% early withdrawal penalty.
ADP tests can be avoided using special safe harbor provisions.
I, II and IV only.
I, III and IV only.
II, III and IV only.
I, II, III and IV.
Solution: The correct answer is A.
Hardship withdrawals are considered premature withdrawals and are subject to income tax and the 10% early withdrawal penalty if the employee is under age 59 1/2.
27
Marilyn Hayward is the sole proprietor and only employee of unincorporated Graphics for Green Promotions. In 2020. Marilyn established a profit sharing Keogh plan with a 25% contribution formula. As of December 31, 2020, Marilyn has $140,000 of Schedule C net earnings. The deduction for one-half of the self-employment tax is, therefore, $9,891. What is the maximum allowable Keogh contribution that Marilyn can make?
$19,500
$24,311
$26,022
$32,560
Solution: The correct answer is C.
Half of the self-employment tax is given, you can skip the 1st step in the self-employment contribution formula (multiplying by 92.35%)
140,000 - $9,891 = 130,109 x 20%*= 26,021.80
*The 20% is from the contribution rate formula: contribution rate / (1 + contribution rate) = self-employment contribution rate
.25/ (1+.25) = .20. Note that if the employer has employees and contributes 15% for them, that is the contribution rate to use in this formula.
28
Gia, age 45, is married and has two children. Her employer, Print, Inc sponsors a target benefit plan in which she is currently covered under. Which of the following statements is true regarding her plan?
She can name anyone she wishes as her beneficiary.
A target benefit plan favors younger employees.
A target benefit plan is covered under PBGC.
The investment risk is on the employee.
Solution: The correct answer is D.
The investment risk is on the employee because this is a defined contribution plan. She can only name someone other than her spouse if she has a valid waiver signed by the spouse. This applies to all pension plans. A target benefit plan favors older entrants. A target benefit is not covered under PBGC.
29
An actuary establishes the required funding for a defined benefit pension plan by determining:
The lump sum equivalent of the normal retirement life annuity benefit of each participant.
The amount of annual contributions needed to fund single life annuities for the participants at retirement.
The future value of annual employer contributions until the participant's normal retirement date, taking an assumed interest rate, the number of compounding periods, and employee attrition into account.
The amount needed for the investment pool to fund period certain annuities for each participant upon retirement.
Solution: The correct answer is B.
Statement "A" is incorrect because it deals with a lump sum, NOT annual contributions. Statement "C" is incorrect because DB plans deal with present value calculations, not future values. Statement "D" is incorrect because DB plans deal with life annuities, NOT period certain annuities
30
Which of the following apply to legal requirements for a qualified thrift/savings plan?
Participants must be allowed to direct the investments of their account balances.
Employer contributions are deductible when contributed.
In-service withdrawals are subject to financial need restrictions.
After-tax employee contributions cannot exceed the lesser of 100% of compensation or $57,000.
Solution: The correct answer is D.
This correctly describes the Section 415(c) limits on maximum contributions permitted by law. Participants do not have to be given the right to direct their investments. Employees make after-tax contributions to a thrift; employers don't make contributions. Answer "C" is incorrect because only 401(k) plans have statutory hardship withdrawal requirements, not thrift/savings plans.
31
The investment portfolio for a defined-benefit retirement plan has declined in value during a year in which most financial market instruments have also incurred losses. Which one of the following entities would be impacted most by this decline in portfolio value?
Individual participants in the plan.
Company sponsoring the plan.
Investment advisory handling the plan assets.
Plan underwriters.
Solution: The correct answer is B.
The company may be required to make increased contributions to fully fund the plan.
32
The maximum retirement benefit a participant in a target-benefit plan will actually receive depends on the:
Initial actuarial computation according to the plan's formula.
Amount of contributions determined in reference to the targeted benefit.
Maximum annual additional amounts.
Value of the participant's account at retirement.
Solution: The correct answer is D.
While Answers "A", "B" and "C" help to increase the final account value, the retirement benefit is determined solely by the account value.
33
Calculate the maximum contribution (both employer and employee elective deferrals) for an employee (age 39) earning $290,000 annually, working in a company with the following retirement plans: a 401(k) with no employer match and a money-purchase pension plan with an employer contribution equal to 12% of salary.
$19,500
$34,200
$53,700
$57,000
Solution: The correct answer is C.
For the purposes of this calculation, the compensation exceeding $285,000 is not recognized. The employer is contributing 12% of $285,000 (or $34,200) for the money purchase plan and the employee may contribute up to $19,500 in 2020 to the 401(k) plan. This totals $53,700.
34
In order to be qualified, money purchase plans must contain which of the following?
A definite and non-discretionary employer contribution formula.
Forfeitures can be reallocated to the remaining participants' accounts in a non-discriminatory manner or used to reduce employer contributions.
An individual account must be maintained for each employee of employer contributions.
The normal retirement age must be specified.
I and II only.
II and IV only.
I, II and III only.
II, III and IV only.
Solution: The correct answer is C.
A normal retirement age must be stated in a defined benefit plan, so Statement "IV" is incorrect. Defined contributions plans (such as a money purchase plan) have retirement benefits which are determined by the value of the individual account whenever the participant retires. Forfeitures may be allocated to employees' individual accounts or used to reduce employer required contributions.
35
In a money purchase plan that utilizes plan forfeitures to reduce future employer plan contributions, which of the following components must be factored into the calculation of the maximum annual addition limit?
Forfeitures that otherwise would have been reallocated.
Annual earnings on all employer and employee contributions.
Rollover contributions for the year.
Employer and employee contributions to all defined contribution plans.
I, II and III only.
I and III only.
II and IV only.
IV only.
Solution: The correct answer is D.
Annual additions are defined as new money contributed into the individual account of a participant. Because forfeitures reduced employer contributions and not added directly to employee's individual accounts, the forfeitures are not included in annual additions. Annual earnings and rollover contributions are not included in annual additions.
36
Which of the following legal requirements apply to Employee Stock Ownership Plans (ESOPs)?
ESOPs must permit participants, who are aged 55 or older and who have at least 10 years of service, the opportunity to diversify their accounts.
ESOPs can be integrated with Social Security.
An employer's deduction for ESOP contributions and amounts made to repay interest on an ESOP's debt cannot exceed 25% of the participant's payroll.
The mandatory 20% income tax withholding requirement does not apply to distributions of employer stock from an ESOP.
I and II only
II and IV only
I, II and III only
I and IV only
Solution: The correct answer is D.
Deductions for interest payments are not limited for ESOP plans. Deductions for repayment of principal is limited to 25% of covered compensation.
37
Which statement(s) is/are true regarding qualified profit-sharing plans?
A company must show a profit in order to make a contribution for a given year.
A profit-sharing plan is a type of retirement plan and thus is subject to minimum funding standards.
Forfeitures in profit-sharing plans must be credited against future years' contributions.
Profit-sharing plans should make contributions that are "substantial and recurring."
IV only.
I and III only.
I, II and IV only.
I, II, III, and IV.
Solution: The correct answer is A.
Profits are not required to make contributions to a profit-sharing plan. Minimum funding is required only in pension plans. Forfeitures may be reallocated to remaining employee accounts.
38
Which statement(s) is/are true for a target benefit plan?
It favors older participants.
It requires annual actuarial assumptions.
The maximum deductible employer contribution is 25% of covered compensation.
The maximum individual allocation is the lesser of 100% of pay or $57,000 (2020).
I and IV only.
II and III only.
I, III and IV only.
I, II, III and IV only.
Solution: The correct answer is C.
Actuarial assumptions are needed at the inception of the plan to provide the target formula.
39
Lisa, age 35, earns $175,000 per year. Her employer, Reviews Are Us, sponsors a qualified profit sharing 401(k) plan, which is not a Safe Harbor Plan, and allocates all plan forfeitures to remaining participants. If in the current year, Reviews Are Us makes a 20% contribution to all employees and allocates $5,000 of forfeitures to Lisa’s profit sharing plan account, what is the maximum Lisa can defer to the 401(k) plan in 2020 if the ADP of the non-highly employees is 2%?
$7,000
$13,500
$17,000
$19,500
Solution: The correct answer is A.
The maximum annual addition to qualified plan accounts is $57,000. If Reviews Are Us contributes $35,000 ($175,000 × 20%) to the profit sharing plan and Lisa receives $5,000 of forfeitures, she may only defer $17,000 ($57,000 - $35,000 - $5,000) before reaching the $57,000 limit (2020). However, she will also be limited by the ADP of the non-highly employees because she is highly compensated (compensation greater than $130,000). If the non-highly employees are deferring 2% then the highly compensated employees can defer 4% (2×2=4). Therefore, she is limited to a deferral of $7,000 ($175,000 × 4%).
40
Carol, age 55, earns $200,000 per year. Her employer, Reviews Are Us, sponsors a qualified profit sharing 401(k) plan, which is not a Safe Harbor Plan, and allocates all plan forfeitures to remaining participants. If in the current year, Reviews Are Us makes a 18% contribution to all employees and allocates $7,000 of forfeitures to Carol’s profit sharing plan account, what is the maximum Carol can defer to the 401(k) plan in 2020 if the ADP of the non-highly employees is 1%?
$4,000
$19,500
$10,500
$26,000
Solution: The correct answer is C.
The maximum annual addition to qualified plan accounts is $57,000. If Reviews Are Us contributes $36,000 ($200,000 × 18%) to the profit sharing plan and Carol receives $7,000 of forfeitures, she may only defer $14,000 ($57,000 - $36,000 - $7,000) before reaching the $57,000 limit. However, she will also be limited by the ADP of the non-highly employees because she is highly compensated (compensation greater than $130,000). If the non-highly employees are deferring 1% then the highly compensated employees can defer 2% (1×2=2). Therefore, she is limited to a deferral of $4,000 (200,000 x 2%). Since she is 50 or older she can also defer the catchup amount of $6,500 which is not subject to the ADP limitation. Therefore, her maximum deferral is $10,500.
41
Select those statements which accurately reflect characteristics of defined contribution pension plans?
Allocation formula which is indefinite.
Account value based benefits.
Employer contributions from business earnings.
Fixed employer contributions based upon terms of plan.
I and II only.
II and III only.
II and IV only.
I, II and III only.
Solution: The correct answer is C.
Defined contribution pension plans must have a definite allocation formula based upon salary and/or age or any other qualifying factor. Contributions may be made without regard to company profits and, because it is a pension plan, are fixed by the funding formula and must be made annually.
42
Richard is covered under his employer’s Defined Benefit Pension Plan. He earns $200,000 per year. The Defined Benefit Plan uses a funding formula of Years of Service × Average of Three Highest Years of Compensation × 3%. He has been with the employer for 25 years. What is the maximum defined benefit that can currently be used to determine contributions?
$57,000
$150,000
$230,000
$285,000
Solution: The correct answer is B.
The maximum defined benefit is the lesser of $230,000 (2020) or his compensation. However, the funding formula will limit his defined benefit to $150,000 (25 × 200,000 × .03).
43
A qualified money purchase pension plan contribution (by the employer) is influenced by which of the following factors:
Total return on portfolio assets.
Forfeitures from non-vested amounts of terminated employee accounts.
Increases in participants' compensation due to inflation or performance-based bonuses.
Minimum funding as determined by an actuary.
I and II only.
II and III only.
III and IV only.
II, III and IV only.
Solution: The correct answer is B.
Forfeitures may reduce employer contributions due to contribution offsets or Section 415 limitation on annual additions. Increased compensation will result in increased contributions by the employer, subject to Section 415 limitations. Returns on portfolio assets and actuary funding are a concern in defined benefit plans. A money purchase plan is defined contribution plan.
44
Robin just started at Financial University Network (FUN) and has been encouraged by several of the “old timers” to save part of her salary into the 401(k) plan. She is not yet convinced as she likes to shop. Which of the following statements is accurate regarding 401(k) plans?
A 401(k) plan must allow participants to direct their investments.
Deferrals into the 401(k) plan must be contributed by the end of the following calendar quarter into the plan.
Employees that join the plan must be provided with a summary plan description.
A 401(k) plan is financially safe because it must have an annual audit.
Solution: The correct answer is C.
Answer c is correct as employees must be given a summary plan description, which provides basic information about the operation of the plan. Answer a is not correct as some 401(k) plans may have the asset managed by an investment manager. However, most 401(k) plans will provide for employee self directing of their 401(k) balances. Answer d is not correct as there is no requirement for an annual audit of a 401(k) plan.
45
James is covered under his employer’s top heavy Defined Benefit Pension Plan. He currently earns $120,000 per year. The Defined Benefit Plan uses a funding formula of Years of Service × Average of Three Highest Years of Compensation × 1.5%. He has been with the employer for 5 years. What is the maximum defined benefit that can be used for him for funding purposes?
$9,000
$12,000
$54,000
$120,000
Solution: The correct answer is B.
The maximum defined benefit is the lesser of $230,000 (2020) or his compensation. However, the funding formula will limit his defined benefit to $12,000 (5 × 120,000 × .02). Note that you would use 2% instead of the 1.5% because the plan is top heavy. He is not a key employee because he is not a 1) greater than 5% owner, 2) greater than 1% owner with compensation greater than $150,000 or 2) an officer with compensation greater than $185,000 (2020). Therefore the plan must use a defined benefit limit of 2% instead of 1.5%.
46
All of the following accurately reflect the characteristics of a stock bonus plan, except:
Useful in cash flow planning for plan sponsor due to cashless contributions.
Provides motivation to employees because they become "owners."
20% withholding does not apply to distributions of employer securities and up to $200 in cash.
May not allow "permissible disparity" or integration formulas.
Solution: The correct answer is D.
Integration formulas are not allowed under an ESOP plan but are allowed under a stock bonus plan. All other statements are accurate in their description of a stock bonus plan.
47
Shane’s Rib Shack has a Target Benefit Plan. They have 10 employees with the following compensations: Employee Compensation
```
$300,000
$100,000
$75,000
$50,000
$50,000
$50,000
$50,000
$25,000
$25,000
$20,000
Based on the actuarial table that was established at the inception of the plan they should fund the plan with $210,000. What is the maximum deductible contribution that can be made to the plan?
```
$182,500
$186,250
$195,000
$210,000
Solution: The correct answer is A.
Since the plan is a defined contribution plan the maximum deductible contribution is 25% of the total covered compensation. The max covered compensation of all employees is $730,000. Thus the maximum deductible limit is $182,500 ($730,000 × 25%). Remember to limit employee 1 to the $285,000 (2020) covered compensation limit. The actuarial table amount is irrelevant because this a defined contribution plan.
48
Which of the following statements accurately reflects the overall limits and deductions for employer contributions to qualified plans?
An employer's deduction for contributions to a money purchase pension plan and profit sharing plan is limited to the lesser of 25% of covered payroll or the maximum Section 415 limits permitted for individual account plans.
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 covered payroll.
Profit sharing minimum funding standard is the lesser of 25% or the Section 415 limits permitted for individual account plans.
I only.
I and II only.
II and III only.
I, II and III.
Solution: The correct answer is A.
Statement "II" is incorrect because there is no 25% of covered payroll limitation in a DB plan. Statement "III" is incorrect because there is no minimum funding standard for profit sharing plans.
49
Which one of the following statements is NOT correct?
Profit sharing plans fall under the broad category of defined contribution plans.
Profit sharing plans are best suited for companies that have unstable earnings.
A company that adopts a profit sharing plan is required to make contributions each year.
The maximum tax deductible employer contribution to a profit sharing plan is 25% of covered compensation.
Solution: The correct answer is C.
Minimum funding (mandatory annual contributions) are a characteristic of pension plans, not profit sharing plans.
50
Which of the following characteristics apply to paired plans (also known as "tandem plans")?
Generally combines a money purchase pension and a profit-sharing plan.
Actuarial assumptions required.
Total contributions to the paired plans limited to 15% of payroll by IRC Section 404.
Employer bears investment risk.
I only.
II and IV only.
I, III and IV only.
IV only.
Solution: The correct answer is A.
Defined contribution plans do not require actuarial assumptions. Total contributions to both plans is limited to lesser of 100% or $57,000 (2020) by IRC Section 415. The profit sharing plan is limited by IRC Section 404 to 25% of covered payroll. Employees bear the investment risk in DC plans.
51
Which of the following is NOT included as one of the provisions for the continuation benefits under the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985?
All employers offering group health insurance must provide COBRA continuation benefits.
COBRA benefit durations vary from 18, 29, or 36 months depending upon the qualifying event.
COBRA eligible coverages do include: dental plans, vision plans, Medical FSAs, prescription drug plans and mental health plans.
COBRA eligibility ceases when a covered participant becomes eligible to participate in another group health plan or Medicare.
Solution: The correct answer is A.
COBRA benefits are required of employers who have 20 or more employees. Employers with fewer employees are not required to provide COBRA continuation, even if they offer a group a health insurance plan to employees.
52
Which of the following accurately describes the benefits of a Section 125 Cafeteria Plan?
Cafeteria plans provide family benefits which are homogenous.
Under a cafeteria plan, a family can effectively create its own benefit plan by the rational selecting of options available.
The law requires the employer to offer at least three options that provide cash benefits.
The law requires that at least two statutory non-taxable benefits be available.
Solution: The correct answer is B.
Family benefit needs are rarely homogenous, but vary from family to family. These unique family needs are met though a cafeteria plan because each family can tailor their benefit package to best meet those needs. Cafeteria plans, by law, must offer at least one taxable "cash" benefit, and one "pre-tax" benefit. The only tax deferral option allowed under Section 125 cafeteria plan is a 401(k). This is a statutory restriction.
53
Which of the following is/are accurate of a Section 125 cafeteria plan?
30% of the total benefits can accrue to key employees.
There must be at least one cash benefit.
Deferral of income is not allowed except through a 403(b).
Salary reductions can be changed at any time during the year.
I only.
II only.
II and III only.
I and IV only.
Solution: The correct answer is B.
Statement "I" is incorrect because only 25% of the total benefits can accrue to key employees. Statement "III" is incorrect because deferrals are allowed only through a 401(k) plan. Statement "IV" is incorrect because mid-year changes in reductions are allowed only for qualified changes in status.
54
Dues to business-related organizations provided as a fringe benefit are:
Includable in taxable income of all covered employees.
Includable in the taxable income of key employees only.
Excludable from the taxable income of all covered employees.
Excludable from the taxable income of non-highly compensated employees only.
Solution: The correct answer is C.
Dues and licenses are excluded from taxable income if directly related to the employee's job
55
Personal use of an employer-provided vacation lodging as a fringe benefit is:
Includable in taxable income of all covered employees.
Includable in the taxable income of key employees only.
Excludable from the taxable income of all covered employees.
Excludable form the taxable income of non-highly compensated employees only.
Solution: The correct answer is A.
Lodging is only excluded if (1) it is furnished on the business premises (the place of work), (2) it is furnished for the employER's convenience, and (3) the employee accepts it as a condition of employment. A vacation stay does not meet any of the these criteria so it is fully taxable.
56
Which of the following accurately describes a qualified group life insurance plan?
The plan must benefit 70% of all employees, or a group consisting of 85% non-key employees, or a non-discriminatory class, or meet the non-discrimination rules of Section 125.
Employees who can be excluded are: those with fewer than 3 years service, part-time / seasonal, non-resident aliens, or those covered under a collective bargaining unit.
A non-discriminatory classification is one which has a bottom tier with benefits no less than 10% of the top tier and no more than 200% increase between tiers.
The minimum group size is 10.
I, II and III only.
I, II and IV only.
I and III only.
I and II only.
Solution: The correct answer is B.
For statement III to be a correct choice, it should state: A qualified group life insurance plan, if using a non-discriminatory classification, will have a bottom tier with benefits no less than 10% of the top tier and no more than 250% increase between tiers.
57
Describe a qualified group life insurance plan
The plan must benefit 70% of all employees, or a group consisting of 85% non-key employees, or a non-discriminatory class, or meet the non-discrimination rules of Section 125.
Employees who can be excluded are: those with fewer than 3 years service, part-time / seasonal, non-resident aliens, or those covered under a collective bargaining unit.
The minimum group size is 10.
58
Cafeteria plans have which of the following characteristics?
Must offer a choice between at least one qualified "pre-tax" benefit and one non-qualified "cash" benefit.
Medical Flexible Spending Accounts (FSAs) can reimburse medical expenses not covered by insurance for the participant and all dependents.
Changes in election amount during the plan year can only occur with a "qualifying change in family status."
Salary reductions are not subject to income taxes but payroll taxes apply.
I, II and IV only.
II, III and IV only.
I, II and III only.
I, II, III and IV.
Solution: The correct answer is C.
Cafeteria Plans (Section 125) allow salary reductions which are taken from an employee's salary before Federal and State withholding tax as well as Social Security and Medicare taxes (FICA). At least one taxable and non-taxable benefit must be offered under a plan. Medical FSAs allow reimbursement for eligible medical expenses for the employee and any dependents. A qualifying change in status is required to make a mid-year change in elections.
59
Ellie's Toy Store provides group health insurance to its 17 employees. After two employees are recruited away by a national chain, Tot Town, Ellie was upset and didn't offer them the opportunity to purchase continuation coverage under COBRA. Which one of the statements below is accurate?
Ellie must pay a penalty of $100 per day for each day that continuation coverage wasn't offered.
Ellie is required to pay any claims incurred by the ex-employees until they are offered continuation coverage.
Ellie is no longer able to deduct health insurance premiums.
Ellie does not have to offer COBRA coverage.
Solution: The correct answer is D.
Ellie only has 17 employees. The mandated COBRA requirement does not take effect until the employer has 20 or more employees.
60
Services provided on a discounted or free basis to employees are not includible in taxable income to the employee under which of the following circumstances?
The employer must incur no substantial cost in providing the service.
Services offered to the employees must be in the line of business in which they are working.
Services cannot be discounted more than 25% of the price that is available to customers.
If there is a reciprocity agreement between two unrelated employers in the same line of business.
I and II only.
II and III only.
III and IV only.
I, II and IV only.
Solution: The correct answer is D.
All statements are correct except for Statement "III". This is because the percentage of discount that is stated is limited to 20%.
61
In order for a group term life insurance plan to be non-discriminatory, which of the following is true?
At least 80% of all employees must benefit from the plan.
At least 85% of the participants must be non-highly compensated employees.
If the plan is part of a cafeteria plan, the plan must comply with the non-discrimination rules of Section 125.
The bottom band of benefits must be no less than 10% of the top band with no more than a 2 times differential between bands.
Solution: The correct answer is C.
A plan must benefit 70% of all employees or a group of which at least 85% are not key employees. If the plan is part of a cafeteria plan, it must comply with Section 125 rules. The difference between the bands in "D" must be no greater than 2.5 times the next smaller band with the bottom band being equal to no less than 10% of the top band.
62
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) impacts an employee and employer in which of the following ways:
An employee without creditable coverage can generally only be excluded by the group health insurance plan (if offered) for up to twelve months.
The waiting period is reduced by the amount of "creditable coverage" at a previous employer.
If the employee does not enroll in the group health insurance plan at the first opportunity, an 18-month exclusion period may apply.
I and II only.
I, II and III only.
II and III only.
II only.
Solution: The correct answer is B.
All three statements are true. If you have a pre-existing condition that can be excluded from your plan coverage, then there is a limit to the pre-existing condition exclusion period that can be applied. HIPAA limits the pre-existing condition exclusion period for most people to 12 months (18 months if you enroll late), although some plans may have a shorter time period or none at all. In addition, some people with a history of prior health coverage will be able to reduce the exclusion period even further using "creditable coverage." People with a history of prior health coverage will be able to reduce the exclusion period even further using "creditable coverage."
63
Jane P. Lane is a clerical worker who has been with her employer for the last 20 years. Last year, she got married in the Swiss Alps, which was quite out of character for her.
She participates in an employer-paid group term life plan and selected term insurance in the amount of $200,000, which is three times her salary.
She has named her spouse as the beneficiary of the policy.
What is the tax consequence of this policy?
Her employer is permitted to deduct the premiums paid on the entire amount of coverage.
Her employer is permitted to deduct the premiums paid on the first $50,000 of coverage.
Jane is subject to tax on the entire benefit.
Jane is subject to tax on the amount which exceeds three times her annual salary or $50,000, whichever is less.
Solution: The correct answer is A.
The employer is permitted to deduct 100% of the premums, but Jane is subject to taxation on the amount in excess of $50,000.
64
The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) mandates employers provide continuation coverage for former employees except under which of the following circumstances:
Employer has fewer than 20 employees.
Employee retires at the age of 65.
Death of the employee.
Involuntary termination of employment due to gross misconduct.
I only.
III only.
I, III and IV only.
I, II and IV only.
Solution: The correct answer is D.
Employers must continue medical coverage to pay for final medical expenses after the death of the employee. Statements I, II, and IV are statutory exemptions to the COBRA requirement. (Note: A 65-year-old retiree would be covered under Medicare.)
65
A new client comes in after his spouse's death. The spouse was an active participant in a qualified retirement plan. There was a cost basis associated with the spouse's retirement account. Which of the following accurately describes the income tax implications due to death payments from the qualified plan as either an income for life or fixed period installment payments?
When the benefits are from life insurance, the cash value portion is taxed under the annuity rules.
When benefits are from "pure insurance," the amount is excludable from gross income.
If the benefits are from funds not related to life insurance, the includible amount is taxed as ordinary income.
If the benefits are not related to life insurance, the beneficiary's cost basis is equal to the participant's cost basis.
II and IV only.
I, III and IV only.
I, II and IV only.
I, II, III and IV.
Solution: The correct answer is D.
All of these statements are accurate.
66
Which of the following is NOT a qualified employee fringe benefit?
Medical expenses NOT covered by medical health plan are paid under a reimbursement plan.
A major medical health insurance plan or HMO premiums.
Long-term disability insurance.
A $150,000 group term life insurance policy.
Solution: The correct answer is D.
Only $50,000 of group term life is a qualified benefit. Amounts of term life insurance in excess of $50,000 is taxable to employee using Section 79, Table 1.
67
Which of the following describe benefits usually available under an employer-provided short-term disability plan?
Short-term disability coverage will start on the first day when disability is related to an illness.
The definition of disability under short-term disability coverage is defined as the inability to perform the normal duties of one's position.
Benefits under a short-term disability plan usually extend for one year.
Generally, short-term disability coverage will start after sick pay benefits have been provided to a covered employee.
I and II only.
III and IV only.
II and IV only.
I, II and III only.
Solution: The correct answer is C.
Short-term disability benefits usually start the eighth day of an illness (first day for an accident) and generally last no more than six months.
68
What cannot be included in a VEBA?
Retirement benefits and commuter benefits cannot be included in a VEBA.
69
Which of the following statements accurately describes a situation where the use of a Flexible Spending Account (FSA) would be advisable?
The employer's medical plan has large deductibles or large coinsurance or copayment provisions.
There is a need for benefits that are sometimes difficult to provide on a group basis, such as dependent care.
The employees are primarily non-union and operating outside of a collective bargaining agreement.
There are a great many employees who have an employed spouse with duplicate medical coverage.
I and II only.
I, III and IV only.
I, II, and III only.
I, II, III and IV.
Solution: The correct answer is D.
All of the choices listed here are reasons why an employer may want to offer an FSA.
70
Which of the following is a correct statement about the income tax implications of employer premium payments for group health insurance?
An S Corporation can only deduct 70% of the premiums for all employees.
In a sole proprietorship, the premiums for both the owner and the non-owner are fully deductible.
If stockholder/employees of a closely held C corporation are covered as employees, the premiums are fully deductible.
Premium costs paid by a partnership are passed through to the partner, who can deduct 70% of the costs on their individual tax returns.
Solution: The correct answer is C.
S Corporations and proprietorships cannot deduct any premiums for group health insurance for owners. Non-owner employee health premiums are fully deductible to both entities. Answer "D" is incorrect because partners are able to deduct 100% of the health insurance premium on their individual tax returns.
71
Which of the following statements does not describe the concept of constructive receipt as it applies to employee benefits and qualified and non-qualified retirement plans?
Funded non-qualified retirement plans do not incur constructive receipt if the agreement was executed prior to the performance of services.
Constructive receipt may occur when the funds or benefits are available or accessible to the employee, regardless of whether the funds are actually received.
Unfunded benefit plans generally avoid constructive receipt because there is a substantial risk of forfeiture.
Salary reduction benefit plans generally avoid constructive receipt if the agreement was executed prior to the performance of services.
Solution: The correct answer is A.
Generally, funded plans result in constructive receipt because the employee has control of the assets and there is no substantial risk of forfeiture. Keep in mind, the question is looking for the false answer.
72
Which of the following statements concerning the basic characteristics of non-qualified deferred compensation plans is accurate?
The employer immediately deducts contributions made into the informal funding arrangement in any given year.
During their working years, employees have the same tax treatment under a non-qualified plan as under a qualified plan.
Under both an unfunded plan and a formally funded plan, the only security or guarantee the employee has is the unsecured promise of the employer.
Under both the funded plan and an informally funded plan, the IRS may likely rule that the employee is in constructive receipt of income unless there is a substantial risk of loss or forfeiture.
Solution: The correct answer is D.
Employer contributions into a non-qualified plan are not tax deductible to the employer until the employee has constructive receipt and is taxed on the income. Most non-qualified plans are designed to avoid constructive receipt by the employee until retirement. In an informally funded plan (Rabbi trust), the employee has the segregated assets as security of the agreement, assuming the employer remains solvent and the assets are not taken by the employer's creditors. This risk of having creditors take the assets inside a "Rabbi trust" is what constitutes a substantial risk of loss or forfeiture and keeps the employee from being considered in "constructive receipt" of the formally funded assets.
73
A supplemental deferred compensation plan that pays retirement benefits on salary, above the Section 415 limits, at the same level as the underlying retirement plan is known as:
A Supplemental Executive Retirement Plan (SERP).
A funded deferred compensation plan.
An excess benefit plan.
A Rabbi trust.
Solution: The correct answer is C.
An excess benefit plan extends the same benefits to employees whose contributions to the plan are limited by Section 415 (e.g., employee earns $285,000 yet receives $57,000 contribution instead of $70,000 contribution due to Section 415 limitation on a 25% money purchase plan). An excess benefit plan would put additional $13,000 into non-qualified retirement plan. Do not confuse with a SERP which provides benefits in excess of the Section 415 limits AND ignores the covered compensation limits (i.e., $285,000 in 2020) applied to qualified plans.
74
A supplemental deferred compensation plan providing retirement benefits above the company's qualified plan AND without regard to Section 415 limits is known as:
A Supplemental Executive Retirement Plan (SERP).
A funded deferred compensation plan.
An excess benefit plan.
A Rabbi trust.
Solution: The correct answer is A.
SERP supplements the pension plan without regard to limits imposed upon salary levels (i.e., maximum salary of $285,000 in 2020) or the maximum funding levels of Section 415. Do not confuse with an excess benefit plan which extends the benefits of a company's qualified plan above the Section 415 limits but still adheres to maximum salary limitations.
75
Bobby’s Bar-b-que wants to establish a social security integrated plan using the offset method. Which of the following plans should he establish?
SIMPLE
ESOP
Money Purchase Pension Plan
Defined Benefit Pension Plan
Solution: The correct answer is D.
He should establish the Defined Benefit Pension Plan. Only defined benefit plans can use the offset method. The Money Purchase Pension plan is a Defined Contribution Plan and must use the excess method. Simple’s and ESOPs cannot be integrated.
76
Pat established his business one year ago. He has hired two assistants. He would like to establish a retirement benefit plan for himself and his two assistants, who want to make voluntary contributions. He is concerned about cash flows for unforeseen business obstacles and future expansion. Which of the following reasons is/are appropriate to recommend the establishment of a retirement plan.
A retirement plan would allow Pat to save for his own retirement.
Tax savings would help to offset the cost of employer contributions.
A retirement plan would give the appearance of business stability and would be an asset in the securing of business loans to meet growth and cash flow needs.
I only.
II only.
I and III only.
I and II only.
Solution: The correct answer is D.
Statement "III" is incorrect because a retirement plan cannot be used as collateral for a loan made to the plan sponsor. This would be a prohibited transaction.
77
Match the following statement with the type of retirement plan which it most completely describes: "This plan can provide for voluntary participant contributions which must be matched by the employer."
Profit sharing plan with a 401(k) component.
Money purchase plan.
SIMPLE IRA.
Defined benefit plan.
Solution: The correct answer is C.
Answers "B" and "D" do not permit employee elective deferrals. The profit sharing plan "A" with 401(k) provisions do not require an employer match.The SIMPLE plan has a mandatory match.
78
Match the following statement with the type of retirement plan that it most completely describes: " A defined benefit plan that has the appearance of a defined contribution plan" is a...
Profit sharing plan.
Money purchase plan.
SIMPLE IRA.
Cash balance plan.
Answer "D" - Cash balance plan provides a defined benefit (returns are guaranteed by the employer) and the employee receives an "account" to see how much they have.
79
Beth, who is 45 years old, spent most of her career in the corporate world and now provides consulting services and serves as a director for several public companies. Her total self-employment income is $450,000. She is not a participant in any other retirement plan today. She would like to shelter some of her earnings by contributing it to a retirement plan. Which plan would you recommend?
Establish a 401(k) plan.
Establish a profit sharing plan.
Establish a Deferred Comp program for her.
Establish a SEP.
Solution: The correct answer is D.
Because her income is so high, she can set up a SEP and max out her 415(c) limit. She cannot set up a deferred compensation arrangement and shelter tax. The SEP is better than the 401(k) because it can be set up in a minimal amount of time and there are no filing requirements. The SEP also has the same limit as a profit sharing plan in her case since she would be able to max out either at 57,000 in 2020.
80
Brisco, age 51, is the Executive VP of sales at Doggie Daycare (DD). His base salary is $300,000 with a potential bonus of 50%. Brisco is a participant in his employer’s 401(k) plan and always defers the maximum amount. The DD 401(k) plan has the following features and characteristics: Includes a Roth account that is not a safe harbor plan, but has a 50% match up to 4%. The ADP for the NHC is 4.5%. The plan has $3 million in assets that are managed by two asset management firms. DD also sponsors a defined benefit plan that provides a benefit based on years of service and final salary. The DD DB plan provides for 1.5 percent per year of service for the first 20 years and 2 percent for years above 20, up to a max of 35 years. On the weekends, Brisco paints murals. His entity, Wall Works LLC (WW), is a single owned LLC taxed as a disregarded entity. Brisco would like to establish a retirement plan for the income that he earns in WW. He expects to earn $60,000 every year in WW and wants to know what the best retirement plan is for his business. Which plan would you recommend for him?
SIMPLE
Defined Benefit Plan
401(k) plan
SEP
Solution: The correct answer is D.
Neither a SIMPLE nor a 401(k) plan will work because he is already deferring $18,525 (6.5% (4.5% + 2%) times $285,000) to his 401(k) plan. Therefore, the choices are a 412(e) plan, which is a defined benefit plan funded with insurance products or a SEP, which is extremely easy to set up and one that he can contribute around $11,000 to annually.
81
Your client, Sue, age 35, is covered by a pension plan at work, but her spouse, age 37, is not covered by a pension plan. Her salary is $45,000 and his salary is $50,000. How much will go into his account if he contributes the maximum amount to a maximum funded, matching SIMPLE IRA?
$13,500
$19,000
$15,000
$19,500
Solution: The correct answer is C.
He can contribute $13,500 (2020) and his employer will match $1 for $1 up to 3% of salary ($50,000 × .03 = $1,500). Therefore, maximum contribution is $13,500 + $1,500 = $15,000.
82
Lien, age 35, recently left his employer, GoGoRoller, a roller blade manufacturer. He left after 18 months because the working conditions were unbearable. GoGoRoller sponsored a SIMPLE IRA. Lien deferred $3,000 into the plan during his time there and the employer contributed $1,500. When he terminated he withdrew the entire account balance of $4,750. Assuming he is in the 12% tax bracket, what is the tax and penalty consequence for this distribution?
$570.00
$775.00
$1,187.50
$1,757.50
Solution: The correct answer is D.
SIMPLE IRAs require a 25% penalty for early withdraws in the first two years if the participant does not meet any of the early withdrawal exceptions. He does not meet any of the exceptions and the distribution is within the first two years. The breakdown of employee deferrals, employer contributions and earnings is irrelevant. Contributions on behalf of Lien were $4,500 plus $250 of growth for a total of $4,750 in the account. Therefore, his tax and penalty consequence is $1,757.50 = $4,750 × 37%. The 37% is represented by 12% tax plus 25% penalty.
83
George, age 35, works for XZY Brothers, Inc., which is installing a new SIMPLE IRA plan in the current year with the maximum match for this year. George makes $30,000 per year and is eligible to participate in the plan. Which of the following is true?
George can have a maximum of $14,400 placed into his account this year.
George may have a maximum of $4,500 placed into his account this year.
George may have a maximum of $13,500 placed in his account this year.
George may have a maximum of $7,500 placed in his account this year.
Solution: The correct answer is A.
George can put in 100% of salary up to $13,500 (2020). XZY will match dollar for dollar up to 3% of salary ($30,000 × .03 = $900). So a total of $14,400 will be placed into the account. All other statements are false.
84
Kyle is 56 and would like to retire in 11 years. He would like to live the “high” life and would like to generate the equivalent of 90% of his current income. He currently makes $150,000 and expects $24,000 (in today’s dollars) in Social Security. Kyle is relatively conservative. He expects to make 8% on his investments, that inflation will be 4% and that he will live until 104. How much does Kyle need at retirement?
$3,631,802
$3,343,308
$3,471,896
$3,480,448
Solution: The correct answer is C.
Salary = 111,000 (150,000* 90%) - 24,000 = 111,000
N = 11 years to retirement
I = 4% inflation
PV = 111,000 in salary
FV = 170,879.40
BEG PMT = 170,879.40
N = 37 104 - 67
I = 3.8462 Inflation adjusted rate of return = [(1.08/1.04) - 1] × 100
Solve for PV
Answer = 3,471,896.37
Answer "A" is the wrong payment (150,000 -24,000* 90%) = 113,400.
Answer "B" is ordinary annuity (end mode).
Answer "D" uses 4% for interest (beg mode).
85
When calculating the Wage Replacement Ratio (WRR), what percentage of income is subtracted for a self-employed individual for Social Security and Medicare Taxes?
7. 65%
6. 20%
15. 30%
13. 3%
Solution: The correct answer is C.
This is an important point to stress as many clients are self-employed and pay both employer and employee portions of the tax.
86
Lois and Ken Clark are age 32. They want to retire at age 62. They have calculated they will need a lump sum of $4,300,000 to provide the inflation-adjusted income stream they desire. Current investment assets are projected to grow to $3,100,000 by age 62. They project they will earn 6% after-tax on their investments and inflation will average 4% over the next 30 years. They would like to fund their retirement in level annual payments. They assume their retirement will last 26 years. Using the capitalization utilization method, what annual end-of-year savings will the Clarks need to deposit during their pre-retirement years?
$15,786
$15,179
$9,600
$9,419
Solution: The correct answer is B.
Amount needed to fund retirement is $4,300,000 which is given in the question. The inflation adjustment has already been made. Current assets will comprise $3,100,000 of the amount needed. $4,300,000 less $3,100,000 leaves a shortfall of $1,200,000. To accumulate $1,200,000 at 6% after-tax over 30 years, they will need to deposit $15,179 at the end of each year. Ignore all the other information which is just "filler."
N=30 (62-32)
i=6
PV=0
PMT=?
FV=1,200,000
87
To calculate a retirement shortfall, which of the following steps can be useful:
Convert all post-retirement cash flows into a present value at retirement age.
Establish the income replacement ratio needed at retirement.
Determine the projected future value of present assets to date of retirement.
Inflate present living expenses to date of retirement.
Determine the exact rate of inflation until retirement.
I and III only.
II and IV only.
I, III and V only.
I, II, III and IV only.
Solution: The correct answer is D.
It is impossible to calculate an exact inflation rate for the future. Only assumptions concerning inflation can be made.
88
You have been hired to analyze the retirement prospects of Tom and Jerri Ruhn. It has been determined they need a retirement capital account of $2,750,000 at retirement which will occur in 30 years. They expect to live in retirement for 35 years. They are anxious to start a savings program to meet this goal. They anticipate an average after-tax rate of return equal to 7%. They are planning on 5% annual inflation. What level of savings put away at the end of each year will provide the Ruhn family with their desired retirement fund?
$27,208
$29,113
$67,787
$68,884
Solution: The correct answer is B.
The client has given us the capital account they want at retirement in 30 years. If it said in today's dollars or the equivalent, then you would account for inflation. That information was a distractor in this question.
N = 30
I = 7
PV = 0
PMT = 29,113
FV = 2,750,000
89
Frank Drebin is concerned about the impact that inflation will have on his retirement income. He currently earns $40,000 per year. Assuming that inflation averages 5.5% for the first five years, 4% for the next five years and 3.5% for the remaining time until retirement, what amount must Frank's first-year retirement income be when he retires thirteen years from now? Assume that Frank wants it to equal the purchasing power of his current earnings.
$62,550
$68,841
$70,520
$80,231
Solution: The correct answer is C.
Step 1: Assuming that inflation averages 5.5% for the first five years
PV = 40,000
I = 5.5
N = 5
PMT = 0
FV = 52,278
Step 2: 4% Assuming that inflation averages for the next five years
PV = 52,278
I = 4
N = 5
PMT = 0
FV = 63,605
Step 3: Assuming that inflation averages 3.5% for the remaining time until retirement
PV = 63,605
I = 3.5
N = 3
PMT = 0
FV = 70,520 Frank's first year income adjusted for inflation.
90
Maria, age 28, has just expressed an interest in retiring at age 55 and having an income of the equivalent of $40,000 per year in retirement income in today's dollars. She assumes that she can make 8% interest after tax and expects inflation to average about 4% per year. Her life expectancy is 85 years old and she wants to know how much she should be saving each year in her savings plan to reach her goal between now and her retirement.
$7,625
$24,159
$8,068
$15,311
Step #1 - NPV at time period zero: 0 CFj, 0 CFj, 26 shift Nj, 40,000 CFj, 30 shift Nj, 1.08/1.04 = -1 = × 100 = i/yr, Shift NPV gives $264,184.34;
Step #2 - Annual savings required: N = 27, I = 8, PV = $264,184.34, PMT = ?, FV = 0, Answer: $24,159.
91
Cher, who just turned 57 years old, took early retirement so she could spend more time with her three grandchildren and to work on her golf game. She has the following accounts: 401(k) Roth account - she has a balance of $100,000. She only worked for the company for four years and contributed $15,000 each year to the Roth account. The company never contributed anything to her account. Roth IRA - she has a balance of $80,000. She first established the account by converting her traditional IRA ($50,000 all pretax) to the Roth IRA 4 years ago and has contributed $5,000 each of the last 4 years. Cher decided that she would take a distribution of half of each account ($50,000 from the Roth 401(k) and $40,000 from the Roth IRA) for the purpose of purchasing a Porsche Cayenne, which of course would be used to carry her new Ping golf clubs. Which of the following is correct regarding the tax treatment of her distributions?
No tax, no penalty on either distribution.
Taxation on $20,000 from the 401(k) Roth and a penalty on $20,000 from the Roth IRA.
No taxation on the distribution from the 401(k) Roth, but income and penalty on $20,000 from the Roth IRA.
Penalty of $2,000 on the Roth distribution and taxation and penalty on $20,000 of the Roth 401(k) distribution.
Solution: The correct answer is B.
Neither distribution is qualified. Non-qualified distributions from a Roth account consist of basis and earnings on a pro rata basis. Therefore, 60% of the Roth account distribution is return of basis. The remaining 40% or $20,000 is subject to income tax. Because the distribution is from a qualified plan and she has separated after the attainment of age 55, there is no penalty. Non-qualified distributions from a Roth IRA come out in the order of contributions, conversions and then earnings. The first $20,000 is not subject to income tax or penalty because it is from contributions. The second $20,000 is from conversions, which have been subject to taxation. However, because she rolled them over within the last five years, she will have a penalty and there is no exception.
92
A client, age 54 and single, chose early retirement and is receiving from his previous employer's qualified pension plan a monthly pension of $750. This year, the client elects to work for a small company and will receive $25,000 in annual compensation. This company does cover him under a qualified pension plan. The client wants to contribute the maximum deductible amount to an Individual Retirement Account (IRA). The amount of the IRA contribution that he can deduct from his gross income in 2020 is:
$0
$4,000
$6,000
$7,000
Solution: The correct answer is D.
Taxpayers who work and have earned income may contribute the lesser of their earned income or $6,000 to an IRA (2020). If the taxpayer is currently covered under an employer's qualified plan, they may still contribute to the plan but (depending on their earnings from the employer with whom they are covered) may render the contributions non-deductible. Since the taxpayer earned in excess of $6,000, he may contribute the full $6,000, and age 50 or over, he may add an additional $1,000, as a catch up for a total of $7,000. His total income is only $34,000, which is much lower than the phaseout limits. Therefore, he can also deduct the $7,000 contribution.
93
Ginger is a 75 year old retired actress. Although she enjoyed a lucrative career, her decline in health has prevented her from working for the last few years. She is currently contemplating contributing to a Roth or Traditional IRA. Which of the following best describes her options?
She can’t contribute to a Traditional IRA because she is too old, but she can contribute to a Roth IRA.
She can’t contribute to a Roth IRA because she is too old, but she can contribute to a Traditional IRA.
She can contribute to either a Traditional IRA or a ROTH IRA but is not entitled to a deduction.
She can’t contribute to either a Traditional or Roth IRA.
Solution: The correct answer is D.
There is no mention of earned income and "her health has prevented her from working." Therefore, she can’t contribute to either one. You cannot assume earned income, and in fact, this question indicates that she hasn’t worked at all for several years. If she did have earned income then she would be able to contribute as there is no age limit for Roth IRAs and was removed for traditional IRA under SECURE Act (2019).
94
Tom, a married 29 year old, deferred 10% of his salary, or $18,000, into a 401(k) plan Roth account sponsored by his employer this year. He also contributed 10% of his income to his church. Katie, his wife, 28 years of age, was unemployed all year and did not receive unemployment compensation. Assuming Tom has no other income, what is the maximum contribution Tom and Katie can make to their Roth IRAs for this year?
$0
$6,000 into Tom’s Roth IRA.
$6,000 into Katie's Roth IRA.
$6,000 into each of Tom and Katie's Roth IRAs for a total of $12,000.
Solution: The correct answer is D.
They can both contribute the annual amount of $6,000 each because their income is below the phase-out limit of $196,000 in 2020. Even though she does not have any earned income of her own, she can use Tom’s earnings to qualify for the contribution.
95
Mayu made a contribution to his Roth IRA on April 15, 2014 for 2013. This was his first contribution to a Roth IRA. Over the years he has made $20,000 in contributions. On May 15, 2020 he withdrew the entire account balance of $45,000 to pay for his daughter’s college education expense. He is 55 years of age. Which of the following statements is true?
He will not include anything in income and will not be subject to the 10% early withdrawal penalty.
He will include $25,000 in income but will not be subject to the 10% early withdrawal penalty.
He will include $25,000 in income and will be subject to the 10% early withdrawal penalty on $25,000.
He will include $45,000 in income and will be subject to the 10% early withdrawal penalty on $45,000.
Solution: The correct answer is B.
Roth distributions are tax free if they are made after 5 years and because of 1)Death, 2)Disability, 3) 59.5 years of age, or 4)First time home purchase. Although he met the 5 year rule, he did not meet one of the four qualifying reasons. His distribution does not received tax free treatment.
The treatment for a non-qualifying distribution allows the distributions to be made from contributions first, then conversions, then earnings. In this case the distinction in distribution order is irrelevant since he withdrew the entire account balance. However, his contribution will be tax free, leaving only the $25,000 in earnings as taxable income. The 10% penalty does not apply to this distribution since he qualifies for the higher education exception to the penalty.
96
Which of the following retirement plans would permit an employee (filing single status) making $100,000 a year to still make the fully deductible contribution to an IRA in the current year?
401(k)
403(b)
SEP
457
Solution: The correct answer is D.
IRC Section 457 plans are nonqualified deferred compensation plan, and therefore do not make the employee an "active" participant in a qualified retirement plan. The 401(k) is a qualified plan and the 403(b) and SEP are ‘wannabe’ be plans that would make the employee an "active" participant.
97
Larry and Terry, who are married and are ages 35 and 36, both contribute the maximum to a TSA at their schools where they teach. They also want to make contributions to their IRAs. Their salaries are $50,000 each, after their TSA contributions are subtracted. How much can they each contribute to their respective IRAs in the current year?
$6,000 each
$7,000 each
$12,000 each
None of the above.
Solution: The correct answer is A.
Everyone (with earned income) can make a $6,000 contribution to an IRA in 2020 without respect to income or "active participation" status. In some cases, however, phaseouts may directly impact the deductibility of these contributions depending on income levels.
98
Deepak made a contribution to his Roth IRA on April 15, 2018 for 2017. He was 58 years of age at the time he made the contribution to his Roth IRA. Over the years he has made $30,000 in contributions. On May 15, 2020 the entire account balance was $50,000 and he took out $45,000 to pay for his wedding and honeymoon. Which of the following statements is true?
He will not include anything in income and will not be subject to the 10% early withdrawal penalty.
He will include $15,000 in income and will be subject to the 10% early withdrawal penalty on $15,000.
He will include $15,000 in income but will not be subject to the 10% early withdrawal penalty.
He will include $20,000 in income but will not be subject to the 10% early withdrawal penalty.
Solution: The correct answer is C.
Roth distributions are tax free if they are made after 5 years and because of
1) Death, 2) Disability, 3) 59.5 years of age, and 4) First time home purchase. He does meet a qualifying reason because he is over 59.5 in 2020 if he was 58 in 2018. However, he did not meet the 5 year holding period. He only has about 4.5 years. His distribution does not receive tax free treatment. The treatment for a non-qualifying distribution allows the distributions to be made from basis first, then conversions, then earnings. His basis will be tax free, leaving only the earnings as taxable income. Since he did not take the entire account balance he will only be subject to tax on the $15,000 of earning withdrawn. The 10% penalty does not apply to this distribution since he qualifies for the 59.5 exception to the penalty.
99
Your client wishes to make a $5,000 contribution to a Roth IRA. The following are sources of income listed on her data form. Which types of income will be used to calculate the maximum allowable contribution?
$5,000 from a Limited Partnership interest.
$1,500 from a home-based business.
$20,000 in municipal bond interest.
$3,000 from child support payments.
$250 capital gains distributed from a mutual fund.
I, II and V
II, IV and V
II only
II and V
Solution: The correct answer is C.
Only earned income qualifies for contributions into an IRA. All of the other sources of income are forms of unearned income.
100
In order to deduct a contribution to an IRA, which of the following requirements must be met?
An individual must have earned income, either personally or jointly from a spouse.
Must not be an active participant in an employer-sponsored qualified plan.
Must be under the age of 70 1/2.
Must make contributions during the tax year or up to the date of filing the federal tax return for the tax year, including extensions.
I and II only.
I only.
II and III only.
IV only.
Solution: The correct answer is B.
In 2020, contributions are limited to the lesser of 100% of earned income or $6,000 or $7,000 if age 50 or over. Deductions may be taken even if an active participant, so being a non-participant is not a requirement. There are no age restrictions to make contributions to an IRA; the taxpayer must have earned income (SECURE Act 2019). Contributions must be made prior to April 15 (or the mandated filing date for the year.) No extension to make the contribution is allowed after that date, even though an extension to file the return is granted.
101
Which of the following is true concerning IRA contributions?
An employee who makes voluntary contributions to a 401(k) plan is not considered an active participant.
An employee who receives no contributions or forfeiture allocations in their employer's profit sharing plan is not considered an active participant.
An employee who makes no voluntary contributions to a thrift plan yet receives forfeiture allocations to a profit sharing plan is not considered an active participant.
An employee participating in a Section 457 plan is considered an active participant if employee pretax deferrals are elected.
Solution: The correct answer is B.
Answers "A" and "C" are conditions of being considered an active participant. Answer "D" is incorrect because 457 plan participants are not considered active participants for IRA contribution purposes.
102
Kyle had contributed $20,000 in nondeductible contributions to his traditional IRA over the years. This year the account balance was $52,000 and he made a withdrawal of $5,000. What amount is reported on Kyle’s Form 1040?
$5,000 only
$1,923 only
$3,077 only
Both $5,000 and $3,077
Solution: The correct answer is D.
On Form 1040 Kyle will report the total distribution of $5,000 and the taxable amount of the distribution of $3,077 calculated as $32,000 ÷ $52,000 × $5,000.
account balance = $52,000
non-deductible contributions = $20,000 (not taxed at distribution)
$32,000 would be taxable.
Because there is both taxable and non-taxable money, each distribution is a pro-rata distribution of both.
32k/52k = .6154
5,000 × 61.54% = 3,076.92
103
Ernest converted his Traditional IRA to a Roth IRA on Dec 15, 2014. He was 35 years of age at the time and had never made a contribution to a Roth IRA. The conversion was in the amount of $60,000 ($10,000 of contributions and $50,000 of earnings). Over the years he has also made $15,000 in contributions. On May 15, 2018 he withdrew the entire account balance of $100,000 to pay for a 1 year trip around the world. Which of the following statements is true?
$25,000 of the distribution will be subject to income tax and $85,000 of the distribution will be subject to the 10% early withdrawal penalty.
$25,000 of the distribution will be subject to income tax and the 10% early withdrawal penalty.
Some of the distribution will be taxable but the entire distribution will be subject to the 10% early withdrawal penalty.
None of the distribution will be taxable nor will it be subject to the 10% early withdrawal penalty.
Solution: The correct answer is A.
Roth distributions are tax free if they are made after 5 years and because of 1)Death, 2)Disability, 3) 59.5 years of age, and 4)First time home purchase. He does not meet the five year holding period or one of the exceptions. His distribution does not received tax free treatment.
The treatment for a non-qualifying distribution allows the distributions to be made from basis first, then conversions, then earnings. His basis will be tax free.
The conversion is also tax free since we paid tax at the time of the conversion on those earnings.
The remaining earnings since establishment of the Roth are $25,000 (100,000 - $15,000 in basis - $60,000 in conversions) and will be taxed.
The 10% penalty does apply to this distribution since he does not qualify for any of the exceptions to the penalty. The contributions escapes penalty but the conversions and earnings of $85,000 are subject to the 10% early withdrawal penalty.
Remember that in order for the conversions to escape the 10% early withdrawal penalty the distribution must occur after a 5 year holding period beginning Jan 1 in the year of conversion or meet one of the 10% early withdrawal exceptions.
104
Your Uncle Ben began receiving required minimum distributions from his IRA in 2005 and has died on December 27, 2019, leaving a balance in his IRA. He has named you as beneficiary (non-spouse beneficiary). Which of the following identifies your minimum distribution rule?
Distributions may be made over your life expectancy (fixed) beginning by December 31st in the year of death.
Distributions may only be made over a five-year period.
Distributions must be made over Uncle Ben’s life expectancy (recalculated) with the first distribution made by December 31st of the year following death.
Distributions may be made over your life expectancy (fixed) beginning by December 31st of the year following death.
Solution: The correct answer is D.
Note that for a non-spouse beneficiary, the Single Life Table is entered once in the year following death based on the age of the beneficiary and then that number declines by a factor of 1 each year to determine the divisor for the following distributions. The non-spouse beneficiary could make a direct transfer to an “inherited IRA”. Answer "A" is incorrect because the distributions to the beneficiary are based on the beneficiary’s life expectancy beginning in the year following death. Do point out that the distribution in the year of death is still based on the owner’s life. Answer "B" is incorrect because the five-year rule is NOT the only choice. Answer "C" is incorrect because a non-spouse beneficiary would not receive distributions based on the owner’s life expectancy nor would a post-death non-spouse distribution be recalculated.
105
Eldrick, age 40, established a Roth IRA 3 years ago and was tragically struck and killed by an errant golf ball hit by a drunk spectator at a golf tournament. Eldrick had contributed a total of $10,000 to the account and had converted $20,000 from his traditional IRA. His 20 year old son, Charlie, inherited the Roth IRA, which now has a balance of $60,000. Which of the following statements is correct?
Charlie can distribute the entire balance from the Roth IRA without it being subject to any income tax or penalty the month after Eldrick dies.
Charlie must take minimum distributions from the Roth IRA the year Eldrick dies.
If Charlie begins taking minimum distributions, then the first distribution will be partially taxable.
Charlie could delay taking a distribution from the Roth IRA for several years and avoid all penalties and income tax on the distribution.
Solution: The correct answer is D.
Answer a is incorrect because the distribution would not be a qualified distribution since the five year rule has not been met. Answer b is not correct as he could begin taking distribution the year following death or take a full distribution within five years. Answer c is not correct, because the first distribution would consist of previously taxed contributions and would therefore not be taxable. Answer d is correct as he could delay taking a distribution from the account for two years. At that point, the distribution would be qualified since it meets the five-year rule and is on account of death. The distribution would avoid all income tax and penalties.
106
Mary Anne has AGI of $1,000,000 (which is all comprised of earned income). She is single and age 55. She is not an active participant in her employer’s qualified plan. Which of the following statements best describes her options?
She can contribute to a Traditional IRA and deduct her contribution.
She can contribute to a Traditional IRA but not deduct her contribution.
She can contribute to a Roth IRA.
She cannot contribute to a Traditional IRA or Roth IRA.
Solution: The correct answer is A.
She can contribute and deduct her contribution to a Traditional IRA since she is not an active participant and therefore not subject to an AGI limitation. She is unable to contribute to a Roth IRA because she is above the AGI limitation of $124,000 - $139,000 (2020).
107
A 56-year-old client becomes unemployed due to a disability. The client tells a CFP® professional that he hopes to go back to work eventually, but is not sure when that might be. Until then, he needs to generate replacement income. His only available asset is his traditional 401(k) plan. What is the best way for the client to replace his income (CFP® Certification Examination, released 8/2012)?
Directly from the 401(k) plan
From a rollover IRA, using Rule 72(t)
From a rollover annuity, using substantially equal payments
From a brokerage account, using net unrealized appreciation (NUA)
Solution: The correct answer is A.
The 401(k) plan is penalty-free and will not require continued payments if the client goes back to work.
108
A premature distribution from a qualified retirement plan is allowed at age 52 without a 10% penalty tax when a participant:
Becomes obligated for payment of plan benefits to an alternate payer under a qualified domestic relations order (QDRO).
Separates from service and takes an accepted form of systematic payment.
Remains with current employer but elects to take systematic payments over the life of the participant and spouse.
I only.
III only.
I and II only.
I, II and III.
Solution: The correct answer is C.
Distributions under a QDRO are not taxable to the taxpayer actually making the disbursement from his/her account. IRC 72(t) allows Substantially Equal Payment Plans (SEPP) to escape the 10% penalty as long as the payments continue for the longer of 5 years or until age 59 1/2. No in-service withdrawals are exempted from the 10% early withdrawal penalty.
109
Chris Barry, 59-years old, has been offered early retirement with an option of a two-year consulting contract. He has been a participant for the past 20 years in both the company defined benefit plan and defined contribution plan. His account balance is $120,000 in the profit-sharing plan and the present value of accrued benefit of the defined benefit plan is $240,000. Both provide for a lump sum distribution. Which of the following option(s) is/are available under the lump sum distribution rules?
Elect ten-year averaging on both plans.
Roll over the taxable portions of both plans to an IRA.
Elect long-term capital gains treatment on the DB plan.
Elect five-year averaging on both plans.
I, II and III only.
I and II only.
II only.
IV only.
Solution: The correct answer is C.
Statement "I" is incorrect because he is not old enough for ten-year averaging. Statement "II" is correct because the taxable portion of any lump sum distribution may be rolled over into an IRA. Statement "III" is incorrect because he is not old enough to qualify for pre-74 capital gain treatment nor does he even have any actual pre-74 capital gain in the plan as he has only been in the plan for the last 20 years. Statement "IV" is incorrect because five-year averaging was repealed in 1999.
110
David Lee, age 63, was a participant in a stock bonus plan sponsored by VH, Inc., a closely held corporation. David’s account was credited with contributions in shares of VH stock to the stock bonus plan and VH Inc. deducted $80,000 over his career at VH. The value of the stock in the account today is worth $1 million. David takes a distribution (year 1) of one-half of the VH stock in his stock bonus plan account valued at a fair market value of $500,000. If David sells the stock for $600,000 nine months after receiving the distribution (year 2), then which of the following statements are true?
David will have ordinary income of $80,000 in year 1 and capital gain of $520,000 in year 2.
David will have ordinary income of $40,000 in year 1 and capital gain of $560,000 in year 2.
David will have ordinary income of $460,000 in year 1 and capital gain of $100,000 in year 2.
David will have ordinary income of $500,000 in year 1 and capital gain of $100,000 in year 2.
Solution: The correct answer is D.
NUA treatment is not applicable because David did not take a lump sum distribution of stock from the plan. Therefore, the distribution is treated as ordinary income.
111
Jacque’s wife just lost her job and they had a death in the family. Jacque is planning on taking a hardship withdrawal from his 401(k) plan to pay for living expenses and funeral costs. Which of the following is correct regarding hardship withdrawals?
Hardship withdrawals can be taken even if there is another source of funds that the taxpayer could use to pay for the hardship.
Hardship withdrawals are beneficial because although they are taxable, they are not subject to the early withdrawal penalty.
Hardship withdrawals can only be taken from elective deferral amounts.
Unless the employer has actual knowledge to the contrary, the employer may rely on the written representation of the employee to satisfy the need of heavy financial need.
Solution: The correct answer is D.
Answer a is not correct as there must not be another source of funds. Answer b is not correct as they are generally subject to a penalty unless there is an exception under IRC 72(t). Answer c is not correct as a hardship distribution can be taken from employee deferrals and employer contributions.
112
Which of the following is/are elements of an effective waiver for a preretirement survivor annuity?
The waiver must be signed within six months of death.
The waiver must be signed only by a plan participant.
The waiver must be notarized or signed by a plan official.
III only
I and II only
II and III only
I, II and III
Solution: The correct answer is A.
On the initial beneficiary selection form, both the plan participant and the nonparticipant spouse must sign the waiver. If the waiver is a separate document, the non-participant spouse must sign. Statement "III" is correct. Statement "I" is unfounded.
113
Which plans listed below are subject to the Qualified Joint and Survivor Annuity requirement?
Cash balance plan.
Target benefit plan.
Defined benefit plan.
Money purchase plan.
I only.
I, II and III only.
II, III and IV only.
I, II, III and IV.
Solution: The correct answer is D.
Pension plans are required to offer a QJSA to participants. All of these plans are pension plans. A profit sharing plan is not subject to QJSA requirements.
114
Which of the following is false regarding incentive stock options?
No regular taxable income will be recognized by the employee when the qualified option is granted or exercised.
The income from sale of the qualified option will always be taxed as capital gains when the stock is sold.
The income from sale of the qualified option will be taxed as ordinary income regardless of when the stock is sold.
The employer will not be able to deduct the bargain element of the option as an expense under any circumstance.
For favorable tax treatment the stock must be held two years from grant and one year after exercise.
II and IV only.
II, III and IV only.
III only.
I, II and V only.
Solution: The correct answer is B.
Only Statements "I" and "V" are true. The rest are all false. In Statement "II", be careful of "always"! In Statement "III," if held longer than one year, they receive capital gains treatment. In Statement "IV," the bargain element will be deductible if the sale is a disqualifying disposition.
115
Kipton is an executive with BigRock. As part of his compensation, he receives 10,000 shares of restricted stock today worth $20 per share. The shares vest two years from today, at which point the stock is worth $30 per share. The vesting schedule is a 2-year cliff schedule. Kipton holds the stock for an additional 18 months and sells at $45 per share. Which of the following is correct?
The grant of stock is taxable to Kipton today.
The value of the shares is taxable to Kipton when the stock vests.
If Kipton were to make an 83(b) election, he would have converted $30 of the gain from ordinary to capital.
When Kipton sells the stock for $45 per share, his basis is $30 regardless of whether he files an 83(b) election.
Solution: The correct answer is B.
Choice a is not correct because the stock is forfeitable. Choice c is not correct because it would have converted $10, not $30. Choice d is not correct, because the basis would be different.
116
Which of the following statements are true in regards to Section 457 plans?
Eligible plan sponsors include non-profit organizations, churches, and governmental entities.
In-service distributions after age 59 1/2 are allowed in a 457 plan.
Salary deferrals are subject to Social Security, Medicare, and Federal unemployment tax in the year of the deferral.
Assets of the plans for non-government entities are subject to the claims of the sponsor's general creditors.
I and III only.
II, III and IV only.
I, II and IV only.
III and IV only.
Solution: The correct answer is B.
Churches are not qualifying sponsors of 457 plans.
117
Which of the following statements regarding determination letters for qualified plans is true?
When a qualified plan is created, the plan sponsor must request a determination letter from the IRS.
An employer who adopts a prototype plan must request a determination letter from the IRS.
If a qualified plan is amended, the plan sponsor must request a determination letter from the Department of Labor.
A qualified plan which receives a favorable determination letter from the IRS may still be disqualified at a later date.
Solution: The correct answer is D.
Determination letters are issued by the IRS at the request of the plan sponsor. The plan sponsor is not required to request a determination letter. Even if the determination letter is requested and approved, the IRS may still disqualify the plan.
118
The maximum service requirement that a profit sharing plan may impose as a condition of participation is:
1 year with semi-annual entry dates (1.5 years).
1 year with quarterly entry dates (1.25 years).
6 months.
2 years.
Solution: The correct answer is D.
This requires "immediate vesting."
119
A parent-subsidiary group exists if the parent company owns what percentage of voting stock in another corporation?
At least 50%.
More than 50%.
At least 80%.
More than 80%.
Solution: The correct answer is C.
This is important because parent-subsidiary companies must have substantially equal benefits or cover employees of all subsidiary companies under the same plan.
120
Which of the following statements are accurate concerning integration ("permissible disparity") rules for qualified plans?
The integration base level for a defined contribution plan can exceed the current year's Social Security taxable wage base.
Permitted disparity levels reduce benefits in a defined benefit plan if employee retires early.
It isn't possible to have a defined benefit plan formula which eliminates benefits for lower paid employees.
I only.
I and II only.
II and III only.
I and III only.
Solution: The correct answer is C.
Statement "I" is incorrect because the integration levels cannot be higher than the Social Security wage taxable wage base. It may be lower, but cannot be higher. All other statements are accurate.
121
Bank Corp has a defined benefit plan with 60 employees. What is the minimum number of employees the defined benefit plan must cover to conform with the requirements set forth by the IRC?
24
30
42
50
Solution: The correct answer is A.
The plan must cover the lesser of 50 people or 40% of all employees. In this case, the lesser would be 40% of 60, or 24 people.
122
Which of the following persons would be considered a fiduciary of a qualified plan?
Person who determines plan benefits of participants.
Anyone who provides services to the plan.
Person with discretionary authority over disposition of plan assets.
Person who provides investment advice for a fee.
I and II only.
II and III only.
III and IV only.
I, II and III only.
Solution: The correct answer is C.
Accountants, printers or anyone providing services wherein they do not have actual control of the funds would not be considered a fiduciary of a qualified plan. An investment advisor, of course, would be considered a fiduciary of the plan.
123
Which of the following statements concerning the use of life insurance as an incidental benefit provided by a qualified retirement plan is (are) correct?
The premiums paid for the life insurance policy within the qualified plan will trigger a taxable event for the participant at the time of payment.
Under the 25 percent test, if term insurance or universal life is involved, the aggregate premiums paid for the policy cannot exceed 25 percent of the employer’s aggregate contributions to the participant’s account. If a whole life policy other than universal life is used, however, the aggregate premiums paid for the whole life policy cannot exceed 50 percent of the employer’s aggregate contributions to the participant’s account. In either case, the entire value of the life insurance contract must be converted into cash or periodic income at or before retirement.
I.
II.
I and II.
Neither I or II.
Solution: The correct answer is C.
Every year the plan participant pays income tax on the dollar value of the actual insurance protection -- approximately equal to the term insurance cost. This is commonly called the PS58 cost. The sum of all those costs is the participant's basis.
124
Which of the following tasks are the primary responsibilities of a plan trustee?
Determining which employees are eligible for participation in the plan, vesting schedule, and plan benefits.
Preparing, distributing, and filing reports and records as required by ERISA.
Investing the plan assets in a "prudent" manner.
Monitoring and reviewing the performance of plan assets.
I and III only.
I and II only.
II and IV only.
III and IV only.
Solution: The correct answer is D.
The duties explained in Statements "I" and "II" are responsibilities of the plan administrator.
125
To retain its qualified status, a retirement plan must:
Have pre-death and post-death distributions.
Stipulate rules under what circumstances employee contributions are forfeited.
Be intended to be permanent.
Be established by the employer.
I and II only.
II, III and IV only.
I, III and IV only.
I, II, III and IV.
Solution: The correct answer is C.
Employee contributions must be vested and cannot be required to be forfeited.
126
As a fiduciary of a plan, you are required to evaluate the appropriateness of assets for the qualified plan. Which of these statements accurately characterize the suitability of particular assets for qualified retirement plans?
Large positions in real estate are NOT appropriate due to their illiquidity.
Each asset class should be evaluated for volatility, risk of loss, opportunity for gain, and viability in the portfolio.
Long-term treasury bonds are suitable for meeting a plan's liquidity needs and marketability requirements.
ERISA requires plan fiduciaries to emphasize investment stability ahead of other considerations (i.e., inflation, duration, etc.)
I and IV only.
II and III only.
III and IV only.
I and II only.
Solution: The correct answer is D.
Long-term treasury bonds are not suitable for short-term liquidity needs due to volatility from interest rate risk. ERISA requires fiduciaries to consider all pertinent factors in asset allocation decisions.
127
Maximum Performance, Inc.’s defined contribution plan has been determined to be top heavy. Which one of the following statements is NOT a requirement that applies to the plan?
The employer must contribute a minimum of 3% of compensation or the contribution rate of the key employees (whichever is lower) per year to non-excludable, non-key employees for each year that the plan is top heavy.
If the employer contribution to key employees is 2%, then the employer contribution to non-excludable, non-key employees must be 2%.
The plan must use a vesting schedule that does not exceed either a 2-year cliff or 6-year graded vesting schedule.
The plan must fully vest after three years of service if the vesting at two years is zero.
Solution: The correct answer is C.
The vesting rules are a 3-year cliff or 2-6 year graded vesting schedule. (Hint: Answer "C" and "D" contradict each other, so it has to be one of these. If you picked up on that, you can easily narrow the questions down to 50/50.)
128
Which of the following statements are reasons to delay eligibility of employees to participate in a retirement plan?
Employees don’t start earning benefits until they become plan participants (except in defined benefit plans, which may count prior service).
Since turnover is generally highest for employees in their first few years of employment and for younger employees, it makes sense from an administrative standpoint to delay their eligibility.
I only.
II only.
I and II.
Neither I or II.
Solution: The correct answer is C.
Both Statements "I" and "II" are correct. The statements speak for themselves. Costs are less with the delay.
129
Which of the following is/are reason(s) employers sponsor pension plans?
Recruit quality employees.
Show stability of the company to lenders.
Fight/discourage collective bargaining.
Provide working capital for the company.
I only.
I and II only.
I and III only.
I, II and IV only.
Solution: The correct answer is C.
Pensions do not demonstrate stability to a lender. In fact, if there is a mandatory contribution to the plan, this may affect company cash flow and credit worthiness. The sponsoring company cannot use pension assets for working capital. This would be a prohibited transaction (self-dealing).
130
Randal was just hired by Chastain, Inc., which sponsors a defined benefit plan. After speaking with the benefits coordinator, Randal is still confused regarding eligibility and coverage for the plan. Which of the following is correct?
The plan could provide that employees be age 26 and have 1 year of service before becoming eligible if upon entering the plan, the employee is fully (100%) vested.
The plan may not cover Randal due to his position in the company, even if Randal meets the eligibility requirements.
Part-time employees, those that work less than 1,000 hours within a twelve-month period, are always excluded from defined benefit plans.
Generally, employees begin accruing benefits as soon as they meet the eligibility requirements.
Solution: The correct answer is B.
Choice a is not correct because the general eligibility is age 21, not 26. Choice c is not correct because a plan could cover part time employees, but will generally not. Choice d is not correct because employees become part of a plan only as early as at the next available entrance date after meeting the eligibility requirements.
131
The Third Party Administrator (TPA) of the Flying Trapeze Manufacturing Incorporated‘s Defined Contribution Plan has just informed you, its administrator, that the plan is top heavy. Which one of the following statements is NOT a requirement that applies to your plan?
Employees must be 100% vested in the plan after three years of service if the vesting at two years is zero.
If the employer contribution to key employees is 2%, then the employer contribution to non-excludable, non-key employees must be 2%.
Flying Trapeze, Inc. must contribute a minimum of 3% of compensation or the contribution rate of the key employees, if it is lower, to non-excludable, non-key employees for each year that the plan is top heavy.
The plan’s vesting schedule must be 100% vested upon participation.
Solution: The correct answer is D.
Answer “A” does apply because the plan must have no longer than a 3 year cliff or 2-6 year graded vesting. If year 2 is zero, it must be a cliff vesting and year 3 must be 100%.
132
Which of the following are correct statements about self-employed retirement plans?
Benefits provided by a self-employed defined benefit plan cannot exceed the lesser of $230,000 or 100% of income in 2020.
May be established by an unincorporated business entity.
Contributions to "owner-employees" are based upon their gross salary.
Such plans are permitted to make loans to common law employee participants.
I and II only.
I and III only.
II and IV only.
I, II and IV only.
Solution: The correct answer is D.
Statements "I", "II" and "IV" are correct. Loans are available to the common law employees of the firm. Statement "III" is incorrect because owner-employee contributions are based upon total earned income in the business, not just "salary."
(Note: Remember S corporation owners are considered common law employees, so their contribution is based solely on salary and cannot include amounts for dividends or pass-through earnings shown on Schedule E of the 1040 form.)
133
Ace Company has a defined benefit plan with 500 employees, of which 300 are nonexcludable employees (100 HC and 200 NHC). It is unsure if it is meeting all of the coverage testing requirements. What is the minimum number of total employees that must be covered by the defined benefit plan on a daily basis to comply with the coverage rules?
40
50
80
120
Solution: The correct answer is B.
The 50/40 rule requires that defined benefit plans cover the lesser of 50 employees or 40% of all eligible employees. Here 40% of the nonexcludable employees equals 120 (300 × 0.40), so 50 is less than 120. This would be the absolute minimum number of covered employees. IRC 401(a)(26)
134
Satish has AGI of $66,000 (which is all comprised of earned income). She is single and age 51. Her employer made a $6,300 contribution to her SEP for the current year. What is her available deduction allowed for a Traditional IRA contribution?
$26,000
$6,300
$6,000
$7,000
Solution: The correct answer is B.
She can contribute to a Traditional IRA since she has earned income. She is considered an active participant because her employer made a contribution to the SEP on her behalf. Her deduction will be limited because she is within the AGI limitation for a single active participant ($65,000 - $75,000) (2020). She is also entitled to the catch up contribution of $1,000 because she is 50 or older. Therefore, her deductible contribution is: 7,000 × ((66,000 - 65,000)/10,000) = $700 is not allowed so $7,000 - $700 = $6,300 is permitted. Although the question didn’t ask - alternatively, she could contribute to a Roth IRA because she is below the AGI limitation of $124,000 - $139,000 (2020).
