Insurance-Based Products - Unit 15
A 68-year-old individual, who purchased a single premium immediate fixed annuity, elected monthly payments for life with a 10-year certain settlement option. If the individual lives to the age of 80, A) monthly payments will continue to the beneficiary(s) for 10 years after the annuitant's death. B) monthly payments will continue until death. C) monthly payments will remain fixed until age 78 and then reduce until death. D) monthly payments will cease at age 78.
B) monthly payments will continue until death. When choosing the settlement option, life with 10 years certain, the annuitant will receive payments until the later of death or 10 years.
Which of these features are common to both variable annuities and scheduled premium variable life insurance? I. Income earned in the separate account is tax deferred. II. Separate account performance below the AIR causes a reduction in cash value. III. Fixed contributions are required. IV. Contract owners have voting rights. A) I and IV B) II and III C) III and IV D) I and II
A) I and IV All variable products offer tax deferral of earnings in the separate account. Unit holders of a variable annuity vote on the basis of the number of units they own; holders of variable life insurance receive 1 vote for each $100 of cash value. With variable life insurance, AIR applies only to the death benefit, not to cash value.
An agent has 4 clients who have purchased variable annuities, all of who are about to enter the annuitization phase. Client 1 purchased a single premium deferred annuity 20 years ago with a premium of $30,000. Client 2 purchased a single premium deferred annuity 10 years ago with a premium of $50,000. Client 3 purchased a periodic payment annuity 15 years ago and has made monthly premium payments totaling $60,000. Each of these 3 annuities has a current surrender value of $100,000. Client 4 just purchased an immediate annuity with a premium of $100,000. Assuming that all of these clients are of the same sex and the same age, when the annuity payout begins, which of the clients will receive the lowest amount of taxable income? A) Client 4 B) Client 2 C) Client 3 D) Client 1
A) Client 4 When it comes to taxation on annuitization, each payment consists of a combination of income and return of principal, how much of which depends on the exclusion ratio. In the case of Client 4, with an immediate annuity, it is unlikely that there is much in the way of income - almost all of the monthly payout will represent a nontaxable return of principal. Each of the other clients has tax-deferred income ranging from Client 1's $70,000 to Client 3's $40,000. When using the exclusion ratio to determine how much is income and how much is return of principal, Client 1 will have the greatest amount of taxable income followed by Client 2 and then Client 3.
Among the special characteristics of a universal life insurance policy is A) death benefits may increase above the initial face amount B) early termination could lead to surrender charges C) the policy may be overfunded D) that policyowners may borrow against the cash value
C) the policy may be overfunded In the case of universal life, the policyowner is permitted to pay in an amount in excess of the stated premiums (one of the reasons universal life is known as flexible premium life). The IRS puts limits on the amount of the overfunding before certain tax advantages are lost, but that is beyond the scope of the exam. Not only universal life, but variable life as well, has the possibility of increased death benefits. In fact, some whole life policies allow policy dividends to be used to increase the death benefit. Permanent forms of insurance policies, including whole life, universal life, and variable life, permit loans against the cash value. Many forms of life insurance have surrender charges for early termination.
Your 55-year-old client owns a nonqualified variable annuity. He originally invested $50,000 4 years ago. The annuity has grown to a value of $60,000. If the client, who is in a 30% tax bracket, makes a random withdrawal of $15,000, what will he pay to the IRS? A) $3,000.00 B) $4,000.00 C) $4,500.00 D) $0.00
B) $4,000.00 Because this is a nonqualified annuity (with no tax deduction), the client pays taxes only on the growth portion or, in this case, $10,000. The tax on this amount is $3,000. However, because the client is not yet age 59½ when making the withdrawal, he also pays a 10% tax penalty, or $1,000. This makes a total of $4,000 tax and tax penalty paid on the random withdrawal.
A 35-year-old client purchases a variable life insurance policy. Under current regulations, the maximum sales charge permitted over the life of the policy is A) 9% per premium payment B) 8.5% per premium payment C) 9% D) 8.5 % of total premiums over the life of the plan
C) 9% A variable life insurance plan may charge a maximum sales charge of 9% over a period not to exceed 20 years.
A 47-year-old investor purchases a single premium deferred variable annuity from the ABC Insurance Company with an initial premium payment of $25,000. Six years later, a 1035 exchange is made to an annuity offered by the XYZ Insurance Company when the value of the account is $35,000. Seven years later, the account has a current value of $50,000 and the investor withdraws $20,000. The tax consequence of this withdrawal is A) ordinary income tax on $20,000. B) ordinary income tax on $20,000 plus a 10% penalty. C) ordinary income tax on $15,000. D) no tax until the withdrawal exceeds $25,000.
A) ordinary income tax on $20,000. Withdrawals from nonqualified annuities (all annuities on the exam are nonqualified unless otherwise specified) are taxed on a LIFO basis. That is, the last money in (the earnings) is considered the first money withdrawn. The investor's cost is $25,000. The 1035 exchange doesn't affect the cost basis because it is nontaxable. Therefore, with the account currently valued at $50,000, the first $25,000 withdrawn is from the earnings. That makes all of the $20,000 in this question taxable as ordinary income. What about the 10% tax penalty for early withdrawal? If you add the years together (47 + 6 + 7), the investor is 60 and, once reaching 59½, there no longer is the tax penalty.
A customer has contributed $1,000 a year for 10 years to his tax-deferred nonqualified variable annuity. The value of the separate account is now $30,000. If the customer takes a withdrawal of $10,000, what are the tax consequences? A) Two-thirds of the withdrawal is taxable as ordinary income. B) The entire $10,000 is taxable as ordinary income. C) Any tax due is deferred. D) There is no tax because the withdrawal is considered return of capital.
B) The entire$10,000 is taxable as ordinary income The $30,000 contract value represents $10,000 of contributions and $20,000 of earnings. When a partial withdrawal is made from an annuity, the earnings are considered to be taken out first for tax purposes (or LIFO). Therefore, ordinary income taxes will apply to the entire $10,000. In addition, if the customer is not at least 59½, there will be a tax penalty of an additional 10%.
An individual is deciding between a flexible premium variable life contract and a scheduled premium variable life contract. If she is concerned about maintaining a minimum death benefit for estate liquidity needs, she should choose A) the flexible premium policy because earnings of the contract directly affect the face value of the policy and earnings can never be negative B) the scheduled premium policy because the contract is issued with a minimum guaranteed face amount C) the flexible premium policy because the contract's face amount cannot be less than a predetermined percentage of cash value D) the scheduled premium policy because earnings do not affect the contract's face amount
B) the scheduled premium policy because the contract is issued with a minimum guaranteed face amount A scheduled premium variable life contract is issued with a guaranteed minimum death benefit. If the individual is concerned about having the minimum guarantee, you should recommend the scheduled contract
A client who purchased a variable life insurance policy 15 months ago has suffered a stroke. In addition, he has developed adult onset diabetes. When receiving treatment for the stroke, he was diagnosed with lung cancer. He has decided to convert his variable policy to a whole life policy. Which of the following statements is CORRECT? I. He will not be able to convert to a whole life insurance policy because his health has deteriorated to such a severe level. II. The new policy will bear the same issue date and age as the original policy. III. The face amount must remain the same. IV. The premium will be rated because his health has taken a marked turn for the worse. A) I, II, III, and IV B) I and IV C) II and III D) II, III, and IV
C) II and III Variable life insurance offers a unique conversion policy. Anytime during the first 24 months after policy issue, the policy may be exchanged for a whole life policy (or some similar form of permanent insurance if the company doesn't offer whole life) using the age and medical condition at issue, regardless of the insured's current health. However, the face amount cannot be changed from its original amount.
Which of the following statements regarding nonqualified annuities is CORRECT? A) Because only insurance companies issue variable annuities, they are not considered securities. B) Because taxes on earnings are deferred, all money withdrawn will be subject to income tax when received. C) It is possible to receive distributions from an annuity before age 59½ without incurring tax penalties. D) The exclusion ratio applies to accumulation units only.
C) It is possible to receive distributions from an annuity before age 59½ without incurring tax penalties. Nonqualified annuities, fixed or variable, are those where contributions are made with after-tax dollars. Withdrawals due to death or disability or taking substantially equal annuity distributions over the life of the insured can begin before age 59½ without being subject to a tax penalty. The exclusion ratio only applies during the payout period. Even though taxes on earnings are deferred, that portion of the withdrawal that represents a return of principal on a nonqualified annuity, is not subject to tax or penalty.
One of the major financial decisions to be made by a family is the amount and type of life insurance to purchase. The form of insurance that offers flexible premiums without a fixed cash value is A) term life. B) variable life. C) whole life. D) universal life
D) universal life A unique feature of universal life is that the premiums are flexible. That is, if the client wishes to pay more or less than the target premium, that may be done. However, the nature of the universal life product is such that cash values can fluctuate. Cash values can fluctuate in variable life, but unless the policy is UVL (universal variable life), premiums are scheduled (fixed). Typically there are no cash values with term insurance and the premiums are fixed and whole life has both fixed premiums and guaranteed cash values.
One way in which universal life and variable life are similar is that both A) have flexible premiums B) permit loans against the cash value C) are considered securities D) have a fixed minimum cash value
B) permit loans against the cash value As long as the policy has cash value, loans are permitted. Neither of these has a fixed minimum cash value, and only universal life has flexible premiums. Only variable life is considered a security.
Annuity companies offer a variety of purchase options to owners. Which of the following definitions regarding these annuity options is NOT true? A) A single premium deferred annuity is a lump sum investment, with payment of benefits deferred until the annuitant elects to receive them. B) A periodic payment deferred annuity allows a person to make periodic payments over time; the contract holder can invest money on a monthly, quarterly, or annual basis. C) An immediate annuity allows an investor to deposit a lump sum with the insurance company; payout of the annuitant's benefits starts immediately (usually within 60 days). D) An accumulation annuity allows the investor to accumulate funds in a separate account prior to investment in an annuity.
D) An accumulation annuity allows the investor to accumulate funds in a separate account prior to investment in an annuity. Accumulation does not refer to a purchase option. The pay-in period for an annuity is known as the accumulation stage. A single premium deferred annuity is an annuity with a lump-sum investment, with payment of benefits deferred until the annuitant elects to receive them. Periodic payment deferred annuities allow a person to make periodic payments over time. Immediate annuities allow an investor to deposit a lump sum, with the insurance company payout of the annuitant's benefits starting immediately (usually within 60 days).
Which of the following would be a difference between a universal life insurance policy and a scheduled premium variable life insurance policy? A) There is a minimum guaranteed return on the variable life, while there is no guaranteed return on the universal. B) The universal life policy will generally outperform the variable life policy during a period of falling interest rates and rising stock prices. C) There is a greater choice of separate account subaccounts in the universal life policy. D) Premiums on a scheduled premium variable life policy are fixed, while those on a universal life policy are flexible.
D) Premiums on a scheduled premium variable life policy are fixed, while those on a universal life policy are flexible. A major difference between these two insurance programs is the payment of premiums. Scheduled premium is just another way of saying fixed premium. In a universal life policy, including universal variable life, the premiums are flexible. There is no choice of separate account subaccounts for universal life. Universal life is designed to benefit from periods of high interest rates, not falling ones. Finally, universal life policies have a minimum guaranteed interest rate; no such guarantee applies to variable life.
