FiCEP Investment and Retirement Basics 5 — Questions and Answers
Question 1: A client receives a pension from a former employer. Under the 'General Rule,' how is a portion of each pension payment treated for tax purposes?
- The entire payment is always tax-free
- A pro-rata portion representing after-tax contributions is tax-free; the rest is taxable (Correct answer)
- Only employer contributions are taxable
- Pension payments are taxed entirely as capital gains
Correct answer: A pro-rata portion representing after-tax contributions is tax-free; the rest is taxable
Under the General Rule, the portion of each pension payment that represents the retiree's after-tax investment (cost basis) is tax-free; the remainder is ordinary income.
Question 2: Which retirement account type allows individuals who are self-employed to contribute both as an employer and as an employee?
- Traditional IRA
- SIMPLE IRA
- Solo 401(k) (Correct answer)
- 457(b) plan
Correct answer: Solo 401(k)
A Solo 401(k), also called an Individual 401(k), allows self-employed individuals to make both employee elective deferrals and employer profit-sharing contributions, maximizing annual contribution limits.
Question 3: An investor holds a bond paying 5% annually. If market interest rates rise to 7%, what happens to the market price of the existing bond?
- The bond price increases
- The bond price remains unchanged
- The bond price decreases (Correct answer)
- The bond is automatically called by the issuer
Correct answer: The bond price decreases
Bond prices and interest rates move inversely; when rates rise above a bond's coupon rate, the bond's market price falls so its yield becomes competitive.
Question 4: What is 'sequence of returns risk' in retirement planning?
- The risk that inflation will outpace investment returns
- The risk that poor investment returns early in retirement can permanently deplete a portfolio (Correct answer)
- The risk of outliving Social Security benefits
- The risk that bond yields will fall below dividend yields
Correct answer: The risk that poor investment returns early in retirement can permanently deplete a portfolio
Sequence of returns risk refers to the danger that negative returns occurring early in retirement, combined with ongoing withdrawals, can severely reduce portfolio longevity even if long-term average returns are adequate.
Question 5: A client's employer matches 50% of 401(k) contributions up to 6% of salary. The client earns $60,000 annually. What is the maximum employer match the client can receive per year?
- $1,800 (Correct answer)
- $3,600
- $1,500
- $3,000
Correct answer: $1,800
6% of $60,000 = $3,600 in employee contributions; the employer matches 50% of that, which equals $1,800 per year.
Question 6: Which of the following is an example of a 'defined benefit' retirement plan?
- 401(k) plan
- Traditional pension plan (Correct answer)
- SEP-IRA
- Roth 403(b)
Correct answer: Traditional pension plan
A traditional pension plan is a defined benefit plan because the employer promises a specific monthly benefit at retirement based on salary history and years of service.
Question 7: Under the SECURE Act, what is the age at which required minimum distributions (RMDs) from traditional IRAs must generally begin (for individuals born in 1951 or later)?
- 70½
- 72
- 73 (Correct answer)
- 75
Correct answer: 73
The SECURE 2.0 Act (2022) increased the RMD starting age to 73 for individuals born between 1951 and 1959, and to 75 for those born in 1960 or later.
FiCEP Investment and Retirement Basics 5
A client receives a pension from a former employer.
Under the 'General Rule,' how is a portion of each pension payment treated for tax purposes?