65-15: Insurance Based Products
Periodic payment deferred annuity
Allows person to make periodic payments -monthly, quarterly, annually
Universal Life Insurance
-Can increase or decrease the death benefit and premiums as needs and financial conditions change -more flexibility
Disadvantages to VAs compared to mutual funds
-Earnings are taxed as ordinary income -expense are typically much higher -withdrawals before 59.5 incur a 10% penalty -surrender in early years will usually involve additional costs
Fixed Annuities
-Monthly payment is fixed -Guaranteed interest rate -Investment risk assumed by insurance company -Portfolio contains fixed income securities and mortgages -General account -Vulnerable to inflation -insurance regulation ONLY -Considered to be an INSURANCE product not a security
Variable Annuities
-Monthly payout varies -Variable ROR -Investment risk assumed by annuitant (owner) -Portfolio consists of equities, debt, money market instruments -Separate account -Resistant to inflation -Insurance AND securities regulation -Considered to be a SECURITY
Flexible Premium Variable Life (Universal)
-Type of variable life with flexible premiums and thus a flexible death benefit -Premiums are only invested in a separate account -Has option to skip, increase or reduce premium but must maintain a minimum cash value
Universal Variable Life Insurance
-flex premiums -variable death benefit -premiums go to separate account -no guaranteed cash value
Scheduled (Fixed) Premium Variable Life
-has minimum guaranteed death benefit -premiums are FIXED
Variable Life Insurance
-scheduled premium -minimum guaranteed plus variable death benefit -premiums to general and separate account -no guaranteed cash value -You have an option to exchange the policy for a WLI within the first two years AT LEAST (no additional underwriting) -Have voting rights -After 3 years, minimum 75% of cash value must be available for policy loan -Insurer is NEVER required to loan 100% of cash value. Full CV is obtained by surrendering the policy
Advantages to VAs compared to mutual funds
-tax deferred growth -guaranteed death benefit -lifetime income -1035 exchange (exchange your annuity to another with no tax consequences) -No age 70.5 restrictions or requirements -No contribution limits -tax free transfer between subaccounts -no probate
***Your 55-year-old client owns a nonqualified variable annuity. He originally invested $50,000 4 years ago. The annuity has grown to a value of $60,000. If the client, who is in a 30% tax bracket, makes a random withdrawal of $15,000, what will he pay to the IRS? A) $4,000.00 B) $0.00 C) $3,000.00 D) $4,500.00
A Because 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 59½ when making the withdrawal, he also pays a 10% tax penalty, or $1,000. This makes a total of $4,000 tax and tax penalty paid on the random withdrawal. U15LO5
Which of the following is a possible advantage of scheduled premium variable life insurance over whole life insurance? A) Possible inflation protection for the death benefit B) Greater guaranteed cash value C) Less risk in the underlying investment instruments D) Flexibility of premium payments
A Scheduled (fixed) premium variable life has fixed, not flexible, premium payments. The distinguishing factor is the variable death benefit. The insured assumes more risk, not less, in exchange for the possibility that the death benefit will provide protection from inflation. U15LO6
All of the following statements regarding scheduled premium variable life insurance are correct EXCEPT A) better than anticipated results in the separate account could lead to a reduction in annual premium B) the policyowner has the right to change the selection of subaccounts C) once selected, the policyowner may change payment modes D) premiums are determined based on age and sex of the insured
A Scheduled (fixed) premium variable life premiums are fixed. It is universal life that has flexible premiums. U15LO7
Which of the following is designed primarily as a retirement vehicle to help protect contract owners from a decline in purchasing power? A) Variable annuities B) Flexible premium fixed annuity C) Retirement income life insurance D) Life-paid-up-at-age-65 life insurance
A The tradeoff with lack of guarantees is the potential to keep pace with inflation. U15LO1
When a client purchased an annuity with a 5% bonus, it means A) the bonus is included every payment period B) the bonus is added to the initial payment C) the bonus is added to the death benefit D) the bonus is added at the last payment
B A bonus annuity is one in which the specified bonus is added to the initial payment. For example, a client invests $100,000 into a 5% bonus annuity. The initial account balance will show as $105,000. In general, all earnings are based on the $105,000 amount. Bonus annuities tend to have longer surrender periods to compensate. U15LO4
An owner of an equity index annuity would be wise to use the high-water crediting method if the underlying index was expected to A) decline. B) be volatile. C) change its objective. D) remain steady.
B An advantage of the high-water crediting method is that the interest is calculated using the highest value of the index during the term. Therefore, in a volatile market, where prices are going up and down, it picks up the highest price. U15LO3
Which of the following is considered an advantage of annuitization? A) Payments under a variable annuity could be reduced if there is a declining market. B) It guarantees income that will last for the client's lifetime. C) A fixed, level periodic payment tends to lose buying power over time due to inflation. D) Once annuitized, the client's draw from the annuity is limited to the annuity payment.
B Annuities offer a guarantee of income that will last for a client's lifetime. The other statements, while true, represent disadvantages of annuitization. Annuitization does limit liquidity and flexibility. U15LO1
A customer purchased a variable annuity from an agent 5 years ago with an initial investment of $200,000. The annuity's surrender fee will expire in year 7, which coincides with the customer's anticipated need for the funds. In the 5th year of the contract, the value of the annuity increased from $300,000 to $375,000. The agent notices that the general market is on the decline and recommends she enter a 1035 exchange of the variable contract for another, thus increasing her death benefit and locking it in at a higher minimum. This recommendation is A) suitable because 1035 exchanges have no adverse tax consequences B) unsuitable because of surrender fees C) suitable because of the increased death benefit D) unsuitable unless the customer agrees with the recommendation
B Incurring the surrender fee for the 1035 exchange of one contract and initiating a new long-term contract is inappropriate for a customer, in general, and particularly for this customer, considering her need to access her funds only two years later. U15LO4
Ask Mack*** (LIFO and FIFO) A 57 year-old client has $100,000 in a non-qualified variable annuity and $100,000 in a mutual fund with a dividend reinvestment plan. Coincidently, each was purchased 10 years ago with a deposit of $50,000. If the client needs $50,000 to use as a down payment for a vacation home, which would have the most severe tax consequences? A) Not enough information to tell B) The variable annuity C) The tax consequences would be the same D) The mutual fund
B There are several differences involved here. First of all, withdrawals from a variable annuity are treated on a LIFO basis. That is, the earnings are considered to be withdrawn first. In that case, all $50,000 taken from the VA are taxed as ordinary income. In addition, because the client is not yet 59 ½, there is the 10% tax penalty tacked on. The mutual funds are part of a dividend reinvestment program which means that a good portion of the $50,000 in gain has already been taxed and, in any event, there is no early withdrawal tax penalty. Finally, profits from the sale of mutual fund shares held this long would be taxed at the long-term gains rate, always lower than ordinary income. U15LO2
Among the reasons why deferred variable annuities might not be a suitable investment for seniors are all of the following EXCEPT A) surrender charges B) potential inflation protection C) improper sub-account selection D) potential capital fluctuation
B Variable annuities do offer potential inflation protection due to their participation in the equity market. The tradeoff is potential capital fluctuation, particularly if the portfolio selected is too aggressive. In addition, unlike mutual funds, they typically carry high surrender charges. U15LO2
If your 60-year-old customer purchases a nonqualified variable annuity and withdraws some of her funds before the contract is annuitized, what are the consequences of this action? A) 10% penalty plus payment of ordinary income tax on all funds withdrawn exceeding basis B) 10% penalty plus payment of ordinary income tax on all funds withdrawn C) Ordinary income tax on earnings exceeding basis D) Capital gains tax on earnings exceeding basis
C Distributions from a nonqualified plan represent both a return of the original investment made in the plan with after-tax dollars (a nontaxable return of capital) and the income from that investment. The income was deferred from tax over the plan's life, so it is taxable as ordinary income once distributed. A 10% penalty applies only if distributions begin before age 59½. U15LO5
Q: annuity owner at age 45 surrenders the annuity to buy a home. Which describes the tax consequences? A. ordinary income taxes and 10% early withdrawal penalty will apply to all money withdrawn B. Capital gains tax will apply to the amount of the withdrawal that represents earnings; there will be no tax on the cost basis C. ordinary income taxes and a 10% early withdrawal penalty will apply to the amount of the withdrawal that represents earnings; there will be no tax on the cost basis D. Ordinary income taxes apply to the amount of the withdrawal that represents earnings; the 10% early withdrawal penalty does not apply to surrendering an annuity
C Interest earnings are taxable as ordinary income. They are also subject to the 10% early withdrawal penalty when withdrawn before age 50.5. Contract holder recovers the cost basis without tax
After the death of an annuitant, beneficiaries under a life and 15 year period certain option are subject to A. Capital gains tax on the total amount of payments received B. Ordinary income tax on the total amount of payments received, plus a 10% withdrawal penalty if the annuitant was under the age of 59.5 C. ordinary income tax on the amount of the payout that exceeds the cost basis based on the exclusion ratio D. tax free payout of all remaining annuity benefits
C Payments from the annuity to the beneficiary through a period certain option are taxed in the same way as other periodic annuity payments; benefits over the amount of the cost basis are taxable as
Which of the following statements regarding nonqualified annuities is CORRECT? A) Because taxes on earnings are deferred, all money withdrawn will be subject to income tax when received. B) The exclusion ratio applies to accumulation units only. C) Because only insurance companies issue variable annuities, they are not considered securities. D) It is possible to receive distributions from an annuity before age 59½ without incurring tax penalties.
D Nonqualified annuities, fixed or variable, are those where contributions are made with after-tax dollars. Withdrawals due to death or disability or taking substantially equal annuity distributions over the life of the insured can begin before age 59½ without being subject to a tax penalty. The exclusion ratio only applies during the payout period. Even though taxes on earnings are deferred, that portion of the withdrawal that represents a return of principal on a nonqualified annuity, is not subject to tax or penalty. U15LO5
When discussing the purchase of a scheduled premium variable life insurance policy with a client, it would be CORRECT to state that A) premiums will vary based upon performance of the separate account B) you will receive a statement of your death benefit no less frequently than semiannually C) if a policy loan exceeds the policy cash value, the deficiency must be remedied within 10 business days to keep the policy from lapsing D) by surrendering the policy, its cash value may be obtained
D Surrender of the contract requires the insurance company to pay out its cash value. Death benefit is adjusted annually. U15LO7
If a customer assumes the risk involved with her variable annuity, what does this mean? I. She is not assured of the return of her invested principal. II. The underlying portfolio is primarily common stocks, which have no guaranteed return. III. As an investor, she can be held liable for the debts incurred by the insurance company.
I and II The annuitant bears the investment risk in a variable annuity. This means that the portfolio is not guaranteed to return a specified rate, and the principal invested will also fluctuate in value according to the securities held in the separate account portfolio. U15LO1
An individual purchasing a flexible premium variable life contract should know which of the following? I. Timing and amount of premiums generally are discretionary. II. The death benefit will generally be higher than that of a comparable whole life policy. III. The face amount is fixed at the beginning of the contract. IV. The performance of the separate account directly affects the policy's cash value.
I and IV A flexible premium policy allows the insured to determine the amount and timing of premium payments, provided minimums are met. Depending on the policy, the face amount (death benefit) is recalculated each year. It is intended that the death benefit receive some inflation protection, but this cannot be guaranteed. If separate account performance causes the cash value to drop below an amount necessary to maintain the policy in force, the policy lapses unless the requisite amount is received within 31 days. U15LO7
Which of the following statements concerning universal life insurance are CORRECT? I. Universal life has flexible premiums. II. Universal life is based on the assumption that level annual premiums are to be paid throughout the insured's life. III. The death benefit can fluctuate, but never below the guaranteed minimum face amount. IV. Cash values can fluctuate and may even fall to zero.
I and IV Universal life features flexible premiums that add to the cash value account, although there are no guarantees and the cash value can disappear if insufficient premiums are paid. There is no guaranteed minimum death benefit as there is with fixed (scheduled) premium variable life. The assumption that level annual premiums are to be paid throughout the insured's life is associated only with ordinary whole life and scheduled premium variable life policies. U15LO6
surrendering to a WL policy
If policyowner decides to stop paying the premiums, policyowner may: -surrender the policy for its cash value -take a reduced paid-up policy where the death benefit is decreased and future premiums are no longer required -take extended term insurance which pays the beneficiaries the full face amount if death occurs within a specific time period
Accumulation Stage
Pay in period for an annuity -investor can miss a payment and is not in danger of forfeiting the contributions -can terminate the contract during this period --might incur surrender charges on amounts withdrawn in the first 5 to 10 years after issuance of contract
Immediate Annuity
Single lump sum -NO accumulation period -Insurance company begins to pay out the benefits immediately, usually within 60 days
Whole vs. Term life
Whole -guaranteed interest rate on cash value buildup -builds cash value with ability to borrow -remains in effect until age 100 as long as premiums are paid Life -term insurance will provide the highest face amount for the lowest premium -term insurance does NOT build cash value -term insurance gives coverage for a specified period; it is pure protection
Deferred Annuity
single lump sum investment -payouts are deferred until annuitant elects to receive them
