Series 7
A 38-year-old investor places $25,000 into a single premium qualified deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor withdraws $50,000. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $16,450. B) $12.500. C) $17,500. D) $11,750.
$12.500. Explanation Because this is a qualified annuity, the entire withdrawal is taxable. In this case, it is all $50,000. That $50,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is younger than 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $50,000.
A registered representative explaining variable annuities to a customer would be correct in stating that a variable annuity guarantees an earnings rate of return. a variable annuity does not guarantee an earnings rate of return. a variable annuity guarantees payments for life. a variable annuity does not guarantee payments for life.
A) II and III Explanation A variable annuity does not guarantee an earnings rate because earnings will depend on the performance of the separate account. However, it does guarantee payments for life (mortality).
Your customer in her early 30s has received a modest inheritance from a relative. Listing tax-deferred growth as an objective for retirement income, which of the following investments is most suitable? A) Tax-free municipal bonds B) A variable annuity C) Corporate debt securities D) Growth mutual funds
B) A variable annuity Explanation Variable annuities offer tax-deferred growth and are suitable for achieving supplemental retirement income. Ideally, they should be funded with readily available cash rather than using funds liquidated from existing investments. None of the other investments listed here offer tax-deferred growth.
A 45-year-old investor takes a lump-sum distribution from a nonqualified variable annuity. How is the distribution taxed? The entire amount is taxed as ordinary income. The growth portion is taxed as ordinary income. The growth portion is taxed as a capital gain. The growth portion is subject to a 10% penalty. A) III and IV B) II and IV C) I and IV D) II and III
B) II and IV Explanation On withdrawals from a nonqualified annuity, taxes are paid only on the amount that exceeds cost basis (the amount paid into the annuity). In this case, the investor is taking a lump-sum distribution before reaching age 59½ and must pay an additional 10% penalty on the taxable amount.
A joint and last survivor annuity is a payout option where A) payments continue until the death of the primary owner. B) two people are covered and payments continue until the second death. C) payments continue for a predetermined time. D) payments continue until age 70½.
B) two people are covered and payments continue until the second death. EX In a joint and last survivor option, the annuity payment is made jointly to both parties while both are alive. When the first party dies, the annuity payment is made to the survivor. When the second party dies, all payments cease.
A joint life with last survivor annuity covers more than one person. continues payments as long as one annuitant is alive. continues payments only as long as all annuitants are still alive. guarantees payments for a certain period. A) II and IV B) I and II C) III and IV D) I and III
C) III and IV Explanation A joint life with last survivor contract covers multiple annuitants and ceases payments at the death of the last surviving annuitant.
An accumulation unit in a variable annuity contract is A) an accounting measure used to determine the contract owner's interest in the separate account. B) none of these. C) fixed in value until the holder retires. D) an accounting measure used to determine payments to the owner of the variable annuity.
C) fixed in value until the holder retires. Explanation When money is deposited into the annuity, it is purchasing accumulation units.
All of the following statements about variable annuities are true except A) such an annuity is designed to combat inflation risk. B) the number of annuity units becomes fixed when the contract is annuitized. C) the rate of return is determined by the underlying portfolio's value. D) a minimum rate of return is guaranteed.
D) a minimum rate of return is guaranteed .The return on a variable annuity is not guaranteed; it is determined by the underlying portfolio's value. Variable annuities are designed to combat inflation risk. The number of annuity units becomes fixed when the contract is annuitized; it is the value of each unit that fluctuates.
A 58-year-old investor owns a single premium deferred variable annuity with a current value of $500,000. The original investment was $150,000 and the contract has a death benefit provision. If this investor wished to exchange this policy for one offered by a competing company, A) the investor would be liable for ordinary income taxes on $350,000. B) the tax-free exchange privilege applies only when the exchange is within the same insurance company. C) the investor would be liable for ordinary income taxes plus the 10% penalty on $350,000. D) using a 1035 exchange would avoid any current taxation.
D) using a 1035 exchange would avoid any current taxation. Explanation Section 1035 of the Internal Revenue Code permits the exchange of an annuity to another annuity, whether issued by the same or a competing company, with the tax-deferral on earnings continuing. These exchanges can also be made from an insurance policy to an annuity, but not from an annuity to an insurance policy.
All of the following statements regarding variable annuities are true except A) variable annuities may only be sold by registered representatives. B) variable annuities offer the investor protection against capital loss. C) insurance companies keep variable annuity funds in separate accounts from other insurance products. D) variable annuities are classified as insurance products.
Explanation A variable annuity is both an insurance and a securities product. An annuitant assumes the investment risk of a variable annuity and is not protected by the insurance company from capital losses.
A client has purchased a nonqualified variable annuity from a commercial insurance company. Before the contract is annuitized, your client, age 60, withdraws some funds for personal purposes. What is the taxable consequence of this withdrawal to your client? A) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis B) Capital gains taxation on the earnings withdrawn in excess of the owner's basis C) A 10% penalty plus the payment of ordinary income tax on funds withdrawn in excess of the owner's basis D) A 10% penalty plus the payment of ordinary income tax on all of the funds withdrawn
Explanation Contributions to a nonqualified annuity are made with the owner's after-tax dollars. Distributions from such an annuity are computed on a last-in, first-out basis, with the income taxed first. Once the cost basis is reached, any further withdrawals are a nontaxable return of principal. Because the client is older than 59½ at the time of distribution, the additional 10% penalty tax is not incurred.
With regard to a variable annuity, all of the following may vary except A) number of annuity units. B) number of accumulation units. C) value of annuity units. D) value of accumulation units.
Explanation During the accumulation phase, the number of accumulation units will increase as additional money is invested. When the contract is annuitized, the annuitant is credited with a fixed number of annuity units. Once annuitized, the number of annuity units does not vary. The value of accumulation and annuity units varies with the investment performance of the separate account.
Which of the following are not defined as securities? A) Variable annuities B) Fixed annuities C) Closed-end investment companies D) Preferred stocks
Explanation Fixed annuities are not included in the long list of items that are defined as a security, primarily because the element of risk is not included.
A customer has an investment objective of keeping pace with inflation while assuming moderate risk. Which of the following recommendations would best meet the customer profile? A) Money market fund B) IPO C) Variable annuity D) Variable life insurance policy
Explanation Insurance companies introduced the variable annuity as an opportunity to keep pace with inflation. For this potential advantage, the investor, rather than the insurance company, assumes the investment risk. A variable life insurance policy should be purchased primarily for its insurance features, not its investment features.
The holder of a variable annuity receives the largest monthly payments under which of the following payout options? A) Joint tenants annuity B) Joint and last survivor annuity C) Life annuity D) Life annuity with period certain
Explanation Life annuity has the largest payout because less risk is assumed by the insurance company; there is no beneficiary in the event the annuitant dies.
An investor begins a periodic payment deferred variable annuity purchase program. One respect in which this differs from purchasing a mutual fund is that A) the variable annuity contract will generally have lower expenses than the mutual fund. B) the investor in the variable annuity contract reports no taxable consequences during the accumulation period. C) the mutual fund will generally have a surrender charge for early withdrawal and variable annuities only charge for surrender when annuitizing. D) there is a minimum guaranteed return with the variable annuity, while there are no guarantees with the mutual fund.
Explanation One of the features of annuities is the tax deferral of all earnings until the money is withdrawn. Mutual fund distributions are taxable when received. On the other hand, when the annuity accumulation is withdrawn, everything above the cost basis is taxed as ordinary income (10% penalty if younger than 59½)—there is never any capital gains treatment with annuities. Variable annuities invariably have higher expense ratios than mutual funds with similar portfolios. Surrender charges are found with annuities. Do not confuse those with the conditional deferred sales charge (CDSC) applied to certain mutual fund share classes.
An individual purchases a single premium deferred variable annuity. There will be income tax ramifications in all of the following situations except A) death prior to annuitization. B) surrender of the contract. C) during the payout period. D) during the accumulation period.
Explanation One of the features of annuities, fixed and variable, is that there are no taxes during the accumulation phase. However, anytime money comes out of the account, whether when annuitized, surrendered voluntarily, or not (as in death), any earnings are subject to taxation.
A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor withdraws $25,000. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $17,500. B) $0.00 C) $6,250. D) $8,750
Explanation Only the deferred growth is taxable on a LIFO (last-in, first-out) basis. In this case, it is the amount of the withdrawal in excess of the cost of $25,000. Using LIFO, all of the withdrawal is part of the $47,000 in earnings that have been generated. That $25,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is under 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $25,000. Remember, all annuities are nonqualified unless stated otherwise in the question.
A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty-two years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $16,450. B) $18,000. C) $11,750. D) $25,200.
Explanation Only the deferred growth is taxable. In this case, it is the difference between the surrender value of $72,000 and the cost basis of $25,000. That $47,000 is taxed at the marginal rate of 25%. Because the investor is older than 59½ (38 + 22 = 60), there is no additional 10% penalty tax. Effectively, this is a 25% tax on $47,000.
Which of the following characteristics is not shared by both a mutual fund and a variable annuity's separate account? A) The client assumes the investment risk. B) The investment portfolio is managed professionally. C) The client may vote for the board of directors or board of managers. D) The payout plans provide the client income for life.
Explanation Only variable annuities have payout plans that provide the client income for life.
A registered representative with ABC Securities has recently become aware of a new variable annuity. As tax time is approaching, the representative decides to recommend the variable annuity to all of her customers as an attractive addition to their portfolios. The representative should recommend the variable annuity to all of her clients because the tax advantage almost always results in a greater return. recommend the variable annuity to those clients whose needs and objectives match the investment. recommend the variable annuity to all of her clients because of the performance potential of the subaccounts. not recommend the investment to all of her clients in spite of the tax advantages and additional features. A) II and III B) II and IV C) I and III D) I and IV
Explanation Recommendations may be made only when it is suitable for the customer's needs. Therefore, she would not recommend the variable annuity to all because some of them may not be able to benefit from those tax advantages.
One of your customers owns a variable annuity. When asking about how the performance of the separate account is measured, you would respond that A) the insurance company's actuaries compute the separate account performance. B) the separate account performance is the same for all subaccounts. C) the separate account performance depends on the performance of the selected subaccounts. D) the primary determinant is the assumed interest rate (AIR).
Explanation Some insurance company separate accounts have dozens of different subaccounts. These subaccounts range from highly aggressive to highly conservative. It is the performance of the specific subaccounts selected by the investor that determines the value of their accumulation unit. The actuaries get involved when determining the payout because that depends on life expectancy. Similarly, the AIR comes into play only during the payout phase.
Variable annuities generally include an assumed interest rate. This is A) the rate used to illustrate the future growth prospects of the contract. B) the annual dividend rate that will be paid to contract holders. C) the annual rate at which annuity payments will increase. D) the annual rate of return required to maintain the level of annuity payments.
Explanation The assumed interest rate (AIR) is the rate the insurance company assumes the separate account will earn during the payout period. If the assumption is wrong, the monthly payments will be adjusted accordingly. If the separate account earns more than the AIR, the next month's payment is increased. If the separate account earns less than the AIR, the next month's payment is reduced. If the account earns the assumed rate, monthly payments will not change.
A customer is choosing a payout option for a variable annuity. Maximizing monthly income for the rest of his life is the customer's key objective. This annuitant has no living relatives, so beneficiaries are not a concern. Which of the following options available would best meet the needs of this annuitant? A) Take random withdrawals from the contract B) A life with a 5-year period certain payout option C) A life with a 20-year period certain payout option D) A straight life payout option
Explanation The largest monthly check an annuitant can receive for the rest of his life is generated by a straight life (life income or life only) payout option. Though there is no beneficiary designation during the annuitization, this is not an issue for this annuitant. Life with period certain will produce a smaller check for life because the insurance company will guarantee payments to a beneficiary for a certain time designated in the contract, should the annuitant die within that period. But again, the need to designate beneficiaries is not an issue for this annuitant. Random withdrawals do not guarantee how long the money will last because large withdrawals can deplete the funds before the annuitant dies.
One of the distinguishing differences between variable annuities and mutual funds is that variable annuities A) generally have lower surrender charges. B) offer a guaranteed rate of return. C) are considered securities. D) have a separate account.
Explanation The variable part of a variable annuity is the separate account. That is what makes it a security product similar to a mutual fund. The only guarantee with a variable annuity is that, once annuitized, payments will continue for life (or the designated period certain). The amount of those payments will vary based on the performance of the separate account. One of the negative features of variable annuities is that they typically have surrender charges that can last a decade or longer.
FINRA Rule 2330 deals with a member's responsibility in the sale of certain insurance company-based products. Specifically the concern is with A) taking loans against the cash value of a variable life insurance policy. B) subsequent changes to the separate account allocations in a deferred variable annuity. C) purchases and sales of deferred variable annuities. D) purchases and sales of deferred annuities. Explanation This FINRA rule applies to purchases and sales of deferred variable annuities and initial allocations to the separate account. It does not apply to fixed annuities or variable life insurance. Because it only deals with the purchase or sale or initial allocations, a client with a deferred variable annuity wishing to change the separate account allocation does not come under the rule.
Explanation This FINRA rule applies to purchases and sales of deferred variable annuities and initial allocations to the separate account. It does not apply to fixed annuities or variable life insurance. Because it only deals with the purchase or sale or initial allocations, a client with a deferred variable annuity wishing to change the separate account allocation does not come under the rule.
A 58 year-old investor owns a single premium deferred variable annuity with a current value of $500,000. The original investment was $150,000 and the contract has a death benefit provision. If the investor suddenly passes away and the beneficiary receives a lump sum payout, A) the beneficiary will owe ordinary income taxes on $500,000 plus 10% penalty if under 59½. B) the beneficiary will owe ordinary income taxes on $500,000. C) the beneficiary will owe ordinary income taxes on $350,000. D) the beneficiary will owe ordinary income taxes on $350,000 plus 10% penalty if under 59½.
Explanation When receiving the death benefit in a lump sum, the beneficiary's tax situation is the same as if the owner surrendered the policy with one critical difference. Surrender before reaching age 59½ leads to the 10% tax penalty, but that penalty is waived in the case of death. It is only the deferred earnings (in this question, the $350,000 difference between the initial deposit and the current value) that is subject to taxes. As is always the case with annuities, the taxation is always as ordinary income, never capital gains.
least suitable recommendation for a qualified retirement account plan account
Municipal bonds provide tax-exempt interest payments and, consequently, offer lower yields. Because earnings in a qualified retirement plan account grow tax deferred, the municipal bond is not a suitable investment. In addition, they will be fully taxed upon withdrawal.
Which of the following investments would be most suitable for an IRA?
Short sales, uncovered calls, and municipal bonds are all inappropriate for individual retirement accounts. Covered calls are allowed and will be covered in detail in Unit 4.
A variable annuity's separate account is: used for the investment of funds paid by contract holders. used to escrow late or otherwise delinquent premium payments. required to be located off of the company's premises. regulated under both securities and insurance laws. A) II and IV B) I and III C) II and III D) I and IV
The separate account is used for both variable life insurance and variable annuity investments. The nature of the securities invested in—bonds and growth stocks—makes it necessary that sales representatives and their principals be licensed in securities as well as insurance.
FINRA Rule 2330 deals with
The subject of the FINRA rule is deferred variable annuities. It applies to the sale or exchange of this specific product.
A married couple are both employed by firms that cover them under the company pension plans, and each earns approximately $300,000 annually. If they both open a traditional IRA and make the maximum contribution, how much of their contribution could they deduct?
They are ineligible to deduct any contribution made.: It is important to recognize that FINRA does not expect you to know the income level at which deductible contributions for those covered under employer-sponsored plans begins to phase out. The question uses numbers that are so much higher than current law just to remind you that such a regulation exists. While each are eligible to make the maximum contribution, at this income level, neither spouse—both of whom are covered under employer-sponsored plans—would be eligible to deduct their contributions to their respective IRAs.
A separate account will invest in a number of different securities. The separate account is not likely to invest in A) money market funds. B) corporate stock. C) equity funds. D) municipal bonds.
municipal bonds. Explanation The earnings on dollars invested into a variable annuity accumulate tax deferred, which is why variable annuities are popular products for retirement accumulation. As with all tax-deferred accounts, municipal bonds are not appropriate investments because interest earned on municipals is already tax exempt at the federal level.
The amount paid into a defined contribution plan is set by
the trust agreement; A defined contribution plan's trust agreement contains a section explaining the formula(s) used to determine the contributions to the retirement plan.
