SR6 Chapter 7 Variable Contracts and Retirement Plans
Nonqualified Retirement Plans
ERISA does not require employers to establish any sort of retirement plan. In fact, in the interests of cost savings or other concerns, some employers may choose to create a plan that does not meet ERISA standards. These plans are often much cheaper to administer and provide employers with much more latitude on the design of the plan. These nonqualified plans may lose most of the tax advantages afforded to the employer/employees under a qualified plan. In some cases, the employer will establish a qualified plan that covers all eligible employees, and a nonqualified plan that is only available to a select group
Qualified retirement plan Contributions
Employer contributions can be deducted for the year in which the contribution was made. If the employee is permitted to make contributions, they are deducted from the employee's salary before taxation, therefore reducing the employee's taxable income. Pre-tax contributions are funded with money that has not been taxed by the IRS yet. The account will then grow tax-deferred
Administrative Expenses
A charge for record-keeping and other administrative expenses. This might be charged as a flat account maintenance fee on a monthly or annual basis. Some refer to this as a policy fee and it can be waived once the policy has exceeded a certain value, such as $100,000.
Keogh (HR-10 Plans)
______ plans may be established as a defined benefit or defined contribution plan and are available to unincorporated self-employed persons (owner-employees). The plan must also be established for any full-time employees who meet the ERISA requirements. Under this type of qualified plan, the employer is allowed to contribute the lesser of 25% of postcontribution income (which is equal to 20% of earnings), up to a specified annual limit, into their own plan. This contribution can only be based on earned income from the self-employed business. If the owner has another job working as an employee, that income cannot be included to determine the allowable contribution. The owner must make contributions to eligible employee plans at the same rate as that of their own plan
Free Look Provision
A _______ applies to all variable insurance policy sales. The policyowner can return the policy and receive a full refund of all premiums paid within 45 days from the date of application or 10 days from receipt of the policy, whichever is later.
Stepped-up Death Benefit
A special feature available on some variable annuities is a ________. This feature guarantees a death benefit based on the account value as of a specified date and may provide for a greater death benefit if the separate account investments have performed well. There is an additional charge for this feature.
Additional Features
Additional optional features may be available for an extra premium charge. A guaranteed minimum income benefit guarantees an minimum monthly benefit, even if there's not enough money in the account to support the payout. Another common feature is a long-term care rider. This provides long-term care insurance in the event the annuitant qualifies for home health care or nursing home care. A waiver of premium benefit may also be available on variable annuities with a scheduled premium. This feature waives the premium in the event of disability or need for long-term care.
Life Income Period Certain
Annuity income is payable for life, or for a specified period of time, whichever is longer. If the annuitant lives beyond the stated period, benefits continue for the life of the annuitant. If the annuitant dies prior to the end of the period certain, a beneficiary receives the balance of the payments for the remaining time period.
Taxation of Contributions to a traditional IRA
Contributions to deductible IRAs may be limited depending on several factors: The taxpayer's income Tax-filing status Participant status in an employer-sponsored qualified retirement plan If a company does not have a retirement plan, income limitations do not apply and the contribution is 100% tax deductible. Key Concept: Assume all contributions into a _____ are with pre-tax dollars unless stipulated otherwise.
Variable Annuity Contract Life Cycle
Here's a summary of the process: 1. The premiums are invested in the separate account and used to purchase accumulation units. 2. The owner chooses the mix of subaccounts to invest in. 3. The accumulation units grow on a tax-deferred basis. 4. The contract owner trades the accumulation units in return for a lifetime income stream upon annuitization. 5. The accumulation units are converted into a fixed number of annuity units. 6. The annuitant's payment will fluctuate each month based on the actual performance of the separate account compared to the AIR.
Catch-up Provisions
In an effort to help individuals who are late to start retirement planning, Congress instituted special "catch-up" provisions. Employees over age 50 can make an additional contribution to a qualified plan. Since the contributions and catch-up limitations are subject to change annually, please refer to the Qualified Plan Annual Contribution Limits supplemental chart in the back of this study manual
Premium Taxes
Some states impose a "State Premium Tax" against the purchase payments. These are deducted before the premium is invested.
Face Amount/Death Benefit
The ____, or ______ of the policy is the amount of money that will be paid to the beneficiary upon the death of the insured. If a policy has unpaid loans (and unpaid interest) at the time of the insured's death, the ____ will be reduced by that amount.
Cash Values
The policy's cash value will fluctuate based on the performance of the underlying investments held in the separate account, and must be calculated at least monthly. Variable Insurance Policy Valuations
Expense Guarantee
This is a guaranteed expense charge that is equal to a certain percentage of the account value that compensates the insurance company for future operating expense risks it assumes under the annuity contract.
Insurance Company Separate Account
Variable product purchasers place money in a _______. The purchaser then selects different pools of securities to invest in. The _______ is considered an investment company product and must be registered with the SEC under the Investment Company Act of 1940. The securities held in the _______ must be registered with the SEC and each offering is considered a new issue, requiring a sale by prospectus only. A policyowner can allocate premium and account value dollars to a variety of investment accounts within a _____. These investment accounts are referred to as subaccounts. The subaccounts allow the owner to tailor an asset allocation for specific investment objectives and risk tolerance. The number of subaccount choices and the specific subaccount options are chosen by the insurance company
Whole Life Insurance
_______ is a traditional form of permanent insurance. Unlike term life insurance, _______will remain in force for the life of the insured as long as premiums are paid. The face value (death benefit) of the policy is fixed and the premiums remain level throughout the insured's lifetime. Policy premiums are deposited in the insurer's general account and a portion of the premium earns a fixed, guaranteed rate of return. The insurance company is at risk for this guarantee. The cash value accumulates in the policy until the amount accumulated equals the face amount and the policy matures. Most ___, by design, are scheduled to mature when the insured reaches age 100. While it is unlikely, if the insured is still living when the policy matures, the face amount of the policy pays as an endowment and coverage ceases
Roth 401(k)
_____ plans may be established in addition to the traditional ____ plan, allowing the employee to make after-tax contributions and receive tax-free withdrawals starting at age 59½. The employee can make contributions to either plan within the same total contribution limits (for both accounts) as a traditional _____. Money cannot be transferred between the two accounts. The employer's contribution may only be made in the traditional _____ plan, meaning on a pre-tax basis.
Immediate Annuity
generates income immediately after the first deposit is made into the account. To be considered an _______, income must begin within one year of the issue date and there is no accumulation period. ______ must be funded with a single premium
Single Premium
A lump sum payment is deposited into the annuity account.
Mortality and Expense Risk
Fixed fees the insurance company charges to cover lifetime income and other operating expenses.
Excess Contributions
If an individual exceeds the allowable contribution limits, the excess contributions are subject to a 6% penalty each year until withdrawn from the account. Withdrawals of excess contributions made prior to age 59½ may also be subject to the 10% penalty tax.
Qualified Plan Contribution Limitations
Qualified plans are subject to annual changes of contribution limitations. Contributions that exceed the required limit are subject to an annual 6% excess contribution penalty until the excess is withdrawn.
Separate Account Valuation
Similar to a mutual fund, the separate account net asset value (NAV) is calculated daily at 4 p.m. Eastern, the close of the NYSE. Variable Insurance Policy Valuations
Charges for Special Features
Additional fees and charges apply to special features added to a variable annuity, such as the stepped-up death benefit, guaranteed minimum income benefit, or long-term care insurance rider.
Tax Treatment of the Death Benefit
Beneficiaries of an annuity contract may be required to pay taxes on a portion of the distribution. Since the death benefit can be the greater of the current account value or the cumulative premiums paid less withdrawals, any amount paid that exceeds the cost basis is taxable to the beneficiary.
Periodic Premium
Continuous premiums are paid into the account, typically on a monthly basis. ______ can be fixed or flexible.
Transfers
In a _____, the account holder never touches the assets. Assets are moved from one trustee or custodian directly to another. This is often the preferred method to move assets since no tax implications exist. There is no limit to the number of ____ that may occur within a year
Catch-up Provisions
Individuals contributing to an IRA who have reached age 50 are allowed to make "catch up" contributions each year, in addition to their normal contribution
Taxation of Qualified Plans
A qualified plan receives certain tax advantages for both the employer and employee. Employees are able to contribute on a pre-tax basis and have earnings grow tax-deferred. Upon withdrawal, if subject to taxation, the amount will be taxed at the investor's current ordinary income rate.
Distributions Of Qualifies Retirement Plans
Since neither the contributions nor the earnings have been taxed, all distributions will be taxed as ordinary income based on the employee's tax bracket in the year the withdrawal is taken, if subject to taxation per the IRS.
Variable Annuities
are a more aggressive choice for investors which makes them most suitable for younger investors. While the potential for growth is greater in a _____ contract, the contract owner risks losing money if the investments perform poorly. ____attract investors looking for a potential hedge against inflation. Funds invested in a ______ are held in the insurance company's separate account, which is registered with the SEC under the Investment Company Act of 1940. The investor is given a choice of several investment options through various subaccounts offered under the contract. The investor assumes the investment risk since no performance guarantees are made by the insurer.
Tax-Sheltered Annuity (TSA) or 403(b) Plans
A _____ is a _________, or may be referred to as a Tax-Deferred Annuity (TDA). This plan was created and authorized under the provisions of Section ____ in the IRC tax code. The plan is available for eligible employees of public school systems and qualified 501(c)(3) nonprofit organizations, including religious organizations, colleges, universities, hospitals, and museums.
Qualified Retirement Plan Distribution Options
Defined benefit pension plans usually allow employees the option of receiving a pension annuity or taking a lump-sum payment. A pension annuity is distributed through the pension plan, not an insurance company, but offers the same payout options. A lump-sum distribution is also an option. This allows the retiree to control the assets and gives them the option of continued tax-deferral with a rollover to an IRA. Taxes are due immediately on any cash payout that is not rolled over. Defined contribution plans like a 401(k) generally allow individuals to take a lump-sum distribution, which is immediately taxable, keep the defined contribution account open, take distributions in the form of an annuity to receive guaranteed income, or choose an IRA rollover
Conversion or Contract Exchange
Insurance companies are required to provide a 24 month, or 2 year, conversion window that allows variable policyowners to convert their contracts into a traditional whole life policy without evidence of insurability
Waiver of Surrender Charges
A common provision in an annuity contract is the ______. This provision will waive or reduce the surrender charge penalty if the annuitant needs access to the annuity funds due to a disability or confinement in a nursing home.
1035 Exchange
The value of a _______ is avoiding a current income tax liability. The taxation will be deferred to the future when the cost basis and gains are transferred to a new insurance policy. All other aspects of the new contract must remain the same. An investor can utilize a _________ from one insurance policy to another insurance policy, one annuity contract to another annuity contract, or a life insurance policy to an annuity contract. An exchange from an annuity to a life policy is not permitted.
Simplified Employee Pension (SEP)
____ plans can be established by corporations, partnerships, or sole proprietors (self-employed) and are designed to be a simple and cost-efficient way for smaller employers to meet their employees' retirement needs. An Individual Retirement Account is established for each employee that is fully funded by the employer. Employers are allowed (but not required) to make annual contributions subject to specified limits of up to 25% of the employee's salary. These limits are much higher than traditional IRA plans. All contributions must be fully vested. All employees age 21 or older with at least $600 annual income in 3 of the last 5 years must be eligible. ______ can be established in addition to another qualified pension and profit sharing plan, such as a 401(k
Profit Sharing
A profit sharing plan is a type of defined contribution plan in which the employer contributes a portion of the firm's profits each year. Contributions are often discretionary and may be skipped or reduced in unprofitable years. The contribution to each employee's profit sharing account is usually based on a percentage of the worker's base salary. Earnings in these accounts accumulate on a taxdeferred basis, and distributions are taxed as ordinary income.
Annuity Units
Once annuitization occurs and ownership of the assets changes, the accumulation units are converted to a fixed number of _______. The investments in the units remain intact and income payments from the insurance company to the annuitant are made based on the value of the contract's underlying _____. The insurance company now owns the assets, which will continue to fluctuate based on performance, even as a portion of the ______ are being distributed. In other words, the number of units remain fixed, but the value of the separate account may fluctuate based on the performance on the underlying securities in the subaccount portfolios.
Premium Deductions
The insurance company deducts its administrative fees, state premium taxes, and sales charge from the premium. A maximum 9% sales charge is allowed for a variable insurance policy.
Annual Report
The insurance company is required to send an annual statement to the policyholder detailing the contract's current death benefit and cash value. The _____ must also list any policy loans outstanding and provide a record of all premium payments made and expenses related to the contract over the past year.
Defined Benefit plan
A ______ plan, or traditional pension plan, promises the employee a specific monthly payout that they will receive upon retirement. Monthly benefits are calculated based on the employee's age, years of service, and highest salary (or average of last 3 years). These plans are designed to benefit older employees who are closer to retirement age. Funding a defined benefit plan is the responsibility of the employer. It is mandatory for the employer to make sufficient contributions to meet the projected payout needs. Selecting the investment mix is also the responsibility of the employer. The employer bears the investment risk and if the plan is not properly funded, the employer will be penalized by the IRS and additional contributions may be required. The Pension Benefit Guaranty Corporation can provide coverage in the event that a terminated defined benefit plan does not have sufficient assets to provide the benefits earned by the participants.
Rollovers
A _____occurs when assets are moved from one IRA to another IRA and the account owner physically takes possession of the assets. The assets must be placed in a new IRA within 60 days. If the distribution is made within the 60-day window, no tax liability is incurred. If the assets are not placed in the new account within the required 60 days, a distribution is deemed to have taken place. Taxes will be due as well as penalties if the account owner is not 59½ years of age. If a ____ occurs due to moving assets from a qualified employer-sponsored plan into an IRA in a lump sum, the same 60-day ____ rule applies, but the employer is required to withhold 20% of the distribution and send this amount to the IRS. This 20% withholding may be refunded when the customer files her next tax return. Only one ______ is allowed per 12-month period for the same funds.
Annuity Payout Options
Once a contract is annuitized, the insurance company takes ownership of funds in the account. In return, the annuitant is entitled to a guaranteed income stream based on the terms of annuitization. Depending on the option chosen, the annuitant may be able to name a beneficiary to receive any remaining benefits available upon the annuitant's death. Annuity income is based on annuity tables, which are similar to mortality tables used for life insurance. Other factors that determine the income include the accumulation amount, interest rate return, age and gender of the annuitant, and the payment option selected.
Deductibility of Contributions
Investors who are not active participants in an employer-sponsored qualified retirement plan may fully deduct contributions regardless of income. For those investors who do participate in a qualified employer-sponsored plan, such as a 401(k) plan, the deductibility of their contribution is dependent on the person's level of adjusted gross income (AGI). If an investor is not eligible (or is limited) to make deductible contributions due to income restrictions, "nondeductible" contributions (after-tax money) may still be made. These amounts will be distributed tax-free upon distribution
General Account
Premiums and payments from traditional insurance company products, such as whole life insurance, are placed in the ________ of the insurance company. These payments are typically invested by the insurance company in a conservative fashion. Since investments in the ________ have a minimum rate of return that is guaranteed by the insurance company, any investment risk belongs to the insurance company. The downside of _____ investments is that the conservative asset allocation may not provide a good hedge against inflation.
1035 Exchange Tax Info
The value of a 1035 Exchange is avoiding a current income tax liability. The taxation of the gains are transferred when one annuity is exchanged for another annuity contract. However, if the annuity is in the surrender period, insurance company surrender charges would still apply. An investor can utilize a 1035 exchange from one insurance policy to another insurance policy, one annuity contract to another annuity contract, or a life insurance policy to an annuity contract. An exchange from an annuity to a life policy is not permitted.
Sales Charges and Expenses
Variable annuity sales charges, if applicable, are deducted before the premium is invested into the separate account. There is no specific maximum allowable sales charge set by FINRA. While many variable annuities shares typically do not charge a front-end sales charge, most impose a contingent deferred sales charges (CDSC) when an investor withdraws money during the accumulation period. A CDSC normally declines and will eventually be eliminated the longer one holds the contract.
Purpose of an Annuity
______ is a contract issued by life insurance companies in which the purchaser makes payments (premiums) that are invested in a tax-deferred account. The funds invested in the contract, in addition to any earnings, are designed to pay out a future stream of income over the lifetime of the owner, or _____. Nonqualified ______ are purchased with after-tax dollars by individuals, generally to provide a supplemental source of monthly retirement income.
Employee Stock Ownership Plans (ESOP)
_______ are defined contribution type retirement plans. They are qualified plans subject to ERISA regulations. With many __, all or part of the employer contributions are used to purchase stock in the employer's company and contribute that stock to the employee's qualified retirement plan. ___ shares could also be held in trust for the employee until the employee retires or resigns
Variable Universal Life Policies
_________combine the investment choices of the separate account in a ______ policy with the flexibility offered in a _________ policy. The premiums paid for a variable life policy are directly deposited in the separate account with no guarantees as to death benefits payable or cash value growth. Policy premiums are flexible, based on the performance and values held in the separate account. The owner may increase, decrease, or choose to skip premiums, and the face amount of the policy is adjustable. Key Concept Features of _______: Flexible premiums deposited directly in the separate account No general account Cash value growth dependent upon performance of separate account No guaranteed minimum death benefit
Life Income with Refund
Annuity income is payable for the lifetime of the annuitant. Upon death, if an annuitant has not received an amount equal to the total of all payments made into the annuity (not the growth), the balance is refunded to the beneficiary, either in a lump sum cash refund, or in installments.
Joint and Last Survivor
Annuity income is payable to 2 named annuitants (in one check) while both are living. Upon the death of the first annuitant, survivor benefits continue, either paying the full amount or reduced to 2/3 or 1/2 for the survivor's income until the survivor dies. These options may be referred to as Joint and Full Survivor, Joint and 2/3 Survivor, or Joint and ½ Survivor.
Required Minimum Distributions
As with other retirement plans, federal regulations require account owners to begin taking required minimum distributions (RMDs) no later than April 1 of the year after they reach age 70½. These required minimum distributions are calculated using a formula based on the investor's life expectancy and account balance. Failure to take the distribution results in a penalty of 50% of the RMD that was not distributed
Premature or Early Distributions
Early distributions (distributions prior to age 59½) may be subject to a 10% penalty on the taxable amount of the distribution. The 10% tax doesn't apply to: Death or Disability of the employee Qualified medical expenses Upon termination prior to age 59½, the employee receives substantially equal periodic payments based on life expectancy until age 59½ or 5 years, whichever is later (this is referred to as a Rule 72(t) withdrawal)
Death Benefits
Since annuities are contracts between an investor and an insurance company, the proceeds, if any, go to the beneficiary if the annuitant dies during the accumulation period. If the annuitant dies prior to annuitization, the beneficiary will receive the greater of the current value of the account as of the date of death or the premiums paid, less any withdrawals.
457 Plans
_____ are nonqualified deferred compensation plans restricted to participation by individuals who work for a state or local municipality or other tax-exempt nongovernmental organization. These plans are generally offered to highly compensated employees, as well as independent contractors. Annual maximum contribution limits apply and catch-up provisions are allowed
401(k) Plans
is considered a type of profit sharing plan in which the employee has the option of taking employer contributions as cash or they can be left in the plan. This is referred to as a cash or deferred arrangement. The employee makes elective pre-tax contributions through payroll deductions. The employer may, but is not required to, make a matching contribution. Earnings accumulate on a tax-deferred basis. Since a traditional ___ plan is funded with pre-tax dollars, all distributions are subject to ordinary income tax upon withdrawal. _____plans include loan provisions permitting employees to borrow a maximum limit from the plan. Withdrawals are also permitted from ______ plans upon termination of employment, death, or disability of the participant
The Accumulation Period (Pay-In)
is the pay-in phase of the annuity, beginning when the first deposit or premium is made. Earnings grow tax-deferred during this time period.
Investment Choices
401(k) plan participants are typically given a selection of investment choices from which to pick. These choices may include investments such as mutual funds, individual stocks, bonds, government securities, or variable annuities. Publicly traded companies may also offer company stock options as an investment in a 401(k). This can allow employees to purchase company stock at a lower price than the current market value. This may be offered as an incentive for the employee to obtain partial ownership and the employer may match at a higher percentage if the employee chooses this as an investment option.
Taxation of TSA Distributions
403(b) plan participants fund their plans on a pretax basis and invest these contributions into tax sheltered annuities. Since the contributions have never been taxed, all distributions from these plans are taxable at ordinary income rates. Plan participants are also subject to early withdrawal penalties for distributions taken prior to age 59½, excess contribution penalties, and required minimum distribution penalties after age 70½.
Deferred Compensation Plans
A ____- arrangement is a nonqualified retirement plan in which employees defer a portion of their income to a specified later date. The premise behind these plans is that the employee will receive the income and pay taxes based on a lower tax bracket. These plans can discriminate and are often only available to senior management or other highly compensated employees. ______ can be risky to the employee. The employer cannot formally set aside the funds for eventual payout so the employer incurs a liability to each participant for the unpaid wages. In the event of corporate bankruptcy, the voluntary deferred wages have a very low priority of payout
Savings Incentive Match Plans for Employees (SIMPLE)
A _____ plan can be adopted by small businesses (self-employed, sole proprietors, partnerships and corporations) that employ 100 or fewer employees and do not have another qualified plan available. In order to be eligible, the employee must have earned at least $5,000 in compensation during any 2 years before the current calendar year and is expected to earn at least $5,000 for the current calendar year. These requirements are the maximum and can be reduced by the employer. ______plans may be established as either an IRA or a 401(k) plan. Employees may make elective contributions based on a stated percentage within the allowable annual contribution limits. All contributions must be fully vested. Employees may deduct their contributions from personal taxable income, while the employer contributions are tax deductible to the business
Modified Endowment Contracts (MECs)
A ______ limits premiums paid into a policy during the first seven years to the total scheduled premiums that would have been paid on a comparable traditional whole life policy during the same time period. Policies failing to meet the 7-Pay Test are classified as ______. Prior to the insured's age 59½, any money taken from a ____ in the form of loans, partial surrenders, or withdrawals, is subject to ordinary income tax plus a 10% IRS penalty. However, the death benefit will still be tax-free.
Prospectus Requirement
A customer must be furnished with a copy of the prospectus prior to or at the time of the sale and cannot be altered in any way. The prospectus will detail all fees and risks associated with the product and explain the various investment choices available. Registered representatives are advised to review this document with a potential customer prior to buying the product. A little extra time spent prior to the sale may avoid misunderstandings and potential conflicts down the road.
Defined Contribution
A defined contribution plan is a qualified retirement plan in which employees direct the employer to withhold a "defined" amount of compensation for contribution to a plan maintained by the employer. The contribution may be defined as a stated dollar amount or percentage. The participant does not know how much the plan will ultimately provide to the employee upon retiring. The amount of the retirement benefit is dependent on the investment performance within the account. Contributions made by the employee are pre-tax contributions, which may be supplemented by employer contributions. In most defined contribution plans, the employee makes investment choices and assumes the risk of the account's performance. Since the level of eventual payouts is linked to the performance of the underlying investments chosen by the employee, retirement benefits may differ substantially among employees of the same employer. Another benefit of a defined contribution plan is that the assets are portable and can be transferred or rolled over into another qualified plan upon termination of employment.
Traditional Individual Retirement Arrangements (Accounts) or IRAs
An IRA can be established for any individual under age 70½ with earned income. Earned income includes wages, salary, tips, or commissions. Investment income such as bond interest, stock dividends, or income from retirement plans is not considered earned income.
Surrender Charge
Annuity contracts are not suitable for short-term investing. To discourage this, the insurance company will charge a penalty, known as a _______. A ________ applies for a specific number of years as identified in the contract. The ________ percentages or dollar amounts are spelled out in the contract and vary greatly from one contract to another. If the annuity is _______ed during this period, the _____ value will be the current cash value less any ________. All annuity contracts permit a certain amount of withdrawal that can be taken without a _______ (usually 10% of the first year or last anniversary account value). The ______ value of an annuity is the sum of money an insurance company will pay the annuity owner in the event the contract is voluntarily terminated before it is annuitized.
Life Income (Pure or Straight Life)
Annuity income is payable for as long as the annuitant lives, and upon death all payments cease. This option provides the highest monthly income than any of the other options.
Taxation of Cash Value, Loans, Withdrawals, and Surrenders
Cash value of both variable and traditional products grows on a tax-deferred basis. Policy loans are not considered a distribution of cash value and are not taxable. Policy holders taking a distribution from the policy are taxed only on the earnings generated within the policy with the contributions (premiums) being returned tax-free. Withdrawals are treated as first-in, first-out (FIFO) based on the cost basis of the policy. This means that withdrawals are not taxable until the cost basis (amount of premiums paid) is exhausted. Policy surrenders are treated as a cancellation and taxed on the earnings.
Accumulation Units
Contributions are valued in "________", which are comparable to shares of a mutual fund. These __________ are an accounting method of measuring the contract owner's interest in the separate account. Units in each subaccount have a net asset value, like mutual funds. The __________ value changes with the value of the securities held in the separate account divided by the total number of ________ outstanding. This is calculated daily at the close of the NYSE. Dollar-cost averaging is applicable to variable annuities. When the variable annuity investment value is decreasing, a fixed amount of invested dollars will buy more ________ than when the securities are more highly priced. Conversely, if the annuity investment value is increasing, the fixed dollar amount will buy fewer _______.
Cash Value
In some contracts, a portion of the premiums are invested and accumulate over time. These accumulated premiums and their earnings are referred to as the _______ of the contract and provide living benefits to the owner. A portion of _______ may be borrowed by the policyowner as long as the contract remains in force. This is referred to as a policy loan. A policy loan does not have to be repaid, but annual interest must be paid for as long as the loan is outstanding
Separate Account Deductions
In addition to the charges deducted from the premium, the insurer also deducts charges from the separate account. These charges include the mortality risk fee to cover the cost of insurance, expense risk fee to cover the insurer's operating costs, and the investment management fee.
Conversion from Traditional to Roth
It's permissible to rollover traditional IRA assets into a Roth. However, income taxes must be paid on the taxable portion of the rollover. There is no 10% penalty imposed. Once taxes are paid on the contributions, the Roth IRA will distribute tax-free funds without penalty based on a qualified distribution. Qualified distributions occur once the plan has been established for at least 5 years and one of the following conditions have been met: The account owner reaches age 59½ The death or disability of the account owner The account owner takes a distribution as a qualified first-time home buyer The beneficiary of a deceased Roth IRA holder receives assets to be used toward the purchase or rebuilding of a first home for a qualified family member
Underlying Fund Expense
Management fees relate to the underlying fund expenses and are separately charged in each of the subaccounts and are the same as an investment adviser's fee in a mutual fund. These fees will vary depending on the various subaccount options within the annuity.
Taxation of Nonqualified Variable Annuity Contracts
Nonqualified annuity contracts are funded with after-tax dollars since taxes have already been paid on the contributions, known as the principal. This is considered the cost basis and is returned to the annuitant tax free. Taxes must be paid on any distributed earnings. Any portion of the distribution that is taxable (earnings) will be taxed at ordinary income rates.
Tax Treatment of an Annuitized Contract
Once the contract is annuitized, the insurance company will begin making a stream of periodic payments. Each check will consist of a combination of principal and earnings. The principal, which has already been taxed, is considered the cost basis of the contract and is returned tax-free. The earnings portion of the distribution is taxable as ordinary income. Since the amount of each payment may differ, each payment may contain a different mix of principal and earnings. The exclusion ratio is the formula used to determine the portion of each payment that is a return of cost basis, and therefore excluded from taxation in fixed annuities. Although a bit more complex, it may simply be described as the cost basis divided by the expected lifetime payments, or "dollars in divided by expected dollars out."
Partial Surrenders or Withdrawals
Prior to annuitizing the contract, partial surrenders or withdrawals may be made at any time, or as a lump sum (terminating the contract). In addition to surrender charges, all money withdrawn from nonqualified annuities comes from earnings first, then as a return of cost basis. This is also known as "last-in, first-out" or LIFO. Remember Once money is contributed to an annuity, there is no way to remove the money without a taxable event occurring (unless it is a variable annuity that has performed poorly). In a nonqualified annuity, gains are taxable as income and are withdrawn first; cost basis is not taxable and may only be withdrawn after all gains are withdrawn. Key Concept Partial surrenders and withdrawals made from an annuity are taxed on a LIFO basis, where earnings will be withdrawn first and subject to ordinary income tax. In any annuity, if a withdrawal is taken prior to age 59½, a 10% federal penalty tax is assessed on the taxable portion of the early distribution, except in the following instances: Withdrawal upon the annuitant's death or disability Distributions taken as a series of substantially equal payments based on the annuitant's life expectancy, whether from an immediate annuity or a deferred annuity, regardless of the annuitant's age A full surrender (termination of the contract) occurs as a lump sum distribution. All earnings are taxable at ordinary income rates and subject to surrender charges and early distribution penalties, if applicable.
Member's Responsibilities Regarding Deferred Variable Annuities
Registered Representatives (RR) recommending the purchase or exchange of a variable annuity contract, or advising a customer on the initial allocation of invested money into subaccounts of an annuity contract, must make sure the recommendation is suitable for the client. In order to ensure the product is appropriate, prior to the recommendation, the RR must obtain adequate information about the customer as required by the FINRA "Know Your Customer" Rule. There must be a reasonable basis to believe the following: The client was provided full and fair disclosure of material information, such as surrender period and charges, potential tax penalties due to premature distributions, fees, risks, and the insurance and investment aspects of the contract. There is customer specific suitability. The features of the variable annuity, such as taxdeferred growth, annuitization, and death benefit would benefit the client. Also, the client would benefit from the underlying subaccounts, contract riders, and any other product enhancements. Once the variable annuity contract application is complete, the RR must promptly transmit the application package to their office of supervisory jurisdiction (OSJ) to be reviewed and approved by a principal of the firm within 7 business days of receipt. RRs and approving principals must be provided training regarding variable annuity contacts. This training must be developed and documented by the BD.
Transfers and Rollovers
Sometimes an investor may wish to move assets from one IRA to another. In others, a retiring or departing employee may wish to move assets from a qualified employer-sponsored plan into an IRA or an IRA into a qualified employer-sponsored plan. Depending on where the assets are being held and where they are being moved to, the method of movement will be done via a transfer or a rollover
Employee Retirement Income Security Act of 1974 (ERISA)
The Employee Retirement Income Security Act established minimum standards to protect the interests of participants and beneficiaries of employer-sponsored retirement plans offered by the private sector. A qualified retirement plan, as deemed under ERISA, must meet these minimum standards to qualify for certain tax benefits under the Internal Revenue Code (IRC). Such benefits include tax deductions on contributions made by the employer, as well as pre-tax contributions and tax-deferred growth for the plan participant (employee). Nonqualified retirement plans do not meet ERISA standards and therefore may lose some or all of these benefits. Qualified plans must be in writing and follow the rules established under ERISA to ensure that they are not discriminatory and the fiduciaries do not misuse the plan assets
Death Benefit
The ______ on a variable life insurance policy is calculated on an annual basis. Variable Insurance Policy Valuations
Taxation of Death Benefits
The ________ includes all earnings in the contract while the insured was alive and is not subject to income tax when paid to the beneficiary.
assumed interest rate (AIR)
The _______is an arbitrary interest rate used by the insurance company to project the rate of growth of the separate account during the contract's payout period. _____is a benchmark percentage used in determining the amount of the initial payment and used as a comparison when determining future payments. The _____ benchmark remains unchanged throughout the life of the contract. Once the initial payment amount has been calculated, each additional monthly payment will depend on the actual performance of the separate account compared to the original _____ benchmark. The following rules are used to determine whether the monthly income payment will increase, decrease, or stay the same as the previous month's payment: If the actual performance of the separate account is greater than the AIR, the amount of the next payment will increase | If the actual performance of the separate account is less than the AIR, the amount of the next payment will decrease | If the actual performance of the separate account is the same as the AIR, the amount of the next payment will be the same as the previous month (not the initial payment)
Voting Rights
The contract owner of a variable product has the right to ____ on matters affecting the separate account. As the sole owner of the separate account, the insurance company is the only person with the ____. However, it agrees to _____, by proxy, the shares or units of each owner in the separate account based upon the instructions received from those owners. _______ rights are described in the prospectus for the contract. Typically, one vote is obtained for every $100 of contract value. The number of _____ is determined by account value as of the record date for the meeting, which can be 90 days or more prior to the meeting
Mortality Guarantee
The insurance company risks the possibility that the annuitant will outlive their life expectancy because it provides the annuitant with lifetime payout options. The insurance company prices these risks as accurately as possible during accumulation, and assesses a charge against the contract value, which is called a mortality expense charge. The amount of this charge is guaranteed as a percentage of the contract value (typically in the range of 1% to 1.25% per year). This charge compensates the insurance company for the life expectancy risks it assumes under the annuity contract
Qualified retirement plan Contribution Limits
The maximum annual contribution per person is the lesser of a specified annual limit or 100% of earned income. Married couples with only one spouse working may set up a separate Spousal IRA and may make an additional contribution for the non-working spouse, as long as the total contribution for each account does not exceed the specified annual limit up to 100% of the working spouse's earned income. Contributions can be made until April 15th of the year following the current tax year. Contributions may only be made until the account holder reaches age 70½. An annual 6% penalty applies on any excess contributions until the excess amount is withdrawn. Growth on the excess contribution loses its tax-deferred status.
Variable Payout
Upon annuitization, the insurance company will calculate the annuitant's initial payment based on the following factors: Principal balance of the contract, Annuitant's age, Payout option selected, Assumed Interest Rate (AIR)
Investment Choices
Traditional IRAs are established under a formal agreement with a trust or custodian. The funds can be invested in: Stocks, bonds, CD's, annuities, mutual funds, government securities, savings accounts, or any combination. U.S. denominated gold coins may be held in an IRA, but not gold bullion or foreign currency. IRAs cannot be funded with life insurance or collectibles, such as antiques, rare stamps, or coins. IRAs can be funded with an annuity. Placing a variable annuity inside of an IRA is permissible but is often viewed as a suspect sales practice due to the higher fees and expenses associated with a variable annuity versus the traditional mutual fund. Reasons for such placement may include the annuity's death benefit or the guarantee of lifelong income to the policyholder. The client must be informed that these benefits will come at the expense of higher fees.
Taxation Upon Distribution
Traditional IRAs grow on a tax-deferred basis and are taxed upon distribution. Distributions from an IRA that represent tax-deductible contributions and tax-deferred earnings are subject to federal and state income taxes. Any contributions that are NOT deductible are withdrawn tax-free and must be specified. All taxable IRA distributions are taxed as ordinary income. IRAs are not subject to more favorable capital gains tax rates. Most distributions taken from an IRA, if under age 59½, are subject to an additional 10% early distribution penalty on the taxable portion unless certain exceptions apply. Exceptions to the rule occur in the event of: Death Disability Unreimbursed medical expenses exceeding 10% of AGI Health insurance premiums for unemployed individuals First-time home buyer - $10,000 Higher education expenses Substantially equal periodic payments
Features Common to Variable Contracts
Variable contracts are products sold through insurance companies that contain investment options that subject the owner to market risk. The investment account, or separate account, operates similarly to that of a mutual fund and is considered a security. As securities contracts, variable life insurance and variable annuities are regulated by the SEC under federal securities laws, including the Securities Act of 1933 and the Investment Company Act of 1940. They are also regulated at the state level as both securities and insurance products. Individuals selling these products must obtain a FINRA registered representative registration (a Series 6 or 7), a state securities registration (Series 63), if required by the state, and a state life insurance license. Some states may also require a separate variable contracts insurance license
The Annuity Period (Pay-Out)
When the accumulation period ends, as determined by the owner or annuitant, the annuitant can elect to cash out or begin income benefits. Lump Sum - The annuitant has the option of cashing out the annuity in a lump sum instead of electing to receive a stream of income. There could be tax penalties depending on the age of the annuitant. Annuitization - The election to receive payments from the annuity account for life, or for a specified period, depending on the settlement option selected
Variable Life Insurance
______ is a permanent policy designed to offer more competitive returns to potentially keep pace with, or act as a hedge against, inflation. _______ requires the owner to pay a fixed and level premium. A portion of the premium is paid into the general account to provide a guaranteed minimum death benefit, which is the face amount of the policy. The balance of the premium is invested in the separate account of the insurance company with no guarantees as to the rate of return. Policyowners are given a choice of investment options and will select an investment mix based on risk tolerance and objectives. The rate of cash value build-up is dependent upon the performance of the separate account. The actual death benefit will fluctuate based on the performance of the separate account, but can never drop below the guaranteed minimum death benefit
Policy Loans
_________provisions relating to variable insurance contracts are more stringent based on the fluctuating value of the separate account. The insurance company must allow the policy holder to borrow at least 75% of the policy's cash value, as long as the policy has been in force for a specified minimum time period. _____ are not taxable and interest is charged on the loan until either repaid, the policy is cancelled, or the insured dies. If the separate account values decrease and any outstanding loans against the policy exceed the cash value, the policy holder has a grace period (often 31 days) to repay enough of the loan to restore positive cash value.
Universal Life Insurance
______is designed to give the customer greater flexibility. Premiums are directly deposited into the policy's cash value, which is held in the insurance company's general account. The insurance company guarantees a minimum rate of return on the funds, but will pay a current rate of return if the actual performance exceeds the minimum guarantee. This allows the account to build up additional cash value. As is the case in a whole life policy, the premiums for ____ policies are set to cover the basic annual cost of insurance, plus an excess amount that is invested. Unlike whole life insurance, the company will deduct mortality and expense loads directly from the cash value and credit the earnings to the account. Due to this "unbundling" feature, ______ life policies have a flexible premium. The policyholder has the flexibility to increase, decrease, or even skip premium payments as long as there is sufficient cash value to cover these expenses. However, there is a risk that if too many payments are skipped and no cash reserves are available, the contract will lapse. Another feature of _______life is the adjustable death benefit. The owner may request an increase or decrease in the face amount of insurance. If the face amount is increased, the insured must medically qualify for the additional benefits and there will be an increase in the mortality charge deducted from the cash value
Roth IRAs
___are subject to the same maximum annual contribution limits and catch-up provisions as the traditional IRA. An individual can have both a traditional IRA and a __ IRA, but the contribution limits apply per person, not per account. Contributions to a ___ are always made on an after-tax basis (are nondeductible) and there is no age limit restriction to make contributions. Individuals may continue to make contributions even after the age of 70½, as long as the investor has earned income. There is no minimum required distribution limit or penalty imposed. All distributions from a ____IRA are tax-free as long as the withdrawal follows the qualified distribution guidelines of the IRS. The main qualified distribution is that the account has been open for at least 5 years and the account holder is at least age 59½. No penalty will apply to any contributions (not earnings) withdrawn from an account to account holders of any age, as long as the account has been open for at least 5 years. One major difference between the Roth and the traditional IRA is contribution eligibility. All individuals that have earned income may contribute to a traditional IRA, but a Roth IRA requires investors to have an Adjusted Gross Income (AGI) below a certain threshold to be eligible to make any Roth contributions. High income Roth account holders who no longer meet the income threshold are not required to liquidate their assets within a previously established Roth.
Deferred Annuity
will begin to make payments starting at a specified time in the future longer than 1 year from the issue date. ______ can be purchased with single premiums or periodic premiums.
