Series 6: Variable Products (Variable Annuity Contracts)
A customer owns 3,250 accumulation units in a separate account, with a value of $7.70 each. She wishes to retire and begin taking a life annuity. The annuity units are currently valued at $2.28 each. Which statement is true?
She will receive 10,975 annuity units in exchange for the accumulation units The customer has 3,250 accumulation units valued at $7.70 each. The total account value is $25,025. The customer annuitizes this account value into annuity units valued at $2.28 each. Divide the $25,025 by the $2.28 to get the number of annuity units this transaction produces (10,975). These annuity units fund the monthly annuity payments from this date forward.
If a variable annuity contract holder wants an annuity payout option that guarantees payments for the life of the contract holder and the contract holder's spouse, this person would select:
joint and last survivor annuity A life annuity makes payments only as long as the annuitant lives, then stops. A life annuity with a period certain pays for a minimum guaranteed period if the contract holder dies early. A unit refund annuity refunds the value of the annuity units left in the separate account to the contract holder's beneficiary upon the contract holder's death. Only a joint and last survivor annuity makes payments as long as either the annuitant or annuitant's spouse is alive. This is what the customer has specified.
Variable annuity sales charges are:
not set by FINRA but must be fair and reasonable FINRA does not set sales charges for variable annuities. FINRA only sets maximum sales charges for mutual fund purchases (which are set at a maximum of 8 1/2% of the amount invested). However, FINRA does state that all charges must be "fair and reasonable."
At the point where a variable annuity separate account interest annuitizes, the holder of the contract receives a:
fixed number of annuity units based on the value of the accumulation units When a variable annuity separate account interest is annuitized, the insurance company divides the value of the separate account interest by an annuity factor (the factor is based on that individual's expected mortality and the annuity payout option selected) to arrive at the number of annuity units. The number of units becomes fixed at this point, but the unit values fluctuate with the changes in the value of the separate account securities funding the annuity units.
Marsha received payments for several years from a non-qualified variable annuity. At her death, her husband received a lump-sum payment. What settlement option had she selected with her annuity?
Unit refund life annuity With a unit refund life annuity, the insurer guarantees to pay a minimum number of annuity units. If the annuitant dies before this minimum payout, the beneficiary receives a lump-sum payment. With a joint and last survivor annuity, payments would continue as long as either spouse is alive and there is no lump sum payment. With a straight life annuity, payments continue only while the annuitant is alive and there is no additional payment to anyone after the annuitant's death. There is no settlement option with variable annuities comparable to the second-to-die life insurance policy.
All of the following statements concerning the valuation of accumulation units are correct EXCEPT:
investment income and capital gains are used to buy additional accumulation units in the separate account Accumulation units represent the purchaser's ownership interest (similar to investment value) in a deferred variable annuity contract. There are no accumulation units with an immediate annuity - only annuity units. The accumulation phase and annuity phase are two separate and distinct parts of an annuity contract. Once the annuity starts, any accumulation units will have been converted to annuity units - accumulation units no longer exist once the annuity starts making payments. Thus, the purchaser of an immediate annuity has all of his or her investment dollars used to purchase "annuity" units that start paying immediately. Additional payments into the contract (the premiums paid) buy additional accumulation units. If the assets in the separate account increase in value, the accumulation unit value will increase. Investment income and capital gains from the underlying mutual fund shares are automatically reinvested in additional mutual fund shares. They do not buy additional accumulation units in the separate account - rather, they increase the value of the existing separate account units owned.
During the pay-in phase of a variable annuity, the ownership interest in a deferred variable annuity is valued on the basis of:
accumulation units Payments (called premiums) into a variable annuity contract buy "accumulation units" of the separate account. An accumulation unit is an accounting measure used for valuing a variable annuity holder's interest in the separate account. At annuitization, the accumulation units are converted into "annuity units." There is no such thing as conversion units.
The owner of a variable annuity has all of the following rights EXCEPT the right to vote:
for distributing income and capital gains Distributions of dividends and capital gains are decided by the variable annuity's Board of Trustees or Board of Managers. The unit holder can vote for the Board of Trustees and can vote to change the investment objective of the separate account. In addition, terminating the trust (a very unlikely event) would require unit holder approval as well.
All of the following features apply during the accumulation period of a variable annuity EXCEPT:
settlement option During the accumulation phase, any premiums invested in the separate account buy designated mutual fund shares, which will hopefully grow in value over time. This will increase the amount paid at annuitization. If, during the accumulation period, the owner of a variable annuity dies, then the net asset value in the separate account is included in the deceased's estate. This is called the death benefit and does not apply once the contract is annuitized. Also, during the accumulation phase, the purchaser can change his mind and choose to "cash out" the annuity contract. If this occurs early in the life of the contract, the insurance company can impose "surrender charges." The net proceeds of the "cash out" is the surrender value. At the time of annuitization, the owner chooses an "annuity option" such as a life annuity or a life annuity-period certain. These are "settlement options." This does not occur during the accumulation phase of the contract.
A customer seeking to maximize her lifetime income buys an immediate annuity. Which payout option will best meet her stated income needs?
Life Annuity The shorter the expected annuity period, the larger the payment. A life annuity lasts only for that person's life with no minimum guaranteed payment period. Since there are no minimum guarantees, the insurer can make a larger monthly payment. A life annuity with period certain continues to pay for a fixed time period (typically for a minimum of 10 years) if the person dies early, so it has a longer guaranteed payout period, reducing the monthly payment. A joint and last survivor annuity pays a surviving spouse when one person dies, and because of this guarantee, the insurer has a longer expected payout period, reducing the monthly payment. Finally, a unit refund annuity pays a lump sum equal to the remaining annuity unit value in the separate account if a person dies early, so there is no "extra value" left in the account when someone dies early. This guarantee reduces monthly payments as well.
Which of the following statements best describes what occurs at the time of annuitization of an annuity?
The contract begins to make payment of benefits to the annuitant At annuitization, the annuity contract changes - the accumulation phase stops and the annuity phase begins. There are no more premium payments into the contract. The accumulation units are converted to annuity units and annuity payments (which will vary) start.
Which is the FALSE statement regarding voting rights of variable annuity contract owners? Owners can vote for:
operating management of the underlying mutual fund Variable annuity owners are the beneficial owners of the mutual fund shares held in the separate account. While the separate account is technically the "owner" of those shares, it must give the unit holders the right to vote their proportionate ownership interest in those shares via proxy. Therefore, any matter put to shareholder vote by the mutual fund is voted on by the unit holders of the separate account. Unit holders get to vote to approve the underlying mutual fund's advisory contract and members of the fund's Board of Directors. At the separate account level, the unit holders have the right to vote to change the investment objective of the separate account. They also vote for the Board of Managers (or Board of Trustees) that oversees the operation of the separate account. There is no voting for the operating management of the fund.
Variable annuities provide what additional protection to the annuitant that is not provided by a fixed annuity?
Annuitant's purchasing power risk will be reduced Variable annuities permit the owner to select the investment(s) held in the separate account, and most separate accounts are invested in equities. The idea is that stocks provide inflation protection that investment in fixed income securities will not. Remember that fixed annuities do not provide inflation protection and providing this reduction of purchasing power risk is a big advantage of variable annuities. With any annuity, either fixed or variable, the owner cannot outlive the annuity payments. The rate of return is only guaranteed for a fixed annuity and not guaranteed for a variable annuity. The purchaser of a fixed annuity has no investment risk - the fixed return is guaranteed by the insurance company. In contrast, the purchaser of a variable annuity carries the investment risk, but also has the chance to have his or her purchasing power grow with inflation.
If the separate account funding a non-qualified variable annuity increased by 10%, which of the following statements are correct? I If the contract is in the annuity period and the AIR is 5%, the owner will receive an increased benefit payment II If the contract is in the accumulation period, the accumulation units will increase in value III If the contract is in the annuity period and the AIR is 15%, the owner will receive an increased benefit payment IV If the contract is in the accumulation period, the owner may lose accumulation units
I and II Remember that the annuity phase and accumulation phase are completely separate. Let's start with the accumulation phase first. If the underlying securities in the separate account increase in value during the accumulation phase (10% in this case), this will increase accumulation unit value. So Choice II is correct. If the underlying securities in the separate account were to decrease in value, then the accumulation unit value would decline; the number of accumulation units stays the same (making Choice IV incorrect). Once the contract is annuitized, the payment is based on the AIR - the Assumed Interest Rate. If the investment return (10% in this case) exceeds AIR, then the next annuity payment will increase (making Choice I correct, since it has an AIR of 5%). If the investment return (10% in this case) is less than AIR, then the next payment will decrease (making Choice III incorrect, since it has an AIR of 15%).
A customer who is planning for retirement wants to buy an annuity to provide additional retirement income. The customer desires inflation protection as well as the comfort of a guaranteed payment from an annuity. What kind of product is most suitable for this customer?
A combination annuity A combination annuity offers the benefits of both a fixed and variable annuity in one product. The premiums are invested partly in the insurer's general account and partly in the separate accounts. The annuitant will receive payments that are partly guaranteed and partly based on equity returns (providing an inflation hedge).
Typically, accumulation units of variable annuities represent an investment interest in underlying:
Growth mutual fund shares The insurance company invests money paid in by variable annuity contract holders in mutual fund shares. Thus, the separate account accumulation units really represent an interest in underlying mutual fund shares. The contract holder has the choice of different types of mutual fund investments. Most variable annuity purchasers choose a "growth" mutual fund, since this provides an inflation hedge.
Which of the following expenses are deducted from a variable annuity contract's net assets annually? I Sales load II Management fee III Expense risk charge IV Mortality risk charge
II, III & IV only The mortality risk charge is a fixed percentage charged against net assets annually in the separate account. In addition, annual charges are made for administrative expenses, expense risk and investment management (by the underlying mutual fund). These typically total about 2% of net assets annually for a variable annuity. Sales loads are taken out up-front from the premiums paid and the net amount is invested in the separate account.
Which of the following investments held in a separate account are representative of the direct method of investing? I 100 shares of DuPont common stock II 222.66 shares of Dreyfus S&P 500 Index Fund III 122.65 shares of Fidelity Magellan Fund IV 100 ADRs for Telefonos de Mexico common stock
I and IV A separate account that invests using the direct method functions as an open-end investment company. The insurance company may invest the money in such an account in securities that the investment adviser selects to meet the investment objective. The separate account may invest in common stock, such as the common stock of DuPont and the ADRs of Telefonos de Mexico. Thus, the separate account itself is managed. A separate account that invests using the indirect method functions as a unit investment trust and makes investments in mutual fund shares, such as the shares of the Fidelity Magellan or Dreyfus Index Fund. This type of separate account is not managed; however the underlying mutual funds are managed. Most separate accounts buy the shares of designated mutual funds and thus are established as UITs that use the indirect method of investing.
Which statements are true about the 2 phases of a variable annuity contract? I During the accumulation phase, no benefits are paid from the separate account II During the accumulation phase, no deposits are made to the separate account III During the annuity phase, no benefits are paid from the separate account IV During the annuity phase, no deposits are made to the separate account
I and IV The accumulation phase is separate from the annuity phase. During the accumulation phase, premiums can be deposited to buy accumulation units, but annuity payments cannot occur. Once the account is annuitized, annuity payments begin, but additional deposits to buy accumulation units are prohibited.
Which of the following statements concerning the valuation of accumulation units are correct? I The value of the accumulation units will increase if the assets in the separate account yield only 1% II Investment income and capital gains are used to buy additional accumulation units in the separate account III Additional premium payments by the owner will buy additional accumulation units IV Accumulation units are the accounting measure of a person's ownership interest in a deferred annuity and do not apply to immediate annuities
I, III and IV Accumulation units represent the purchaser's ownership interest (similar to investment value) in a deferred variable annuity contract. There are no accumulation units with an immediate annuity - only annuity units. The accumulation phase and annuity phase are two separate and distinct parts of an annuity contract. Once the annuity starts, any accumulation units will have been converted to annuity units - accumulation units no longer exist once the annuity starts making payments. Thus, the purchaser of an immediate annuity has all of his or her investment dollars used to purchase "annuity" units that start paying immediately. Additional payments into the contract (the premiums paid) buy additional accumulation units. If the assets in the separate account increase in value, the accumulation unit value will increase. Investment income and capital gains from the underlying mutual fund shares are automatically reinvested in additional mutual fund shares. They do not buy additional accumulation units in the separate account - rather, they increase the value of the existing separate account accumulation units owned.
A customer tells his registered representative that his neighbor just purchased a bonus annuity. He is interested in this product and asks her to explain its features. What information should the registered representative include in the explanation? I Bonus annuities tend to have lower fees than other annuities II Bonus annuities generally have longer surrender fee schedules than other annuities III The insurer contributes an additional percentage of premium payments to the account IV Bonus annuities permit partial withdrawals free of surrender charges, tax, and penalties
II and III only Bonus annuities give the purchaser a "bonus credit" of 3-6% of the premium paid by the customer to buy additional accumulation units. This "credit" amount is paid by the insurance company and is a great marketing feature, but it comes at a cost. All bonus annuities have surrender charges, and they generally have longer surrender schedules and higher surrender fees than other annuities. In addition, they charge higher expenses than non-bonus annuity contracts. Bonus annuities may permit withdrawals of limited amounts (typically 10%-15% of account value) without imposing surrender charges, but withdrawals are subject to federal income tax on the "build-up" in the separate account plus a 10% penalty tax if the owner is under age 59 1/2.
Which of the following statements concerning bonus annuities are correct? I The owner pays additional premiums initially for reduced expenses later II The fees are lower than with other annuities III The insurer contributes an additional percentage of premium payments to the account IV Withdrawal of some premiums or earnings may be permitted without penalty
III and IV only Bonus annuities give the purchaser a "bonus credit" of 3-6% of the premium paid by the customer to buy additional accumulation units. This "credit" amount is paid by the insurance company and is a great marketing feature, but it comes at a cost. All bonus annuities have surrender charges, and they generally have longer surrender schedules and higher surrender fees than other annuities. In addition, they charge higher expenses than non-bonus annuity contracts. Bonus annuities may permit withdrawals of limited amounts (typically 10%-15% of account value) without imposing surrender charges, but withdrawals are subject to federal income tax on the "build-up" in the separate account plus a 10% penalty tax if the owner is under age 59 1/2.
Which statement about variable annuity settlement options is FALSE?
Installments for a designated amount will provide payments that continue for the entire life of the annuitant One variable annuity settlement option is to deplete the separate account by taking payments in installments rather than annuitizing the separate account. This is the only annuity option that can cause payments to stop before the owner dies. When the owner selects "installments for a designated time" (say 20 years), the insurance company will calculate the monthly payment required to deplete the account over 20 years. If the owner lives longer than 20 years, no further payments are made, making Choice (A) correct. By selecting "installments of a designated amount," the insurer will pay that amount monthly until the separate account is depleted, after which no more payments are made - making Choice (C) false. Under a "life annuity with a period certain" (say 10 years is the guaranteed minimum or certain, payment period), payments continue to a beneficiary if the owner dies before the 10-year period is completed and stop at the end of 10 years - making Choice (B) a true statement. With a unit refund life annuity, the value of any remaining annuity units in the separate account is refunded to a beneficiary upon the owner's death, making Choice (D) a true statement.
A 60-year-old man wishes to receive an annuity payment for himself and his beneficiary for at least 15 years. The recommended payout option is:
Life annuity with period certain A life annuity with period certain will pay benefits for a person's life. However, if the person dies early, the annuity will still pay for the designated period. In this case, the period certain would be 15 years. A life annuity simply pays for one's lifetime. Once that person dies, payments cease. A unit refund annuity pays the remaining balance as a lump sum if the annuitant dies "early." This does not meet the man's requirement of a 15-year payout minimum. Rather than annuitizing, a variable annuity account holder can choose to take retirement income in installments. The account owner can specify installments of a fixed dollar amount; installments to be paid to deplete the account over a fixed time period, etc. The risk of taking installments is that the account can be depleted and then payments stop before that person dies. This cannot occur if the contract holder annuitizes.
A customer bought a variable annuity at age 50 and made periodic premium payments until age 65. The annuity paid benefits under the straight life option for four years until the customer died. The customer's daughter is named as his beneficiary. What will the customer's daughter receive as a death benefit from the variable annuity?
Nothing There is no death benefit payable from a straight life variable annuity after the annuity payout period begins. The annuity will pay for the owner's life and nothing more is paid once the annuitant dies.
When an investor's investment objectives become more aggressive, what should a registered representative advise the investor to do in connection with a variable annuity?
The investor should exercise the exchange privilege When the investor's investment objectives become more aggressive, the investor can change the investments of the separate accounts in the variable annuity by exercising the exchange privilege. This is permitted during either the accumulation phase or the annuity phase of the contract, making Choice (B) incorrect. Selection of a settlement option occurs when the contract is annuitized and once selected, cannot be changed, making Choice (A) incorrect. Surrendering the annuity for its account balance is not necessary and not advisable in order to change the investments of the separate accounts. Surrendering early can result in the imposition of a surrender fee. Also, an exchange of one annuity for another is not a taxable event, whereas surrendering the annuity does create a taxable event.
A registered representative explains to a client that the variable annuity he has recommended includes a 7-year surrender period that declines by one percent each year. To illustrate the surrender charge, he tells the client that the surrender charge is similar to a:
contingent deferred sales charge (CDSC) Annuity contracts may include a declining surrender charge for withdrawals from the accumulation account prior to annuitization. The surrender fee typically starts at around 7% if redemption occurs within the first year of the contract and then declines by 1 or 2% annually, so that if redemption occurs after 5-7 years, there is no fee. The surrender charge is similar to a Contingent Deferred Sales Charge (CDSC) on Class B mutual fund shares. Certain annuity contracts permit limited early withdrawals from the accumulation account without surrender charges, usually of no more than 10-15% of NAV. Any withdrawal would be subject to applicable income taxes and tax penalties of 10% of the amount withdrawn if the owner is under age 59 1/2. Also note that such withdrawals can only occur prior to annuitization.
All of the following statements concerning fixed and variable annuities are correct EXCEPT the:
mortality risk is carried by the owner or annuitant The mortality risk is the risk that the annuitant lives longer than his or her expected mortality. The insurance company assumes this risk with both fixed and variable annuities, since it will pay the annuity for the purchaser's life. Expense risk is the risk that expenses the insurer can charge against the annuity contract increase faster than expected. These are capped in the annuity contract, and any increases beyond the capped expense percentage are the responsibility of the insurance company and not the annuitant. The payout options for both fixed and variable annuities are similar. For example, one could choose either a life annuity or a joint and last survivor annuity. The ways that the annuity can be purchased are the same for both fixed and variable annuities. The insurance company will take your money in any manner that you wish to give it! Payment can be made in smaller periodic amounts or can be made as a lump sum payment.
All of the following statements concerning the valuation of accumulation and annuity units are correct EXCEPT the:
value of the annuity units will increase any year in which the market prices of securities in the separate account increase Remember that the annuity phase and accumulation phase are completely separate. Let's start with the accumulation phase first. If the underlying securities in the separate account increase in value during the accumulation phase, this will increase accumulation unit value. If the underlying securities in the separate account decrease in value during the accumulation phase, this will decrease accumulation unit value. So Choices (A) and (D) are correct. Once the contract is annuitized, the payment is based on the AIR - the Assumed Interest Rate. If the investment return exceeds the AIR, then the annuity unit value will increase and the next annuity payment will increase (making Choice (C) correct). However, if the investment return is less than AIR, then the annuity payment will decrease. Thus, Choice (B) is incorrect. The value of annuity units will increase only if the investment returns exceed the AIR.
For which of the following contracts will the insurance company typically invest the premium in one or more separate accounts? I Fixed annuity II Variable annuity III Variable life insurance
II & III only Insurance companies invest premiums for fixed annuities in their general account. They invest premiums for variable annuities and variable life insurance in their separate accounts.
Which statements are true regarding variable annuities during the annuity phase? I Periodic payments of fixed dollar amounts are made II Periodic payments of varying dollar amounts are made III Payments are based on a fixed number of units IV Payments are based on a varying number of units
II and III Once the separate account interest is "annuitized," the accumulation units are converted into a fixed number of annuity units. Since the NAV of the underlying mutual fund shares held in the separate account will vary, each payment based on a fixed number of annuity units also varies (hence the term variable annuity).
Which of the following statements concerning the valuation of accumulation units are correct? I The value of the accumulation units will increase if the assets in the separate account increase in value II Investment income and capital gains are used to buy additional accumulation units in the separate account III Accumulation units are the accounting measure of a person's ownership interest in an immediate annuity IV Accumulation units are the accounting measure of a person's ownership interest in a deferred annuity
I and IV Accumulation units represent the purchaser's ownership interest (similar to investment value) in a deferred variable annuity contract. There are no accumulation units with an immediate annuity - only annuity units. The accumulation phase and annuity phase are two separate and distinct parts of an annuity contract. Once the annuity starts, any accumulation units will have been converted to annuity units - accumulation units no longer exist once the annuity starts making payments. Thus, the purchaser of an immediate annuity has all of his or her investment dollars used to purchase "annuity" units that start paying immediately. Additional payments into the contract (the premiums paid) buy additional accumulation units. If the assets in the separate account increase in value, the accumulation unit value will increase. Investment income and capital gains from the underlying mutual fund shares are automatically reinvested in additional mutual fund shares. They do not buy additional accumulation units in the separate account - rather, they increase unit value.
A customer is preparing to annuitize her variable annuity. She asks her registered representative what factors will influence the amount of her monthly payouts. Which of the following should the registered representative's explanation include? I The performance of the separate account II Her gender III The payout option she selects IV Her age when she annuitizes
I, II, III, IV Gender and age at annuitization factor into the life expectancy calculation. The younger the person is, the longer the insurance company expects to pay, so the insurer reduces the monthly payment. Women live longer than men, so the monthly payment for a woman will be less than for a man who is the same age at annuitization. The performance of the securities held in the separate account determines account value at annuitization. A greater account value will result in a greater number of annuity units. Finally, the payout option selected also influences the monthly payment. For example, a life annuity (which pays only for that person's life) will give a larger monthly payment than a joint and last survivor annuity (which pays over the expected lifespan of a husband and wife).
Which of the following statements concerning variable annuity contracts are correct? I Premiums are deductible II Premiums are not deductible III Investment earnings accumulate tax deferred IV Investment earnings are taxable in the year earned
II and III only There is no deduction for premiums paid into a variable annuity contract. The tax benefit is that dividends and capital gains from the underlying mutual fund held in the separate account must be reinvested, but these build "tax-deferred." As a comparison, when making a direct purchase of a mutual fund, there is no tax deduction for the investment made - so that is the same as when a variable annuity is purchased. However, with a mutual fund investment, any dividends and capital gains do not have to be reinvested, but they are taxable, whether they are reinvested or not. Once payments commence from the annuity contract, the portion of the payments that represent the "build-up" is taxable (since these dollars were never taxed). The portion of the payments that represent original investment dollars is not taxed (since these dollars were already taxed - there was no deduction for payments made into the contract).
A separate account that makes indirect investments: I is structured as a management company II is structured as a unit investment trust III invests in common stocks and fixed income securities IV invests in mutual fund shares
II and IV Most variable annuities are structured as "unit investment trusts" that buy shares of a designated mutual fund. The underlying fund shares are managed, so this is called "indirect investing." Direct investment means that the separate account is actually making "direct investments" in selected common stocks and bonds (as opposed to making investments in a designated mutual fund - which is the case with indirect investment). Such a separate account is structured as a management company - there is an investment adviser managing the assets held in the separate account. This is a very rare structure for a variable annuity separate account.
Which statement concerning the AIR of a variable annuity contract is TRUE?
It applies only during the annuity period AIR refers to the assumed interest rate used to determine the initial monthly payment to the annuitant - it is set when the contract is annuitized and only applies during the annuity period. Once the first annuity payment is made based on the chosen AIR, if the earnings in the separate account are greater than the AIR, the next payment increases. If the earnings in the separate account are less than the AIR, the next payment decreases. The AIR has no meaning during the accumulation period. Also note that the prospectus has an "AIR Illustration" that is an estimate of the annuity to be paid based on a conservative growth estimate, but the actual AIR is not set until the contract is annuitized.
A customer, age 40, has decided to invest $500 a month in a variable annuity to provide a lifetime income starting at an expected retirement age of 65. The customer is covered by a corporate pension plan but wants additional income at retirement. The customer is willing to take moderate risk. What kind of annuity should be recommended to the customer?
Periodic payment, deferred variable annuity The customer is 25 years from retirement and wishes to make monthly payments towards an annuity contract. Periodic payments (monthly) for the next 25 years will result in a decent amount accumulated in the separate account that can be annuitized at that time for monthly income. Since this customer is willing to assume some risk, a variable annuity is a better recommendation than a fixed annuity.
Issuers offer all of the following products as variable annuities EXCEPT:
Periodic premium-immediate annuity An insurance company can offer a variable annuity for a single (lump sum) payment or for a series of periodic payments. The purchaser of a variable annuity who deposits a lump sum payment can buy either an immediate annuity or a deferred annuity. If the purchaser makes periodic payments, a deferred annuity must be purchased. Remember, the balance in the accumulation account must undergo annuitization for payments to begin. At that point, accumulation units convert into annuity units. A purchaser cannot have both accumulation units and annuity units under the same contract at the same time. Thus, there is no such thing as an annuity contract that offers periodic payments with an immediate annuity.
Which of the following statements concerning features of variable annuity contracts is correct?
Premiums are not deductible for federal income tax purposes There is no deduction for premiums paid into a variable annuity contract. The tax benefit is that dividends and capital gains from the underlying mutual fund held in the separate account must be reinvested, but these build "tax-deferred." As a comparison, when making a direct purchase of a mutual fund, there is no tax deduction for the investment made - so that is the same as when a variable annuity is purchased. However, with a mutual fund investment, any dividends and capital gains do not have to be reinvested, but they are taxable, whether they are reinvested or not. Once payments commence from the annuity contract, the portion of the payments that represent the "build-up" is taxable (since these dollars were never taxed). The portion of the payments that represent original investment dollars is not taxed (since these dollars were already taxed - there was no deduction for payments made into the contract).
Which of the following expenses is deducted from the premium paid to purchase accumulation units in a variable annuity contract?
Sales load Sales loads and premium taxes are taken out up-front from the premiums paid and the net amount is invested in the separate account. The mortality risk charge is a fixed percentage charged against net assets in the separate account. In addition, annual charges are made for expense risk. Aside from these "risk" charges, the account is also charged an administrative expense fee and investment management fee (of the mutual fund held in the subaccount). These typically total about 2% of net assets annually for a variable annuity.
Richard, a 40-year-old sales representative, is married with a 12-year-old daughter. His annual household income is $50,000. The family owns their home. He has coverage under Social Security and a 401(k) plan. Richard carries a $70,000 whole-life policy and has $8,000 in a savings account. He has recently inherited $50,000 and wants to invest in an annuity to maximize returns. Which product should his registered representative recommend?
Single premium deferred annuity A single premium deferred annuity allows Richard's investment of his $50,000 to start growing immediately, tax-deferred. Because he is only 40, he cannot take an immediate annuity without incurring tax penalties (10% penalty tax for taking retirement funds prior to age 59 1/2). The fixed annuity would not maximize his return since fixed annuities invest primarily in fixed-income securities. To maximize return, variable annuities invested in a growth separate account would be the best recommendation.
A customer is a 65 year-old teacher with an annual income of $49,000. She is divorced with grown children. The customer owns her home and has coverage under Social Security and a retirement plan through her employer. She has $50,000 of group life insurance and $20,000 in savings. She recently won $100,000 in the state lottery and has decided that now is a good time to retire. She wants to use the lottery winnings to provide supplemental retirement income. Which annuity product should her registered representative recommend?
Single premium, immediate annuity Because the customer wants to retire immediately, an immediate annuity is the best choice. A single premium permits all of her $100,000 winnings to be invested at once and annuitized, so that monthly payments will start immediately.
Which of the following is available to purchasers of variable annuity contracts?
The guarantee of a minimum growth rate in the separate account if a higher annual fee is paid for this rider A "GMIB" - Guaranteed Minimum Income Benefit - is a rider that can be purchased in a variable annuity contract. It guarantees that the separate account will be annuitized based on a minimum annual growth rate (say 4% per year), regardless of how the investments in the separate account actually perform. This is a nice feature, but it comes at a cost of around 1% a year in additional fees. At retirement age (59 1/2 or later), distributions can be taken from the separate account without a 10% penalty tax (but tax on the build-up in the account must be paid). The customer can either take a lump sum distribution or can annuitize the separate account. With a lump sum distribution, the customer gets to deplete the account value and can do this in installments. The risk is that the customer depletes the entire account with many years left to live. This leaves the customer without an income stream in later life. If the customer annuitizes, he or she gets payments for life, but loses any value in the account if he or she dies early. A Life Annuity option only pays for 1 person's life, so if it were a Life Annuity on a husband, and he dies, the annuity stops and the surviving spouse gets no more payments. To cover both lives, a Joint and Last Survivor Annuity option must be chosen. Finally, annuity contributions are not tax deductible (these are non-qualified annuities). When distributions are taken after age 59 1/2, the portion of the distribution representing the tax-deferred build up in the separate account is taxable and the portion of any payment attributable to principal is a tax-free return of capital (since there was no deduction for the contribution amount).
Which of the following is TRUE about annuity units in a variable annuity?
The number of annuity units is fixed at the time the account is annuitized At annuitization, the insurer converts accumulation units into a fixed number of annuity units. Changes in the value of assets in the separate account cause changes in the value (but not the number) of the annuity units. As a result, the dollar amount of each benefit payment is subject to change.
Which of the following statements concerning valuation of a variable annuity accumulation unit and annuity unit is/are correct?
The value of the annuity unit increases only if the investment return exceeds the AIR The value of the accumulation unit is completely separate from the value of the annuity unit The value of the accumulation unit will increase each year if there is only a 1% net investment yield Remember that the annuity phase and accumulation phase are completely separate. Let's start with the accumulation phase first. If the underlying securities in the separate account increase in value during the accumulation phase, this will increase accumulation unit value. So Choices B and C are correct. Once the contract is annuitized, the payment is based on the AIR - Assumed Interest Rate. If the investment return exceeds AIR, then the next annuity payment will increase (making Choice A correct). If the investment return is less than AIR, then the next payment will decrease.
Owners of variable annuity separate accounts may vote for all of the following EXCEPT:
approval of the fund sponsor of the underlying fund Variable annuity owners are the beneficial owners of the mutual fund shares held in the separate account. While the separate account is technically the "owner" of those shares, it must give the unit holders the right to vote their proportionate ownership interest in those shares via proxy. Therefore, any matter put to shareholder vote by the mutual fund is voted on by the unit holders of the separate account. Unit holders get to vote to approve the underlying mutual fund's advisory contract; the Board of Directors of the fund and the independent auditor of the fund. They also vote for the Board of Managers (or Board of Trustees) that oversees the operation of the separate account. There is no voting for who is the sponsor of either a mutual fund or a variable annuity separate account, nor for the amount of distributions to be made by either the underlying fund or the separate account.
All of the following statements about variable annuity settlement options are true EXCEPT that with:
installments for a designated amount, payments will continue for the stated number of years only One variable annuity settlement option is to deplete the separate account by taking payments in installments rather than annuitizing the separate account. This is the only annuity option that can cause payments to stop before the owner dies. When an owner selects installments of a designated amount, the insurer will pay that amount monthly until the separate account is depleted, after which no more payments are made. The actual length of time that payments are made depends on the monthly withdrawal amount and the performance of the assets in the separate account, making Choice (A) false. With installments for a designated time (say 20 years), the insurance company will calculate the monthly payment required to deplete the account over 20 years. If the owner lives longer than 20 years, no further payments are made, making Choice (C) correct. With a life annuity with a period certain (say 10 years), payments continue to a beneficiary if the owner dies before the 10-year period certain is completed and stop at the end of 10 years - making Choice (B) a true statement. With a unit refund life annuity, the value of any remaining annuity units in the separate account is refunded to a beneficiary upon the owner's death, making Choice (D) a true statement.