Chapter 12 Annuities

Variable annuities are regulated by: A) the state insurance departments. B) the Securities and Exchange Commission. C) the National Association of Insurance Commissioners. D) both the state insurance departments and the Securities and Exchange Commission.

D

The annuitant of an annuity can be compared to which of the following with respect to a life insurance policy? A) Insured. B) Policyowner. C) Creditor. D) Beneficiary.

A

Employees of nonprofit charitable, educational, and religious organizations may participate in tax-sheltered annuity (TSA) plans.

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A principal function of annuities is to: A) liquidate an estate. B) create an estate. C) reduce income taxes. D) provide for surviving dependents.

A The principal function of life insurance is to create an estate. The principal function of annuities is to liquidate an estate.

Which of the following statements about annuities is NOT correct? A) The 10% penalty tax on early distributions does not apply to distributions made to pay for higher education. B) The 10% penalty tax is imposed on the interest earned and withdrawn, not on the principal. C) Annuities may be appropriate investments for both individuals and corporations. D) The 10% penalty tax on early distributions does not apply to distributions made to the annuity owner after separating from service from the employer after the owner reaches age 55.

A To ensure that annuities are used for retirement purposes, a 10% penalty tax is imposed on distributions from a deferred annuity to a person who has not yet reached age 59½. This penalty is imposed on the interest earned and withdrawn, not on the principal. However, the penalty tax does not apply to distributions made to an annuity owner who separates from service from an employer and has reached age 55. The penalty is also inapplicable to distributions made under a deferred annuity contract purchased by the employer at the termination of a qualified plan and held until the taxpayer separates from service.

Bill owns a nonqualified deferred annuity that has a current value of $50,000. He has 2 children, ages 11 and 17. If he decides to devote this annuity solely to help pay for their college education, which of the following is the best option if the goal is to maximize the annuity income payments? A) Convert to an immediate annuity using a 10-year period certain and life annuity income option. B) Convert to an immediate annuity using a 10-year period certain annuity option. C) Convert to an immediate annuity using straight life annuity income option. D) Convert to an immediate annuity with an installment refund annuity income option.

B Distributing a lump sum of money over a specified period of time with a period-certain-only annuity will generate a higher annuity payment amount than any option that includes a life contingency.

If an annuitant has a refund annuity and dies after the annuity income begins, his or her beneficiary will receive: A) a lump-sum cash payment equal to the starting annuity fund, less the amount of income already paid the deceased. B) a predetermined lump-sum cash payment. C) nothing. D) a lump-sum cash payment equal to the starting annuity fund.

A If an annuitant has a cash refund annuity and dies after the annuity income begins, his or her beneficiary will receive a lump-sum cash payment equal to the annuity fund, less the amount of income already paid the deceased.

What type of annuity payment option provides a guaranteed income to the annuitant for life and, if the annuitant dies before the annuity is depleted, a lump-sum cash payment to the annuitant's beneficiary? A) Cash refund option. B) Straight life option. C) Period certain option. D) Installment refund option.

A A period certain option guarantees payments for a certain amount of time, whether or not the annuitant is alive. The payments stop when the specified period is over. A straight life option pays the annuitant a guaranteed income for his or her lifetime. No further payments are made after the annuitant dies. An installment refund option pays out what is left to the beneficiary in the form of continued annuity payments.

Which annuity settlement arrangement guarantees to pay at least a minimum amount equal to the original investment? A) Installment refund annuity. B) Period certain annuity. C) Joint and full survivor annuity. D) Pure life annuity.

A An installment refund annuity assumes that the total annuity fund will be paid to the annuitant, his or her beneficiary, or both.

Annuities may be purchased with all of the following EXCEPT: A) a single payment that may be deferred for 5 years. B) a single lump-sum payment. C) a schedule of fixed payments. D) a schedule of flexible payments.

A Annuities may be purchased with a single lump-sum, a scheduled payment, or a flexible payment.

Sidney, age 58, owns a deferred variable annuity that he purchased 15 years ago and into which he has paid $25,000 in the form of periodic premiums. Today its cash value is $37,000. If he dies today, which of the following statements best describes the tax treatment this transaction will receive? A) Of the cash value, $25,000 is payable to the beneficiary income tax free, $12,000 is subject to income taxation, and there is a penalty tax. B) Of the cash value, $25,000 is payable to the beneficiary income tax free and $12,000 is subject to income taxation. C) Of the cash value, $12,000 is payable to the beneficiary income tax free and $25,000 is subject to income taxation. D) The full $37,000 is payable to the beneficiary income tax free.

B There are no tax-free death benefits associated with annuities as there are with life insurance. The portion of the cash value death benefit that constitutes gain is subject to income taxation. Because the payout is the result of death, there is no early withdrawal penalty tax.

Tony, age 65 and in excellent health, wants to buy an annuity with $100,000 he recently gained on the sale of his home. He wants to select an income option that will provide him the highest monthly income possible. Which annuity income option best meets Tony's objective? A) A straight life annuity income option. B) A 10-year period certain and life annuity income option. C) An installment refund annuity income option. D) It is not possible to answer this question with the limited information provided.

A Regardless of the annuitant's age, health, or marital status, a straight life annuity income option will provide more monthly income than any life annuity income option that includes a guarantee feature.

What are the 3 main types of Social Security benefits? A) Life insurance, disability, and retirement B) Death benefits, Medicaid, retirement C) Retirement, survivors, disability D) Retirement, disability, Medicaid

C

Annuity payments are taxable to the extent that they represent interest earned rather than capital returned. What method is used to determine the taxable portion of each payment? A) Marginal tax formula. B) Surtax ratio. C) Exclusion ratio. D) Annuitization ratio.

C An exclusion ratio is applied to each benefit payment the annuitant receives to determine the amount that is excluded from taxation: investment in the contract is equal to exclusion ratio divided by expected return. The investment in the contract is the amount of money paid into the annuity. The expected return is the annual guaranteed benefit the annuitant receives, multiplied by the number of years he or she will receive benefits.

All of the following statements about immediate annuities are correct EXCEPT: A) the income flow must be fixed rather than variable. B) they can only be funded with a single payment. C) they have relatively short accumulation periods. D) the first benefit payment is typically made one month from the purchase date.

A The income flow from immediate annuities can be either fixed or variable. With a fixed immediate annuity, the annuitant is guaranteed an income flow without risk of market fluctuations affecting the amount of income. With a variable immediate annuity, the investment risk is transferred to the annuitant. This means that once an income stream is created, the payments can increase or decrease depending on the performance of the underlying investments.

Premiums paid into a variable annuity, after deduction for expenses, are applied regularly to purchase: A) stock units. B) annuity units. C) variable units. D) accumulation units.

D

Annuities can be classified as immediate or deferred, depending on when benefits begin. An immediate annuity begins benefit payouts one payment interval following the annuitant's initial payment to the company. Immediate annuities are always purchased with a single payment. In contrast, a deferred annuity begins benefit payouts after a period longer than one payment interval.

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Tax-sheltered annuities are available to employees of certain nonprofit organizations, such as schools. Participants do not pay current taxes on their contributions, but will be taxed on benefits when they are received.

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