AFC Investment and Retirement Planning 2 — Questions and Answers
Question 1: A client contributing 3% to their 401(k) has a 50% employer match on up to 6%. What should the counselor recommend?
- Maintain current contribution and focus on debt
- Increase contributions to at least 6% to capture the full employer match (Correct answer)
- Switch to a Roth IRA instead
- Reduce contributions to fund an emergency account
Correct answer: Increase contributions to at least 6% to capture the full employer match
The employer match represents an immediate 50% return on investment. Contributing 6% captures the full match.
With a 50% match on 6%, an employee earning $60,000 who contributes 6% ($3,600) receives $1,800 in free contributions. Currently at 3%, they receive only $900, leaving $900/year uncaptured. Over 30 years at 7% return, that gap compounds to approximately $85,000. Capturing the full match should be highest priority after basic emergency needs.
Question 2: What is the key difference between a Traditional IRA and a Roth IRA regarding tax treatment?
- Traditional IRAs have higher contribution limits
- Traditional IRA contributions may be tax-deductible with taxable withdrawals, while Roth contributions are after-tax with tax-free withdrawals (Correct answer)
- Roth IRAs are only available through employers
- Traditional IRAs require distributions at 65
Correct answer: Traditional IRA contributions may be tax-deductible with taxable withdrawals, while Roth contributions are after-tax with tax-free withdrawals
Traditional IRA contributions may be deductible now with taxes on withdrawals; Roth contributions are after-tax with tax-free qualified withdrawals.
Traditional IRA: contributions may be deductible, earnings grow tax-deferred, withdrawals are taxed, RMDs begin at age 73. Roth IRA: contributions are after-tax, earnings grow tax-free, qualified withdrawals are tax-free, no RMDs during owner's lifetime. Choose Roth if expecting higher future tax bracket; Traditional if expecting lower. Both have same contribution limits.
Question 3: A 28-year-old asks whether to invest aggressively or conservatively for retirement. What principle should guide the recommendation?
- Always choose the highest historical returns
- Time horizon is critical - longer horizons generally support higher equity allocations (Correct answer)
- Conservative investments are always safer
- Base the choice solely on current income
Correct answer: Time horizon is critical - longer horizons generally support higher equity allocations
With approximately 37 years until retirement, the client's long time horizon allows them to weather volatility and benefit from higher equity returns.
A 28-year-old has time to recover from downturns, benefits from compounding, dollar-cost averages over decades, and needs inflation protection. A common guideline is '110 minus age' as equity percentage (82% for a 28-year-old). However, risk tolerance also matters - a client who panics during downturns needs a moderately aggressive rather than aggressive allocation.
Question 4: What is dollar-cost averaging and why do counselors recommend it?
- Investing a lump sum at the market's lowest point
- Investing a fixed dollar amount at regular intervals regardless of market conditions (Correct answer)
- Diversifying equally across all asset classes
- Adjusting investment amounts based on market performance
Correct answer: Investing a fixed dollar amount at regular intervals regardless of market conditions
Dollar-cost averaging involves investing a fixed amount at regular intervals, automatically buying more shares when prices are low and fewer when high.
DCA means investing consistently regardless of market prices. When prices are low, the fixed amount buys more shares; when high, fewer. Benefits include removing emotional timing decisions, preventing paralysis of waiting for the 'right' time, and aligning with paycheck-based contributions. While lump-sum investing outperforms DCA about two-thirds of the time, DCA's behavioral benefits often produce better real-world outcomes.
Question 5: A client nearing retirement has 90% of their portfolio in employer stock. What risk should the counselor highlight?
- Tax inefficiency
- Concentration risk: both income and savings depend on one company (Correct answer)
- Insufficient dividends
- Employer stock typically underperforms
Correct answer: Concentration risk: both income and savings depend on one company
Both employment income and retirement savings depend on one company's performance, creating dangerous concentration risk.
If the company has financial difficulties, the client faces simultaneous job loss and portfolio decline. Historical examples include Enron and Lehman Brothers. Counselors should recommend diversifying to no more than 5-10% employer stock, considering tax implications and emotional attachment to the company's stock.
Question 6: At what age can an individual begin receiving reduced Social Security retirement benefits?
- 59 1/2
- 62 (Correct answer)
- 65
- 67
Correct answer: 62
Reduced benefits can begin at age 62, though they are permanently reduced compared to full retirement age.
For those born in 1960 or later, full retirement age is 67. Claiming at 62 reduces benefits by approximately 30%. Delaying beyond FRA earns 8% per year until age 70. Example: $2,000 FRA benefit yields approximately $1,400 at 62 and $2,480 at 70. The breakeven point between 62 and 67 is typically age 78-80.
AFC Investment and Retirement Planning 2
A client contributing 3% to their 401(k) has a 50% employer match on up to 6%.
What should the counselor recommend?