Series 7 Chapter 12: Variable Annuities

Your client owns a variable annuity contract with an AIR of 4%. In March, the actual net return to the separate account was 8%. If this client is in the payout phase, how would his April payment compare to his March payment? A) It will be lower. B) It cannot be determined until the April return is calculated. C) It will stay the same. D) It will be higher.

Your answer, It will stay the same., was incorrect. The correct answer was: It will be higher. If the separate account of a variable annuity with an AIR of 4% had actual net earnings of 8% in March, the April payment will be higher than the March payment.

If a customer is about to buy a variable annuity contract and wants to select an annuity with a payout option providing the largest possible monthly payment, which of the following payout options would be most suitable? A) Unit refund life option B) Life annuity with 10-year period certain C) Life-only annuity D) Life annuity with period certain

Your answer, Life-only annuity, was correct!. Generally, a life-only contract pays the most per month because payments cease at the annuitant's death.

Distributions from nonqualified variable annuities are: A) taxed at a reduced rate. B) taxed as ordinary income only to the extent of earnings. C) tax free. D) taxed as ordinary income.

Your answer, taxed as ordinary income., was incorrect. The correct answer was: taxed as ordinary income only to the extent of earnings. As contributions are made with after-tax dollars, only the earnings generated are taxed on withdrawal.

You have 4 clients each expressing interest in a variable annuity contract. Which 2 of the 4 client profiles would a VA be least suitable for? A 45-year-old employed individual with no other retirement accounts in place A 58-year-old individual near retirement who is in good health and anticipates a lengthy retirement A 32-year-old with a company-sponsored 401k plan who will need a lump sum soon to finance graduate school tuition A 60-year-old individual, nearing retirement who has both IRAs and a 401k in place, is comfortable with market risk associated with the stock market, and has a lump sum in cash available to fund the annuity A) I and III B) II and IV C) II and III D) I and II

Your answer, I and III, was correct!. VAs are less suitable for individuals who have not yet made maximum contributions to other retirement accounts such as IRAs and 401ks. They are also not considered suitable for anyone who anticipates needing a lump sum within a short time frame to fund other endeavors. They are more suitable for individuals who can fund the annuity with cash, want to supplement existing retirement benefits they have already funded, are comfortable with the market risk associated with a VA separate account portfolio and anticipate a long retirement.

If an investor has a fixed-annuity contract with an insurance company, which of the following risks is assumed by the investor? A) Mortality risk. B) Value of each annuity unit each month. C) Investment risk. D) Purchasing power risk.

Your answer, Investment risk., was incorrect. The correct answer was: Purchasing power risk. An investor who purchases a fixed annuity contract assumes purchasing-power risk. Fixed annuities pay a fixed monthly benefit which loses purchasing power if there is inflation.

If your 60-year-old customer purchases a nonqualified variable annuity and withdraws some of her funds before the contract is annuitized, what are the consequences of this action? A) Ordinary income tax on earnings exceeding basis. B) 10% penalty plus payment of ordinary income tax on all funds withdrawn. C) 10% penalty plus payment of ordinary income tax on all funds withdrawn exceeding basis. D) Capital gains tax on earnings exceeding basis.

Your answer, 10% penalty plus payment of ordinary income tax on all funds withdrawn., was incorrect. The correct answer was: Ordinary income tax on earnings exceeding basis. Distributions from a nonqualified plan represent both a return of the original investment made in the plan with after-tax dollars (a nontaxable return of capital) and the income from that investment. The income was deferred from tax over the plan's life, so it is taxable as ordinary income once distributed. A 10% penalty applies only if distributions begin before age 59-½.

Your 55-year-old client invested $50,000 four years ago in a nonqualified variable annuity. The original investment 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 the tax liability to the IRS be? A) 4000. B) 4500. C) 3000. D) 0.

Your answer, 3000., was incorrect. The correct answer was: 4000. Since 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 59-½ when making the withdrawal, he also pays a 10% penalty, or $1,000. This makes a total of $4,000 tax and penalty paid on the random withdrawal.

Of the four client profiles below which might be the best suited for a variable annuity recommendation? A) A 30 year old construction worker recently unemployed who wants to invest his severance pay amounting to 9 months salary. B) A 50 year old individual with $50,000 cash to invest who has already made the maximum contributions to an IRA and the 401(k) plan at his place of employment and would like to minimize some of the tax consequences of his currently high tax bracket. C) A 75 year old women, who is a former executive retired for over ten years who wants to preserve as much capital as she can to leave to her two grandchildren. D) A 25year old public school teacher who would like to save enough for the purchase of her first home within the next 3 to 5 years.

Your answer, A 30 year old construction worker recently unemployed who wants to invest his severance pay amounting to 9 months salary., was incorrect. The correct answer was: A 50 year old individual with $50,000 cash to invest who has already made the maximum contributions to an IRA and the 401(k) plan at his place of employment and would like to minimize some of the tax consequences of his currently high tax bracket. Of the four customer profiles the individual already making the maximum retirement account contributions available to him and wanting to minimize the tax consequences of being in a high income tax bracket would be most suitable for a VA recommendation. Supplemental income stream for retirement, not preservation of capital should be the catalyst to consider a VA and for anyone who may need access to the sum invested for any reason a VA would not be considered a suitable recommendation.

An investor who has purchased a nonqualified variable annuity has the right to: vote on proposed changes in investment policy. approve changes in the plan portfolio. vote for the investment adviser. withdraw funds without any tax consequences. A) I and IV. B) II and IV. C) I and III. D) II and III.

Your answer, I and III., was correct!. Owners of variable annuities, like owners of mutual fund shares, may vote on changes in investment policy and for an investment adviser. Withdrawals from a nonqualified variable annuity are made on a LIFO basis, so the taxable earnings are considered taken out before principal.

Which of the following are defined as securities? Fixed annuities. Variable Annuities. Options. CDs insured by the FDIC. A) II and IV. B) I and III. C) I and IV. D) II and III.

Your answer, I and III., was incorrect. The correct answer was: II and III. A security is any investment for profit with management performed by a third party. In addition, an element of risk must be present. Fixed annuities are not considered securities as return is guaranteed by the insurance company issuer. Similarly, CDs are insured, thereby eliminating risk and guaranteeing a return.

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 IV. B) I and IV. C) II and III. D) I and III.

Your answer, I and III., was incorrect. The correct answer was: II and III. 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).

Once a customer annuitizes a variable annuity, which of the following statements are TRUE? The number of annuity units is fixed. The number of annuity units varies. The value of the annuity units is fixed. The value of the annuity units varies. A) II and III. B) I and IV. C) II and IV. D) I and III.

Your answer, I and IV., was correct!. Once a variable annuity is annuitized, the accumulation units are converted into a fixed number of annuity units. The value of these units varies with the performance of the separate account.

Which of the following statements regarding variable annuities are TRUE? The number of accumulation units is always fixed throughout the accumulation period. The number of accumulation units can rise during the accumulation period. The number of annuity units is fixed at the time of annuitization. The number of annuity units rises once annuitization begins. A) II and III. B) I and IV. C) I and III. D) II and IV.

Your answer, I and IV., was incorrect. The correct answer was: II and III. The number of variable annuity accumulation units can rise during the accumulation period when additional units are being purchased. When a variable annuity contract is annuitized, the number of annuity units is fixed.

If your customer invests in a variable annuity and chooses to annuitize at age 65, which of the following statements are TRUE? She will receive the annuity's entire value in a lump-sum payment. She may choose to receive monthly payments for the rest of her life. The accumulation unit's value is used to calculate the total value of the account. The annuity unit's value represents a guaranteed return. A) II and III. B) I and III. C) I and IV. D) II and IV.

Your answer, I and IV., was incorrect. The correct answer was: II and III. When a variable contract is annuitized (distributed in regular payments, not as a lump sum), the number of accumulation units is multiplied by the unit value to arrive at the account's current value. An annuity factor is taken from the annuity table, which considers, for example, the investor's sex and age. This factor is used to establish the dollar amount of the first annuity payment. Future annuity payments will vary according to the separate account's performance.

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) I and IV. B) III and IV. C) II and IV. D) II and III.

Your answer, I and IV., was incorrect. The correct answer was: II and IV. 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 59-½ and must pay an additional 10% penalty on the taxable amount.

For an insurance company, mortality risk turns out unfavorably if: an annuitant lives longer than expected. an annuitant dies sooner than expected. a life insurance holder lives longer than expected. a life insurance holder dies sooner than expected. A) II and III. B) I and IV. C) II and IV. D) I and III.

Your answer, II and III., was incorrect. The correct answer was: I and IV. Mortality assumptions are based on life expectancy or mortality tables prepared by insurance company actuaries. If an annuitant lives longer than expected, the insurance company will have to continue payments longer than expected. If an insurance holder dies sooner than expected, the insurance company will have to pay the death benefit sooner than expected-that is, before receiving some of the expected premium payments.

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 of time. A) I and II. B) III and IV. C) II and IV. D) I and III.

Your answer, II and IV., was incorrect. The correct answer was: I and II. A joint life with last survivor contract covers multiple annuitants and ceases payments at the death of the last surviving annuitant.

An investor owning which of the following variable annuity contracts would hold accumulation units? Periodic payment deferred annuity. Single payment deferred annuity. Immediate life annuity. Immediate life annuity with 10-year period certain. A) I and II. B) II and IV. C) II and III. D) I and III.

Your answer, II and IV., was incorrect. The correct answer was: I and II. Accumulation units represent units of ownership in a life insurance company's separate account when the contract is in the accumulation stage. Annuity units are units of ownership when the contract is in the payout stage. Immediate annuities purchase annuity units directly.

Universal variable life policies have investment risk that is assumed by the investor do not have a separate account can be sold by someone with only an insurance license are purchased primarily for their insurance features A) I and IV B) I and II C) III and IV D) II and III

Your answer, III and IV, was incorrect. The correct answer was: I and IV Universal variable life policies are insurance company products that should be purchased primarily for the insurance features they offer rather than as an investment. Because they have a separate account in which the investor assumes the investment risk, they can only be sold by individuals with both insurance and securities licenses.

The payout of an annuitized variable annuity account changes from month to month in a manner determined by which of the following? The separate account performance compared to last month's performance. The payout compared to the initial payout upon annuitization. The separate account performance compared to an assumed interest rate. The payout compared to last month's payout. A) I and III. B) I and II. C) III and IV. D) II and IV.

Your answer, III and IV., was correct!. A variable annuity payout is determined by comparing account performance with AIR, and this month's payout with last month's payout.

If an investor has purchased an immediate variable annuity, which of the following statements best describe the investment? It was a lump-sum purchase. Distribution of dividends occurs during the accumulation period. Distributions to the annuitant will fluctuate during the payout period. The investor purchased accumulation units. A) I and II. B) III and IV. C) II and IV. D) I and III.

Your answer, III and IV., was incorrect. The correct answer was: I and III. An immediate annuity has no accumulation period. A single lump-sum investment is made, and payments begin immediately, since the investor has purchased annuity units. During payout, distributions will fluctuate due to performance in the separate account.

Variable annuities must be registered with: the state banking commission. the state insurance commission. the SEC. FINRA. A) II and IV. B) II and III. C) III and IV. D) I and III.

Your answer, III and IV., was incorrect. The correct answer was: II and III. A variable annuity is a combination of 2 products: an insurance contract and a mutual fund. Therefore, variable annuities must be registered with the state insurance commission and the Securities and Exchange Commission.

John is the annuitant in a variable plan, and Sue is the beneficiary. Upon John's death during the accumulation period, Sue takes a lump-sum payment. What is her total tax liability? A) The entire amount is taxed as ordinary income, because it is not life insurance. B) The proceeds minus John's cost basis taxed as ordinary income at Sue's tax rate. C) None, because it is the proceeds from a life insurance company. D) The ordinary income on the proceeds over the cost basis plus 10% of the net gain (if any) if Sue is younger than 59-½ years old.

Your answer, None, because it is the proceeds from a life insurance company., was incorrect. The correct answer was: The proceeds minus John's cost basis taxed as ordinary income at Sue's tax rate. Annuity death benefits are generally paid in a lump sum. The beneficiary is taxed at ordinary income rates during the year the lump sum is received. The amount taxed is the amount of the lump-sum payment minus the deceased's cost basis in the investment.

A registered representative's (RR) customer is speaking of a variable life insurance contract he owns. He makes several statements regarding the contract. Which of the following is NOT an accurate statement concerning a variable life insurance contract? A) The portion of the premium invested in the insurance company's general account is used to provide for the minimum guaranteed amount of the death benefit. B) The death benefit cannot ever be more than the guaranteed benefit. C) The policy provides a minimum guaranteed death benefit. D) There is no guarantee regarding the investment results of the separate account.

Your answer, The death benefit cannot ever be more than the guaranteed benefit., was correct!. The minimum guaranteed death benefit is provided by that portion of the payment invested in the insurance company's general account. The remainder of the premium is invested in the separate account. While there is no guarantee on how investments in the separate account will perform, depending on its investment performance, the separate account could provide for a larger death benefit than the minimum guaranteed amount.

For an investor, which of the following is the most important factor in determining the suitability of a variable annuity investment? A) The fact that the annuity payment may increase or decrease. B) The investor's concerns about taxes. C) The fact that periodic payments into the contract may increase or decrease. D) The investor's marital status.

Your answer, The investor's marital status., was incorrect. The correct answer was: The fact that the annuity payment may increase or decrease. The most important consideration in purchasing a variable annuity is to be aware that benefit payments will fluctuate with the investment performance of the separate account. Periodic payments are not a consideration because normally the payments into an annuity are level or in a lump sum.

A registered person recommends the purchase of a variable annuity to one of his clients. He wants to ensure that the client, in addition to meeting suitability requirements, is aware of certain variable annuity contract characteristics. All of the following are accurate statements to make to the client EXCEPT A) a variable annuity contract will provide a fluctuating monthly check upon the annuitization of the contract B) a variable annuity contract is not required to be sold by prospectus because it is an insurance contract C) a variable annuity contract is subject to fluctuating values due to market fluctuations of the underlying separate accounts D) a variable annuity contract does not guarantee any type of return

Your answer, a variable annuity contract is not required to be sold by prospectus because it is an insurance contract, was correct!. Variable annuity contracts must be sold by prospectus due to the characterization of the separate accounts as securities, which must be registered under the Securities Act of 1933 and the Investment Company Act of 1940.

If the owner of a variable annuity dies during the accumulation period, any death benefit will: A) be paid to the issuing company to complete the plan. B) be paid to a designated beneficiary. C) be returned to the separate account. D) be paid to any legal heirs as recognized by the annuitant's state of domicile.

Your answer, be returned to the separate account., was incorrect. The correct answer was: be paid to a designated beneficiary. The accumulation period of a variable annuity may continue for many years. If the annuitant should die during that time, any death benefit would be paid to a beneficiary designated by the annuitant at the time the annuity was purchased.

Once a variable annuity has been annuitized: A) each annuity unit's value and the number of annuity units vary with time. B) the number of annuity units is fixed, and their value remains fixed. C) each annuity unit's value varies with time, but the number of annuity units is fixed. D) each annuity unit's value is fixed, but the number of annuity units varies with time.

Your answer, each annuity unit's value varies with time, but the number of annuity units is fixed., was correct!. During the payout period, payments are based on a fixed number of annuity units established when the contract was annuitized. The value of an annuity unit varies from month to month according to the performance of the separate account in comparison to the assumed interest rate.

All of the following characteristics are shared by both a mutual fund and a variable annuity's separate account EXCEPT: A) the client may vote for the board of directors or board of managers. B) the payout plans provide the client income for life. C) the client assumes the investment risk. D) the investment portfolio is managed professionally.

Your answer, the payout plans provide the client income for life., was correct!. Only variable annuities have payout plans that provide the client income for life.

All of the following statements about variable annuities are true EXCEPT: A) a minimum rate of return is guaranteed. 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) such an annuity is designed to combat inflation risk.

Your answer, the rate of return is determined by the underlying portfolio's value., was incorrect. The correct answer was: 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.

An important basic characteristic of common stocks that makes them a suitable type of investment for the separate account of variable annuities is: A) the safety of the principal invested. B) changes in common stock prices tend to be more closely related to changes in the cost of living than changes in bond prices. C) the yield is always higher than bond yields. D) the yield is always higher than mortgage yields.

Your answer, the safety of the principal invested., was incorrect. The correct answer was: changes in common stock prices tend to be more closely related to changes in the cost of living than changes in bond prices. Because common stocks are not fixed dollar investments, they have the opportunity to keep pace with inflation.

An 18-year-old, unmarried high school student sought a safe investment for a $30,000 bequest until after she graduated from college. Her intent was to use the funds for the down payment on a house after graduation. Her agent recommended she choose a variable annuity as a safe haven for the funds. This recommendation is: A) suitable due to the relative safety of the investment. B) unsuitable because her situation exposes her to surrender charges and early withdrawal penalties in exchange for insufficient benefits. C) suitable due to the death benefit features of a variable annuity. D) unsuitable because the return on something as conservative as a variable annuity tends to be low.

Your answer, unsuitable because her situation exposes her to surrender charges and early withdrawal penalties in exchange for insufficient benefits., was correct!. This customer has no spouse or dependents, which negates the value of the death benefit. The funds are not liquid due to the surrender fees, and there is also a 10% penalty on withdrawals before age 59-½.

A prospectus for a variable annuity contract: must provide full and fair disclosure. is required by the Securities Act of 1933. must be filed with FINRA. must precede every sales presentation. A) I and II. B) I and III. C) III and IV. D) II and IV.

Your answer, I and II., was correct!. A variable annuity is a security and must be registered with the SEC, not FINRA. As part of the registration requirements, a prospectus must be filed and distributed to prospective investors. Distribution can take place before or during any solicitation for sale.

Changes in payments on a variable annuity correspond most closely to fluctuations in the: A) prime rate. B) value of underlying securities held in the separate account. C) cost of living. D) Dow Jones Industrial Average.

Your answer, cost of living., was incorrect. The correct answer was: value of underlying securities held in the separate account. Payments from a variable annuity depend on the securities' value in the separate account's underlying investment portfolio.

A rider or statement of condition that allows a variable life insured to maintain policy coverage after becoming disabled is a benefit known as A) minimum guaranteed death benefit B) waiver of premium C) early annuity phase-in D) life income

Your answer, early annuity phase-in, was incorrect. The correct answer was: waiver of premium Waiver of premium is a benefit available on qualified life insurance contracts, usually in the form of a rider, which provides for the waiver of premium payments that fall due while the policyholder is totally disabled.