Financial Advisor Personal Financial Advisor 3 — Questions and Answers
Question 1: A client is age 55 and wants to retire at 60. Which account allows penalty-free withdrawals before age 59½ under the Rule of 55?
- Traditional IRA
- Roth IRA
- 401(k) with a current employer from which you separated at 55 (Correct answer)
- Health Savings Account (HSA)
Correct answer: 401(k) with a current employer from which you separated at 55
The Rule of 55 allows penalty-free 401(k) withdrawals if you separate from service at age 55 or older in the same year you retire.
Question 2: What does the Sharpe ratio measure?
- Total return relative to benchmark performance
- Risk-adjusted return per unit of total risk (Correct answer)
- The correlation between two asset classes
- A portfolio's sensitivity to market movements
Correct answer: Risk-adjusted return per unit of total risk
The Sharpe ratio measures excess return (above risk-free rate) per unit of standard deviation, showing how much return is earned per unit of risk taken.
Question 3: Which estate planning document designates who manages a person's finances if they become incapacitated?
- Last will and testament
- Durable power of attorney (Correct answer)
- Revocable living trust
- Advance healthcare directive
Correct answer: Durable power of attorney
A durable power of attorney grants a designated agent authority to manage financial decisions if the principal becomes incapacitated.
Question 4: An advisor recommends a variable annuity to a 70-year-old client in a high tax bracket who has already maxed out all tax-advantaged accounts. Which concern is MOST valid?
- Variable annuities have no death benefit
- The high fees and ordinary income taxation on withdrawals may outweigh the tax-deferral benefit (Correct answer)
- Variable annuities are not suitable for clients over age 65
- The client cannot access funds before age 72 without penalty
Correct answer: The high fees and ordinary income taxation on withdrawals may outweigh the tax-deferral benefit
For clients already in tax-advantaged accounts, high annuity fees combined with ordinary income tax on gains often outweigh the additional tax-deferral benefit.
Question 5: Which of the following best describes a Roth IRA conversion?
- Moving funds from a Roth IRA to a traditional IRA tax-free
- Transferring traditional IRA funds to a Roth IRA and paying income tax on the converted amount (Correct answer)
- Rolling over a 401(k) into a Roth IRA without any tax consequences
- Converting after-tax contributions to a traditional IRA
Correct answer: Transferring traditional IRA funds to a Roth IRA and paying income tax on the converted amount
A Roth conversion moves pre-tax funds from a traditional IRA to a Roth IRA, requiring the taxpayer to pay ordinary income tax on the converted amount in the year of conversion.
Question 6: What is the primary difference between term life insurance and whole life insurance?
- Term insurance builds cash value; whole life does not
- Term insurance provides coverage for a fixed period with no cash value; whole life provides permanent coverage with a cash value component (Correct answer)
- Whole life premiums are always lower than term premiums
- Term insurance covers any cause of death; whole life excludes accidental death
Correct answer: Term insurance provides coverage for a fixed period with no cash value; whole life provides permanent coverage with a cash value component
Term life provides pure death benefit protection for a specified period, while whole life combines a death benefit with a cash value savings component.
Question 7: A client wants to minimize required minimum distributions (RMDs) from their retirement accounts. Which account type is NOT subject to RMDs during the owner's lifetime?
- Traditional IRA
- SEP-IRA
- Roth IRA (Correct answer)
- 401(k)
Correct answer: Roth IRA
Roth IRAs are not subject to RMDs during the original owner's lifetime under current tax law, making them useful for clients wanting to minimize forced distributions.
Financial Advisor Personal Financial Advisor 3
A client is age 55 and wants to retire at 60.
Which account allows penalty-free withdrawals before age 59½ under the Rule of 55?