Retirement & Estate Planning Fundamentals Flashcards

What is the primary purpose of a 401(k) retirement plan?

Answer: To save for retirement

A 401(k) is an employer-sponsored retirement savings plan that allows employees to contribute a portion of their pre-tax salary to an investment account. Contributions and earnings grow tax-deferred until withdrawal in retirement. Its primary purpose is to help individuals save and invest for their financial future after they stop working, often with employer matching contributions.

Which type of IRA allows for tax-free withdrawals in retirement?

Answer: Roth IRA

Roth IRAs are funded with after-tax contributions, meaning the money grows tax-free, and qualified withdrawals in retirement are also tax-free. This contrasts with Traditional IRAs, where contributions are often tax-deductible, but withdrawals in retirement are taxed. The key benefit of a Roth IRA is the tax-free income stream it provides in retirement.

What is the purpose of a will in estate planning?

Answer: To name beneficiaries and asset distribution

A will is a legal document that outlines how an individual's assets should be distributed after their death. It allows the testator to name specific beneficiaries for their property and appoint an executor to manage the estate. Without a will, assets are distributed according to state intestacy laws, which may not align with the deceased's wishes.

Which document appoints someone to manage financial affairs if you're incapacitated?

Answer: Durable power of attorney

A durable power of attorney is a legal document that grants a designated agent the authority to make financial decisions on your behalf. This power remains in effect even if you become incapacitated, ensuring your financial affairs can be managed without interruption. It is a crucial component of comprehensive estate planning.

What is the main advantage of a trust in estate planning?

Answer: Avoid probate

A trust is a legal arrangement where assets are held by a trustee for the benefit of beneficiaries. Unlike a will, assets held in a trust typically bypass the probate process, which is the court-supervised validation of a will and distribution of assets. Avoiding probate can save time, money, and maintain privacy for the beneficiaries.

When should retirement planning ideally begin?

Answer: As early as possible

Retirement planning benefits significantly from the power of compound interest, where earnings on investments also earn returns over time. Starting early allows more time for investments to grow, even with smaller initial contributions. Delaying planning means needing to save much more later to reach the same financial goals.