T1-M4 Personal Financial Planning

Question 1

what are the advantages of tax qualified retirement plan?

Answer 1

• pretax contributions
• tax-deductible contributions
• tax-deferred accumulation of earnings
• asset protection from the claims of a taxpayer’s creditors
• avoidance of probate when retirement plan is part of a trust arrangement or insurance contract
• 4 most commonly known plans:
• Employer-sponsored section 401(k) plans
• Traditional IRAs
• Roth IRAs
• Annuity contracts

Question 2

what are the two groups of employer-sponsored retirement plans?

Answer 2

• defined benefit plans: promised employees a specified monthly benefit at normal retirement age
• defined contribution plans: does not promise a specific benefit payment to employee upon retirement

Question 3

what are types of self-employed retirement plans?

Answer 3

• beginning in 2023, qualified self-employed retirement plans can be designated as Roth plans, which means contributions are not deductible and qualified distributions are nontaxable
• SEP IRAs (simplified employee pension): max contribution is lesser of 20% of SE NI reduced by 50% of SE tax deduction; or $66K
• SIMPLE IRAs (savings incentive match plan for employees: max contribution is lesser of 100% of SE NI reduced by 50% of SE tax deduction; or $15.5K
• Solo 401(k)s: max contribution is lesser of 20% of SE NI reduced by 50% of SE tax deduction; or $66K

Question 4

what are annuities?

Answer 4

Annuities are like IRAs - long term contract with earnings on tax-deferred basis. The parties includes taxpayers and insurance company.

• 2 types:
  + Immediate annuity: purchased with a single payment and taxpayer receives income payments immediately within 30 days or 1 year

+ Deferred annuity: purchased with series of deposits over time in exchange for a promised future benefit of income payments. 2 phases: accumulation phase and payout phase

Question 5

what to consider when selecting a retirement plan?

Answer 5

• individual’s current and expected future marginal income tax rates are considered when selecting a retirement plan
  + Traditional account: current marginal tax rate > expected future marginal tax rate
  + Roth account: current marginal tax rate < expected marginal tax rate
• an advantage of employer-sponsored 401(k) plans is matching contribution made by the employers, so employees should contribute max dollar amount the employers match to take full advantage

Question 6

what is nonsystematic risk?

Answer 6

• risk that is unique to a certain industry or company. It’s also called a business risk
• does not affect the entire system, so investor could reduce the risk by diversifying investments
• examples:
  + default risk: issuers of bond failed to make interest payments or to repay principal when your bond matures
  + management risk: inherent risk in any company’s day-to-day operations such as discontinuation of sales or loss of a key executive

Question 7

what is systematic risk?

Answer 7

• affects the entire system such as capital market or economy as a whole
• ways to reduce systematic risk is to invest in derivatives or short selling (selling an investment in a hope to buy it back at lower price later)
• examples:
  + currency risk
  + inflation risk
  + sociopolitical risk

Question 8

what are the tax-efficient vehicles for parents to plan for their children’s education?

Answer 8

1. Section 529 qualified tuition programs
2. Coverdell education savings accounts
3. U.S. series EE savings bonds
4. Uniform gift to minors act (UGMA)/Uniform transfer to minors act (UTMA) custodial accounts
5. Others: financial aid (Stafford loans), Pell grants, federal grants, scholarships,..

Question 9

what are 4 methods of risk mitigation?

Answer 9

1. Avoidance: high frequency and high severity => remove the risk
2. Reduction: high frequency but low severity => ex: reduce risk of theft by installing security system or reduce risk of house burn down => install sprinkler system
3. Retention: low frequency and low severity => absorb all risks
4. Transfer: low frequency but high severity => sharing risk with insurance company

Question 10

what is long-term care insurance?

Answer 10

• provide benefits to individuals who are either cognitively impaired, or who are unable to perform two the daily activities: eating, bathing, dressing, toileting, walking, and continence
• health insurance contracts EXCLUDE coverage for the costs of long-term care
• Long-term care benefits are available under Medicare, but they are inadequate. Basically, long-term care picks up where Medicare leaves off

Question 11

what is return on investment (ROI) and after tax ROI?

Answer 11

• ROI = (investment sale price - cost of investment)/cost of investment
• After-tax ROI = ROI x (1 - tax rate)