Retirement Planning Practice Questions for the CFP® Exam

The BIF Crew is going back through our archives, and we put together some practice questions for the CFP^® Exam related to retirement planning. Test your knowledge and then read our instructor insights and CFP Board explanations for how we got these answers. 

Social Security and Medicare

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

Each of the following statements about taking a Social Security retirement benefit are correct, except:

1. A worker may choose to start receiving benefits as early as age 62 regardless of full retirement age.
2. If taken early, Social Security retirement benefits are reduced 5/9 of 1% for each month, up to a maximum of 36 months.
3. The total reduction to one’s Social Security benefit if taken four years early would be 20%.
4. By delaying retirement beyond full retirement age, one’s Social Security base can grow 8.0% per year up to age 70.

Correct answer: C. The total reduction to one’s Social Security benefit if taken four years early would be 20%.

Instructor insight:

The total reduction for retiring four years early would be 25%.

Benefits are reduced 5/9 of 1% for each month of early retirement, up to a maximum of 36 months. A further reduction applies for each month over 36 months at the rate of 5/12 of 1% per month. Therefore, retirement benefits will be reduced by 20% over the first three years (5/9 x 36), followed by a further reduction of 5% in the fourth year (5/12 x 12). The total reduction for retiring four years early would be 25%.

CFP^® Exam insight:

Although Social Security retirement benefits that are accessed early will be reduced in relation to one’s primary insurance amount (PIA) at full retirement age (FRA), the reduced benefit will adjust annually with a cost of living adjustment (COLA). This allows the benefit to keep pace with inflation as measured by the Consumer Price Index (CPI).

Tax Advantaged Retirement Plans #1

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

Pete, age 62, plans to retire at age 65 and in the past few years he has tried to maximize his retirement savings. Pete loves to teach. He has taught high school finance classes for the same school for 40 years. He also teaches part-time at a private test-prep company and part-time for the city through the park district in the summer.  His salary at the high school is $95,000 and Pete earns $15,000 per year at the private test-prep company, and $6,000 each summer through the city. Respectively, his three employers sponsor a Section 403(b) plan, a Section 401(k) plan, and a public Section 457 plan. What is the maximum Pete can contribute collectively to the three plans?

1. $50,000
2. $57,000
3. $25,500
4. $35,000

Correct answer: D. $35,000

Instructor insight:

The elective deferral limit is $19,500 plus $6,500 catch-up between the Section 403(b) plan and the Section 401(k) plan combined. Pete is eligible for the special catch-up under the Section 403(b) plan which allows him to defer an additional $3,000. Section 457(b) plan deferrals are not aggregated with other deferrals. Therefore, Pete can defer the lesser of 1) 100% of compensation from the city and 2) $19,500. In this question, Pete can defer 100% of his compensation, $6,000, into the Section 457(b) plan. The maximum deferral total across the three plans is $35,000.

CFP® Exam insight:

Remember that all elective deferrals must be aggregated in applying the applicable limit EXCEPT deferrals into a Section 457 plan.

Tax Advantaged Retirement Plans #2

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

Gloria and Art, aged 52 and 60 respectively, file MFJ and have a MAGI of $203,000 in 2020. The couple would like to contribute to a Roth IRA this year. What is the maximum contribution Gloria and Art can make to a Roth IRA in 2020?

Correct answer: $2,100

Instructor insight:

Roth IRA phaseouts:

From the Provided Tax Tables:

CFP® Exam insight:

If the MAGI for a given client allows for a contribution to a Roth IRA and an above-the-line deduction for a Traditional IRA, the total combined annual contribution cannot exceed the limits of $6,000 (2020), and an over-50 catch-up of $1,000, or the total taxable compensation (if less than the contribution limits).

Tax Advantaged Retirement Plans #3

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

Jack and Jill, each age 45, want to make maximum contributions to traditional IRA this year. Their MAGI this year is $175,000. Jill’s employer maintains a profit-sharing plan with a 401(k) option. Jill has suspended elective deferrals into the 401(k) but she received $1,000 into her profit-sharing account from reallocated forfeitures. Jack’s employer does not sponsor a retirement plan. What is the maximum deduction Jack and Jill may claim if they each contribute $6,000 to their respective IRAs?

1. $6,000 deduction
2. $12,000 deduction
3. $0 deduction
4. $11,000 deduction

Correct answer: A. $6,000 deduction

Instructor insight:

There are two deduction phaseout thresholds applicable in this example. Even though Jill has suspended her Section 401(k) deferrals she is still considered an active participant because her account was credited with $1,000 in reallocated forfeitures. Her applicable deduction phaseout threshold is $104,000 to $124,000. Their MAGI of $175,000 precludes Jill from deducting any of her IRA contribution.

Jack is not an active participant in an employer sponsored plan. His applicable IRA deduction phaseout threshold is $196,000 to $206,000. Their MAGI is below the entry threshold; therefore, they can deduct Jack’s full IRA contribution of $6,000.

CFP^® Exam insight:

In an exam question of this nature, it is critical to read carefully to determine the type of plan in which an employee is participating. Also illustrated in this question is that annual additions include any reallocated forfeitures.

Types of Retirement Plans

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

Debra, age 50, is an executive with a small but very successful consulting firm. Her salary is $300,000. The company sponsors a money purchase pension plan with a 25% contribution. What will be the contribution made on Debra's behalf this year?

1. $75,000
2. $19,500
3. $57,000
4. $71,250

Correct answer: C. $57,000

Instructor insight:

The maximum covered compensation in any qualified plan benefit formula for 2020 is $285,000. A 25% plan contribution based on $285,000 of covered compensation is $71,250. This, however, exceeds the annual additions limit applicable to all defined contribution plans of $57,000 for 2020.

CFP^® Exam insight:

This question requires application of two areas of knowledge about qualified plans. The covered compensation limit of $285,000 (2020) for benefit formulas applies to all qualified plans. A money purchase pension plan is a defined contribution plan, subject to the annual additions limit.

Be mindful of the various rules in play for a given type of plan, but remember knowing whether a plan is a defined contribution plan or a defined benefit plan is critical in solving this type of application question.

Retirement Plan Contributions

This question was discussed in detail during the January 2021 episode of the BIF Bites podcast!

Harry and Emma, both age 71, file taxes as Married Filing Jointly. Emma retired last year, and Harry continues to work full-time simply because he loves his job. Harry earns $75,000 annually and continues to contribute to his employer’s Section 401(k) plan. Their MAGI is $85,000. Harry has asked how much they can contribute and deduct to a traditional IRA for 2020?

1. Contribute $0; deduct $0.
2. Contribute $6,000; deduct $0.
3. Contribute $14,000; deduct $7,000.
4. Contribute $14,000; deduct $14,000.

Correct answer: D. Contribute $14,000; deduct $14,000.

Instructor insight:

The SECURE Act passed in 2019 removes the age limit for contributions to a traditional IRA. Previously, the maximum age contributions to an IRA could be made was 70 ½ which was also the age RMDs began. Under current regulations RMDs do not need to begin until the age of 72 and there is no age limit on when contributions can be made.  This means that even if individuals are forced to withdraw funds from their IRA to satisfy their RMD, they can redeposit the funds back into that same IRA so long as they meet the other contribution requirements.

Contributions and deductions are subject to the active participation and MAGI rules. Harry has enough income to allow a $7,000 contribution and deduction for himself and a $7,000 contribution and deduction for Emma under the spousal IRA rules. While Harry is an active participant in an employer-sponsored retirement plan, their MAGI is below the applicable thresholds, thus allowing a full deduction for the contributions.

Corporate Retirement Plans

This question was discussed in detail during the February 2021 episode of the BIF Bites podcast!

John, an employee of ABC, Inc., is concerned because he has not received an annual addition to the ABC profit-sharing plan for the past two years. John, who earns $100,000 per year, is age 40 and married. Which of the following are true?

1. All defined contribution plans are subject to minimum funding rules.
2. He cannot contribute to an IRA because he is an "active participant" in an employer plan.
3. He can make a deductible contribution of $6,000 to an IRA.
4. He can't make a deductible IRA contribution because ABC hasn't made contributions to the profit-sharing plan.

Correct answer: C. He can make a deductible contribution of $6,000 to an IRA.

Instructor insight:

Defined Benefit Plans (i.e., money purchase & defined benefit pension plans) are subject to minimum funding rules, but profit-sharing plans are a type of Defined Contribution Plan and are not subject to minimum funding rules.

To be considered an active participant in an employer-provided Defined Contribution Plan, no reallocated forfeitures, employer contributions, and/or employee deposits can be credited to the employee account.

In John’s scenario, if ABC, Inc. does not contribute to the profit-sharing plan in a given year, John is not considered an active plan participant (even though he is covered under the plan). Note: relocated forfeitures and employee contributions were not credited, as well.

If one spouse is an active participant and the other spouse is not an active participant, the non-active participant spouse may make a deductible IRA contribution if their combined adjusted gross income (AGI) is less than $196,000 [phased out at $206,000 (2020)]*.

For active participants, deductible IRA contributions are phased out between the AGI limits shown*.

*In both cases, each spouse may elect to make non-deductible contributions to their traditional IRAs if they are above phaseout limits. Phaseout numbers are provided on your CFP® exam.

CFP^® Exam tip:

Determining active participation status is essential to figuring out if a deductible IRA contribution is permitted. Defined Benefit Plans and Defined Contribution Plans have different active participation criteria.

• Defined Benefit Plans: If an employee is eligible to participate in the plan, they are considered an active participant.
• Defined Contribution Plans: If any of the following were deposited to an employee’s account they are considered an active participant:
  • employee contributions
  • employer contributions
  • forfeitures

Social Security Integration

This question was originally discussed during the August 2020 episode of the BIF Bites podcast!

Assume that an 8% money purchase plan is to be integrated with Social Security. What is the plan’s maximum permitted disparity?

1. 4.3%
2. 7.65%
3. 5.7%
4. 13.7%

Correct answer: C. 5.7%

Instructor insight:

Social Security retirement benefits inherently discriminate against higher paid workers. Social Security retirement benefits replace a much higher percentage of a lower paid worker’s income than do the benefits for a higher paid worker. This happens because the formula for benefits includes only compensation up to the Social Security taxable wage base each year and the “bend points” in the formula are heavily weighted at lower income levels. Considering the inherent discrimination, qualified plans can recognize the existence of Social Security retirement benefits in the plan’s benefit formula, allowing higher benefits for higher paid plan participants. An integrated qualified plan provides two levels of benefits:

1. A first tier of benefits typically based on compensation up to the Social Security wage base (called the integration threshold), and
2. A second, higher benefit structure based on compensation in excess of the integration threshold.

Integration of a defined contribution plan focuses on the plan contribution percentages and is called the excess method. Integration of a defined benefit plan typically focuses on the promised final benefit based on compensation at the two levels and is called the offset method.

CFP® Exam tip:

Most qualified plans in existence today are defined contribution plans. The CFP Board exam is more likely to test the excess method used for defined contribution plans. Under an excess method approach, contributions consist of a base contribution up to the integration threshold and a higher contribution percentage for income in excess of the integration threshold. The maximum excess contribution of the benefit level above the threshold cannot exceed the lesser of 1) 2x the base level percentage or 2) the base level percentage plus 5.7%.

For example, if the base level contribution is 5%, the maximum percentage above the threshold is 10%. If the base contribution rate is 6%, the maximum contribution above the threshold is 11.7% [6% + 5.7%)]. Memorize “maximum excess contribution is the lesser of 2x the base rate or the base rate plus 5.7%.”

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