Retirement Management

Question 1

What is a 401(k) plan?

Answer 1

cash or deferred arrangement (CODA) plan, is a qualified profit-sharing or stock bonus plan that contains a salary deferral feature.
Contributions to the plan are tax-deferred until distribution.

a 401(k) plan is not a stand-alone plan. 
It is combined with a qualified profit-sharing plan, generally the employer does not contribute to the profit-sharing plan. 
THINK-  all 401(k) plans are profit-sharing plans while not all profit-sharing plans have a 401(k) feature.

Question 2

5 examples of when an employer would implement a 401(k) plan?

Answer 2

1. interested in supplementing an existing defined benefit or other qualified retirement plan to provide an additional employee savings vehicle.
2. interested giving a qualified retirement plan for employees but cannot afford a significant investment beyond plan installation and administration costs. employers may make contributions to a plan, the plan may be funded almost entirely from employee salary deferrals.
3. the employee group is young, has the ability to accumulate several years of contributions, and is willing to accept investment risk on their accounts.
4. When the employee group is interested in a certain degree of choice in the amounts that they wish to tax-defer for retirement savings.
5. When the organization is private taxpayer or is tax-exempt. Government employers are not eligible for 401(k) plans. certain tax-exempt organizations such as a not-for-profit hospital are eligible to offer 401(k) plans to their employees as a substitute for 403(b) files.

Question 3

What is a profit-sharing plan?

Answer 3

A qualified, defined contribution plan that allows an employer to contribute to the plan under either a discretionary or formula provision.

May be funded according to either a discretionary or a formula provision.

Question 4

4 examples of when a profit-sharing plan would be used?

Answer 4

1. company profits tend to vary widely from year to year
2. the employer would like to supplement a defined benefit plan to provide a more balanced employee retirement plan.
3. the employer wants to implement a qualified plan that includes an employee incentive to participate in the increase in company profits.
4. the employee group is young, with the ability to accumulate several years of contributions, and is willing to accept a certain degree of investment risk on their individual accounts.

Question 5

What type of plan specifies the amount of benefit the employee will receive at retirement

Answer 5

defined benefit pension plan

Question 6

Three examples of when would an employer or businessperson use a defined benefit pension plan?

Answer 6

1. the employer is interested in, and capable of, guaranteeing a specific benefit amount to employees at retirement.
2. the business owner is an older and needs to defer a large amount of taxable income. Defined benefit pension plans provide the maximum tax shelter potential available under any qualified plan.
3. When the employer is interested in providing an attractive retirement benefit for highly compensated or older participants, regardless of length of servic

Question 7

What is a cash balance pension plan?

Answer 7

a qualified pension plan in the defined benefit category that provides a specified employee benefit, which is funded by annual employer contributions to hypothetical individual employee accounts.

The accounts themselves are fictitious.
The actual employer contributions are commingled in a large trust account with money allocated at a specified rate to individual employee accounts by means of an accounting entry.

Investment returns on contributions are also hypothetical and are based on a fixed rate specified in the plan or on a floating rate based on an external index.

Question 8

What is a hybrid plan?

Answer 8

A hybrid plan is a defined benefit plan that provides a benefit derived from employer contributions, which is based partly on the balance of the separate account of a participant.

The dollar limitations, a hybrid plan is treated as a defined contribution plan to the extent that benefits are based on the separate account of a participant, and as a defined benefit plan with respect to the remaining portion of the plan’s benefits.

Question 9

How do you calculate the present value of a fixed sum?

Answer 9

The present value of a fixed sum is determined by taking the future value of a sum of money and calculating what it is worth today, using a discount rate. The more frequent the compounding, the smaller the present value.

The formula used is:
PV = FV/(1 + r)n

Question 10

Calculate the present value of $15,000 to be received in 5 years using an annual interest rate of 10%.

Answer 10

Solution:

15,000 FV, 10 R, 5 N, calculate PV → $9,313 (ignore the sign)

Question 11

How do you calculate the future value of a fixed sum?

Answer 11

The future value of a fixed sum is the amount invested today that will grow over time when it is compounding interest.

The formula for finding the future value of a single cash flow is:
FV = PV (1 + r)n
Where,
PV = Present value or value of investment today
FV = Future value of an investment at the end of n years
r = interest rate during each compounding period
n = number of compounding periods

Question 12

Calculate the future value of $15,000 invested for 5 years using an annual interest rate of 10%.

Answer 12

Solution: −15,000

PV, 10 I, 5 N, calculate FV → $24,157

Question 13

Calculate the future value of an ordinary annuity that will pay $1,000 per year for each of the next 15 years while
earning a 10% rate of return.

Answer 13

Solution: 15 N, 10 I, 1000 PMT, CPT FV → $31,772

Question 14

Calculate the NPV of a project with an initial cost of $25,000 that produces the following cash flows: year 1, +5,000; year 2, +5000; year 3, +12,000; year 4, −3000; year 5, +4000. The cost of capital is 5%.

Answer 14

Solution: −25,000[CF0]; 5,000

[CFj]; 5,000 [CFj]; 12,000 [CFj]; −3,000 [CFj]; 4,000 [CFj]; 5 [i]; CPT NPV → −$4,670

Question 15

How do you calculate the internal rate of return (IRR)?

Answer 15

The IRR calculates the rate of return at which the present value of a series of cash inflows will equal the present value of the project’s cost: PV (Inflows) equals PV (Investment costs).

Question 16

Calculate the IRR of a project that has an initial outflow of 25,000 and will generate the following cash flows: year 1, 7,000; year 2, −5,000; year 3, 9,000; year 4, 7,000; year 5, 15,000. Solution: −25,000 [CF0]; 7,000 [CFj]; −5,000 [CFj]; 9,000 [CFj]; 7,000 [CFj]; 15,000 [CFj];

Answer 16

CPT IRR → 7.64%

Question 17

What is a secular trust?

Answer 17

funded trust where specific funds are set aside for the employee.
The funds are insulated from the claims of the employer’s general creditors. However, all assets placed in the trust are taxable to the employee.

They are generally used as a conversion vehicle for rabbi trusts in instances where the employee participant may have concerns about the employer’s ability to avoid creditor claims and prefers a greater level of asset security.

Question 18

What is a rabbi trust?

Answer 18

type of unfunded non-qualified plan that is subject to the claims of the employer’s general creditors.
unlike a traditional unfunded plan, the employer is barred from accessing participant funds.
the participant in a rabbi trust receives more protection from the potentially unscrupulous actions of an employer.
The employer likewise is not tempted by the easy access and availability of employee retirement plan funds.

Question 19

How do you determine the inflation adjusted interest rate?

Answer 19

The inflation premium is an adjustment to the real risk-free rate to compensate investors for expected inflation and tightening or easing of monetary policy due to inflationary expectations.

Nominal rate of return investors require is:
Nominal risk-free rate = (1 + real risk-free rate) (1 + inflation rate) − 1

Question 20

How do you calculate the risk free rate?

Answer 20

Real risk-free rate = [(1 + nominal risk-free rate) / (1 + inflation rate)] − 1

Question 21

What are serial payments?

Answer 21

A serial payment is a payment that increases at some constant rate on an annual basis.
The constant rate is usually the inflation rate.
The last serial payment will have the same purchasing power as the initial serial payment.

Question 22

What are 3 characteristics of a Jumbo Mortgage?

Answer 22

1. Jumbo mortgages typically carry a higher interest rate compared to conventional mortgages.
2. Jumbo mortgages typically enforce stricter qualification standards and/or rules.
3. Jumbo mortgages typically require higher down payments (e.g., 20% minimum).

> $548,250 (as of 2021) as “jumbo”.
$647,200 (as of 2022) as “jumbo”.

Question 23

Disparities in which years (earlier/later) have a magnified effect over time

Answer 23

earlier

Question 24

where someone is contributing to an account, it is preferable to experience market losses when and why?

Answer 24

early in the period (as opposed to later) so they could purchase more shares at lower prices.

Question 25

If someone is withdrawing from an account, it is generally less harmful to experience heavy market declines when?

Answer 25

in the later years of withdrawals as there is less value to be negatively impacted.

Question 26

What is Monte Carlo Simulation?

Answer 26

a statistical method that simulates probable outcomes by attempting to model real world situations.

will not give an exact value of a portfolio at any specific time, but it will indicate the possible range of these values and the probability of that range.

assumptions have to be made helps evaluate the tradeoffs between risk and return without the limitations inherent to a linear forecasting model

Question 27

Taxable on withdrawal may be subject to early withdrawal penalty unless:

Answer 27

▪ Over age 59 ½
▪ Disabled
▪ Deceased (and distributed to a beneficiary)
▪ Paying for health insurance premiums for the unemployed
▪ College expenses for IRA owner or a dependent
▪ First-time homebuyer (subject to limits)
▪ Medical expenses >10% of AGI (>7.5% in limited situations)
▪ Properly rolled over (as a direct rollover or within 60 days)
▪ For qualified plans only: Separation from service after age 55
▪ Substantially equal periodic payments

Question 28

What are the 2 methods for calculating the 72(t) payments?

Answer 28

– Annuitization
– Amortization
– Life expectancy

Question 29

72(t) distributions must be taken for the longer of _____ years or until age _____.

Answer 29

5 years

59 1/2

Question 30

When must RMDs be taken?

Answer 30

by April 1st of the year following the year in which owner/participant turns 72 (70 ½ if one reached 70 ½ in 2019).

Question 31

What is the penalty for not taking an RMD?

Answer 31

s 50% of required amount not taken plus applicable taxes

Question 32

What is the tax treatment of NUA?

Answer 32

Ordinary income up to basis.
Long term cap gains for gains above that at distribution.
Capital gains on sale after distribution.

Question 33

What is asset location?

Answer 33

an exercise in which certain assets and investments, based on tax status and preferences, into different accounts (e.g., taxable, tax-deferred, or tax-exempt) to minimize taxes during the growth and distribution phases of each account

Question 34

What 5 types of assets are best in a taxable account?

Answer 34

– Index and other passive funds
– Growth funds with low turnover
– Tax-managed funds
– REITs (could be better for either type of account)
– Municipal bonds

Question 35

What 5 types of assets are best in a tax deferred account?

Answer 35

– Dividend stocks
– Most taxable bonds
– Actively management, high turnover funds
– Partnerships “IF” they avoid UBTI

Question 36

What is are the RMD rules for a deceased owner?

Answer 36

if they die after April 1 of the calendar year following attainment of age 72 (70½ if one turned 70 ½ in 2019) they are required to receive an RMD for the year of death even though they die prior to December 31 of that year.

A surviving spouse may not roll over any minimum distribution amount that the deceased IRA owner was required to receive for the year of death.

Question 37

Five rules if beneficiaries of a trust are to be considered designated beneficiaries of an IRA for stretch purposes:

Answer 37

1. Trust must be valid under state law
2. Beneficiaries must be identifiable from the trust
3. Trust must be irrevocable or become irrevocable upon the death of the participant
4. Required documentation must be provided to the plan administrator by Oct. 31st of the year following the calendar year the participant died.
5. All beneficiaries of the trust must be individuals