FINRA Series 6 — All Questions

Apart from money market funds, an open-end mutual fund may not acquire an illiquid investment if, right after the purchase, illiquid investments would exceed what share of its net assets?

• a.25%, the figure used for a money market fund's daily liquid assets
• b.15%, measured against net assets right after the purchase✓
• c.10%, the figure that caps a fund's share of an issuer's voting stock
• d.5%, the figure that caps any one issuer in the diversification test

Rule 22e-4 prohibits an open-end fund from buying an illiquid investment if illiquid holdings would then exceed 15% of net assets. Money market funds are excluded from the rule and operate under Rule 2a-7 with their own, stricter liquidity requirements. The 25% figure resembles a money market daily-liquid threshold, which is a minimum, not a cap on illiquid holdings.Investment Company Act of 1940 Rule 22e-4

A mutual fund realizes net capital losses for the year, and shareholders ask whether they can claim the loss on their own returns. How are the fund's losses treated?

• a.They are deducted on the fund's income dividends, reducing each shareholder's ordinary income
• b.They pass through to shareholders in proportion to shares held on the record date
• c.The fund carries them forward to offset its future capital gains, and shareholders cannot deduct them✓
• d.They expire at year-end if the fund does not sell enough winning securities to offset them

A regulated investment company cannot pass its net losses to shareholders; it carries them forward to offset gains it realizes in later years, which reduces future capital gain distributions. Shareholders can claim only losses on their own sales of fund shares. Losses do not reduce income dividends, and they do not expire at year-end.Internal Revenue Code Section 1212

A money market fund's policies and procedures limit every beneficial owner of its shares to natural persons. How does Rule 2a-7 classify the fund, and what pricing method may it use?

• a.A retail money market fund, which may use amortized cost or penny rounding to hold a stable NAV✓
• b.A government money market fund, which must invest 99.5% of assets in government securities and repos
• c.A retail money market fund, which must float its NAV because only government funds may use amortized cost
• d.A prime money market fund, which must float its NAV because it holds corporate debt

Rule 2a-7 defines a retail money market fund by its policies and procedures reasonably designed to limit all beneficial owners to natural persons, and retail and government funds may use amortized cost or penny rounding to maintain a stable NAV. Funds that are neither retail nor government must price to at least the fourth decimal place, which is the floating NAV. The government fund label depends on what the fund holds (99.5% or more in cash, government securities and fully collateralized repurchase agreements), not on who owns it. Retail funds are not required to float, and a fund holding corporate debt is not automatically a floating-NAV fund if it is limited to natural persons.17 CFR 270.2a-7(a)(21), (c)(1)

A money market fund reports a dollar-weighted average maturity of 45 days, a dollar-weighted average life of 130 days, daily liquid assets of 30% and weekly liquid assets of 55%. Which Rule 2a-7 limit does it breach?

• a.The 50% minimum for weekly liquid assets as a share of total assets
• b.The 120-day limit on dollar-weighted average life of the portfolio✓
• c.The 25% minimum for daily liquid assets as a share of total assets
• d.The 60-day limit on dollar-weighted average maturity of the portfolio

Rule 2a-7 caps dollar-weighted average maturity at 60 days, dollar-weighted average life at 120 days, and requires at least 25% daily liquid and 50% weekly liquid assets. At 130 days the fund exceeds the average-life limit. Its 45-day maturity is under 60, its 30% daily liquidity is above 25%, and its 55% weekly liquidity is above 50%, so none of those limits is breached.17 CFR 270.2a-7(d)

A 6% bond with eight years to maturity is quoted at 105. Which statement about its yields is correct?

• a.Yield to maturity and current yield both equal the 6% coupon because the coupon is fixed
• b.Yield to maturity is below current yield, which is below the 6% coupon✓
• c.Current yield is below yield to maturity, and both are above the 6% coupon rate
• d.Current yield is above the 6% coupon rate, and yield to maturity is below the current yield

For a premium bond, current yield = $60 / $1,050 = 5.71%, which is below the 6% coupon, and yield to maturity is lower still (about 5.2%) because the premium is amortized away by maturity. The ordering with yield to maturity above current yield describes a discount bond. A fixed coupon does not fix the yield, which moves with price. Current yield can exceed the coupon only when the bond sells at a discount.

An investor in the 24% federal bracket compares a 3.9% municipal bond fund with a taxable bond fund yielding 5.0%. Ignoring state taxes, which statement is correct?

• a.The taxable fund is better, because after 24% tax it still keeps about 4.2% against the 3.9% municipal yield
• b.The taxable fund is better, because its 5.0% yield is higher than the municipal fund's 3.9% yield
• c.They are equal, because 3.9% is the 5.0% taxable yield reduced by a 22% federal tax rate
• d.The municipal fund is better; its taxable equivalent is about 5.13%, above the 5.0% taxable yield✓

The taxable equivalent yield is 3.9% / (1 - 0.24) = 5.13%, which beats 5.0%; equivalently the taxable fund keeps 5.0% x 0.76 = 3.80%, below 3.9%. Comparing the stated yields ignores the tax difference. The two funds would tie only at a 22% rate, since 3.9 / 5.0 = 0.78, which is not this investor's bracket. The 4.2% figure is not what 24% tax leaves of 5.0%.

A TIPS has a $1,000 original par value and a 2.0% coupon. After CPI adjustments the principal is $1,050. What is the next semiannual interest payment?

• a.$10.50, which is 1% of the $1,050 adjusted principal✓
• b.$5.25, which is 0.5% of the adjusted principal each period
• c.$21.00, which is 2% of the adjusted principal paid at one time
• d.$10.00, which is 1% of the $1,000 original par value

TIPS pay a fixed rate on the adjusted principal every six months, so each payment is 2.0% / 2 = 1% of $1,050 = $10.50. Using original par ignores the inflation adjustment, which is the point of the security. $21.00 is a full year of interest, and TIPS pay twice a year. $5.25 would be a quarterly payment.

A TIPS was issued at $1,000 par. Deflation over its life leaves the adjusted principal at $960 on the maturity date. What principal does the holder receive at maturity?

• a.$960, because principal is always paid at its inflation-adjusted amount
• b.$1,040, which restores the amount lost through a deflation make-whole payment
• c.$1,000, because the greater of adjusted or original principal is paid✓
• d.$980, the average of the original principal and the adjusted principal

At maturity a TIPS pays the greater of its inflation-adjusted principal or its original principal, so the holder gets $1,000 even though the adjusted figure is $960. Paying the adjusted principal would remove the deflation floor. Averaging has no basis in the terms, and no make-whole payment exists above original par.

A client wants to buy 2040 Treasury STRIPS directly in a TreasuryDirect account to avoid a dealer markup. What is the accurate response?

• a.STRIPS are limited to institutional investors, so individuals must buy a STRIPS fund
• b.TreasuryDirect sells them, but only to investors who agree in writing to hold them until maturity
• c.STRIPS are sold only through a financial institution, broker or government securities dealer✓
• d.TreasuryDirect sells STRIPS directly at auction in $100 increments, with no intermediary or markup

Treasury STRIPS are held in the commercial book-entry system, and the Treasury states that they can be bought, held, sold and redeemed only through a financial institution, broker or dealer that handles government securities. TreasuryDirect does not sell them at auction or on a hold-to-maturity basis. Individuals may buy STRIPS directly through a broker, so no fund is required.

Market interest rates rise sharply after an investor buys a 30-year mortgage pass-through certificate. What happens to the certificate's expected average life?

• a.It stays the same, because the certificate follows a fixed 30-year schedule
• b.It lengthens, because fewer homeowners refinance or prepay, which is extension risk✓
• c.It lengthens, because the guarantor delays principal payments until market rates fall again
• d.It shortens, because homeowners prepay faster, which is contraction risk

When rates rise, refinancing and prepayments slow, so principal comes back later and the expected average life extends, while the price falls; this is extension risk. Faster prepayment and a shorter life occur when rates fall. Prepayments are not scheduled, so average life is not fixed. A guarantor stands behind timely payment and does not delay principal.

A private fund avoids registering as an investment company by relying on Section 3(c)(1) of the Investment Company Act of 1940. Which condition must it meet?

• a.Its securities have no more than 100 beneficial owners and are not publicly offered✓
• b.Its shares must be redeemable on demand at net asset value so investors can leave at any time
• c.Every investor must be a qualified purchaser, though there is no limit on the number of investors
• d.It must register under Section 8 but may skip the board and shareholder-vote requirements

Section 3(c)(1) excludes an issuer whose outstanding securities are beneficially owned by not more than 100 persons and which is not making a public offering. The qualified-purchaser approach with no investor cap is Section 3(c)(7). A fund relying on 3(c)(1) is excluded from the definition and does not register under Section 8. Daily redemption is a feature of registered open-end funds, not a condition of the exclusion.Investment Company Act of 1940 Section 3(c)(1)

A closed-end fund's board decides each period whether to make a repurchase offer under the tender offer rules, and no fundamental policy requires the fund to do so. Which type of fund is it?

• a.A tender offer fund, because it has no fundamental policy obliging periodic repurchases✓
• b.A unit investment trust, because the sponsor repurchases units only when it chooses to
• c.An open-end fund, because shareholders may redeem at net asset value on any business day
• d.An interval fund, because interval funds repurchase shares only when the board approves each offer

An interval fund under Rule 23c-3 must adopt a fundamental policy to repurchase a stated percentage of shares at fixed intervals, while a tender offer fund makes repurchase offers under Rule 13e-4 at the board's discretion with no obligation. An open-end fund must redeem on demand. A unit investment trust is not a closed-end fund and has no board.Investment Company Act of 1940 Rule 23c-3

A U.S. fund owns a Japanese stock whose yen price is unchanged, and the yen weakens 5% against the dollar. What happens to the holding's value in dollars?

• a.It stays flat, because a fund's holdings are valued in local currency
• b.It rises by about 5%, because a weaker yen boosts the exporter's earnings
• c.It stays flat, because the stock's own price in yen did not move at all
• d.It falls about 5%, a currency loss despite the unchanged yen price✓

A fund reports in dollars, so a foreign holding's value reflects both the local price and the exchange rate. With the yen price unchanged and the yen down 5%, the dollar value drops about 5%: currency risk. A flat local price does not mean a flat dollar value, and funds convert foreign holdings to dollars rather than reporting them in local currency. Any earnings boost would show up in the local price, which is stated to be unchanged.

A $1,000 convertible bond converts at $40 of par per common share. The stock trades at $46 and the bond trades at $1,180. What is the bond's conversion (parity) value?

• a.$1,000, the par value repaid at maturity
• b.$1,180, the bond's current market price
• c.$1,840, from 40 shares at $46 each
• d.$1,150, which is 25 shares at $46 each✓

The conversion ratio is $1,000 / $40 = 25 shares, and 25 x $46 = $1,150. The bond sells for $1,180, so it trades at a premium of $30 over parity. $1,840 uses the $40 conversion price as the share count. $1,000 is par, which is unrelated to what the shares are worth now.

A commodity ETF holds near-month futures and rolls each contract into a later month that costs more than the expiring one. With the spot price unchanged, what does the roll generally cause?

• a.A drag on return, because the fund sells the expiring contract low and buys the next one higher✓
• b.No effect, because futures prices always converge with the spot price at expiration
• c.A gain, because the fund collects the price difference between the two contract months
• d.A cash payment to shareholders, because the price difference is passed through as a dividend

When later contracts cost more than expiring ones (contango), each roll sells low and buys high, which erodes the fund's return even if the spot price does not move. The difference is a cost, not a gain. Convergence at expiry is why the roll costs matter and does not remove them. The difference is not a dividend and is not distributed.

A fund holds senior bank loans whose coupons reset to a short-term benchmark every 90 days. If short-term rates rise one percentage point, how does its price sensitivity compare with a fixed-rate bond fund of similar credit quality?

• a.Prices tend to rise, because the fund's income increases by the full one percentage point
• b.Prices tend to fall more, because floating coupons are linked to short-term benchmark rates
• c.Prices are unaffected, because senior loans are secured and carry no credit risk
• d.Prices tend to fall less, because coupons reset higher, although credit risk remains✓

Coupons that reset every 90 days keep the loans close to par when rates rise, so a loan fund typically falls much less than a fixed-rate bond fund, although it still bears credit risk and can lose value if borrowers default. Linkage to short rates is the reason for lower, not higher, price sensitivity. Being secured does not remove credit risk. Higher income does not automatically push prices above par.

A firm's designated office receives a complete deferred variable annuity application package on a Monday. A registered principal approves the application on the Thursday of the following week. Did the firm meet the timing requirement of FINRA Rule 2330?

• a.No; the review was due within seven business days of receiving the package✓
• b.Yes; Rule 2330 gives the principal ten business days from receipt of the complete package
• c.Yes; the review period runs from the date the insurer issues the contract
• d.No; Rule 2330 requires approval on the same business day the package arrives

Rule 2330(c) requires a registered principal to review and approve or reject a deferred variable annuity application before it goes to the insurer, and no later than seven business days after the member's office of supervisory jurisdiction receives a complete and correct application package. Approval on the Thursday of the following week falls on the eighth business day after receipt, past the deadline. Ten days is not the rule, the clock does not wait for contract issuance, and same-day approval is not required.FINRA Rule 2330(c)

A variable annuity is annuitized under a life with 10-year period certain option, and the annuitant dies after four years of payments. What happens to the payments?

• a.The beneficiary receives the remaining payments through the end of the tenth year✓
• b.The insurer pays the beneficiary the remaining account value in one lump sum
• c.Payments stop at death, because the payout was based on the annuitant's life
• d.Payments continue for the beneficiary's lifetime at the same number of annuity units

A period certain option guarantees payments for at least the stated period even if the annuitant dies early, so the beneficiary collects the remaining six years of payments. Ending payments at death describes a life-only option. After annuitization the owner no longer has an account value to refund. The guarantee covers the stated period, not the beneficiary's lifetime.

In a non-qualified variable annuity, an owner moves $50,000 from an equity subaccount, which has a gain, to a bond subaccount in the same contract. What is the immediate federal tax result?

• a.No current tax; the gain stays deferred until withdrawn or annuitized✓
• b.The gain is ordinary income that year, plus 10% if the owner is under 59 1/2
• c.The gain is taxable only if the transfer exceeds 10% of the contract value in the year
• d.The gain is taxed as a long-term capital gain in the year of the transfer

Transfers among subaccounts inside one annuity contract are not distributions, so earnings stay tax deferred until withdrawal or annuitization, and then they are taxed as ordinary income. Annuity gains never receive capital gain treatment. The 10% additional tax applies to taxable distributions, and no transfer limit of 10% triggers tax.Internal Revenue Code Section 72(e)

The investment in the contract of a non-qualified annuity is $60,000, and the expected return under the contract is $90,000. Each monthly payment is $1,200. How much of each payment is taxable as ordinary income?

• a.$800, which is the portion of each payment that is excluded
• b.$1,200, because every annuity payment is fully taxable ordinary income
• c.$400, because two-thirds of each payment is excluded from tax✓
• d.$600, because half of each payment returns the owner's cost

The exclusion ratio is the investment in the contract divided by the expected return: $60,000 / $90,000 = 66.67%. Of each $1,200 payment, $800 is excluded and $400 is taxable. The $800 figure is the tax-free part. Payments are not fully taxable because part returns the owner's after-tax cost, and the exclusion ratio is not fixed at one half.Internal Revenue Code Section 72(b)

A variable annuity pays the greater of the account value or the highest contract anniversary value as its death benefit. The owner paid $100,000, anniversary values were $112,000, $104,000 and $108,000, and there were no withdrawals. The owner dies when the account value is $95,000. What is the death benefit?

• a.$100,000, the premium the owner paid at issue
• b.$112,000, the highest anniversary value✓
• c.$108,000, the value on the most recent anniversary
• d.$95,000, the account value on the date of death

The contract pays the greater of account value or the highest anniversary value, and the highest of the three anniversary values is $112,000, which exceeds the $95,000 account value. The latest anniversary is not the highest. A return-of-premium benefit would be $100,000, but this contract is not written that way. The account value alone would ignore the step-up feature.

A variable annuity charges a 1.15% M&E charge, a 0.15% administrative fee, 0.70% in subaccount fund expenses and a 0.80% rider fee, all as a percentage of a $150,000 account value. What is the total annual cost in dollars?

• a.$3,150, leaving out the fund expenses
• b.$4,200, the sum of all four charges✓
• c.$3,975, leaving out the administrative fee
• d.$3,000, leaving out the rider fee

The four charges add to 1.15% + 0.15% + 0.70% + 0.80% = 2.80%, and 2.80% of $150,000 is $4,200. Dropping the rider fee gives 2.00% = $3,000. Dropping fund expenses gives 2.10% = $3,150. Dropping the administrative fee gives 2.65% = $3,975. Each omitted layer understates the real cost.

A 76-year-old owns a Traditional IRA and a non-qualified deferred variable annuity bought with after-tax money. During the owner's lifetime, which of these carries required minimum distributions?

• a.Both, because any tax-deferred account must start distributions after the required age
• b.The annuity only, because insurers must start payouts at the owner's required beginning date
• c.The Traditional IRA only, because the non-qualified annuity has no lifetime required distribution✓
• d.Neither, because required distributions apply only to employer plans such as a 401(k)

Traditional IRAs follow the required minimum distribution rules during the owner's life, and at 76 this owner is already past the starting age of 73 or 75 under SECURE 2.0. A non-qualified annuity has no lifetime RMD; its own rules require distribution only after the holder's death. Tax deferral alone does not trigger RMDs, and IRAs are covered along with employer plans. Insurers are not required to begin payouts for the owner at a set age.Internal Revenue Code Section 408(a)(6)

A 50-year-old owns a non-qualified annuity worth $70,000 with a $50,000 after-tax investment. She withdraws $30,000 before annuitizing. What is the 10% additional tax?

• a.$0, because the withdrawal is less than her $50,000 investment
• b.$1,000, which is 10% of the $10,000 withdrawn above the earnings
• c.$3,000, which is 10% of the entire $30,000 withdrawal
• d.$2,000, which is 10% of the $20,000 of earnings withdrawn first✓

Withdrawals from a non-qualified annuity are taxed earnings first, so the first $20,000 is taxable and subject to the 10% additional tax for an owner under 59 1/2, which gives $2,000; the remaining $10,000 is a return of investment. The tax does not apply to the whole withdrawal. Treating basis as coming out first would erase the tax, which is the opposite of the earnings-first rule.Internal Revenue Code Section 72(q)

An owner gives a non-qualified annuity worth $90,000, with a $60,000 investment in the contract, to an adult child. What is the owner's immediate income tax result?

• a.None until the child surrenders the contract, when the child pays tax on the gain
• b.None, because a gift is not taxable income to the person who gives it
• c.The $30,000 gain is treated as received by the owner at the time of the gift✓
• d.The full $90,000 value is taxable to the owner as ordinary income

Transferring an annuity without full consideration triggers the deferred gain: the owner is treated as receiving the excess of the contract's value over the investment in the contract, here $30,000, and the transfer is not a tax-free gift for the gain. Transfers between spouses or incident to divorce are excepted. Only the gain is taxed, not the $60,000 of the owner's own after-tax money.Internal Revenue Code Section 72(e)(4)(C)

An insurer accepts a customer's variable annuity application, and four business days later the customer tenders the contract for redemption. What must the sales agreement between the member and the insurer provide about the selling commission?

• a.The member must return the commission to the issuing insurance company✓
• b.The commission is paid to the customer on top of the contract value redeemed
• c.The insurer and the member split the commission equally between them
• d.The member keeps it, since the sale was complete once the application was accepted

Rule 2320 requires the sales agreement to provide that the sales commission be returned to the issuing insurer if the contract is tendered for redemption within seven business days after the application is accepted. Keeping it contradicts that term. The commission is a cost the insurer recovers, not an amount owed to the customer, and the rule has no equal split.FINRA Rule 2320(e)

A customer sends payment on Tuesday for a variable life contract, and the representative promises the contract will be priced at Monday's closing unit value. What is wrong with that promise?

• a.The price must be set at the unit value on the day the representative first quotes the contract to the customer
• b.Nothing is wrong, provided the insurer agrees in writing to honor the earlier value
• c.Nothing is wrong, because the prior close is the latest value the insurer has published
• d.A variable contract must be sold at a value determined after the insurer receives the payment✓

Rule 2320(c) bars a member from selling a variable contract on any basis other than a value to be determined following receipt of payment, in accordance with the contract's terms, so Monday's value cannot be promised for a Tuesday payment. Using the latest published value is backward pricing. Pricing as of the quote or signing date looks back before the payment, and an insurer's side agreement to honor an earlier value cannot override what the rule requires.FINRA Rule 2320(c)

A variable life policy is a modified endowment contract with a $80,000 cash value and $50,000 of premiums paid. The 45-year-old owner takes a $20,000 policy loan. What are the federal tax results?

• a.$20,000 is taxable income, but the 10% additional tax does not apply to loans
• b.$20,000 is taxable income and a $2,000 additional 10% tax applies✓
• c.$30,000 is taxable income, because the loan triggers tax on the entire gain
• d.Nothing is taxed, because a loan against cash value is never a taxable event

Loans from a modified endowment contract are treated as distributions taxed earnings first. The gain is $30,000, so the $20,000 loan is all taxable, and an owner under 59 1/2 also owes the 10% additional tax of $2,000. Loans from a policy that is not a MEC are generally not taxed, which is why the first choice fails. The additional tax is not waived for loans, and only the amount borrowed is taxed, not the whole gain.Internal Revenue Code Sections 72(e)(10) and 72(v)

A variable universal life policy with an increasing death benefit option has a $300,000 face amount and a $60,000 cash value. What death benefit is paid if the insured dies?

• a.$240,000, face amount reduced by the cash value
• b.$60,000, which is the cash value in the policy
• c.$360,000, the face amount plus the cash value✓
• d.$300,000, the face amount stated in the policy

With an increasing (face plus cash value) option, the death benefit equals the face amount plus the cash value: $300,000 + $60,000 = $360,000. Paying only the face amount describes the level option. Subtracting the cash value gives the net amount at risk, which is not what is paid. The cash value is part of the benefit, not all of it.

A life insurer sells a funding agreement to an institutional investor. How is the product best described?

• a.A deposit contract paying interest and principal, backed by the insurer's general account and credit✓
• b.A separate account contract whose payments rise and fall with its subaccount portfolio
• c.A policy that pays a death benefit to a named beneficiary when the insured dies
• d.A unit investment trust that holds the insurer's bonds and issues redeemable units to investors

A funding agreement is an insurance product in which the purchaser, usually an institution, deposits money and receives scheduled interest and principal; the deposit goes to the insurer's general account, so the insurer's general credit backs the payments. Separate account payments vary with the portfolio, which is a variable contract. A death benefit describes life insurance. A UIT is a registered trust of securities and not an insurer's obligation.

A variable life insurance owner becomes totally disabled and the policy includes a waiver of premium rider. What is the effect of the rider?

• a.The owner's premiums are reduced by half but must continue until the policy matures
• b.The full death benefit is paid to the owner immediately as a disability benefit
• c.The insurer cancels the policy and refunds the premiums already paid
• d.The insurer waives premiums during the disability and the policy stays in force✓

A waiver of premium rider has the insurer cover the premiums while the owner is totally disabled, so coverage continues without payment. It does not cancel the policy or refund premiums. A death benefit is not an accelerated payout under this rider, and the rider does not simply halve the premium.

A 529 account owner changed the investment option for existing contributions in March and again in July. In November the owner asks for a third change, with no change of beneficiary. What does the federal rule on qualified tuition programs provide?

• a.It is allowed if the owner pays the plan's fee for an additional change
• b.It is allowed, because the limit applies only to new contributions, not to existing balances
• c.A plan may not allow it, because investment direction is limited to two changes a year✓
• d.It is allowed once the owner has held the current option for 90 days

Section 529 conditions qualified status on the plan limiting a contributor's or beneficiary's direction of investment of contributions, and earnings on them, to no more than two times in a calendar year. The limit covers existing balances as well as new money, and it cannot be bought back with a fee or waived after a holding period. The owner could reallocate again in the next calendar year.Internal Revenue Code Section 529(b)(4)

A 529 account holds $60,000, of which $45,000 is contributions. The owner changes the beneficiary from her son to an unrelated family friend. What are the federal tax results?

• a.No tax results, because an owner may name any person as beneficiary at any time
• b.The $15,000 of earnings is taxable, but no additional tax applies to a change of beneficiary
• c.A nonqualified distribution: $15,000 of earnings is taxable, plus a $1,500 additional tax✓
• d.The full $60,000 is taxable, because the account must be closed when the beneficiary is replaced

A change of beneficiary avoids tax only when the new beneficiary is a member of the family of the old one. A friend is not, so the change is treated as a distribution not used for education. Only the earnings, $60,000 - $45,000 = $15,000, are included in income, and the 10% additional tax on earnings is $1,500. The owner cannot name anyone without tax effect. The additional tax is not waived for beneficiary changes, and the owner's contributions are not taxed again.Internal Revenue Code Section 529(c)(3)(C)

A married couple will use five-year averaging and gift splitting to fund one grandchild's 529 plan in 2026, when the annual gift tax exclusion is $19,000. What is the most they can contribute at once without using any lifetime exemption?

• a.$95,000, which is one donor's five years of annual exclusions
• b.$19,000, which is one annual exclusion for one year
• c.$38,000, which is two donors' annual exclusions for a single year
• d.$190,000, which is $19,000 x 2 donors x 5 years✓

A donor may elect to treat a contribution above the annual exclusion as made ratably over five years, so one donor can contribute 5 x $19,000 = $95,000. A married couple that elects gift splitting doubles that to $190,000 (the election is made on a gift tax return). $38,000 ignores the five-year election, and $19,000 is one donor with no averaging.Internal Revenue Code Section 529(c)(2)

A 529 account is worth $50,000, with $35,000 of contributions and $15,000 of earnings. The owner withdraws $10,000 for a vacation, and each dollar withdrawn is treated as drawn proportionally from contributions and earnings. What is the 10% additional tax?

• a.$300, which is 10% of the $3,000 earnings portion✓
• b.$1,000, which is 10% of the entire $10,000 withdrawal
• c.$1,500, which is 10% of all the earnings in the account
• d.$0, because the owner's contributions exceed the amount withdrawn

Earnings are 30% of the account ($15,000 / $50,000), so $3,000 of the $10,000 withdrawal is earnings. That $3,000 is taxable income and carries the 10% additional tax, $300. The tax does not apply to the contributions returned, and it does not reach earnings left in the account. The contribution total does not shelter the withdrawal, because each dollar comes out proportionally.Internal Revenue Code Section 529(c)(3)(A)

A public school teacher's 403(b) plan holds its assets in a custodial account instead of an annuity contract. What may the custodial account invest in under the Internal Revenue Code?

• a.Shares of regulated investment companies, which are mutual funds✓
• b.Individual stocks and bonds chosen by the teacher, but never mutual funds
• c.Only fixed annuity contracts issued by an insurance company
• d.Any investment the custodian approves, including real estate and collectibles

A 403(b)(7) custodial account must be invested in stock of regulated investment companies (mutual funds), or in a group trust under current law. That is why mutual fund companies sell 403(b) custodial accounts to school employees. The account is not limited to individual securities, annuities or any investment a custodian chooses.Internal Revenue Code Section 403(b)(7)

A 30-year-old beneficiary's 529 plan has been maintained for 16 years. She has put $2,000 into her own IRAs this year, the 2026 IRA limit is $7,500, she has ample earned income, and $20,000 has already been rolled from 529 plans to her Roth IRA in earlier years. What is the most that can be rolled to her Roth IRA in 2026?

• a.$13,000, which is the lifetime balance less this year's IRA contribution
• b.$5,500, which is the $7,500 limit less the $2,000 already contributed✓
• c.$7,500, which is the full IRA limit for 2026
• d.$15,000, which is the remaining lifetime amount

The rollover is capped by the Roth contribution limit for the year, reduced by the beneficiary's other IRA contributions: $7,500 - $2,000 = $5,500. The lifetime cap of $35,000 less the $20,000 already rolled leaves $15,000, which is higher and so does not bind. The full $7,500 ignores the IRA contributions already made, and $13,000 mixes the two limits.Internal Revenue Code Section 529(c)(3)(E)

A 529 plan has been maintained for the beneficiary for 16 years and is worth $40,000. Of that, $9,000 is made up of contributions from the last five years together with the earnings on them. Ignoring the annual and lifetime caps, how much qualifies for rollover to the beneficiary's Roth IRA?

• a.$0, because any contribution within five years disqualifies the whole account
• b.$31,000, which excludes the recent contributions and their earnings✓
• c.$9,000, which is the amount contributed in the last five years
• d.$40,000, because the account has been open more than 15 years

The Roth rollover is limited to the amount contributed, and earnings on it, before the five-year period ending on the distribution date, and only once the program has been maintained for 15 years. Here $40,000 - $9,000 = $31,000 qualifies. The 15-year age of the account does not remove the five-year exclusion. The rule excludes the recent contributions only, not the whole account.Internal Revenue Code Section 529(c)(3)(E)

In 2026 a 41-year-old woman, whose disability began when she was 38, wants to open an ABLE account. Is she eligible based on the age of disability onset?

• a.No, because onset must have occurred before age 18
• b.Yes, but only if a parent opens the account for her
• c.No, because onset must have occurred before age 26
• d.Yes, because eligibility now requires onset of the disability before age 46✓

Beginning in 2026, an ABLE account is available to a person whose disability began before age 46; the earlier cutoff was age 26. Her onset at 38 meets the current test. The age-18 limit is not an ABLE rule, and an eligible adult can open her own account without a parent.Internal Revenue Code Section 529A(e)(1)

A mother contributes $9,000, a father $8,000 and an uncle $4,000 in one calendar year to an ABLE account for a beneficiary with no earned income. Assume the account's annual contribution limit that year is $20,000. What is the result?

• a.The $1,000 above the limit is allowed, because the limit applies only to the beneficiary's own deposits
• b.The $4,000 from the uncle is the excess, because only parents count toward the limit
• c.There is no excess, because each contributor may give up to $20,000
• d.$1,000 is an excess contribution, because the limit applies to all contributors combined✓

The annual limit is a single ceiling on total contributions to the account from all sources in the calendar year. The three gifts total $21,000, which is $1,000 over $20,000. The limit is not per contributor, it does not count only parents, and it is not limited to deposits by the beneficiary.Internal Revenue Code Section 529A(b)(2)

An ABLE account beneficiary dies with $60,000 in the account. Medicaid paid $45,000 for the beneficiary during life, and the state has filed a claim. Ignoring other expenses, how much may the state recover from the account?

• a.Up to $45,000, the total medical assistance paid✓
• b.Nothing, because ABLE account assets are exempt from claims
• c.The whole $60,000, whatever Medicaid actually paid
• d.$30,000, which is half of the account balance

At the beneficiary's death, a qualified ABLE program must pay the state, from the remaining balance, up to the total medical assistance paid for the beneficiary after the account was opened. The state's claim is capped by what Medicaid paid, not by the whole balance. The exemption during life does not extend to the payback, and there is no half-of-balance rule.Internal Revenue Code Section 529A(f)

Which of the following is a municipal fund security under MSRB Rule D-12?

• a.An interest in a local government investment pool✓
• b.A general obligation bond issued by a county
• c.Shares of a registered open-end fund that holds municipal bonds
• d.A revenue bond secured by bridge tolls

Municipal fund securities are municipal securities issued by an issuer that, but for Section 2(b) of the Investment Company Act of 1940, would be an investment company; 529 plans, ABLE programs and local government investment pools are examples. Bonds are municipal securities but not municipal fund securities. A registered municipal bond fund is an investment company security sold by prospectus.MSRB Rule D-12

An employee earning $120,000 defers $10,000 into a 401(k) plan. The employer matches 50% of the employee's deferrals up to 6% of salary. How much does the employer contribute?

• a.$5,000, which is 50% of the full $10,000 deferral
• b.$7,200, which is 6% of salary matched dollar for dollar
• c.$3,600, which is 50% of the 6% of salary that is matched✓
• d.$600, which is 6% of the employee's deferral

The match applies only to deferrals up to 6% of salary, which is $7,200. The employer pays 50% of that amount, or $3,600. Matching half of the whole $10,000 ignores the 6% cap on matched pay. Matching the $7,200 dollar for dollar ignores the 50% rate, and taking 6% of the deferral confuses the cap with the base.Treas. Reg. 1.401(m)-1: employer matching contributions under the plan formula

A diversified open-end fund has $400 million in total assets. For the 75% portion of the diversification test, what is the most it can hold in any one issuer's securities, other than government securities, and still count that holding?

• a.$20 million, which is 5% of the fund's total assets✓
• b.$40 million, which is 10% of the fund's total assets
• c.$15 million, which is 5% of the 75% portion alone
• d.$300 million, which is the 75% portion itself

To be diversified, at least 75% of total assets must be in cash, government securities, other investment company shares and other securities, with no issuer counted for more than 5% of the fund's total assets, and the fund must hold no more than 10% of an issuer's voting stock. The 5% is measured against total assets, so it is $20 million here. Applying 5% to the 75% portion understates it, the 10% figure is the voting-stock cap, and $300 million is the size of the basket.Investment Company Act Section 5(b)(1)

A large asset manager buys the investment adviser of a mutual fund family by acquiring a controlling block of the adviser's voting stock. What happens to the funds' existing advisory contracts?

• a.They terminate automatically, because the transfer of control is an assignment✓
• b.They continue if the adviser gives shareholders 60 days' written notice of the sale
• c.They continue unchanged until the board's next annual review of the contracts
• d.They continue, because only a change of portfolio manager can end an advisory contract

An advisory contract must provide that it terminates automatically upon assignment, and a transfer of a controlling block of the adviser's stock is treated as an assignment. The fund then needs a new contract approved by its board and shareholders. The 60-day notice is the fund's right to cancel a contract without penalty, not a way to keep a contract alive, and a change of portfolio manager does not end the contract.Investment Company Act Section 15(a)(4)

A fund has 100 million shares outstanding, and holders of 70 million shares attend a special meeting to change a fundamental policy. Under the Act's definition of a majority of the outstanding voting securities, how many shares must vote in favor?

• a.More than 35 million, which is a majority of those present
• b.At least 66.7 million, which is two-thirds of all shares outstanding
• c.At least 46.9 million, which is 67% of the shares present✓
• d.More than 50 million, which is over half of the shares outstanding

The Act defines the vote as the lesser of 67% or more of the shares present, if more than 50% of the outstanding shares are present, or more than 50% of the outstanding shares. Here 70 million is more than half of the 100 million outstanding, so the first test applies: 67% x 70 million = 46.9 million, which is less than 50 million. Neither a simple majority of shares present nor two-thirds of all outstanding shares is the standard.Investment Company Act Section 2(a)(42)

A 45-year-old holds a target-date fund described as a through fund. How does its asset allocation behave after the target date arrives?

• a.It becomes a money market fund and redeems its equity holdings
• b.It keeps shifting toward more conservative holdings✓
• c.It holds its most conservative allocation without any further changes
• d.It guarantees the investor's principal as of the target date itself

A through target-date fund continues to lower its equity exposure for some years after the target date, while a to fund stops shifting at the target date. Neither design converts to a money market fund, and a target-date fund guarantees neither principal nor a level of income, even at the target date. The description of the first option fits a to fund.

A fund named the Pacific Health Sciences Fund has net assets of $500 million and no borrowings. Under the SEC names rule, what is the least it must invest in health sciences investments?

• a.$450 million, which is 90% of the fund's total net assets
• b.$375 million, the 75% figure used in the diversification test
• c.$400 million, which is 80% of the fund's $500 million in net assets✓
• d.$250 million, which is a simple majority of its net assets

Rule 35d-1 requires a fund whose name suggests a type of investment or an industry to adopt a policy of investing at least 80% of its assets in that area, and 80% of $500 million is $400 million. The 75% figure comes from the diversification test, a simple majority is not the standard, and no 90% standard applies to sector names.Investment Company Act Rule 35d-1

A fund markets itself as a small-cap value fund. Over three years its holdings drift to mostly large-cap growth stocks, and its prospectus never changes. What is this called, and why does it matter to an investor?

• a.Style drift, which can leave an investor's allocation different from the one intended✓
• b.Rebalancing, which returns the holdings to the targets set in the prospectus
• c.Churning, which means excessive trading by a registered representative to earn commissions
• d.Window dressing, which means buying recent winners before the fund reports its holdings

Style drift is a departure from the stated investment style, and it matters because the investor may have chosen the fund to fill a particular slot in an allocation. Window dressing is pre-report buying of winners, churning is a sales practice abuse by a representative, and rebalancing is a return to the targets rather than a move away from them.

An S&P 500 index fund returns 9.70% for the year while the index returns 10.00%. What is the most likely main source of the 0.30% shortfall?

• a.A front-end sales charge, deducted from the fund's reported total return
• b.Capital gains distributions, which are excluded from the fund's reported total return
• c.The manager's decision to overweight sectors that lagged the market during the year
• d.The fund's operating expenses and trading costs, which the index does not bear✓

An index is a calculation with no costs, while the fund pays operating expenses and the trading costs of tracking it, so it usually trails by about the size of its expense ratio. An index fund does not make sector bets, a sales charge is not deducted from the fund's own return, and total return counts distributions that are reinvested.