1 Unit 12 - Variable Annuities

A customer has an investment objective of keeping pace with inflation while assuming moderate risk. Which of the following recommendations would best meet the customer profile? A) IPO. B) Variable annuity. C) Universal variable life policy. D) Money market fund.

Your answer, Variable annuity., was correct!. Insurance companies introduced the variable annuity as an opportunity to keep pace with inflation. For this potential advantage, the investor, rather than the insurance company, assumes the investment risk. A universal variable life policy should be purchased primarily for its insurance features, not its investment features. Reference: 12.1.2 in the License Exam Manual.

An annuity may be purchased under all of the following methods EXCEPT: A) periodic payment immediate annuity. B) single payment immediate annuity. C) single payment deferred annuity. D) periodic payment deferred annuity.

Your answer, periodic payment immediate annuity., was correct!. A periodic payment immediate annuity is a contradiction in terms. The annuitant may not contribute and withdraw simultaneously. Reference: 12.2 in the License Exam Manual.

All of the following investment strategies offer either fully or partially tax-deductible contributions to individuals who meet eligibility requirements EXCEPT: A) IRAs. B) defined contribution plans. C) Keogh plans. D) variable annuities.

Your answer, variable annuities., was correct!. Contributions to a nonqualified variable annuity are not tax deductible. Contributions to an IRA may be tax deductible, depending on the individual's earnings and participation in a company-sponsored qualified retirement plan. Reference: 12.3.3 in the License Exam Manual.

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

Your answer, II and III., was correct!. 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). Reference: 12.1.2 in the License Exam Manual.

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 III. B) I and II. C) II and IV. D) III 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. Reference: 12.1.2 in the License Exam Manual.

Your 55-year-old client owns a nonqualified variable annuity. He originally invested $50,000 four years ago. The annuity has grown to value of $60,000. If the client, who is in a 30% tax bracket, makes a random withdrawal of $15,000, what will he pay to the IRS? A) 0. B) 4000. C) 3000. D) 4500.

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. Reference: 12.3.3 in the License Exam Manual.

Your customer in his early 30s has received a modest inheritance from a relative. Listing tax-deferred growth as an objective for retirement income, which of the following investments is most suitable? A) Tax-free municipal bonds B) Growth mutual funds C) Corporate debt securities D) A variable annuity

Your answer, A variable annuity, was correct!. Variable annuities offer tax-deferred growth and are suitable for achieving supplemental retirement income. Ideally they should be funded with readily available cash rather than using funds liquidated from existing investments. None of the other investments listed here offer tax-deferred growth. Reference: 12.3.4 in the License Exam Manual.

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

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. Reference: 12.1.4 in the License Exam Manual.

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

Your answer, I and III., 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. Reference: 12.3.1 in the License Exam Manual.

A variable annuity's separate account is: used for the investment of funds paid by contract holders. used to escrow late or otherwise delinquent premium payments. required to be located off of the company's premises. regulated under both securities and insurance laws. A) I and III. B) I and IV. C) II and IV. D) II and III.

Your answer, I and IV., was correct!. The separate account is used for both variable life insurance and variable annuity investments. The nature of the securities invested in-bonds and growth stocks-makes it necessary that sales representatives and their principals be licensed in securities as well as insurance. Reference: 12.1.2.1.1 in the License Exam Manual.

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, II and III., was correct!. 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. Reference: 12.1.2 in the License Exam Manual.

The holder of a variable annuity receives the largest monthly payments under which of the following payout options? A) Joint and last survivor annuity. B) Life annuity. C) Life annuity with period certain. D) Joint tenants annuity.

Your answer, Life annuity., was correct!. Life annuity has the largest payout because less risk is assumed by the insurance company; there is no beneficiary in the event the annuitant dies. Reference: 12.3.2.1 in the License Exam Manual.

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) Life annuity with period certain . B) Unit refund life option. C) Life annuity with 10-year period certain. D) Life-only annuity

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. Reference: 12.3.2.1 in the License Exam Manual.

A client has purchased a nonqualified variable annuity from a commercial insurance company. Before the contract is annuitized, your client, currently age 60, withdraws some funds for personal purposes. What is the taxable consequence of this withdrawal to your client? A) A 10% penalty plus the payment of ordinary income tax on all of the funds withdrawn. B) Capital gains taxation on the earnings withdrawn in excess of the owner's basis. C) A 10% penalty plus the payment of ordinary income tax on funds withdrawn in excess of the owner's basis. D) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis.

Your answer, Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis., was correct!. Contributions to a nonqualified annuity are made with the owner's after-tax dollars. Distributions from such an annuity are computed on a LIFO basis with the income taxed first. Once the cost basis is reached, any further withdrawals are a nontaxable return of principal. Since the client is older than 59½ at the time of distribution, the additional 10% penalty tax is not incurred. Reference: 12.3.3 in the License Exam Manual.

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

Your answer, Purchasing power risk., was correct!. 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. Reference: 12.1.1 in the License Exam Manual.

An accumulation unit in a variable annuity contract is: A) none of these. B) fixed in value until the holder retires. C) an accounting measure used to determine the contract owner's interest in the separate account. D) an accounting measure used to determine payments to the owner of the variable annuity.

Your answer, an accounting measure used to determine the contract owner's interest in the separate account., was correct!. When money is deposited into the annuity, it is purchasing accumulation units. Reference: 12.2.1 in the License Exam Manual.

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 mortgage yields. D) the yield is always higher than bond yields.

Your answer, changes in common stock prices tend to be more closely related to changes in the cost of living than changes in bond prices., was correct!. Because common stocks are not fixed dollar investments, they have the opportunity to keep pace with inflation. Reference: 12.1.2.1.1 in the License Exam Manual.

Your customer, still working, informs you that she will be funding a variable annuity you have recommended from 2 sources: a refinancing of her primary home where she will be able to draw out equity that has built up since it was purchased 15 years ago, and cashing out another variable annuity that she recently purchased within the past 2 years without a lifetime income rider like the one you have recommended. Based only on these facts, the variable annuity recommendation is A) suitable if she has enough equity in the home to fund the variable annuity without cashing out the other VA contract B) not suitable because a lifetime income rider is only for someone who is already retired C) suitable regardless of funding sources D) not suitable

Your answer, not suitable, was correct!. Based on the information given in the question, the VA recommendation would not be suitable. Refinancing a home to draw out equity has been identified by FINRA as an abusive sales tactic regarding the sales of VAs. Cashing out life insurance policies or VAs where steep surrender charges are likely to exist, particularly in the earlier years of those contracts, is also considered abusive. Life income riders are best suited for those who anticipate a lengthy retirement and are generally not yet retired when making the VA purchase. Reference: 12.3.2.1 in the License Exam Manual.

With regard to a variable annuity, all of the following may vary EXCEPT: A) value of annuity units. B) value of accumulation units. C) number of accumulation units. D) number of annuity units.

Your answer, number of annuity units., was correct!. During the accumulation phase, the number of accumulation units will increase as additional money is invested. When the contract is annuitized, the annuitant is credited with a fixed number of annuity units. Once annuitized, the number of annuity units does not vary. The value of accumulation and annuity units varies with the investment performance of the separate account. Reference: 12.2.1 in the License Exam Manual.

A registered representative recommends a variable annuity with an income rider to a client. The client's investment objectives, tax bracket, investment experience and risk tolerance all align well with a VA recommendation. The client agrees to purchase the contract and informs the RR that he will be cashing out a VA he purchased 2 years ago to fund the new contract and will forward the check as soon as he receives it. Based on this information the RR should: A) suggest to the client that perhaps a loan or refinancing his vacation home might be a better way to fund the contract purchase. B) reevaluate whether the recommendation for the VA contract is still suitable based on the clients proposed funding of the investment. C) complete all paper work to purchase the annuity contract and obtain the clients signature immediately. D) contact the issuer of the clients existing VA contract to facilitate the clients surrender of the contract.

Your answer, reevaluate whether the recommendation for the VA contract is still suitable based on the clients proposed funding of the investment., was correct!. Funding a VA contract by cashing out either life insurance policies or existing VA contracts, especially those held for a short period of time is not suitable. These contracts come with high surrender charges. Suggesting that loans or drawing equity from a home to fund VA contracts have also been targeted as abusive sales practices. Of the answer choices given the best would be to reevaluate the recommendation based on the new information tendered by the client. Reference: 12.1.2.1.3 in the License Exam Manual.

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

Your answer, taxed as ordinary income only to the extent of earnings., was correct!. As contributions are made with after-tax dollars, only the earnings generated are taxed on withdrawal. Reference: 12.3.3 in the License Exam Manual.

Variable annuity salespeople must register with all of the following EXCEPT: A) FINRA. B) the state banking commission. C) the state insurance department. D) the SEC.

Your answer, the state banking commission., was correct!. Variable annuity salespeople must be registered with FINRA and the state insurance department. Registration with FINRA is de facto registration with the SEC; no registration is required by the state banking commission. Reference: 12.1.2 in the License Exam Manual.

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

Your answer, value of underlying securities held in the separate account., was correct!. Payments from a variable annuity depend on the securities' value in the separate account's underlying investment portfolio. Reference: 12.3.1 in the License Exam Manual.

All of the following statements regarding variable annuities are true EXCEPT: A) variable annuities offer the investor protection against capital loss. B) variable annuities are classified as insurance products. C) insurance companies keep variable annuity funds in separate accounts from other insurance products. D) variable annuities may only be sold by registered representatives.

Your answer, variable annuities offer the investor protection against capital loss., was correct!. A variable annuity is both an insurance and a securities product. An annuitant assumes the investment risk of a variable annuity and is not protected by the insurance company from capital losses. Reference: 12.1.4.1 in the License Exam Manual.

All of the following statements concerning a variable annuity are correct EXCEPT: A) separate account may consist of mutual funds. B) a majority vote from the shareholders is required to change the investment objectives. C) variable annuities will protect an investor against capital loss. D) the invested money will be professionally managed according to the issuers' investment objectives.

Your answer, variable annuities will protect an investor against capital loss., was correct!. As the name implies, the investment performance of a variable annuity's portfolio (separate account) can vary, and the investor bears the risk of any potential decline in its value. Many variable annuities invest the separate account in mutual funds. Reference: 12.1.4.1 in the License Exam Manual.