Terms

Question 1

What are the Definitions of Disability?

Answer 1

1. Own Occupation - best definition for the insured (Most Liberal)
2. Modified any occupation
3. Split definition - Own then modified
4. Any Occupation (Social Security definition)
5. Loss of Income

Question 2

Types of Agency Authority (Law of Agency)

Answer 2

• Express Authority – specifically conferred by the agent OR occasionally.
• Implied Authority – not expressly granted, but assumed to have in order to transact business.
• Apparent Authority – ostensible authority; the appearance of, or assumption of authority, based on agent’s actions (it appears that agent is acting within the scope of authority).

Example is if I a new life insurance agent and I just sold a life insurance policy to a client. Then the client said that want to get new home owners insurance. Since I am a new agent, I can’t sell home owners yet, but I say yes, we can get that for you and give them a quote. Then the company is liable because the client doesn’t know that I can’t do that, but I could get sued or fired for this. APPARENT AUTHORITY INVOLVES APPEARANCES

Question 3

What is subrogation?

Answer 3

Subrogation is a provision that is designed to prevent the insured from making a profit on a claim. Subrogation is the act of one party claiming the legal rights of another that it has reimbursed for losses. Subrogation occurs in property/casualty insurance when a company pays one of its insured’s for damages, then makes its own claim against others who may have caused the loss, insured the loss, or contributed to it.

Is in place to make sure the insured doesn’t make a profit or get back more than he put out on the transaction.

For Example: Suppose another driver runs a red light and your car is totaled. You have insurance on your car, so you call your insurance carrier and they pay you for all of your expenses related to the accident. Your insurance company, realizing that the other driver had an insurance policy, then seeks reimbursement from the at-fault party’s insurance carrier. Your insurer is “subrogated” to the rights of your policy and can “step in your shoes” to recover any amount paid out on your behalf. This is the definition of subrogation.

Question 4

What does NonCancellable mean in disability insurance?

Answer 4

A noncancellable insurance policy is a life or disability insurance policy that an insurance company can’t cancel, increase the premiums on or reduce the benefits of as long as the customer pays the premiums. Noncancellable insurance policies give the policyholder peace of mind that the cost, amount of coverage and term are known and that they won’t have to re-qualify for the policy at some point in the future when their health might not be as good and insurance might be harder to get.

It means the insurance company can NOT incresae the premium for the policy term.

Question 5

What does Guaranteed Renewable mean in disability insurance?

Answer 5

A guaranteed renewable policy is an insurance policy feature that obligates the insurer to continue coverage as long as premiums are paid on the policy. While re-insurability is guaranteed, premiums can rise based on the filing of a claim, injury, or other factors that could increase the risk of future claims. Premiums can also be raised on an entire class of insured people during the life of a guaranteed renewable policy for health, life or disability insurance.

Guaranteed renewable means they can NOT increase the premium for individuals but they can increase the premium rate for an entire policyholder class.

Question 6

What does waiver of premium mean in disability insurance?

Answer 6

A waiver of premium rider is an insurance policy clause that waives premium payments in the event the policyholder becomes critically ill, seriously injured, or disabled. Other stipulations may apply, such as meeting specific health and age requirements.

Rider that pays for the premium if I become disabled.

Question 7

Current Ratio

Answer 7

Current Assets ÷ Current Liabilities

Question 8

Current Assets

Answer 8

• Cash Equivalents
• Marketable Securities
• Accounts Receivable
• Inventory

Question 9

Current Liabilities

Answer 9

• Accounts Payable
• Credit Card Debt
• Taxes Payable

Question 10

Basic Components of a Legal Contract as Applied to Insurance

Answer 10

​Hint: O C L C L

1. Offer and acceptance - Two parties, offerer and acceptor
2. Consideration - Something of value (money)
3. Legal Object - Legal in purpose
4. Competent Parties - Principle must have legal capacity to execute contract:

► Intoxicated adults have limited or no capacity

► Minors only have capacity to contract for necessities (food, clothing, shelter)

5. Legal Form - Contract must meet requirements

Question 11

Law of Agency (Insurance)

Answer 11

Express Authority - Written, explicit direction from principal to agent

Implied Authority - Is that which the public believes the individual holds and includes signage, rate books, etc. Implied is actual authority that the agent has to carry out the principal’s business

Apparent Authority - Arises out of negligence of the principal in allowing the agent to appear to have authority because of certain actions of the agent in the past. This typically affects terminated agents.

Question 12

Debt Ratio Analysis?

Answer 12

Write it out Yearly and Monthly and calculate each

Housing Debt (PITI or Front End) < 28% GROSS

Consumer (Auto + Credit) Debt < 20% NET

Total Debt (Back End) < 36% GROSS

Question 13

What is Unsystematic Risk?

Answer 13

Known as diversifiable risk, may alslo be referred to a non-systematic risk.

• Business Risk - refers to the nature of the firm’s operations (i.e., possibility of loss due to new technology)
• Financial Risk - Refers to how the firm finances its assets (i.e., the possibility of loss due to heavy debt financing)

Question 14

What is Systematic Risk?

Answer 14

Also known as non-diversifiable risk. This part of risk is inescapable because no matter how well an investor diversifies, the risk of the overall market cannot be avoided.

Beta is measure of systematic risk or volatility of the market. If the beta is 1.2 then your portfolio has 20% more risk/volatility than the market. Systematic risk can be further defined by measuring the R-squared. You get to R-squared by squaring the correlation of a stock/portfolio relative to its benchmark. R-squared equals systematic risk.

Ex: The fund has a correlation of 0.87 with the Russell 2000, and squaring the correlation would give us an R-squared of 0.76, meaning there is 76% systematic risk and 24% unsystematic risk.

Total Risk is measured by Standard Deviation or variability of returns from the mean.

Question 15

Duration

(Principles to Remember)

Answer 15

First thing to do is to think if there were two bonds with similar varibales and then the variable below is different. How would the duration react.

Years to Maturity (Remember duration and maturity are positively related)

Annual Coupon (Remember duration is inversely related to coupon rate)

YTM, the current yield on comparative bonds (duration is inversely related)

How to Remember: Coupon and yield are interest rates - inversely related.

Ex: A bond’s coupon rate is a key factor in calculation duration. If we have two bonds that are identical with the exception on their coupon rates, the bond with the higher coupon rate will pay back its original costs faster than the bond with a lower yield. The higher the coupon rate, the lower the duration, and the lower the interest rate risk so it has an inverse relationship.

Question 16

Rules for using Duration to Manage Bond Portfolios

Answer 16

• If interest rates are expected to rise, shorten duration. (interest rates up, shorten duration. Remember: UPS - UP for up, and S for shorten.)
• If interest rates are expected to fall, lengthen duration. Buy low coupon bonds with long maturities. Interest rates fall → lengthen duration. Remember: FALLEN - FAL for fall and LEN for Lengthen.

Question 17

Conclusions to Fluctuations in Bond Prices

Answer 17

• The smaller the coupon, the greater the relative price fluctuation
• The longer the term to maturity, the greater the price fluctuation
• The lower the market interest rate, the greater the relative price fluctuation

Question 18

What is Kurtosis?

Answer 18

Kurtosis is the characteristics of a bell cureve that has lots of returns clustered around the mean (lots of small surprises) but some extremely large positive or negative returns (few large surprises)

Question 19

What is skewness?

Answer 19

Skewness represented by a bell curve that looks off-center, with flat or skinny tails at on or both ends. A positively skewed distribution has a large hump to the left and a long right tail; a negatively skewed distribution has a large hump to the right and a long left tail. Investment reuturns generally are postitively skewed.

Question 20

Covariance, Correlation Coefficient and Coefficient of Determination Pyramid.

Answer 20

Covaraiance

Can be any number and measures the strength of the relationship between the returns of two securities.

The only reason Covariance may be needed is as an input into the formula for Standard Deviation of a portfolio.

Correlation Coefficient or (R)

Between -1 and +1

Coefficient of Determinatin or (R-squared)

Found by squaring the Correlation Coefficient

Question 21

What is the Coefficient of Variation Formula?

Answer 21

CV = Standard Deviation / Mean or CV = σ / x

choose the lower number when considering two securities.

Question 22

Coefficient of Variation

Answer 22

Coefficient of Variation: Hint is to choose the lower number

A. The coefficient of variation is a way to compare the relative variation of two or more securities.

1. The security with the lowest CV generally should be chosen when given a question that requires choosing from two or more securities.

2. The CV communicates the extent to which an investor can depend on the security being able to achieve its expected mean return. The lower the CV, the greater the reliability.

3. The CV can be considered another method of computing a risk-adjusted return, since both risk and return measures are used in the equation.
4. The CV equation is not given on the CFP Certification Examination formula sheet. You must memorize the formula.
   a. The formula for coefficient of variation is as follows:

CV = σ₁ / x₁ or S₁ / Mean₁

To Solve a question on the Test:

b. For any of the formulas, use simple numbers and change one of the variables if you forget which way is preferable, example with the CV:
(1) Mean return is 10% for both investments, one has a standard

deviation of 10 (Choice A), the other 20 (Choice B), so

(2) 10/10 = 1, and 20/10 = 2, so you would choose the lower

number. Both give you the same return, but your chances of

achieving that return are greater with Choice A—so with CV

choose the lower number.

Example. Asset A has a mean return of 10% and a standard deviation of 6%. Asset B has a mean return of 12% and a standard deviation of 9%.

Which one provides the least amount of risk per unit of return? Asset A has a CV of 0.60 (6/10). Asset B has a CV of 0.75 (9/12).

Question 23

Covariance and Correlation Coefficient

Answer 23

They communicate the same informaiton. They both measure the strength of the relationship between the returns of two securities.

The only reason Covariance may be needed is as an input into the formula for Standard Deviation of a portfolio.

You may be given the correlation coefficient and the standard deviation of two assets and then be asked to compute the covariance using the following formula COV_ij = ρ_ijσ_iσ_j and you would divide each side by σ_iσ_j to get COV_ij / σ_iσ_j = ρ_{ij or} R_ij

Question 24

Definition of Correlation Coefficient?

Answer 24

Correlation is described as a measure in statistics, which determines the degree to which two or more random variables move in tandem. During the study of two variables, if it has been observed that the movement in one variable, is reciprocated by an equivalent movement another variable, in some way or the other, then the variables are said to be correlated.

Correlation is of two types, i.e. positive correlation or negative correlation. The variables are said to be positively or directly correlated when the two variables move in the same direction. On the contrary, when the two variables move in opposite direction, the correlation is negative or inverse.

The value of correlation lies between -1 to +1, wherein values close to +1 represents strong positive correlation and values close to -1 is an indicator of strong negative correlation. There are four measures of correlation:

• Scatter diagram
• Product-moment correlation coefficient
• Rank correlation coefficient
• Coefficient of concurrent deviations

Question 25

What are the EMH anomolies?

Answer 25

1. P/E effect => low P/E outperforms high P/E stocks
2. Small Firm effect => small firms outperform large firms
3. January effect => sell in Dec and buy in Jan
4. Un-excellent/excellent effect => excellent firms outperform
5. Neglected Firm Effect => firms followed by few analysts outperform - may be extension of small firm effect
6. Value Line Phenomenon => Stocks ranked 1 outperform those ranked 5
7. Book Value / Market Value Effect => high book value to market value outperforms

Question 26

What is Convexity and how does it work with Bonds?

Answer 26

1. For expected changes in rates of less than 1%, duration alone does a good job of explaining the expected change in bond price.
2. For changes in rates exceeding 1%, convexity must be considered.
3. The following graphic shows how convexity affects bond prices.
4. When rates fall, convexity causes the price increase to be greater than duration alone would indicate.

Question 27

What is the Random Walk Theory?

Answer 27

The random walk theory suggests that stock price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market cannot be used to predict its future movement. In short, this is the idea that stocks take a random and unpredictable path.

Price movements are not predictable, rather they are random.

Question 28

What are the 5 categories of Fundamental Analsyis Ratio Analysis?

Answer 28

1. liquidity (current ratio which is current assets/current liabilities)
   
   1. quick ratio is current assets minus inventory/current liabilities
2. activity (inventory turnover)
3. profitability (EBITDA, ROE, return on capital)
   
   1. focus on these
4. leverage (debt to equity)
5. financial statement

Question 29

What are Savings Bonds?

Answer 29

Series I Bonds - similar to TIPS

1. Similarities between TIPS and I Bonds
   
   1. Both offer protection from purchasing power risk.
   2. Both have no default risk, because they are U.S. Treasury guaranteed.
   3. Both reduce interest rate risk because of the inflation adjustments.
2. Features of Savings Bonds

Question 30

Eurodollar Bonds and Yankee Bonds

Answer 30

1. Both are priced in U.S. dollars
2. Eurodollar bonds are sold by U.S. firms outside the U.S. (such as GE issuing a bond in London)
3. Yankee bonds are issued by foreign firms and sold in the U.S., (such as British Airways selling a bond in the U.S.).

Question 31

Efficient Market Hypothesis (EMH) Weak Form?

Historical Prices (Technical Analysis) do not give predictive power of an underlying future price.

Public (earnings reports, financial statements, etc) may not be known to investors.

Private (new products, unnanounced earnings and legal issues) may not be known to investors.

Used as an argument against Technical Analysis

Answer 31

The Weak Form of the EMH argues that all new public information (earnings reports, financial statements, etc) and private information (new products, upcoming earnings, legal issues) may or may not be available to investors, and that only historical price information is. It suggests that all information is not incorporated in the current stock price. It’s used as an argument against technical analysis, and suggests that past price performance does not give predictive power on an underlying’s future price. In other words, a historical price chart can’t help predict an underlying’s future price.

Ex. Just because Transocean’s (ticker symbol RIG) stock price is at a 30 day low doesn’t mean the stock is more likely to go up or down in the future.

Fundamental Analysis ONLY works in the WEAK FORM

Question 32

Efficient Market Hypothesis (EMH) Semi-Strong Form?

Historical Prices (Technical Analysis) do not give predictive power of an underlying future price.

Public (earnings reports, financial statements, etc) information does not give predictive power of an underlying future price.

Private (new products, unnanounced earnings and legal issues) may not be known to investors.

Used as an argument against Fundamental Analysis

Answer 32

The Semi-Strong Form of the EMH argues that, in addition to the historical price data available in the weak form of EMH, public information about a company is available to investors and is incorporated into the current price of the stock. As information becomes publicly available, traders price the underlying immediately to reflect the new information. It’s used as an argument against fundamental analysis, and suggests that any public information does not give predictive power on an underlying’s future price. This means that performing fundamental analysis or watching the news can’t give traders a better ability to predict an underlying’s future price.

Ex. When a company releases earnings, we can watch the stock price change as the market digest the earnings information in after-hours trading.

Question 33

Efficient Market Hypothesis (EMH) Strong Form?

Historical Prices (Technical Analysis) do not give predictive power of an underlying future price.

Public (earnings reports, financial statements, etc) information does not give predictive power of an underlying future price.

Private (new products, unnanounced earnings and legal issues) information does not give predictive power of an underlying future price.

Used as an argument against Insider Information.

Answer 33

The Strong Form of the EMH argues that, in addition to the information in the weak and semi-strong forms, even non-public insider knowledge is factored into the current price of the stock. Even if the information is not available to investors, and is only known to corporate directors, the current stock price still reflects it. This means that even knowing insider information cannot improve price prediction leading to “abnormal profit over time.”

Ex. Private information that only a company’s CEO knows, like a new equity offering or revenue numbers, is encapsulated in stock prices.

Question 34

What is Mental Accounting Bias?

Answer 34

Mental accounting is creating different categories for assets, and treating one dollar differently from another.

Question 35

What is Anchoring Bias?

Answer 35

Anchoring is the tendency to hold onto certain beliefs even when faced with new information that should alter those beliefs.

Question 36

What is Confirmation Bias?

Answer 36

Confirmation bias is when investors search for and rely on information that supports their decisions, and essentially ignore information that contradicts or conflicts with their decision.

Question 37

What is Framing Bias?

Answer 37

Framing is looking at how a concept is presented to an individual, which can then influence their behavior.

Question 38

What is Endowment Bias?

Answer 38

Endowment is valuing something that one owns more than assets that are not owned.

Question 39

What is Self-Attribution Bias?

Answer 39

Self-attribution describes the tendency of individuals to take credit for their successes, and to blame others for their failures.

Question 40

What is Recency Bias?

Answer 40

Recency Bias is placing too much emphasis on recent events, rather than looking at the long-term objective and time frame.

Question 41

What is Hindsight Bias?

Answer 41

Hindsight bias is looking back in the past and believing that events that took place were more predictable than they really were.

Question 42

Step Transaction

Answer 42

Ignore the individual transaction and instead tax the ultimate transaction

Example: The XYZ Corporation sells property to an unrelated purchaser who subsequently resells the property to a wholly owned subsidiary of XYZ.

Question 43

Sham Transaction

Answer 43

A transaction that lacks a business purpose and economic substand will be ignored for tax purposes.

Example: A sale by XYZ to ABC, but both XYZ and ABC are owned by the same persons.

Question 44

What is FICA and What does FICA Stand for?

Answer 44

FICA taxes are the Social Security and Medicare taxes paid by individuals and employers. FICA taxes are called payroll taxes because they are based on the amounts paid to employees.

FICA taxes have two elements. withheld from employee paychecks and paid by employees and employers for (1) Social Security (OASDI) and (2) Medicare. This article gives you information about how to calculate FICA taxes, how to report and pay these taxes, what earnings are not part of FICA taxes, and more.

The term “FICA” is short for the Federal Insurance Contributions Act. The Act was introduced in the 1930s to pay for Social Security; Medicare was added later.

Question 45

What is OASDI and What does OASDI Stand for?

Answer 45

Within that 7.65%, the OASDI (Old Age, Survivors, and Disability program, AKA, Social Security) portion is 6.2% (5.7% is OA + 0.50% is SDI), up to the annual maximum wages subject to Social Security.

The Medicare portion is 1.45% for each employee, on all employee earnings.

The Social Security portion is capped each year at a set amount (2017 is $127,200); the Medicare portion is not capped.

Question 46

How much is the FICA Tax?

Answer 46

The total FICA tax is 15.3%. That percentage is applied to the employee’s gross pay.The employer and employee each pays 7.65%.

Here is the breakdown of these taxes:

Within that 7.65%, the OASDI (Old Age, Survivors, and Disability program, AKA, Social Security) portion is 6.2% (5.7% is OA + 0.50% is SDI), up to the annual maximum wages subject to Social Security.

The Medicare portion is 1.45% for each employee, on all employee earnings.

The Social Security portion is capped each year at a set amount (2017 is $127,200); the Medicare portion is not capped.

Question 47

Deductions FOR AGI? Deductions FOR AGI (use this and delete the other one)

Answer 47

Study Hint: I EMBRACED HITS

• I nterest from student loans paid for you, spouse or dependent ($2,500 AGI Phaseout on CFP handout)
• 1/2 self E mployment tax (Net Inc x 0.9235 = S/E Taxable Income, then take S/E Taxable Income x 0.1530 = S/E Total Tax, then take S/E Total Tax x 0.50 = 1/2 S/E Tax Deduction)
• M oving expenses for qualified job
• B usiness expenses (certain exp from reservists, performing artists and fee-basis govt officials)
• R ent, royalty, and pass through entities (ONLY Addition)
• A limony paid (recipient must include in Gross Income)
• C ontributions to S/E SEP, SIMPLE, Keogh and Qualified Plans
• E arly withdrawal savings & CDs penalty
• jury D uty fees paid to ER
• H ealth Savings Account (HSA) Deduction
• I RA Contribution (What for A/P and Phaseouts)
• T uition ONLY up to $4K or $2K or $0 (Subject to Phase out on CFP handout)
• S /E Health Insurance Deduction for medical and LTC

Question 48

Deductions FROM AGI (use this and delete the other one)

Answer 48

Study Hint: M M C C R I S T T T for Mother G Mary C C R I S T

• M edical expenses (10% AGI)
• G ambling losses deducted here => gains are added to Gross Income.
• M ortgage interest on primary and secondary residence (up to $1MM acquisition and $100K HELOC)
• C haritable contributions
• C asualty and theft losses
• R eal Estate Taxes and Personal Property Taxes like DMV Registration
• I nvestment interest expense
• S tate and Local Income Taxes Paid
• T ier II misc deductions over 2% of AGI
  
  • U nreimbursed Business Expenses
  • E xpenses incurred in “production of income”
  • E xpenses related to recovering tax collection liability

Question 49

What is 1231 Property?

Answer 49

1231 property, defined by section 1231 of the U.S. Internal Revenue Code, is real depreciable business property used in a trade or business or held for the production of income and held for over a year.

Section 1231 property includes buildings, machinery, land, timber and other natural resources, unharvested crops, cattle, livestock and leaseholds that are at least a year old, but does not include poultry, trademarks, or inventory

1231 gains and losses are subject to netting process. Look at 5 year lookback period immediately preceding the current tax year.

Question 50

What is Section 1245 Property?

Answer 50

• Section 1245 Property is any new or used tangible or intangible personal property that has been or could have been subject to depreciation or amortization. It is Personalty Property.
  
  • Examples of tangible personal property are machinery, vehicles, equipment, grain storage bins and silos, blast furnaces, and brick kilns.
  • Examples of intangible personal property are patents, copyrights and trademarks.
• Section 1245 property is NOT land or land improvement, nor its buildings or inherently permanent structures, nor its structural components.
  
  • Examples of property that is NOT personal property are land, buildings, walls, garages and HVAC.

Question 51

Is 1245 Recapture Personalty or Realty and how is it taxed?

Answer 51

1245 is recaptured Personalty

Final Sale is Above Original Cost Basis is 1231 gain and taxed at LTCG

Final Sale Between Original Cost and Adjusted Basis is 1245 Income and taxed at Ordinary Income

Final sale Below A is 1231 loss and taxed as Ordinary Loss

Question 52

Is 1250 Unrecapture Personalty or Realty and how is it taxed?

Answer 52

1250 is unrecaptured Realty

Final Sale is Above Original Cost Basis is 1231 gain and taxed at LTCG (15%-20%)

Final Sale Between Original Cost and Adjusted Basis is 1250 which takes on 1231 Income tax rates and taxed at max 25% LTCG rate

Final sale Below A is 1231 loss and taxed as Ordinary Loss

Question 53

What is Section 1250?

Answer 53

Section 1250 is a section of the United States Internal Revenue Service Code that states that a gain from selling real property that has been depreciated should be taxed as ordinary income, to the extent that the accumulated depreciation exceeds the depreciation calculated using the straight-line method.

Section 1250 bases the amount of tax due on the type of property, such as residential or nonresidential property, and on how many months the property was owned.

Question 54

What is Boot?

Answer 54

1. Boot is anything that is not qualified, like-kind property—cash, NET debt relief, or other nonqualifying property.
2. If a taxpayer is relieved of a mortgage liability due to the like-kind exchange, such relief is treated as a receipt of cash by the taxpayer and, as such, is treated as boot.
3. If the taxpayer assumes and is relieved of a mortgage liability, only the net debt relief is considered to be boot.

Question 55

What is Section 179?

Answer 55

It is a depreciaiton method that allows business owners the right to depreciate Personalty (such as Autos, Trucks, Cars, Computer equipment and software) Not Realty, in the year of the purchase instead of using another depreciation method like MACRS. The limit for 2017 is $510,000.

Essentially, Section 179 of the IRS tax code allows businesses to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year. That means that if you buy (or lease) a piece of qualifying equipment, you can deduct the FULL PURCHASE PRICE from your gross income. It’s an incentive created by the U.S. government to encourage businesses to buy equipment and invest in themselves.

Question 56

Joint Tenancy with Rights of Survivorship

(JTWROS)

Answer 56

• Property can be held by husband and wife, parent and child or children, siblings and business partners
• Control, ownership and enjoyment shared equally by all joint tenants
• Upon death of each tenant, property immediately passes to surviving joint tenants in equal shares.
• Property NOT controlled by terms of the will
• Avoids probate
• Only one-half the value of qualified spousal property held gets a step up in basis

Question 57

Tenancy by the Entirety

Answer 57

• Ownership can only be held by a husband and wife
• Transfer of property can only occur with the mutual consent of both parties
• In most states, property is protected from the claims of each spouse’s separate creditors, but NOT protected from the claims of both spouse’s joint creditors
• Avoids probate
• Only one-half the value of qualified spousal property held gets a step up in basis

Question 58

Tenancy in Common

Answer 58

• Two or more owners each own an undivided interest in the property
• Any income is distributed according to each owner’s respective share in the property
• Owners are free to transfer their respective share of the property to other individuals
• Ownership stake goes through probate upon death
• TIC property receives a step up in basis depending on the ownership interest percentage of the decedent.

Question 59

What is fee simple ownership?

Answer 59

Absolute ownership and control by one individual in life and in death.

Question 60

What is a Power of Appointment?

Answer 60

A power of appointment is a power to dispose of property.

The power can be as broad or limited as the creator desires depending on whether the creator chooses to give general power of appointment or special powers of appointment.

A power of appointment can also be presently exercised or postponed until a specified event occurs or a condition is met.

Question 61

What is a life estate?

Answer 61

In common law and statutory law, a life estate is the ownership of land for the duration of a person’s life. In legal terms, it is an estate in real property that ends at death when ownership of the property may revert to the original owner, or it may pass to another person.

Question 62

Community Property

Answer 62

• Ownership can only be held by a husband and wife
• Each spouse has 1/2 interest in most property acquired during marriage regardless of title.
• Property controlled by terms of the will.
• Does not Avoid Probate
• Full value of qualified spousal property held gets a Full step up in basis, not 1/2 like other JTWROS, TIE, etc.

Question 63

Per Stirpes vs. Per Capita

Answer 63

Per Stirpes: Per Class or Per stripe. If you have 3 kids - son1, son2, son3. Son1 dies and Son3 dies, then his son 2 gets 1/3 and Son1 kids split his 1/3 share and Son3 kids split his 1/3 share.

Per Capita: By total headcount per generation. If you have 3 kids - son1, son2, son3. Son1 dies and Son3 dies, the son2 get his 1/3 while son1’s 2 kids split the remaining share with son3 kid.

Question 64

What is a direct skip?

Answer 64

1. Only skip parties have a current beneficial interest in the transferred property, and in which no nonskip party has any interest.
2. GSTT in addition to gift or estate tax, reported on same return, and due at the same time

Example: Derrick’s grandfather placed $50,000 in an irrevocable trust of which Derrick was the sole income and remainder beneficiary. Both of Derrick’s parents were alive at the time of the completed transfer.

Question 65

What is an Indirect Skip?

Answer 65

1. At least one non-skip party has a current beneficial interest in the property after the transfer; and at least one skip party must have an interest in the transferred property.
2. GSTT in addition to gift or estate tax, and will be reported on same return, but tax will not be due at the same time.
3. GSTT will be due upon taxable termination or distribution.

Example: Derrick’s grandfather placed $500,000 in an irrevocable trust of which Derrick (skip) was the 10 year income beneficiary and Derrick’s parents were the remainder beneficiaries. Both of Derrick’s parents (non-skip) were alive at the time of the completed transfer.

Question 66

What are Charitable Remainder Trusts?

Answer 66

1. Decedent gives qualified charity a vested remainder interest
   
   1. Charitable deduction for present value of remainder interest
2. Decedent names noncharitable beneficiary to receive income interest
   
   1. If beneficiary is the spouse => marital deduction for present value of income interest
   2. If beneficiary is nonspouse => tax will be due on present value of income interest
   3. Income interest must be an annuity (CRAT—% of initial FMV of trust assets) or unitrust (CRUT—% of net FMV of trust assets valued annually) amount
   4. Income interest may last for up to 20 years or for a life in being

Question 67

What are Charitable Lead Trusts?

Answer 67

1. Income interest given to qualified charity for period of years or life in being
   
   1. Income interest must be a unitrust (CLUT) or annuity (CLAT) amount
   2. Charitable deduction for present value of income interest
   3. Grantor is entitled to income tax charitable deduction for inter vivos CLT only if grantor pays income tax on trust income—i.e., trust is a grantor trust
2. Remainder interest given to noncharitable beneficiary
   
   1. if beneficiary is the spouse => marital deduction for present value of remainder interest
   2. if beneficiary is nonspouse => tax will be owed for present value of remainder interest

Question 68

What is the beneficial interest classes retained in a Grantor Retained Trust?

Answer 68

1. Property is given to an irrevocable inter vivos trust to last for a term certain
   
   1. Grantor retain a beneficial interest:
      
      1. All income from trust assets (GRIT),
      2. An annuity interest (GRAT),
      3. A unitrust interest (GRUT), and
      4. The right to use a personal residence (QPRT). Qualified Personal Residence Trust

Question 69

What is a Grantor Retained Trust?

Answer 69

1. Property is given to an irrevocable inter vivos trust to last for a term certain
   
   1. Grantor retain a beneficial interest:
      
      1. All income from trust assets (GRIT),
      2. An annuity interest (GRAT),
      3. A unitrust interest (GRUT), and
      4. The right to use a personal residence (QPRT).
2. Remainder interest is given to beneficiaries specified by the grantor
3. Removes assets from grantor’s gross estate while allowing grantor to retain benefit of the asset during trust term as long as grantor lives longer than the term. If grantor dies during term then the assets are included in his/her gross estate.
4. Grantor is taxed on income of interest retained
   
   1. Excess income, if any, is accumulated and taxed to the trust.
5. Transfer to a related family member (Section 2702 Chapter 14 Rules)
   
   1. Gift tax due on FMV of trust property, less the present value of the retained interest
      
      1. Exception: FMV of all property given to a GRIT (non-qualified interest) is subject to gift tax
      2. QPRTs are expressly exempt from Chapter 14 rules
         
         1. Asset is removed from grantor’s gross estate unless grantor dies during trust term, in which event Section 2036 requires inclusion.

The grantor’s death during the term of any type of grantor retained interest trust (GRIT, GRAT, GRUT, or QPRT) will cause the date-of-death fair market value of trust assets to be included in his or her gross estate because of the retained interest.

Question 70

What is the QTIP Election

Answer 70

It allows the surviving spouse to get a marital deduction on assets that would be split into a marital A Trust.

The property within the QTIP providing funds to a surviving spouse qualifies for marital deductions, meaning the value of the trust is not taxable after the first spouse’s death. Instead, the property becomes taxable after the second spouse’s death, with liability transferring to the named beneficiaries of the assets within the trust.

Question 71

Summary of Qualified Plan Characteristics in 2017 Chart?

Answer 71

Question 72

What type of plan favors older EE’s?

Answer 72

Defined Benefit Plan - why?

Target Benefit Plan - why?

Question 73

What type of plan favors younger EE’s?

Answer 73

PSP/Stock Bonus

MPP - why?

CBP - average salary ONLY

Question 74

What is the most appropriate Qualified Plan to meet the objective

Answer 74

Question 75

Selecting the most appropriate plan. Start with DC or DB?

Answer 75

1. Choosing the right plan means aligning the objectives of the owner and/or company with the possibilities presented by the company’s financial situation, the employee census, and the owner’s age and income relative to the other employees.
2. Objectives include the following:
   
   1. personal—i.e., lowering personal taxes or reaching the retirement goal
   2. business— i.e., lowering business taxes or enhancing recruiting and retention
   3. altruistic motivation— i.e., a retirement income for employees /
   4. savings need
   5. business maturity/performance
3. Factors to be considered include
   1. cost of compliance.
   2. cost of funding the plan and financial stability of the business,
   3. willingness to shoulder the administrative burden and cost,
   4. business outlook, and
   5. The employee census and how the owner fits within it.

Question 76

Points to remember when selecting the most appropriate plan?

Answer 76

1. If profits are volatile, the only choices are SEP or profit sharing plans.
   
   1. Choose the SEP if there are no part-time employees, and choose the profit sharing plan if there are part-time employees.
   2. Where the owner is concerned about compliance or the cost of compliance and doesn’t need or want to contribute more than $12,500, plus a maximum of 3% of participant’s pay, choose the SIMPLE IRA. There is no top-heavy test, 415 compliance, ADP/ACP or government reporting. The plan is one with minimal administration cost.