Unit 3- Annuity Plans

A client is in the annuitization stage of a variable annuity. If the separate account earned 8% during the current month, which of the following statements is correct? I-The next check will increase if the AIR is 5%. II-The next check will increase if the AIR is 10%. III-The number of annuity units owned will increase. IV-The number of annuity units owned will remain the same. A)II and III. B)II and IV. C)I and III. D)I and IV.

D)I and IV. During a period in which the separate account's performance exceeds the AIR, the next check will increase. Regardless of performance, once the contract is annuitized the number of annuity units remains unchanged. It is the value of the units that changes.

John is the annuitant in a variable plan, and Sue is the beneficiary. Upon John's death during the accumulation period, Sue takes a lump-sum payment. What is her total tax liability? A)None, because it is the proceeds from a life insurance company. B)The ordinary income on the proceeds over the cost basis plus 10% of the net gain (if any) if Sue is younger than 59½ years old. C)The entire amount is taxed as ordinary income, because it is not life insurance. D)The proceeds minus John's cost basis taxed as ordinary income at Sue's tax rate.

D)The proceeds minus John's cost basis taxed as ordinary income at Sue's tax rate. Annuity death benefits are generally paid in a lump sum. The beneficiary is taxed at ordinary income rates during the year the lump sum is received. The amount taxed is the amount of the lump-sum payment minus the deceased's cost basis in the investment.

Which of the following statements about a straight-life variable annuity is TRUE? A)The number of accumulation units a client owns never changes. B)The monthly payout is fixed to the Consumer Price Index. C)The number of annuity units a client owns never changes. D)If a client dies during the annuity period, the remaining funds are distributed to the beneficiary.

C)The number of annuity units a client owns never changes. Once annuitized, the number of annuity units remains fixed. For straight-life, the annuitant receives a check for the rest of their life (there is no beneficiary).

An investor purchased a variable annuity some years ago and has been making regular payments into it. He has encountered financial difficulties and asks his registered representative if he can arrange to delay his next few payments. The registered representative explains that: A)if he starts missing payments, there will be penalties. B)the customer should exchange his annuity for a variable life insurance contract under Section 1035 to avoid tax consequences. C)the customer may pay in as much or as little, as frequently or as infrequently, as he pleases, with no penalty. D)if he cannot meet his commitments, he should not have invested in the first place.

C)the customer may pay in as much or as little, as frequently or as infrequently, as he pleases, with no penalty. A variable annuity does not require scheduled premium payments. The customer may miss as many payments as he wishes with no fear of forfeiting earlier payments.

A 75 year old customer asks if it is possible to sell his $500,000 variable life insurance policy to a party other than the insurance company that issued the policy. If a sale occurs, known as a life settlement, which of the following would be a violation of FINRA rules? A)Requiring the customer to relinquish all ownership rights to the policy B)Quoting the price using an exclusive buyer that handles all the firm's life settlements C)Disclosing that the buyer becomes responsible for all premiums while the insured is living D)Not requiring the insured to pass a physical exam prior to the sale

B)Quoting the price using an exclusive buyer that handles all the firm's life settlements Because of the limited secondary market for life settlements, any firm that engages in these transactions should obtain several bids in order to ensure the customer receives a fair price for their policy.

Which of the following statements is TRUE regarding the annuity units during the annuitization period of a variable annuity contract? A)The number of units changes, but the valuation of each unit remains the same. B)The number of units remains the same, but the value of each unit changes. C)Both the number and the value of the units change. D)Both the number and the value of the units remain the same.

B)The number of units remains the same, but the value of each unit changes. During the payout phase of variable annuities, the number of annuity units will remain the same, but the value of each unit will vary. It is important to remember that an annuity unit is not the same as an accumulation unit.

During the accumulation phase of a variable annuity, the value of the contract owner's portion of the separate account is equal to: A)the number of annuity units times the value per unit. B)the number of accumulation units times the value per unit. C)the number of accumulation units minus the mortality expense multiplied by the value per unit. D)the annuitant's total investment divided by the number of accumulation units.

B)the number of accumulation units times the value per unit During the accumulation phase, a variable annuity contract holder owns accumulation units. The value of one accumulation unit multiplied by the number of accumulation units equals the total value of the contract holder's investment.

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)suitable because 1035 exchanges have no adverse tax consequences. B)unsuitable because of surrender fees. C)suitable because of the increased death benefit. D)unsuitable unless the customer agrees with the recommendation.

B)unsuitable because of surrender fees 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 late

If an annuity's separate account has a portfolio that contains mostly common stocks, what does this mean? I-In a rising market, the value of the account may rise. II-In a rising market, the value of an accumulation unit may rise. III-The owner of the annuity is protected from loss. IV-The owner of the annuity is guaranteed a minimum return. A)III and IV. B)I and III. C)II and IV. D)I and II.

D)I and II. The variable annuity owner assumes the investment risk of the contract. If the market rises, the separate account's value increases, reflecting an increase in accumulation unit value and, ultimately, in the account value. If the market falls, the separate account's value decreases.

When evaluating the purchase of an immediate variable annuity for a retiree, the most important factor in determining suitability is: A)the uncertainty of the amount of the monthly check. B)marital status of the annuitant. C)the guaranteed minimum check amount D)tax status of the annuitant.

A)the uncertainty of the amount of the monthly check. The most important factor to consider in purchasing an immediate variable annuity is that monthly payments are subject to fluctuation based on the performance of the separate account. There is no guaranteed minimum amount.

Jeremy has been investing in a variable annuity for the past six months and has paid $800 in sales charges. If he owns 1,000 accumulation units valued at $5 each, the value of his interest in the separate account is: A)$5,800.00 B)$5,000.00 C)$1,300.00 D)$4,200.00

B)$5,000.00 To determine the value of Jeremy's interest in the separate account, multiply the number of accumulation units by the value of each unit; sales charges are not a factor when calculating this value.

Which of the following statements regarding variable annuities and index annuities are NOT true? I-Both index and variable annuities are securities products. II-Index annuities provide a guaranteed minimum return, whereas variable annuities do not. III-Index annuities typically have longer surrender periods than variable annuities do. IV-Variable annuities typically have longer surrender periods than index annuities do. A)II and III B)I and IV C)I and III D)II and IV

B)I and IV Variable annuities are classified as securities; index annuities are not. Index annuities have a guaranteed minimum return and longer surrender periods.

Which of the following are advantages of a periodic payment deferred annuity over a lump-sum deferred annuity? I-Smaller individual payments spread out over time are easier to meet than a single large payment. II-Tax deferral of growth and accumulation is available only if periodic payments are made. III-Insurance companies must impose a higher sales charge if payment is made in a lump sum. IV-With periodic payments, the investor's commitment is spread out over years and is easier to reverse if necessary than is payment of a lump sum. A)II and III. B)I and IV. C)I and III. D)II and IV.

B)I and IV. Tax deferral is available for annuities whether they are bought with a lump sum or by periodic payments. Insurance companies are not required to impose a higher or lower sales charge according to the purchase method.

The value of which of the following is used to determine an annuitant's payment amount during the payout period of a variable annuity contract? A)Accumulation unit. B)Cost of Living Index. C)Annuity unit. D)Dow-Jones Industrial Average.

C)Annuity unit. The annuity unit is the accounting measure used to determine each payment amount during the payout period of a variable annuity contract.

Upon annuitization of variable annuities, holders receive the largest monthly payments under which of the following payout options? A)Life with period certain. B)Joint and last survivor annuity. C)Straight life. D)Cashing in the annuity.

C)Straight life. A straight life payout provides the investor with the largest payments when the contract is annuitized. Cashing in, of course, cannot be done if the contract is annuitized.

John owns a nonqualified, tax-deferred annuity. When he retires, what will be the tax consequences of his annuity payments? A)His annuity payments are all taxable as ordinary income. B)His annuity payments are partly taxable and partly tax-free return of capital. C)His annuity payments are partly taxable as capital gain and partly taxable as ordinary income. D)His annuity payments are tax free.

B)His annuity payments are partly taxable and partly tax-free return of capital. The key word here is nonqualifed! The investment John made was with after-tax dollars, the money grows tax-deferred, and only the earnings are taxed at distribution. A computation will be made at John's retirement called the exclusion ratio, to determine how much of each retirement payment will be treated as a return of cost basis and how much as taxable ordinary income. No annuity payment is treated as a distribution of capital gains.

If a variable annuity has an assumed interest rate of 5% and the annualized return of the separate account is 4%, the value of the: I-accumulation unit will rise. II-annuity unit will rise. III-accumulation unit will fall. IV-annuity unit will fall. A)I and II. B)I and IV. C)III and IV. D)II and III

B)I and IV. The accumulation unit will increase in value because the portfolio earned 4%. However, the annuity unit value will decrease because the actual return of the portfolio (4%) was less than the assumed interest rate of 5% necessary to maintain payment amount.

A variable annuity contract guarantees: I-a minimum rate of return. II-fixed mortality expense. III-capped administrative expense. IV-against investment risk. A)I and IV. B)II and IV. C)II and III. D)I and III.

C)II and III. A variable annuity does not guarantee an earnings rate; it lets the investor take the investment risk. However, it does guarantee payments for life (mortality), and normally guarantees that expenses will not increase above a specified level.

Which of the following statements characterize the accumulation phase of a variable annuity? I-The number of accumulation units remains constant as investment continues. II-The value of an accumulation unit increases only if the separate account outperforms AIR. III-The number of accumulation units increases as investment continues. IV-The value of an individual accumulation unit depends only on the performance of the separate account, regardless of AIR. A)I and II. B)II and III. C)III and IV. D)I and IV.

C)III and IV. During the accumulation phase of a variable annuity, the investor is purchasing accumulation units. The number of accumulation units increases each time a periodic payment is made, and their value depends only on the performance of the separate account. AIR becomes a factor only if the account is annuitized.

A variable annuity has an AIR of 4%. In January, the separate account earned 9%; in February it earned 6% and in March it earned 5%. Based on this information, how will the April payment compare to the March payment? A)Stay the same. B)Not enough information to tell. C)Lower. D)Higher.

D)Higher. Anytime the actual return exceeds the AIR, the next payment will increase. In March, the actual earnings were 5% and, because that is higher than the AIR of 4%, April's payment will go up. You must remember to only compare the actual to the AIR, not to the previous month's return.