Free ChFC Practice Exam

1. Question 1

   For a nonqualified deferred compensation arrangement to successfully defer income taxation to the employee until benefits are actually received, which of the following must generally be true?

   • A.The amount must remain subject to a substantial risk of forfeiture, or be governed by a valid and timely deferral election, with the employee having no current, unrestricted right to the funds (no constructive receipt).
   • B.The employer must fund the benefit through a trust that is irrevocably protected from the claims of the employer's general creditors, so the executive is assured of payment.
   • C.The plan must be offered to all employees on a nondiscriminatory basis, similar to a qualified plan, and must satisfy the coverage and participation tests that apply to qualified plans.
   • D.The employee must be given an unsecured promissory note that the employee can freely sell or pledge as collateral, so the deferred amount has a readily determinable market value.
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   Correct answer: A. The amount must remain subject to a substantial risk of forfeiture, or be governed by a valid and timely deferral election, with the employee having no current, unrestricted right to the funds (no constructive receipt).

   For NQDC to defer taxation, the arrangement must avoid constructive receipt. The employee must not have current, unrestricted access to the funds. Which is typically achieved through a valid deferral election made before the compensation is earned (and compliant with Section 409A) and/or by keeping the benefit subject to a substantial risk of forfeiture. B is incorrect and actually counterproductive: funding through a trust protected from the employer's general creditors (a 'secured' arrangement) would cause current taxation, defeating the purpose of NQDC. C is wrong because NQDC plans are intentionally selective, unlike qualified plans. D is wrong because a freely transferable/pledgeable note would itself trigger current taxation.

   • AA. Correct. To avoid constructive receipt, the deferred amount must remain subject to a substantial risk of forfeiture, or the deferral election must be valid and timely made before the compensation is earned, so the employee has no current unrestricted right to the funds.
   • BB. Funding through a trust irrevocably protected from the employer's general creditors (a secular trust) actually causes current taxation to the employee; true NQDC deferral typically relies on remaining unfunded and subject to employer creditors (as in a rabbi trust).
   • CC. Nondiscriminatory coverage and participation requirements are hallmarks of qualified plans; NQDC arrangements are valued because they can be offered selectively to a select group of management or highly compensated employees.
   • DD. A note the employee can freely sell or pledge as collateral would itself be a current, unrestricted economic benefit with a determinable value, triggering constructive receipt (or a cash-equivalent doctrine problem) and destroying the deferral.

   • Source: IRC section 409A (nonqualified deferred compensation)
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2. Question 2

   A U.S. citizen leaves $3,000,000 outright to his wife, a resident noncitizen of the United States. Under the federal estate tax rules, how is the marital deduction treated?

   • A.The unlimited marital deduction applies exactly as it would for a citizen spouse
   • B.No marital deduction is available for any transfer to a noncitizen spouse
   • C.The deduction is denied unless the assets pass to a QDOT or the spouse becomes a citizen before the estate tax return is filed
   • D.The deduction is limited to the annual gift tax exclusion amount for a noncitizen spouse, adjusted for inflation, with the balance taxed at the top rate
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   Correct answer: C. The deduction is denied unless the assets pass to a QDOT or the spouse becomes a citizen before the estate tax return is filed

   Under IRC Section 2056(d), the marital deduction is generally denied for property passing to a noncitizen spouse unless it passes in a qualified domestic trust (QDOT) or the spouse becomes a U.S. citizen before the estate tax return is filed.

   • AA. The unlimited deduction is denied for outright transfers to a noncitizen spouse.
   • BB. A deduction is available if the property passes into a QDOT or the spouse becomes a citizen in time.
   • CC. This states the QDOT and citizenship exceptions under Section 2056(d).
   • DD. The noncitizen-spouse annual exclusion applies to lifetime gifts and is not a cap on the estate tax marital deduction, which is denied outright unless a QDOT or timely citizenship applies.

   • Source: 26 U.S.C. § 2056
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3. Question 3

   An older client suddenly requests a large transfer to a previously unknown individual while repeating instructions that sound scripted. The request is inconsistent with past behavior. What is the most appropriate adviser response?

   • A.Process the transfer as instructed because the client signed the request, and note the unusual features in the file afterward.
   • B.Follow firm escalation and protective procedures, verify independently, and comply with applicable privacy and reporting rules.
   • C.Contact the recipient directly to ask about the relationship with the client and confirm the transfer is legitimate before taking any other step.
   • D.Proceed with the transfer because the client has not been shown to lack legal capacity, and exploitation concerns apply mainly to diminished capacity.
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   Correct answer: B. Follow firm escalation and protective procedures, verify independently, and comply with applicable privacy and reporting rules.

   Red flags of possible exploitation call for measured escalation, independent verification and legally authorized protective steps. Firm policy and applicable securities or elder-protection rules guide any hold or report.

   • AA. A signature shows the client submitted the request but does not resolve red flags such as a sudden large transfer to an unknown party and scripted instructions. Firm procedures call for inquiry and escalation before the transfer is processed, not a file note afterward.
   • BB. Escalating, verifying independently and following reporting and privacy rules protects the client appropriately.
   • CC. Contacting the recipient directly discloses confidential client information to a possible perpetrator, may tip off a scammer, and bypasses firm escalation. It is not independent verification, which should go through the client and approved channels such as a trusted contact person.
   • DD. Exploitation can affect clients with full legal capacity, and scams often target them. The absence of a capacity finding does not remove the red flags, so the adviser still needs to escalate and verify before acting.

   • Source: FINRA Rule 2165
   • Source: FINRA Rule 4512
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