STEP Financial Analysis & Planning 3 — Questions and Answers
Question 1: A trustee is considering investing trust assets in a hedge fund with a 2-and-20 fee structure. What does this fee structure mean?
- 2% performance fee and 20% management fee annually
- 2% annual management fee and 20% performance fee on profits (Correct answer)
- 2% upfront load and 20% redemption fee
- 2% quarterly fee and 20% annual fee
Correct answer: 2% annual management fee and 20% performance fee on profits
A '2-and-20' structure means a 2% annual management fee on assets under management plus a 20% performance fee on profits generated.
Question 2: When a trust sells a long-term capital asset, the maximum federal long-term capital gains tax rate applicable to trust income that is not distributed to beneficiaries reaches the top rate at a much lower threshold than for individuals. In 2024, what is the top federal long-term capital gains rate for trusts?
- 15%
- 20%
- 23.8% (Correct answer)
- 37%
Correct answer: 23.8%
Trusts are subject to the 20% long-term capital gains rate plus the 3.8% Net Investment Income Tax (NIIT), resulting in a maximum effective federal rate of 23.8% at relatively low income thresholds.
Question 3: A Charitable Remainder Unitrust (CRUT) pays the income beneficiary a fixed percentage of the trust's net fair market value, revalued annually. If trust assets increase in value, the annual payout to the beneficiary will:
- Remain fixed at the original dollar amount
- Decrease proportionally with the percentage rate
- Increase because the percentage is applied to the higher asset value (Correct answer)
- Be suspended until assets return to original value
Correct answer: Increase because the percentage is applied to the higher asset value
A CRUT's payout is a fixed percentage of annually revalued assets, so as asset value grows, the dollar amount paid to the beneficiary increases proportionally.
Question 4: A STEP practitioner calculates the Sharpe ratio for a trust's equity portfolio. The portfolio return is 10%, the risk-free rate is 4%, and the standard deviation is 12%. What is the Sharpe ratio?
- 0.50 (Correct answer)
- 0.67
- 0.83
- 1.20
Correct answer: 0.50
Sharpe ratio = (Portfolio return – Risk-free rate) / Standard deviation = (10% – 4%) / 12% = 6% / 12% = 0.50.
Question 5: Which of the following best describes the 'prudent investor rule' as it applies to trust investment management?
- Trustees must invest only in government-guaranteed instruments to avoid loss
- Trustees must manage assets as a prudent investor would, considering the trust's overall portfolio in light of risk and return objectives (Correct answer)
- Trustees are personally liable for any investment loss regardless of process
- Trustees must obtain court approval before making any investment decision
Correct answer: Trustees must manage assets as a prudent investor would, considering the trust's overall portfolio in light of risk and return objectives
The prudent investor rule requires trustees to apply reasonable care, skill, and caution when managing trust assets, evaluating investments in the context of the overall portfolio and the trust's specific objectives.
Question 6: A family trust holds $2 million in a taxable investment account. The trustee wants to use tax-loss harvesting. Which scenario correctly describes a permissible harvest?
- Selling a bond fund at a loss and immediately buying an identical bond fund
- Selling a technology ETF at a loss and buying a broadly diversified S&P 500 ETF 31 days later (Correct answer)
- Selling a stock at a loss and repurchasing the same stock the next day
- Selling a mutual fund at a loss and buying the same fund within the same week
Correct answer: Selling a technology ETF at a loss and buying a broadly diversified S&P 500 ETF 31 days later
To avoid the wash-sale rule, the trustee must wait at least 31 days before repurchasing the same or a substantially identical security; buying a different but correlated ETF also avoids the rule.
Question 7: In estate planning, a 'Section 7520 rate' is used to value which of the following?
- Retirement account distributions
- Charitable deductions, GRATs, and split-interest trusts (Correct answer)
- Real property appraisals
- Business entity discount calculations
Correct answer: Charitable deductions, GRATs, and split-interest trusts
The IRC Section 7520 rate is the applicable federal rate used to calculate the present value of annuities, life estates, remainders, and reversions in split-interest trusts such as CRATs, CRUTs, and GRATs.
STEP Financial Analysis & Planning 3
A trustee is considering investing trust assets in a hedge fund with a 2-and-20 fee structure.
What does this fee structure mean?