Retirement Planning Quiz Flashcards
Nicholas, age 49, is employed by both NGL Company and Rice Services, which are unrelated companies. Both companies sponsor Section 401(k) plans. Nicholas earns $30,000 at each job and qualifies to participate in both plans. Nicholas’ spouse, Kelly, age 50, earns $75,000 and wants to invest for retirement in an IRA. She participates in a Section 457 plan and defers $18,000 per year. What is the maximum 2017 total of elective deferrals that Nicholas can make to his companies’ retirement plans, and what amount can Kelly contribute to her IRA and deduct for income tax purposes for 2017?
Nicholas Kelly
A)
$53,000 $5,500
B)
$18,000 $6,500
C)
$36,000 $0
D)
$23,000 $0
B
Michael, age 56 and the owner of Davis Engineering, would like you to recommend a qualified retirement plan for his company that might allow him to maximize retirement benefits for himself. He has owned the firm for 12 years and has a current salary of $140,000. The other employees are between the ages of 25 and 40 with salaries ranging from $40,000 to $65,000. Michael feels that the company can spend approximately $350,000 on retirement benefits this year and in the future. Based on this information, which of the following plans would you recommend?
A) Target benefit pension plan. B) Defined benefit cash balance pension plan. C) Employee stock ownership plan (ESOP). D) Traditional defined benefit pension plan.
D
A traditional defined benefit pension plan would maximize retirement benefits for Michael because he is older than the other employees and has a considerably higher salary. Due to these factors, the major portion of the corporate contribution would go toward funding Michael’s benefits. The company has the financial stability to maintain this degree of funding over the next nine years to Michael’s age 65. A target benefit pension plan is a defined contribution plan that initially projects an actuarially targeted retirement benefit; however, no subsequent adjustments are made in later years, so there is no guarantee of achieving that benefit. An ESOP is similar to a profit-sharing plan except that the participants’ accounts are invested in company stock. An ESOP will not provide Michael with the retirement benefit he needs in such a short period. A defined benefit cash balance pension plan is not likely to provide as high a retirement benefit as a traditional defined benefit pension plan because cash balance pension plan contributions are based as a percentage of compensation with a minimal interest rate credit. Given Michael is to retire in 9 years, the traditional DB pension would likely provide greater benefits.
Joe, age 52, has opened a consulting company. He currently employs 6 people who range in age from 22 to 31 years. Joe estimates that the average employment period for his employees will only be approximately 3 years. He would like to start a retirement plan that will favor older participants and include an appropriate vesting schedule. In addition, he would like the employees to bear the risk of investment performance within the plan. Which of the following plans is the most appropriate for Joe's consulting company? A) Target benefit pension plan. B) SIMPLE IRA. C) Traditional defined benefit pension plan. D) Cash balance pension plan.
A
A target benefit pension plan is the best choice because it favors older participants. Also, because a target benefit pension plan is a qualified plan, Joe could incorporate a vesting schedule to accrue benefits (probably 2-to-6-year graduated vesting).
The others are incorrect choices because:
A SIMPLE does not favor older participants. In addition, SIMPLEs provide for 100% immediate vesting of employer contributions.
Although a traditional defined benefit pension plan favors older participants and allows vesting schedules, it is not appropriate in this situation because the company would bear the investment risk.
A cash balance pension plan does not typically favor older participants and does not require the employees to bear the investment risk.
Ray is 71 years old and must take a required minimum distribution from his IRA. The calculation will be based on an account balance of $200,000. His 51-year-old wife, Susie, is his beneficiary. Based on the following information and the minimum distribution rules, determine the lowest amount Ray can receive from his IRA without incurring a penalty (round to the nearest dollar).
Owner / Spouse Beneficiary Ages
71 / 61
71 / 51
Life Expectancy Factor
- 5
- 2
A) $4,739. B) $6,780. C) $5,848. D) $7,547.
C
Based on the required minimum distribution rules, the lowest amount Ray can withdraw without incurring a penalty is $5,848. The minimum distribution rules automatically factor in a 10-year age difference for the single life expectancy table; however, when the beneficiary is a spouse who is more than 10 years younger, the joint life expectancy factor may be used. Therefore, Ray can use the 34.2 factor ($200,000 divided by 34.2 equals $5,848).
A client reaches age 70½ on March 15 of the current year and must begin to receive a required minimum distribution (RMD) from his traditional IRA. The client's IRA had a value of $132,500 at the end of last year. The distribution period for a 70-year-old individual is 27.4, and for a 71-year-old individual it is 26.5. If the client takes a $3,500 distribution April 1 of next year, what will be the amount of the minimum distribution tax penalty, if any? A) $750. B) $150. C) $1,500. D) $0.
A
Because the client is age 71 at the end of this year, the required minimum distribution for the client is $5,000 ($132,500 ÷ 26.5). Because the client only took a distribution of $3,500, the minimum distribution penalty would apply to the $1,500 shortfall. Therefore, the minimum distribution penalty is $750 (50% of the $1,500 shortfall).
A prospective client’s objectives are to adopt a plan that has predictable costs, is administratively convenient, and is easily communicated to employees. Which plan represents the best choice?
A)
A Section 401(k) plan with a matching employer contribution.
B)
Money purchase pension plan.
C)
Traditional defined benefit pension plan.
D)
Cash balance pension plan.
B
A traditional defined benefit pension plan maximizes owner-key employee and older employee benefits but its costs are unpredictable and high. The money purchase pension plan fulfills all the client’s objectives. The Section 401(k) plan has increased administrative costs and complexity.
Mary, age 56 and earning a current salary of $125,000, works for a company that sponsors a Section 401(k) plan. The plan allows her to contribute up to 15% of her salary each year, up to the annual Section 401(k) elective deferral limit. The company matches her contribution dollar-for-dollar, up to 3% of compensation. Because Mary would like to retire within the next 5 years, she is concerned about having a sufficient retirement benefit from the Section 401(k) plan. Based on life expectancy tables, Mary is expected to live until age 85. Which of the following factors can affect Mary’s retirement benefits from her Section 401(k) plan?
- The number of years of service multiplied by a benefit formula.
- Mary’s investment selections.
- The value of the Mary’s account balance at retirement.
2 and 3
In 2014, Debbie, then age 56, worked part time and earned $3,000. In 2015 and 2016 she earned $3,500 each year. In 2009, she began to receive $24,000 in alimony annually and continues to receive it today. On March 15, 2015, Debbie made an initial contribution of $2,000 to a Roth IRA for the 2014 tax year. She made a $6,000 contribution on March 15, 2018 for the 2017 tax year. Which of the following statements is(are) NOT correct?
- A $2,000 withdrawal on April 15, 2019, would not be considered a qualified distribution because the distribution would be made within 5 years following the initial contribution.
- The contribution Debbie made for the 2017 tax year will be disallowed because it exceeds earned income.
- Part of the contribution Debbie made for the 2017 tax year will be disallowed because it exceeds the maximum contribution allowable for a Roth IRA.
- Debbie must take a required minimum distribution by April 1 of the year following the year in which she attains age 70½.
all are incorrect
Statement 1 is incorrect. The 5-taxable-year period begins on January 1 of the taxable year for which the first contribution was made. Therefore, the period begins on January 1, 2014, and ends on January 1, 2019 and the 5 year test has been satisfied. In this case, it is a qualified distribution because Debbie is past age 59½. She would have turned 60 in 2018. Statement 2 is incorrect. Although contributions to Roth IRAs cannot exceed earned income, alimony is considered earned income for IRA purposes. Therefore, Debbie’s 2017 contribution does not exceed her annual earnings of $27,500. Statement 3 is incorrect. Because Debbie is older than age 50, her maximum allowable contribution for 2017 is $6,500. Statement 4 is incorrect. Minimum distribution rules do not apply to the original owners of Roth IRAs.
Shelly, age 35, converted a $90,000 traditional IRA to a Roth IRA in 2014. Shelly’s basis in the traditional IRA was $18,000. She also made a contribution of $5,000 to the Roth IRA in 2016. If Shelly takes a $5,000 distribution from her Roth IRA during 2017, how much total federal tax, including penalties, is due as a result of the distribution, assuming her federal income tax rate is 30%?
A) $400. B) $1,500. C) $500. D) $0.
D
Although the distribution is not a qualified distribution, it is not taxable because the contribution is considered to have been paid from regular contributions first. Thus, the basis in the distribution will equal the amount of the distribution. Because the $5,000 is neither includable in gross income, nor does it relate to a conversion within the last 5 years, it is not subject to the 10% penalty.
Raul is a 50-year-old businessowner with one employee, who earns $18,000 per year. Raul earns $170,000 per year and is establishing a profit-sharing plan that uses an age-weighted feature. The age-weighting formula allocates $27,850 to Raul and $350 to the employee. Which of the following statements is CORRECT?
A)
The plan cannot allow the employee to direct the investment of his share of the plan’s assets.
B)
Raul can make a deductible contribution of up to $4,500 for his employee.
C)
A 3 to 7-year graded vesting schedule would be appropriate for this plan.
D)
The contribution that must be made to the employee’s account is $540.
D
The plan is top heavy, resulting in a minimum contribution to all nonkey employees of 3%. Therefore, the contribution that must be made to the employee’s account is $540 (3% of $18,000). Top-heavy plans must use either a 3-year cliff or a 2- to 6-year vesting schedule. An employer can actually contribute more than $4,500 for employees as long as total contributions for all employees do not exceed 25% of aggregate covered compensation and the contributions do not violate the nondiscrimination rules. Either the employer (or plan trustee) can invest the plan’s assets or employees can be allowed to choose from among several different investment options in which to invest their own account balance.
Walter terminated his employment with Montclair, Inc. After termination, he received a lump-sum distribution from the company’s employee stock ownership plan (ESOP) in the form of 1,500 shares of Montclair stock. The market value at the time of distribution was $100,000. The cost basis of the stock when contributed to the plan on Walter’s behalf was $60,000. Walter did not elect NUA treatment at the time of the distribution. Three years later, Walter sold the stock for $150,000. What is the amount of capital gain on which Walter will be taxed because of the sale?
A) $100,000. B) $50,000. C) $90,000. D) $40,000.
B
Because Walter did not elect NUA treatment at the time of the lump-sum distribution, the entire $100,000 was taxable as ordinary income, which became his basis in the stock. His subsequent sale of the stock for $150,000 results in a LTCG of $50,000.
In 2014, Nicole (age 40) converted her traditional IRA ($10,000) to a Roth IRA. She then contributed $2,000 to her Roth IRA for 2015 and $2,000 for 2016. Her total earnings to date in the Roth IRA have been $1,260. In 2017, the following events occurred.
- In April, Nicole’s house flooded and she needed to replace her carpet. She withdrew $3,500 from her Roth IRA to cover this expense.
- In July, Nicole took the CFP® Certification Examination and passed. To reward herself, she withdrew $4,000 from her Roth IRA to go on vacation in the Bahamas.
- In September, Nicole decided to go back to school and get her master’s degree. She withdrew $7,000 for tuition expense.
- In November, Nicole’s accountant sent her a letter along with a bill for $50 reminding her that the purpose of her Roth IRA was not to withdraw money but to put money in. Nicole promptly took out $50 from her Roth IRA and paid her accountant’s bill in full.
In which of these events would the 10% early withdrawal penalty apply to Nicole’s Roth IRA withdrawals?
2 and 4
None of the distributions is a qualified distribution because the Roth is only 4 years old in 2017. Thus, the very first test for a qualified distribution, the 5 year test, has failed. Distributions from a Roth IRA are ordered as follows:
From regular contributions (no tax, no penalty)
From conversions, FIFO (no tax, subject to penalty if attributed to conversion within 5 years)
Earnings (subject to income tax and the 10% early withdrawal penalty)
Nicole’s first withdrawal is attributed to regular contributions. Her second distribution is attributed partially to regular contributions and partially to a conversion that is within 5 years. A penalty applies to the conversion portion. Nicole’s third withdrawal is attributed partially to a conversion within 5 years and partially to earnings. The third distribution starts out as subject to the penalty because it is within 5 years of the conversion, however, the funds were distributed to pay for higher education, so an exception to the penalty applies. Her fourth withdrawal is attributed to earnings and is subject to both income tax and the early withdrawal penalty.
The deductible contribution to a money purchase pension plan on behalf of a self-employed individual whose income from self-employment is $20,000 and whose deductible Social Security taxes are $1,413 is limited to: A) $3,717. B) $4,618. C) $4,000. D) $5,000.
A
The maximum contribution is $3,717, calculated as follows:
$20,000 Schedule C net income
− 1,413 Less: Deductible Social Security tax
$18,587 Adjusted net self employment income
× 20% Multiplied by: adjusted contribution percentage
$3,717 Maximum contribution to money purchase pension plan
The adjusted contribution percentage is calculated by dividing the maximum employer-deductible contribution percentage (25% for a money purchase pension plan) by 1 plus the percentage (1.25). For a money purchase pension plan, the adjusted contribution percentage is 20% (25% divided by 1.25). The adjusted net self employment income is then multiplied by the adjusted contribution percentage to arrive at the maximum contribution. The adjusted contribution percentage only applies to self-employed persons and not to their employees.
Justin, age 55, earns $50,000 annually working for Stone, Inc., an S corporation. He owns 10% of Stone, Inc.’s stock. Justin is a participant in the Stone, Inc., defined contribution plan. His spouse Meghan is 50 years old and is employed by JP Co. She earns $40,000 annually and participates in JP’s Section 401(k) plan, under which JP will make matching contributions of up to 3% of salary. Assuming that both the Stone, Inc., plan and JP plan have loan provisions, which of the following statements is(are) NOT correct?
- If Justin takes a loan from the Stone, Inc., plan, he will be assessed a 10% penalty tax because he is younger than age 59½.
- Justin cannot take a loan from the Stone, Inc., plan because he is a greater than 5% shareholder of the company.
- If Meghan’s Section 401(k) plan vested account balance is $10,000, she may borrow the entire amount.
- In both plans, the maximum loan is limited to 50% of the participant’s annual compensation.
1, 2, and 4
Statements 1, 2 and 4 are incorrect. Loans from qualified plans are never assessed a 10% penalty at the beginning of a loan. Retirement plan loans are subject to both ordinary income tax rates and the 10% early withdrawal penalty on the defaulted amount when a loan is not properly repaid. Loans from qualified plans to sole proprietors, more than 10% partners, and more than 5% shareholders in an S corporation are permitted. Generally, loans are limited to one-half the vested account balance and cannot exceed $50,000. When account balances are less than $20,000, however, loans up to the lesser of $10,000 or the vested account balance are available. Maximum loans from qualified plans is limited by account balance in the plan, not by the participant’s compensation.
Which of the following statements is correct regarding a target benefit pension plan?
- The participant does not know ahead of time exactly the retirement benefit he will receive.
- The employer bears the investment risk.
- Forfeitures reallocated by the employer to participants are not considered in applying the annual additions limit.
- Contributions to the plan are flexible.
1 only
