Series 6 Chapter 7
Life Income with Refund (Unit Refund Life)
Annuity income is payable for the lifetime of the annuitant. Upon death, if an annuitant has not received an amount equal to the total of all payments made into the annuity (not including growth), the balance is refunded to the beneficiary, either in a lump sum cash refund or in installments.
Joint and Last Survivor
Annuity income is payable to 2 named annuitants (in one check) while both are living. Upon the death of the first annuitant, survivor benefits continue, either paying the full amount or reduced to 2/3 or 1/2 for the survivor's income until the survivor dies. These options may be referred to as joint and full survivor, joint and 2/3 survivor, or joint and 1/2 survivor.
A variable contract must be sold by: A An illustration B A prospectus C Direct mail D A person in the business at least 5 years
B A prospectus The securities held in the separate account must be registered with the SEC, and each offering is considered a new issue, requiring a sale by prospectus only.
A client inherits a substantial sum of money and wants to have the money distributed to their heirs over the rest of the client's life. Which product offered by the life insurance industry will allow them to accomplish this? A Flexible pay out arrangement B An immediate annuity C Deferred distribution arrangement D Systematic installment
B An immediate annuity An immediate annuity involves payment of a single sum to the annuity, with periodic payments commencing within 1 year of deposit of the sum.
How often must the death benefit on a variable life insurance policy be calculated? A Monthly B Annually C Semiannually D Daily
B Annually The NAV of the subaccounts within the separate account must be computed daily. The cash value of the contract must be computed at least monthly. The death benefit of the policy must be computed at least annually.
Retirement Accounts
Since VAs are a tax-deferred vehicle, the recommendation to purchase them in a retirement account must be done for reasons other than tax savings, such as guaranteed income or death benefits. Since VAs are intended as a supplement to retirement income, investors should maximize their contributions into retirement accounts before funding a VA.
Death Benefits
Since annuities are contracts between an investor and an insurance company, the proceeds, if there are any, go to the beneficiary if the annuitant dies during the accumulation period. If the annuitant dies prior to annuitization, the beneficiary will receive the greater of the current value of the contract or the owner's cumulative premiums, paid less any withdrawals.
Annuitization
The choice to receive payments from the annuity account for life or for a specified period, depending on the settlement option selected
Funding
The preferred funding method for purchase of a contract is currently available cash. Cashing out existing annuity or insurance contracts to purchase a new contract is only suitable in certain circumstances, and any such recommendations may be considered abusive. Withdrawing money from the value of a home or existing property to enable the purchase of a variable annuity is also considered unsuitable.
The number of votes is determined by
account value as of the record date for the meeting, which can be 90 days or more before the meeting
Investments made into variable contracts are used to purchase
accumulation units.
The original principal is
distributed tax-free, and earnings are taxable as ordinary income.
Expense Guarantee
equal to a certain percentage of the account value, that compensates the insurance company for future operating expense risks it assumes under the annuity contract.
immediate annuity
generates income immediately after the first deposit is made into the account. income must begin within 1 year of the issue date, and there must be no accumulation period.
If the actual performance of the separate account is greater than the AIR, the amount of the next payment will
increase
The maximum allowable sales charge for a variable life insurance policy
is 9% over the life of the contract. The life of the contract, for purposes of this calculation, is 20 years.
annuity
is a contract issued by a life insurance company where the contract owner, makes payments (premiums) that are invested in a tax-deferred account.
Variable life insurance
is a permanent life insurance policy that protects the insured for life, provided the required premiums are paid.
Guaranteed Minimum Income Benefit Riders (GMIBs)
is also offered by many insurers. This rider guarantees a minimum income benefit regardless of the contract value. The contract will pay a specified amount of income even if there is not enough money in the contract to support those payments. This rider also comes with additional fees.
Assumed Interest Rate (AIR)
is an arbitrary interest rate used by the insurance company to project the rate of growth of the separate account during the contract's payout period.
1035 Exchange
is avoiding a current income tax liability. The taxation will be deferred to the future when the cost basis and gains are transferred to a new insurance policy. All other aspects of the new contract must remain the same.
Any benefit above the contract's cost basis
is taxable to the beneficiary as ordinary income.
accumulation period
is the pay-in phase of the annuity, beginning when the first deposit or premium is made. Earnings grow tax deferred during this time period. The owner can fund an annuity with a single premium or make periodic premium payments. Periodic premiums can be scheduled or made at the owner's discretion.
Death benefits on annuity contracts do not
pass tax-free to the beneficiary.
accumulation phase
phase where the investor contributes money to the contract
Variable universal life
policies combine the investment choices of the separate account in a variable life policy with the flexibility offered in a universal policy. The premiums paid for a variable universal life policy are directly deposited in the separate account, with no guarantees as to death benefits payable or cash value growth
Investments in the subaccounts can only be sold through a
prospectus.
f the actual performance of the separate account is the same as the AIR, the amount of the next payment will be
the same as the previous month (not the initial payment)
If separate account performance deteriorates, policyowners have a grace period
(often 31 days) to repay at least a portion of outstanding loans
Administrative Expenses
A charge for recordkeeping and other administrative expenses. This might be charged as a flat account maintenance fee on a monthly or annual basis. Some refer to this as a policy fee, and it can be waived once the policy has exceeded a certain value.
Variable Payout
Principal balance of the contract Annuitant's age Payout option selected Assumed interest rate (AIR)
Policyowners can exchange their variable contract for a traditional whole life contract. Federal law requires that the owner be allowed to make this exchange for a minimum of
2 years from the original contract date
Each policyowner must be provided with a minimum
45-day free look provision.
Insurance companies typically allow the policyowner to borrow up to
75% to 90% of the cash value
A customer owns a variable life insurance contract and wishes to utilize the conversion privilege. How long is the conversion window available for the customer? A 24 months from the date of issuance of the variable life insurance contract B 30 days from the date of issuance of the variable life insurance contract C The conversion privilege is a permanent feature of the contract that does not expire D 7 business days from the date of issuance of the variable life insurance contract
A 24 months from the date of issuance of the variable life insurance contract Variable contract owners may convert or exchange their policy to whole life within 24 months from the date of issuance without evidence of insurability.
Which of the following is not a feature of both variable life and variable universal insurance policies? A Both have fixed premiums B Both are securities C Both have a variety of investment options in the separate account D Both allow policyowners to take loans against the cash value
A Both have fixed premiums Variable life and variable universal insurance are both considered securities. Variable life insurance requires the owner to pay a fixed and level premium. Premiums paid for a variable universal life policy are flexible based on the performance and values held in the separate account. The owner may increase, decrease, or choose to skip premiums, and the face amount of the policy is adjustable.
Which of the following is not true regarding the assumed interest rate (AIR) of a variable annuity? A It changes each year throughout the life of the contract B It is used in determining the amount of the initial payment C It is used as a comparison to actual investment performance when determining future payments D If the actual performance of the separate account is greater than the AIR, the amount of the next payment will increase
A It changes each year throughout the life of the contract The AIR of a variable annuity contract remains unchanged throughout the life of the contract.
When recommending a variable annuity to a prospect, which would not be a consideration? A Marital history B Their savings account C Their employer's pension plan D The amount of their insurance
A Marital history While marital status is a suitability factor, marital history is not. Each of the other factors is relevant in determining suitability of a variable annuity.
A client has invested $74,000 into a nonqualified variable annuity. At retirement, the annuity is worth $220,000. The taxable portion of withdrawals will be treated as: A Ordinary income B Passive income C Tax-exempt D Capital gain
A Ordinary income Nonqualified annuities are those that are funded with after-tax dollars. Since taxes have already been paid on the contributions, this portion is returned to the customer tax-free when withdrawn. Taxes will be due on any distributed earnings. However, one downside to the tax deferral provided by annuities is that they are not eligible for long-term capital gains treatment. Any portion of the distribution that is taxable (earnings) will be taxed at ordinary income rates. This question asks only about the taxable portion, and therefore the client will pay ordinary income tax on that portion of the withdrawal.
All the following are types of annuities, except: A Periodic payment immediate contract B Single premium immediate contract C Periodic payment deferred contract D Single premium deferred contract
A Periodic payment immediate contract A periodic payment immediate contract is not allowed.
During the accumulation period of a variable annuity, the assets of the separate account could decrease as a result of all the following, except: A Sales charges B Administrative expenses C Investment management fee D Mortality and expense risk
A Sales charges If the variable annuity imposes sales charges, those are deducted from the premium before it is invested into the separate account. Therefore, sales charges would not cause a decrease in the assets of the separate account. Other expenses and fees that are deducted from the assets of the separate account will cause a decrease. These include the investment management fee, mortality and expense risk, premium taxes, and administrative expenses. Additionally, a decrease in the separate account may be attributed to the performance of the subaccounts.
A customer owns a $500,000 variable life insurance policy that has a cash value of $120,000. Their registered representative has recommended that they take a $100,000 loan from the policy to invest in the ABC Growth Fund. The ABC Growth Fund charges a 4% front-end sales charge. This recommendation is: A Unsuitable B Unsuitable only if the customer is age 59 1/2 or older C Suitable if the interest on the loan is less than the sales charge to be paid on the mutual fund investment D Suitable for all investors
A Unsuitable The variable life policy that the customer owns probably has subaccount options similar to the ABC Growth Fund. Therefore, taking out a loan, paying interest on the loan and a 4% front-end sales charge, is clearly an unsuitable recommendation that will accomplish little more than adding a commission to the RR's ledger.
Waiver of Surrender Charges
A common provision in an annuity contract is the waiver of surrender charge. This provision waives or reduces the surrender charge penalty if the annuitant needs access to the annuity funds due to a disability or confinement in a nursing home. In most cases there is no charge for this.
Charges for Special Features
Additional fees and charges apply to special features added to a variable annuity, such as the stepped-up death benefit, guaranteed minimum income benefit, or long-term care insurance rider
Life Income (Pure or Straight Life)
Annuity income is payable for as long as the annuitant lives, and upon death all payments cease. This option provides the highest monthly income compared to any of the other options.
Life Income Period Certain (Life with Period Certain)
Annuity income is payable for life, or for a specified period of time, whichever is longer. If the annuitant lives beyond the stated period, benefits continue for the life of the annuitant. If the annuitant dies prior to the end of the period certain, a beneficiary receives the balance of payments for the remaining time period.
Which of the following statements is an accurate description of what happens upon annuitization? A The contact is converted to a life insurance contract with a death benefit B The accumulation period ends, and the contract begins to make payments to the annuitant based partly on the payment option selected C The contract is surrendered, and the earnings are now taxable in a lump sum D The contract adds all investment earnings to the premium payments
B The accumulation period ends, and the contract begins to make payments to the annuitant based partly on the payment option selected Once a contract is annuitized, the insurance company takes ownership of funds in the account. In return, the annuitant is entitled to a guaranteed income stream based on the terms of annuitization. Annuity income is based on annuity tables, which are similar to mortality tables used for life insurance. Other factors that determine the income include the accumulation amount, interest rate return, age and gender of the annuitant, and the payment option selected.
Your client was a professional baseball player who had contributed $1 million to a single premium deferred annuity (SPDA) during their playing days. Unfortunately, their career was cut short at the age of 32 due to a severe ankle injury. To make ends meet, the former gold glove winner took a job doing radio commentary for a minor league team. Your client makes occasional withdrawals from the SPDA to supplement their radio broadcast earnings. What is the tax treatment of the annuity contract distributions? A The client may be subject to a 10% tax penalty on the entire amount of any distributions taken prior to age 59 1/2 with withdrawals being taxed on a FIFO basis B The client may be subject to a 10% tax penalty on the taxable portion of any distributions taken prior to age 59 1/2 with the withdrawals being taxed on a LIFO basis C The client will be subject to taxation on a FIFO basis D All withdrawals are 100% taxable as long-term capital gains
B The client may be subject to a 10% tax penalty on the taxable portion of any distributions taken prior to age 59 1/2 with the withdrawals being taxed on a LIFO basis Annuity distributions taken prior to age 59 1/2 are typically subject to a 10% penalty on the taxable portion of the distribution. If a contract holder takes withdrawals from their annuity but does not annuitize, the earnings are assumed to be withdrawn first. This is considered LIFO treatment. If the contract holder were to annuitize, the resulting payments would be a blend of principal and interest. Although their career ended due to an injury it was not a total disability which would have allowed the client to claim an exception to the early withdrawal penalty. All earnings are taxed at ordinary income levels, never as capital gains.
All the following statements regarding variable contracts are true, except: A Variable contracts require delivery of a prospectus prior to or at the time of the sale B The insurance company that issues the contract retains the investment risk C Variable contracts offer the contract owner voting rights on matters affecting the separate account D Variable contracts are regulated at the federal and state level
B The insurance company that issues the contract retains the investment risk Variable contracts are products sold through insurance companies that contain investment options that subject the owner to market risk. Variable contracts are regulated at the state level, by the state insurance department, and at the federal level by the SEC. The contract owner of a variable product has the right to vote on matters affecting the separate account. The insurance company agrees to vote, by proxy, the shares of each contract owner based upon the instructions received from those owners. A customer must be furnished with a copy of the prospectus prior to or at the time of the sale and cannot be altered in any way. The prospectus will detail all fees and risks associated with the product and explain the various investment choices available.
An investor is considering purchasing life insurance and would like a permanent policy with the most flexibility possible in terms of premium payments and investment choices. The best choice for this investor would be: A Whole life B Variable universal life C Variable life D Universal life
B Variable universal life All the mentioned policies are permanent insurance. Whole life has fixed premiums, and any cash value is invested in the insurance company's general account. Universal life has flexible-premium options, but the cash value must also go to the general account. Variable life offers investment choices, but again has fixed premiums. Variable universal life (VUL) would provide the greatest flexibility in terms of both premium payments and investment choices.
An individual has invested $160,000 in a variable annuity that has a current market value of $126,000. During the accumulation period, the annuitant unexpectedly dies. What funds will the heirs be entitled to upon the annuitant's death? A None, the individual died during the accumulation period B $126,000 C $160,000 D A minimum of 90% of the contract's current market value
C $160,000 During the accumulation period, the death benefit is the greater of the contributions made into the contract or the current market value.
Which one of the following is not permitted under the 1035 exchange rules? A Life to life B Life to annuity C Annuity to life D Annuity to annuity
C Annuity to life The value of a 1035 exchange is avoiding a current income tax liability. The taxation will be deferred to the future when the cost basis and gains are transferred to a new insurance policy. An investor can utilize a 1035 exchange from one insurance policy to another insurance policy, one annuity contract to another annuity contract, or a life insurance policy to an annuity contract. An exchange from an annuity to a life policy is not permitted under a 1035 exchange.
How often is the net asset value of a variable annuity usually calculated? A Weekly B Twice each day C Daily D Monthly
C Daily The net asset value (NAV) of a variable annuity is usually calculated at the end of each trading day. Annuities can calculate it more often, but the tendency is to do a daily calculation so that investors can identify the value of their investments daily.
All the following statements are true regarding death benefits for annuities, except: A In the accumulation phase, variable annuities pay out a death benefit equal to the greater of all premium payments or the current NAV of the contract B Fixed annuities will pay the current cash value to beneficiaries C Death benefits are exempt from taxes D In a straight life payout option, no death benefits are payable if the annuitant dies during the annuity period
C Death benefits are exempt from taxes During the accumulation period, annuities typically pay a death benefit which is the greater of the premiums paid or the current value of the contract. Death benefits from an annuity are subject to taxes on any amount above the original cost basis. All the other statements are true.
All the following statements are true regarding VUL policies, except: A Policyowner may skip premium payments B Premiums are deposited in the separate account C Death benefits have a minimum guarantee D Cash value is not guaranteed
C Death benefits have a minimum guarantee Variable universal life policies do not guarantee a minimum death benefit.
Which of the following variable annuity riders will provide a specified minimum amount of income: A Waiver of premium rider B Disability rider C Guaranteed minimum income benefit rider D Long-term care rider
C Guaranteed minimum income benefit rider This GMIB rider guarantees a minimum income benefit regardless of the contract value.
All the following regulate variable annuities, except: A Securities Act of 1933 B Securities Exchange Act of 1934 C Insurance Company Act of 1940 D Investment Company Act of 1940
C Insurance Company Act of 1940 The Securities Act of 1933 is the federal law that regulates issuers and securities in the primary market. The Investment Company Act of 1940 was designed to protect investment company shareholders from self-dealing and other conflicts of interest by those who operate and distribute such investments, including investment advisers acting as portfolio managers. The Securities Exchange Act of 1934 regulates broker-dealers and the sales practices regarding variable products. There is no Insurance Company Act of 1940.
Which statement is false regarding the taxation of an annuity if the annuitant should die during distribution? A If the annuitant chose the life income option, nothing is included in the gross estate B If a lump sum goes to a beneficiary, only the amount in excess of the policyowner's investment is included in the beneficiary's gross income for federal tax purposes C Interest earned during the accumulation period is not taxable D If annuity payments are to continue to another person upon an annuitant's death, the survivor's proceeds are included in the gross estate
C Interest earned during the accumulation period is not taxable Interest earned during the accumulation period is tax deferred, not tax-free. The other statements are accurate.
A client recently annuitized and selected a payout option that will provide income only while living. However, if this client dies before receiving the amount contributed to the annuity, their beneficiary will receive a lump sum payment for the balance of the principal. What payout option has been selected? A Joint and last survivor B Straight life C Life income with refund D Life with period certain
C Life income with refund Under a cash refund life payout option, the annuitant will receive payment for life. But, if the client dies before at least receiving the amount that was contributed, a beneficiary will receive a refund of the rest of that amount.
Under which of the following circumstances is it permissible for a FINRA member firm to advertise a variable annuity as an acceptable short-term investment option? A The annuity is being purchased inside of a tax-advantaged account B The annuity has a CDSC of 2% or less C Never, this practice is a direct violation of FINRA rules D The annuity is being purchased by an aggressive investor
C Never, this practice is a direct violation of FINRA rules Considering that variable life insurance and variable annuities frequently involve substantial charges and/or tax penalties for early withdrawals, there must be no representation or implication that these are short-term, liquid investments. Presentations regarding liquidity or ease of access to investment values must be balanced by clear language describing the negative impact of early redemptions. Examples of this negative impact may be the payment of contingent deferred sales charges and tax penalties, and the fact that the investor may receive less than the original invested amount. With respect to variable life insurance, discussions of loans and withdrawals must explain their impact on cash values and death benefits.
An annuity contract contained a stepped-up death benefit rider. The annuitant was receiving payments under the life income payout option. Upon the annuitant's death, what amount will the beneficiary receive? A The stepped-up value minus any withdrawals B The greater of the current contract value or a stepped-up value minus withdrawals C Nothing D The current contract value
C Nothing Since the annuitant was receiving payments under the life income payout option, the beneficiary is entitled to no benefit upon the annuitant's death. It makes no difference which death benefit option the contract owner chose if, upon annuitization, the option chosen was straight life income.
In a variable annuity, the investment management fee is deducted from the: A Sales charge B Monthly payment upon annuitization C Subaccount D Premium
C Subaccount The investment management fees are separately charged in each of the subaccounts and are the same as an investment adviser's fee in a mutual fund.
A 45-year-old individual has invested $74,000 into a nonqualified variable annuity. The contract value is currently $220,000. If they withdraw $10,000 to pay for private high school tuition for their son, what will be the tax implications? A Taxes on $10,000 B A $1,000 penalty C Taxes on $10,000 and a $1,000 penalty D $1,000 in taxes
C Taxes on $10,000 and a $1,000 penalty The IRS treats this distribution as LIFO, so the withdrawal is considered 100% earnings for tax purposes. The investor will owe taxes on the full $10,000 and will have to pay a penalty of 10% ($1,000 in this case) on the amount withdrawn since they are younger than age 59 1/2.
A client has contributed $24,000 into a nonqualified variable annuity over 10 years. The current contract value is $40,000. The client annuitizes the contract and starts receiving a $600 monthly payment. The monthly payment has $360, which is considered return of capital. What are the tax consequences? A The payment will include $240 of tax-free return of premium B The payment will include $360 of ordinary income C The contract has $16,000, which has accumulated tax deferred D The cost basis is greater than $24,000
C The contract has $16,000, which has accumulated tax deferred This client's cost basis is equal to their non-deductible contributions of $24,000. The difference between the cost basis and the current contract value has accumulated tax deferred. Contract value of $40,000 minus the cost basis of $24,000 equals accumulated amount of $16,000. The $16,000 is taxable as ordinary income when it is withdrawn. Out of the $600 payment, $360 is return of capital which means it represents part of the $24,000 which has already been taxed. The other $240 is part of the $16,000 which has not been taxed.
Which of the following statements is true regarding variable annuity contractual provisions? A The mortality expense charge compensates the beneficiary of a deceased annuitant if the annuitant dies before their life expectancy B The expense charge refunds contract owners if the actual expenses are less than the anticipated expenses under the annuity contract C The expense charge compensates the insurance company for future operating expense risks it assumes under the annuity contract D The mortality expense charge compensates the annuitant that chooses a life income annuity, providing a greater monthly benefit for the risk of premature death
C The expense charge compensates the insurance company for future operating expense risks it assumes under the annuity contract The expense charge compensates the insurance company for future operating expense risks it assumes under the annuity contract. The mortality expense charge compensates the insurance company for the life-expectancy risks it assumes under the annuity contract.
What would be payable to a beneficiary in the event an annuitant dies during the accumulation period? A The amount paid into the contract (cost basis) only B The lesser of the annuity balance or the amount paid into the plan C The greater of the annuity balance or the amount paid into the plan D The face amount
C The greater of the annuity balance or the amount paid into the plan Should an annuitant die during the accumulation period, the beneficiary is assured of receiving the annuity balance or the cost basis, whichever is greater.
Which of the following statements is false regarding the contract life cycle of a variable annuity? A During the pay-in phase the value of the annuity is based on accumulation units held B The variable annuity grows tax deferred C The number of annuity units will fluctuate D During the payout phase, each payment will vary depending upon the performance of the separate account compared to the AIR
C The number of annuity units will fluctuate The premiums are invested in the separate account and used to purchase accumulation units. The owner chooses the mix of subaccounts to invest in. The accumulation units grow on a tax-deferred basis. When the contract owner annuitizes the contract, the accumulation units are converted into a fixed number of annuity units. The annuitant's payment will fluctuate monthly based on the performance of the separate account compared to the assumed interest rate (AIR).
Which of the following statements is true regarding a variable annuity that offers a guaranteed minimum income benefit (GMIB)? A This is a required provision that guarantees an annual "raise" based on the CPI during the annuity period B This is a required provision that guarantees a minimum death benefit if the annuitant dies before receiving the total value of the separate account C This is an optional rider that guarantees a minimum monthly benefit during the annuity period D This is an optional rider that guarantees a maximum rate of return that will be applied to the separate account
C This is an optional rider that guarantees a minimum monthly benefit during the annuity period Variable annuities may offer additional optional features for an extra premium charge. A guaranteed minimum income benefit guarantees a minimum monthly benefit, even if there's not enough money in the account to support the payout.
An individual owns a variable life insurance policy. They are looking to purchase a new sailboat. The individual is considering taking a loan against their life insurance policy to complete the transaction. Which of the following statements concerning variable policy loans is correct? A Policyowners are only permitted to take loans if they are first time home buyers B Variable life policies do not have loan features C Typically, policyowners are only able to borrow a portion of their policy's cash value D Policyowners are permitted to borrow 100% of their policy's cash value
C Typically, policyowners are only able to borrow a portion of their policy's cash value Variable life insurance contracts typically allow the owner to borrow a portion of the contract's cash value. Many policies will allow the owner to borrow 75%-90% of the cash value once the contract has been in force for a minimum time period (typically three years). There are no restrictions regarding the use of the borrowed funds.
Which of the following would be considered securities? A Term insurance B Whole life insurance C Variable life D Universal life
C Variable life Variable insurance, variable universal life, and variable annuity products are considered securities. Term, whole life, and universal life are fixed products that are not securities.
A client has approximately $10,000 earmarked for their grandchildren. They are most concerned with finding a suitable insurance product that would provide their heirs with a current substantial death benefit and protection for their savings against the ravages of inflation. Which of the following products would best meet this client's needs? A Term life insurance B Whole life insurance C Variable life insurance D A variable annuity
C Variable life insurance Although both variable annuities and variable life policies provide an inflation hedge, the client is looking for a product that would provide their heirs with a current substantial death benefit. If the client were to die in the near term, the variable annuity would only pay the heirs the greater of the contract's current market value or the original investment. In addition, the client can purchase substantially more face value of a variable life policy thus providing a greater current death benefit. Variable life insurance is a better choice based on this client's needs. Term and whole life policies are not good hedges against inflation.
If a withdrawal is taken from a nonqualified annuity prior to age 59½, a penalty tax of _____ % may be assessed on the taxable portion of the early distribution. A 5 B 15 C 20 D 10
D 10 In any nonqualified annuity, if a withdrawal is taken prior to age 59½, a 10% federal penalty tax is assessed on the taxable portion of the early distribution, unless an exception applies.
Which of the following situations is considered a 1035 exchange? A A customer wants to exchange an annuity policy for a life insurance policy B A customer wants to exchange shares in a growth mutual fund for shares in an income mutual fund and both funds have different investment advisers C A customer wants to exchange a whole life policy for a variable annuity and have the benefits payable to a different person D A customer wants to exchange a whole life insurance policy for a variable life insurance policy of a different insurer
D A customer wants to exchange a whole life insurance policy for a variable life insurance policy of a different insurer A 1035 exchange is a tax-free exchange when accumulated cash values are transferred from one type of policy to another or one company to another. The tax-free exchange rules allow a person to exchange a life insurance policy for an annuity, but not to exchange an annuity for life insurance. Mutual fund shares do not qualify for the 1035 exchange. A life insurance policy being exchanged for another life insurance policy qualifies as a tax-free exchange. A whole life policy could be exchanged for an annuity, but not one written on a different person.
All the following are similarities between an open-end investment company and a variable annuity, except: A Types of securities holding B Administrative expenses C Investment management fees D Mortality risk
D Mortality risk Both mutual funds and variable annuities have investment managers. The mutual fund has the board of directors and the variable annuity has the board of managers. Both investments levy administrative fees. Investments may be similar in that both could purchase similar types of investments including common stock and bonds. Variable annuities will pay a guaranteed income for life, but mutual funds will not.
Which of the following risks are assumed by the insurance company for a variable annuity? A Expense risk and investment risk during the accumulation period B Investment risk during the accumulation and annuity periods C Mortality risk and investment risk during the annuity period D Mortality risk and expense risk
D Mortality risk and expense risk The insurer does not assume investment risk at any time in a variable annuity. If the insurer offers a minimum death benefit equal to premiums paid, it does absorb some risk (for which a premium is charged) that the cash value will be below what was paid into the annuity at the time the annuity holder dies.
If a death benefit is paid to a deceased beneficiary's children, the designation is specified as: A Contingent B Per capita C Tertiary D Per stirpes
D Per stirpes A per stirpes designation specifies that a deceased beneficiary's benefit would follow the bloodline and pay to children or grandchildren. Per capita specifies that the benefit will only be paid to the surviving beneficiaries.
According to FINRA, who is responsible for design and implementation of product specific training, policies, and programs to ensure the RR is complying with the appropriate regulation regarding selling deferred annuities to a customer? A The RR B The principal C The SEC D The broker-dealer
D The broker-dealer Member firms (broker-dealers) are responsible for designing and implementing the training policies and programs designed to ensure that RRs are disclosing suitability information correctly to customers regarding deferred variable annuities. Registered principals are the ones who conduct the sessions on behalf of the firm.
All the following statements are true about variable insurance policy valuations, except: A The separate account NAV is calculated daily B The death benefit is calculated on an annual basis C The cash value changes based on market fluctuation D The cash value must be calculated at least daily
D The cash value must be calculated at least daily Similar to a mutual fund, the separate account net asset value (NAV) is calculated daily at 4 p.m. Eastern, the close of the NYSE. The policy's cash value will fluctuate based on the performance of the underlying investments held in the separate account and must be calculated at least monthly. The death benefit on a variable life insurance policy is calculated on an annual basis.
Once an annuity is annuitized, who takes ownership of the funds in the annuity? A The beneficiary B The annuitant C The owner D The insurer
D The insurer Once a contract is annuitized, the insurance company takes ownership of funds in the account.
What is taxable on a periodic payment made to the annuitant in the payout period? A The payment less its proportionate share of the cost basis B No payments until the cost basis has been paid out C All payments until the value of the account falls to below the cost basis D The payment less: the cost basis for the entire contract divided by a mortality factor
D The payment less: the cost basis for the entire contract divided by a mortality factor Annuity payments received upon annuitization are a combination of the original principal and earnings. The original principal is distributed tax-free and earnings are taxable as ordinary income. The exclusion ratio determines the return of cost basis. Exclusion Ratio = Cost Basis ÷ Expected lifetime payments
Which of the following is an example of a 1035 exchange? A The beginning of the annuitization phase of an annuity B A type of mutual fund exchange privilege C The transfer of assets between pension plans D The tax-free exchange of one variable annuity for another
D The tax-free exchange of one variable annuity for another An example of a 1035 exchange is a transfer of funds from one annuity to another without causing a taxable event. Life policy cash values can also be exchanged for an annuity as well as a life policy to a life policy, but never an annuity into a life policy under Section 1035 of the IRC.
Long-term care riders that are purchased with a variable annuity contract have restrictions on the uses of the benefits. When do most riders typically payout benefits? A When the annuitant becomes disabled B When the annuitant dies C When the annuitant's spouse dies D When the annuitant is unable to perform a specified number of daily living activities
D When the annuitant is unable to perform a specified number of daily living activities Those having long-term care riders may have to meet the standards of the inability to perform a specified number of daily living activities, such as bathing, before the policy will payout the benefits.
With an immediate annuity, annuitants begin receiving payments: A Within 60 days once proper paperwork is completed B At a specified date next year C Within 1 month D Within 1 year
D Within 1 year With an immediate annuity the idea is to have immediate access to income. There is no accumulation period. Benefits begin within 1 year of the issue date.
The following charges are deducted from the separate account:
Expense risk fee Mortality risk fee Investment management fee
Mortality and Expense Risk
Fixed fees the insurance company charges to cover lifetime income and other operating expenses.
Tax-free 1035 exchange is permitted for:
Life insurance to life insurance Annuity to annuity Life insurance to annuity
Underlying Fund Expense
Management fees related to the underlying fund expenses and separately charged in each of the subaccounts. This expense is the same as an investment adviser's fee in a mutual fund. These fees will vary depending on the various subaccount options within the annuity.
The policyowner instructs the insurance company on how to vote for:
Members of the board of managers (insurance companies have managers, not directors) Ratification of the election of an independent registered public accounting firm Approval of investment advisers Any other matters subject to the vote of contract owners
Riders
Most riders come with an additional charge. This charge must be appropriate and suitable to the needs of the investor.
Disadvantages of 1035 exchanges include:
Potential surrender charges on existing policy New surrender schedule on new policy Potentially higher fees and expenses on new policy
Supervision
Principal approval is required for all variable contracts and sales. The completed applications must be submitted promptly to the representative's office of supervisory jurisdiction. The supervisory principal has 7 business days to determine suitability and either accept or reject the contract.
Premium Taxes
Some states impose a state premium tax against the purchase payments. These are deducted before the premium is invested.
Lump Sum
The annuitant has the option of cashing out the annuity in a lump sum instead of electing to receive a stream of income. There could be tax penalties depending on the age of the annuitant.
mortality expense charge
The insurance company prices these risks as accurately as possible during accumulation and assesses a charge against the contract value. The amount of this charge is guaranteed as a percentage of the contract value. This charge compensates the insurance company for the life-expectancy risks it assumes under the annuity contract.
Risk Tolerance
The separate accounts in VAs invest in a variety of asset classes. Many of the subaccounts are highly concentrated in equities or correlated to equities and would not be suitable for an investor that is risk averse.
Mortality and Expense Fees
These fees are charged to cover the expense of providing a guaranteed death benefit
stepped-up death benefit rider
This rider may guarantee a death benefit greater than the regular calculation method. It allows investors the ability to lock in annuity contract values on specific dates. It then guarantees the stepped-up amount or contract value minus withdrawals, whichever is greater. This could protect investors holding an appreciated contract that later dropped in value due to market conditions from realizing those losses. This type of rider typically comes at an additional cost.
Long-Term Care Riders
This rider promises to pay specified amounts toward the costs of home care or care in a facility in the event the insured meets the qualifications detailed in the contract. This usually means that they must meet the definition associated with needing chronic care and fulfill a waiting period, typically 60-120 days. They may have to meet the standards of the inability to perform a specified number of daily living activities, such as bathing. An additional charge is associated with this rider.
Sales Charges/Surrender Charges
Though most annuities do not have upfront sales charges, they may have a CDSC or an annual charge.
Liquidity
VAs are considered illiquid and should not be recommended for investor funds that will be needed in the near future. The investor's age and available liquid assets should also be taken into consideration due to the illiquidity of VAs
Seniors
Variable annuities are not suitable for seniors in most cases. Representatives must use extreme caution when making VA recommendations to seniors.
Annuity payments received upon annuitization, and 72(q) distributions
are a combination of the original principal and earnings.
accumulation units
are an accounting method used to measure the contract owner's interest in the separate account. Units in each subaccount have a net asset value, like mutual funds.
Nonqualified annuity contracts
are funded with after-tax dollars since taxes have already been paid on the contributions (known as the principal). This is considered the cost basis and is returned to the annuitant tax-free. Taxes must be paid on any distributed earnings. Any portion of the distribution that is taxable (earnings) will be taxed as ordinary income.
Fixed annuities
are insurance company products where the principal and interest are guaranteed by the insurer. Dollars accumulated during the accumulation phase are placed in the insurer's general account. The insurance company bears all the investment risk. The insurer's general account invests in conservative investments and offers a low fixed rate of return with a guaranteed minimum rate if the annuity is held for a specified period.
Exchanges from annuity to life
are not permitted under Section 1035 and are taxable.
annuity period
begins when the annuitant elects to receive income benefits. This decision is irrevocable once the election is made.
If the actual performance of the separate account is less than the AIR, the amount of the next payment will
decrease
The exclusion ratio determines the
return of cost basis and gives you the percentage of each annuity payment that is not taxed (excluded from taxation).
Subaccount Fees
that hold investment company securities each have operating expenses along with the expenses of the contract itself. This may cause the VA to be more expensive than investments in similar mutual funds held outside of an annuity contract. The investor must be purchasing the annuity for additional benefits.
Variable annuities
the contract owner risks losing money if the investments perform poorly. The investor assumes the investment risk (market risk) since no performance guarantees are made by the issuer. attract investors looking for a potential hedge against inflation and who also have a long-term investment time horizon.
deferred annuity
will begin to make payments starting at a specified time in the future, which must be longer than 1 year from the issue date.
subaccounts
within the separate account are securities. As security contracts, variable life insurance and variable annuities are regulated by the SEC under federal securities laws, including the Securities Act of 1933 and the Investment Company Act of 1940.
