Series 65 Unit 2 - Insurance Based Products
Which of the following would be a difference between a universal life insurance policy and a scheduled premium variable life insurance policy? A) There is a minimum guaranteed death benefit in the variable life while no such minimum applies to a universal life policy. B) The universal life policy will generally outperform the variable life policy during a period of falling interest rates and rising stock prices. C) There is a greater choice of separate account sub-accounts in the variable life policy. D) There is a minimum guaranteed return on the universal life while there is no guaranteed return on the variable.
Answer: A Universal life, including UVL, does not have a minimum guaranteed death benefit. There is no choice of separate account sub-accounts for universal life. Universal life is designed to benefit from periods of high interest rates, not falling ones.
A thirty-five year-old client purchases a variable life insurance policy. Under current regulations, the maximum sales charge permitted over the life of the policy is: A) 8.5% of total premiums over the life of the plan. B) 9%. C) 8.5% per premium payment. D) 9% per premium payment.
Answer: B A variable life insurance plan may charge a maximum sales charge of 9% over a period not to exceed 20 years.
Current IRS regulations permit an unlimited contribution to which of the following tax-deferred plans? A) 401(k) B) SEP-IRA C) Annuity D) Roth IRA
Answer: C Nonqualified annuities offer tax deferral similar to that of qualified retirement plans. However, unlike qualified plans and IRAs, the IRS places no limitation on the amount that may be contributed.
Larry purchased a deferred annuity and, at age 65, annuitized the product under a life with 15-year certain option. His wife, Linda, is the beneficiary. Which of the following statements is CORRECT? A) Payments would be made to Larry as long as he lives. B) Payments would be made to Larry until his death, then to his wife for another 15 years. C) Payments would be made to Larry until he is 80, then to his wife for the remainder of her life. D) Payments would be made to Larry until he is 80, then cease.
Answer: A Larry selected the life with 15-year certain option. This pays Larry for his life, regardless of how long, but continues to pay his beneficiary if he dies before the end of 15 years. That is the 15-year certain part.
Which of these features are common to both variable annuities and scheduled premium variable life insurance? Income earned in the separate account is tax deferred. Separate account performance below the AIR causes a reduction in cash value. Fixed contributions are required. Contract owners have voting rights. A) I and IV. B) I and II. C) II and III. D) III and IV.
Answer: A All variable products offer tax deferral of earnings in the separate account. Unit holders of a variable annuity vote on the basis of the number of units they own; holders of variable life insurance receive one vote for each $100 of cash value. With variable life insurance, AIR applies only to the death benefit, not to cash value.
A policy loan provision must be offered by the insurer after three years, allowing the variable life policy contract holder to borrow at least what percentage of cash value? A) 100% B) 125% C) 75% D) 90%
Answer: C The minimum that must be available in a VLI contract after three years is 75% of cash value.
An individual purchasing a flexible premium variable life contract should know which of the following? Timing and amount of premiums generally are discretionary. The death benefit will generally be higher than that of a comparable whole life policy. The face amount is fixed at the beginning of the contract. The performance of the separate account directly affects the policy's cash value. A) I and IV. B) I and III. C) II and III. D) II and IV.
Answer: A 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.
All of the following are advantages of universal life insurance EXCEPT: A) the policy is guaranteed never to lapse. B) ability to change death benefit amount. C) ability to adjust the amount of premium payments. D) when the cash value is sufficient, no premium payment is required.
Answer: A A universal life policy may lapse if the accumulation fund drops below a specified level and an additional premium is not paid.
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) $4,000.00 B) $0.00 C) $3,000.00 D) $4,500.00
Answer: A 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% tax penalty, or $1,000. This makes a total of $4,000 tax and tax penalty paid on the random withdrawal.
Variable annuities: A) may have 20 or more sub-account investment options. B) may invest only in money market mutual funds. C) generally provide more security of principal than fixed annuities. D) provide a guaranteed minimum annuity payout.
Answer: A Some variable annuity separate accounts have 50 or more sub-accounts to choose from. There are no guarantees as far as the amount of payout.
A customer has contributed $1,000 a year for 10 years to his tax-deferred nonqualified variable annuity. The value of the separate account is now $30,000. If the customer takes a withdrawal of $10,000, what are the tax consequences? A) The entire $10,000 is taxable as ordinary income. B) There is no tax as the withdrawal is considered return of capital. C) Two-thirds of the withdrawal is taxable as ordinary income. D) Any tax due is deferred.
Answer: A The $30,000 contract value represents $10,000 of contributions and $20,000 of earnings. When a partial withdrawal is made from an annuity, the earnings are considered to be taken out first for tax purposes (or LIFO). Therefore, ordinary income taxes will apply to the entire $10,000. In addition, if the customer is not at least 59-½, there will be a tax penalty of an additional 10%.
If a customer assumes the risk involved with her variable annuity, what does this mean? She is not assured of the return of her invested principal. The underlying portfolio is primarily common stocks, which have no guaranteed return. As an investor, she can be held liable for the debts incurred by the insurance company. A) I and II. B) II and III. C) III only. D) I, II and III.
Answer: A 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.
All of the following statements regarding universal life insurance are correct EXCEPT: A) premiums are fixed for the life of the policy. B) there are two death benefit options. C) offers the policyowner exceptional flexibility in adjusting the premiums, cash value, and death benefit. D) may include a minimum guaranteed interest rate.
Answer: A The single most distinguishing characteristic of universal life is the fact that premiums are flexible and not fixed.
The value of a variable annuity during the accumulation period is determined by the: A) number of accumulation units owned multiplied by the value of each unit. B) total payments made by the evaluation date. C) number of accumulation units owned multiplied by the number of payments made into the account. D) value of the securities in the general account of the insurance company.
Answer: A The value of a variable annuity during the pay-in period is based on the value of the accumulation units multiplied by the number of units the investor owns. The value of a unit is based on the value of the securities held in the separate account, not in the general account of the insurance company.
Under the exchange provision, within the first 24 months, a variable life policy may be converted into a A) permanent form of life insurance policy B) variable annuity C) mutual fund shares D) term insurance policy
Answer: A The variable life exchange provision allows a policyholder to convert the variable policy into a permanent form of life insurance policy within the first 24 months of variable policy ownership. The insurance company must use the initial contract date and can not require proof of insurability.
In a variable life contract, which of the following has a guaranteed minimum? A) The death benefit. B) The cash value. C) The maturity value. D) There are no guarantees.
Answer: A There is a guaranteed minimum death benefit. The cash value will vary according to the performance of the investments in the separate account.
Which of the following statements concerning universal life insurance are CORRECT? Universal life has flexible premiums. Universal life is based on the assumption that level annual premiums are to be paid throughout the insured's life. The death benefit can fluctuate, but never below the guaranteed minimum face amount. Cash values can fluctuate and may even fall to zero. A) I and IV. B) III and IV. C) II and III. D) I and II.
Answer: A 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.
Universal variable life policies: have investment risk that is assumed by the investor. do not have a separate account. guarantee the minimum face amount with the opportunity for increases based upon the performance of the separate account. are purchased primarily for their insurance features. A) I and IV. B) I and II. C) II and III. D) III and IV.
Answer: A Universal variable life policies are insurance company products that should be purchased primarily for the insurance features they offer rather than as an investment. Because they have a separate account, the investor assumes the investment risk. Unlike scheduled premium variable life, flexible premium (universal) variable life does not guarantee a minimum death benefit equal to the face amount of the policy.
A fixed-premium variable life insurance contract offers a: guaranteed maximum death benefit. guaranteed minimum death benefit. guaranteed cash value. cash value that fluctuates according to the contract's performance. A) II and III. B) II and IV. C) I and III. D) I and IV.
Answer: B A fixed-premium variable life contract offers a minimum death benefit and a variable death benefit over the minimum. Its cash value fluctuates with the performance of the separate account.
An individual is deciding between a flexible premium variable life contract and a scheduled premium variable life contract. If she is concerned about maintaining a minimum death benefit for estate liquidity needs, she should choose: A) the flexible premium policy because the contract's face amount cannot be less than a predetermined percentage of cash value. B) the scheduled premium policy because the contract is issued with a minimum guaranteed face amount. C) the flexible premium policy because earnings of the contract directly affect the face value of the policy and earnings can never be negative. D) the scheduled premium policy because earnings do not affect the contract's face amount.
Answer: B A scheduled premium variable life contract is issued with a guaranteed minimum death benefit. If the individual is concerned about having the minimum guarantee, you should recommend the scheduled contract.
Which of the following is guaranteed by a variable life policy? A) Minimum separate account performance. B) Minimum death benefit. C) Cash value. D) Policy loans after the policy has been in effect for at least 24 months.
Answer: B A variable life policy has a minimum guaranteed death benefit, but there is no minimum guaranteed cash value. There is no performance guarantee on separate accounts and policy loans are required after the policy has been in effect for at least 3 years (36 months).
According to federal law, an insurance company under the provisions of the Investment Company Act of 1940 must allow a variable life policyholder the option to convert the policy into a whole life contract for a period of: A) 18 months. B) 24 months. C) 45 days. D) 12 months.
Answer: B Although state law may allow for periods longer than 24 months, federal law requires a two-year conversion privilege.
In the past 20 years, 55-year-old James has put $27,000 into accumulation units in his nonqualified variable annuity. The current value of his units is $36,000. He wishes to withdraw $16,000 to assist with his grandchild's college education. If he is in the 28% tax bracket, what is his tax consequence on the withdrawal? A) $4,480.00 B) $3,420.00 C) $0.00 D) $2,520.00
Answer: B Because this is nonqualified, the investments are in after-tax dollars. Therefore, any value of the account over the investment is growth. Withdrawals from tax-deferred plans treat the growth as ordinary income for tax purposes. The portion attributable to growth is considered to be withdrawn first under the Tax Code. Here, we have $9,000 worth of growth taxable at 38% (28% + 10% penalty) because James is younger than 59-½. Yes, the earnings on a non-qualified annuity are subject to the 10% penalty; it is only the principal that escapes the tax and penalty. The remaining $7,000 withdrawn is considered a withdrawal of principal and is therefore nontaxable.
A customer purchased a variable annuity from an agent five years ago with an initial investment of $200,000. The annuity's surrender fee will expire in year seven, which coincides with the customer's anticipated need for the funds. In the fifth 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) unsuitable unless the customer agrees with the recommendation. B) unsuitable because of surrender fees. C) suitable because of the increased death benefit. D) suitable because 1035 exchanges have no adverse tax consequences.
Answer: 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.
A 45-year-old investor takes a lump-sum distribution from a nonqualified variable annuity. How is the distribution taxed? The entire amount is taxed as ordinary income. The growth portion is taxed as ordinary income. The growth portion is taxed as a capital gain. The growth portion is subject to a 10% penalty. A) III and IV. B) II and IV. C) I and IV. D) II and III.
Answer: B On withdrawals from a nonqualified annuity, taxes are paid only on the amount that exceeds cost basis (the amount paid into the annuity). In this case, the investor is taking a lump-sum distribution before reaching age 59-½ and must pay an additional 10% penalty on the taxable amount.
The main benefit that variable life insurance has over whole life insurance is: A) the availability of policy loans. B) the potential for a higher cash value and death benefit. C) a lower sales charge. D) an adjustable premium.
Answer: B Premiums of variable life insurance policyholders are invested in the insurer's separate account. This allows the policyholder the opportunity (though there are no guarantees) to enjoy significant returns and substantially higher cash values than are obtainable through a whole life policy.
An owner of an annuitized annuity can do all of the following EXCEPT: A) have a joint life with last survivor clause, with payments paid, until the death of the last survivor. B) receive monthly payment for a defined period and then two years later change the contract to payment for life. C) receive the benefits on a monthly basis until the time of death. D) receive the benefits for life with a certain minimum period of time guaranteed.
Answer: B The contract is annuitized when the investor converts from the accumulation (pay-in) stage to the distribution (payout) stage. Once that happens, the owner no longer has control over the asset. All payout decisions must be selected in advance since they cannot be changed.
The death benefit of a variable life policy must be calculated at least: A) semiannually. B) annually. C) weekly. D) monthly.
Answer: B The death benefit must be calculated annually and the cash value monthly.
A client needs funds for an unexpected medical emergency. If the client takes out a loan against the cash value of his life insurance policy and does not pay it back, the insurance company can do which of the following? A) Cancel the policy B) Reduce the death benefit when the client dies C) Reduce the cash value at the next anniversary D) Increase the premium amortized over the life of the policy
Answer: B Unpaid cash value loans reduce the death benefit.
A variable annuity has: A) a high degree of liquidity. B) different investment options known as subaccounts. C) fixed payments once it has been annuitized. D) a guaranteed rate of return.
Answer: B Variable annuities pay variable payments once annuitized, do not guarantee a rate of return, and are not considered liquid investments; they do offer multiple investment options through the subaccounts
A customer in his twenties, who is not risk averse, is in the market for life insurance. His main worry is that what looks like a generous death benefit today may not be sufficient for a beneficiary 40 or 50 years from now. A registered representative might consider recommending: A) an aggressive, long-term strategy of investment in small-cap stocks. B) variable life insurance. C) term life insurance. D) whole life insurance with the option of purchasing additional coverage.
Answer: B Variable life insurance has the advantage of offering possible inflation protection for the death benefit. The insured assumes investment risk for this benefit, but pays a fixed scheduled premium for the life of his contract.
Which of the following describe differences between variable and universal variable life insurance? Variable life insurance has a minimum guaranteed death benefit, whereas universal variable life insurance does not. Universal variable life insurance typically provides a higher death benefit than variable life insurance. Variable life insurance provides no inflation protection for the death benefit, whereas universal variable life insurance does. Variable life insurance requires scheduled premium payments, whereas universal variable life insurance permits flexible premium payments. A) III and IV. B) I and IV. C) I and II. D) II and III.
Answer: B Variable life insurance provides a minimum guaranteed death benefit because some of the premium goes into the general account and some goes into a separate account. With universal variable life insurance, the entire premium goes into a separate account, so that no guaranteed death benefit is provided, beyond a very small amount designed to meet funeral expenses. Variable life has a scheduled premium payment for the life of the contract. Universal variable life is far more flexible, though there are minimum payments that must be made. Both provide inflation protection for the death benefit.
A 64 year-old woman wishes to withdraw funds from her non-qualified single premium deferred variable annuity purchased a number of years ago. The withdrawal would be: A) subject to the required minimum distribution rules. B) taxed as ordinary income. C) taxed as capital gain. D) subject to a 10% penalty unless annuitized.
Answer: B Yes, I know that only the portion of the withdrawal that exceeds the cost basis is subject to tax, but what else are you going to pick here? Sometimes you have to go with the best choice, even if it isn't the most accurate.
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 funds withdrawn in excess of the owner's basis. B) Capital gains taxation on the earnings withdrawn in excess of the owner's basis. C) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis. D) A 10% penalty plus the payment of ordinary income tax on all of the funds withdrawn.
Answer: C 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 59-½ at the time of distribution, the additional 10% penalty tax is not incurred.
The return that will be earned over the life of a fixed annuity: A) is tied to a portfolio of common stocks selected by the annuity owner. B) is tied to an investment index such as the Standard & Poor's 500. C) will always be at least equal to the guaranteed minimum specified in the contract. D) may decrease over time due to the increase in surrender charges.
Answer: C Fixed annuities are what the term implies - the return is fixed for the life of the contract. In some cases, a fixed annuity may actually pay more (but never less) than the guaranteed amount. This would be true if the insurance company earned what is referred to as "excess interest".
In a scheduled premium variable life insurance policy, which of the following are guaranteed? A) The right to exchange the policy for a permanent form of insurance with comparable benefits within the first 24 months of issue, as long as the insured passes a new physical examination B) The ability to borrow a maximum of 75% of the cash value once the policy has been in force at least 3 years C) A minimum death benefit D) A minimum cash value
Answer: C In a variable life insurance policy, a minimum death benefit is guaranteed, but no cash value is guaranteed. There is a contract exchange privilege during the first 24 months allowing the conversion of the variable policy to a comparable form of permanent insurance, but no physical is required. The 75% cash value loan is a minimum, not a maximum, and applies after the third year of coverage.
A 35 year-old client indicates that he needs $500,000 of life insurance coverage for the next 20 years. The lowest out-of-pocket cost would be if he purchased a A) whole life policy B) variable annuity with an extended death benefit C) 20-year level term policy D) 20-pay life policy
Answer: C In almost all circumstances, certainly for short-to-immediate time periods, term life will be the least expensive form of insurance. A 20-pay life is a permanent policy where the premiums are paid in a 20-year period rather than until death. Variable annuities are not life insurance policies even though they are issued by life insurance companies.
Which of the following would most likely limit the amount of interest earned on an index annuity? A) The annuity reset rate B) The CDSC C) The cap rate D) The participation rate
Answer: C Most index annuities have a cap rate. That represents the maximum return that can be credited to the annuity, regardless of the performance of the index. Yes, the participation rate does affect how much can be credited, but, if there is no cap, there is theoretically no limit on the earnings. This is an example where you have to select the best answer.
Flexible premium payments are a feature of: A) whole life. B) term life. C) universal variable life. D) variable life.
Answer: C Only universal and universal variable life policies have flexible premium payments.
Among the unique characteristics of a universal life insurance policy is A) death benefits may increase above the initial face amount B) early termination could lead to surrender charges C) the policy may be overfunded D) that policyowners may borrow against the cash value
Answer: C Only with universal life is the policyowner permitted to pay in an amount in excess of the stated premiums (one of the reasons universal life is known as flexible premium life). The IRS puts limits on the amount of the overfunding before certain tax advantages are lost, but that is beyond the scope of the exam. Not only universal life, but variable life as well, has the possibility of increased death benefits. In fact, some whole life policies allow policy dividends to be used to increase the death benefit. Permanent forms of insurance policies, including whole life, universal life, and variable life, permit loans against the cash value. Many forms of life insurance have surrender charges for early termination.
An individual has borrowed $500,000 for a business loan. The loan agreement requires payment in one lump sum at the end of 7 years and stipulates that protection be provided in the form of a life insurance policy on the individual. Which type of insurance would probably be most appropriate in this situation? A) Whole life B) Variable universal life C) Level term D) Decreasing term
Answer: C Term insurance is frequently referred to as temporary insurance, because it is often used to cover a specific need. In this case, because the payback is in a lump sum, level term is most appropriate. If it were being amortized over the seven years (similar to a mortgage), then perhaps the decreasing term would be the best choice.
One of your clients owns an equity index annuity with a participation rate of 85% and a cap of 11%. During the past 12 months, the index used in the computation showed a gain of 12.80%. As a result, the client's account value was credited with a gain of A) 11.00% B) 12.80% C) 10.88% D) 9.35%
Answer: C The client is entitled to participate in 85% of the 12.80% gain with a maximum (capped) limit of 11%. Computing 85% of 12.80% gives us 10.88% which is below the 11% cap.
A variable annuity annuitant bears all of the following risks EXCEPT: A) market risk. B) interest rate risk. C) mortality risk. D) inflationary risk.
Answer: C The insurance company issuing the variable annuity bears mortality risk, or the danger that some annuitants will live to surpass their average life expectancy. The investor in a variable annuity bears inflationary risk, market risk, and interest rate risk.
A customer has a nonqualified variable annuity. Once the contract is annuitized, monthly payments to the customer are: A) 100% tax free. B) 100% tax deferred. C) partially a tax-free return of capital and partially taxable. D) 100% taxable.
Answer: C The investor has already paid tax on the contributions but the earnings have grown tax-deferred. When the annuitization option is selected, each payment represents both capital and earnings. The money paid in will be returned tax free, but the earnings portion will be taxed as ordinary income.
Which of the following statements are TRUE of a variable annuity? The number of annuity units is fixed when payout begins. The value of accumulation units is fixed at purchase. The monthly annuity payment is a variable amount. The annuity payments are not subject to income taxes. A) II and III. B) III and IV. C) I and III. D) I and II.
Answer: C The number of annuity units is fixed when an annuitant starts the payout process, and the monthly payment will vary with the market value of the securities in the separate account portfolio. The value of accumulation units varies with the value of the portfolio, and the growth portion of the monthly payments is subject to income tax.
The difference between a fixed annuity and a variable annuity is that the variable annuity: offers a guaranteed return. offers a payment that may vary in amount. will always pay out more money than the fixed annuity. attempts to offer protection to the annuitant from inflation. A) I and IV. B) II and III. C) II and IV. D) I and III.
Answer: C Variable annuities differ from fixed annuities because the payments vary and are designed to offer the annuitant protection against inflation.
Which of the following is indicative of the primary difference between variable life insurance and straight whole life insurance? A) Amount of insurance that can be issued. B) Cost of the insurance. C) Way in which the cash values are invested. D) Tax treatment of the death proceeds.
Answer: C Variable life insurance allows the policyowner to decide how the cash value is invested through a number of sub-accounts.
Which of the following types of life insurance has premiums that increase each time the policy is renewed, and no cash value buildup? A) Universal life. B) Ordinary whole life. C) Variable life. D) Term.
Answer: D A term policy provides life insurance only with no savings element. Upon renewal, the rates are higher as you age.
Annuity companies offer a variety of purchase options to owners. Which of the following definitions regarding these annuity options is NOT true? A) A single premium deferred annuity is a lump sum investment, with payment of benefits deferred until the annuitant elects to receive them. B) A periodic payment deferred annuity allows a person to make periodic payments over time; the contract holder can invest money on a monthly, quarterly, or annual basis. C) An immediate annuity allows an investor to deposit a lump sum with the insurance company; payout of the annuitant's benefits starts immediately (usually within 60 days). D) An accumulation annuity allows the investor to accumulate funds in a separate account prior to investment in an annuity.
Answer: D Accumulation does not refer to a purchase option. The pay-in period for an annuity is known as the accumulation stage. A single premium deferred annuity is an annuity with a lump-sum investment, with payment of benefits deferred until the annuitant elects to receive them. Periodic payment deferred annuities allow a person to make periodic payments over time. Immediate annuities allow an investor to deposit a lump sum with the insurance company payout of the annuitant's benefits starting immediately (usually within 60 days).
One of the features of an index annuity is the ability for the principal value to increase based on the performance of the specified index. Which of the following is not used as a method to compute the amount of interest to be credited to the account? A) Annual reset B) High-water mark C) Point-to-point D) Participation rate
Answer: D Although the participation rate is a component of the computation, it is not a method of computing the interest credit. In the annual reset index method, interest, if any, is determined each year by comparing the index value at the end of the contract year with the index value at the start of the contract year. Interest is added to the annuity each year during the term. Using the high-water mark the index-linked interest, if any, is decided by looking at the index value at various points during the term, usually the annual anniversaries of the date the annuity was purchased. The interest is based on the difference between the highest index value and the index value at the start of the term. Interest is added to the annuity at the end of the term. And finally, with the point-to-point method, the index-linked interest, if any, is based on the difference between the index value at the end of the term and the index value at the start of the term. Interest is added to the annuity at the end of the term. In each of these, the insurance company will specify the participation rate (what percentage of the increase will be credited) and a cap rate (the maximum amount to be credited).
Which of the following is considered to be an advantage of annuitization? A) Once annuitized, the client's draw from the annuity is limited to the annuity payment. B) A fixed, level periodic payment tends to lose buying power over time due to inflation. C) Payments under a variable annuity could be reduced if there is a declining market. D) It guarantees income that will last for the client's lifetime.
Answer: D 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.
Bob, age 60, has invested $17,000 in his nonqualified variable annuity over the years. The total value has reached $26,000. He wishes to withdraw $15,000 to send his son to college. What is his tax consequence on the withdrawal? A) The entire amount is nontaxable. B) The entire amount is taxable. C) $6,500 is nontaxable; $8,500 is taxable. D) $9,000 is taxable; $6,000 is nontaxable.
Answer: D Because this is a nonqualified plan, the $17,000 invested is after-tax dollars. Under the Tax Code, the taxable portion is considered to be withdrawn first in any lump-sum distribution. Therefore, the first dollars withdrawn are all taxable until the amount of withdrawal meets or exceeds the growth in the account. Because Bob is over 59-½, there is no 10% tax penalty on his withdrawals.
An agent presenting a variable life insurance (VLI) policy proposal to a prospect must disclose which of the following about the insured's rights of exchange of the VLI policy? A) The insurance company will allow the insured to exchange the VLI policy for a permanent form of life insurance policy within 45 days from the date of the application or 10 days from policy delivery, whichever is longer. B) Within the first 18 months, the insured may exchange the VLI policy for either a permanent form of life insurance or universal variable policy, issued by the same company, with no additional evidence of insurability. C) The insured may request that the insurance company exchange the VLI policy for a permanent form of life insurance policy, issued by the same company, within two years. The insurance company retains the right to have medical examinations for underwriting purposes. D) Federal law requires the insurance company to allow the insured to exchange the VLI policy for a permanent form of life insurance policy, issued by the same company, for two years, with no additional evidence of insurability.
Answer: D Federal law requires that issuers of variable life insurance policies allow exchange of these policies for a permanent form of life insurance policy, issued by the same company for a period of no less than two years. The exchange must be made without additional evidence of insurability.
In a scheduled premium variable life insurance policy, all of the following are guaranteed EXCEPT A) a minimum death benefit B) the right to exchange the policy for a permanent form of insurance, regardless of health, within the first 24 months C) the ability to borrow at least 75% of the cash value after the policy has been in force at least 3 years D) a minimum cash value
Answer: D In a variable life insurance policy, a minimum death benefit is guaranteed, but no cash value is guaranteed. There is a contract exchange privilege during the first 24 months allowing the conversion of the variable policy to a comparable form of permanent insurance and the 75% cash value loan minimum applies after the third year of coverage.
A client purchased an index annuity from you three years ago and made an initial deposit of $100,000. The contract calls for a 90% participation rate with a 15% cap. The index had a return of + 20% in the first year, - 5% the second year, and +10% the third year. The investor's current value is approximately A) $126,500 B) $128,620 C) $117,829 D) $125,350
Answer: D In the first year, the index gained 20%. With a 90% participation rate, the investor might have earned 18%, but was limited by the 15% cap. So, after one year the value was $115,000. In the second year, the index lost money. However, with an index annuity there are never any reductions in a down market so the account remained at $115,000. In the third year, the investor received 90% of the 10% growth and that increased the account value to $125,350. This resulted in an overall gain of 25.35%, or an average return of almost 8.5% per year.
A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk? A) Common stock. B) Fixed annuity. C) REIT. D) Variable annuity.
Answer: D Longevity risk is the uncertainty that one will outlive his money. The only instrument that guarantees a payout for as long as one lives is an annuity. Because the question asks for a security, only the variable annuity is correct, otherwise the fixed annuity would also offer protection.
With an annuity: taxes on earned dividends, interest, and capital gains are paid annually until the owner withdraws money from the contract. random withdrawals are taxed on a LIFO basis. money invested in a nonqualified annuity represents the investor's cost basis. upon withdrawal, the amount exceeding the investor's cost basis is taxed as ordinary income. A) I only. B) I, II and IV. C) IV only. D) II, III and IV.
Answer: D Money randomly withdrawn (not annuitized) is handled under LIFO tax rules. Money invested in an annuity represents the investor's cost basis and on withdrawal, the amount exceeding the investor's cost basis is taxed as ordinary income. Taxes on earned dividends, interest, and capital gains are not paid annually. They are deferred and paid later, when the owner withdraws money from the contract.
Which of the following statements regarding non-qualified annuities is CORRECT? A) Since only insurance companies issue variable annuities, they are not considered securities. B) The exclusion ratio applies to accumulation units only. C) Because taxes on earnings are deferred, all withdrawal proceeds will be subject to income tax when received. D) It is possible to start distributions from an annuity before age 59 ½ without incurring tax penalties.
Answer: D Non-qualified 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 59 ½ 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 non-qualified annuity, is not subject to tax or penalty.
A client of an IAR mentions that he has received a prospectus for a variable annuity, but does not really understand the product. It would be reasonable for the IAR to explain that a variable annuity offers an investor A) lifetime income guaranteed never to drop below the initial rate B) a product very similar to a mutual fund, but with lower costs and expenses C) the insurance company's backing of the annuity' performance D) the opportunity to invest in equity securities on a tax-deferred basis
Answer: D One of the most attractive features of variable annuities is that all earnings are tax-deferred until withdrawal. The sub-accounts are usually invested in equities (although there are some with fixed income as the primary component of the portfolio), but the expenses are generally higher than for a mutual fund with similar goals. There are no guarantees on the amount of income when the VA is annuitized.
A customer has invested a total of $10,000 in a nonqualified deferred annuity through a payroll deduction plan offered by the school system where he works. The annuity contract is currently valued at $16,000, and he plans to retire. On what amount will the customer be taxed if he chooses a lump-sum withdrawal? A) $10,000.00 B) $16,000.00 C) He will not owe taxes because the annuity was nonqualified. D) $6,000.00
Answer: D Payments into a nonqualified deferred annuity are made with after-tax money; taxes must only be paid on the earnings of $6,000.
All of the following statements regarding scheduled premium variable life insurance are correct EXCEPT: A) the policy owner has the right to change the selection of sub-accounts. B) premiums are determined based upon age and sex of the insured. C) once selected, the policy owner may change payment modes. D) better than anticipated results in the separate account could lead to a reduction in annual premium.
Answer: D Scheduled (fixed) premium variable life premiums are fixed. It is universal life that has flexible premiums.
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 ten business days to keep the policy from lapsing. D) by surrendering the policy, its cash value may be obtained.
Answer: D Surrender of the contract requires the insurance company to pay out its cash value. Death benefit is adjusted annually.
A 60-year-old man has invested $27,000 in his nonqualified variable annuity over a period of 5 years. The current value of the separate account is $36,000. He wishes to withdraw $16,000 to assist in his grandchild's college education. If he is in the 28% tax bracket, what will be his tax consequence on the withdrawal? A) $0.00 B) $3,420.00 C) $4,480.00 D) $2,520.00
Answer: D The client has a nonqualified annuity so payments to the annuity were on an after-tax basis. Therefore, only the amount representing earnings would ever be subject to taxation. Those earnings are taxed as ordinary income on a LIFO basis meaning that the earnings are considered the last money into the account and the first out. If the client withdraws $16,000, $9,000 of that amount (representing the earnings) is taxable at the client's tax rate of 28% (28% × $9,000 = $2,520). Because this individual is older than 59-½, the 10% penalty does not apply.
A widowed customer with no children has a portfolio invested in mutual funds valued at $250,000. The portfolio generates a monthly income of $1,600, an amount that exceeds her living expenses by $300. The investment portfolio is her sole source of income. Her agent recommends she sell $30,000 worth of her mutual funds and purchase a deferred variable annuity to take advantage of the tax deferral and death benefit features. This recommendation is: A) suitable because it offers a growth opportunity with a death benefit for a portion of her holdings. B) suitable because it provides tax deferral features. C) suitable because it provides diversification. D) unsuitable.
Answer: D The customer has no need for the death benefit (she has no immediate survivors) or tax deferral features (with $19,200 in annual income, there are virtually no income taxes due) of a variable annuity, so this transaction is unsuitable. Finally, she would be replacing income generating assets with one that does not offer immediate income and that could reduce her income cushion to an uncomfortable margin of safety.
Which of the following best describes the death benefit provision of a variable annuity? A) Upon death, the beneficiary has a choice of settlement options. B) If death should occur prior to age 59½, the 10% early withdrawal penalty does not apply. C) Upon death, the proceeds pass to the beneficiary free of federal income tax. D) The principal amount at death is the greater of the total of premium payments or the current market value.
Answer: D The death benefit insures that the investor will never receive back less than the original amount contributed to the account. Unlike life insurance proceeds, with annuities, anything above the cost basis is taxed as ordinary income.
Marianne has a fixed premium variable life policy in which the separate account has been performing extremely well, and the face value has been increasing as a result of the investment performance. However, recently the separate account performance has been negative. If this continues, the face value could decrease: A) to 0. B) to 25% of the original face value. C) to 50% of the original face value. D) to the original face value.
Answer: D The face value in an insurance policy is the death benefit. In a variable life policy, the face value will fluctuate with the separate account's performance, but it will never decrease below the original minimum face value.
All of the following statements about variable annuities are true EXCEPT: A) the rate of return is determined by the underlying portfolio's value. B) such an annuity is designed to combat inflation risk. C) the number of annuity units becomes fixed when the contract is annuitized. D) a minimum rate of return is guaranteed.
Answer: D The return on a variable annuity is not guaranteed; it is determined by the underlying portfolio's value. Variable annuities are designed to combat inflation risk. The number of annuity units becomes fixed when the contract is annuitized; it is the value of each unit that fluctuates.
Which of the following is designed primarily as a retirement vehicle to help protect contract owners from a decline in purchasing power? A) Flexible premium fixed annuity. B) Retirement income life insurance. C) Life paid-up at age 65 life insurance. D) Variable annuities.
Answer: D The trade-off with lack of guarantees is the potential to keep pace with inflation.
For a given amount of principal, which annuity option would produce the largest monthly income stream? A) Life with term certain. B) Joint and 100% survivor. C) Joint and 50% survivor. D) Straight life.
Answer: D This is just an example of the risk/reward philosophy. Taking payments for life only (which can end rather suddenly) exposes the annuitant to greater risk than period certain and joint payout so the rewards are higher.
Which of the following statements is TRUE concerning variable life separate account valuation? A) Unit values are computed monthly and cash values are computed daily. B) Unit values are computed weekly and cash values are computed monthly. C) Unit values are computed monthly and cash values are computed weekly. D) Unit values are computed daily and cash values are computed monthly.
Answer: D Unit values are computed each day. Policy cash values are a monthly computation.
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) Ordinary income tax on earnings exceeding basis. B) 10% penalty plus payment of ordinary income tax on all funds withdrawn. C) 10% penalty plus payment of ordinary income tax on all funds withdrawn exceeding basis. D) Capital gains tax on earnings exceeding basis.
Answer: A 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 59-½.
A popular vehicle for saving for retirement is the variable annuity. An agent explaining the benefits of this product would probably be in violation of the NASAA Statement of Policy on Dishonest and Unethical Business Practices of Broker/Dealers and Agents by claiming that variable annuities offer: A) lower overall expenses than a mutual fund with similar investment objectives. B) tax deferral on earnings until withdrawn from the account. C) the choice of a large number different sub-accounts with varying objectives. D) the ability to transfer funds between sub-accounts without incurring a tax liability under IRS Code section 1035.
Answer: A In general, variable annuity expenses are higher than those of a mutual fund with similar objectives. That doesn't mean the fund is good and the VA bad, it is that there are guarantees and other features offered by the VA that a fund does not have and they have to be paid for.
A policy owner could surrender a whole life insurance policy and choose from all the following EXCEPT A) transferring the policy to another person B) taking the cash value C) purchasing an extended term life policy D) purchasing a reduced coverage whole life policy
Answer: A Life insurance policies are non-transferrable. Upon surrender, the cash value may be taken or used to purchase extended term insurance or a reduced value, paid up, whole life policy.
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) Flexibility of premium payments C) Greater guaranteed cash value D) Less risk in the underlying investment instruments
Answer: 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.
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 capital fluctuation. C) improper sub-account selection. D) potential inflation protection.
Answer: D 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, they typically carry high surrender charges.
A client who purchased a variable life insurance policy 15 months ago has suffered a stroke. In addition, he has developed adult onset diabetes. When receiving treatment for the stroke, he was diagnosed with lung cancer. He has decided to convert his variable policy to a whole life policy. Which of the following statements is CORRECT? He will not be able to convert to a whole life insurance policy because his health has deteriorated to such a severe level. The new policy will bear the same issue date and age as the original policy. The face amount must remain the same. The premium will be rated as his health has taken a marked turn for the worse. A) I and IV B) I, II, III and IV C) II, III and IV D) II and III
Answer: D Variable life insurance offers a unique conversion policy. Anytime during the first 24 months after policy issue, the policy may be exchanged for a whole life policy (or some similar form of permanent insurance if the company doesn't offer whole life) using the age and medical condition at issue regardless of the insured's current health. However, the face amount cannot be changed from its original amount.