STEP Financial Analysis & Planning 2 — Questions and Answers
Question 1: A trust holds a portfolio with a 60/40 equity-to-bond allocation. After a strong equity rally, the allocation shifts to 72/28. What action best restores the target allocation?
- Sell equities and reinvest proceeds into bonds (Correct answer)
- Buy additional equities to match the new weighting
- Liquidate the entire portfolio and rebuild
- Transfer all bond proceeds to a money market fund
Correct answer: Sell equities and reinvest proceeds into bonds
Rebalancing requires selling the over-weighted asset class (equities) and purchasing the under-weighted class (bonds) to restore the target allocation.
Question 2: When calculating a beneficiary's required minimum distribution (RMD) from an inherited IRA under the SECURE 2.0 Act, which rule generally applies to non-spouse adult beneficiaries?
- 5-year rule requiring full withdrawal by end of year 5
- 10-year rule requiring full withdrawal by end of year 10 (Correct answer)
- Life expectancy payments over the beneficiary's lifetime
- Single lump-sum distribution in the year of inheritance
Correct answer: 10-year rule requiring full withdrawal by end of year 10
Under the SECURE 2.0 Act, most non-spouse adult beneficiaries must fully withdraw inherited IRA assets within 10 years of the original owner's death.
Question 3: A STEP practitioner is evaluating the internal rate of return (IRR) of a real estate investment held in a family trust. The IRR is best described as:
- The annual appreciation rate of the property
- The discount rate that makes the net present value of all cash flows equal to zero (Correct answer)
- The cap rate divided by total acquisition cost
- The ratio of net operating income to total debt service
Correct answer: The discount rate that makes the net present value of all cash flows equal to zero
IRR is the discount rate at which the NPV of all cash inflows and outflows equals zero, reflecting the investment's true annualized return.
Question 4: A trustee holds a portfolio with a modified duration of 7. If interest rates rise by 1%, what is the approximate change in the bond portfolio's value?
- Increases by 7%
- Decreases by 7% (Correct answer)
- Decreases by 1%
- Increases by 1%
Correct answer: Decreases by 7%
Modified duration measures price sensitivity: a 1% rise in rates causes a portfolio decline approximately equal to its modified duration percentage, so the value falls by about 7%.
Question 5: A grantor trust's income is taxed to the grantor because:
- The trust pays no federal income tax under any circumstances
- The grantor retains certain powers or benefits that cause the trust to be disregarded for income tax purposes (Correct answer)
- All irrevocable trusts are grantor trusts by default
- Beneficiaries elect grantor trust status on their personal returns
Correct answer: The grantor retains certain powers or benefits that cause the trust to be disregarded for income tax purposes
A trust is classified as a grantor trust when the grantor retains specific powers enumerated in IRC Sections 671–679, causing income to be attributed to the grantor for tax purposes.
Question 6: In estate financial planning, the 'present value of an annuity due' differs from an 'ordinary annuity' primarily because:
- Payments occur at the end of each period rather than the beginning
- Payments occur at the beginning of each period rather than the end (Correct answer)
- It compounds semi-annually instead of annually
- It assumes a variable discount rate
Correct answer: Payments occur at the beginning of each period rather than the end
An annuity due makes payments at the beginning of each period, which increases its present value compared to an ordinary annuity that pays at period end.
Question 7: A STEP practitioner is reviewing a trust that holds a private business interest. Which valuation discount is most commonly applied to a minority non-controlling interest in a closely held business?
- Control premium discount
- Discount for lack of control (DLOC) (Correct answer)
- Inflation adjustment discount
- Capital gains tax discount
Correct answer: Discount for lack of control (DLOC)
A discount for lack of control (DLOC) reflects that minority interests cannot direct corporate decisions, reducing the interest's fair market value compared to a pro-rata share of the whole.
STEP Financial Analysis & Planning 2
A trust holds a portfolio with a 60/40 equity-to-bond allocation.
After a strong equity rally, the allocation shifts to 72/28.
What action best restores the target allocation?