Retirement Management (Section IV.C) (12-13 Questions)

Question 1

401k Plan

Answer 1

• Also known as a cash or deferred arrangement (CODA) plan, is a qualified
  profit-sharing or stock bonus plan that contains a salary deferral feature. Participants in a 401(k) plan
  have the ability to defer taxation on a portion of their salaries by electing to contribute money into the
  plan rather than receiving that portion as taxable compensation. Contributions to the plan are tax-
  deferred until distribution.

Question 2

Profit Sharing Plan

Answer 2

• a qualified, defined contribution plan that allows an employer to contribute to
  the plan under either a discretionary or formula provision.
• generally not structured to provide a pension benefit at
  retirement but rather to offer employee participation in company profits. Funding of the plan may vary greatly from
  year to year.

Question 3

Defined Benefit Pension Plan

Answer 3

• plan that specifies the amount of benefit promised to the employee at retirement. As with any other defined benefit plan, the employer assumes the risk of providing the anticipated benefit amount to the employee at retirement.
• An employee retiring at age 65 would be entitled to receive an annual benefit of no more than
  $265,000 (2023 limit).

Question 4

Cash Balance Pension Plan

Answer 4

• 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 5

Hybrid Plans

Answer 5

• For purposes of 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 6

Secular Trust

Answer 6

• a type of funded trust where specific funds are set aside for the employee. These funds are insulated from the claims of the employer’s general creditors. However, all assets placed in
  the trust are taxable to the employee. Secular trusts 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 7

Rabbi Trust

Answer 7

• a type of unfunded nonqualified plan that is subject to the claims of the employer’s
  general creditors. However, in a rabbi trust, unlike a traditional unfunded plan, the employer is barred from accessing participant funds. In this way, 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 8

TVM Resources

Answer 8

Financial Calculator tutorial (if needed) at www.tvmcalcs.com.

Question 9

Present Value

Answer 9

• 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
• Know how to calculate.

Question 10

Future Value

Answer 10

• 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.
• Know how to calculate.

Question 11

Ordinary Annuity and Annuity Due

Answer 11

• An ordinary annuity is when cash flows begin at the end of each year.
• An annuity due is when cash flows begin on the same day as the initial investment.
• EXAMPLE 1-7
  Finding the future value of an ordinary annuity. 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. Solution: 15 N, 10 I, 1000 PMT, CPT FV → $31,772
• EXAMPLE 1-8
  Finding the future value of an annuity due. Calculate the future value of an annuity paying $1,000 beginning today and continuing each year for the next 15 years while earning a 10% rate of return. Solution: Your calculator should be set at beginning mode; 15 N, 10 I, 1000 PMT, CPT FV → $34,949.

Question 12

Net Present Value

Answer 12

• the amount of cash flow (in present value terms) that a project generates after repaying the invested capital and required rate of return on that capital. It is the present value of future cash flows discounted at the firm’s cost of capital less costs from the project. If the project generates a positive NPV, then shareholder wealth
  increases. In contrast, a negative NPV will decrease shareholder wealth. The decision rule holds that if NPV is greater than zero, accept the project; if NPV is less than zero, reject the project.
• EXAMPLE 1-13
  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%. 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 13

Internal Rate of Return (IRR)

Answer 13

• 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). It is also defined as the rate of return in which the net present value of a project is zero. It assumes that all cash flows are reinvested at the IRR. The IRR
  is equivalent to the yield to maturity (YTM), the geometric average return, and the compounded average rate of
  return. The decision rule holds that if IRR is less than cost of capital, reject the project; if IRR is greater than cost of capital, accept the project.
• EXAMPLE 1-14
  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]; CPT IRR → 7.64%.

Question 14

Irregular Cash Flows

Answer 14

• It is common for the stream of cash flows to change from year to year for projects or investments—so it’s not an
  annuity. The uneven cash flow is simply just a stream of (annual) single cash flows. To determine the FV/PV of irregular cash flows, you need to find the FV/PV of each cash flow and then add them up. The PV only of an uneven cash flow
  stream is also calculated using the NPV function on your calculator.

Question 15

Irregular Cash Flows - Calculating Future Value on uneven cash flows.

Answer 15

Question 16

Inflation-Adjusted Rate

Answer 16

• 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 17

Serial Payments

Answer 17

• 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. Serial payments are not fixed payments like annuities; the first serial payment will be less than an annuity payment, but the last serial payment will be more than an annuity payment.
• EXAMPLE 1-17
  Assume Jeff wants to start a business in 5 years. He needs to have $150,000 (today’s dollars) in 5
  years to finance his business. Inflation is expected to average 3%, and Jeff can earn a 7% annual compounded rate on his investments. In order to determine what serial payment he should invest at the end of the first year, he uses the following formula: Solution: 150,000 FV; 5 N; 0 PV;
  [(1.07÷1.03) − 1] × 100 [i]; CPT PMT [x] 1.03 → 28,591.

Question 18

Mortgage & Mortgage Payments

Answer 18

• Mortgages > $726,200 are considered jumbo mortgages.
• Jumbos typically carry a higher interest rate compared to conventional mortgages.
  -Typically have more strict qualifications and higher down payments.

Question 19

Capital Needs Analysis

Answer 19

• Determinants:
  *Savings
  *Time
  *Spending
  *Rate of Return

Question 20

Return Sequencing

Answer 20

• The sequence of returns matter a lot.
  -Disparities in the early years have a magnified effect over time.
  -The extent of volatitility matter too.

Question 21

Order of returns

Answer 21

• If an individual is making contributions then it is preferable to experience market losses early in the period so that they could purchase more shares at a lower price.
• If an individual is withdrawing it is generally less harmful to experience heave market declines in the later years of withdrawals as there is less value to be negatively impacted.

Question 22

Taking Withdrawals from Retirement Accounts

Answer 22

May be subject to penalties unless:
-Over 59..5
-Disabled
-Deceased (and distributed to a bene)
- Paying for health insurance premiums for the unemployed
- College expenses for IRA owner or dependent.
- First time home buyers
- Medical expenses >10% of AGI
- Substantially equal periodic payments.

Question 23

IRS Code Section 72t (substantially equal periodic payments)

Answer 23

• Distribution must be taken for the longer of 5 years or until age 59.5.
• 3 mehtods to calculate payments
• Annuitization
  -Amortization
  -Life Expectancy

Question 24

Required Minimum Distributions (RMDs)

Answer 24

• Must be taken by April 1st of the year following the year in which owner/participant turns 73.
  -Per Secure act 2.0, the penalty for not taking RMD has been reduced by 25% of required amount not taken plus applicable taxes. Penalty can be reduced to 10% if corrected in a timely manner.

Question 25

Required Minimum Distribution Decision Tree

Answer 25

Question 26

QDRO: Qualified Domestic Relations Order

Answer 26

• A QDRO is used to split asset between divorcing couples for qualified plans.
• effective during life and/or after death.
• Could be based on dollar amount or percentage of benefits.
• The alternative payee may not be someone other than a spouse, former spouse, child or other dependent of the participant.

Question 27

Bracket Stacking (Distribution Method)

Answer 27

• Delaying distributions can drive up tax brackets in later years.
• Withdrawing too much can drive up tax brackets now.
• Bracket Stacking: “fill” lower tax brackets buckets, and defer the remainder.

Question 28

Net Unrealized Appreciation (NUA)

Answer 28

• Means to trade ordinary income taxation on retirement assets for long-term capital gains treatment.
• Applies to employer securities held in a qualified retirement plan (ESOP, Pension, 401k, etc.)
• Must elect lump sum, in kind distributions from plan.

Question 29

Tax Treatment of NUA

Answer 29

Question 30

Asset Location - Taxable Accounts

Answer 30

• Index and other passive funds
• Growth funds with low turnover
• Tax-managed funds
• REITs
• Muni’s

Question 31

Asset Location - Tax-Deferered Accounts

Answer 31

• Divident Stocks
• Most taxable bonds
• Actively managed, high turnover funds
• Partnerships “IF” they avoid UBTI.

Question 32

Roth IRA Conversion Rules

Answer 32

wealthier individuals who will continue to be in a high tax bracket after retirement, and who do not need the income and would rather pass the account assets on to their heirs. These individuals are in need of tax-advantaged investments, and nothing is better than a Roth account for protecting
investment income from tax. Now that there is no income limit on conversions, many higher income individuals would benefit from converting their traditional IRAs to Roth IRA.

Question 33

Stretch IRA

Answer 33

• Secure act 2.0 limits stretching IRAs to 10 years after the death of the IRA Participant.
• Smaller RMD
• Flexibility for bene’s in timing receipts of income.
• Potentially longer streams of payments.

Question 34

Income in Respect of a Decedent (IRD)

Answer 34

• Applies to income the decedent had the right to, but never received.
• Subject to income and estate tax.
• IRD deduction is taken as the income is received by the beneficiaries.

Question 35

Distributions at Death - Basic Concepts Review

Answer 35

Question 36

Distributions Strategies at Death Multiple Beneficiaries.

Answer 36

Question 37

Trusts as Beneficiaries

Answer 37

Five rules if beneficiaries of a trust are to be considered designated bene’s of an IRA for stretch purposes.
1. Trust must be valid under state law
2. Beneficiaries must be identifiable from the trust instrument
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.

Question 38

Social Security & Medicare Basics

Answer 38

2023 Social Security wage base $160,200
Employee and employer portion of the tax is 6.2% each
2023 Medicare wage base – all earned income subject
Employee and employer portion of the tax 1.45% each
2.90% if self-employed
Additional 0.9% Medicare tax for income over $250k MFJ
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