Deck 18: Pension Funds

Question 1

Private pension funds are funds administered by
I) the federal government
II) state and local governments
III) insurance companies
IV) banks and mutual funds

A) I and II only
B) II and III only
C) III and IV only
D) II, III, and IV only
E) I and III only

Answer 1

C

Question 2

If you are terminated before you are fully vested in an employer-sponsored plan you may not get to keep previous contributions to your pension made by your employer.

Answer 2

True

Question 3

Assets in 401(k) plans are now greater than assets in private defined benefit plans.

Answer 3

True

Question 4

In terms of assets managed and numbers of plans, defined contribution plans are becoming more predominant and defined benefit plans are declining.

Question 5

In a defined benefit plan, the retirement benefit will vary according to rates of return on pension fund reserves.

Question 6

Noninsured pension plans generally invest in riskier assets than insured pension plans.

Question 7

A defined benefit pension plan expects to pay out $25 million per year over the next 10 years to pensioners. The fund currently has $155 million in pension assets that are earning 10% per year. This plan is underfunded.

Question 8

A pension plan has promised to pay out $25 million per year over the next 15 years to its employees. Actuaries estimate the rate of return on the fund's assets will be 5.50%. What amount of pension fund reserves (to the nearest dollar) are needed for the plan to be fully funded?

A) $375,000,000
B) $310,945,678
C) $250,939,524
D) $202,345,555
E) $198,466,231 25,000,000 x PVIFA (5.50%, 15 yrs) = 250,939,524

Question 9

Pension fund reserves held by life insurance companies represent about 50% of the typical life insurer's assets.

Question 10

Congratulations, you have just been employed! You now have a choice between a flat benefit at retirement equal to $4,000 times your years of service, or a career average formula of 3.50% of your average salary times your years of service. You expect to work 40 years. At what average salary would you be indifferent between the two alternatives?

A) $160,000
B) $145,444
C) $114,286
D) $101,104
E) $98,976 ($4000 * 40)/(0.035 * 40) = $114,286

Question 11

If you are married and you and your spouse make $160,000 total per year you are not allowed to contribute to an IRA.

Question 12

Most state and local pension funds are unfunded.

Question 13

Pension contributions paid to insured pension funds and the assets purchased with these funds become the legal property of the insurance company and are not the legal property of the individual pension fund contributors.

Question 14

Of the different types of defined benefit plans, plans using the final pay method will usually produce the biggest retirement benefit to employees.

Question 15

If you believe that taxes are going to go up and you will likely have to pay a high tax rate when you retire, you will probably be better off with a Roth IRA than with a traditional IRA.

Question 16

In recent years defined contribution plans have grown faster than defined benefit plans in which of the following areas?
I) Fund assets
II) Number of funds
III) Number of plan participants

A) I only
B) I and II only
C) II and III only
D) I, II, and III
E) II only

Question 17

Pension plans administered by the federal government are called insured pension plans.

Question 18

In general terms, which one of the following plan types is the riskiest for an employee on a year-to-year basis?

A) Defined contribution plan invested in fixed income securities
B) Defined contribution plan invested in equities
C) Final pay defined benefit plan
D) Career average defined benefit plan
E) Overfunded defined benefit plan

Question 19

A Keogh plan is designed for self-employed individuals.

Question 20

There are now Roth versions of 401(k) plans and 403(b) plans as well as Roth IRAs.

Question 21

You want to have $1,200,000 when you retire and you are in a defined contribution plan. You can earn 9% per year on the money invested and you will retire in 25 years. Your employer also contributes to your plan. The employer will contribute 4% of what you put into the plan each year. How much do you have to contribute per year to meet your goal?

A) $18,435.43
B) $17,654.87
C) $16,879.32
D) $13,622.60
E) $15,999.44 1,200,000/FVIFA (9%, 25 years) = $14,167.50 total annual payment required. Your contribution must be 14,167.50/1.04 = $13,622.60

Question 22

The main advantage of a profit sharing Keogh plan over a money-sharing Keogh plan is that profit sharing plans

A) are eligible for PBGC insurance and money sharing plans are not.
B) have higher maximum contributions than money sharing plans.
C) can have contributions that vary from year to year with profits, while money-sharing plan contributions are fixed.
D) both A and B are advantages
E) none of the above

Question 23

A retirement account specifically designed for self-employed persons is a

A) Roth IRA
B) traditional IRA
C) Keogh
D) Penny Benny
E) public pension plan

Question 24

Employee plus employer contributions to a 401(k) are $15,000 per year. Equity funds are earning 15%, bond funds 8%, and money market funds 6%. The employee wants to retire as soon as possible with $1 million in retirement assets. If he puts 50% of his money in stocks, 30% in bonds, and 20% in money funds, how long until he can expect to retire?

A) 3.3 years
B) 9.7 years
C) 4.6 years
D) 2.4 years
E) 12.2 years rate of return = (15%x0.5) + (8%x0.3) + (6%x0.2) = 11.10%; 1,000,000/15,000 = FVIFA (11.10%, N); solve for N with financial calculator or use log rule and annuity formula.

Question 25

Vesting refers to

A) how long until an employee owns any employer contributions to the employee's pension plan.
B) how long until an employee can transfer any of their own contributions to a new plan if they switch jobs.
C) eligibility requirements to retire early.
D) restrictions on asset allocations within a defined contribution plan.
E) the extent to which an employee materially participated in a given business in a given year. The book uses the word vesting in a different manner to refer to the time until one is eligible to receive any pension benefits.

Question 26

An employee contributes 6% of her salary to her 401(k) plan and her employer contributes another $1,900. The employee earns $75,000 and is in a 28% tax bracket. If the employee earns 8.50% on all funds invested each year and her salary does not change, how much will she have in her account in 20 years?

A) $195,369
B) $213,133
C) $244,667
D) $289,055
E) $309,613 [(6% x 75,000) + 1,900] x PVIFA (8.50%, 20) = 309,613

Question 27

Which of the following is/are true about a Roth IRA?
I) Contributions are tax deductible.
II) Withdrawals after retirement are not taxed.
III) You must begin withdrawals at age 70 ½.
IV) Employers match contributions.
V) They are only available to individuals earning less than $50,000, or households earning less than $90,000.

A) I, II, and IV
B) II, IV, and V
C) I, III, and IV
D) II only
E) V only

Question 28

A defined benefit pension plan has expected payouts of $15 million per year for 8 years and then $20 million over the following 15 years. Actuaries have estimated that the fund can be expected to earn an average of 5.25% on its assets. The fund currently has reserves of $185,475,000. The plan is ___________ by about ___________ million.

A) underfunded; $100
B) underfunded; $59
C) overfunded; $30
D) overfunded; $24
E) underfunded; $46 185.475M - [15M x PVIFA (5.25%, 8) + 20M x PVIFA (5.25%, 15)/PVIF (5.25%, 10)] = -46M

Question 29

An employee who has worked for his firm for 30 years can retire right now and receive a constant annual benefit of $45,000. He has a final pay plan that pays his average salary over his final 5 years times 2% times years of service. He has decided he will keep working five more years but only if by doing so his retirement benefits will grow at 6% per year. How much would his expected average salary (to the nearest dollar) have to be over the next 5 years to keep him working?

A) $54,198
B) $86,029
C) $51,617
D) $66,911
E) $53,147 (45,000 x 1.06⁵ )/(0.02*35) = 86,029

Question 30

Under ERISA, pension fund managers are required to invest fund assets as wisely as if they were investing their own money. This requirement is called the

A) owl rule.
B) vesting requirement.
C) 403(b) requirement.
D) prudent person rule.
E) funding rule.

Question 31

The PBGC
I) insures participants of defined benefit plans if plan funds are insufficient to meet contractual pension obligations.
II) insures participants of defined contribution plans if investment returns are insufficient to meet expected pension obligations.
III) regulates day-to-day pension fund operations.

A) I only
B) II only
C) I and III only
D) II and III only
E) I, II, and III

Question 32

Under ERISA the maximum time period allowed for vesting is _____________ years.

A) 3
B) 5
C) 8
D) 10
E) 15

Question 33

The Pension Protection Act of 2006 requires companies to correct funding shortfalls in their defined benefit plans within:

A) 1 year
B) 3 years
C) 5 years
D) 10 years
E) 20 years It was 20 years before the law went into effect.

Question 34

ERISA established all but which one of the following?

A) Prudent man rule
B) Maximum vesting times
C) Minimum funding requirements
D) Insurance for pension plan participants
E) Minimum payouts for defined contribution plans

Question 35

An employee contributes 9% of his salary to his 401(k) plan and the employer matches with 40% of the first 6% of the employee's salary. The employee earns $90,000 and is in a 28% tax bracket. If the employee earns 10% on the plan investments, what is his one-year rate of return relative to the net amount of money he invested?

A) 16.28%
B) 51.25%
C) 90.07%
D) 93.52%
E) 29.72% FV1 = 90,000 x (9% + (.4 x .06)) x 1.10 = 11,286; Employee after-tax contribution = 90,000 x (9% x (1-28%)) = 5,832; HPR = (11,286/5,832) - 1 = 93.52%

Question 36

A(n) ___________ plan does not require the employer to guarantee retirement benefits nor to maintain a minimum level of pension reserves.

A) defined benefit
B) insured pension
C) corporate pension
D) uninsured pension
E) defined contribution

Question 37

Which of the following statements about 401(k) plans are true?
I) They are defined benefit plans.
II) They allow employer and employee contributions.
III) Earnings accrue tax-free during the employee's working years.
IV) They allow employee discretion in asset allocation.
V) They always have minimum guaranteed rates of return.

A) I, IV, and V only
B) I, II, and V only
C) II and III only
D) II, III, and IV only
E) all are true

Question 38

Employee plus employer contributions to a 401(k) are $11,000 per year. Equity funds are earning 10%, bond funds 5%, and money market funds 3%. The employee will retire in 30 years. How much money will he have if he earns the average return from putting 65% of his money in equities, 30% in bond funds, and the rest in money market funds?

A) $1,280,925
B) $1,838,526
C) $1,654,320
D) $1,978,565
E) $1,248,550 r = (65% * 10) + (30% * 5) + (5% * 3) = 8.15%; FV30 = 11,000 * FVIFA (8.15%, 30) = 1,280,925

Question 39

Which of the following statements are true about a traditional IRA?
I) Subject to an income limit, in 2011 a single person could contribute up to $5,000 per year of pretax income to an IRA.
II) All withdrawals are tax-free.
III) Earnings on the IRA account are not taxed until withdrawn.
IV) You must begin withdrawals at age 59 ½.
V) Withdrawal(s) can be a lump sum or installments.

A) I, II, IV
B) I, II, IV, and V
C) I, III, and V
D) II, IV, and V
E) III, IV, and V

Question 40

At your new job you estimate that your average salary over your working years will be $95,000 per year. How many more years would you have to work to receive as much benefit from a flat benefit of $3,000 times years of service as you would receive from 3.75% of your average salary times years of service?

A) 1.33 times as many years
B) 0.75 times as many years
C) 1.19 times as many years
D) 2.40 times as many years
E) 1.50 times as many years (0.0375 * 95,000)/3,000 = 1.19

Question 41

A country where the link between public pension benefits and amounts paid in is weak is

A) Sweden
B) Italy
C) Great Britain
D) Chile
E) France

Question 42

You are 30 years old and you make $110,000 per year. You calculate that you can't retire until you have accumulated a lump sum amount of $2,000,000 to live on after retirement. You contribute 6% of your salary to your 401(k) and your employer contributes 3% of your salary. You plan on investing 65% of your funds in equities on which you expect to earn an average rate of return of 10%, and the rest in bonds projected to earn 5%. If your salary does not grow, how old will you be when you can retire?

Question 43

How sound is the PBGC? How much do firms pay for pension fund insurance? Describe President Bush's proposal to increase funding for PBGC.

Question 44

Why do employees increasingly prefer defined contribution plans to defined benefit plans?

Question 45

A 55-year-old has just changed jobs and has a choice between a defined benefit plan [final pay] and a defined contribution plan. He will work for 10 more years. What should he consider in making his decision?

Question 46

How is Social Security different from a private defined benefit plan? When and why is Social Security projected to become insolvent?

Question 47

Social Security began running a deficit for the first time in what year?

A) 1990
B) 1995
C) 2000
D) 2005
E) 2010

Question 48

How do public pension plans differ in other countries? Has privatization worked overseas?

Question 49

IRAs are

A) self-directed investment vehicles designed to provide supplemental retirement income.
B) corporate retirement plans for self-employed individuals and small businesses.
C) specific classes of investments such as equities or bonds issued by certain corporations.
D) investment vehicles created by ERISA.
E) special types of life insurance policies.

Question 50

Why do insured pension plans invest in less risky assets than uninsured pension plans?

Question 51

An individual is considering contributing $4,000 per year to either a traditional or a Roth IRA. Payments would begin in one year. If she uses the traditional IRA, her contributions would be fully deductible. She is 40 years old and is in a 28% tax bracket. On either IRA she can earn 7%. When she retires at age 65 she believes she will be in a 28% tax bracket. Which type of IRA should she choose if she invests not only the $4,000 per year, but any tax savings due to the deductibility of her contributions in a taxable investment earning a pretax rate of 7%? She will withdraw all her money upon retirement and may owe taxes then, depending on the type of IRA chosen.

Question 52

Suppose that a corporate defined benefit plan had decided it will keep pension fund reserves equal to the present value of expected future pension benefits to be fully funded. The plan has expected payouts of $12 million per year for 15 years and then $22 million per year for the subsequent 10 years. All payments are at year-end. At the current 5.75% rate of return on the plan's assets, the plan is currently fully funded. If the plan can increase the proportion of stock investments the fund holds and raise the expected rate of return to 8.00%, how many dollars of pension assets can be freed up by the corporation?

Question 53

An individual is considering contributing $4,000 per year to either a traditional or a Roth IRA. Payments would begin in one year. If she uses the traditional IRA, her contributions would be fully deductible. She is 40 years old and is in a 28% tax bracket. On either IRA she can earn 7%. When she retires at age 65 she believes she will be in a 15% tax bracket. Which type of IRA should she choose if she invests not only the $4,000 per year, but any tax savings due to the deductibility of her contributions in a taxable investment earning a pretax rate of 7%? She will withdraw all her money upon retirement and may owe taxes then, depending on the type of IRA chosen.

Question 54

What are the main provisions of ERISA?