Unit 1

Question 1

The amount paid into a defined contribution plan is set by

Answer 1

The trust agreement

A defined contribution plan’s trust agreement contains a section explaining the formula(s) used to determine the contributions to the retirement plan.

Question 2

Which of the following would not be eligible for a tax-sheltered 403(b) annuity?

Answer 2

Student at a private college

All of the individuals listed meet the requirement of being a school system employee except for the student, who is a client—rather than an employee—of the school system.

Question 3

Which of the following securities is the least suitable recommendation for a qualified retirement account plan account?

A) Investment-grade municipal bond
B) Blue-chip common stock
C) Treasury bill
D) A-rated corporate bond

Answer 3

A) Investment-grade municipal bond

Municipal bonds provide tax-exempt interest payments and, consequently, offer lower yields. Because earnings in a qualified retirement plan account grow tax deferred, the municipal bond is not a suitable investment. In addition, they will be fully taxed upon withdrawal.

Question 4

Dale Wells, a British citizen temporarily working in the United States, wants to form a business venture with other investors. Wells is looking for favorable tax treatment of earnings and losses. Wells also wants to limit the number of investors but is willing to share control of the enterprise with others to attract them. What business form would you advise?

Answer 4

General partnership

Limited partnerships would not work because the other investors have limited say in how the enterprise is run. C corporations do not provide favorable tax treatment of gains or losses. Although an S corporation appears to be the right answer, only U.S. citizens or resident aliens can own one.

Question 5

If your 50-year-old client wants to withdraw funds from her traditional IRA, the early withdrawal will be taxed as

Answer 5

ordinary income plus a 10% penalty.

An early withdrawal from an IRA is taxed as ordinary income plus a 10% penalty.

Question 6

Compared to defined contribution plans, defined benefit plans give the highest return to employees who

I. are highly compensated.
II. receive lower compensation.
III. have fewer years until retirement.
IV. have many years left until retirement.

Answer 6

I and III

Highly compensated employees who have fewer years until retirement will experience advantages over other employees with this type of plan. Their retirement benefits are predefined and generally linked to the compensation level they attained while employed. After a short time with the company, a person may qualify for benefits comparable to those it would have taken many years to attain under a defined contribution plan.

Question 7

If three individuals open up a joint account with your firm, and one of the parties to the account possesses written authorization from the other parties granting her authority to make all trading decisions, the new account form must contain information on

Answer 7

all three individuals.

Information is required for all three individuals because they all have ownership in the account.

Question 8

The type of brokerage account that does not pass assets to other participants at the death of a participant is

Answer 8

tenants in common.

At the death of a participant in a tenants in common account, the decedent’s assets do not pass to the other members. Rather, they pass to the estate of the deceased. With JTWROS, at the death of a participant, the assets are distributed equally to the surviving members. In those states where community property is the law, upon the death of a spouse, the assets in the account generally pass to the surviving spouse. Transfer on death is simply a designation that allows an account to avoid probate court. It is not available with tenancy in common.

Question 9

Payments received by the owner of a 403(b) plan are
A) taxable only to extent of the owner’s cost basis.
B) taxable only to extent of earnings.
C) not taxable.
D) 100% taxable.

Answer 9

D) 100% taxable.

When tax-sheltered annuity funds are withdrawn, they are fully taxed at ordinary income rates. Funds were contributed pretax and earnings accumulate tax deferred. Because no taxes were ever paid, the full withdrawal is taxable.

Question 10

All of the following people could open a joint account except

Answer 10

a father and 10-year-old son.

Joint accounts can only be opened between adults.

Question 11

A corporation wishes to set up a retirement plan that will cover only certain executives. Which of the following would be appropriate?

Answer 11

A deferred compensation plan

The key to this question is that the company wishes to discriminate and only cover some employees. That means a non-qualified plan such as deferred compensation. Isn’t a Section 457 plan also technically non-qualified? Yes, but those are not available for corporations.

Question 12

All of the following must be verified or determined about a new customer except

Answer 12

whether she has a brokerage account at another broker-dealer.

Though individual firms may require it, there is no industry requirement to verify or determine that a customer has an account at another broker-dealer.

Question 13

An employee of a FINRA member firm wishes to open an account at another member firm. The employee opening the account must

Answer 13

receive prior written consent from his employer.

Persons associated with one FINRA member firm may open securities accounts at other member firms, as long as prior written notice was made to, and prior written consent was received from, the employing broker-dealer before the account is opened. Neither notification nor consent is required from FINRA or the SEC.

Question 14

Designating a beneficiary with a transfer on death (TOD) provision may be done in which of the following accounts?

Answer 14

Individual account and joint tenants with right of survivorship (JTWROS)

The TOD designation is limited to the individual account and the JTWROS account.

Question 15

An employee not covered under his company’s pension plan has been contributing to a traditional IRA for five years. If he leaves his current job, starts a new job, and is covered under the new corporation’s pension plan, which of the following statements is true?

Answer 15

Contributions to his traditional IRA may continue.

An employee covered under a qualified retirement plan may continue to own and contribute to an IRA. The contributions to a traditional IRA may not be fully tax deductible, depending on the amount of compensation earned, but the employee benefits from the tax deferral of IRA earnings.

Question 16

Prime brokerage accounts are most often used by

A) broker-dealers.
B) investment bankers.
C) investment advisers.
D) Institutions.

Answer 16

Institutions.

Although any of these could use prime brokerage accounts, their primary users are institutional investors.

Question 17

When an investor opens a new account at a member firm, FINRA rules require

Answer 17

the signature of the principal signifying that the account has been accepted.

The only signature required on the new account form for an individual client is the signature of the partner, officer, or manager (a registered principal) denoting that the account has been accepted in accordance with the member’s policies and procedures for acceptance of accounts. It is the customer identification program (CIP) that requires the date of birth and Social Security or tax ID number. All FINRA requires is a statement that the applicant is of legal age. FINRA states that each member shall also make reasonable efforts to obtain, prior to the settlement of the initial transaction in the account, the applicant’s Social Security or tax ID number. Please notice that the question is differentiating between what is “need to know” and what is “nice to know.”

Question 18

A new client turns in the new account form. While reviewing the information on the form, the registered representative handling the account notices that the space for listing the Social Security number is blank. Under the provisions of the USA PATRIOT Act of 2001,

Answer 18

the account cannot be opened until the number has been received.

The customer identification program (CIP), a part of the USA PATRIOT Act of 2001, requires a Social Security or tax identification number included on the new account form. The firm can open the account if the number has been applied for. In this instance, the firm must obtain the number within a reasonable period and the account card must be marked applied for.

Question 19

Which of the following employer-sponsored plans is not required to meet the nondiscrimination provisions of ERISA?

Answer 19

Deferred compensation plans

Deferred compensation plans, by design, are nonqualified and not subject to ERISA. Therefore, they may discriminate as to who may participate. In any question on the exam, a qualified plan sponsored by a business will most likely have to comply with ERISA.

Question 20

An incorporated business model that allows flow-through of business income and losses directly to shareholders in order to avoid double taxation is

Answer 20

an S corporation.

The S corporation, the general partnership, and the limited partnership are business models where all income or loss flows through to the owners. This avoids the double taxation on the business level and owner level, as is the case with the C corporation. With C corporations, corporate earnings taxed once at the business level and again when they are paid out to shareholders as dividends. Because the question is asking about the incorporated business model, the correct choice is the S corporation.

Question 21

Which of the following business structures will generally have the fewest number of owners?

Answer 21

A sole proprietorship

A sole proprietorship has only one owner. That is what the “sole” means. Although S corporations and LLCs can be formed with a single shareholder or member, that would be the exception rather than the rule. A partnership needs at least two persons.

Question 22

Features of an employee stock purchase program (ESPP) include all of the following except

Answer 22

contributions are made with pre-tax dollars.

Employee stock purchase plans (ESPPs) are not qualified plans. That means that the employee purchases the stock with after-tax dollars. For example, an individual has a monthly salary of $5,000 and elects to contribute 10% of gross salary to the plan. The employer will take $500 per month out of the paycheck after subtracting withholding tax and Social Security contributions and any other deductions. Before enrolling in the plan, this employee’s monthly take-home pay might have been $3,700. Now it will be $3,200.

Question 23

A customer who has just started an IRA will be vested

Answer 23

immediately.

Investors are always vested immediately in their IRAs.

Question 24

Buying municipal bonds would normally not be considered suitable for

Answer 24

a defined benefit plan portfolio

A defined benefit plan is a form of qualified tax-deferred corporate pension plan. Tax-free municipal bonds would never be considered suitable for a tax-deferred account on the exam. An individual investor, a mutual fund portfolio, and a corporate investment account could benefit from receiving tax-free municipal bond interest.

Question 25

Which of the following activities are disallowed under FINRA rules?

I. Opening an account for a 16-year-old individual
II. Accepting a sale in a joint account from one of the owners and having the check payable in the name of that individual
III. Accepting a sale order from the husband only in a joint account owned by both husband and wife
IV. Requiring written discretionary authorization before accepting orders for a discretionary account

Answer 25

I and II

The question is asking for the nonallowable practices. We cannot open an account for a minor, nor may we make a check payable to only one of the parties in a joint account.

Question 26

Which of the following permits the highest annual contributions?

Answer 26

A SEP IRA

Under most circumstances, the annual contribution to a SEP IRA will be higher than those allowed for education savings accounts or traditional or Roth IRAs.

Question 27

All of the following statements about SEP IRAs are true except

Answer 27

there are no minimum earning requirements to be an eligible participant.

Eligibility to participate in a SEP IRA is limited to employees who have earned a minimum of $600 for the year in question.

Question 28

An unmarried couple wants to open a new account registered as joint tenants with rights of survivorship (JTWROS). Which of the following should occur?

I. The registered representative should discuss the resulting consequences of opening an account registered as JTWROS, should one party to the account die.
II. A principal of the firm should be notified immediately so that a report can be filed with FINRA regarding the account registration.
III. The registered representative must refuse to open the account.
IV. The registered representative may open the account.

Answer 28

I and IV

In an account registered as JTWROS, if one party to the account dies, the deceased party’s ownership interest in the account passes to the surviving tenant, rather than to the deceased party’s estate. There are no rules prohibiting opening an account registered as JTWROS for two unmarried persons, but the registered representative should take all steps needed to be certain that the unmarried individuals understand the resulting consequences should one party to the account die.

Question 29

Which of the following are qualified plans?

I. Payroll deduction
II. Deferred compensation
III. Defined benefit
IV. Defined contribution

Answer 29

III and IV

Defined benefit and defined contribution plans are funded with pretax contributions, and are thus qualified plans. Payroll deduction and deferred compensation plans are funded with after-tax contributions and thus are nonqualified plans.

Question 30

For individual retirement accounts, the IRS mandates that if distributions do not begin by April 1 of the year after the individual turns age 72, a 50% insufficient distribution penalty applies. The amount to be withdrawn each year is based on IRS life expectancy tables. These IRA distribution concepts are known as

I. a required beginning date (RBD).
II. a required minimum distribution (RMD).
III. lockup provisions.
IV. vesting.

Answer 30

I and II

For individual retirement accounts, the IRS mandates that distributions must begin by April 1 of the year after the individual turns age 72. This is known as the RBD. The amount to be withdrawn each year is based on IRS life expectancy tables. This is known as the RMD.

Question 31

When an account is owned by an individual who is 65 years old or older, or the client is 18 years old or older and a member firm believes the client has an impairment that prevents the person from defending their interests, a temporary hold is permitted on disbursements for how many days if the firm comes to reasonably believe that an attempt at exploiting the person has been made?

Answer 31

15 business days

FINRA Rule 2165 permits firms to place a temporary hold of 15 business days on disbursements from the accounts of individuals aged 65 or older and individuals aged 18 or older whom firms reasonably believe have an impairment that prevents them from protecting their own interests (a specified adult). This is done if the firm has a reasonable belief that financial exploitation of the specified adult has occurred or been attempted. This gives the firm time to notify a trusted contact person and begin an internal review.

Question 32

The owner of an IRA, age 45, has contributed $10,000 into the account and the IRA is now worth $20,000. The owner is going to convert the entire $20,000 into a Roth IRA. What are the tax consequences of this conversion?

Answer 32

The $20,000 is taxable as ordinary income in the year of the conversion.

When converting from a traditional IRA to a Roth IRA, the distribution is all taxed as ordinary income in the year of the conversion. There is no 10% tax penalty if the conversion is done prior to age 59½.

Question 33

In an account opened by two individuals as joint tenants with right of survivorship, all of the following are true except

Answer 33

stock certificates may be delivered in the name of either party.

In a JTWROS account, each party has an equal, undivided interest in the account. Upon the death of one party in a two-party account, the other party assumes full ownership of the account. Orders may be entered by either party, and mail may be directed to either party. However, disbursements of cash or securities must be in the name of all parties to the account.

Question 34

Greater Growth Capital (GGC), a FINRA member firm, has just been acquired by Better Retirement Outcomes (BRO), a much larger FINRA member. If GGC would like to effect a bulk transfer of its customer accounts using a negative consent procedure, FINRA rules

Answer 34

prohibit GGC from charging a fee to any existing GGC customers who decide to transfer their accounts to a different firm.

In the case of a bulk transfer, such as when a member firm is acquired by another member, some customers may wish to opt out of the transfer. In those cases, it is prohibited for them to be charged any fees for transferring their accounts to another member firm. This is true only if the customer opts out during the allowable time period, which is 30 calendar days, not 60. The FINRA rule permits negative consent as long as the requirements are met.

Question 35

If two customers are tenants in common in a joint account, which of the following statements are true?

I. If one of the tenants dies, the survivor will automatically assume full ownership.
II. They need not make equal investments in the account.
III. They need not have equal interests in the property in the account.
IV. If one of the tenants dies, the account need not be frozen.

Answer 35

II and III

Under tenants in common, the tenants may make unequal investments in the account and may own a disproportionate interest in the property in the account. If one of the tenants dies, their assets are passed to their estate, not to the surviving joint tenant. The account must be frozen until this is carried out.

Question 36

Under ERISA, all of the following retirement plans must set standards for vesting, eligibility, and funding except

Answer 36

deferred compensation plans.

Deferred compensation plans are not qualified plans and may be discriminatory. Keogh, profit-sharing, and corporate pension plans must meet set standards for vesting, eligibility, and funding under ERISA.

Question 37

A customer asks your advice regarding a deferred compensation plan at work. You should state that

Answer 37

deferred compensation plans may be somewhat risky because the employee covered by the plan becomes a general creditor if the business fails.

If the business fails, the employee can lose everything they put in the plan. The participant will become a general creditor of the company and will be on the same level as unsecured bondholders in the liquidation priority.

Question 38

o comply with the regulations regarding customer identification programs, the minimum identifying information that must be obtained from each customer before opening an account includes which of the following?

I. Their name
II. Oral assurance that the customer is of legal age
III. A street address, unless the primary mailing address is a post office box located in the state of residence
IV. A taxpayer identification number

Answer 38

I and IV

Oral assurance that the customer is of legal age is not sufficient; the actual date of birth must be obtained. A post office box is never acceptable without a physical address. In addition, the identity of the person opening the account must be verified through documentation such as an unexpired drivers license or passport.

Question 39

All of the following securities would be suitable investments for a traditional IRA except

Answer 39

AAA rated municipal bonds.

Municipal bonds, which generate tax-free interest income, are unsuitable for retirement plans. One loses the federally tax-free income at distribution.

Question 40

One of the major concerns of the regulatory bodies is the growing problem of senior exploitation. To combat this issue, at the time of an account opening, whether margin or cash, a member firm must disclose in writing that the member or an associated person is

Answer 40

authorized to contact the trusted contact person provided on the new account form by the customer and to disclose information about the customer’s account in addressing possible exploitation.

Member firms must obtain the name and contact information for a trusted contact person who is 18 or older. This person may be contacted about the customer’s account. This is required for retail but not institutional accounts. At the time of the account opening, the member firm must disclose in writing to the customer that the member or an associated person is authorized to contact the trusted contact person. Contacting is done to disclose information about the customer’s account to address possible exploitation. The absence of the name and contact information for a trusted contact person does not prevent a member from opening or maintaining an account for a customer, as long as the member makes a reasonable effort to obtain this information.

Question 41

Your customer, age 60, is retired and living at home with a fully paid-off mortgage. Her portfolio contains growth stocks and high-quality bonds, and she is a long-time investor and comfortable with moderate risk. Her objective is a moderate level of current income to supplement her corporate pension plan distributions and the earnings from her traditional IRA. How are the distributions taxed from her IRA?

Answer 41

All taxable distributions from a traditional IRA are taxed as ordinary income.

All taxable distributions from a retirement account, including IRAs, are taxed as ordinary income, not capital gains.

Question 42

When a customer, who is at least 59½, withdraws money from a traditional IRA that has been funded totally with deductible contributions,

Answer 42

the entire amount withdrawn is subject to taxation at ordinary income tax rates.

All withdrawals from a traditional IRA that has been funded with pretax contributions are subject to taxation at ordinary income tax rates. There is no 10% penalty once the account holder has reached age 59½.

Question 43

Perhaps the most important thing to understand when a business is organized as a sole proprietorship is that

Answer 43

the owner is liable for all the debts of the business.

The most important characteristic to understand as a sole proprietor is that you are responsible if the business liquidates and, therefore, you could lose everything.

Question 44

One concern that FINRA has with fee-based accounts is that they might lead to

Answer 44

reverse churning.

Churning is the practice of over-trading an account, resulting in higher commissions. Reverse churning occurs when a client in a fee-based account pays more in fees than would be paid in a commission-based account. This is generally the case when the customer trades infrequently.

Question 45

One of your existing clients wishes to open a new account in the name of his spouse and enter orders on her behalf. Which of the following statements is true?

Answer 45

This action is prohibited unless the spouse signs a trading authorization.

Effecting transactions without specific written authority from the beneficial owner of the account is prohibited. This customer cannot sign a trading authorization on behalf of his spouse. The spouse must sign the authorization.

Question 46

Your customer has contributed $1,000 annually into her Roth IRA for seven years. Which of the following statements concerning her Roth IRA distributions is true?

Answer 46

She will not be taxed on the distributions if she is over age 59½ and the money has been held in the account for five years beginning with the first tax year for which a contribution was made to any Roth IRA established for her.

Distributions from Roth IRAs made after age 59½ are tax free if the money was in the account for five years beginning with the first tax year for which a contribution was made to any Roth IRA established for the individual. Contributions to Roth IRAs are made with after-tax dollars.

Question 47

If an investor wishes to open a cash account in her name only and allow her spouse to make trading decisions as well as withdraw cash and securities, she must instruct her broker-dealer to open

Answer 47

a cash account with full power of attorney.

For a person other than the account owner to be able to withdraw assets, a full power of attorney is required. A limited power of attorney allows someone other than the account owner to trade in the account, but not to withdraw assets.