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CFP Module 4 study materials
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CFP Module 4 practice questions

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Question 1Financial Planning

A client earns a salary of $90,000 and has monthly mortgage payments of $1,800, a car loan of $450, and minimum credit card payments of $150. Using the standard 28/36 qualifying ratios, what is the maximum total monthly debt payment the lender will typically allow?

  1. $3,240
  2. $2,400
  3. $2,520
  4. $2,700 Correct answer.

Explanation

The back-end ratio of 36% is applied to gross monthly income. Gross monthly income is $90,000 / 12 = $7,500, and 36% of $7,500 equals $2,700, which caps total monthly debt including housing.

Question 2Financial Planning

Which document establishes the client's legal ownership interest in real property and is recorded in the public registry?

  1. The deed Correct answer.
  2. The closing disclosure
  3. The title insurance policy
  4. The promissory note

Explanation

A deed is the legal instrument that transfers and evidences ownership of real property and is recorded in the public records. The promissory note evidences the debt, title insurance protects against title defects, and the closing disclosure itemizes loan costs.

Question 3Financial Planning

A client wants a mortgage with an interest rate that stays fixed for the first five years and then adjusts annually. Which loan feature is being described?

  1. A graduated payment mortgage
  2. A reverse mortgage
  3. A 5/1 adjustable-rate mortgage Correct answer.
  4. A balloon mortgage

Explanation

A 5/1 ARM fixes the rate for five years and then adjusts once each year thereafter. Graduated payment loans step up payments on a schedule, balloon loans require a large final payment, and reverse mortgages pay the borrower.

Question 4Financial Planning

A homeowner has a $300,000 mortgage at 6% annual interest with monthly payments. Approximately how much of the first monthly payment goes toward interest?

  1. $1,800
  2. $2,500
  3. $1,250
  4. $1,500 Correct answer.

Explanation

Monthly interest equals the outstanding balance times the annual rate divided by twelve. $300,000 × 0.06 / 12 = $1,500, and only the remainder of the payment reduces principal.

Question 5Financial Planning

Which type of life insurance policy builds cash value that the owner can access through policy loans or withdrawals?

  1. Decreasing term insurance
  2. Term life insurance
  3. Annual renewable term
  4. Whole life insurance Correct answer.

Explanation

Whole life insurance is permanent coverage with a savings component that accumulates cash value. Term policies, including renewable and decreasing term, provide pure death protection with no cash value.

Question 6Financial Planning

A client has a $500,000 whole life policy with a $40,000 cash value and a $15,000 outstanding policy loan. If the insured dies, what amount will the beneficiary generally receive?

  1. $500,000
  2. $485,000 Correct answer.
  3. $540,000
  4. $460,000

Explanation

The death benefit is reduced by any outstanding policy loan. The beneficiary receives $500,000 minus the $15,000 loan, or $485,000; cash value itself is not subtracted because the insurer pays the face amount.

Question 7Financial Planning

Which of the following best describes the purpose of disability income insurance?

  1. To replace a portion of earned income lost when the insured cannot work due to illness or injury Correct answer.
  2. To provide a lump sum upon diagnosis of a critical illness
  3. To pay medical expenses resulting from an accident or illness
  4. To cover long-term custodial care costs in a nursing facility

Explanation

Disability income insurance replaces a percentage of earned income during a period of disability. Medical expense coverage, critical illness lump sums, and long-term care coverage address different risks.

Question 8Financial Planning

Under the uniform simultaneous death act, when the order of death of a husband and wife cannot be determined, how is each spouse's property generally distributed?

  1. It passes as if each spouse had survived the other Correct answer.
  2. It is divided equally between both estates
  3. It passes entirely to the surviving spouse's estate
  4. It escheats to the state

Explanation

The act treats each person as having survived the other for purposes of distributing their own property, so each estate passes to its own heirs. This prevents the entire combined estate from flowing to one side's heirs.

Question 9Financial Planning

A client's gross estate totals $12,000,000 and allowable deductions and adjusted taxable gifts reduce the taxable estate to $10,500,000. If the applicable exclusion amount is $13,610,000, what estate tax is owed?

  1. $0 Correct answer.
  2. $2,000,000
  3. $1,500,000
  4. $510,000

Explanation

Estate tax applies only to the taxable estate above the available exclusion. Because $10,500,000 is below the $13,610,000 exclusion, no federal estate tax is due.

Question 10Financial Planning

Which estate planning tool allows property to pass directly to named beneficiaries without going through probate?

  1. Intestate succession
  2. A revocable living trust Correct answer.
  3. A will
  4. A guardianship proceeding

Explanation

Assets titled in a revocable living trust pass to the trust beneficiaries outside probate. A will is probated, intestate succession applies when there is no will, and guardianship concerns incapacity.

Question 11Financial Planning

A client wants to give $19,000 to each of four grandchildren this year. Assuming the annual gift tax exclusion is $19,000, what is the total amount that can be given free of gift tax?

  1. $19,000
  2. $76,000 Correct answer.
  3. $38,000
  4. $0

Explanation

The annual exclusion applies per donee, so the client may give $19,000 to each of four grandchildren. Four times $19,000 equals $76,000 without using any lifetime exclusion.

Question 12Financial Planning

Which of the following is a key advantage of a Section 529 qualified tuition program over a Coverdell education savings account?

  1. Contributions are deductible for federal income tax purposes
  2. 529 plans may be used for elementary and secondary tuition Correct answer.
  3. There are no contribution limits tied to the annual gift tax exclusion
  4. Only 529 plans permit tax-free qualified distributions

Explanation

Section 529 plans allow tax-free withdrawals for qualified K-12 tuition as well as college costs, while Coverdell accounts are limited to $2,000 per beneficiary per year. Neither type provides a federal deduction for contributions.

Question 13Financial Planning

A family has a child who will begin college in 15 years. They want a savings vehicle with tax-deferred growth and contributions that are not federally deductible. Which account is most consistent with these goals?

  1. A traditional IRA
  2. A custodial UGMA account
  3. A Roth IRA held in the parent's name
  4. A Section 529 savings plan Correct answer.

Explanation

A 529 savings plan offers tax-deferred growth and tax-free qualified withdrawals, with contributions made from after-tax dollars. Roth and traditional IRAs are retirement vehicles with annual contribution caps, and UGMA accounts are taxed to the child without deferral advantages specific to education.

Question 14Financial Planning

A client's investment portfolio is heavily concentrated in a single stock. Which strategy best reduces unsystematic risk while preserving the client's overall expected return?

  1. Holding the position until it reaches a target price
  2. Purchasing put options on the single stock
  3. Increasing the position size to average down the cost basis
  4. Diversifying into a broad mix of uncorrelated asset classes Correct answer.

Explanation

Unsystematic risk is company-specific and can be reduced by holding a diversified mix of assets. Put options hedge price declines but do not diversify, and adding to or holding the position does not reduce concentration risk.

Question 15Financial Planning

An investor buys a bond with a 5% coupon at a price of $1,050. What is the current yield?

  1. 4.76% Correct answer.
  2. 5.00%
  3. 5.25%
  4. 4.55%

Explanation

Current yield equals annual coupon interest divided by the bond's market price. A $50 coupon divided by $1,050 equals approximately 4.76%, which is below the coupon rate because the bond trades at a premium.

Question 16Financial Planning

A retired client needs $50,000 per year from a $1,000,000 portfolio. What withdrawal rate is the client using?

  1. 10%
  2. 6%
  3. 5% Correct answer.
  4. 4%

Explanation

The withdrawal rate equals annual withdrawals divided by the portfolio value. $50,000 divided by $1,000,000 equals 5%, a rate commonly compared against sustainable withdrawal research.

Question 17Financial Planning

Which of the following best describes the purpose of a health savings account paired with a high-deductible health plan?

  1. To replace Medicare coverage after age 65
  2. To allow tax-advantaged saving for qualified medical expenses with unused balances carrying forward Correct answer.
  3. To fund long-term care premiums only
  4. To provide first-dollar coverage for routine medical expenses

Explanation

An HSA permits tax-deductible contributions, tax-deferred growth, and tax-free withdrawals for qualified medical expenses, with balances rolling over year to year. It is not first-dollar coverage and does not replace Medicare.

Question 18Financial Planning

A client has a 30-year mortgage at 7% and can earn 4% after tax on conservative savings. Which action is most financially advantageous assuming adequate emergency reserves?

  1. Refinance to a longer term to lower monthly payments
  2. Prepay the mortgage principal with surplus cash Correct answer.
  3. Reduce mortgage payments to increase discretionary spending
  4. Invest surplus cash in the 4% savings account

Explanation

Prepaying a 7% mortgage produces a guaranteed after-tax return of 7%, which exceeds the 4% available on savings. The comparison of the mortgage rate to the after-tax investment return determines which use of cash is more efficient.

Question 19Financial Planning

A client wants to retire in 20 years with $1,000,000. Assuming an 8% annual return compounded annually and no current savings, approximately how much must be saved at the end of each year?

  1. $50,000
  2. $10,000
  3. $21,852 Correct answer.
  4. $31,500

Explanation

Using the future value of an ordinary annuity factor for 20 years at 8% (about 45.76), $1,000,000 divided by 45.76 equals roughly $21,852 per year. This reflects compound growth on each annual deposit.

Question 20Financial Planning

Which of the following correctly states a fundamental difference between a traditional IRA and a Roth IRA?

  1. Roth IRA contributions are limited to $1,000 per year
  2. Traditional IRA contributions are always tax-deductible, while Roth contributions never are
  3. Traditional IRAs have no required minimum distributions, while Roth IRAs do
  4. Roth IRA qualified withdrawals are tax-free, while traditional IRA withdrawals are generally taxable Correct answer.

Explanation

Roth IRAs are funded with after-tax dollars and qualified withdrawals are tax-free, whereas traditional IRA withdrawals are generally taxable as ordinary income. Deductibility of traditional contributions depends on income and plan coverage, and RMDs now apply to Roth accounts only after the owner's death.

Question 21Financial Planning

A client's employer offers a 401(k) match of 50% on the first 6% of salary contributed. The client earns $80,000 and contributes 4% of salary. What is the employer match?

  1. $4,800
  2. $2,400
  3. $3,200
  4. $1,600 Correct answer.

Explanation

The client contributes 4% of $80,000, or $3,200, and the employer matches 50% of that amount because it falls within the first 6%. Half of $3,200 equals $1,600.

Question 22Financial Planning

A client with a large estate wants to transfer assets to heirs while retaining an income stream for life. Which strategy best accomplishes this goal?

  1. A bypass trust funded at death
  2. An outright gift of the assets to the heirs now
  3. A grantor retained annuity trust Correct answer.
  4. A charitable remainder trust

Explanation

A grantor retained annuity trust lets the grantor retain an annuity income interest for a term while the remainder passes to heirs at a reduced gift tax value. The retained interest reduces the taxable gift compared with an outright transfer.

Question 23Financial Planning

A married couple wants to maximize the step-up in basis for assets passing at the second death while ensuring the surviving spouse has access to income. Which estate planning approach is most appropriate?

  1. Using a credit shelter trust funded at the first death with the remainder passing to a marital trust Correct answer.
  2. Placing all assets in an irrevocable life insurance trust
  3. Leaving the entire estate outright to the surviving spouse
  4. Titling all assets as joint tenants with right of survivorship

Explanation

A credit shelter trust uses the first spouse's exclusion while preserving the surviving spouse's own exclusion, and the marital trust provides income and access. This structure can allow a basis step-up on the assets in the credit shelter trust at the survivor's death.

Question 24Financial Planning

An investor holds a bond with a 4% coupon purchased at par. If market interest rates rise to 6%, what is the most likely effect on the bond's price?

  1. The price falls below par Correct answer.
  2. The price rises above par
  3. The price is unaffected because the coupon is fixed
  4. The price remains at par

Explanation

Bond prices move inversely to market interest rates, so when rates rise above the coupon, the bond must trade at a discount to offer a competitive yield. The fixed coupon itself does not change, but the market price adjusts.

Question 25Financial Planning

A client is in the 32% marginal tax bracket and owns a municipal bond yielding 4.2%. What taxable yield would an equivalent-risk corporate bond need to provide the same after-tax return?

  1. 4.20%
  2. 5.54%
  3. 6.18% Correct answer.
  4. 5.88%

Explanation

The equivalent taxable yield equals the municipal yield divided by one minus the marginal tax rate. 4.2% divided by 0.68 equals approximately 6.18%, which is the taxable yield needed to match the tax-exempt return.

Question 26Financial Planning

A client's only life insurance is a $250,000 term policy naming the spouse as primary beneficiary and the estate as contingent beneficiary. The client dies while the policy is in force with no outstanding loans. How is the death benefit treated for federal estate tax purposes?

  1. Only the cash value at death is included in the gross estate
  2. The full proceeds are included in the gross estate because the estate is a contingent beneficiary Correct answer.
  3. The full proceeds are included in the gross estate because a general power of appointment exists
  4. The full proceeds are excluded from the gross estate because the spouse receives them

Explanation

Proceeds of a policy on the decedent's own life are pulled into the gross estate under IRC Section 2042 when the decedent held incidents of ownership or when proceeds are payable to the estate. Naming the estate as contingent beneficiary creates that inclusion even though the spouse is primary. The exclusion for a surviving spouse applies only to the marital deduction, not to whether the asset enters the gross estate.

Question 27Financial Planning

A client with a $3,000,000 estate wants to transfer a rental property to an adult child but continue receiving the rental income for life. Which arrangement accomplishes this goal?

  1. An outright gift of the property with a retained leaseback at fair market rent
  2. A grantor retained annuity trust funded with the property
  3. A qualified personal residence trust funded with the property
  4. An irrevocable trust reserving the rental income to the client for life and granting the adult child the remainder interest in the property Correct answer.

Explanation

A trust reserving the rental income to the client for life and giving the remainder to the adult child matches both goals. The client retains the lifetime income interest, and the child receives the property when that interest ends.

Question 28Financial Planning

A client wants to fund a grandchild's education but is concerned that a large gift will use lifetime gift tax exemption. Which feature of a Section 529 plan addresses this concern when the client elects five-year gift tax averaging?

  1. The contribution is treated as made ratably over five years for gift tax purposes Correct answer.
  2. The contribution is excluded from the gross estate after three years
  3. The contribution is treated as a completed gift to the account owner
  4. The contribution is fully deductible against ordinary income on the federal return

Explanation

Under Section 529(c)(2)(B), a lump-sum contribution may be elected to be treated as made ratably over five calendar years for gift tax purposes. This allows the client to use five years of annual exclusions at once without consuming lifetime exemption. The election does not create a federal deduction or accelerate estate exclusion.

Question 29Financial Planning

An investor in the 35% federal bracket and a 5% state bracket is considering a corporate bond yielding 6.1% or a municipal bond exempt from both federal and state tax. What is the minimum municipal yield that makes the municipal bond the better after-tax choice?

  1. 4.58%
  2. 3.66% Correct answer.
  3. 2.14%
  4. 3.97%

Explanation

The combined marginal rate is 40% (35% plus 5%), so the after-tax yield on the corporate bond is 6.1% times 0.60, or 3.66%. A municipal bond yielding more than 3.66% on a tax-exempt basis produces the higher after-tax return. The calculation requires combining both taxes because the municipal bond is exempt from both.

Question 30Financial Planning

A client's will leaves the residue of the estate to the spouse, but the client's adult child from a prior marriage is named as a beneficiary of a revocable living trust holding the business interests. What is the most significant planning risk in this arrangement?

  1. The child will owe income tax on the trust's unrealized appreciation at the client's death
  2. The trust assets will be included in the gross estate if the client retained the power to revoke Correct answer.
  3. The trust assets will pass through probate, delaying distribution to the child
  4. The spouse will be entitled to an elective share of the trust assets in every state

Explanation

A revocable living trust does not remove assets from the grantor's gross estate because the grantor retains the power to revoke, which is a retained right under Sections 2036 and 2038. The trust still avoids probate, which is its main non-tax purpose. The arrangement therefore controls disposition but not estate inclusion.

Question 31Financial Planning

A client has $200,000 of credit card debt at 22% interest and $150,000 in a taxable brokerage account earning 5% annually. Which action is most consistent with sound financial planning?

  1. Keep the brokerage account intact and pay only the minimum on the cards
  2. Use the brokerage account to pay down the credit card debt before adding to savings Correct answer.
  3. Borrow against the brokerage account to invest in a higher-return fund
  4. Increase retirement contributions while paying the minimum on the cards

Explanation

Paying down debt carrying a 22% interest rate produces a guaranteed 22% return, far exceeding the 5% expected on the taxable account. Financial planning prioritizes eliminating high-cost consumer debt before taxable investing. Continuing to hold the debt while investing creates a negative arbitrage.

Question 32Financial Planning

A client wants to name a trust as the beneficiary of a traditional IRA but is concerned about the ability to stretch distributions. Which requirement must be satisfied for the trust to be treated as a see-through trust?

  1. The trust must distribute all income annually to the beneficiaries
  2. The trust must be a charitable remainder trust
  3. The trust must be revocable by the account owner at all times
  4. The trust must be valid under state law and the beneficiaries must be identifiable from the trust instrument Correct answer.

Explanation

A see-through trust must be valid under state law, irrevocable at the owner's death, and have identifiable beneficiaries named in the trust document or through a power of appointment. These conditions allow the IRA custodian to look through the trust to the underlying beneficiaries for distribution purposes. Revocability and mandatory income distributions are not requirements.

Question 33Financial Planning

A client is self-employed and wants to maximize tax-deferred retirement savings while keeping administrative costs low. Which plan type generally permits the largest contribution for a sole proprietor with no employees?

  1. A SIMPLE IRA
  2. A solo 401(k) with profit-sharing feature Correct answer.
  3. A SEP IRA
  4. A traditional IRA

Explanation

A solo 401(k) allows both employee deferrals and employer profit-sharing contributions, producing a higher combined limit than a SEP IRA for the same self-employment income. A SIMPLE IRA and a traditional IRA have substantially lower contribution ceilings. For a sole proprietor with no employees, the solo 401(k) is generally the most efficient vehicle.

Question 34Financial Planning

A client is 58 years old, retired, and needs cash from a traditional IRA. Which exception to the 10% early distribution penalty applies to a distribution taken in substantially equal periodic payments?

  1. The first-time homebuyer exception
  2. The Section 72(t) substantially equal periodic payment exception Correct answer.
  3. The separation from service exception for employees over 55
  4. The qualified higher education exception

Explanation

Section 72(t) permits penalty-free distributions taken as a series of substantially equal periodic payments based on life expectancy or an annuity method. The payments must generally continue for five years or until age 59½, whichever is later. The separation-from-service exception applies only to employer plans, not IRAs.

Question 35Financial Planning

A client's employer offers a Roth 401(k) option. The client is currently in a 24% marginal bracket and expects to be in a 12% bracket at retirement. Which choice is generally more tax-efficient?

  1. Traditional 401(k) contributions, because the deduction is taken at a higher rate than the expected withdrawal rate Correct answer.
  2. Roth 401(k) contributions, because Roth accounts are not subject to required minimum distributions
  3. An even split between Roth and traditional contributions
  4. Roth 401(k) contributions, because qualified withdrawals are tax-free

Explanation

When the current marginal rate exceeds the expected retirement rate, deferring tax at the higher rate and paying at the lower rate produces more after-tax wealth. Traditional contributions deduct at 24% and withdrawals are taxed at 12%. The Roth advantage arises when the current rate is lower than the future rate.

Question 36Financial Planning

A client receives a $60,000 lump-sum distribution from a former employer's qualified plan and deposits it into a traditional IRA 45 days later. What is the tax consequence?

  1. The distribution is tax-free because the rollover occurred within 60 days Correct answer.
  2. The distribution is fully taxable because the rollover exceeded 30 days
  3. The distribution is taxable except for the 20% withheld amount
  4. The distribution is taxable because a direct trustee-to-trustee transfer was required

Explanation

A rollover completed within 60 days of receipt preserves tax deferral for the amount rolled over. The client must replace the 20% mandatory withholding from other funds to roll over the full $60,000. A direct trustee-to-trustee transfer is preferable but not required.

Question 37Financial Planning

A client's portfolio has a beta of 1.4 and a standard deviation of 18%. The market return is 9% and the risk-free rate is 3%. Using the capital asset pricing model, what is the client's required return?

  1. 8.4%
  2. 9.0%
  3. 14.6%
  4. 11.4% Correct answer.

Explanation

The CAPM formula is the risk-free rate plus beta times the market risk premium, or 3% plus 1.4 times the 6% premium, which equals 11.4%. Standard deviation is a measure of total risk and does not enter the CAPM calculation. Beta captures only systematic risk, which is what the model prices.

Question 38Financial Planning

A client wants to reduce the interest rate risk of a bond portfolio while maintaining a target duration. Which strategy accomplishes this?

  1. Concentrating the portfolio in zero-coupon bonds of a single maturity
  2. Increasing the portfolio's allocation to high-yield corporate bonds
  3. Immunizing the portfolio by matching duration to the investment horizon Correct answer.
  4. Purchasing bonds with longer maturities and higher coupons

Explanation

Immunization matches the duration of assets to the duration of the liability or horizon, so price and reinvestment risk offset each other. This reduces the effect of interest rate changes on the ability to meet a future obligation. Duration matching does not require a single maturity or higher coupons.

Question 39Financial Planning

A client's employer provides group term life insurance of $200,000. The client is 52 years old. How is the coverage taxed?

  1. The entire premium is taxable income to the client
  2. The coverage is entirely tax-free regardless of the amount
  3. The cost of coverage above $50,000 is imputed income to the client Correct answer.
  4. The coverage is taxable only if the client pays part of the premium

Explanation

Under Section 79, employer-paid group term coverage up to $50,000 is excluded from income, and the cost of coverage above that amount is imputed using IRS Table I rates. The imputed amount is reported as wages. The exclusion applies regardless of whether the employee contributes to the premium.

Question 40Financial Planning

A client with a high-deductible health plan wants to maximize the tax advantages of a health savings account. Which statement correctly describes the tax treatment of HSA contributions and distributions?

  1. Contributions are pre-tax, but all distributions are taxable as ordinary income
  2. Contributions are made with after-tax dollars, and qualified distributions are tax-free
  3. Contributions are deductible only if made through an employer
  4. Contributions are pre-tax or deductible, growth is tax-deferred, and qualified distributions are tax-free Correct answer.

Explanation

An HSA provides a triple tax benefit: contributions are pre-tax or deductible, earnings grow tax-deferred, and qualified medical distributions are tax-free. Nonqualified distributions are taxable and subject to a penalty before age 65. Contributions may be made by the individual, an employer, or both.

Question 41Financial Planning

A client has a $1,200,000 portfolio and wants to withdraw $60,000 in the first year of retirement, increasing the amount each year with inflation. Which withdrawal strategy is being used?

  1. A fixed-dollar withdrawal strategy
  2. A systematic percentage-of-portfolio strategy
  3. A dynamic spending strategy based on portfolio performance
  4. An inflation-adjusted fixed-dollar strategy Correct answer.

Explanation

Withdrawing a set dollar amount and adjusting it annually for inflation describes an inflation-adjusted fixed-dollar strategy, similar to the 4% rule. The initial withdrawal rate here is 5%, which is above the traditional 4% guideline and warrants a Monte Carlo review. Percentage-of-portfolio and dynamic strategies vary the withdrawal based on account value or performance.

Question 42Financial Planning

A client's estate is valued at $20,000,000, and the client wants to leave $5,000,000 to charity at death while transferring the remainder to children. Which technique removes the charitable bequest and the assets funding it from the taxable estate while providing an estate tax charitable deduction?

  1. A private foundation funded during life with the client as manager
  2. A donor-advised fund funded at death
  3. A charitable remainder unitrust with the children receiving payments first
  4. A charitable lead annuity trust with the charity receiving payments first Correct answer.

Explanation

A charitable lead annuity trust pays an income stream to charity for a term, with the remainder passing to the children at a reduced gift or estate tax value. The charitable interest qualifies for a deduction, and the remainder interest is discounted for the retained charitable term. A charitable remainder trust reverses the order and pays the family first.

Question 43Financial Planning

A client wants to provide for a surviving spouse while ensuring the assets pass to children from a prior marriage after the spouse's death. Which arrangement best accomplishes this?

  1. A joint tenancy with right of survivorship with the spouse
  2. A transfer-on-death designation naming the spouse
  3. A qualified terminable interest property trust election Correct answer.
  4. An outright bequest of all assets to the spouse

Explanation

A QTIP trust gives the surviving spouse a qualifying income interest for life while allowing the grantor to control the remainder beneficiaries, who can be the children. The executor may elect QTIP treatment to obtain the marital deduction. Outright bequests and survivorship arrangements give the spouse control over the remainder.

Question 44Financial Planning

A client is considering a Section 1035 exchange of an existing variable annuity with a $50,000 basis and a $70,000 value into a new variable annuity with lower fees. What is the tax result of the exchange?

  1. The exchange is tax-free and the basis in the new contract becomes $70,000
  2. The gain is taxed as long-term capital gain
  3. The $20,000 gain is recognized as ordinary income at the time of exchange
  4. The exchange is tax-free and the $50,000 basis carries over to the new contract Correct answer.

Explanation

Section 1035 permits a tax-free exchange of an annuity contract for another annuity contract, with the basis carrying over to the new contract. No gain is recognized at the time of exchange. The basis does not step up to the contract value.

Question 45Financial Planning

A client's employer provides a defined benefit pension that pays 1.5% of final average salary for each year of service. The client has 25 years of service and a final average salary of $120,000. What is the annual pension benefit?

  1. $60,000
  2. $30,000
  3. $18,000
  4. $45,000 Correct answer.

Explanation

The benefit equals 1.5% times 25 years times $120,000, which is $45,000 per year. The formula multiplies the accrual rate by years of service and final average salary. A defined benefit plan promises this formula-driven amount rather than a balance based on contributions.

Question 46Financial Planning

A client with a $4,000,000 estate wants to reduce estate taxes using annual exclusion gifts to 10 family members. Which statement about annual exclusion gifts is correct?

  1. Annual exclusion gifts must be made in cash
  2. Gifts that qualify for the annual exclusion require no gift tax return and use no lifetime exemption Correct answer.
  3. Annual exclusion gifts are limited to $10,000 per recipient
  4. Gifts must be reported on a gift tax return only if they exceed the annual exclusion

Explanation

Gifts within the annual exclusion do not require a gift tax return and do not consume lifetime exemption. They remove the gifted assets and future appreciation from the estate. Gifts may be made in property as well as cash, and the exclusion exceeds $10,000.

Question 47Financial Planning

A client's business is organized as a limited liability company with two equal members. One member dies, and the operating agreement requires the surviving member to purchase the decedent's interest at fair market value. What is the primary purpose of this buy-sell arrangement?

  1. To avoid probate of the business interest
  2. To obtain a step-up in basis for the surviving member
  3. To provide liquidity for the estate and prevent an unwanted co-owner Correct answer.
  4. To convert the entity into a corporation

Explanation

A buy-sell agreement funded by life insurance provides cash to the decedent's estate and ensures the surviving owner retains control of the business. It also fixes the value of the interest for estate tax purposes if the agreement meets the requirements of Section 2703. Probate avoidance and basis step-up are not its primary purposes.

Question 48Financial Planning

A client is 70 years old and considering a single premium immediate annuity with a 10-year period certain. Which risk does the period certain feature address?

  1. The risk that the client outlives the annuity payments
  2. The risk that inflation erodes purchasing power
  3. The risk that the insurer becomes insolvent
  4. The risk that the client dies before recovering the premium Correct answer.

Explanation

A period certain guarantees payments for a minimum number of years, so if the annuitant dies early the remaining payments go to a beneficiary. This protects against early death before the premium is recovered. Longevity risk is addressed by life-contingent payments, and inflation and insurer insolvency are separate risks.

Question 49Financial Planning

A client has a $600,000 traditional IRA and names the spouse, age 60, as sole beneficiary. The client dies at age 78 after required beginning date. Which distribution rule generally applies to the spouse?

  1. The spouse must take distributions over the client's remaining life expectancy
  2. The spouse may treat the IRA as her own and use the uniform lifetime table Correct answer.
  3. The spouse may defer distributions until age 73
  4. The spouse must withdraw the entire balance within five years

Explanation

A surviving spouse who is the sole designated beneficiary may elect to treat the inherited IRA as her own, which resets the required minimum distribution calculation to her own age. This generally produces smaller required distributions than the decedent's remaining life expectancy. The five-year rule applies only to certain non-spouse beneficiaries and only when the owner died before the required beginning date.

Question 50Financial Planning

A client in the 24% bracket has $10,000 to invest and is choosing between a taxable corporate bond yielding 5% and a municipal bond yielding 3.5%. Assuming the municipal interest is federally tax-exempt, which investment produces the higher after-tax return?

  1. The municipal bond, because its equivalent taxable yield is about 4.61% Correct answer.
  2. The corporate bond, because its pre-tax yield is higher
  3. The two are equal after tax
  4. The corporate bond, because municipal interest is subject to the alternative minimum tax

Explanation

The municipal bond's equivalent taxable yield is 3.5% divided by 0.76, or about 4.61%, which is below the corporate bond's 5% pre-tax yield. On an after-tax basis, the corporate bond yields 5% times 0.76, or 3.8%, which exceeds 3.5%. The comparison must therefore favor the corporate bond, not the municipal bond; the correct answer is the corporate bond based on the after-tax calculation.