Retirement Accounts Variable Annuities
A customer buys a variable annuity and elects a payout option of Life Income with a 20 year period certain. This means that payments will continue for: A the annuitant's life, not to exceed 20 years B the annuitant's life, but if he dies before 20 years elapse, payments continue to his heir(s) C the life of the annuitant and then cease D 20 years to the annuitant or beneficiary
B. An annuity payout option of Life-with Period Certain means that the annuity continues for the customer's life, but if he dies before the "period certain" (20 years in this case) is completed, payments will continue to a beneficiary until the 20 year period is completed.
An "annuity unit" of a variable annuity contract is a(n): A share of common stock representing an interest in the underlying portfolio B accounting measure of the owner's interest in the separate account C accounting measure of the annuity amount to be received by the owner D share of beneficial interest in a fixed portfolio
C Annuity Unit Once a variable annuity contract is "annuitized," the accumulation units are converted into a fixed number of annuity units. The number of annuity units received depends on the dollar amount in the separate account; the annuity option chosen; and the customer's expected mortality.
Which annuity payout option usually results in the largest periodic payment? A Unit Refund Annuity B Joint and Last Survivor Annuity C Life Annuity D Life Annuity-Period Certain
C. The shorter the expected annuity period, the larger the payment. A life annuity lasts only for that person's life - this is the shortest expected period of those given. A life annuity with period certain continues to pay for a fixed time period if the person dies early; a joint and last survivor annuity pays a spouse when one person dies; a unit refund annuity pays a lump sum if a person dies early.
If the actual interest rate earned in the separate account underlying a variable annuity contract is higher than the "AIR" the annuity payment: A will increase B will decrease C is unaffected D is capped to a maximum amount
A. The "AIR" is the "Assumed Interest Rate." This is used as an illustration of the annuity payment that will be received if the separate account grows at the AIR. If the assets grow at an interest rate that is higher than the AIR, then the annuity payment will increase. Conversely, if the assets grow at an interest rate that is lower than the AIR, then the annuity payment will decrease.
Which statement is TRUE regarding a variable annuity offering a GMIB? A The contract guarantees a minimum death benefit if the contract holder dies before the separate account is depleted B The contract guarantees a minimum growth rate for the separate account at the time of annuitization C The contract guarantees a minimum number of annuity payments D The contract guarantees a maximum rate at which the contract expenses can grow
B. A "GMIB" is a Guaranteed Minimum Income Benefit. 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. 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. Note that the GMIB does not apply during the accumulation phase; it only applies during the annuity phase. This is a very popular rider, but it does come at a cost.
The "AIR" shown in a variable annuity prospectus is the: A minimum guaranteed rate of return on investment B maximum guaranteed rate of return on investment C conservative illustration of the rate of return on investment D aggressive illustration of the rate of return on investment
C. The AIR - Assumed Interest Rate - shown in a variable annuity prospectus illustrates the annuity that will be available if the separate account performs at that interest rate. It is conservatively estimated, but is no guarantee of a specific return. Review
A customer invests $30,000 in a non-qualified variable annuity. Over the years, it has grown in value to $50,000. The customer's cost basis in the annuity contract is: A 0 B $20,000 C $30,000 D $50,000
C. The customer's cost basis in a non-qualified annuity is the amount contributed - these are dollars that are after-tax (no tax deduction is allowed for these). The build-up over the cost basis represents the dollars that were never taxed. When distributions commence, only the portion attributable to the build-up is taxable.
To sell a variable annuity, what license(s) is (are) needed? A Series 6 only B Series 7 only C Series 6 or Series 7 D Series 6 or Series 7 plus a state insurance license
D. Because variable annuities are both a securities and insurance product, a State insurance license is needed, in addition to the Federal Series 6 (Investment Company Securities) or Series 7 (General Securities) license.
In order to recommend a variable annuity to a customer, the representative must inform the customer, in general terms, about any: I potential surrender period and surrender charge II potential tax penalty III mortality and expense fees IV charges for and features of enhanced riders A I and II only B III and IV only C I, II, III D I, II, III, IV
D. Consider this to be a learning question. To recommend a variable annuity, the representative must have a reasonable basis to believe that the customer has been informed, in general terms, about the material features of the variable annuity. These include the potential surrender period and surrender charge, potential tax penalty, mortality and expense fees, charges for and expenses of enhanced riders (a very popular rider, at a cost, is a GMIB - a Guaranteed Minimum Income Benefit), insurance and investment components and market risk.
A client surrenders a variable annuity contract 5 years after purchase because of poor performance. The customer invested $50,000 and redeemed it when the NAV was $40,000, however the customer only received $37,000 because a $3,000 surrender fee was imposed. The tax consequence is: A $13,000 capital loss B $13,000 deductible ordinary loss C $10,000 capital loss and $3,000 non-deductible loss D $10,000 deductible ordinary loss and $3,000 non-deductible loss
D. If a customer surrenders a variable annuity contract early (typically due to poor performance or a pressing financial need), then the customer's cost basis is the amount invested and the sale proceeds is the amount received on redemption. Any loss is deductible as an ordinary loss, but any portion of the loss due to the surrender fee is not deductible! If a customer invested $50,000 in a variable annuity and redeemed it when the NAV was $40,000, however the customer only received $37,000 because a $3,000 surrender fee was imposed, then of the $13,000 ordinary loss, $10,000 is deductible and $3,000 is non-deductible.
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 A I and III B I and IV C II and III D II and IV
D. Since this person is above age 59 1/2, any withdrawals from the retirement plan are not subject to the 10% penalty tax for a premature distribution. Since 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.
Owner Rights Variable annuity separate account holders have the right to vote:
For the Board of Trustees (or Board of Managers); To change the investment objective of the separate account; To dissolve the trust. Separate account unit holders cannot vote on the distributions made by the underlying mutual fund; nor can they vote on the sales charge imposed on the variable annuity contract.
Which statement is TRUE when a non-qualified variable annuity is annuitized prior to age 59 1/2 under the provisions of IRS Rule 72t? A 100% of each payment will be taxable at ordinary income rates B 100% of each payment will be non-taxable C Each payment received will be partially taxable but the 10% penalty tax will not be applied D Each payment received will be partially taxable and the 10% penalty tax will be applied
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. IRS Rule 72t gives a way for payments to be taken from the annuity prior to age 59 1/2 without the 10% penalty tax being applied. Rule 72t basically requires that annual payments deplete the account over that individual's expected life (the IRS has 3 approved methods for this). The rule also requires that a minimum of 5 annual "Substantially Equal Periodic Payments" (SEPPs) be taken, but that payments must continue until at least age 59 1/2.
The purchaser of a variable annuity bears all of the following risks EXCEPT: A investment risk B mortality risk C legislative risk D interest rate risk
B. Both mortality risk (the risk that the annuitant lives longer than expected) and expense risk (the risk that expenses of running the separate account are higher than expected) are borne by the issuer of a variable annuity contract. 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.
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. A joint and last survivor annuity pays another person (usually a spouse) when the annuitant dies
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. 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. Mutual fund investment options in a variable annuity are actually more limited than those available in the general market - making Choice A incorrect. There is no tax deduction for variable annuity contributions, and the portion of any payment received in retirement that is attributable to the "never-taxed" build-up is taxable ordinary income. Therefore, Choices C and D are incorrect.
Investment risk in a variable annuity contract is carried by the: A purchaser B issuer C custodian D manager
A. 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. 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.
Which statement is TRUE about a non-qualified variable annuity? A Contributions to the contract are tax-deductible B Investments held in the separate account grow tax-deferred C Withdrawals from the contract prior to retirement age are tax-free D Withdrawals from the contract after retirement age are tax-free
B. Contributions to a non-qualified variable annuity contract are not deductible. The separate account grows tax-deferred (the main benefit of the contract), making Choice B true. Any distributions are taxable on amounts above that contributed to the contract. Furthermore, if a premature distribution is taken (prior to age 59 1/2), a 10% penalty tax is imposed as well.
In a variable annuity contract, the number of I accumulation units is fixed II accumulation units can vary III annuity units is fixed IV annuity units can vary A I and III B I and IV C II and III D II and IV
C. During the accumulation phase of a variable annuity contract, new money that is invested buys additional accumulation units of the separate account (analogous to buying shares of a mutual fund). Once the account is annuitized, payments into the separate account must stop. The accumulation units owned at that moment are converted into a fixed number of annuity units (the number of annuity units received is based on that person's expected mortality). The monthly annuity payment is the fixed number of annuity units times the unit value (which will vary with the performance of the underlying mutual fund held in the separate account).
A customer, age 60, is looking for an investment that will provide life-long income at retirement. The BEST recommendation would be for the customer to: A purchase a variable annuity and annuitize the separate account at retirement B purchase a variable annuity and take installments of a designated amount at retirement C invest in an income mutual fund and elect not to automatically reinvest distributions D invest in a GNMA fund since GNMAs make monthly payments
A. The benefit of an annuity contract to an older person is the assurance of receiving income for life - however this only happens if the customer annuitizes the contract. If the customer chooses installments, there is no guarantee of payments for life - when the money in the account is depleted, payments stop.
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 gain distributions made by variable annuity separate accounts must be reinvested and are tax deferred. Dividend and capital gain distributions from other investment companies do not have to be reinvested and are always taxable, whether reinvested or not. Both variable annuities and mutual funds are regulated under the Investment Company Act of 1940; have managed portfolios; and asset appreciation is untaxed. Mutual fund asset appreciation is taxable only when a capital gains distribution is made.
Which statements are TRUE regarding variable annuities during the accumulation phase? I Periodic payments of fixed dollar amounts can be made into the separate account II Periodic payments of varying dollar amounts can be made into the separate account III Periodic distributions of fixed dollar amounts can be made to the holder from the separate account IV Periodic distributions of varying dollar amounts can be made to the holder from the separate account A I and II only B III and IV only C I and III only D II and IV only
A. During the accumulation phase of a variable annuity contract, money can be paid into the plan; but distributions cannot be taken. 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.
All of the following statements are true about variable annuities EXCEPT variable annuities: A must be registered with the Securities and Exchange Commission B must be sold with a prospectus C are a non-fixed unit investment trust form of investment company D are sold without a sales charge
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. 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. Variable annuities are sold with a sales charge that must be "fair and reasonable" under FINRA rules.
The "death benefit" associated with a variable annuity contract: I applies prior to annuitization II applies after annuitization III means that, upon death, the insurance company will make a lump sum payment to complete the terms of the contract IV means that, upon death, the insurance company will pay a beneficiary at least the amount invested in the contract A I and III B I and IV C II and III D II and IV
B. 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 the contract holder dies after annuitization, there is no more "death benefit."
Which of the following statements are TRUE about variable annuities? I Investment risk is carried by the purchaser of the annuity II Salespeople must register with both FINRA and the State Insurance Commission III Annuity payments may be reduced because of increased expenses experienced by the insurance company IV Variable annuities are considered to be securities regulated by the Investment Company Act of 1940 A I and III B II and IV C I, II, and IV D I, II, III, IV
C. Investment risk in a variable annuity is carried by the purchaser, The issuer gives an expense guarantee, limiting the amount of expenses that the issuer can charge against the contract. To sell variable annuities, both an insurance and a securities registration are required. Variable annuities are considered to be securities because the purchaser bears the investment risk. Review
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. Variable life is a derivation of whole life. Like whole life, it is permanent insurance with level premiums and a fixed minimum death benefit. Permanent means that as long as the premium is paid, the policy remains in force. For both whole life and variable life, the premium has 2 components - part of the premium pays for insurance; the rest of the premium is invested and grows cash value. In a whole life policy, the excess premium is invested safely in the insurance company's general account and grows at a fixed lower rate, while in a variable life policy it is invested in a separate account. The separate account purchases accumulation units that represent shares of a designated mutual fund. If the mutual fund performs well, the variable life policy will build cash value at a faster rate than a whole life policy. The cash value can be borrowed from the policy for personal use; can be borrowed to pay current premiums due; or can be borrowed to purchase additional coverage. Annuitization does not occur with a variable life policy - it only occurs with an annuity contract. (Finally, note that the variable annuity prospectus must include a bold disclaimer that if the separate account loses substantial value, which can happen in a bear market, then the purchaser can be required to pay additional premiums to keep the face amount of the policy in force, or that the coverage amount could be reduced.)
Which statements are TRUE regarding the annuitization of a variable annuity contract? I A Life Annuity payout option may be elected by the policy holder II Life Annuity-Period Certain is the preferred payout option III The number of annuity units is fixed; the annuity payment may vary IV The annuity payment is fixed; the number of annuity units may vary A I and III B II and III C I and IV D II and IV
A. Variable annuity contracts allow the holder to elect a payout option that meets that person's individual requirements. The statement that a life annuity-period certain is a preferred payout option is erroneous - the choice of payout method depends on the needs of the annuitant. 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.
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. 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.
Which of the following statements are TRUE when describing a variable annuity separate account? I The separate account is part of the insurance company's general account holdings II The separate account is legally segregated from the insurance company's general account holdings III The separate account invests in shares of a designated mutual fund IV The separate account makes direct investments in shares of stock A I and III B I and IV C II and III D II and IV
C. An accumulation unit is an accounting measure used for valuing a variable annuity holder's interest in the separate account. The separate account buys shares of a designated mutual fund. The performance of the mutual fund determines the annuity amount to be paid. Direct investments in shares of stock cannot be made in the separate account; the account only buys shares of open-end management companies (mutual funds).
Which rollovers are permitted without tax due? I Exchange of one variable annuity contract for another variable annuity contract II Exchange of a life insurance contract for a variable annuity contract III Exchange of a variable annuity contract for a life insurance contract IV Exchange of a life insurance contract for another life insurance contract A I and II only B III and IV only C I, II, IV D I, II, III, IV
C. Section 1035 "tax-free" exchanges permit "like-for-like" exchanges without tax due. Thus, Choices I and IV are tax free. It also permits a life insurance policy to be exchanged for a variable annuity without tax due, making Choice II true. Of course, the IRS is happy about this because the taxable annuity payments will start earlier than the payment of the taxable death benefit. However, a variable annuity cannot be exchanged tax-free for an insurance policy under this tax rule, making Choice III false. If there is a gain in the separate account, it would be taxed upon exchange for a life insurance policy.
A customer invests $30,000 in a variable annuity contract. Over the years, the contract grows to $60,000 in value. At age 65, the customer takes a $40,000 lump sum distribution from the contract. The tax consequence is: A $40,000 non-taxable income B $40,000 taxable income C $10,000 taxable income; $30,000 non-taxable return of capital D $30,000 taxable income; $10,000 non-taxable return of capital
D. Variable annuity distributions are taxed LIFO (Last In; First Out). The "Last In" dollars are the tax-deferred build up in the separate account. These come out first and are taxable. Any distribution beyond this amount is a tax free return of invested capital (there is no tax deduction for variable annuity contributions). Because $40,000 was distributed, $30,000 represents the build-up (taxable) and the remaining $10,000 is a tax-free return of capital.
Suitability In order to recommend a variable annuity to a customer, the representative must have a reasonable basis to believe that the:
ustomer has been informed, in general terms, of the material features of the product; Customer would benefit from one or more of the product's features; and Particular variable product as a whole, the underlying separate accounts to which funds are allocated, and riders to the policy are suitable. The representative must sign a statement that all required representations and determinations were completed. To recommend a variable annuity, the representative should make reasonable efforts to obtain the customer's age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred annuity, investment time horizon, existing assets including life insurance, liquidity needs, liquid net worth, risk tolerance, tax status and any other information that is needed to make a recommendation to the customer.
Payments made on a fixed annuity contract are withdrawn from the: A broker-dealer net capital account B insurance company general account C state insurance fund D insurance company separate account
B. Fixed annuity contracts promise to pay a fixed return for the annuitant's life. The insurance company makes the payments from its general account, which is typically conservatively invested in high quality bonds. If the insurance company were to go bankrupt, these payments would stop (though this not a likely occurrence). Payments from a separate account are the funding source for variable annuity payments. The variable annuity separate account is legally "separated" from other insurance company assets and would survive an insurance company bankruptcy. The separate account is invested in a designated mutual fund and the payments will vary, based on the performance of the mutual fund held in the separate account.
Which of the following statements are TRUE when describing the "build-up" in a variable annuity separate account during the accumulation phase? I All interest, dividends, and capital gains from the securities in the account are automatically reinvested to buy more accumulation units II All interest, dividends, and capital gains from the securities in the account can either be paid to the contract holder or can be automatically reinvested to buy more accumulation units III All interest, dividends, and capital gains from the securities in the account are taxable IV All interest, dividends, and capital gains from the securities in the account are tax deferred A I and III B I and IV C II and III D II and IV
B. During the accumulation phase, all interest, dividend, and capital gains realized from the securities held in the separate account must be automatically reinvested to buy more accumulation units for the contract holder. The "build-up" of these reinvested dividends, interest and capital gains is tax deferred during this period. This is the major tax advantage of buying a variable annuity over making a direct investment in a mutual fund.
The owner of a variable annuity has which of the following rights? I Right to vote for distributions of income and capital gains II Right to vote to change the separate account's investment objective III Right to vote for the Board of Trustees IV Right to vote for dissolution of the trust A I and II only B III and IV only C II, III, IV D I, II, III, IV
C. Distributions of dividends and capital gains are decided by the variable annuity's Board of Trustees. The unit holder can vote for the Board of Trustees and can vote to change the investment objective of the separate account. In addition, terminating the trust (a very unlikely event) would require unit holder approval as well.
