Chapter 5: Annuities
Who bears all of the investment risk in a fixed annuity?
The insurance company
What form of the annuity settlement options provides payments to an annuitant for the rest of the annuitant's life and ceases at the annuitant's death?
pure life A Pure Life Annuity has the potential for providing the maximum income per dollar of premium if the annuitant lives beyond their life expectancy. However, if the annuitant dies before his or her life expectancy, and before the total benefit has been paid out, payments cease and there is no refund of payments to survivors.
All of the following employees may use a 403(b) plan for their retirement EXCEPT
The CEO of a private corporation. Not all public employees are eligible for 403(b) plans, or tax-sheltered annuities, only employees of public education (local, state, or federal), as well as employees of charitable organizations.
If an annuitant dies before annuitization occurs, what will the beneficiary receive?
Either the amount paid into the plan or the cash value plan, whichever is the greater amount
The form of life annuity which pays benefits throughout the lifetime of the annuitant and also guarantees payment for a minimum number of years is called
Life income with period certain.
All of the following would be different between qualified and nonqualified retirement plans EXCEPT
Taxation on accumulation Taxation on accumulation is deferred in both types of plans. The rest of the characteristics would differ.
What happens if a deferred annuity is surrendered before the annuitization period?
The owner will receive the surrender value of the annuity.
Which of the following is NOT true regarding the Life with Guaranteed Minimum annuity settlement option?
It does not guarantee that the entire principal amount will be paid out.
When an annuity is written, whose life expectancy is taken into account?
Annuitant
A couple near retirement is planning for their golden years. They want to make sure that their retirement annuity provides monthly benefits for the rest of their lives. Should one of them die, the other would still like to continue receiving benefits. Which settlement option should they choose?
Joint and Survivor
In a fixed annuity, which of the following is true regarding the guaranteed interest rate on the investment?
The annuitant will receive the higher of either the guaranteed minimum rate or current rate.
If a beneficiary is NOT named for annuity benefits, to which entity will the benefit be paid?
The annuitant's estate
Under a SIMPLE plan, which of the following is TRUE regarding taxation on both contributions and earnings?
They are tax deferred until withdrawn. Taxation is deferred on both contributions and earnings until funds are withdrawn.
What is the primary purpose of a 401(k) plan?
retirement Profit-sharing plans are qualified plans where a portion of the company's profit is contributed to the plan and shared with employees. A 401(k) qualified retirement plan allows employees to take a reduction in their current salaries by deferring amounts into a retirement plan. The company can also somehow match the employee's contribution, whether it is dollar for dollar or on a percentage basis.
According to the nonforfeiture law, if the owner decides to surrender a deferred annuity prior to annuitization, the owner is entitled to which of the following?
Guaranteed surrender value The nonforfeiture law stipulates that a deferred annuity must have a guaranteed surrender value that is available if the owner decides to surrender the annuity prior to annuitization.
All of the following statements are true regarding installments for a fixed period annuity settlement option EXCEPT
It is a life contingency option. Under the installments for a fixed period annuity settlement option, the annuitant selects the time period for the benefits; the insurer determines how much each payment will be. This option pays for a specific amount of time only, and there are no life contingencies.
Which of the following is NOT true about a joint and survivor annuity benefit option?
Payments stop after the first death among the annuitants. A joint and survivor annuity will pay until the last annuitant has died; however, the surviving annuitant may receive reduced payments.
Which of the following best describes what the annuity period is?
The period of time during which accumulated money is converted into income payments The annuity period is the time during which accumulated money is converted into an income stream.
Under SIMPLE plans, participating employees may defer up to a specified amount each year, and the employer then makes a matching contribution up to an amount equal to what percent of the employee's annual wages?
3 Under SIMPLE plans, participating employees may defer up to a specified amount each year, and the employer can then contribute up to an amount equal to 3% of the employees' annual compensation. Contributions and earnings are both tax-deferred until funds are withdrawn.
Which of the following will NOT be an appropriate use of a deferred annuity?
Creating an estate Deferred annuities grow tax deferred, and are best suitable for accumulating retirement income or funds for children's college education. Unlike life insurance, annuities do not create an estate, but liquidate it.
Under which installments option does the annuitant select the amount of each payment, and the insurer determines how long they will pay benefits?
Fixed Amount
Which of the following is true about a defined benefit plan?
High-salaried employees with only a few years until retirement receive the highest contribution. Defined benefit plans favor owners and key employees nearing retirement. The contribution formula is weighted toward these employees.
Which of the following is NOT true regarding Equity Indexed Annuities?
They earn lower interest rates than fixed annuities. Equity Indexed Annuities invest on an aggressive basis in order to yield higher returns. Like a fixed annuity, Equity Indexed Annuities have guaranteed minimum interest rates. The insurance company often keeps a predetermined percentage of the return and pays the rest to the annuity owner. Equity Indexed Annuities are less risky than variable annuities and earn higher interest rates than fixed annuities.
Annuities can be used to fund which of the following?
Retirement plans Since annuities are a popular means to provide retirement income, they are often used to fund qualified retirement plans.
Which of the following is a feature of a variable annuity?
Benefit payment amounts are not guaranteed Under a variable annuity, the issuing insurance company does not guarantee a minimum interest rate or the benefit payment amounts. The annuitant's payments into the annuity are invested in the insurer's separate account. Agents selling variable annuities are required to have a securities license in addition to their life agent's license.
The president of a company is starting an annuity and decides that his corporation will be the annuitant. Which of the following statements is true?
The annuitant must be a natural person.
Which of the following is NOT true regarding the annuitant?
The annuitant cannot be the same person as the annuity owner.
Which of the following is TRUE regarding variable annuities?
The annuitant assumes the risks on investment The payments that the annuitant invests into the variable annuity are invested in the insurer's separate account. The separate account under many annuities provides the annuitant with a dozen or more investment options ranging from "money market funds" to "growth stock funds" to "precious metal funds". Therefore, the annuitant assumes the risk of the investment.
Under a defined benefit retirement plan, who determines what benefits a retired employee will receive?
Employer Correct! The employer defines the benefits by the use of a formula that applies to all employees.
Your client is planning to retire. She has accumulated $100,000 in a retirement annuity, and now wants to select the benefit option that will pay the largest monthly amount for as long as she lives. As her agent, you should recommend
Straight life. With the straight life option, the annuity payments cease at death. However, because there are no other guarantees that might incur additional charges, this option provides the highest monthly benefits for an individual annuitant.
A 403(b) plan, commonly referred to as a TSA, is available to be used by
Teachers and not-for-profit organizations Tax sheltered annuities, commonly referred to as 403 (b) plans are designed for teachers and not-for-profit organizations.
If a company has a Simplified Employee Pension plan, what type of plan is it?
A qualified plan for a small business A Simplified Employee Pension (SEP) is a type of qualified plan suited for the small employer or for self-employed. A SEP is an employer-sponsored IRA with an expanded contribution rate up to 25% of compensation or a specified maximum contribution amount.
Why is an equity indexed annuity considered to be a fixed annuity?
It has a guaranteed minimum interest rate. While equity indexed annuities earn higher interest rates than fixed annuities, both types of annuities guarantee a specific minimum interest rate.
Which of the following is another term for the accumulation period of an annuity?
Pay-in period The accumulation period is also known as the pay-in period. It is the period of time over which the annuitant makes payments (premiums) into an annuity.
Equity indexed annuities
Seek higher returns
Which two terms are associated directly with the way an annuity is funded?
Single payment or periodic payments Annuities are characterized by how they can be paid for: either a single payment (lump sum) or through periodic payments in which the premiums are paid in installments over a period of time. Periodic payment annuities can be either level, in which the annuitant/owner pays a fixed installment, or the payments can be flexible, in which the amount and frequency of each installment varies.
The annuity owner dies while the annuity is still in the accumulation stage. Which of the following is TRUE?
The beneficiary will receive the greater of the money paid into the annuity or the cash value. If the annuitant dies during the accumulation period, the beneficiary receives benefits from the annuity: either the amount paid into the plan or the cash value, whichever is greater.
If the annuitant dies during the accumulation period, who will receive the annuity benefits?
beneficiary If the annuitant dies during the accumulation period, the beneficiary receives benefits from the annuity: either the amount paid into the plan or the cash value - whichever is greater.
Under a straight life annuity, if the annuitant dies before the principal amount is paid out, the beneficiary will receive
Nothing; the payments will cease
The main difference between immediate and deferred annuities is
When the income payment begins
The term "fixed" in a fixed annuity refers to all of the following EXCEPT
Death benefit A fixed annuity is fixed in the sense that it provides a guaranteed minimum rate of interest and income payments that do not vary from one to the next. The company also guarantees the specified dollar amount for each payment and the length of the payout period. Annuities do not provide a death benefit.
If a deferred annuity is surrendered prematurely, a surrender charge is imposed. How is the surrender charge determined?
It is a percentage of the cash value and decreases over time. If a deferred annuity is surrendered prematurely, a surrender charge is imposed. The charge is generally a percentage that reduces over time until it ends.
If an annuitant selects the straight life annuity settlement option, in order to receive all of the money out of the contract, it would be necessary to
Live at least to his life expectancy. A straight life annuity pays as long as the annuitant lives. The amount is based on the annuitant's life expectancy.
Which of the following can surrender a deferred annuity contract?
Only the annuity owner
Which of the following is NOT a term for the period of time during which the annuitant or the beneficiary receives income?
Depreciation period The "annuitization period" is the time during which accumulated money is converted into an income stream. It is also referred to as the annuity, liquidation or pay-out period.
An annuity owner is funding an annuity that will supplement her retirement. Because she does not know what effect inflation may have on her retirement dollars, she would like a return that will equal the performance of the Standard and Poor's 500 Index. She would likely purchase a(n)
Equity indexed annuity The interest rates of Equity Indexed Annuities are tied to the Standard and Poor's Index.
Which of the following is NOT true about a joint and survivor annuity benefit option?
Payments stop after the first death among the annuitants. A joint and survivor annuity will pay until the last annuitant has died; however, the surviving annuitant may receive reduced payments.
Which of the following is another term for the accumulation period of an annuity?
pay period The accumulation period is also known as the pay-in period. It is the period of time over which the annuitant makes payments (premiums) into an annuity.
A lucky individual won the state lottery, so the state will be sending him a check each month for the next 25 years. What type of annuity products are they likely to use to provide these benefits?
Immediate annuity
Which of the following best describes what the annuity period is?
The period of time during which accumulated money is converted into income payments The annuity period is the time during which accumulated money is converted into an income stream
A married couple's retirement annuity pays them $250 per month. The husband dies and his wife continues to receive $125.50 per month for as long as she lives. When the wife dies, payments stop. What settlement option did they select?
Joint and survivor Under a joint settlement option, payments would stop at the first death, but under the joint and survivor, payment would continue until both recipients die. Usually, the surviving beneficiary receives 1/2 or 2/3 of the amount received when both beneficiaries were alive.
In a defined contribution plan
The contribution is known and the benefit is unknown. In a defined contribution plan the contribution is defined (known) and the benefit is undefined (unknown).
Which of the following is TRUE regarding the accumulation period of an annuity?
It is a period during which the payments into the annuity grow tax deferred.
How are contributions to a tax-sheltered annuity treated with regards to taxation?
They are not included as income for the employee, but are taxable upon distribution. Funds contributed are excluded from the employee's current taxable income, but are taxable upon withdrawal.
All of the following statements about equity index annuities are correct EXCEPT
the annuitant receives a fixed amount of return Equity indexed annuities have a guaranteed minimum interest rate, so while they are aggressive in nature, the annuitant will not have to worry about receiving less than what the minimum interest rate would yield.
The annuity owner dies during the accumulation period without naming a beneficiary. Annuity cash value exceeds premiums paid. Which of the following is TRUE?
The cash value will be paid to the annuitants estate.
Under the 401(k) bonus or thrift plan, the employer will contribute
An undetermined percentage for each dollar contributed by the employee. Under the bonus or thrift plan, the employer will contribute certain amount or percentage for each dollar contributed by the employee. There is no specific rule as to how much the employer must contribute.
An insurance company forwards fixed annuity premiums to their general account, where the money is invested. The guaranteed minimum interest is set at 2.5%. During an economic downswing, the investments only drew 2%. What interest rate will the insurer pay to its policyholders?
2.5%
Who bears all of the investment risk in a fixed annuity?
The insurance company. Fixed annuities guarantee a minimum amount of interest to be credited to the purchase payment. Income payments do not vary from one payment to the next. The insurance company can afford to make guarantees because the money of a fixed annuity is placed in the general account of the insurance company, which is part of its investment portfolio. The company makes conservative enough investments to insure a guaranteed rate to the annuity owners.
An IRA purchased by a small employer to cover employees is known as a
Simplified Employee Pension plan. A Simplified Employee Pension (SEP) is an employer sponsored IRA. Contributions to the plan are not included in the employee's taxable income for the year, to the extent that they do not exceed the maximums allowed. Distributions from a SEP are taxable as ordinary income when received at retirement.
Which of the following is a feature of a variable annuity?
Benefit payment amounts are not guaranteed. Under a variable annuity, the issuing insurance company does not guarantee a minimum interest rate or the benefit payment amounts. The annuitant's payments into the annuity are invested in the insurer's separate account. Agents selling variable annuities are required to have a securities license in addition to their life agent's license.
Which of the following types of annuities will generally provide the highest monthly income?
Straight Life Pure or straight life annuity settlement option will only pay for as long as the annuitant lives; therefore, it has the potential to provide the highest monthly income. Any time a "period certain" option is included, it will reduce the monthly payout amount because, even if the annuitant dies, the company must continue to pay benefits for the period certain.
Two attorneys operate their practice as a partnership. They want to start a program through their practice that will provide retirement benefits for themselves and three employees. They would likely choose
HR-10 (Keogh Plan). HR-10 (Keogh Plans) are plans specifically for self-employed and their employees.
Fixed annuities provide all of the following EXCEPT
Hedge against inflation. Fixed annuities invest premium payments into a general account - a safe and conservative investment portfolio. They also provide a specified dollar amount for each annuity payment regardless of the purchasing power of the money. Variable annuities premiums are invested in securities, hopefully maintaining a constant purchasing power, and therefore providing protection against inflation.
Which of the following characteristics applies to defined benefit plans but not defined contribution plans?
The amount of contributions made by the employer is determined by an actuarial formula. Defined benefit plans offer benefits that are based on a definite contribution formula. Defined contribution plans may specify that contributions are made based on corporate profits, so contributions may not be made when that corporation is not profitable. Both are qualified plans subject to the rules of ERISA.
A man purchased a $90,000 annuity with a single premium, and began receiving payments 2 months after that. What type of annuity is it?
immediate With an immediate annuity, distribution starts within 1 year of purchase.
An individual has been making periodic premium payments on an annuity. The annuity income payments are scheduled to begin after 1 year since the annuity was purchased. What type of annuity is it?
Deferred
Under which of the following annuity options does the annuitant select the time period for the benefits, and the insurer determines how much each payment will be?
Installments for a fixed period Under the "installments for a fixed period" option, the annuitant selects the time period for the benefits, and the insurer determines how much each payment will be. This option pays for a specific period of time only, and there are no life contingencies.