Free AFC Investment and Retirement Planning Questions and Answers 1 — Questions and Answers
Question 1: A 25-year-old client is in a low tax bracket but expects their income and tax rate to increase significantly in the future. They want to start saving for retirement in an IRA. Which type of account would an AFC® most likely explain as being potentially more advantageous for this client's long-term tax situation?
- Roth IRA (Correct answer)
- Traditional IRA
- SEP IRA
- SIMPLE IRA
Correct answer: Roth IRA
A Roth IRA is funded with after-tax dollars, meaning qualified withdrawals in retirement are tax-free. For a young person in a low tax bracket who expects to be in a higher bracket later, paying taxes on contributions now (while their rate is low) is generally more beneficial than deferring taxes until retirement when their tax rate will likely be higher.
Question 2: A client is leaving their job and has a significant balance in their 401(k). They want to move the funds to an IRA to gain more investment options while avoiding immediate taxes and penalties. Which of the following methods is the most secure and recommended way to accomplish this?
- An indirect rollover where a check is made out to the client.
- A direct rollover where funds are transferred from the 401(k) custodian to the IRA custodian. (Correct answer)
- A 401(k) loan followed by a deposit into the new IRA.
- Cashing out the 401(k) and depositing the funds into an IRA within 90 days.
Correct answer: A direct rollover where funds are transferred from the 401(k) custodian to the IRA custodian.
A direct rollover is the safest and most recommended method because the funds are transferred directly from one financial institution to another. This avoids the mandatory 20% tax withholding and the strict 60-day deadline associated with an indirect rollover, thus preventing potential taxes and penalties.
Question 3: Which of the following investment principles is primarily designed to reduce unsystematic (or diversifiable) risk by holding a variety of assets that do not move in the same direction at the same time?
- Market Timing
- Dollar-Cost Averaging
- Diversification (Correct answer)
- Compounding
Correct answer: Diversification
Diversification is the strategy of investing in a variety of assets (like stocks, bonds, and real estate across different industries and geographies) to minimize the impact of poor performance from any single asset. This technique is specifically used to reduce unsystematic risk, which is risk that is unique to a specific company or industry.
Question 4: A client earns $70,000 per year and their employer offers a 401(k) plan with a dollar-for-dollar match on contributions up to 4% of their salary. The client is currently contributing 2%. To receive the full employer match, what is the minimum additional annual amount the client must contribute?
- $700
- $2,800
- $2,100
- $1,400 (Correct answer)
Correct answer: $1,400
The full employer match is on 4% of the client's salary, which is $70,000 * 0.04 = $2,800. The client is currently contributing 2%, which is $70,000 * 0.02 = $1,400. To get the full match, they need to contribute an additional $1,400 ($2,800 - $1,400).
Question 5: An individual has a Traditional IRA and was born in 1958. According to the SECURE 2.0 Act, at what age must they begin taking Required Minimum Distributions (RMDs)?
- Age 73 (Correct answer)
- Age 59 ½
- Age 70 ½
- Age 75
Correct answer: Age 73
The SECURE 2.0 Act of 2022 increased the RMD age. For individuals born between 1951 and 1959, the age to begin taking RMDs from tax-deferred retirement accounts like a Traditional IRA is 73.
Question 6: When the Social Security Administration calculates a person's retirement benefit, what is the primary factor used to determine their Primary Insurance Amount (PIA)?
- The individual's highest single year of earnings.
- The performance of the stock market in the five years before retirement.
- The average of the highest 35 years of inflation-indexed earnings. (Correct answer)
- The total number of years the individual paid into Social Security.
Correct answer: The average of the highest 35 years of inflation-indexed earnings.
Social Security benefits are calculated using a formula based on a worker's lifetime earnings. The Social Security Administration indexes the worker's earnings for inflation and then calculates the average from the 35 years with the highest earnings to determine the Average Indexed Monthly Earnings (AIME), which is then used to find the PIA.
Free AFC Investment and Retirement Planning Questions and Answers 1
A 25-year-old client is in a low tax bracket but expects their income and tax rate to increase significantly in the future.
They want to start saving for retirement in an IRA.
Which type of account would an AFC® most likely explain as being potentially more advantageous for this client's long-term tax situation?