Retirement Q&A from Text

Question 1

Dan Nelson is age 51 and married. Dan and his wife Jane (age 51) expect to retire in 14 years (at age 65). Either Dan or Jane expects to live to at least age 95 (30 years) after retiring due to unusual longevity in both families. They also want you to assume there will be no reduction in retirement needs after the death of one spouse.
They determined that their annual retirement income need in today’s dollars is $80,000. They feel confident that they can earn 6% after- tax on their investments and would like to assume that inflation will average 4% over the long term.
1. What amount will the Nelsons need at the beginning of the retirement period (age 65) to fund annual income that increases annually with inflation?
A. $2,755,232 (+ $10) C. $3,135,730 (+ $10)
B. $3,045,190 (+ $10) D. $3,196,045 (+ $10)

Answer 1

D

Question 2

Dan Nelson is age 51 and married. Dan and his wife Jane (age 51) expect to retire in 14 years (at age 65). Either Dan or Jane expects to live to at least age 95 (30 years) after retiring due to unusual longevity in both families. They also want you to assume there will be no reduction in retirement needs after the death of one spouse.
They determined that their annual retirement income need in today’s dollars is $80,000. They feel confident that they can earn 6% after- tax on their investments and would like to assume that inflation will average 4% over the long term.Dan and Jane review your figures and tell you that they feel they need at least $3,200,000 to feel comfortable. They now presume that their assets will grow to a value of $1,900,000 at the first year of retirement. How much must they set aside by the end of each year to meet their retirement goal?
A. $58,359 (+ $10) C. $80,259 (+ $10)
B. $61,861 (+ $10) D. $81,802 (+ $10)

Answer 2

B End mode $1,300,000 FV, 6 i, 14 n = $61,861 PMT
NOTE: Both the $3.2 million and $1.9 million already has inflation factored into it. Simply solve for a payment based on future value of the difference.

Question 3

1. Toby Adams has determined he needs $350,000 when he retires in
   12 years. He plans to start a level savings program making payments at the beginning of each month. He estimates his pension plan will have accumulated $150,000 in 12 years. He anticipates that he will earn an average 11% after-tax return and that inflation will average 5%. What monthly payments should he make?

A. $668 C. $1,557
B. $901 D. $1,587

Answer 3

A - The question never says in today’s dollars.” Inflation is not a factor in the calculation.
Begin mode
12C $200 000 FV 11 enter 12 �� I 12
enter 12 x n PMT = $667.66

Question 4

2. Joe works at the local PM plant. He is 55 and plans to retire at age 65. He has been a union member but is about to accept a management position. He wants to retire on $2,000 per month (begin). The union estimates his benefits will be $1,000 per month at age 65. PM has a 401(k) with no company matching. How much does Joe need to contribute to PM’s 401(k), at the end of each month assuming a 10% return and presuming that he will live to age 95? [Joe has not started contributing to the 401(k) yet.] A. $561 B. $677 C. $771 D. $1,177

Answer 4

A First calculate the amount needed at 65 to pay
$1,000 per month (begin). Why begin? A retiree can’t wait until year end for benefits.
10BII/17BII+ (Begin) 12 P/YR, $1,000 PMT, 10 I/YR, 30 gold xP/YR, PV = $114,900
Then discount that value back to age 55. (End) $114,900 FV, 10 I/YR, 10 gold xP/YR, PMT = $561
12C (Begin) $1,000 PMT, 10 enter 12 �� i, 30 enter 12 x n, PV = $114,900
Then discount that value back to age 55. (End) $114,900 FV, 10 enter 12 �� i,
10 enter 12 x n, PMT = $561

Question 5

With regard to retirement planning versus estate planning, which of the following is true?
A. To many clients, retirement planning plays a secondary role to estate planning.
B. When planning for a surviving spouse, retirement planning must account for payment of estate taxes at the retiree’s death.
C. A gift at death of the remaining retirement assets to a charitable organization will be income and estate tax-free.
D. Retirement assets are only subject to income taxes not estate taxes. They cannot be double taxed.
E. The primary goal of retirement planning is to distribute assets whereas the primary goal of estate planning is to accumulate assets.

Answer 5

C Estate planning, wealth accumulation, and tax reduction normally play a secondary role to retirement planning. There is no estate tax at the death of the retiree when survived by a spouse. Retirement assets are subject to income tax and can be subject to estate taxes.

Question 6

1. Tommy, age 55, plans to retire in 10 years. He plans to convert all his retirement accounts to cash at that time. He has the following accounts.

$2,000,000 in profit sharing (currently 60% vested)
$500,000 in a deductible IRA
$1,000,000 in a non-qualified variable annuity originally
purchased for $500,000

Presuming Tommy can make 5% on these accounts and he will be in a 50% federal, state, and local combined tax bracket, how much will he realize after paying the taxes?
A. $2,340,508 C. $3,100,566
B. $2,600,566 D. $2,199,008

Answer 6

C
3,500,000 PV,
5i, 10n = $5,701,131 FV
[$5,701,131 '
500,000* (basis)] x 50% = 2,600,566
$2,600,566 + $500,000* = $3,100,566

*Why subtract and add the $500,000? The annuity ($500,000) was purchased with after-tax dollars.

Question 7

2. Larry and Roberta Young have been told that using a straight- line calculation they will have to save $20,000 per year to meet their retirement goal. Between paying off college debt, raising two children, and just plain living, their budget indicates they can only save $10,000 today. However, they feel they can bring their college debt down and their employment earnings are increasing. What do you suggest they do?

I. Save $10,000 and not worry about the projection
II. Find another financial planner who can do a serial payment
III. Work more years until they retire
IV. Increase the projected after-tax return of the projection

A. I C. III, IV
B. II,III D. IV

Answer 7

B With a serial payment, the amount of savings increases from year-to-year based on an inflation projection. A serial payment would start smaller today*. Answer C is another possibility. Answer D is using a projection that is not realistic. *For example, $10,000 today could be $10,800 next year then $11,664 the 3rd year which means they will save 8% more each year. No calculation, concept question only.

Question 8

3. Robert Dunbar works as an engineer for EEE, Inc. Robert divorced his wife some years ago, and she claimed half of his pension under the divorce decree. Robert at age 55 married Lucy, age 45, four years ago. Robert would like to retire in 5 years taking early Social Security. EEE, Inc. has a money purchase plan. Because of the law requirements Robert had to name Lucy his beneficiary. Because of her age (10 years younger), his divorce, and market conditions, the projected joint and survivor annuity at age 64 will only be $4,000 per month. What could he do if he wants to retire in 5 years?

A. Work overtime or second job
B. Work longer, like to normal retirement age
C. Ask for a pension max calculation
D. Divorce Lucy

Answer 8

C

With pension max, the payout can be based on his life expectancy. Lucy, a 10 year younger female, is pulling the payout down. Answer C can only be done if Lucy agrees and signs a consent to waive her rights. He also has to be insurable and take a policy out to cover her benefits. Answer B is not a bad answer. He is 59 now and in 5 years he will be 64. His NRA is age 66. This would increase his pension payout and Social Security payment.

Question 9

4. Horace Jones has asked a financial planner to do a projection based on a reasonable return but an exceptionally long retirement period plus a large dollar amount remaining when he dies at the end of that period. His concern is that both he and his wife have had family members live well beyond normal life expectancies. The result with inflation is a dollar amount at normal retirement age that is way beyond what Horace can save per year. The financial planner showed both level savings and a serial payment (increased savings each year) but neither could reach the client’s goals. What should the financial planner suggest?

A. Horace should invest more aggressively to achieve a higher return.
B. Horace should increase his age to retire.
C. Horace should work a second job
D. At retirement, Horace should buy a single life (pure life) annuity.

Answer 9

B Answer A is not realistic. Answer C is debatable. Answer D will be a level payment for his life but there is no inflation hedge or residual value for his wife. If he increases his years to retirement, he can save more. Then his years in retirement are fewer with more money available to fund his goals.

Question 10

1. Tim Owens, CFPﾶﾩ, works for a money management type firm. The firm has developed various financial products to fit client’s needs. The firm has a mathematical method of fitting a client into products. The company has told him that he should follow the computer guidelines. What does the firm not understand?
   I. This method will not deal with particular investor biases or fears.
   II. This is not the appropriate way to meet client’s needs.

A. I C. I and II
B. II D. Neither I or II

Answer 10

C There is a danger if advisors and their clients concentrate on financial products as a consequence of implementing behavioral finance principals. Rather than products, self- determination is the most important part of applied behavioral finances. It is about building a decision making process to get people to make their own decisions. This means working closely with clients.

Question 11

2. Beverly’s grandfather lost all of his money when the bank collapsed during the Great Depression. Her grandfather concluded that he would not make the same mistake again and put every dime in a lockbox in the attic. Beverly’s investment attitude will be which of the following?

A. Invest in quality blue chip stocks
B. Invest in variable annuities
C. Invest in Treasuries
D. Invest in CDs and saving accounts

Answer 11

C Beverly will be very conservative. She will definitely avoid the stock market (Answers A and B) and even possibly banks. She may be very anxious about money.

Question 12

Mr. Axel is self-employed. He employs his 16-year-old daughter to input customer data into his computer. He pays her approximately
$5,000 per year ($10/hr.). Which of the following is/are true?
I. He must withhold taxes.
II. He must withhold FICA taxes.
III. He must match her FICA taxes.
IV. He is not required to withhold any taxes.
A. I, II, III C. I
B. II, III D. IV

Answer 12

D Her earned income will be less than her standard deduction ($6,200). A child, under age 18 and employed by a parent in an unincorporated business, does not have to pay self-employment or FICA taxes nor does the parent.

Question 13

1. Mrs. Bell (fully insured worker) dies. Mr. Bell, age 50, has three children in his care, ages 17, 15, and 14. Is he entitled to benefits?
   A. Yes, he has a child in care under age 16, and Mrs. Bell was insured.
   B. No, he is under age 60.
   C. Yes, he has a child in care under age 18, and Mrs. Bell was insured.

Answer 13

A Answer B refers to retirement benefits. Answer C refers to dependent benefits.

Question 14

2. Which of the following dependents receives Social Security benefits of a deceased insured worker?
A. A 19 year old child in college
B. A 19 year old child working
C. A 19 year old child in high school
D. A 19 year old child who is disabled

Answer 14

D

The disability began before age 22. The child must be under age 19 and in high school.

Question 15

1. Which of the following persons is eligible for retirement benefits under her first husband’s retirement benefits provision?
   A. Helen, age 62, married 1976-1988, ex-husband employed 1973-2008, divorced, never remarried, ex-husband dies
   B. Jane, age 62, married 1979-1993, first husband employed 1973-2010, remarried, divorced, remarried
   C. Judith, age 63, married 1971-2000, first husband employed 1988-2011, remarried, second husband has died
   D. Emily, age 60, married 1973-1998, first husband employed 1978-2008, remarried 1993
   E. Susan, age 68, married 1990-1998, first husband employed 1973-2011, remarried, divorced

Answer 15

A Answer B indicates that Jane is remarried. Answer C indicates that Judith can collect under her second husband. Answer D indicates that Emily is age 60 and remarried. Answer E indicates that Susan was married for fewer than 10 years.

Question 16

2. Mr. Kidd is age 58. He is fully insured and is receiving Social Security disability benefits. His wife is age 53. He has three children.
   - Larry, age 30, disabled due to an accident at age 16
   - Tim, age 18, still in high school
   - Vicky, age 19, graduated from high school and is currently working full time and living at home
   Which of the family members are entitled to Social Security benefits?

I. Mr. Kidd IV. Vicky
II. Mrs. Kidd V. Larry
III. Tim

A. I, II, III, IV D. II, III
B. I, II, III, V E. I, V
C. I, III

Answer 16

B - Mrs. Kidd is eligible because she has a child in care. In care means (1) care of a child under age 16 or a mentally incompetent child 16 or over or (2) performs personal services for a disabled mentally competent child age 16 or over. Larry is entitled because the disability began before he reached age 22. Tim is still in high school.

Question 17

What is added to AGI when determining the taxation of Social Security benefits?
A. Workers’ compensation C. Gifts
B. Municipal bond interest D. Net passive losses

Answer 17

B Tax-exempt interest is added to AGI.

Question 18

Professor Smith had been employed at State University. He earned
$40,000 per year. The university funds a disability policy (180 day elimination period) to replace 60% of his income. The policy is coordinated with Social Security benefits. In addition, he has a financial consulting practice that produces $30,000 in net Schedule C income. He purchased an individual disability policy (90 day wait) based on 60% of his consulting income (with no Social Security coordination). Assume that he is totally and permanently disabled and is awarded $800 per month disability payments from Social Security. What will be his gross benefit in the 5th, 6th, and 7th month from all three sources?

A. $1,500; $1,500; $2,300 C. $2,300; $2,300; $3,500
B. $1,500; $2,300; $3,500 D. $2,300; $2,300; $4,300

Answer 18

B There is a five-month waiting period under Social Security during which time no benefits are paid. There is no coverage under Social Security for disability when it is clear that the disability will last fewer than twelve months. In this case, payments are $1,500 from his individual policy for month 5, then an additional $800 from Social Security for month 6 ($2,300). The $2,000 benefit from the university is offset by Social Security payments in the 7th month or a net of $1,200 more ($3,500 total).

Question 19

1. Sally Smith, age 62, is divorced for 12 years. She earned
   $15,000 when she began working 20 years ago, and now makes
   $150,000. She is debating whether to retire now, wait until NRA, or look to see if she can elect more coverage from Social Security because her ex-husband makes $1,000,000 per year. What do you suggest she do?
   A. Retire now and claim 50% of her ex-husband’s benefits.
   B. Retire at NRA and claim 50% of her ex-husband’s benefits.
   C. Retire now and collect 100% of her benefits.
   D. Wait until NRA and collect her benefits.

Answer 19

D Her benefits are the greater of her benefits or 50% of his. But she has been making well over the Social Security maximum threshold and should receive more than 50% of his benefits Answer B). If she retires now, she is retiring 4 years early and will lose well over 20% of her NRA benefits Answer C). Nothing indicates she must retire now. Waiting to NRA increases benefits by 7-8% per year because she will have a higher 35 year average wage base (answer D). But if she retires now (Answer A), she can get 50% of his benefits and leave her benefits grow. Then at NRA or age 70 take her benefits, but she must retire, no wages above the threshold.

Question 20

2. George Winslow has been married four times. He is currently married to Lucy. Lucy is 2 years younger than George. George’s first wife died 30 years ago during childbirth. His son is now 30 (George Jr) and single. George’s second wife divorced him 15 years ago. She remarried 10 years ago. They had a son, Larry. Larry is age 18 and lives with George. He remarried Cindy (3rd wife) 13 years ago. Cindy divorced him 2 years ago because Larry was impossible to handle (mentally disabled). Lucy seems to be able to handle Larry’s condition. George has worked all his life and is approaching age 62. If George died who would get Social Security benefits?
   I. George IV. Lucy
   II. Second wife V. Larry
   III. Third wife

A. All of the above D. III, IV
B. II, III, IV, V E. III, V
C. III, IV, V

Answer 20

C II is out because she (second) remarried. III is in all the answers. It really does not say whether she remarried or what her age is. But, she is in all the answers. Cindy was married to George for 10+ years. We do not know when Larry’s disability started except that his third wife divorced him 2 years ago over Larry (then age 16). Larry and Lucy (age 60) will get benefits.

Question 21

3. Mr. Vance is approaching retirement age. He has paid in enough to qualify for $2,000 per month at NRA. Mr. Vance feels that his Social Security plus his retirement plan ($1,000 per month) and municipal bond interest ($1,000 per month) will provide a nice retirement income. How much of his Social Security benefits will be included in his taxable income?

A. $0 at retirement age B. $1,000
C. $1,700 D. $2,000

Answer 21

C His base amount is greater than $34,000 single.

Social Security at 50% = $12,000
Retirement plan 12,000
Muni bond 12,000
MAGI $36,000

$2,000 x 85% = $1,700

Question 22

4. Gale, single at 64, has a NRA of age 66. She is trying to decide if she should retire and take Social Security early or work to her NRA. She does not expect any major pay changes at work and her employer has asked her to stay on while they find and train a person to do her job. She is trying to determine her return (the increase in benefits) by waiting because everyone has told her to take her benefits now. What will the approximate return in benefits be if she waits?
   A. She is at maximum benefits now. B. 13.33%
   C. 16.67%
   D. 20.00%

Answer 22

B She will retire 24 months early. 24 �� 180 =
13.33 loss of benefits. She will get 13.33% more at NRA. In others words, if she retires now she will get 86 2/3 of her benefits at NRA.

Question 23

5. Are Social Security benefits ever subject to tax if you are normal retirement age (NRA) or older?

A. No, not unless you continue to work then you can keep your benefits tax-free.
B. Yes, if your taxable income is above certain base amounts.

Answer 23

B Please keep straight working after retirement (Section D) and Taxation of benefits (Section E). They are different.

Question 24

Mac, the president of MAC, Inc., earns $300,000. The company has a 15% money purchase plan. How much can the company contribute on his behalf?
A. $30,000 C. $39,000 E. $52,000
B. $38,750 D. $45,000

Answer 24

C 15% of $260,000 (Salary cap is $260,000.)

Question 25

Which of the following factors least affects a defined contribution plan participant’s account balance?
A. Investment return C. Employer contributions
B. Inflation D. Life expectancy

Answer 25

D Inflation will affect salary levels and investment returns. At retirement, the employee will only get the account balance. Life expectancy affects defined benefit plans.

Question 26

1. Lana, age 55 and making $100,000 yearly, has been told her target benefit will be 50% of salary at age 65 ($50,000). The actuary determines that $660,000 will need to be in the account at age 65. Based on a 7% projected return, what is the required employer contribution?
   A. $40,000 C. $51,000 E. $50,000
   B. $47,769 D. $52,000

Answer 26

B $660,000 FV, 7i, 10n = $47,769 PMT (end)
Remember, the maximum contribution is the lesser of 100% of $100,000 or $52,000. $47,769 is less than $52,000, so it is the correct answer.

Question 27

2. From question 1 above, what would be the correct answer if the actuarially determined account balance is $770,000?

Answer 27

D $770,000 FV, 7i, 10n = $55,731 PMT (end) Although the target benefit formula requires an annual contribution of $55,731, the most the employer could contribute is $52,000 (2014). This is the 100% rule with no calculation, concept only.

Question 28

1. Which of the following is an advantage to an employee when his/her employer provides a profit-sharing plan?
   A. Employees get a predictable level of funding under the plan.
   B. Employees may get forfeitures from other employee accounts.
   C. Employees bear no investment risk under the plan.
   D. Employees of all ages receive adequate levels of retirement benefits.

Answer 28

B For a profit-sharing plan to remain viable, contributions must be substantial and recurring. Contributions are discretionary, not predictable. Contributions are generally pooled for investment purposes and then allocated to each individual participant’s account. The plan favors younger employees who have substantial time to accumulate retirement savings.

Question 29

2. Which of the following is the biggest disadvantage to an employee when the employer does a profit-sharing plan?
   A. The employee forfeitures can reduce employer contributions.
   B. Employer contributions are subject to FICA and FUTA.
   C. Contributions are purely discretionary amounts.
   D. The benefits at retirement are unpredictable.

Answer 29

C Although Answer A is true, forfeitures are normally allocated to the employee account balances. Answer B is false because employee deferrals are subject to FICA [see 401(k) below]. Answer D is also true, but Answer C is the biggest disadvantage. The employer could contribute nothing or small amounts.

Question 30

Can the $17,500 401(k) deferral limit be exceeded by a person age 40?
A. No B. Yes

Answer 30

A The deferral amount can be supplemented by direct employer contributions up to the lesser of 100% of compensation or $52,000, but the deferral is $17,500.

Question 31

1. Which of the following types of business cannot establish an ESOP?
   A. S corporations C. Public traded corporations
   B. Partnerships (KEOGH) D. Closely held C corporations

Answer 31

B Partnerships may offer other types of qualified plans, but they cannot have stock bonus or ESOP plans because partnerships do not issue stock. Any business established as a corporation may establish ESOPs.

Question 32

2. How do ESOPs and stock bonus plans differ from profit-sharing plans?
   A. Stock bonus and ESOP plans typically invest plan assets mainly in employer’s stock while profit-sharing plans cannot invest in employer’s stock.
   B. Stock bonus and ESOP plans must base contributions on company profits while profit-sharing plans do not have to be based on company profits.
   C. Stock bonus and ESOP plans are looked upon as a way to finance company operations while profit-sharing plans are not viewed as a way to finance company operations.
   D. Stock bonus and ESOP plans require participants to take distributions in the form of employer stock while profit- sharing plans generally do not.

Answer 32

C Answer A is wrong because profit-sharing plans can invest in a limited amount of employer stock normally 10% of total plan assets, but they may go beyond unless the plan document states otherwise (could be more or less than 10% depending on plan language). Answer B is wrong because stock bonus and ESOP plans do not need to be based on company profits. Answer D is wrong because stock bonus and ESOP plans do not require participants to take distributions in employer stock; it is an option. Employer contributions in a stock bonus or ESOP plan are typically in the form of cash (not stock). The plan then uses the cash to purchase shares from the company, thereby funding company operations.

Question 33

Participant Compensation Contribution %
Mr. Walters $260,000 $52,000 20%
Employee #1 $50,000 $ 2,500 5%
Employee #2 $40,000 $ 2,000 5%
Employee #3 $40,000 $ 2,000 5%
Employee #4 $30,000 $ 1,500 5%

Which one of the following is a false statement about a cross- tested plan?
A. Cross-testing measures plan’s ultimate benefits for nondiscrimination although the plan is a defined contribution plan.
B. The regulations have a gateway requirement (the lesser of at least 1/3rd of the allocation rate of the HCE with the highest allocation rate or 5% of the NHCE’s compensation).
C. Self-employed persons can adopt a money purchase cross-tested Keogh plan.
D. All defined contribution plans can use cross-testing.

Answer 33

D - All makes Answer D wrong (false). ESOPs cannot be cross-tested. Self-employed persons who adopt qualified plans (Keogh type plans) can use a cross- tested design. Keogh plans are qualified plans.

Question 34

1. If XYZ pension plan provides a life annuity equal to 3% of earnings per year up to 30 years of service, how much will an employee with an average annual compensation of $280,000 receive as an annual pension after 30 years?
   A. $52,000 C. $210,000
   B. $200,000 D. $252,000

Answer 34

C 30 years times 3% is 90%. 90% x $255,000 (not 90% of $280,000) = $252,000 Remember: The salary cap is $260,000, but the benefit cap is $210,000.

Question 35

2. Mr. Enderlee has owned and operated E4, Inc. for 20 years. After many financially difficult years, E4 has substantial retained earnings and a very positive future earnings outlook. Mr. Enderlee wants to establish a defined benefit plan that will benefit him. He employs about 10 older employees (reasonably paid) and 15 younger employees (lower paid). Almost all employees would be eligible, but most employees have been employed by E4 for only a few years. Which type of benefit formula do you suggest?
   A. Unit-benefit formula
   B. Flat-percentage-of-earnings formula (also called fixed benefit formula)
   C. Flat-amount formula
   D. Final average method

Answer 35

A - The unit-benefit formula factors both service and salary in determining the participant’s pension benefits. The formula can give him credit for prior service he has been with the company 20 years, other employees have only been with the company for a few. Answer B relates solely to salary. Answer C treats all employees alike. Answer D uses compensation at retirement.

Question 36

3. Which is the most frequently used defined benefit formula?
   A. Flat-amount-per-year-of-service formula
   B. Percentage-of-earnings-per-year-of-service formula
   C. Flat-percentage-of-earnings formula
   D. Income-replacement formula

Answer 36

B - Answer B is also known as the unit-benefit formula. Answer A is related solely to service but does not reflect an employee’s salary. Answer C is related solely to salary and does not reflect an employee’s service. Answer D is not a DB formula; it represents the amount of an employee’s gross income that will be replaced under the benefit formula.

Question 37

4. Which of the following is not a defined benefit characteristic?
   A. Specified retirement benefit
   B. Risk of pre-retirement inflation assumed by employee
   C. Benefits based on past service provided
   D. Contributions not attributed to specified employees

Answer 37

B - All of the other answers are DB plan characteristics. The employer assumes the risk of pre-retirement inflation in a DB plan. DB plan contributions are not earmarked to specified employees.

Question 38

5. Of the disadvantages to an employer of installing a defined- benefit plan, which is most concerning?
   I. Annual employer contributions are required, and the employer’s future costs are not precisely known.
   II. They are more costly to administer than defined contribution plans, and the employee assumes responsibility for pre-retirement inflation and investment results.

A. I only C. Both I and II
B. II only D. Neither I nor II

Answer 38

A The benefits to the employee are known. It is the employer who assumes responsibility for pre- retirement inflation and investments results, not the employee. The employer makes up any deficiency.

Question 39

6. Mark retires after 32 years of service with his employer. He will receive a monthly pension commencing at normal retirement date and paid out in a life annuity equal to 2.2% of final- average monthly salary ($10,000) multiplied by years of service. Service is limited to 30 years. What is the Mark’s income replacement ratio under this unit-benefit formula?

A. 64% C. 66%
B. 60% D. Not enough information

Answer 39

C - The ratio is 2.2% x 30 = 66%. Although most employers generally choose an income replacement of between 40 and 60% of final-average salary for employees, higher income replacement ratios may be offered.

Question 40

What effects do the events below have on a defined benefit plan?

1. The company hires older employees.
2. Investment earnings are up significantly.
3. New employees rarely stay one year.
4. Inflation is lower than expected.

A. Increases company contributions
B. Decreases company contributions
C. No effect

Answer 40

1-A, 2-B, 3-C, 4-B
Employees who stay fewer than one year are normally never in the plan (one year of eligibility). If inflation is low, the stock market (investments) should rise. Increased earnings decrease company contributions. If the plan uses an acturial assumption of 6% and the plan actually makes 12%, the plan has excess funding and contributions can be decreased. Lower inflation means salaries should remain constant rather than increasing.

Question 41

5. Which of the following is not a defined contribution plan characteristic?
   A. Defined employer contributions
   B. Benefits for past service are not provided.
   C. Employer assumes risk of pre-retirement inflation.
   D. Employee assumes risk of adequacy of retirement income.

Answer 41

C Contributions are designed by formula. Only defined benefit plans can provide for past service. All of the other answers are DC plan characteristics.

Question 42

1. Which of the following is true about a cash balance plan?
   I. The interest credited to the account is guaranteed by the employer.
   II. Investment discretion is offered to each participant.
   III. If the trust assets earn a higher return than guaranteed, future employer contributions are reduced.
   IV. If the trust assets earn a lower return than guaranteed, future employer contributions are increased.

A. All of the above C. I, III, IV
B. I, II D. II

Answer 42

C - A cash balance plan provides a hypothetical individual account for each participant. These accounts are funded by the employer once a year with interest credit” (the guarantee). The actual return can therefore lower or increase employer contributions.

Question 43

2. Which of the following is true about cash balance plans?
   I. Past service credit is available.
   II. They do not involve an employer minimum rate of return.
   III. The plan works somewhat like a money purchase plan.
   IV. Forfeitures must be used to reduce employer contributions.
   A. All of the above D. II, III
   B. I, II, IV E. III, IV
   C. I, III, IV

Answer 43

C The plan has a minimum rate of return.

Question 44

1. LLM, Inc. wants to adopt a pension plan.  They want to make a reasonable yearly contribution of 10-15%.  	They want the investment risk to fall on the participants, not on the company. They would like the plan to be simple to explain to the employees.  Which plan should they adopt?
A. Cash balance
B. Money purchase
C. Target benefit
D. Profit sharing
E. 401(k) SIMPLE

Answer 44

B - In a cash balance plan LLM, Inc. has to guarantee the return. In a target benefit plan contribution are based on age, compensation and other factors. It is not a level percentage for each employee and is not simple to explain.
Profit sharing and 401(k) SIMPLE are not pension plans.

Question 45

2. Ellen joined Employee Outsourcing, Inc. (EOI) twenty years ago. EOI told her they had a target benefit plan that was designed to provide 30% of her salary at retirement. She is 62 and plans to retire early and take Social Security. What can she expect from the target benefit plan at age 62?
   A. She will get slightly less than 30% because she is retiring early (62), the plan benefit was based on age 65.
   B. She will get 30% of her salary.
   C. She will get the account balance.
   D. She will get 30% of her salary that she was paid at age 42.

Answer 45

C - Although she was told that the plan was designed to provide a benefit, she will get the account balance which could provide more or less than 30% of her final salary.

Question 46

3. Ralph Thompson is confused. He has worked for Trucker’s Unlimited, Inc. as a driver for 40 years. TUI has had a defined benefit plan for all 40 years. He was promised 1% of earnings for each year of service up to 30 years under a unit benefit formula plan. During his last year of work he earned $100,000. His first monthly check was for $2,500. He thought he should get more. What would you say to him?
   A. The amount is correct.
   B. The amount is incorrect. He should have gotten $3,333.33 per month.
   C. Ralph, go back to the company and request an audit.
   D. Ralph, they are discounting your benefits because you retired early.

Answer 46

A - 30% of $100,000 is $30,000 per year or $2,500 per month. Answer D could be true in some situations but Ralph’s age is not given and he should be around 60 years old or older.

Question 47

4. Alice is concerned about her retirement benefits. Some years ago, the company discontinued the defined benefit plan and rolled her account value into a cash balance plan. Now she realizes that she will just get the account balance at retirement. Unfortunately, Alice, due to a messy divorce and related health problems, does not have much more for retirement except this plan. Now as year ends, she has seen the stock market lose 30% and bonds lose 15%. Should she be concerned about the company contribution and her account balance?
   A. She should be concerned about the company contribution if the economy is doing so poorly.
   B. She should be concerned about the account balance if the economy is doing so poorly.
   C. She should be concerned about both the company contribution and the account balance if the economy is doing so poorly.
   D. Unless the company she works for is failing, (and even then) she should not be concerned.

Answer 47

D The employer guarantees not only the contribution level but also a minimum rate of return. If the company fails, the PBGC takes over the guarantees.

Question 48

The term year of service for purposes of meeting the one-year-of-service or two-year-of-service eligibility requirement is illustrated in which of the following examples? (Hours shown include sick time vacations and holidays for the year 2013.)
A. An employee is hired on 12/31/2012 and works three 8-hour days per week through 12/31/2013.
B. An employee is hired on 12/31/2012 and works two 8-hour days per week through 12/31/2013.
C. An employee is hired on 12/31/2012 and works 1000 hours through 7/31/2013.
D. An employee is hired on 1/3/2013 and works 1000 hours through 7/31/2013.
E. An employee is hired on 1/3/2013 and works 1000 hours through 12/31/2013.

Answer 48

A - Two requirements must be met: one full year of service and at least 1,000 hours of service during the year. Answer B is wrong because fewer than 1,000 hours were worked in a 12-month period. Answer C is wrong because only one of the two requirements has been met. This employee would become eligible to participate after completing 12 months of service. Answer D is wrong because the employee has not worked a full 12 months (just a few days shy).

Question 49

1. Which of the following statements is/are true?
   I. Under the percentage test, a plan will satisfy the coverage tests if it benefits at least 70% of the employees.
   II. The ratio test requires a plan to benefit a percentage of non-highly compensated employees equal to at least 70% of the percentage of highly compensated employees benefited under the plan.

A. I C. I, II
B. II D. Neither I or II

Answer 49

A - Two requirements must be met: one full year of service and at least 1,000 hours of service during the year.

Question 50

2. If an employer wants to limit coverage, the rules allow the exclusion of which of the following employees?
   A. If a plan covers 100% of the highly compensated employees, up to 30% of the non-highly compensated employees can also be excluded.
   B. All key employees can be excluded.
   C. If the plan excludes some of the highly compensated employees, even more than 30% of the highly compensated employees can be excluded.
   D. If the plan excludes 50% of the highly compensated employees, more than 65% of the non-highly compensated employees may be excluded.

Answer 50

Answer B is wrong because fewer than 1,000 hours were worked in a 12-month period. Answer C is wrong because only one of the two requirements has been met. This employee would become eligible to participate after completing 12 months of service. Answer D is wrong because the employee has not worked a full 12 months (just a few days shy). not more than 65%. Answer A is a more likely answer for the exam than Answer D. Answer A uses the 70% concept.

Question 51

1. Which of following individuals is a highly compensated employee (HCE)?
   A. John Smith, retired, owns exactly 5% of the outstanding stock of ABC, Inc.
   B. Karen Jones, an officer with ABC, Inc., made $110,000 last year and will make no more than $115,000 this year.
   C. Tim Donaldson owns exactly 10% of the outstanding stock of ABC, Inc. will make $250,000 this year.
   D. Jean Kellerman, a new employee of ABC, Inc., will make well over $115,000 this year.

Answer 51

C An HCE is an employee who made more than $115,000 last year (2013) or an employee who was more than a 5% employee owner last year or this year. Someone who made exactly $115,000 last year is not an HCE. Answer A is wrong because it does not indicate John is an employee. He is retired. Picky. Answer B is wrong because she would have had to make over $115,000 last year to be an HCE. Answer D is wrong because Jean did not work for ABC in the look-back year; therefore, her income for that year is deemed to be $0. Answer C is for sure a HCE.

Question 52

2. Which individual of a company is not a key employee?
   A. A person who owns more than 5% of the company
   B. A person with annual compensation in excess of $115,000 last year.
   C. A person who is more than a 1% owner and had compensation in excess of $170,000
   D. An officer with annual compensation of $180,000

Answer 52

B - Answer B identifies a HCE, not a key employee.

Question 53

Concerning the special top-heavy vesting requirement, which of the following vesting alternatives are acceptable after PPA 2006?
I. A top-heavy plan that formerly used a 7-year graded schedule now uses a 3-year-cliff schedule.
II. A top-heavy plan that formerly used a 5-year cliff schedule now uses a 6-year graded schedule.
A. I only C. Both I and II
B. II only D. Neither I nor II

Answer 53

C A 7-year graded vesting schedule can be converted to either a 3-year cliff or a 2- through-6-year graded schedule. A 5-year cliff vesting schedule can be converted to either a 3-year cliff or a 2-through-6-year graded schedule.

C A 7-year graded vesting schedule can be converted to either a 3-year cliff or a 2- through-6-year graded schedule. A 5-year cliff vesting schedule can be converted to either a 3-year cliff or a 2-through-6-year graded schedule.

Question 54

1. Tilly is a participant in her company’s 7-1/2% money purchase plan.
   The plan uses a 2-through-6-year graded vesting schedule with a
   one- year eligibility requirement. Tilly has been with the company

5 full years.  How much of her account balance is vested?
End of year     Salary
    1           $30,000    
    2           $32,000
    3           $34,000
    4           $36,000
    5           $40,000

A. $6,390 B. $8,250 C. $8,520

Answer 54

C - You must ignore the first year of salary. To solve, add contributions for years 2, 3, 4, and 5 ($142,000). $142,000
at 7-1/2% is $10,650. She is 80% vested.($10,650 x 80% = $8,520)

C - You must ignore the first year of salary.  To solve, add contributions for years 2, 3, 4, and 5 ($142,000). $142,000 at 7-1/2% is $10,650. She is 80% vested.($10,650 x 80% = $8,520)

Question 55

2. Sally is a participant in her company’s profit sharing 401(k). The plan uses a 2-through-6 year graded vesting schedule with a one- year eligibility requirement. Sally has been with the company 3 full years. How much of the deferral and profit-sharing account balance is vested?

A. 0%/40% C. 100%/0%
B. 40%/40% D. 100%/40%

2. Sally is a participant in her company’s profit sharing 401(k). The plan uses a 2-through-6 year graded vesting schedule with a one- year eligibility requirement. Sally has been with the company 3 full years. How much of the deferral and profit-sharing account balance is vested?

A. 0%/40% C. 100%/0%
B. 40%/40% D. 100%/40%

Answer 55

D - Deferrals are always vested.

Question 56

3. Under pension plan participation rules, the client wants to adopt a plan using the most stringent service requirement. Which schedule should the client adopt?
   A. 2-year/100 percent schedule D. 2-through-6-year graded
   B. 3-year cliff E. 3-through-7-year graded
   C. 5-year cliff

Answer 56

A - The question is asking about the most stringent service requirement. All the other answers have a one year or less” service requirement. Only answer A can have a two-year service requirement. All the other answers have a one-year service requirement. Do not confuse this with the most stringent vesting requirement.

Question 57

4. The following company plan is not considered top-heavy. Which
   kind of vesting schedule can the company use (defined benefit plan) to retain employees?
   ‘ Three eligible officers (more than 5% owners) make a total of $250,000 (not $250,000 each, $250,000 in total)
   ‘ Six employees make a total of $180,000 (all eligible).
   I. Plan is top-heavy, can use 3-year cliff.
   II. Plan is not top-heavy, can use 5-year cliff.
   III. Plan is top-heavy, can use 2- to 6-year graded.
   IV. Plan is not top-heavy, can use 3- to 7-year graded.
   A. I, III C. II, IV
   B. I D. II

Answer 57

C - Since this is a DB plan, it can use the slower schedule. The information says the plan is not top- heavy. Answers I and III do not apply. They are just there to confuse you.
$250,000/$430,000* = 58.14%

*The total of the 3 officers salaries is $250,000, not each one making $250,000. Since benefits are not given just use salaries to do the calculation. All employees would have the same percentage of salary.
NOTE: The calculation was not necessary. It simply justifies why the plan is not top heavy.

Question 58

5. An older client wants to establish a pension plan for himself at age 55. He’s considering a defined benefit plan. He knows the plan will be considered top-heavy. He wants to use a vesting schedule to retain employees. What is the most restrictive schedule he can use?
   A. 3-year cliff C. 2- to 6-year graded
   B. 5-year cliff D. 3- to 7-year graded

Answer 58

C If the plan is top-heavy, he only has a choice of Answer A or C. With Answer C, employees will be convinced that it is economically desirable to delay a job change until they become fully vested. When the word retained” appears use a graded schedule for the exam.

Question 59

Susan wants to establish a qualified plan to retain employees. Susan’s, Inc. has the following census as of 12/31/2014.
Employee DOB DOH Ownership Compensation
1 Susan 5/8/71 6/1/00 100% $270,000
2 Frost 2/16/59 6/1/00 -0- $120,000
3 Louis 9/12/67 8/1/05 -0- $48,000
4 Johnson 4/15/85 2/1/07 -0- $35,000
5 Ripley 12/7/89 10/1/08 -0- $32,000
6 Sidney 10/23/9 06/1/08 -0- 29,000
7 Hansen 5/17/92 4/1/08 -0- 25,000
8 Budd 6/12/94 12/1/12 -0- 18,000
9 Davidson 12/7/91 8/1/13 -0- 15,000
$592,000
1. Assume Susan’s proposed plan uses a graded vesting schedule.
Which employees may be excluded (for the year 2014) because of the failure to satisfy statutory participation requirements?
A. All employees are excluded except for Susan and Frost.
B. Only Davidson is excluded.
C. Davidson and Budd are excluded.
D. Davidson, Budd, and Sidney are excluded.
E. No employees are excluded; all employees must be eligible for a new plan, so it is not discriminatory.

Answer 59

C - Budd is excluded due to age (19), and Davidson is excluded due to service (less than one year).

Question 60

Susan wants to establish a qualified plan to retain employees. Susan’s, Inc. has the following census as of 12/31/2014.
Employee DOB DOH Ownership Compensation
1 Susan 5/8/71 6/1/00 100% $270,000
2 Frost 2/16/59 6/1/00 -0- $120,000
3 Louis 9/12/67 8/1/05 -0- $48,000
4 Johnson 4/15/85 2/1/07 -0- $35,000
5 Ripley 12/7/89 10/1/08 -0- $32,000
6 Sidney 10/23/906/1/08 -0- 29,000
7 Hansen 5/17/92 4/1/08 -0- 25,000
8 Budd 6/12/94 12/1/12 -0- 18,000
9 Davidson 12/7/91 8/1/13 -0- 15,000
$592,000
2. Assume that a 10% money purchase plan was adopted and installed before 12/31/14 and that Susan’s Inc. makes its initial contribution to the plan in December, 2014. Will the qualified plan be considered top-heavy in the first year (year 2014)?
A. Yes, 43% of benefits accrue to the key employee.
B. No, only 47% of benefits accrue to the key employee.
C. Yes, 68% of benefits accrue to the key employee.
D. Yes, the plan will not pass the ratio percentage test.
E. Yes, the plan will not pass the average benefit test.

Answer 60

B - Susan’s comp. = ($260,000)* = 47%

Eligible comp.

$260,000 + 289,000**

• $270,000 is $10,000 over the salary cap for 2014.
• • Budd’s $18,000 and Davidson’s $15,000 are not included.

Note: Frost is not a key employee.
NOTE: The account balances at year end would be 10% of the compensation. To simplify the calculation use compensation to calculate the key employee rule. Frost is a highly compensated employee but not a key employee. B - Susan’s comp. = ($260,000)* = 47%

Eligible comp.

$260,000 + 289,000**

• $270,000 is $10,000 over the salary cap for 2014.
• • Budd’s $18,000 and Davidson’s $15,000 are not included.

Note: Frost is not a key employee.
NOTE: The account balances at year end would be 10% of the compensation. To simplify the calculation use compensation to calculate the key employee rule. Frost is a highly compensated employee but not a key employee.

Question 61

Susan wants to establish a qualified plan to retain employees. Susan’s, Inc. has the following census as of 12/31/2014.
Employee DOB DOH Ownership Compensation
1 Susan 5/8/71 6/1/00 100% $270,000
2 Frost 2/16/59 6/1/00 -0- $120,000
3 Louis 9/12/67 8/1/05 -0- $48,000
4 Johnson 4/15/85 2/1/07 -0- $35,000
5 Ripley 12/7/89 10/1/08 -0- $32,000
6 Sidney 10/23/906/1/08 -0- 29,000
7 Hansen 5/17/92 4/1/08 -0- 25,000
8 Budd 6/12/94 12/1/12 -0- 18,000
9 Davidson 12/7/91 8/1/13 -0- 15,000
$592,000
Assume that a money purchase (DC) plan was adopted.
Which of the following vesting schedules would Susan probably use?

A. 3-year cliff C. 2- to 6-year graded
B. 5-year cliff D. 3- to 7-year graded

Answer 61

C Since there is no employer matching, she would probably use the slower schedule to retain employees. All DC plans must use a faster schedule. I think this is the most appropriate schedule for Susan’s, Inc. to use. Only non-top heavy defined benefit plans can use Answers B and D.

Question 62

ABC has a 401(k) plan with the following census as of 12/31/14.
Emp. Officer DOB DOH Owner Compensation Hrs. worked
1 Mr.A Yes 7/12/65 10/1/02 50% $80,000 2080
2 Mrs.A Yes 8/2/69 10/1/02 -0- 39,000 2080
3 Mr.B Yes 9/20/69 10/1/02 50% 80,000 2080
4 Mrs.B Yes 10/8/73 10/1/02 -0- 39,000 2080
5 Gus No 9/1/63 7/3/05 -0- 4,000 520
6 Mel No 11/7/61 2/1/07 -0- 6,000 750
7 Sally No 1/10/83 6/2/09 -0- 32,000 2080
8 Ray No 2/7/88 8/4/11 -0- 30,000 2080
9 Tim No 3/14/91 4/2/13 -0- 30,000 2080
10 Randy No 1/28/94 12/19/13-0- 28,000 2081
11 Jane No 1/28/92 7/15/14 -0- 22,000 1120
$390,000

1. Which of the following employees are ineligible to participate using the 21-and-one rule for the year 2014?

I. Gus III. Tim V. Jane
II. Mel IV. Randy

A. All of the above C. II, IV
E. III, IV B. I, III, V
D. I, II, IV, V

Answer 62

D - Gus and Mel worked fewer than 1000 hours. Randy is under 21, and Jane has less than one-half year of service.
D - Gus and Mel worked fewer than 1000 hours. Randy is under 21, and Jane has less than one-half year of service.

Question 63

ABC has a 401(k) plan with the following census as of 12/31/14.
Emp. Officer DOB DOH Owner Compensation Hrs. worked
1 Mr.A Yes 7/12/65 10/1/02 50% $80,000 2080
2 Mrs.A Yes 8/2/69 10/1/02 -0- 39,000 2080
3 Mr.B Yes 9/20/69 10/1/02 50% 80,000 2080
4 Mrs.B Yes 10/8/73 10/1/02 -0- 39,000 2080
5 Gus No 9/1/63 7/3/05 -0- 4,000 520
6 Mel No 11/7/61 2/1/07 -0- 6,000 750
7 Sally No 1/10/83 6/2/09 -0- 32,000 2080
8 Ray No 2/7/88 8/4/11 -0- 30,000 2080
9 Tim No 3/14/91 4/2/13 -0- 30,000 2080
10 Randy No 1/28/94 12/19/13-0- 28,000 2081
11 Jane No 1/28/92 7/15/14 -0- 22,000 1120
$390,000
2. Is the plan top-heavy?
A. Yes B. No
ABC has a 401(k) plan with the following census as of 12/31/14.
Emp. Officer DOB DOH Owner Compensation Hrs. worked
1 Mr.A Yes 7/12/65 10/1/02 50% $80,000 2080
2 Mrs.A Yes 8/2/69 10/1/02 -0- 39,000 2080
3 Mr.B Yes 9/20/69 10/1/02 50% 80,000 2080
4 Mrs.B Yes 10/8/73 10/1/02 -0- 39,000 2080
5 Gus No 9/1/63 7/3/05 -0- 4,000 520
6 Mel No 11/7/61 2/1/07 -0- 6,000 750
7 Sally No 1/10/83 6/2/09 -0- 32,000 2080
8 Ray No 2/7/88 8/4/11 -0- 30,000 2080
9 Tim No 3/14/91 4/2/13 -0- 30,000 2080
10 Randy No 1/28/94 12/19/13-0- 28,000 2081
11 Jane No 1/28/92 7/15/14 -0- 22,000 1120
$390,000
2. Is the plan top-heavy?
A. Yes B. No

Answer 63

A An individual is considered to own stock in a corporation owned directly or indirectly by his/her spouse (ownership attribution to the wives).
$80,000(A) + 80,000(B) + 78,000 (two wives) = 72%
$330,000 (from $390,000 ‘ 60,000*)
Gus, Mel, Randy, and Jane’s salaries A An individual is considered to own stock in a corporation owned directly or indirectly by his/her spouse (ownership attribution to the wives).
$80,000(A) + 80,000(B) + 78,000 (two wives) = 72%
$330,000 (from $390,000 ‘ 60,000)
*Gus, Mel, Randy, and Jane’s salaries

Question 64

ABC has a 401(k) plan with the following census as of 12/31/14.
Emp. Officer DOB DOH Owner Compensation Hrs. worked
1 Mr.A Yes 7/12/65 10/1/02 50% $80,000 2080
2 Mrs.A Yes 8/2/69 10/1/02 -0- 39,000 2080
3 Mr.B Yes 9/20/69 10/1/02 50% 80,000 2080
4 Mrs.B Yes 10/8/73 10/1/02 -0- 39,000 2080
5 Gus No 9/1/63 7/3/05 -0- 4,000 520
6 Mel No 11/7/61 2/1/07 -0- 6,000 750
7 Sally No 1/10/83 6/2/09 -0- 32,000 2080
8 Ray No 2/7/88 8/4/11 -0- 30,000 2080
9 Tim No 3/14/91 4/2/13 -0- 30,000 2080
10 Randy No 1/28/94 12/19/13-0- 28,000 2081
11 Jane No 1/28/92 7/15/14 -0- 22,000 1120
$390,000

3. What would be the most appropriate vesting schedule?

A. 2- to 6-year graded C. 3-year cliff
B. 3- to 7-year graded D. 2-year cliff

Answer 64

A - Only the faster schedules are available for DC plans. Generally a graded schedule helps keep employees. After three years (cliff) the employee is 100% vested.

Question 65

ABC has a plan where the NHCE’s average deferral is 4%. Under ADP/ACP what is the maximum amount that Hal, age 49 owner and only (HCE), can defer if he earns $300,000 in 2013?

A. $15,000 C. $17,000 E. $23,000
B. $15,600 D. $17,500

Answer 65

B Using test #2, $260,000 x 6% = $15,600 (4% + 2% = 6%).

Question 66

If Hal, from the question above, were age 50, what would have been the maximum amount he could have contributed in 2014?

A. $15,000 C. $17,500 E. $23,000
B. $15,600 D. $21,100

Answer 66

D - $15,300 plus $5,500 catch-up contribution

Question 67

1. Dr. Adams and Dr. Walters enter into an equal partnership for the practice of medicine. The partnership then forms a separate service organization to provide all support services for the
   medical practice. The service organization will employ all of the support employees. Each of the doctors would own 50% of the service organization. The doctors wish to adopt a qualifying plan covering only themselves and none of the regular employees. Which of the following rules would eliminate this type of planning?
   A. Personal service corporation (PSC) rules
   B. Affiliated service group rules
   C. Parent-subsidiary rules
   D. Leased employee rules

Answer 67

B - This is an affiliated service group. It is neither a parent-subsidiary nor a personal service corporation (no mention of a corporation).

Question 68

2. Mr. Land owns Land, Inc. Land, Inc. has a 25% money purchase plan. Mr. Land gets a $52,000 annual contribution. Land, Inc. recently purchased 90% of another corporation. Can Mr. Land install another defined contribution plan at the second corporation and benefit from it?
   A. No. This is a parent-subsidiary corporation, and annual additions are limited to $52,000.
   B. No. This is a brother-sister controlled group, and annual additions are limited to $52,000.
   C. Yes. This is an unrelated corporation, and Mr. Land can have a second plan up to the annual additions based on his compensation from the second corporation.

Answer 68

A - Land, Inc. (parent company) owns >80% of second company. This is a parent-subsidiary relationship.

Question 69

If ADAM, Inc. installs a DB plan with a base of 24.25%, how much will the excess percentage be?

A. 24.25% C.48.50%
B. 26.25% D.50.50%

Answer 69

C - The permitted disparity is the lesser of the base benefit percentage or 26.25%. 24.25% + 24.25% = 48.50%

Question 70

1. What is the permitted maximum disparity allowed with an integrated money purchase plan?

A. 5.7% C. 7.65%
B. 6% D. 26.25%

Answer 70

A - It is the lesser of the base or 5.7%.

Question 71

2. What is the permitted disparity if the base contribution is 5%? A. 5% C. 7.65%
   B. 5.7% D. 10.7%

Answer 71

A 5% + 5% = 10%

Question 72

3. Which of the following is false concerning the profit-sharing allocation formula?
   A. May allocate contributions on a pro-rata basis
   B. Must be definite and predetermined
   C. May discriminate in favor of highly compensated employees
   D. May skew contributions to participants

Answer 72

B Contributions do not need to be allocated on a pro-rata basis and may be skewed to older participants through allocation methods such as Social Security integration, age-weighting, or cross-testing. Answer D is true. Nevertheless, even these methods must not be discriminatory. Answer B is false because the profit-sharing allocation is flexible and is not determined until year end.

Question 73

1. Kathy Overachiever works for ABC, Inc. Her salary is $200,000 and ABC has a money purchase plan that contributes 20% to her account each year. Kathy is age 50, and is single. She only has $440,000 in her money purchase plan. She wants to retire in 10 years. She projects that there should be about $1 million in her account at age 60 providing about a $50,000 ‘ 60,000 payout over her life expectancy. She feels that will not be enough. Another company (XYZ) approached her to work part-time for them (20 hours per week). They promised her $100 per hour or approximately $100,000 per year. If XYZ has a 20% profit sharing plan, can she participate?
   A. Yes, if ABC and XYZ are not a controlled group. She can get a contribution of $20,000.
   B. Yes, if ABC and XYZ are not a controlled group. She can get a contribution of $11,000 ($51,000 max).
   C. No, she is not considered a full-time employee.
   D. No, ABC and XYZ an affiliated service group.

Answer 73

A There is nothing to indicate that ABC and XYZ are a controlled group. 1,000 hours a year qualifies her under ERISA as a year of service.

Question 74

2. David Youngblood is very upset. The company has a 401(k) profit sharing plan. Due to hard times the company first discontinued making a profit sharing contribution. They then stopped offering a match. Now the company informed him that he can only defer 4% of his $200,000 salary (HC). Because of this plan, he cannot make a deductible $5,500 IRA contribution (2014). In addition, due to AGI phaseout, he also cannot make a Roth IRA contribution. What happened to the plan?
   A. The company had to reduce the percentage when they stopped the match.
   B. The number of NHCEs deferring has diminished to the point that the plan does not meet coverage ADP/ACP requirements.
   C. The company decided to cap the percentage so employees would have more cash to spend without raising salaries.
   D. The company installed another plan that coordinates with the 401(k) plan.

Answer 74

B When the NHCEs do not participate the plan does not meet the coverage percentage (ratio percentage).
This is going to trigger ADP/ACP testing. Answers A, C and D are crazy, nonsense answers.

Question 75

3. Dale joined Axcel, Inc. 4 years ago. After 3 months with the company, he became eligible for the 401(k). The company does not make a match but does make a profit sharing contribution with a 1- through-5 year vesting schedule. How much of his account is vested? (ignore earnings)

Deferral
Company Contribution
1
$10,000
$15,000
2
$12,000
$20,000
3
$13,000
$12,500
4
$15,000
$22,500

A. $56,000 D. $106,000
B. $92,000 C. $96,000
E. $120,000

Answer 75

D - First the deferrals are never subject to vesting ($50,000 deferral total). Second the company contribution ($70,000) are 80% vested:
Year 1 20%; Year 2 40%; Year 3 60%; Year 4 80%

$70,000 x 80% = $56,000

$50,000 + $56,000 = $106,000

Question 76

4. Bert, age 50, is a participant in his company’s 401(k) profit sharing plan. He usually contributes $17,500 and the company’s usual contribution is 10% of his salary of $120,000 or $12,000. To get more money in his plan, he is going to do the $5,500 catch-up. He has asked you how this will affect his deferral or the company contribution?
   A. It will not affect either the deferral or the company contribution.
   B. It will reduce his deferral by $5,500.
   C. It will reduce his salary by $5,500 and his profit sharing contribution to $114,500 at 10%.
   D. He will be capped by $52,000.

Answer 76

A Catch-up contributions do not affect deferrals, company contributions or the $52,000 maximum contribution.

Question 77

Darlene earned $140,000 as a computer programmer last year. She is employed by Computerland, Inc. Due to very high turnover last year (prompted by merger talks), Darlene should have received a forfeiture contribution that would have caused her annual additions to exceed the 415 limit. What are her employer’s options regarding the excess forfeiture amount?
I. The excess may be reallocated to those participants who have not reached their 415 limit.
II. The excess may be held in a suspense account and reallocated in a subsequent year to the participant who had the excess (Darlene).
III. The excess may be used by employer to reduce future plan contributions.
IV. The employer may remove the excess forfeiture amount from the plan.
A. I, II, III C. II, III, IV
B. I, III, IV D. All of the above

Answer 77

A - Plan assets must be used for the exclusive benefit of the participants and their beneficiaries.

Question 78

1. Arnold’s compensation is $120,000. He is 45 years old and is not an officer or owner. His employer makes a 10% money purchase contribution, a 10% profit-sharing contribution, and Arnold defers $17,500 into the 401(k) plan that matches $0.50/$1 up to 5% of compensation. In addition, he’ll receive $8,500 in forfeitures. How much will Arnold actually receive in his account?
   A. $51,000 C. $53,000
   B. $52,000 D. $44,500 because he is not eligible to receive any forfeitures

Answer 78

B - He can receive up to the 415 annual addition limit ($52,000). However, the excess forfeiture ($1,000) cannot be applied to his account this year (see question on page 5-1). Furthermore, any of the other types of contributions are also limited for those participants whose annual additions would exceed the 415 limit.
MP ‘ $12,000
PS ‘ $12,000
Deferral ‘ $17,500 120,000 x 5% x ? ‘ $ 3,000
Forfeitures ‘ $ 7,500
$52,000

Question 79

3. The owner of a company, age 30, earns $210,000. How large a deferral can be made to a 401(k) with no employer match and a 15% contribution to a profit-sharing plan for 2013?

A. $17,000 C. $20,500 E. $52,000
B. $17,500 D. $23,000

Answer 79

B The Section 415 limit is $52,000. If the company contributes can defer a 15% of $210,000 ($31,500), the owner maximum of $17,500. The answer cannot defer $20,500.

Question 80

1. Matt’s salary is $150,000. He defers $9,000 into a 401(k) plan and $6,000 into a Section 125 plan. If his employer makes a 10% profit-sharing plan contribution, how much would be contributed to his account?

A. $13,500 C. $15,000
B. $14,400 D. $24,000

Answer 80

C - 10% of $150,000 (Contribution is based on pre- deferral salary.) His salary is not reduced by the deferrals ($9,000 and $6,000). Contributions are by the employer. Deferrals are made by the employee.

Question 81

2. A defined contribution plan or defined benefit plan can’t define compensation to include or exclude which of the following?
   A. Overtime
   B. Bonuses
   C. Compensation that exceeds $260,000 (2014)
   D. Nonrecurring compensation (e.g. one-time bonus, etc.)

Answer 81

C Compensation that exceeds $260,000 (2014) cannot be included. It must be excluded. The rest may be included or excluded providing the definition of compensation is not discriminatory.

Question 82

3. Victoria Sanderson, an outside director of a publicly traded corporation, receives a $75,000 fee for her services as a director. She wants to shelter as much of her director’s fees as possible. What do you tell her?
   I. As a director, she is not eligible to establish a qualified retirement plan because no employer/employee relationship exists between her and the corporation.
   II. She is eligible to fund an IRA because director fees are earned income.
   A. I C. I, II
   B. II D. Neither I or II

Answer 82

B An outside director (an individual that is not an employee of the corporation for which he or she is a director) may establish a qualified retirement plan on the basis of director fees. Board of Director fees qualify as compensation.

Question 83

4. If Victoria does a qualified plan, can she do a deductible IRA based on the information in the prior question?
   A. Yes if she is single
   B. Yes if she is married
   C. Answers A and B are correct.

Answer 83

C The phaseout for single is $60,000 - $70,000 and
$96,000 - $116,000 for married (2014). With only the director’s fees shown she could contribute 25% ($18,750). $75,000 ‘ 18,750 is less than $60,000 (phaseout).

Question 84

1. George is the sole proprietor of George’s Plumbing. He has established a 25% money purchase plan. In the current year, his business will produce $50,000 of net earnings. How much can
   he contribute to his Keogh plan?
   A. $9,235 +/- $1 C. $10,000 +/- $1
   B. $9,294 +/- $1 D. $12,500 +/- $1

Answer 84

B $50,000 minus $3,532 ($50,000 x 92.35% x .0765) times 20% (owner-employee contribution) equals
$9,294 or use shortcut $50,000 x .1859 = $9,295

Question 85

2. Which of the following is/are true about net earnings?
   I. Net earnings are determined after taking into account all appropriate business deductions, including the deduction for the employee only retirement contribution.
   II. The self-employed person’s contribution or benefit is based on net earnings.
   A. I only C. Both I and II
   B. II only D. Neither I nor II

Answer 85

C Both statements are true.

Question 86

An employer can make contributions to a profit-sharing plan whether or not there are profits. However, what are the contributions subject to?
I. A substantial and recurring requirement
II. A minimum funding requirement
A. I only C. Both I and II
B. II only D. Neither I nor II

Answer 86

A - Pension plans (DB, CB, MP, and TB) are subject to a stringent minimum funding standard whereas profit- sharing plans are subject to a more flexible standard. Contributions only need to be substantial and recurring.

Question 87

1. Plan loans are not allowed in which of the following type of plans?
   A. Target benefit plan C. SAR-SEP
   B. Defined benefit plan D. ESOP

Answer 87

C SEPs, SIMPLEs, and IRAs are prohibited from having loan provisions. All qualified plans may have loan provisions although defined benefit, ESOP, and stock bonus plans seldom do.

Question 88

2. Plan loans that are made available to plan participants must be which of the following?
   I. Available to all participants on a reasonably equivalent basis and must not be available to non-highly compensated employees in an amount greater than the amount made available to other employees
   II. Adequately secured and bear a reasonable (market) rate of interest
   A. I only C. Both I and II
   B. II only D. Neither I nor II

Answer 88

B - Loans must be available to all participants on a reasonably equivalent basis and must not be available to HIGHLY compensated employees (HCEs) in an amount greater than the amount made available to other employees. Discrimination against HCEs is always safe, but discrimination against the NHCEs is not.

Question 89

3. Which of the following is true about loans from 403(b) plans?
   A. They are not allowed (not a qualified plan).
   B. The loans don’t have to be adequately secured.
   C. Interest deductions are prohibited if the loan on the plan is secured by amounts attributable to salary reductions.
   D. There are no limits on the amount each participant can borrow (not a qualified plan).

Answer 89

C They are allowed; they have to be adequately secured, and limits apply ($50,000, etc.). Secured by what? The loan can be secured by the plan assets or if the loan was used to purchase a home, then it could be secured by the home.

Question 90

4. Mr. A owns AB, Inc. with Mr. B. Mrs. A also works for AB, Inc. If Mr. A defers $17,500 and AB, Inc. contributes $33,000 to his account, can Mrs. A defer and get a company contribution under the attribution rules?
   A. She can only defer but she cannot get a company contribution.
   B. She cannot defer because her husband has deferred the maximum, but she can get a company contribution.
   C. She can both defer and get a company contribution.

Answer 90

C - The attribution rules only affect whether a plan is top heavy or not. There are no limitations when both spouses work for the same company.

Question 91

1. Tom Jones owns TJ, Inc. He works alone. He has become successful at age 50 doing specialized projects for large companies on a fee basis. His salary ranges between $300,000 to
   $500,000. He normally retains $25,000 in excess earnings in TJ, Inc. each year and has accumulated $150,000 in retained earnings (in a money market account). What is the maximum the company can contribute for him if adopts a profit sharing plan?
   A. The 415 limit B. 25% of salary
   C. 18.59% of salary D. 25% of excess earning E. $25,000

Answer 91

A The 415 limit. He is not self-employed, he owns a corporation. In 2014, the amount would be $52,000 under 415. But you say where would the money come from? He would reduce his salary or use retained earnings.

Question 92

2. Debra Hammer owns an S corporation. She takes a salary of
   $2,000 per month and usually the corporation has additional earnings of $200,000. Her basis in the corporation is zero, so her K-1 usually reflects an additional $200,000 of unearned income. She wants to establish a money purchase plan for herself to put the maximum away. How much can the corporation contribute?
   A. $6,000
   B. $24,000
   C. $52,000
   D. We do not know her age to determine if she can get $29,000 plus $5,500 catch up.

Answer 92

A The definition of compensation is salary. The K- 1 income is unearned income. She is limited to compensation. Under 415, she can get up to 100% of compensation. However, under 404 she can only get 25% or $6,000. There are no other employees that would allow her to get Answer B. Remember in the overall, the plan cannot exceed 25%. There is no mention of employees; therefore, there are no employees.

Question 93

3. Jerry Knight works for two unrelated companies. It is not easy both need his specialized services. He usually works for one or the other 30 plus hours per week. He enrolled in both of their SIMPLE plans and defers the maximum. His salary ranges between
   $125,000 to $150,000 in total for both companies. How much can he defer to the SIMPLE plans?

A. $12,000 in total B. $12,000 plus catch-up of $2,500 in total
C. $12,000 plus 3% of salary in total D. $17,500
E. $29,500

Answer 93

A - Deferrals are in the aggregate. There is nothing to indicate his age. When no age is given you cannot use catch-up.

Question 94

4. Stan White is an insurance salesman. He is self-employed. He has no other employees working for him. He usually has gross income of $140,000 and regular business expenses of $20,000. To get much of his business he joined various organizations. His entertainment expenses are another $40,000. If he sets up a maximum profit sharing plan how much can he contribute to the plan?
   A. $18,590 C. $26,026
   B. $25,000 D. $35,000

Answer 94

A - You must first calculate his net income.

Question 95

Which of the following income sources can be used to determine the amount of deductible IRA contribution allowed?
I. S corporation distributions
II. Deferred compensation (informal funding)
III. Professional fees
IV. Board of director fees
V. Alimony received under a divorce settlement
A. All of the above C. III, IV, V E. IV
B. II, III, IV D. III, IV

Answer 95

C - S corporation distributions are unearned income (K-1 distributions). Informal funded deferred
compensation is not constructively received. It is not income until it is constructively received.

Question 96

John, an employee of ABC, Inc., is concerned because he has not received an annual addition to the ABC profit-sharing plan for the past two years. John, who makes $100,000 per year, is age 40 and married. Which of the following is/are true?
I. All defined contribution plans are subject to minimum funding rules.
II. He cannot contribute to an IRA because he is an active participant” in an employer plan.
III. He can make a deductible contribution of $5500 to an IRA.
IV. He can make a deductible contribution of up to $11000 using a spousal IRA.
V. He can make a deductible IRA contribution because ABC hasn’t made contributions to the profit-sharing plan.
A. I II C. III, IV, V E. III
B. II D. III, IV

Answer 96

D If ABC, Inc. does not make a contribution to a profit- sharing plan in a given year, John is not considered an active plan participant although he is covered under the plan. This is true as long as there were no annual additions” made to the employee’s account under the plan. Answer V says contributions not annual additions that makes Answer V incorrect. Money purchase and defined benefit plans are subject to minimum funding rules but profit-sharing plans are not subject to minimum funding rules(Answer I).

Question 97

Indicate whether each of the following taxpayers is entitled to a full (F), a partial (P), or a spousal only (S) deduction for a $5,000 contribution made to an IRA. NOTE: All individuals are under age 50. 1. A single individual, AGI $75,000, not an active participant in an employer-sponsored qualified retirement plan 2. A single individual, AGI $65,000, an active participant in an employer-sponsored qualified retirement plan but not yet vested 3. A married couple filing jointly, AGI $189,000 combined, neither spouse actively participating in an employer- sponsored qualified retirement plan 4. A married couple filing jointly, AGI $105,000 combined, Both spouses actively participating in an employer- sponsored qualified retirement plan 5. A married couple filing jointly, AGI $116,000 combined, spouse A” actively participating in an employer-sponsored qualified retirement plan while spouse “B” is not covered by an employer-sponsored qualified retirement plan “

Answer 97

Question 1 - F (not participating) Question 2 - P (in phaseout $60,000 - $670,000) Question 3 - F (neither participating) Question 4 - P (both spouses in phaseout) Question 5 - S (spouse B” only spouse “A” phased out $96000 - $116000) NOTE: Spouse A could do a nondeductible IRA.

Question 98

Which of the following IRA distributions is exempt from the 10% early withdrawal penalty? I. Hardship withdrawal II. First home acquisition cost of $10,000 III. Qualified loan of $10,000 for first home IV. Qualified education cost for participant’s child V. Separation from service at age 55
A. I, II, III, IV, V B. II, III, IV D. III, IV
C. II, III E. II, IV

Answer 98

E First home purchase and qualified educational cost are exempt. Hardship withdrawals are in 401(k)s; loans and separation from service apply to qualified plans. IRA loans are not allowed.

Question 99

Ken, who has an opportunity to make a quick 50% return on his money, is strapped for cash. He has $30,000 in his IRA. He doesn’t feel the 60-day window is a long enough time period, so he takes a $15,000 collateralized loan. He pledges his whole IRA for the loan. Which of the following is true?
A. As long as the term wasn’t greater than 5 years and the amount less than ? of the account, this is an allowable transaction.
B. Ken faces a 10% penalty and income tax on the $15,000 collateralized loan.
C. The loan, if made at a reasonable interest rate and adequately secured, would be an allowable transaction.
D. This is considered a prohibited transaction, and it results in a loss of IRA status on the whole account.

Answer 99

D Answer B would be correct if the question indicated that he only pledged $15,000 of the account balance.

Question 100

Paul and Mary, married filing jointly, have an AGI of $117,000. Mary participates in a 401(k) plan at work. Paul does not. Which of the following are true?
I. Both Paul and Mary can do Roth IRAs.
II. Only Paul can do a Roth IRA.
III. Only Mary can do a Roth IRA.
IV. Only Paul can do a deductible IRA.
V. Both Paul and Mary can do deductible IRAs.

A. I, II, V C. I, IV
B. II, IV D. III, V

Answer 100

C Their AGI limit is below $181,000. Paul can fund a deductible IRA; Mary can’t above $117,000, and both Paul and Mary can fund Roth IRAs.

Question 101

Mrs. Teal, age 66, plans to retire soon. She currently makes
$140,000 per year and has approximately $800,000 in her account in the company’s profit-sharing 401(k) plan. She has substantial non- qualified assets. (Her husband died, leaving her well off.) She is concerned about RMD requirements in a few years. What would you suggest she do with her 401(k) account to avoid RMD requirements?
A. Leave the money in the 401(k) plan after retirement
B. After retirement, roll the 401(k) money into an IRA and then do some careful tax planning to do a conversion Roth IRA
C. After retirement, roll the 401(k) money into an IRA and then immediately roll it into a Roth IRA
D. After retirement, use distributions from the 401(k) to buy an annuity
E. After retirement, roll the 401(k) money into a Roth IRA

Answer 101

B The rollover (conversion) can be directly from the 401(k) to the Roth (Answer E). If she retires soon, she will have 3-4 years (depending on 70?) to do careful tax planning. Answer B is a better answer.

Question 102

1. Which of the following IRAs are not subject to required minimum distribution rules? NOTE: RBD means required beginning date
   I. A Roth IRA
   II. A Roth inherited by a spouse rolled into his/her own Roth IRA
   III. A Roth inherited by a child of the owner (death before RBD)
   IV. A Roth inherited by a child of the owner (death after RBD)
   A. I, II, III C. I, II
   B. I, II, IV D. III, IV

Answer 102

C Only a Roth and a Roth inherited by a spouse are not subject to RMD rules.

Question 103

2. In 2004, Beth age 52 deposited $2,000 in her Roth IRA. In 2004 she also converted her $20,000 IRA to her Roth IRA. In 2005 she contributed $2,000 to the Roth. The account currently is worth
   $40,000. What happens if she withdraws the whole $40,000 today?
   A. $36,000 is subject to income tax and a 10% penalty.
   B. $16,000 is subject to income tax and a 10% penalty.
   C. $16,000 is subject a 10% penalty.
   D. The withdrawal is tax-free.

Answer 103

D In January 2004 Beth was age 52. She has attained age 61 in 2014 and meets the five-year holding period. The contribution ($4,000), the conversion funds($20,000), and the earnings ($16,000) are tax-free.

Question 104

Patrick, age 44, and his wife Janet, age 34, have an AGI of $83,000. Patrick works for Y2, Inc. The company has a 401(k) plan. Patrick is contributing 6% (the maximum allowable) of $100,000 to the 401(k), and the company matches 50%. Patrick and Janet have a traditional IRAs (contributing $5,500 each per year) with $100,000 in them.
Janet is a stay-at-home mom, and they have two children (ages 9 and 7). They would like to retire by age 62.
1. If Patrick wants to roll his traditional IRA into a Roth IRA, which of these statements is correct?
A. Patrick cannot roll his traditional IRA into a Roth IRA because of his income and current 401(k) plan.
B. Patrick can roll his traditional IRA into a Roth IRA, but he will have to pay a penalty and federal tax.
C. If Patrick uses the converted Roth for the post-secondary education of his children, he will have to pay ordinary income tax from the distributions (on earnings only).
D. Patrick must take distributions from the conversion Roth after age 70-1/2 because he converted it before age 50.

Answer 104

C

There are no income restrictions. Patrick can roll his traditional IRA into a Roth. If he does roll (Answer B), he will have to pay regular income tax (federal tax) but no penalty. Patrick does not have to take distributions from the Roth at any age (Answer D). He may have to pay income tax on the earning he withdraws for educational needs, but the conversion distributions will be tax-free (already paid tax). See page 6-7 (remaining special provisions) Answer C is the best answer.

Question 105

Patrick, age 44, and his wife Janet, age 34, have an AGI of $83,000. Patrick works for Y2, Inc. The company has a 401(k) plan. Patrick is contributing 6% (the maximum allowable) of $100,000 to the 401(k), and the company matches 50%. Patrick and Janet have a traditional IRAs (contributing $5,500 each per year) with $100,000 in them.
Janet is a stay-at-home mom, and they have two children (ages 9 and 7). They would like to retire by age 62.2. Patrick and Janet want to save an additional $2,000 per year for retirement. They would like to save in the most tax-advantaged way. What would you advise them to do?
A. Patrick and Janet should dollar cost average into a small cap growth fund over the next 18 years.
B. Patrick should increase his contribution to the Y2, Inc. 401(k) plan.
C. Patrick should purchase a variable annuity.
D. Janet should open a traditional IRA.

Answer 105

C Answer A might be the best answer if the small cap did not pay any yearly gain. It did not say that. Then fund distributions at retirement would be subject to LTCG in excess of basis. Answer B is wrong because he is contributing the maximum allowed. Answer D is wrong because they are already contributing $5,500 each to traditional IRAs. Answer C would give them tax- deferred growth until retirement. Then the distributions would be based on the annuity income distribution rules.

Question 106

1. A participant can roll over his/her Roth 401(k) account to which of the following?
   I. Traditional IRA
   II. 401(k) plan with Roth 401(k) option
   III.Governmental 457 plan with 457(b)option
   IV. 403(b) plan with Roth 403(b) option
   V. Other qualified plan without Roth 401(k) option
   A. I, II, III, IV C. I, III, V
   B. II, III, IV D. II, IV

Answer 106

B A participant cannot roll over his/her Roth 401(k) account to a traditional IRA, a governmental 457, or any type of qualified plan without a Roth 401(k) type option. Answers II, III, and IV have Roth 401(k) type options. A participant can roll over his/her Roth 401(k), Roth 403(b) or Roth 457(b) account to Roth IRA, but that option is not given in this question.

Question 107

2. Lauren is considering deferring some of her salary into her employer’s 401(k) plan in 2014. She is 52 years old and expects to make $100,000 this year. Her employer’s plan will be
   adding a Roth 401(k) feature to the existing plan. She is looking to you for information and advice on contributing to a Roth 401(k) account. What do you tell her?
   I. She can defer up to $23,000 into her regular 401(k) account or her Roth 401(k) account but cannot contribute $23,000 to both.
   II. She can contribute $6,500 to a Roth IRA even though she will be an active participant in her employer’s Roth 401(k) plan.
   III. Her employer can make a Roth matching contribution (after- tax).
   IV. Her active participation will prevent her from contributing to a Roth IRA and a deductible IRA.

A. All of the above C. II, III
B. I, II D. IV

Answer 107

B She is 52 in 2014. She can fund a $5,500 catch-up in her 401(k) ‘ Roth or regular ‘ in 2014. Her Roth IRA contribution will begin to be phased out at $114,000. In 2014, the Roth contribution limit is $5,500, but the catch-up amount is $1,000. Employers may match on Roth 401(k) deferrals, but the match must be in pre-tax dollars. Her active participation will prevent her from doing a deductible IRA only. She can do a Roth IRA that makes Answer IV incorrect.

Question 108

1. Larry Booth, age 65, is single.  He walks into your office.  He wants to make a simple investment of $5,500.  You find out his AGI is $80,000.  What would you tell him he could do?
I. A deductible IRA
II. A non-deductible IRA
III. A Roth IRA
IV. Purchase a mutual fund
A. I, III, IV	D.  II, III
B. I, III	E.  IV
C. II, III, IV

Answer 108

E - He does not state he has compensation. AGI is not compensation. To do an IRA, he must have compensation.

Question 109

2. Tom Terrific owns T2, Inc. and makes $1,000,000. T2 has about
   100 employees. Tom is divorced, age 55. How much can he contributed to a deductible IRA?
   A. $0 D. $11,000
   B. $5,500 E. $13,000 C. $6,500

Answer 109

C There is nothing to indicate T2 has a retirement plan. No retirement plan, no AGI phaseout. He is over 50, so he gets $1,000 catch-up plus $5,500.

Question 110

3. Harry Baker, age 72, continues to work at XYZ, Inc.  His salary is $100,000.  XYZ has a profit sharing 401(k) and he is still a participant. Harry's wife died 3 years ago, age 69. He has started taking distributions from her IRA.  His AGI due to additional 1099s he receives is $150,000.  Which of the following is an allowable contribution?
A. A deductible IRA
B. A non-deductible IRA
C. A Roth IRA
D. A Contribution to his wife's IRA
E. None of the above

Answer 110

E Age rules out Answer A and B. AGI rules out Answer C (AGI = $150,000). No, he cannot do Answer D; his wife died.

Question 111

4. Sue, age 55, is doing everything she can to fund for retirement. Sue went through a messy divorce in which attorney fees and court action consumed much of their assets. The company she works for has a Roth 401(k) and she is contributing $23,000. If the company does a 3% match on her $200,000 salary. Which of the following could she do to fund for retirement?

A.$5,500 deductible IRA
B.$6,500 deductible IRA
C.$6,500 non-deductible IRA
D.$5,500 to a Roth IRA
E.$6,500 to a Roth IRA

Answer 111

C She is a participant in a retirement plan and is subject to IRA phaseout (Answer A and B). Her AGI even after subtracting $23,000 from her salary is above phaseout for a Roth. NOTE: These are the only two numbers given. That is all you can use.

Question 112

1. Which of the following statements about a SEP is false?
   A. SEP contributions cannot exceed the lesser of 25% of each participant’s eligible compensation or $52,000 (corporations only).
   B. Contributions to a SEP plan cannot exceed 20% of the self- employee’s eligible net earned income less the self- employment tax (like a Keogh).
   C. A SEP is available only to a company with up to 25 eligible employees.
   D. Most employers use Form 5305-SEP to install a SEP plan.
   E. Employer contributions to the employee’s account must be immediately vested.

Answer 112

C - Answer C refers to a SARSEP not a SEP. A SARSEP is only available to a company with up to 25 eligible employees if established prior to 1997. A corporation can contribute up to 25% of
$260,000 of compensation for each employee ($52,000). Sole proprietors and partners can contribute up to 20% of net earned income less self-employment tax like a Keogh. (see Lesson 5)

Question 113

2. Several years ago, Mrs. Wells age 55 made the following contribution to a SARSEP: $7,500 employer and $2,500 employee. She now works for a hospital. What should she do with the old SARSEP?
   A. Take a tax-free distribution.
   B. Roll it into an existing IRA, a new IRA, or a qualified plan.
   C. Roll over $7,500 into an IRA and take out $2,500 free of penalty and ordinary income tax.
   D. Take a full distribution and pay ordinary income tax.

Answer 113

B Answers A and C are wrong. SARSEP distributions are pretax money. Answer D is wrong because she’d also have to pay a 10% early distribution penalty. (She is still subject to the age 59 1/2 rules.)

Question 114

3. When is an employee able to participate in a SEP?
   A. In the current year if he/she attains age 21 by December 31st
   B. If the employee performed services for the employer in at least 3 of any 5 preceding years
   C. If the eligible employee received a minimum of $550 in the current year of employment and worked for the employer during 3 out of the 5 preceding calendar years
   D. If all of the above are met

Answer 114

C Answer A is wrong because the employee must have attained age 21 to be a participant. Answer B is wrong because the employee must have worked there for at least 3 of the immediately preceding 5 years.

Question 115

4. A simplified employee pension (SEP) does not have which of the following characteristics?
   A. Loans and hardship withdrawals are not available.
   B. Age-weighting or cross-testing is not permitted.
   C. Social Security integration is not permitted.
   D. Employer matching is not permitted.

Answer 115

C A SEP uses individual IRA accounts. Individual IRAs do not have hardship or loan provisions.
SEPs cannot be age-weighted. SEPs can be integrated with Social Security. A one-person sole proprietorship can install a SEP. It does not have to be a stand-alone plan like a SIMPLE.

Question 116

1. What is the maximum amount that a 35-year-old employee can defer to a SIMPLE plan?
   A. $ 9,000 as indexed C. $10,500
   B. $10,000 as indexed D. $11,500

Answer 116

B $10,000 as indexed ($12,000in 2014)

Question 117

2. Because a SIMPLE plan is funded with individual retirement accounts, which of the following is true?
   A. Assets can be invested in collectibles or annuities.
   B. Participant loans are allowed.
   C. Participants can invest in U.S. government gold coins.
   D. An employee is fully vested after one year of service.

Answer 117

C - Annuities may be used as a funding vehicle, but life insurance is not allowed. Collectibles cannot be used as a funding vehicle, but U.S. government gold coins are acceptable. Participant loans are never allowed. Vesting is immediate.

Question 118

3. Which of the following is true about a SIMPLE plan?
   A. The employer can have more than 100 employees who earn
   $5,000 or more.
   B. A SIMPLE can operate in tandem with a money purchase plan.
   C. A SIMPLE plan can be an IRA or a 401(k).
   D. An employer must match employee contributions.

Answer 118

C D is wrong because the employer has the option of making a (non-matching) 2% nonelective contribution to all eligible employees. The 2% contribution is not dependent on deferrals. In other words, anyone who is eligible to participate in the plan would receive the 2% contribution even if he/she were not deferring.

Question 119

4. What is the maximum deferral limit for a SIMPLE in 2014? I. $12,000
   II. Answer I can be exceeded by those who have attained age 50 (catch-up provision)

A. I C. Both I and II
B. II D. Neither I or II

Answer 119

C - A participant can be 49 and still make a catch-up deferral providing the participant will attain age 50 by December 31st of the current plan year.

Question 120

5. When using a 3% match formula, the maximum possible contribution (employer and employee combined) that can be made this year to a SIMPLE or a SIMPLE 401(k) for a 49-year-old participant earning
   $400,000 is which of the following?
   I. $24,000 for a SIMPLE when using the formula (3%)
   II. $19,650 for a SIMPLE 401(k) when using the formula (3%)
   A. I only C. Both I and II
   B. II only D. Neither I nor II

Answer 120

C Under a SIMPLE using the maximum match formula, someone under age 50 making $400,000 is capable of receiving a match of $12,000 (3% x $400,000 plus another $12,000 from deferral. Regarding SIMPLE 401(k)s, the $260,000 compensation cap applies regardless of which method of employer contribution is used ‘ match or nonelective deferral. Under a SIMPLE 401(k), the answer is $12,000 plus 3% of $260,000 ($7,800) or $19,800.

Question 121

Adam age 45 participates in his tax-exempt employer’s 403(b) plan. This year will be Adam’s sixth year of service. His salary will be
$49,000. He has contributed $50,000 over the past five years. How much can he defer this year?
A. He can defer 20% of his compensation or $9,800.
B. He can defer the annual exclusion allowance of (20% of $49,000 x 6) ‘ $50,000 = $8,800.
C. He can defer 25% of his compensation or $12,250.
D. He can defer $17,500.

Answer 121

D He can defer the lesser of $17,500 or 100% of compensation. Answer B was an old rule which as you can see was very limiting and confusing.

Question 122

1. Which of the following types of funding vehicles is not approved for 403(b) plans?
   A. Mutual fund C. Cash value life insurance
   B. Variable annuity contract D. Unit investment trust

Answer 122

D - Cash value life insurance must be an incidental benefit. Only open-end mutual funds are allowed, not UITs, closed-end funds, or individual securities.

Question 123

2. Which of the following entities may not sponsor a 403(b) program?
   A. State of Florida
   B. 501(c)(3) organizations
   C. Educational institutions of a state or political subdivision of a state
   D. A state or local government with regard to employees who perform service, directly or indirectly, for an educational organization

Answer 123

A A state or local government can be a qualified employer but only with regard to employees who perform service, directly or indirectly, for an educational organization (Answer C).

Question 124

3. Which of the following plans does not provide the same maximum deferral limit (disregard allowable catch-up)?
A. SARSEP
B. Stock bonus 401(k)
C. SIMPLE 401(k)
D. Profit sharing 401(k)

Answer 124

C - The deferral limit for Answers A, B, and D is
$17,500 (2014) plus applicable catch-up ($5,500 for age 50). A SIMPLE 401(k) has a deferral limit of $12,000 (2014) plus applicable catch-up ($2,500 for age 50).

Question 125

4. Which of the following contributions are always 100% vested to the employee?
   I. Matching contributions for SIMPLE/SIMPLE 401(k)
   II. Employer contributions for SARSEP and SEP
   A. I only C. Both I and II
   B. II only D. Neither I nor II

Answer 125

C SIMPLE, SIMPLE 401(k), SEP, and SARSEP employer contributions are always 100% vested. Employee deferrals in any type of plan also are always 100% vested.

Question 126

5. You are interested in working in the 403(b) market.  Which of the following entities is eligible to do a 403(b) plan?
I.   Private universities
II.  Non-profit hospital
III. State of Florida
IV.  Church
V.   Public school

A. All of the above D. II, IV
B. I, II, IV, V E. III
C. I, V

Answer 126

B - The State of Florida employees would be eligible for a 457 plan.

Question 127

Which of the following employers can adopt a 457 plan?

I.   Public accounting firm
II.  State government
III. Municipal government
IV   United Way
V.   A church

A. All of the above B. II, III, IV C. II, III, V
D. II, IV E. IV, V

Answer 127

B A state, city, and any agency of a state or political subdivision of a state( for example, a school system or the water authority) are eligible. Any organization that is exempt from federal income tax, except a church or a synagogue, is eligible.

Question 128

1. Larry Jones, self-employed, wants to start a retirement plan. His Schedule C net income is usually $200,000.  He is 45 years old and has no employees.  What do you suggest?
A. Keogh profit sharing plan
B. Keogh defined benefit plan
C. SEP
D. SIMPLE

Answer 128

C The Keogh profit sharing plan is subject to all The ERISA filings and requirements. The Keogh DB does not fit for his income or age. The SEP has the same contribution limits (18.59%) (see page 5-8), but is simple to install. He could contribute $37,180. The SIMPLE is a combination of deferral $12,000 plus 3% of salary $6,000 for a total of $18,000. For simplicity and contribution limits, Answer C is the best answer.

Question 129

2. Herb Littleton has just retired at age 70 in January. He worked for the State of Florida for 40 years. He is taking distributions from his 457 plan. The State of Florida wants to hire him as an independent contractor and pay him $84,000 ($7,000 a month). To do this job, he will have little or no expenses and plans to just file a Schedule C for this 1099 income. Which of the following can he do?
   I. Make contributions of 25% ($16,800 to a SEP)
   II. Make contributions of $52,000 to a SEP
   III. Make non-deductible contributions to an IRA
   IV. Make contributions of $15,615.60 to a Keogh money purchase Plan
   V. Make a $12,000 deferral and contribute $2,520 (employer) to a SIMPLE

A. I, III, IV, V D. IV, V
B. I, IV E. None of the above
C. I, V

Answer 129

D - The SEP is like a Keogh for self-employed (18.59%). He cannot do 100% of compensation for a SEP. He will be 70? this year. No IRA contributions. He can do IV (18.59%) and V (the SIMPLE) based on $84,000.

Question 130

3. Bill Richblood owns Richblood, Inc. For years, although very profitable, Bill has resisted doing a retirement plan because of all the paperwork and mandatory employer contributions. But employees are leaving to work for competitors and he feels he has to offer some kind of retirement plan to retain key employees. He has consulted various financial planners and he wants to know which one has the best advice?
   A. #1 FP ‘ do a SEP because it can be integrated with Social Security. This means a bigger percentage of the company contribution will go to Bill. In addition, the plan is simple to install.
   B. #2 FP ‘ do a defined benefit plan because the largest contribution will go to Bill.
   C. #3 FP ‘ do a SIMPLE because of small mandatory employer Contributions.
   D. #4 FP ‘ do a cash-less ESOP because the company can contribute stock rather than cash.

Answer 130

A You should be able to eliminate two answers right away. A defined benefit plan is not simple and can require large mandatory contributions. An ESOP means Bill has to share stock with his employees. There is no indication he is will do so. With a SEP there is no mandatory contributions and it is simple to install. There is no indication that the employees would want to contribute to a SIMPLE and employer contributions are very limited (3%). The SEP will allow for higher employer contribution. Debatable question/answer.

Question 131

4. Sonia Appletree owns an upscale gift shop.  Business varies so much that she cannot hire full-time employees and provide benefits.  She has decided to limit the number of full time to two employees and the remainder of her employee needs can be met by numerous prior employees who only want to work part-time (500 hours per year at most).  What kind of benefits could she offer to the full-time employees that would exclude the part-time employees.
I. Profit sharing plan
II. SEP
III. Group health insurance
IV. SIMPLE 401(k)

A. I, III, IV D. II, III
B. I, III E. IV
C. I, IV

Answer 131

A - Profit sharing and SIMPLE 401(k) are ERISA plans (1,000 hours per year requirement). Group health normally requires 30 hours per week. The SEP only requires the 3 year rule which many of the part-time employees may already qualify for.

Question 132

5. Harry Stonewall owns HS, Inc.  HS is a small manufacturer of parts sold to larger manufacturers.  Harry's business varies from month-to-month.  Harry feels he can train an employee to run a piece of equipment in a matter of an hour, sometimes minutes.  Harry fires employees for various legitimate reasons. Most employees only last a month or two due to firing and layoffs.  Harry wants a retirement plan for his company what would you suggest?
A. Defined benefit pension plan
B. Profit sharing plan
C. SEP
D. SIMPLE
E. SIMPLE 401(k)

Answer 132

C With a SEP, it is doubtful an employee would meet the 3-year requirement. In addition, the company could contribute the maximum of 25% or $51,000.

Question 133

1. Your client (the owner of XYZ Corporation) has a profit-sharing plan. The plan invests in money markets, T-bills, T-bonds, and corporate bonds. Which option do the employees in the plan have?
   A. Sue him for lack of diversification
   B. Report him to the Department of Labor
   C. Sue him because the investments are not an inflation hedge
   D. Do nothing

Answer 133

D - In my opinion, because this is a profit-sharing plan, not a 401(k), they can do nothing. The plan calls for prudent investments, and a fiduciary is not required to be successful in managing the plan’s assets. NOTE: This plan
is funded solely with employer funds, not employee deferrals.

Question 134

2. A company has a 401(k) plan where the participants are allowed to choose among several alternative funds in accordance with DOL Reg. 2550. Funds range from money market funds to aggressive, highly volatile growth funds. Several of the participants have lost substantial amounts of their elective deferrals in the highly volatile funds. What is the company’s liability according to the prudent man” rule?
   A. No liability
   B. A 5% penalty and replacement of lost funds
   C. The employer is relieved of fiduciary responsibility for any investment directed by the participant.
   D. The company is responsible to pool employee accounts; therefore the company must replace lost funds.
   E. The fiduciary may be liable under the prudent man rule

Answer 134

E - As long as the company (the fiduciary) contracts for the investment services, it may be liable.
Investments tend toward bonds, money market, and liquid cash-type media. Small plans use a family of funds.

Question 135

1. Under ERISA which organization is charged with the administration of defined benefit plan termination rules?
   A. ERISA C.DOL E. IRS
   B. PBGC D.PWBA

Answer 135

B - PBGC insures against loss of benefits and also oversees plan terminations. The Department of Labor (DOL), through the Pension and Welfare Benefits Administration (PWBA), is charged with the enforcement of reporting, disclosure, and fiduciary provisions of ERISA.

Question 136

2. The Pension Benefit Guaranty Corporation’s (PBGC) main responsibility is to insure benefit payments to participants in, and beneficiaries of, most of the following types of employee benefit plans except which of the following?
   A. Defined benefit plans C. Cash balance plans
   B. Target benefit plans D. Integrated DB plans

Answer 136

B - Defined benefit plans (which include cash balance plans) are generally eligible for
coverage under PBGC. A target benefit plan is not covered by PBGC because it is a defined contribution plan.

Question 137

3. The PBGC may not require a plan to be involuntarily terminated for which of the following reasons?
   A. The plan isn’t funded per applicable legal standards.
   B. The plan is not able to meet its benefit payments.
   C. The plan has a possible long-run loss that may get significantly worse over time.
   D. The plan sponsor has not paid its compulsory PBGC premiums.

Answer 137

D - Only the first three reasons may justify a PBGC involuntary terminations.

Question 138

4. Cash balance plans have which of the following significant advantages over defined contribution plans?
   A. PBGC insurance coverage is provided.
   B. Benefits are fully funded at all times and beyond the reach of the employer’s creditors.
   C. Cash balance plan participants will be better off because they are credited with a guaranteed, steady rate of return.
   D. Cash balance plans require past service credits.

Answer 138

A Assets already paid into either plan are beyond the reach of the employer’s creditors, but if the company fails, the plan defined contribution may not have sufficient assets to meet the plan’s obligations (an event that would not be covered by the PBGC). The cash balance plan has coverage under the PBGC. Answer C may be true for the year of 2008 but will not necessarily be true every year. Cash balance plans can allow past service credits, but they are not required to do so. This is not a significant advantage.

Question 139

1. XYZ, Inc. is a small cash-type company. It has a profit sharing plan in place. At year end, although profitable, it does not have the cash to contribute to the plan. If XYZ, Inc. can make a contribution to the plan, it can save 39% on taxes. What should the corporation do?
   A. Pay the IRS the 39% in taxes and hope they can have the cash available to fund the plan.
   B. Make the contribution by the corporate filing due date.
   C. If necessary file for a corporate extension and try to find the cash necessary to fund the plan.
   D. Since the funding is not complete by year end, the company cannot do anything.

Answer 139

C They only have to come up with 61% because taxes will fund 39%. Answer C makes more sense than Answer B. It gives the corporation more time. The funding has to be in place before the tax filing, but not by year end. The 39% is correct. Corporations have a special make-up rule. The 39% is shown on Income Tax page 4-2.

Question 140

2. ABC, Inc. is an accrual based firm. At year end (Christmas) they sell a lot of inventory. The concern is that although they book” a lot of sales they may not get the cash until sometime next year. They always have problems funding the company’s existing profit sharing plan. What should the company do if the company is reasonably profitable (39%)?
   A. Change their accounting method to cash from accrual.
   B. If they cannot fund the plan by their tax filing date borrow the necessary funds from a bank if they want to fund the plan.
   C. Let the year go by and pay the corporate taxes due.
   D. File the corporate tax form showing an amount owed to the profit sharing plan as a deduction

Answer 140

B - The company cannot change into a cash type accounting system. They can do answer C, but why not save on 39% taxes? Answer D is not allowed, the cash must be contributed to the plan.

Question 141

An S corporation has the following investments in its ESOP. Which of the investments is subject to UBTI?
A. Dividends from S corporation stock
B. Annuities
C. Apartment complex using 80% debt financing
D. Equipment leasing limited partnership

Answer 141

D - Income from a limited/general partnership interest (except real estate) is considered UBTI income.

Question 142

1. Which of the following plans cannot provide for death benefits paid from life insurance?
   A. ESOP C. Profit-sharing ‘ 401(k
   B. 403(b) D. SIMPLE

Answer 142

D - The only plans that are allowed to purchase life insurance are the qualified plans (answers A and C) and the 403(b). A SIMPLE is an IRA.

Question 143

2. Medical Associates, Inc. has been informed by its plan administrator that its defined benefit plan is overfunded. The plan administrator comments that it may be a long time before additional employer contributions can be added to the
   plan. What can Medical Associates do to continue to contribute new money to the plan?
   A. Nothing.
   B. Use life insurance to fully fund the plan
   C. Continue to make contributions until the IRS finds out
   D. Find a new plan administrator who will allow them to make contributions

Answer 143

B - With a fully funded whole life DB plan, you can use the actuarial assumptions of the whole
life contract. The actuarial assumptions of the cash value insurance policy are normally lower than the plan assumptions, allowing for additional contributions.

Question 144

3. Under the 25% safe harbor test (incidental rules for death benefits), there are actually two separate tests: a 25% test and a 50% test. Which of the following statements is (are) true?
   I. If term insurance is used, the aggregate premiums paid for the policy cannot exceed 25% of the participant’s total plan cost.
   II. If whole life or universal life is used, the aggregate premiums paid for the policy cannot exceed 50% of the participant’s total benefit because about half of the premiums paid under cash value policies represents pure insurance protection and the other half represents the investment element of the policy.

A. I only C. Both I and II
B. II only D. Neither I nor II

Answer 144

A - Universal life and term must follow the 25% rule.

The 50% rule only applies to Whole life, not Universal or Term.

Question 145

4. When life insurance is purchased in a plan to provide death benefits, the current cost of the pure insurance” protection is subject to taxation. The cost attributable to this pure life protection will be the lower of which of the following?
   A. PS 58 cost and Table 2001
   B. Table 2001 and the employee’s cost basis
   C. Actual cost as provided by the carrier and Table 2001
   D. PS 58 and the employee’s cost basis “

Answer 145

C PS 58 is no longer used.

Question 146

5. Which statement is true concerning incidental safe harbor rules for death benefits in retirement plans?
   I. They apply to qualified plans (defined contribution and defined benefit) and 403(b) plans.
   II. They do not apply to SEPs; therefore, there is no limit to the amount of life insurance that can be held by a SEP.

A. I only C. Both I and II
B. II only D. Neither I nor II

Answer 146

A - The incidental rules for death benefits do not apply to SEPs (and SIMPLEs). However, the reason they do not apply is that SEPs (and SIMPLEs) cannot have life insurance. They are IRAs.

Question 147

6. Business owners sometimes need to use qualified plan assets to purchase life insurance for estate planning purposes. (The most available client assets to pay the premiums may well be in the qualified plan.) A popular planning device is to purchase a second-to-die insurance policy in a qualified plan. Which of following qualified plan(s) can hold second-to-die insurance?

A. Cash-balance plan C. Money purchase plan
B. Profit-sharing plan D. All of the above

Answer 147

B Only profit-sharing plans can hold second-to-die insurance. Pension plans cannot. Cash balance plans and money purchase plans are pension plans.

Question 148

7. Which of the following types of qualified plans offer disability insurance?
   A. DB pension plan C. 401(k)/profit-sharing plan
   B. ESOP D. All of the above

Answer 148

D - Qualified plans are eligible to hold disability insurance.

Question 149

1. Dr. Ames was recently divorced due to marital differences. The messy divorce significantly reduced his net worth due to attorney fees and the settlement. Now at age 55, he is in poor health but does a procedure that should earn him a $1 million after business expenses. He proposed to his girlfriend, age 50, but she is concerned about the lack of financial assets. Her contested divorce left her with minimal assets. Money is an issue between them. What kind of retirement plan would maximize benefits both for him and her if he should die prematurely?
   A. Target benefit plan using an aggressive money manager
   B. 412(i) using whole life insurance
   C. Profit sharing 401(k) with catch-up invested in commodity ETFs
   D. Cash balance pension plan guaranteeing 20% contribution and 10 % return using a well diversified portfolio.

Answer 149

B - The 412(i) is a fully funded insurance plan.
This would allow for large contributions. The life insurance, even if he was rated, would be charged to him at standard rate (based on Table 2001). This charge is taxable. It would build a tax-free basis at retirement. In addition should he die before retirement the beneficiary would receive the pure death benefit income tax-free (see 412(i) ‘ Lesson 3). At retirement, he could buy this policy from the plan to keep it into his retirement years. This is the best solution; although the others are not bad answers. However, if he dies within one or two years, there is not much in the plan.

Question 150

2. Mr. and Mrs. Yelson have been married 40 years. They live in the same town they grew up in. They attend the same church they got married in 40 years ago. Mr. Yelson has worked at the GM plant in town since he graduated from high school and is now a supervisor at the plant. Which of the following issues do you think Mr. and Mrs. Yelson discuss?

I.  Their children
II. Retirement goals
III.GM
IV. Their grandchildren
V.  Moving to Florida

A. All of the above D. II, III
B. I, III, IV E. II, V
C. II, III, IV

Answer 150

B Various surveys concluded that couples are not discussing their retirement goals. 62% do not even agree on what the expected retirement age should be. The husbands seemed to be more involved with money. This is a very subjective behavioral finance type question. All of the above is not an impossible answer. Writer- opinion answer

Question 151

3. Mr. Adams, age 68, had just been considering retiring. He had discussed his retirement options with his wife before he died. A participant in a profit sharing 401(k) plan, he had accumulated $1.5 million. Mr. and Mrs. Adams had very little invested outside the plan except their home and personal property. He had not taken Social Security benefits. Mrs. Adams, age 65, also had not taken Social Security benefits. Mrs. Adams has no investment knowledge and has trouble making basic decisions. If she applies for benefits under Social Security, what do you suggest she do with his retirement plan?
   A. Roll it into an IRA in her name and hire a good money manager.
   B. Leave it in his 401(k) account until she needs the income.
   C. Roll it into an IRA and take a guaranteed lifetime income option.
   D. Roll it into a Roth IRA in her name and use the money manager who was handling the 401(k).

Answer 151

C - His Social Security benefits may not be enough to support her lifestyle. While living, Mr. Adams never saved any money. By taking the guaranteed lifetime income, she will not be forced to make a decision. Answer A and B do not address her needs for money now. Answer D would be subject to income tax. Writer-opinion answer

Question 152

4. Mr. Smithton owns a small business. He hires a variety of part- time employees who work either daily or hourly. Some work once or twice a month and some only work during peak times. These part-time employees are mainly semi-retired and work because they get bored. They have worked for Mr. Smithton for years. Mr. Smithton wants to fund a retirement plan for last years profit. At year end, he found out that he made too much money and would pay too much in taxes. Is there anything he could do?
   A. Establish a profit sharing plan and fund it this year but take a deduction for last year.
   B. Establish a SIMPLE plan and fund it this year but take a deduction for last year.
   C. Establish a SEP and fund it this year but take a deduction for last year
   D. Nothing

Answer 152

C - Well, he can do the SEP until his business files its tax return or extensions. However, he will have to make contributions for those part-time employees who qualify. Nothing may be the best answer.

Question 153

1. The 401(k) salary deferral part of a profit-sharing plan is not subject to which of the following special rules?
   A. In-service withdrawals can only be made by those who have reached age 55 or have a financial hardship.
   B. 401(k) salary reductions are immediately vested.
   C. 401(k) salary reductions cannot be forfeited.
   D. Salary deferrals are subject to the Actual Deferral Percentage (ADP) test ‘ a type of nondiscrimination test.

Answer 153

A - In-service withdrawals can only be made by those who have reached age 59 1/2 or have a financial hardship regardless of age.

Question 154

2. Under the safe harbor rules for hardship distributions, which of the following specific circumstances constitute hardships?
   A. Purchase of a vacation residence for the participant
   B. Payment of K-8, secondary, and postsecondary tuition for education for a participant, his or her spouse, children, or dependents
   C. Medical expenses for the participant, spouse, or dependents
   D. Payment of amounts necessary to prevent the eviction of the participant from his or her vacation residence or from foreclosure on his or her mortgage

Answer 154

C - Answers A and D are wrong because they do not specify principal” residence. Second homes, vacation homes, or rental property owned by the participant do not qualify under the hardship rules. Answer B is wrong because it included K-8 and secondary tuition. Only payment of “postsecondary” tuition is included under the hardship rules.

Question 155

3. Which of the following characteristics is not included in a profit-sharing plan?
   A. It can allow for in-service distributions.
   B. It cannot invest the plan’s assets in the sponsoring company’s stock.
   C. The employee assumes the risk of preretirement inflation, investment performance, and adequacy of retirement income.
   D. The employer can deduct up to 25% of the compensation of all eligible participants.

Answer 155

B A plan subject to ERISA may not acquire or hold qualifying securities if the total fair market value of such assets exceeds 10% of the plan’s portfolio at the time of acquisition. The plan can invest up to 100% of the plan’s assets in the sponsoring company’s stock if, and only if, the plan document allows it.

Question 156

Which of the following qualified plan distributions is exempt from the 10% early withdrawal penalty?
A. First home acquisition cost
B. Qualified education cost for participant’s child
C. Substantially equal periodic payments
D. Death

Answer 156

D - The first two answers are for IRA distributions, not qualified plan distributions. Substantially equal periodic payments from qualified plans must be due to separation from service. With IRA distributions, A, B, C, and D would be true.
In general, a premature distribution is a distribution prior to age 59-1/2. Section 72(t) provides for a number of exceptions to the 10% additional tax. Among these exceptions is that the 10% additional tax will not apply to a distribution which is part of a series of substantially equal periodic payments.”

”

Question 157

The QPSA and QJSA death benefits are not provided by which of the following types of qualified retirement plans?
A. Money purchase pension plan
B. Target benefit pension plan
C. Money purchase pension plan that has been merged into a profit- sharing plan
D. Profit-sharing plan

Answer 157

D - Profit-sharing type plans do not have to offer the QPSA or QJSA although they can. Profit-sharing plans are not pension plans. Money purchase plans that have been merged into a profit-sharing plan must retain the QPSA and QJSA provisions (on the merged monies only). Pension plans (there are 4) are subject to QPSA and QJSA.
A distribution from a 457 governmental plan can be rolled over to a qualified plan or to an IRA. Transfers to another 457 plan remain the only option for nongovernmental tax-exempt organizations.

Question 158

Brad quit his job at Baker Industries. He took a distribution check from his 401(k). In less than 60 days, he invested 100% in an IRA money market account. Which of the following can he do?
I. Move from the money market account to one of the funds with his IRA account
II. Take a distribution check to move to another family of funds
III. Do a trustee-to-trustee transfer to another family of funds
IV. Make a direct transfer to another family of funds
A. All of the above C. II, IV
B. I, III, IV D. III, IV

Answer 158

A - The first distribution is a 401(k) distribution (a qualified 60 day”). It doesn’t count as a 60-day IRA distribution. Therefore he can also do a 60-day IRA distribution within the next year.

Question 159

Debbie has a qualified plan at Company A. She has decided to quit her job at Company A and plans to join Company B. Company B also has a qualified plan, but she will not be able to enter the plan for one year. What is the best advice you can give her?
A. Roll the qualified plan assets from Company A into her existing contributory IRA.
B. Roll the qualified plans assets from Company A into her existing nondeductible IRA.
C. Take the distribution in cash.
D. Roll the qualified plan assets from Company A into a conduit IRA.

Answer 159

D After Tax Act 2001, rollovers are generally permitted between one traditional IRA and another or in some cases, between a traditional IRA and a qualified plan. However, in order to preserve capital gains and special averaging treatment, a distribution from a qualified plan may still need to be made to a conduit IRA.” Answer D is the safest answer to cover all bases for the exam.

”

Question 160

Bill age 59 has worked for the State of Florida for 40 years. He has been contributing to a Section 457 plan and wants to take a full distribution of $400,000. Which of the following is true with regard to the $400,000 distribution?
A. He can roll over the distribution into an IRA.
B. He will be eligible for 10-year averaging. NOTE: Had to attain age 60 by 1/1/96.
C. He will have a 20% mandatory withholding on the distribution but will not be subject to the 10% early withdrawal penalty.
D. He can’t take any distributions until age 59-1/2.
E. None of the above.

Answer 160

E The problem does not indicate separation from service. He’s still employed. Therefore, he cannot take an in- service withdrawal until he reaches age 70-1/2. Since he is still employed, he cannot take a distribution now. Once he separates from service, he can take a distribution. Governmental 457 can be rolled into an IRA but not until age 70-1/2 or separation from service. 457s do not qualify for 10-year averaging. 10-year averaging is a special tax treatment. It is still in effect. Doubtful, it will be tested. In addition, he was not 60 by 1/1/1996. 457s are not qualified plans subject to mandatory withholding.

Question 161

1. If an IRA owner was born before June 30th, what is the owner’s age for purpose of calculating his or her first RMD?
   A. age 70 B. age 71 C. 70-1/2

Answer 161

A An IRA owner who was born before July 1st will attain age 70-1/2 in the same year that he or she attained age 70. The required beginning date is April 1st of next year using age 70.

Question 162

2. Mr. Thomas will turn age 70-1/2 in the fall of this year. He has a $1,000,000 IRA at the beginning of this year and estimates he will have $1,050,000 at the beginning of next year. His wife is age 67. What is the required minimum distribution he must take by April of next year based on the Uniform Lifetime Table”?
   A. $36 192.26 C. $37 735.85
   B. $36 496.35 D. $37 812.42

Answer 162

B $1,000,000 = $36,496.35
27.4
Although he has until next year (age 71) to take the distribution, it is made for this year when he is age 70. The table or the distribution period will be given on the exam. Same as question #1.

Question 163

3. If an IRA owner was born on July 30th, what is the owner’s age for purpose of calculating his or her first RMD?
   A. age 70 B. age 71

Answer 163

B He or she will attain age 70-1/2 in the same year in which he or she attained age 71 (next year). This July 30th, he turns age 70; RMD is not required until next year when the owner turns 70-1/2. 7/1 - 12/31 age 70 / next year 1/1 - 6/30 age 70-1/2 use age 71

Question 164

4. An IRA owner turns 70 on December 15th of 2013. What will be the RBD of his or her IRA account?
   A. By April 1st of next year (2014) using age 70
   B. By April 1st of next year (2014) using age 71
   C. By April 1st of the following year (2015) using age 70
   D. By April 1st of the following year (2015) using age 71
   E. By April 1st of the following year (2015) using age 72

Answer 164

D He or she will attain age 70-1/2 in the same year in which he or she attained age 71 (2014). You use age 71 for RMD. Same as question #3.

Question 165

5. Mr. Able age 70 will turn age 70-1/2 next year. He owns a
   $1,000,000 IRA at the beginning of this year and estimates he will have $1,050,000 at the beginning of next year. What is the required minimum distribution he must take next year?
   A. $36,496.35 C. $39,622.64
   B. $38,321.17 D. $39,636.85

Answer 165

C $1,050,000 = $39,622.64 See Question 3 - by 26.5 4/1/15, but for 2015 (use age 71) He can delay taking his 2015 RMD until April 2016, but it is for 2015. In this case, he is both 70 ? and 71 in the same year, then use age 71 (26.5). But, the distribution is for the year of 2015. He can delay taking the distribution until 2016. Practice question Mr. Thomas is age 70 in June. He has a $1,000,000 IRA. If Mrs. Thomas is 50 years old, what is the minimum distribution he must take by April of next year based on the spousal table below? $1,000,000 : 34 = $29,411.76 This would allow for even more stretch out” of payments versus $39622.64 in question #5.

Question 166

1. In the fall of this year, James will turn 70-1/2. He named his wife Betty age 45 the beneficiary of his IRA. For the current distribution year, which life expectancy factor is James entitled to use? A. 26.5 C. 38.2 B. 27.4 D. 38.3

Answer 166

D - The exception to the new uniform lifetime table only applies if the sole primary beneficiary is the spouse and he or she is more than 10 years younger.

Question 167

2. In June, James turns age 70. He names his daughter Sandy age 45 the beneficiary of his IRA. In the current distribution year, which life expectancy factor is James entitled to use? A. 26.5 C. 38.2 B. 27.4 D. 38.3

Answer 167

B - The exception to the new uniform lifetime table only applies if the sole beneficiary is the spouse. From the table on page 9-8

Question 168

1. Phil and his four brothers are equal owners of Brothers, Inc. Phil does not want to retire although he just turned age 70. His account balance in the company money purchase plan is $1,000,000. (Uniform Lifetime Table factor is 27.4.) Does he have a distribution problem this year? A. No, he hasn’t retired yet. B. Yes, he will have to pay an excise tax of $36,496.35. C. No, but he has to take a distribution by April 1st of the year following the year in which he attained age 70 1/2.

Answer 168

C - He is more than a 5% owner. He just turned 70. He must take a distribution (per Answer C). If he doesn’t take the required minimum distribution, the penalty will be $36,496.35* times 50% or $18,248.17. *(1,000,000��27.4)

Question 169

2. Marge, a widow, continues to work past age 70 1/2. She continues to add to her SIMPLE at work. She has $200,000 in her IRA and $20,000 in her SIMPLE plan. Does she have to take minimum distributions? A. Yes, from her IRA only (She isn’t retired.) B. Yes, from both the IRA and the SIMPLE C. No D. Yes, from her SIMPLE only

Answer 169

B - See required beginning date for SIMPLEs.

Question 170

3. Mr. Potts will be 70 on June 1st. His IRA has a value of $500,000 at the beginning of this year. If he only takes a $9,000 distribution by April 1st of next year (for this year), what will be the amount of his penalty? A. $ -0- C. $4,624 B. $4,500 D. $18,248

Answer 170

C - $500,000 : 27.4 (age 70) = $18,248 $18,248 ‘ 9,000 = $9,248 $9,248 x 50% = $4,624

Question 171

1. Dave is age 70. His wife Kate is age 62. If he dies, what is her best option for his IRA if she wants to delay his distributions as long as possible? A. Roll over his IRA into her IRA and take distributions based on her own required beginning date B. Keep the assets in his IRA and take distributions when Dave would have reached 70-1/2 C. Fully deplete the IRA within five years of Dave’s death D. Disclaim the proceeds

Answer 171

A - Kate is younger than Dave. She can delay his distributions until her RBD.

Question 172

2. Dave is age 70. His wife Kate is age 62. If she dies, what is his best option for her IRA if he wants to delay her distributions as long as possible? A. Roll over her IRA into his IRA and take distributions based on his own required beginning date B. Keep the assets in her IRA and take distributions when Kate would have reached her RBD C. Fully deplete the IRA within five years of Kate’s death D. Disclaim the proceeds

Answer 172

B - Kate is younger than Dave. He can delay his distributions until she would have reached her RBD. The disclaimed IRA must be paid to another party.

Question 173

Jan and Beth (twin sisters) died within months of each other at age 70. Both were divorced, and each left her entire estate, including her IRAs, to their sons. The son of Jan was Allan (age 45), and Beth’s son was Timothy (age 48). Jan named Allan as her designated beneficiary.
Beth never got around to naming a beneficiary except her estate. What will happen to the IRAs? I. Payments for each sister must be taken based on the sister’s life expectancy (the uniform table) for this year (of death). II. Allan can take distributions next year based on his own life expectancy using the -1 method. III. Timothy can take distributions next year based on his own life expectancy using the -1 method. IV. Allan must withdraw all the money from Jan’s IRA within five years of her death. V. Timothy has to withdraw all the money from Beth’s IRA within five years of her death.
A. I II III C. II III E. III IV z
B. I II V D. II V

Answer 173

D - No distributions were required in the year of death. (Neither sister was 70-1/2.) Allan was a named beneficiary (Answer II), but Timothy was not named. The assumption here is that Timothy inherited the IRA. (No other answer was given.)

Question 174

Mark Emnott died last year leaving his IRA in equal shares to his sister, brother, and a charity by way of a trust. (Mark’s only brother, Dale, was named as trustee.) Mark had not reached the required beginning date. Dale is concerned about missing various deadlines as it relates to the handling of Mark’s IRA. What deadlines must Dale adhere to?
I. The charity must be paid-out no later than September 30 of next year to assure that each designated beneficiary can then use his or her own life expectancy.
II. Trust documentation must be delivered to the IRA plan administrator by December 31st of this year.
III. Separate accounts” for each designated beneficiary must be established within the trust by December 31st of this year.
IV. A designated beneficiary is determined as of September 30th of the year following death.
A. I II C. I II III
B. I IV D. III IV

Answer 174

B - Trust documentation must be delivered to the IRA plan administrator by October 31st of the year following the year of death. The charity’s interest should be cashed out before September 30th of the year following the year of the owner’s death. If the deadline is met, the charity is disregarded in determining the payout term. A designated beneficiary must be an individual (that is not a charity) if minimum distributions are to be based on the beneficiary’s life expectancy. NOTE: Probably not tested.

Question 175

1. Rebecca is a participant in her employer’s ESOP. Over the years, the company has transferred stock with a cost basis of $100,000. Rebecca is retiring. The stock has a value of $300,000. She is planning to sell the stock years later. If, upon retirement, Rebecca takes a lump-sum distribution, what are her income tax implications? A. $300,000 as ordinary income now. B. $100,000 as ordinary income now, $200,000 as a long-term capital gain when she sells the stock later. C. $200,000 as ordinary income now, $100,000 as a long-term capital gain when she sells the stock later.

Answer 175

B - NUA is a tremendous advantage over a normal distribution from a money purchase or profit- sharing plan.

Question 176

2. Continuing with the question above, what happens if Rebecca sells the stock for $330,000 six months later? A. $30,000 is short-term gain, and $200,000 is long-term gain. B. $230,000 is short-term gain. C. $230,000 is long-term gain. D. $30,000 is short-term gain.

Answer 176

A - The extra $30,000 is either short-term or long- term depending on the holding period after distribution. A In regards to Answer II, there is an income tax deduction for estate taxes paid on the NUA (if any). Since she is a spouse, there will be none. The NUA is considered IRD even when it involves a beneficiary receiving a distribution from an ESOP (covered in the estate planning).

Question 177

4. Linda Myers, married, is about to retire at age 68. She plans to directly rollover her profit sharing 401(k) to a personal IRA. Who can be the beneficiary of the IRA?
   I. Robert Myers, her husband II. Susan, her daughter
   III. Phillip, her son IV. Clara Hobbs, her mother
   A. All of the above C. I, IV
   B. I, II, III D. II, III, IV

Answer 177

A Only pension plans require the husband to be the beneficiary. There may be reason to name any one of them, but there is no indication of that reason.

Question 178

5. Mr. T owns 100% of T Inc. He is turning 70 1/2 at year end. He has a profit sharing 401(k). What is his situation for this year and next year with regards to the plan distributions and contributions if he plans to continue to work next year?
   I. He will not have to take a distribution for this year under RBD/RMD.
   II. He will have to take a distribution for this year under RBD/RMD.
   III. He can continue to defer and receive profit sharing contributions next year.
   IV. He cannot defer or receive profit sharing contributions next year.
   A. I, II C. II, III
   B. I, IV D. II, IV
   .

Answer 178

C - He is more than a 5% owner. He can wait until April 1st to take the distribution, but it is for this year. He is both 70 and 70 ? this year. He can be a participant in the plan next year

Question 179

1. Bob turned 70 at the beginning of the year. He had a marketable product that could be outsourced (produced by a separate manufacturer). By year end, the business produced a $500,000 profit above his salary of $120,000. If the business is filed as an S corporation entity, which of the following are true?
   I. If he starts a profit sharing plan, the business could contribute $51,000 if he has other employees.
   II. If he starts a SEP, the business could only contribute 18.59% of $120,000.
   III.If he does a retirement plan he will have to take a required minimum distribution at year end.
   IV. He should take more salary to maximize the company contribution.
   V. He cannot do anything, he will be 70? this year.
   A. I, IV D. III, IV
   B. II, III, IV E. V
   C. II, V

Answer 179

A Answer I is only true if he has other employees because he is still limited by the 25% rule. Remember 415 says 100% of compensation or $52,000. The company can contribute $52,000. See page 5-3. He will be 70? this year. Answer II is false. He is an S Corporation. The corporation can contribute 25%. Picky. Answer III is false. The contribution will not go into the plan until next year for this year. But the distribution (70?) is based on the account balance as of the end of the prior year which was zero. The account balance is the contribution for this year even though the corporation contributed it next year. Answer IV is true. Answer V is false. IRA contributions are not allowed after 70? but SEP’s and qualified contribution are allowed.

Question 180

2. Sam Shephard is single. He has decided to retire. The company he worked for never had a retirement plan. For years he has contributed to a deductible IRA. With successful investment management he has accumulated $1.1 million. He is going to split the IRA into two IRAs. One worth $800,000 will continue to grow and one for $300,000 will be distributed using substantial equal payments to avoid the 10% early withdrawal penalty. What happens if Sam ceases receiving payments at age 62 after four annual payments?
   A. Nothing, he will have attained 59?
   B. Nothing, the remaining funds are still in the IRA
   C. The penalty will be 10% of the total annual payments received by Sam before he attained 59? plus interest
   D. The penalty recapture will be 10% of the total annual payments received by Sam plus interest

Answer 180

C - Recapture will apply because he ceased receiving payments before the end of the five year period. The recapture will be as shown but for only those payments before he turned 59?. He turned 62 after four payments.

Question 181

3. A new client calls you with a question. He is turning age 70 in May of this year. In the prior year, he rolled over $2,000,000 from his previous employer’s profit sharing 401(k) plan into an IRA. At year end it was worth $2,100,000. He wants to know how much will he have to take as a distribution this year, if any? NOTE: Please refer to uniform lifetime table.
   A. $72,992.70 by April 1st of next year but for this year’s RMD
   B. $76,642.34 by April 1st of next year but for this year’s RMD
   C. No distribution is required for this year
   D. No distribution is required because he is still an active participant in the company’s profit sharing 401(k) plan

Answer 181

B He will be both 70 and 70? this year. The distribution period is 27.4 of the value of the account at the end of the prior year. There is nothing to indicate he is still a participant but it does not matter the money is in the IRA account. Distribution is required.

$2,100,000 / 27.4 = $76,642.34

Question 182

4. Matt Williams owns MT, Inc. Matt has had a SEP for himself and his employees for years. Matt is turning 70 early next year. A financial advisor told him he should stop the SEP. The financial advisor said he should start a profit sharing plan. Then he would not have to take required minimum distributions on any of the money until he retires. Matt is seriously considering that. What would you respond?
   A. He will have to take required minimum distributions next year, but can delay them until April 1st of the following year.
   B. The financial advisor is correct.
   C. He can wait until he is 70? to take required minimum distributions.
   D. He cannot move the SEP money to the profit sharing plan.

Answer 182

A Unfortunately he is a greater than 5% owner. He will be both 70 and 70? this year. Although C is a correct answer, he will be both 70 and 70? next year. Answer A is the more complete answer. Answer D is false. The funds could have been moved.

Question 183

Which of the following is true about a nonqualified deferred compensation plan?
I. The contribution may be structured as additional compensation to the employee.
II. The contribution may be paid from the current compensation.
III. The plan may provide for benefits in excess of qualified plan limits.
IV. The plan may not discriminate.

A. I, II, III, IV C. II, III
B. I, II, III D. IV

Answer 183

B I is correct. It describes a salary continuation plan. II is correct. It refers to a pure deferred compensation plan. III is correct because that is the purpose of nonqualified deferred compensation.

Question 184

What are the characteristics of funded and unfunded plans?
I. An unfunded plan must have its assets held by a third-party custodian.
II. A funded plan can be a naked promise to pay; but, it must be guaranteed by the employer.
III. Unfunded plan assets are beyond the reach of creditors in the event of a hostile takeover.
IV. A funded plan is beyond the reach of an employer’s insolvency and bankruptcy creditors.
A. I, II C. IV E. II, IV
B. III, IV D. I, IV

Answer 184

C An unfunded plan can be a naked promise” to pay but a funded plan cannot be. Certain unfunded plans
(also known as informally funded) are within the reach of the employer’s insolvency or bankruptcy
creditors. Answer IV is the only correct answer.

Question 185

1. You demanded an extra incentive to join FP, Inc. FP gave you a
   $1 million variable life policy. FP paid the premium. Which of the following is true?
   A. This is a funded nonqualified deferred compensation program.
   B. This is an unfunded nonqualified deferred compensation program.
   C. The program is informally funded.
   D. The premiums are taxable to you.
   E. The premiums are nondeductible by FP.

Answer 185

D You have constructive receipt. This is a Section
162 insurance plan. Section 162 insurance is a direct cash bonus made to an insurance company to pay the premium on a policy owned by the employee. A 162 double bonus is an additional cash bonus to the employee to pay the tax on the bonus. This is not a funded nonqualified deferred compensation plan.

Question 186

You demanded an extra incentive to join FP, Inc. FP gave you a $1 million variable life policy. FP paid the premium. Which of the following is true? If FP had been the owner and beneficiary of the variable life policy in the prior question, then which answers would have been correct?

Answer 186

B, C and E would have been correct.

Question 187

A rabbi trust would be used as a planning tool for which of the following situations?
I. Hostile takeover	III. Acquisitions
II. Mergers		IV.  Bankruptcy
A. All of the above	C.  II, III
B. I, II, III		D.  IV

Answer 187

B - The rabbi trust provides no benefit security for an executive should the employer file bankruptcy. The executive must stand in line with the other creditors.

Question 188

XYZ establishes a secular trust for Bob. Which of the following is/are true?
I. Bob will be able to defer a portion of his current income.
II. The benefits will be subject to the creditors of XYZ.
III. The plan is an informally funded plan.
IV. Because there is no substantial risk of forfeiture, taxation will occur at the time the contribution is made.
A. All of the above C. I, II E. IV
B. None of the above D. II, IV

Answer 188

E Because the assets in a secular trust are beyond the reach of the employer’s bankruptcy or insolvency creditors, taxation will occur at the later of the following two dates: 1) when the funds are deposited into the plan or 2) when there is no longer a substantial risk of forfeiture. (Normally there is no substantial risk of forfeiture with a secular trust.) Since answer IV states, there is no substantial risk of forfeiture taxation will occur at the time the funds are deposited into the plan.

Question 189

John has just joined his grandfather’s firm (grandfather-CEO and father-President). John has extensive experience as sales manager of a competitor and has been made V.P. of sales. The firm has established a nonqualified restricted stock grant plan for John. He will qualify if he stays with the firm for ten years. Are the benefits taxable income now or in the future?
A. There is a substantial risk of forfeiture; the stock grant will be taxable in the future.
B. This is an informally funded plan; the stock grant will be taxable when exercised.
C. This is an unfunded plan, where forfeiture provisions are unnecessary; the stock grant will be taxable in the future.
D. This is a funded plan and stock grant is taxable now.
E. There is no substantial risk of forfeiture; the stock grant is taxable now.

Answer 189

E There is no substantial risk of forfeiture. When your grandfather and father run the firm, there is no substantial risk of forfeiture. Informally funded plans mainly use life insurance, not stock grants or options. Stock grant plans (Restricted stock grants) normally have provisions for substantial risk of forfeiture and are not taxable under normal circumstances.

Question 190

1. Myles Levings, an executive, and his corporate employer executed an agreement to defer a portion of future compensation using a deferred compensation plan. The plan provides for contributions based on corporate profits otherwise paid in bonuses to Myles at the end of the corporation’s fiscal year. Contributed amounts remain an asset of the employer at all times although the plan is credited with investment earnings on Myles’ behalf. At age
   60 or his date of retirement, whichever occurs first, Myles will be entitled to distributions from the plan. Which statement correctly identifies the income tax implication of this deferred compensation plan for Myles?
   A. This is a funded salary continuation plan. Contributed amounts remain an asset of the employer; thus, the employee has no current taxation.
   B. Contributions are based on bonuses paid at the end of the fiscal year; therefore, they are taxed to the employee.
   C. The employer takes a deduction for the plan contributions and earnings only at the time Myles includes them in income (i.e., age 60 or date of retirement).
   D. This type of funded plan can use life insurance as an investment vehicle to avoid taxation of the cash value growth to the employee until he attains age 60 or retires.

Answer 190

C - A, B, and D are wrong because this is an unfunded plan, not a funded plan. The investment remains an asset of the employer at all times.

Question 191

2. Of the following entities, which can effectively implement a deferred compensation plan for its executives?

A. Limited Liability Partnership D. General Partnership
B. Corporation E. S-corporation
C. LLC

Answer 191

B All of these entities could use a deferred compensation plan. However, with pass-through entities (A, C, D, and E) contributions to nonqualified plans are nondeductible at the time of contribution. The owners will have to report the amount contributed to the deferred compensation plan on their personal returns. Regular corporations do not have this problem because they are separate tax entities.

Question 192

Mr. Phillips has ISO options with a $15 strike price. He transfers the options one year later to his daughter Susan when the market price is $19. What is (are) the income ramification(s) if she exercises them at $25 two years later?
A. $4 ordinary income to Mr. Phillips / $6 ordinary income to Susan
B. $10 ordinary income to Mr. Phillips
C. $10 ordinary income to Susan
D. $6 ordinary income to Mr. Phillips / $4 ordinary income to Susan
E. $10 capital gains to Susan

Answer 192

B - A gift before exercise to Susan is a disqualifying disposition. (The ISO becomes an NSO.) Mr. Phillips is charged with the income. The only exception to the transfer before exercise is if Mr. Phillips dies before he can exercise the options. If that occurs, it maintains its ISO status when his daughter exercises.

Question 193

1. Mr. B receives 10,000 ISOs to purchase LMN Corporation stock at
   $10 per share. Within two years of the grant date, he exercises them when the stock is $25 per share. Several years later, he sells the 10,000 shares of LMN for $100 per share. Which of the following are true?
   I. There is no taxable event on the grant of the options.
   II. He’ll have $150,000 of additional income for regular tax purposes upon exercise.
   III. He’ll have a long-term capital gain of $900,000 when he sells the stock.
   IV. He’ll have a long-term capital gain of $750,000 when he sells the stock.
   A. I, II, III C. I, III
   B. I, II, IV D. I, IV

Answer 193

C - Before selling the exercised ISO shares, he held them at least one year from the date of exercise and two years from the grant date. This is a qualified” disposition. The bargain element (an AMT add-back item) is $15 per share. The gain (long-term) at the time of the sale is $90 per share.

”

Question 194

2. Aero Space rewards its employees for ideas by giving them ISOs. John (employee) was given a $50,000 option for company stock some years ago. At the time of exercise, the market value was
   $100,000. John exercised the option and sold the stock for
   $200,000 thirteen months later. What were the tax implications?
   A. $50,000 was subject to ordinary income tax at exercise, $100,000 capital gain at sale.
   B. $150,000 was subject to ordinary income tax at exercise, $0 at sale.
   C. $0 was subject to ordinary income tax at exercise, $150,000 capital gain at sale.
   D. $100,000 was subject to ordinary income tax at exercise, $50,000 capital gain at sale.

Answer 194

C There is no ordinary income tax at exercise. The basis is $50,000, and the difference is a capital gain. The grant was some years ago (more than 2). Answer C is correct, see the next question.

Question 195

3. When John (Question 2) exercised the option, how much was considered an add-back item for purposes of AMT?
   A. $0 C. $100,000
   B. $50,000 D. $200,000

Answer 195

B - The bargain element is the excess of the fair market value of the stock at the exercise date over the option price. The stock’s market value at the time of exercise is $100,000, and the exercise price is $50,000. This is an add-back item.

Question 196

4. Mr. Z receives 10,000 ISOs to purchase LMN Corporation stock at
   $10 per share. Once vested, he exercises the options when the market price of LMN is $25 per share. Several years later, he sells the 10,000 shares of LMN for $100 per share. Ignoring any AMT adjustments, which of the following is/are true?
   I. There is no taxable event on the grant of the option.
   II. Mr. Z will have no additional income for regular tax purposes upon exercise.
   III. Mr. Z will have a long-term capital gain of $900,000 when he sells the stock.
   IV. The AMT bargain element is $25 per share.
   A. All of the above C. II, IV
   B. I, II, III D. III

Answer 196

B The bargain element is the difference between the market price at exercise ($25) and the option price ($10). The $100,000 ISO limit does not apply to the amount of gain. It applies only to the amount of options that become exercisable in any given year.

Question 197

5. On January 1, 2013, Harry (an employee of Zebra) was granted 1000 ISOs to purchase Zebra stock at the fair market value on the date of grant ($20). On June 30, 2013, he exercised all of the ISOs when the market price was $35, and he sold them for $35 the next day. Which of the following is true?
   A. There is no taxable event on the exercise of the options.
   B. Harry will have to recognize $15 per share as compensation (ordinary income) on the date of exercise. There will be no gain or loss at the time of sale.
   C. Harry will have to recognize $15 per share as short-term capital gain on the date of the sale.
   D. Harry will have an AMT adjustment of $15 on the exercise date.

Answer 197

B - Exercise to sale less than 1 year is a disqualifying event. The ISOs became NSOs. Answers A and D are false. He will have no gain or loss on the date of sale since his basis ($35) is the same as the sale price ($35). If he had sold them for a gain, the gain would have been short-term. If he sold them for a loss, the loss would have been short-term.

Question 198

6. On January 1, 2012, Sally (an employee of Able Corp.) is
   granted 1,000 ISOs to purchase shares of Able at the fair market value of the stock on the date of grant ($20). On June 30, 2012, Sally exercises all the ISOs when the stock’s fair market value is $40. On December 30, 2013, she sells 500 shares for
   $50 per share. Which of the following are true?
   I. This is a disqualifying disposition.
   II. Sally will recognize ordinary income of $20,000.
   III. Sally will recognize ordinary income of $10,000.
   IV. Sally will also recognize short-term capital gains of
   $5,000 when she sells the shares.
   V. Sally will also recognize long-term capital gains of
   $5,000 when she sells the shares.

A. I, II C. I, II, IV E. II, V
B. I, III D. I, III, V

Answer 198

D - This is a disqualifying disposition (but only for the shares that were sold). The ordinary income is $40 less $20 times 500 or $10,000. Her basis in the shares sold is $40 per share. However, she only sold 500 shares at $50. ($50 less $40 times 500 equals $5,000.) The gain is long term. As long as the other 500 shares are not sold before January 1, 2014, they retain ISO tax treatment.

Question 199

1. Karen works for ATQ Corporation (a publicly traded company). On January 1, 2011, she was granted 10,000 nonqualified stock options and 5,000 incentive stock options, both with a strike price of $40. She intends to exercise the options as they vest. She will be 50% vested (NSOs and ISOs) on July 1, 2012, when the share price will be $47. The remaining options will vest on July 1, 2015 when the share price will be $67. She expects to sell all shares more than 12 months after exercise. What will Karen’s total long-term/short-term capital gain be if the shares vested in 2012 are sold at $57 and the remaining shares are sold at $77?
   A. $135,000 LTCG ‘ ISO; $185,000 LTCG - NSO B. $135,000 LTCG ‘ ISO; $100,000 LTCG - NSO C. $50,000 LTCG ‘ ISO; $185,000 LTCG - NSO
   D. $42,500 STCG and $92,500 LTCG ‘ ISO; $100,000 LTCG - NSO

Answer 199

B For ISOs, if the shares are sold at least two years after the grant date and at least one year after the exercise date, ISO status is maintained, and the difference between the option (grant) price and the sale price is a long-term capital gain. If both holding-period requirements are met for ISOs, the resulting gain will always be a long-term capital gain. A short-term capital gain associated with an ISO indicates that a disqualifying disposition has taken place. (That is, the shares were sold within 12 months of the exercise date). For nonqualified stock options, the difference between the exercise price and the sale price is either a long- or short-term capital gain depending on the length of the holding period after exercise. NOTE: This does not violate the $100,000 rule because the vesting is 50%/50%. 2,500 x $40 per share is $100,000

ISO (granted 1/1/2010)
(2012) Sell @ $57 strike price $40 = $17 x 2,500 = $ 42,500 (2015) Sell @ $77 strike price $40 = $37 x 2,500 = $ 92,500
Long-term capital gain = $135,000
NSO (granted 1/1/2010)
(2012) Exercise @ $47 strike price $40 = $7 ordinary income;
Basis increases to $47; Sell @ $57 basis $47 = $10 x 5,000 = $ 50,000 (2015) Exercise @ $67 strike price $40 = $27 ordinary income;
Basis increases to $67; Sell @ $77 basis $67 = $10 x 5,000 = $ 50,000
Long-term capital gain = $100,000

Question 200

2. Your client was granted ISOs valued at $75,000 (1,000 shares) in March 2013. This grant of ISOs vests in two years. In June
   2014 your client was granted another $85,000 of ISOs (1,000 shares) that vest in one year. Your client exercises the options as they vest. (Stock price at time of exercise is $100.) What are the tax implications upon exercise? Assume the stock has not been sold.
   A. There are no tax implications until the stock is sold.
   B. There is no income tax implication, but a bargain element of $60,000 is a add-back item for AMT.
   C. There is an income tax liability on the NSO portion (taxable wages) and a bargain element on the ISO portion (add-back item).
   D. There is only an income tax liability because more than $100,000 of ISOs were exercised in the same year.

Answer 200

C - Answer D is wrong because when more than $100,000 worth of ISOs are vested in the same calendar year, only the first $100,000 will be treated as ISOs, and the balance of options that are vested in the same year will be treated as NSOs (regardless of when they are exercised). The value of ISOs granted in a given calendar year does not cause any of the ISOs to be treated as NSOs so long as the value of ISOs vested in a given calendar year does not exceed $100,000. In other words, $200,000 of ISOs could be granted today, but as long as no more than $100,000 vests in any given year, no income tax liability will be generated upon exercise. For this type of problem just look for an answer that includes both an income tax liability and an AMT bargain element.