variable annuities

The "tax advantage" of a variable annuity is that during the...

accumulation phase

True or false: fixed annuities are non - taxed qualified

true

Any changes in value of a variable annuity unit are directly related to changes in the: A Standard and Poor's 500 Average B Value of the securities funding the separate account C Consumer Price Index D Dow Jones Averages

B Value of the securities funding the separate account Since the separate account of investments funds a variable annuity, annuity unit values are directly influenced by changes in the values of the securities in the separate account.

Define: the risk that expenses of running the separate account are higher than expected Who takes on this risk and for what kind of contract?

expense risk; issuer; variable annuity

A client surrenders a variable annuity contract 5 years after purchase because of poor performance. Any surrender fee imposed: A increases cost basis B reduces cost basis C is deductible D is not deductible

D is not deductible

non-taxable

has already been taxed

What 3 rights do Variable annuity separate account holders have the right to vote for?

1. Board of Trustees (or Board of Managers); 2. change the investment objective of the separate account; 3. dissolve the trust.

Any changes in value of a variable annuity accumulation unit are directly related to changes in the: A Standard and Poor's 500 Average B Value of the securities funding the separate account C Consumer Price Index D Dow Jones Averages

B Value of the securities funding the separate account Since the separate account of investments funds a variable annuity, accumulation unit values are directly influenced by changes in the values of the securities in the separate account. *the separate account purchases accumulation units*

A customer contributed $20,000 to a variable annuity contract. The account value has grown over the years and the NAV is now $35,000. The customer is now age 60, and takes a lump-sum distribution of $20,000 to pay for expenses. Which statement is TRUE? A The entire $20,000 distribution is not taxable B $5,000 of the distribution is taxable and $15,000 is not taxable C $15,000 of the distribution is taxable and $5,000 is not taxable D The entire $20,000 distribution is taxable

C $15,000 of the distribution is taxable and $5,000 is not taxable

True or false: During the accumulation phase, any earnings in the separate account must be reinvested

TRUE!

Where are fixed annuity premiums and variable annuity premium invested?

fixed: in the company's general account and grow at a guaranteed rate variable: in an insurance company "separate account" (which buys shares of a designated mutual fund) *account grows based on performance of mutual fund so purchaser subject to investment risk

All of the following terms are associated with a variable life insurance policy EXCEPT: A separate account B accumulation unit C death benefit D annuitization

D annuitization

True or false: variable annuities are non-managed

FALSE! variable annuities are managed

Do distributions in separate accounts have to be reinvested?

Yes, and they build tax deferred

True or false: variable annuities are non-tax qualified

true

The IRS requires that LIFO account be used when --- from a variable annuity.

withdrawing

If something is not tax deductible was it already taxed?

yes

Why do variable annuities require a securities license to sell them?

because they are non exempt & sold by insurance companies that are only regulated on the state level

true or false: only the portion attributable to the build-up is taxable.

true!

Define that annuity: If the contract holder dies earlier than expected, the balance left in the separate account is refunded to a beneficiary.

unit refund annuity

Define that annuity: As an example, a customer, age 40, decides to deposit $500 every month for the next 25 years to an annuity contract. At age 65, the customer annuitizes and starts taking the annuity payments.

periodic payments - deferred There is no periodic payments immediate. The customer cannot put money into an annuity contract and take it out at the same time!

During the accumulation phase of a variable annuity: A payments can be made into the plan; but distributions may not be taken from the plan B distributions may be taken from the plan; but payments may not be made into the plan C both payments may be made into the plan; and distributions may be taken from the plan D neither payments may be made into the plan; nor distributions may be taken from the plan

A payments can be made into the plan; but distributions may not be taken from the plan When distributions commence in the annuity phase, no more monies can be paid into the plan. Thus, the accumulation phase allows payments to be made into the plan; but distributions cannot be taken out of the plan.

The "death benefit" associated with a variable annuity contract means that if the contract holder dies: A prior to annuitization, the amount invested in the contract is returned to a beneficiary B after annuitization, the amount invested in the contract is returned to a beneficiary C prior to annuitization, the insurance company will make a lump sum payment to complete the terms of the contract D after annuitization, the insurance company will pay for the insured's burial expenses

A prior to annuitization, the amount invested in the contract is returned to a beneficiary If the contract holder dies after annuitization, there is no more "death benefit."

Which of the following annuity payment options will continue payments to another person for their life after the annuitant dies? A Life Annuity B Life Annuity with Period Certain C Joint and Last Survivor Annuity D Unit Refund Annuity

C Joint and Last Survivor Annuity A joint and last survivor annuity pays another person (usually a spouse) when the annuitant dies.

All of the following statements are true for both mutual funds and variable annuities that are in the accumulation phase EXCEPT: A both are regulated by the Investment Company Act of 1940 B both have portfolios that are managed C dividend and capital gains distributions are taxable each year for both D asset appreciation is untaxed for both

C dividend and capital gains distributions are taxable each year for both Distributions from mutual funds do not have to be reinvested and are taxable; while distributions in separate accounts must be reinvested and build "tax-deferred."

During the accumulation phase of a variable annuity contract, reinvested: I dividends and interest are tax deferred II capital gains are tax deferred III dividends and interest are taxable IV capital gains are taxable

I and II During the accumulation phase of a variable annuity contract, all dividends, interest and capital gains earned from the securities in the separate account must be reinvested and build tax deferred. The tax deferral of the build-up is the major benefit of buying a variable annuity.

A variable annuity is a(n): I security regulated under the Investment Company Act of 1940 II insurance product that is not regulated under the Investment Company Act of 1940 III security that must be sold with a prospectus IV insurance product that has no prospectus requirement

I and III Because the purchaser bears the investment risk in a variable annuity contract, these are defined by the SEC as a non-exempt security that must be registered and sold with a prospectus. Because these are structured as non-fixed unit trusts, variable annuities are regulated under the Investment Company Act of 1940

Which of the following statements are TRUE regarding the taxation of payments from variable annuities? I FIFO accounting is used to determine the taxation II LIFO accounting is used to determine the taxation III The tax deferred amount above the basis comes out first, followed by the original contribution IV The original contribution comes out first, followed by the tax deferred build-up

II and III The IRS requires that LIFO account be used when withdrawing from a variable annuity. This means that taxable earnings (the tax deferred build-up) comes out first, followed by the tax free return of original capital (the original after-tax capital contribution).

Variable annuity contracts contain which of the following guarantees? I Interest Rate Guarantee II Investment Guarantee III Mortality Guarantee IV Expense Guarantee

III and IV If one dies later than expected, the company continues to pay the annuity. If expenses rise, the company absorbs them above a set percentage. However, no guarantee is given for the rate of return (investment guarantee or interest rate guarantee) - this is only given for a fixed annuity.

The number of annuity units received depends on what?

The dollar amount in the separate account; the annuity option chosen; and the customer's expected mortality

Define that annuity: As an example, a customer, age 65, has a large amount of cash and wants to retire. He or she deposits uses all the cash to buy a variable annuity contract and immediately annuitizes.

lump sum payment - immediate

Distributions from the mutual fund held in the separate account build...

tax-deferred (never taxed)

Define this insurance: permanent insurance with a fixed annual premium.

variable life insurance the premium has 2 components - a portion covers the cost of insurance and the rest is invested - in this case in a separate account.

In order to recommend a variable annuity to a customer, the representative should have a reasonable basis to believe that the customer would benefit from: I tax-deferred growth of the separate account II the assurance of receiving income for life III any living or death benefit provided by the contract

I, II, III To recommend a variable annuity, the representative must have a reasonable basis to believe that the customer would benefit from certain features of these products, such as tax-deferred growth, annuitization, or a death or living benefit.

If an individual, aged 65, wishes to withdraw money from her variable annuity, which of the following statements are TRUE regarding the taxation of her withdrawal? I All of the withdrawal is subject to income tax II Part of the withdrawal is subject to income tax III The amount is subject to a 10% penalty tax for early withdrawal IV The amount is not subject to a 10% penalty tax for early withdrawal

II and IV - over 59 1/2 so no penalty - the contribution amount in the non-tax qualified plan was not tax deductible (meaning the amount contributed was already taxed), this portion of the investment is returned without any tax consequence. Thus, only part of the monthly payment is taxable (the portion that represents the tax deferred build up). The portion that represents the original after-tax contribution of capital is not taxed.

Upon annuitization, a customer's insurer calculated the assumed interest rate (AIR) of his annuity as 5 percent. The account earned 6 percent after the first year. The customer's next payout amount will: A increase B decrease C remain unchanged D increase by the changes in the CPI

A increase Payout amounts will change depending upon the actual earnings of the separate account assets. AIR - Assumed Interest Rate - is the assumed investment return needed to maintain a level monthly payment. If the actual investment return exceeds AIR (as in this example), then the monthly payment will increase. If actual investment return is less than the AIR, then the monthly payment will decrease.

Investment risk in a variable annuity contract is carried by the: A purchaser B issuer C custodian D manager

A purchaser Variable annuities differ from other products sold by insurance companies in that the purchaser bears the investment risk; as opposed to the insurance company bearing the investment risk. For example, if an insurance company achieves poor investment results, this does not affect the amount of death benefit that one gets from a traditional insurance policy; if the separate investment account funding a variable annuity achieves poor investment results, the annuity payment will drop.

Do mutual funds have to be reinvested?

no, they are taxable

Define that annuity: Pays only for that person's life.

life annuity

Which of the following statements are TRUE regarding a life annuity? I The shorter the expected annuity period, the larger the monthly payment II The longer the expected annuity period, the larger the monthly payment III A life annuity usually pays the largest amount of all of the annuity payment options IV A life annuity usually pays the smallest amount of all of the annuity payment options

I and III A life annuity pays for that person's life only. This annuity payment option will result in the largest monthly payments (since the insurance company has the shortest expected payment period across the whole population of annuitants).

The separate account that the insurance company maintains for a variable annuity is: A directly invested in common stocks B invested in Legal List securities only C invested in designated mutual funds D invested in U.S. Government guaranteed securities

C invested in designated mutual funds The performance of the mutual fund shares held in the separate account determines the amount of the annuity to be received.

A 50-year old man has purchased a variable annuity contract. He wants payments for his life, but wants to make sure that payments are made for at least 20 years, should he die prematurely. He should choose a: A joint and last survivor annuity option B systematic withdrawal plan that provides for 20 years of payments C life annuity with a 20 year period certain D unit refund annuity

C life annuity with a 20 year period certain A life annuity with a 20 year period certain will pay for the life of the annuitant, but if the annuitant dies early, it will pay for a minimum of 20 years regardless. These payments will be made to a designated beneficiary.

A variable annuity can be exchanged for which of the following without a tax consequence? I Another variable annuity contract II A fixed annuity contract III A term life insurance policy IV A whole life insurance policy

I and II Section 1035 of the tax code allows for so-called "like-kind" exchanges without taxes being due. The only valid reason to exchange a variable annuity contract is to get another variable annuity contract or a fixed annuity contract with better features or lower costs. Variable annuities are non-tax qualified and fixed annuities are also non-tax qualified - and one can exchange between them without tax due.

Growth in the separate account of a variable annuity offering a GMIB is: I guaranteed as to minimum rate II not guaranteed as to minimum rate III capped as to maximum rate IV not capped as to maximum rate

I and IV GMIB - Guaranteed Minimum Income Benefit will give a minimum guaranteed growth rate for an additional cost. This guarantee only occurs at annuitization and covers the accumulation phase. The maximum rate that can be earned in the separate account during the accumulation phase is not capped by the GMIB rider.

The purchaser of a variable annuity bears which of the following risks? I Interest rate risk II Expense risk III Mortality risk IV Investment risk

I and IV The customer assumes the investment risk, since the annuity payment varies with the performance of the securities funding the separate account. With any investment, customers assume legislative risk and interest rate risk. Legislative risk for a variable annuity contract would be Congress changing the tax law. Interest rate risk is inherent in any product that gives the holder a stream of payments - if market interest rates rise, the value of the stream of payments decreases.

Define that annuity: Period Certain: Pays for that person's life, but if that person dies before a stated time period (say 10 years), the annuity will be paid to a beneficiary for the balance of the 10 year certain period.

life annuity

Define that annuity: As an example, a customer, age 40, deposits a lump sum amount and lets it build for 25 years. At age 65, the customer annuitizes and starts taking the annuity payments.

lump sum payment - deferred annuity

Which is the BEST definition of an "annuity unit"? A An accounting measure used to determine the number of units the contract holder may purchase in the separate account B An accounting measure used to establish the contract holder's ownership interest C An accounting measure upon which the amount of pay out is determined D An accounting measure used to determine the contract holder's death benefit

C An accounting measure upon which the amount of pay out is determined Once a variable annuity contract is annuitized, accumulation units are converted to annuity units. These determine the annuity payments to be made.

A variable annuity prospectus includes an AIR illustration using a 5% rate. This means that the: A purchaser is guaranteed a minimum 5% annual return B annuity payment is guaranteed to grow at a minimum of 5% per year C return could be less than 5% D sales charge will be no higher than 5%

C return could be less than 5% AIR is just an illustration of what return COULD BE, if separate account grows at AIR. Could go up or down.

Define: The account that holds funds paid by variable annuity contract holders. The funds are kept separate from the insurer's general account and are invested in a portfolio of securities that match the contract holders' objectives.

separate account

Define: It is an optional rider offered by many variable annuity contracts. It guarantees that when the separate account is annuitized, if the account has not grown at the guaranteed minimum rate, then the account will be annuitized as if it grew at that guaranteed minimum rate. example: So if the separate account grows by only 2% a year; and the GMIB is 5%; then the account will be valued at annuitization based on compounding at the 5% minimum benefit.

GMIB (Guaranteed Minimum Income Benefit)

When a variable annuity contract is annuitized can more payments be made into the contract?

No The contract holder receives a fixed number of annuity units; and receives a monthly payment equal to the fixed number of annuity units x annuity unit value (which varies).

The customer's cost basis in a non-qualified annuity is the...

amount contributed (after tax dollars)

If the actual investment return exceeds AIR (as in this example), then the monthly payment will...

increase

Define that annuity: Pays a married couple until the second party dies.

joint and last survivor annuity

Which recommendation would be most suitable for a 40-year old client whose main objective is retirement income and preservation of capital? A Fixed deferred annuity B Fixed immediate annuity C Variable deferred annuity D Variable immediate annuity

A Fixed deferred annuity Because this customer is looking for income in retirement and he or she is only 40 years old, a deferred annuity is the right choice. Because the customer wants preservation of capital, a fixed annuity ensures a fixed guaranteed growth rate, while the growth rate of a variable annuity can go higher, or lower, or negative. So for preservation of capital, a fixed annuity is best. Note that at retirement age, the holder of an annuity can opt for a lump sum payment instead of taking annuity payments, and a fixed annuity guarantees a fixed amount of capital at retirement age, whereas a variable annuity does not.

All of the following statements are true regarding the annuitization of a variable annuity contract EXCEPT: A variable annuity contracts require the holder to select a Life Annuity - Period Certain payout option B the variable annuity payout may vary depending on the performance of the underlying securities C the number of variable annuity units is fixed D the holder may not change the payout option after it is elected

A variable annuity contracts require the holder to select a Life Annuity - Period Certain payout option Variable annuity contracts allow the holder to elect a payout option that meets that person's individual requirements. The choice of payout method depends on the needs of the annuitant; and cannot be changed once elected. Once the contract is annuitized, the number of annuity units is fixed. However, the value of each unit varies with the performance of the underlying securities, hence the monthly annuity payment may vary.

Which of the following statements are TRUE about variable annuities? I To sell variable annuities, salespersons must be registered with FINRA II To sell variable annuities, salespersons do not have to be registered with FINRA III To sell variable annuities, salespersons must be registered with the State Insurance Commission IV To sell variable annuities, salespersons do not have to be registered with the State Insurance Commission

I and III To sell a variable annuity, salespersons must be registered with FINRA with either a Series 6 (mutual funds and variable annuities only) license or Series 7 (general securities) license. In addition, the salesperson must be registered with the State Insurance Commission (since these products are sold by insurance companies; and insurance companies are regulated only at the state level).

Once a variable annuity contract is "annuitized," the accumulation units are converted into what?

a fixed number of annuity units

A 50-year old man owns a non-qualified variable annuity contract that has appreciated substantially over the years. He wishes to annuitize the account for additional income using IRS Rule 72t. How will the first payment be taxed? A 100% taxable ordinary income B 100% non-taxable cost basis C Part ordinary income and part cost basis D 10% penalty tax applied because the client is under age 59 1/2

C Part ordinary income and part cost basis Instead of taking a lump sum distribution, the owner of a variable annuity contract can "annuitize" and receive annuity payments for life. Each payment has 2 components - an earnings portion that is taxable and a return of capital portion (cost basis) that is not taxable. The non-taxable portion represents the return of the original investment that was made with "after tax" dollars.

surrender fee

Penalty for early withdrawal not deductible!

Define that annuity: Pays for that person's life, but if that person dies before a stated time period (say 10 years), the annuity will be paid to a beneficiary for the balance of the 10 year certain period.

life annuity - period certain

The "death benefit" of a variable annuity contract is not really much of one. If the contract holder dies prior to annuitization, the insurance company pays the greater of...

current NAV or the amount invested to a beneficiary

If actual investment return is less than the AIR, then the monthly payment will decrease.

decrease

Why would a client purchase a mutual fund within a variable annuity? A Because there are more investing options in a variable annuity B Because a variable annuity offers tax-deferred growth C Because a variable annuity offers tax-free income after annuitization occurs D Because a variable annuity offers tax-deductibility of contributions made

B Because a variable annuity offers tax-deferred growth The "tax advantage" of a variable annuity is that during the accumulation phase, dividends and capital gains must be reinvested, and they build tax deferred. If a mutual fund is purchased directly, dividends and capital gains do not have to be reinvested, and they are taxable, whether they are reinvested or not.

Which rollover would result in a tax event? A Exchange of one variable annuity contract for another variable annuity contract B Exchange of a life insurance contract for a variable annuity contract C Exchange of a variable annuity contract for a life insurance contract D Exchange of a life insurance contract for another life insurance contract

C Exchange of a variable annuity contract for a life insurance contract *you can exchange a life insurance for variable annuity but NOT a variable annuity for life insurance (getting too good of a deal)

When a non-qualified variable annuity is annuitized prior to age 59 1/2 under the provisions of IRS Rule 72t, the initial payment is: A 100% taxable as ordinary income and the 10% penalty tax will be applied B 100% taxable as ordinary income but the 10% penalty tax is not applied C partially taxable as ordinary income with the 10% penalty tax applied and partially a non-taxable return of investment D partially taxable as ordinary income without the 10% penalty tax applied and partially a non-taxable return of investment

D partially taxable as ordinary income without the 10% penalty tax applied and partially a non-taxable return of investment Instead of taking a lump sum distribution, the owner of a variable annuity contract can "annuitize" and receive annuity payments for life. Each payment has 2 components - an earnings portion that is taxable and a return of capital portion (cost basis) that is not taxable. The non-taxable portion represents the return of the original investment that was made with "after tax" dollars.

Define: the risk that the annuitant lives longer than expected Who takes on this risk and for what kind of contract?

mortality risk; issuer; variable annuity