Unit 15 Quizzes
Which of the following best describes the death benefit provision of a variable annuity? A) Upon death, the beneficiary will receive the benefit as a lump sum. B) The principal amount at death is the greater of the total of premium payments or the current market value. C) Upon death, the proceeds pass to the beneficiary free of federal income tax. D) If death should occur before age 59½, the 10% early withdrawal penalty does not apply.
B 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. Receiving the benefit as a lump sum is only one of the options available to a beneficiary of a variable annuity death benefit. There are others, such as annuitizing the benefit.
Variable life Policy Loans: Several testable facts about policy loans are as follows. - A minimum of 75% of the cash value must be available for policy loan after the policy has been in force three years. - The insurer is never required to loan 100% of the cash value. Full cash value is obtained by surrendering the policy to the insurer. - If the insured dies with a loan outstanding, the death benefit is reduced by the amount of the loan. - If the insured surrenders the contract with a loan outstanding, cash value is reduced by the amount of the loan.
Until a variable life policy is in force for a minimum of 3 years (this one is a bit less than 21⁄2 years), there is no requirement to make the loan provision available. Once the 3-year mark is reached, that minimum becomes 75% of the computed cash value
**Which of the following statements is TRUE concerning variable life separate account valuation? A) Unit values are computed weekly and cash values are computed monthly. B) Unit values are computed monthly and cash values are computed weekly. C) Unit values are computed daily and cash values are computed monthly. D) Unit values are computed monthly and cash values are computed daily.
**C Unit values are computed each day. Policy cash values are a monthly computation.
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) will always be at least equal to the guaranteed minimum specified in the contract C) may decrease over time due to the increase in surrender charges D) is tied to an investment index such as the Standard & Poor's 500
B 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 called "excess interest."
Your client purchased an index annuity from you last year with an investment of $100,000. The particular index tied to this product had an annual return of -4%. If the participation rate is 90% with a cap of 5% and no annual minimum guarantee, the value of the account would be A) $96,400. B) $100,000. C) $96,000. D) $103,600.
B Please note that the return is negative (-4%). An index annuity does not participate in losses of the index, only gains. With no gain, and no guaranteed annual minimum, the account value remains at $100,000.
A customer has a nonqualified variable annuity. Once the contract is annuitized, monthly payments to the customer are A) 100% tax deferred B) 100% taxable C) 100% tax free D) partially a tax-free return of capital and partially taxable
D 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.
***A 54-year-old individual invests $25,000 into a nonqualified single premium deferred variable annuity. Five years later, with an account value of $35,000, the investor engages in a Section 1035 exchange into a variable annuity issued by a different insurance company. Four years later, with an account value of $50,000, the investor withdraws $20,000. The tax consequence of the withdrawal is A) $15,000 of ordinary income, $5,000 nontaxable return of principal. B) $20,000 of ordinary income plus a 10% penalty tax. C) $15,000 of ordinary income, $5,000 of long-term capital gain. D) $20,000 of ordinary income.
***D A partial withdrawal from a nonqualified annuity is taxed on a LIFO basis. That is, the last money in (assumed to be earnings), is the first money out. The cost basis is the original $25,000. The 1035 exchange merely carried that cost basis over and resulted in no current tax on the $10,000 of earnings. When $20,000 is withdrawn, all of it represents the earnings and that is taxed as ordinary income. There is never capital gains taxation on an annuity and there is **no 10% penalty tax because this investor is older than 59½ at the time of the withdrawal.**
Thirty years ago, an investor deposited $100,000 into a single premium deferred variable annuity. Today, the value of the accumulation units is $1.5 million. The investor is ready to annuitize and wishes to maximize monthly payments to be received. You would suggest which of the following settlement options? A) Straight life B) Joint and survivor C) Life with 20 years certain D) Life with 10 years certain
A When one annuitizes, the amount of the annuity payment is highest when the annuitant takes the most risk (and the insurance company the least). Straight life payments end upon the death of the individual, and if that should be the following month, the insurance company keeps the rest of the money. In the period certain choices, the insurance company is "on the hook" for that number of years, even if the annuitant does not live that long.
Contribution and Taxation of Annuities: Contributions to an annuity that is not part of an employer-sponsored retirement plan (qualified annuities) are made with after-tax dollars, (nonqualified). - Cost basis is not taxed BUT interest, dividends, and capital gains in excess of cost basis are taxed as ordinary income at withdrawal Random withdrawals: Taxed under Last In First Out Method (LIFO) - earnings are considered to be drawn first (taxed as ordinary income), then the contributions are withdrawn tax free Lump-Sum Withdrawals: Lump-sum withdrawals are taken by using the LIFO accounting method. If an investor receives a lump-sum withdrawal before age 59 1⁄2, the earnings portion withdrawn is taxed as ordinary income and is subject to an additional 10% tax penalty under most circumstances (unless withdrawn after 59.5, death, disability, or part of life income plan with fixed payments) - Beneficiaries are taxed the same way
A contract with a $100,000 value consists of $40,000 in contributions and $60,000in earnings. If the investor withdraws all $100,000 at once, the $60,000 in earnings is taxed as ordinary income and the $40,000 cost basis is returned tax free. If the investor is at least 591⁄2, there is no 10% tax penalty; if younger, the 10% tax penalty applies. However, the penalty only applies to the taxable portion ($60,000)—there is never a penalty tax on money that is not taxable. If the investor withdraws $10,000, (or any amount up to $60,000), under the LIFO rule, it is considered a withdrawal of earnings and will be taxed as ordinary income. There is never a capital gain with an annuity.
The main benefit that variable life insurance has over whole life insurance is A) an adjustable premium B) the potential for a higher cash value and death benefit C) the availability of policy loans D) a lower sales charge
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.
Peter and Connie are thinking about selecting a settlement option for their variable annuity. If their objective is to have the annuity provide income until both of them are deceased, which of the following settlement options will best meet their needs? A. Straight life annuity B. Joint and survivor annuity C. Installment refund annuity D. Life annuity with period certain
B The joint and survivor annuity (choice B) will allow the couple to have the annuity provide income until both of them are deceased. The payment will be lower than on a straight life annuity because two lives are involved rather than one—more risk for the insurance company; less risk for the annuitants.
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 of the increased death benefit B) unsuitable unless the customer agrees with the recommendation C) unsuitable because of surrender fees D) suitable because 1035 exchanges have no adverse tax consequences
C 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.
The main benefit that variable life insurance has over whole life insurance is A) a lower sales charge B) an adjustable premium C) the potential for a higher cash value and death benefit D) the availability of policy loans
C 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.
Among the special characteristics of a universal life insurance policy is A) that policyowners may borrow against the cash value B) death benefits may increase above the initial face amount C) the policy may be overfunded D) early termination could lead to surrender charges
C This question is looking for a feature found in universal life that is not generally found in other forms of life insurance, i.e, something special. In the case of universal life, the policyowner is 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. Therefore, being able to borrow against the cash value is nothing special. Many forms of life insurance have surrender charges for early termination.
Concerning index annuities and their method of crediting interest, which of the following is TRUE? A) On average, annual reset has a higher participation rate than point to point. B) Annual reset offers the best return regardless of market fluctuations. C) Point to point offers the best return when the market has had a single drastic decline during the period. D) High-water mark with look back offers the best return during periods of high volatility.
D Using the annual high-water mark with look back will generally result in the highest return during periods of high volatility. The reason is because under this method, the highest anniversary value is used to determine the gain. In a volatile market, there is likely to be a high spike sometime during the period and that is the value used. The problem with point to point when there is a single drastic decline during the period is that the decline might occur at or just prior to the annual crediting computation. Annual reset does ignore the daily market fluctuations, but if the index is lower at the end of the year, there is nothing credited. In reality, annual reset has a lower participation rate than point to point.
Advantages to Investing in Variable Annuities Compared to Mutual Funds - Tax-deferred growth - Guaranteed death benefit: Most variable annuities offer an option stating that if the investor dies during the accumulation period, the beneficiary will receive the greater of the current value of the account or the amount invested. - Lifetime income: Although a variable annuity cannot guarantee how much will be paid, choosing a payout option with lifetime benefits gives assurance that there will be a check every month as long as the annuitant is alive. This benefit protects against longevity risk, the uncertainty that one will outlive one's money. - IRS Section 1035 exchanges: If you don't like the annuity you're in, you can exchange into another one without any tax consequences. However, it is possible there will be a surrender charge. This is unlike mutual funds, for which use of the exchange privilege is a taxable event. - No age 70 1⁄2 restrictions or requirements: Unlike traditional retirement plans that have required minimum distributions after the age of 70 1⁄2, an investor can delay withdrawals as desired and, in fact, can continue to contribute. - No contribution limits - Tax-free transfer between sub-accounts: Unlike mutual funds where the exchange between funds is a taxable event, the investor can transfer from one sub-account to another without any current tax liability. - No probate: Because the annuity calls for direct designation of a beneficiary, upon death, the asset passes directly without the time and expense of probate.
Disadvantages to Investing in Variable Annuities Compared to Mutual Funds - Earnings are taxed as ordinary income: Even though it is possible that most of the increase in value is generated through long-term capital gains, all earnings will be taxed at the higher ordinary income rate. - The administrative and insurance-related expense fees are typically much higher than the fees incurred by owning a mutual fund. - Withdrawals made before age 591⁄2 will generally incur a 10% penalty, in addition to the ordinary income tax. - Most variable annuities carry a conditional deferred sales charge. Therefore, surrender in the early years will usually involve additional costs.
Flexible premium payments are a feature of A) term life B) whole life C) universal variable life D) variable life
C Only universal and universal variable life policies have flexible premium payments.
Which of the following types of annuity settlement options provides a lifetime income to the annuitant regardless of how long he lives and the highest monthly payment amount? A. Straight life annuity B. Life annuity with period certain C. Installment refund annuity D. Joint and survivor annuity
Answer: A. A straight life annuity, (choice A), provides a lifetime income to the owner/annuitant regardless of how long he lives. If the annuitantis fortunate to outlive his anticipated life expectancy, he has made a wise distribution choice. However, if he dies shortly after beginning distribution, he has made an imprudent choice because, after the annuitant dies, the issuer makes no further payments. Nevertheless, for a given purchase price, a single life annuity provides the highest monthly payment amount because the annuity provides no guarantees beyond the annuitant's life.
1. 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. Tax treatment of the death proceeds D. Way in which the cash values are invested
Answer: D. Variable life insurance allows the policyowner to decide how the cash value is invested (choice D) through a number of subaccounts. With a whole life policy, all investment decisions are made by the insurance company.
The owner of a fixed annuity is protected against A) purchasing power risk. B) longevity risk. C) loss of money due to early death. D) inflation risk.
B Because a fixed annuity promises a fixed monthly payment for life, longevity risk is not a concern. However, the fixed payments are subject to purchasing power risk, also known as inflation risk. One other risk is that of dying after only receiving payments for several months after having chosen the life only option.
One way in which universal life and variable life are similar is that both A) have a fixed minimum cash value B) are considered securities C) have flexible premiums D) permit loans against the cash value
D As long as the policy has cash value, loans are permitted. Neither of these has a fixed minimum cash value, and only universal life has flexible premiums. Only variable life is considered a security.
****Life insurance is generally purchased to replace the lost income of the insured. A client wishing to purchase a policy with a level death benefit and level premium for as long as the premiums are paid would choose A) a 5-year renewable term policy. B) a decreasing term policy. C) a whole life policy. D) a universal life policy.
***C Whole life insurance is permanent insurance with a level premium and a level death benefit. The renewable term policy may have a level death benefit, but every 5 years, the premium will increase. Universal life has flexible premiums and, depending on the option chosen, the death benefit can increase.
***You have a 37-year-old client whose wife has just given birth to triplets. Because of the added responsibilities, he wants to maximize the amount of life insurance he can acquire. Which of the following types of insurance will give him the greatest amount of coverage for the lowest initial premium? A) Variable life B) Universal life C) Whole life D) Annual renewable term
***D At any given age, term insurance always carries the lowest premium and, of the term policies available, annual renewable term always has the lowest initial premium. Of course, because the premium tends to increase each year the policy is renewed, at older ages it can become unaffordable. But, remember, this question is only asking about initial cost.
If a client wishes to purchase a life insurance policy that doesn't invest in the market, but allows the holder to pay additional premium if desired, the recommendation is A) universal life. B) index annuity. C) term life. D) variable life.
A Universal life (not universal variable life) does not invest in the market through a separate account. That is only true of life insurance policies using the word "variable." These policies are frequently overfunded (premium over the required amount is paid-in by the policyowner). Term life cannot be overfunded and annuities of any type are not life insurance policies.
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. A) I and II B) III and IV C) I and IV D) II and III
C 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.
Annuitized payouts are typically made monthly and are taxed according to an exclusion ratio. The exclusion ratio: expresses the percentages of the annuity's value upon annuitization of contribution basis to the total. (contribution basis:Total) ***Upon annuitization, there is never a 10% tax penalty, even if annuitization commences before age 59 1⁄2.***
If $50,000 in after-tax dollars was contributed to an annuity contract worth $100,000 at annuitization, 50% of each payment will be treated as ordinary income, whereas the other 50% of each payment will be treated (for tax purposes) as nontaxable return of basis.
Term insurance: is protection for a specified period, hence the description, term. Term insurance provides pure protection and is the least expensive form of life insurance. - the term may be 1 year, 5 years, 10 years, 30 years, or to a specified age (such as age 65). - They pay the death benefit only if the insured dies during the term of coverage. For example, a person buying a 20-year term policy at age 35 who dies at 56 will receive nothing. - **For test purposes, younger people with children are better off purchasing term insurance because the lower premiums allow significantly more protection. For those age 60 and older, the rates are generally prohibitive.*** whole life insurance (WLI): provides protection for the whole of life. Coverage begins on the date of issue and continues to the date of the insured's death, provided the premiums are paid. The benefit payable is the face amount, or face value, of the policy, which remains constant throughout the policy's life. The premium is set at the time of the policy's issue and it, too, remains level for the policy's life. - Unlike term insurance, which provides only a death benefit, WLI combines a death benefit with an accumulation, or a savings element. This accumulation, commonly referred to as the policy's cash surrender value, increases each year the policy is kept in force. In traditional WLI, the insurer invests reserves in conservative investments Policy Loans: Once an insured has accumulated cash value, it cannot be forfeited. An insured may cash in a policy at any time by surrendering it in exchange for its cash value. - An insured may also borrow a portion of the cash value in the form of a policy loan, but this must be paid back (with interest) to restore policy values. universal life policies: that might pay higher interest rates (such as 8%, 10%, or even 12%) during inflationary times. These policies also provide greater flexibility, because they allow policy owners to adjust the death benefits and/or premium payments based on current needs assessment.
Surrendering the Policy If the policy owner decides to stop paying the premiums, the policy owner 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; or - take extended term insurance which pays the beneficiaries the full face amount if death occurs within a specified time period.
