Series 6: Chp 7
Tax Treatment of an Annuitized Contract
The principal, which has already been taxed, is considered the cost basis of the contract and is returned tax-free. The earnings portion of the distribution is taxable as ordinary income.
ROTH IRA
Contributions nondeductible No RMD Distributions are generally tax-free
An investor that has purchased a variable annuity contract has the right to vote for all the following, except: A A change of investment objective in the separate account B Approval of investment advisers C The board of managers D Distribution of income and capital gains
D Distribution of income and capital gains are decided by the board of managers, just like payment of dividends is decided by board of directors for a corporation, otherwise investors would always vote to get paid! All the other choices are matters that the investor can vote for.
Traditional IRA
Distributions generally taxable as ordinary income Contributions may be deductible RMD at age 72 Contributions allowed until 72
403(b) Plans
The plan is available for eligible employees of public school systems and qualified 501(c)(3) nonprofit Organizations and allows for employee salary deferral (salary reduction) contributions up to an annual limit.
Simplified Employee Pension (SEP)
Used by corporations, partnerships, or sole proprietors (self-employed) and are designed to be a cost-efficient way for smaller employers to meet their employees' retirement needs by establishing an Individual Retirement Account for each employee that is fully funded by the employer.
A separate account is used to fund all the following, except: A Variable life insurance B An indexed annuity C A variable annuity D A variable universal policy
B A separate account is used to fund a variable insurance product, such as a variable annuity, VUL, or variable life insurance. Unlike the insurance company's general account, the investor assumes the investment risk in the separate account. An indexed annuity is a type of fixed annuity, and fixed annuities are funded through the insurance company's general account.
During the payout phase of an annuity contract, which of the following is true? A The value of the contract is fixed B The contract value is based on annuity units C Premiums are used to purchase accumulation units D The insurance company guarantees a fixed rate of return
B At the beginning of the payout (annuity) phase, the accumulation units are converted to a fixed number of annuity units. The investments in the units remain intact and income payments from the insurance company to the annuitant are made based on the value of the contract's underlying annuity units.
Once an annuity is annuitized, who takes ownership of the funds in the annuity? A The annuitant B The insurer C The owner D The beneficiary
B Once a contract is annuitized, the insurance company takes ownership of funds in the account.
In recommending the purchase or exchange of a variable annuity contract the registered representative must make sure that the recommendation is: A Suitable for the insurer B Suitable for the registered representative C Suitable for the client D Affordable for the client
B Registered Representatives (RR) recommending the purchase or exchange of a variable annuity contract or advising a customer on the initial allocation of invested money into subaccounts of an annuity contract, must make sure the recommendation is suitable for the client.
full surrender
(termination of the contract) occurs as a lump sum distribution. All earnings are taxable at ordinary income rates and subject to surrender charges and early distribution penalties, if applicable.
IRA funds can be invested in all of the following, except: A Mutual funds B Life insurance C Annuities D Certificates of deposit
B IRAs cannot be funded with life insurance or collectibles, such as antiques, rare stamps, or coins. Typically, IRA funds are invested in annuities, CDs, mutual funds, stocks and bonds.
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 20 B 10 C 5 D 15
B 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.
All the following are part of the modified endowment contracts (MECs) rule, except: A Policies failing to meet the 7-pay test are classified as modified endowment contracts (MECs) B Earnings taken from a modified endowment contracts (MECs) prior to age 59 ½ are subject to ordinary income tax plus a 10% tax penalty C It limits the amount of premiums that can be paid into a life policy within the first 10 years D Modified endowment contracts (MECs) death benefits are income tax-free
C A modified endowment contract (MEC) limits premiums paid into a policy during the first 7 years to the total scheduled premiums that would have been paid on a comparable traditional whole life policy during the same time period. Policies failing to meet the 7-pay test are classified as modified endowment contracts (MECs). Prior to the insured's age 59½, any money taken from a MEC in the form of loans, partial surrenders, or withdrawals, is subject to ordinary income tax plus a 10% IRS penalty. However, the death benefit will still be tax-free.
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 20 C 10 D 15
C 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.
A client has invested $10,000 into a variable annuity. After subtracting any premium charges, the insurance company will place this client's remaining investment amount into: A A mutual fund invested in real estate B Any individual security that the client chooses C The separate account D The insurance company's general account
C Premiums paid by variable annuity purchasers are placed into the insurance company separate account. The assets in the separate account are invested in a wider range of securities than those in a fixed annuity. The separate account is often divided into several subaccounts, each of which may have a different asset mix or risk profile.
All the following statements are true about variable insurance policy valuations, except: A The death benefit is calculated on an annual basis B The separate account NAV is calculated daily C The cash value must be calculated at least daily D The cash value changes based on market fluctuation
C 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.
Which of the following is not a characteristic of a separate account? A The securities in a separate account must be registered with the SEC B Investment accounts within the separate account are called subaccounts C Separate account values are fixed and guaranteed D The separate account operates like a mutual fund
C p107 A separate account operates similarly to that of a mutual fund and is considered a security. Investment options are subject to market risk. They are not fixed and guaranteed.
Which of the following statements is true of the cash value in variable life insurance? A The full premium is invested in the separate account B The entire cash value may be borrowed C There is a minimum cash value guarantee D There is no guarantee of cash value
D In a variable policy, only a portion of the cash value may be borrowed, not the entire amount. The net premium, not the full premium, is invested in the separate account. The full premium minus the sales charge, rider charges, and premium tax, if any, is the net premium.
A client has invested $25,000 into a variable annuity. This client is ready to retire, and the annuity is worth $250,000. If they take a distribution of $150,000, how will the withdrawal be treated for tax purposes? A 10% will be tax-free while 90% will be taxed as ordinary income B The entire $150,000 is reported as a capital gain C 10% will be tax-free while 90% will be taxed as a capital gain D The entire $150,000 is reported as ordinary income
D Since this is a single distribution, the IRS uses last-in, first-out tax treatment (LIFO). Therefore, the entire initial distribution would be taxable as ordinary income. If the client were to continue to take out single distributions, they would be forced to pay taxes until all the $225,000 in earnings have been removed from the account. Eventually, the final $25,000 would come out tax-free.
Tax-free 1035 exchange is permitted for
Life insurance to life insurance Annuity to annuity Life insurance to annuity Exchanges from annuity to life are not permitted under Section 1035 and are taxable.
Retirement plans can be funded by all of the following, except: A Spousal contributions B Both employee and employer contributions C Employee contributions D Employer contributions
A Retirement plans may be funded by the employee, the employer, or a combination of both. Contributions made into the plan by an employee are typically considered a salary reduction. Employer contributions to a qualified plan are tax deductible to the employer.
Deductibility of contributions to a traditional IRA may be limited depending on all the following factors, except: A The state in which the taxpayer lives B Income level C Taxpayer's income D If the taxpayer participates in an employer-sponsored qualified retirement plan
A State of residency has no bearing on deductible contributions to an IRA.
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 as a comparison to actual investment performance when determining future payments C It is used in determining the amount of the initial payment D If the actual performance of the separate account is greater than the AIR, the amount of the next payment will increase
A The AIR of a variable annuity contract remains unchanged throughout the life of the contract.
401(k) Plans
A type of profit sharing plan in which the employee has the option of taking employer contributions as cash or they can be left in the plan and the employer may make a matching contribution.
Savings Incentive Match Plans for Employees (SIMPLE)
Adopted by small businesses (self-employed, sole proprietors, partnerships and corporations) that employ 100 or fewer employees and do not have another qualified plan available.
Qualified annuities
Annuities held within retirement plans or IRAs. Funded with pretax dollars Total distribution is subject to ordinary income tax
A life insurance policy is classified for income tax purposes as a modified endowment contract or MEC if it fails the ____ pay test. A 10 B 5 C 3 D 7
D Failure to meet the 7-pay test would mean that a life insurance policy would be classified as a modified endowment contract or MEC for income tax purposes.
Which of the following statements concerning the AIR in a VA contract is correct? A AIR stands for anticipated internal return B FINRA rules allow for a maximum AIR of 8.5% to be used in a policy illustration C The AIR changes monthly based on the performance of a contract's underlying subaccounts D The AIR is used to help determine the amount of an annuitant's initial payment
D The assumed interest rate (AIR) is a hypothetical rate of growth assigned to assets in a variable annuity during the annuitization period. This number (expressed in percentage terms) is used as a benchmark to calculate the contract holder's initial payment. The AIR benchmark remains unchanged throughout the life of the contract.
Under which of the following federal laws does a variable annuity separate account register? A The Investment Company Act of 1940 and the Securities Exchange Act of 1934 B The Investment Advisers Act of 1940 and the Securities Act of 1933 C The Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 D The Securities Act of 1933 and the Investment Company Act of 1940
D The separate account of a variable annuity is registered as an investment company under the Investment Company Act of 1940. As securities, variable annuities are registered under the Securities Act of 1933. Variable annuities, which are funded through separate accounts, are regulated by the SEC and state insurance laws, whereas annuities based on the general account (i.e., fixed annuities) are not securities-they are regulated under state insurance laws only. The 1933 Act requires broker-dealers to deliver a prospectus to customers purchasing variable annuities. Those selling variable annuities are regulated under the Securities Exchange Act of 1934.
Which of the following is not a factor in determining the number of annuity units an investor will receive after annuitizing a variable annuity? A Assumed interest rate B The investor chooses a life with period certain payout C Investor's age D The investor's family history of heart disease
D When an annuitant decides to annuitize and begin receiving payouts, the insurance company will determine the amount of annuity units and the future payouts based on the payout option, assumed interest rate (AIR), annuitant's age, and principal balance of the contract.
Nonqualified annuities
Funded with after-tax dollars Growth portion of distribution is subject to ordinary income tax Assume all annuities are nonqualified unless specified otherwise
In recommending the purchase or exchange of a variable annuity contract the registered representative must make sure that the recommendation is: A Suitable for the insurer B Affordable for the client C Suitable for the client D Suitable for the registered representative
Registered Representatives (RR) recommending the purchase or exchange of a variable annuity contract or advising a customer on the initial allocation of invested money into subaccounts of an annuity contract, must make sure the recommendation is suitable for the client.
Variable Annuity Contract Life Cycle
1. The premiums are invested in the separate account and used to purchase accumulation units. 2. The owner chooses the mix of subaccounts to invest in. 3. The accumulation units grow on a tax-deferred basis. 4. The contract owner trades the accumulation units in return for a lifetime income stream upon annuitization. 5. The accumulation units are converted into a fixed number of annuity units. 6. The annuitant's payment will fluctuate each month based on the actual performance of the separate account compared to the AIR.
What is the name of the plan that was created for eligible employees of public school systems and qualified 501(c)(3) nonprofit organizations, including religious organizations, colleges, universities, hospitals, and museums? A 403(b) B Pensions C SIMPLE D SEP
A A 403(b) plan is a qualified Tax-Sheltered Annuity (TSA), or may be referred to as a Tax-Deferred Annuity (TDA). This plan was created and authorized under the provisions of Section 403(b) in the IRC and is available for eligible employees of public school systems and qualified 501(c)(3) nonprofit organizations, including religious organizations, colleges, universities, hospitals, and museums.
All the following statements are true regarding qualified retirement plans, except: A Withdrawals are taxed at preferential rates B Employees make contributions on a pretax basis C Qualified plans grow tax deferred D Employer contributions are tax deductible
A A qualified plan receives certain tax advantages for both the employer and employee. Employees can contribute on a pretax basis and have earnings grow tax deferred. Employer contributions can be deducted for the year in which the contribution was made. All contributions consist of money that has not been taxed by the IRS yet, so the account has a cost basis of zero. The account will grow tax deferred (not tax-free), and upon withdrawal the amount will be taxed at the investor's current ordinary income rate.
Whenever an individual receives monies from a qualified plan, the IRS allows the individual to place the monies into an IRA without having to pay income tax on the amounts placed into the IRA. What is this procedure? A Rollover B Sinking fund C Qualified transfer D Spillover
A A rollover is the proper way to reinvest qualified plan money once it has been received to avoid current income-tax liability. Only one rollover (where the participant receives the funds) is permissible per year. However, an unlimited number of plan trustee to trustee transfers is allowed. A sinking fund is a way of saving to repay a bond. 'Spillover' is a distractor.
Variable universal life is really a combination of: A Variable and term life B Variable and universal life C Term and whole life D Whole life and universal life
B 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.
Which type of retirement plan permits employees of a small printing company to take a reduction in their present wages and defer that amount into a retirement account? A 501(c)3 plan B 457 plan C 401(k) plan D 403(b) plan
C 401(k) plans are available to private corporations. 403(b)s are for schools and 501(c)3 nonprofit organizations. 457s are for governmental employees.
If a rollover occurs due to moving assets from a qualified employer-sponsored plan into an IRA in a lump sum, the same 60-day rollover rule applies, but the employer is required to withhold what % of the distribution and send this amount to the IRS? A 6 B 10 C 50 D 20
D If a rollover occurs due to moving assets from a qualified employer-sponsored plan into an IRA in a lump sum, the same 60-day rollover rule applies, but the employer is required to withhold 20% of the distribution and send this amount to the IRS. This 20% withholding may be refunded when the customer files their next tax return.
The account holder of a qualified plan must take required minimum distributions (RMDs) no later than April 1st of the year after the account owner turns age: A 65 B 62 C 59½ D 72
D The account holder of a qualified plan must take required minimum distributions (RMDs) no later than April 1st of the year after the account owner turns age 72, based on changes enacted by the SECURE Act.
Keogh (HR-10 Plans)
Established as a defined benefit or defined contribution plan and are available to unincorporated self-employed persons (owner-employees) and any full-time employees who meet the ERISA requirements.
What type of retirement plan does ERISA require employers to establish for employees? A ERISA does not require an employer to establish any type of retirement plan for their employees B Defined benefit C Profit-sharing D Defined contribution
A ERISA does not require employers to establish any sort of retirement plan.
What is a unique feature of a Roth IRA compared to a traditional IRA? A Tax-free distributions may be postponed beyond reaching the age of 72 B Catch up provisions allow people age 50 or older to make contributions greater than the normal annual maximum C Earnings grow on a tax-deferred basis D Penalty free distributions may be taken before reaching the age of 59½
A The age 72 minimum distribution rules ensure that qualified plan covered individuals take some taxable income in retirement. Because Roth IRA distributions are traditionally tax-free, there is no need for such rules.
A variable contract must be sold by: A A prospectus B An illustration C A person in the business at least 5 years D Mail order only
A 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.
Which of the following is not true regarding the assumed interest rate (AIR) of a variable annuity? A It is used in determining the amount of the initial payment B It changes each year throughout the life of the contract 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
B The AIR of a variable annuity contract remains unchanged throughout the life of the contract.
Which of the following is not a factor when determining the initial payment upon annuitization of an annuity contract? A Payout option selected B Annuitant's health C Assumed interest rate D Annuitant's age
B The calculation of the initial payment on a variable annuity that has been annuitized will be based on the principal balance of the contract, annuitant's age, payout option selected, and assumed interest rate used in the calculation. The annuitant's health is not a factor in this calculation.
Which type of qualified plan does not specify a predetermined fixed contribution, but is still classified as a defined contribution plan? A Corporate pension B Profit-sharing plan C SEP D Tax sheltered annuity
B The employer has no fixed contribution obligation (and may choose not to contribute in certain years). The employer's contributions are dependent upon profits so are not defined. A corporate pension is a defined benefit plan. A tax-sheltered annuity (TSA) is a 403(b) and may or may not have an employer match. If the plan has a match, it is a specified amount which is required. A SEP is for small self-employed companies where the employer contributes a specified amount into an IRA for each employee.
An individual has invested $50,000 into an annuity that will provide a fluctuating stream of income as well as an inflation hedge. The insurance company will place the investment amount into: A The insurance company's general account B A separate account C A mutual fund invested in real estate D Any individual security that they choose
B This individual has purchased a variable annuity. Premiums paid by variable annuity purchasers are placed into an insurance company separate account. The assets in a separate account are invested in a wider range of securities than those in a fixed annuity. The separate account is often divided into a variety of subaccounts, each of which may have a different asset mix or risk profile. When a customer initiates the purchase of a variable annuity, they may allocate their money among the subaccounts in a way that reflects their investment goals.
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 Variable life policies do not have loan features B Typically, policyowners are only able to borrow a portion of their policy's cash value C Policyowners are permitted to borrow 100% of their policy's cash value D Policyowners are only permitted to take loans if they are first time home buyers
B 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 up to 75% 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.
A public-school principal has contributed $300,000 to a 403(b) plan on a pretax basis. The account is currently worth $500,000. What will be the tax treatment of any distributions taken from the account upon retirement? A The account has a zero cost basis and all distributions will be treated as ordinary income B The account has a zero cost basis and all distributions will be taxed at preferential long-term capital gains rates C The account has a $300,000 cost basis and will be subject to taxation on the $200,000 of earnings at ordinary income rates D The account has a $300,000 cost basis and will be subject to taxation of the $200,000 in earnings at preferential long-term capital gains rates
C Any retirement plan that has been funded exclusively with pretax contributions has a zero cost basis. In this case, the entire amount of any distribution would be taxed as ordinary income.
All of the following are true about Roth IRAs, except: A Contributions are not age limited B There are no RMDs C Contributions can be made even if the individual has no earned income D Contributions are made on an after-tax basis
C Contributions to a Roth are always made on an after-tax basis (are nondeductible) out of earned income and there is no age limit restriction to make contributions. Individuals may continue to make contributions even after the age of 72. There is no RMD or penalty imposed.
Which of the following statements regarding a variable life policy death benefit is false? A The amount of the death benefits paid could be included in the decedent's estate for estate tax purposes B Proceeds from the death benefits are income tax free to the beneficiary C There is a guaranteed minimum death benefit D The death benefit must be calculated on a monthly basis
D Variable life insurance policies have a death benefit that will fluctuate based on the performance of the separate account but can never drop below the guaranteed minimum death benefit. The death benefit on a variable life insurance policy must be calculated on an annual basis. The death benefit passes income tax free to the beneficiaries. However, the death benefit could be included in the decedent's estate for purposes of calculating estate taxes if the deceased person is also the policyowner. If the policy is owned by a third party, the beneficiary, or an ILIT this can be avoided.
