SIE - Retirement Plans Pt. 1

All of the following statements are true regarding both mutual funds and variable annuities EXCEPT:

A the return to investors is dependent on the performance of the securities in the underlying portfolio B the Investment Company Act of 1940 is the regulating legislation Correct answer C distributions from the underlying mutual fund are taxable to the holder in the year the distribution is made D the underlying portfolios are managed Dividends and capital gains in variable annuity separate accounts must be reinvested during the accumulation phase and build tax deferred. In contrast, mutual fund distributions are taxable. Both mutual funds and variable annuities are managed, are regulated by the Investment Company Act of 1940, and have investors carry "investment risk" and corresponding gain or loss potential.

All of the following statements are true regarding the annuitization of a variable annuity contract EXCEPT: Correct answer A. You did not choose this answer.

Correct answer A variable annuity contracts require the holder to select a Life Annuity - Period Certain payout option B the variable annuity payout may vary depending on the performance of the underlying securities C the number of variable annuity units is fixed D the holder may not change the payout option after it is elected Variable annuity contracts allow the holder to elect a payout option that meets that person's individual requirements. The choice of payout method depends on the needs of the annuitant; and cannot be changed once elected. Once the contract is annuitized, the number of annuity units is fixed. However, the value of each unit varies with the performance of the underlying securities, hence the monthly annuity payment may vary.

Which statement is TRUE about the taxation of dividends, interest and capital gains in the separate account during the accumulation phase?

All dividends, interest and capital gains are tax deferred During the accumulation phase of a variable annuity contract, all dividends, interest and capital gains earned from the securities in the separate account must be reinvested and build tax deferred. The tax deferral of the build-up is the major benefit of buying a variable annuity.

Which statement is TRUE about a non-qualified variable annuity?

Investments held in the separate account grow tax-deferred

Which of the following annuity payment options will continue payments to another person for their life after the annuitant dies?

Joint and Last Survivor Annuity A joint and last survivor annuity pays another person (usually a spouse) when the annuitant dies.

All of the following statements are true about variable annuities EXCEPT variable annuities:

A must be registered with the Securities and Exchange Commission B must be sold with a prospectus C are a participating unit investment trust form of investment company Correct answer D are sold without a sales charge Variable annuities differ from other products sold by insurance companies in that the purchaser bears the investment risk; as opposed to the insurance company bearing the investment risk. For example, if an insurance company achieves poor investment results, this does not affect the amount of death benefit that one gets from a traditional insurance policy; if the separate investment account funding a variable annuity achieves poor investment results, the annuity payment will drop. Because the purchaser bears the investment risk in a variable annuity contract, these are defined by the SEC as a non-exempt security that must be registered and sold with a prospectus. Because these are structured as participating unit trusts, variable annuities are regulated under the Investment Company Act of 1940. Variable annuities are sold with a sales charge that must be "fair and reasonable" under FINRA rules.

What does NOT have to be discussed with a customer when recommending a variable life policy?

Correct answer A Probate fees B State premium fees C Mortality expense charges D Administrative expense charges Probate fees are the fees charged by attorneys to process the estate of a deceased person through probate court in that state. They have nothing to do with the recommendation of a variable life policy. Insurance companies are state-regulated and the way that the state gets reimbursed for the cost of this is by imposing a premium tax or fee on insurance premiums. This cost should be disclosed to the client. The mortality expense charge is essentially the fee charged by the insurance company to pay for risk of death - the older the person, the higher the fee. This should be discussed with the customer. Finally, the insurance company can charge a fee against the policy for its administrative expenses - another fee to be discussed with the client.

All of the following terms apply to a variable life policy EXCEPT:

A permanent insurance B cash value Correct answer C general account D level premium Any "variable" product, either a variable annuity or variable life insurance, takes the premium and invests it in a designated separate account, also called a subaccount, that invests in a specified mutual fund. The performance of the mutual fund builds cash value in a variable life policy. This cash value build can be borrowed from the policy. If the cash value grows to more than the death benefit and has not been borrowed, then the policy will pay the higher cash value on death. Variable life is "permanent insurance" - as long as the premium is paid, the policy is in effect. This contrasts with term insurance, which has a stated term, after which the policy expires and must be renegotiated. The premium amount is level - the same premium payment is paid periodically. What will vary is the cash value build and the amount of insurance coverage, based on the performance of the separate account. In contrast, whole life is another form of permanent insurance. It invests premiums in the insurance company's general account, which is typically invested safely, mainly in bonds. The cash value builds at a fixed rate, and the coverage amount does not vary.

Which statement is TRUE regarding variable annuities during the accumulation phase?

Periodic payments of fixed or varying dollar amounts can be made into the separate account During the accumulation phase of a variable annuity contract, money can be paid into the plan; but distributions cannot be taken. When distributions commence in the annuity phase, no more monies can be paid into the plan. Thus, the accumulation phase allows payments to be made into the plan; but distributions cannot be taken out of the plan.

To sell a variable annuity, what license(s) is (are) needed?

Series 6 or Series 7 plus a state insurance license Because variable annuities are both a securities and insurance product, a state insurance license is needed, in addition to the federal Series 6 (Investment Company Securities) or Series 7 (General Securities) license.

An "annuity unit" of a variable annuity contract is a(n):

accounting measure of the annuity amount to be received by the owner Once a variable annuity contract is annuitized, accumulation units are converted to annuity units. These determine the annuity payments to be made.

Payments into a variable annuity contract are deposited to the insurance company's:

separate account Monies deposited to a variable annuity are deposited into a separate investment account (that is, separate from the insurance company's general investment account). The separate account buys shares of a designated mutual fund. The performance of the mutual fund shares held in the separate account determines the amount of the annuity received.

In a period of inflation, it would be expected that payments from a:

variable annuity contract would increase Variable annuity investments are held in a separate account and typically consist of growth mutual funds. During an inflationary period, these companies have the ability to raise prices faster than the rate of inflation, so their profitability and value goes up. The NAV of the mutual fund in the separate account times the number of annuity units held (this is fixed at the date of annuitization) determines the monthly payment, so if NAV rises, so does the payment. Fixed annuity premiums are invested by the insurance company in its general account, typically in safe bonds. The interest rate is fixed and is typically low. It does not change over the life of the contract.

All of the following are purchase and payout options for variable annuity contracts may be employed EXCEPT:

A Lump sum payment; Immediate annuity B Lump sum payment; Deferred annuity Correct answer C Periodic payments; Immediate annuity D Periodic payments; Deferred annuity An investor can buy a variable annuity contract with a lump sum payment. Once the monies are used to purchase accumulation units, annuitization can occur immediately or can occur years in the future. An investor can also make periodic payments into a variable annuity contract, but cannot annuitize until payments stop. Thus, there is no option of periodic payments with an immediate annuity. The annuity must be deferred until the payments are completed.

In order to recommend a variable annuity to a customer, the representative must inform the customer, in general terms, about all of the following EXCEPT:

A potential surrender period and surrender charge B potential tax penalty C mortality and expense fees Correct answer D premium reductions available for enhanced riders Consider this to be a learning question. To recommend a variable annuity, the representative must have a reasonable basis to believe that the customer has been informed, in general terms, about the material features of the variable annuity. These include the potential surrender period and surrender charge, potential tax penalty, mortality and expense fees, charges for and expenses of enhanced riders (a very popular rider, at a cost, is a GMIB - a Guaranteed Minimum Income Benefit), insurance and investment components and market risk. Enhanced riders increase the premium cost - they do not reduce premium cost!

When comparing fixed annuities to variable annuities, which statement is TRUE?

A fixed annuity account grows at a guaranteed rate Fixed annuity premiums are invested in an insurance company's general account and grow at a guaranteed rate (which is usually fairly low). There is no investment risk. At retirement, the customer received a fixed periodic payment for life. Variable annuity premiums are invested in an insurance company "separate account" which buys shares of a designated mutual fund. The account grows based on the performance of the underlying mutual fund, so the investor is subject to investment risk. A fixed annuity ensures a fixed guaranteed growth rate, while the growth rate of a variable annuity can go higher, or lower, or negative. So for preservation of capital, a fixed annuity is best. That said, fixed annuities often provide modest returns which may not prove to be an effective inflation hedge.

Which statement is TRUE when describing the "build-up" in a variable annuity separate account during the accumulation phase?

All interest, dividends, and capital gains from the securities in the account are automatically reinvested and build tax deferred During the accumulation phase, all interest, dividend, and capital gains realized from the securities held in the separate account must be automatically reinvested to buy more accumulation units (NOT annuity units) for the contract holder. The "build-up" of these reinvested dividends, interest and capital gains is tax deferred during this period. This is the major tax advantage of buying a variable annuity over making a direct investment in a mutual fund.

The "AIR" stated in a variable annuity prospectus is a:

conservative illustration of an interest rate for the annuity The Assumed Interest Rate shown in a variable annuity prospectus illustrates the annuity that will be available if the separate account performs at that rate. It is conservatively estimated, but is no guarantee of a specific return.

Upon annuitization, a customer's insurer calculated the assumed interest rate (AIR) of his annuity as 5 percent. The account earned 6 percent after the first year. The customer's next payout amount will:

increase Payout amounts will change depending upon the actual earnings of the separate account assets. AIR - Assumed Interest Rate - is the assumed investment return needed to maintain a level monthly payment. If the actual investment return exceeds AIR (as in this example), then the monthly payment will increase. If actual investment return is less than the AIR, then the monthly payment will decrease.

Typically, accumulation units of variable annuities represent an investment interest in underlying:

mutual fund shares To fund variable annuity contracts, the monies paid in by contract holders are invested in a separate investment account that buys designated 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 that can be made by the separate account.

Growth in the separate account of a variable annuity is:

not capped as to maximum rate Variable annuity separate accounts are subject to investment risk - there is no minimum guaranteed growth rate and no cap on the growth rate. Also note that the insurance company selling the annuity can offer a rider called a GMIB - Guaranteed Minimum Income Benefit - that will give a minimum guaranteed growth rate for an additional cost. However, this is an optional feature, and is not part of the basic variable annuity contract.

Which statement is TRUE when comparing a Life Annuity to a Life Annuity with Period Certain?

The periodic payment for a Period Certain Annuity will be lower than the periodic payment for a Life Annuity A life annuity ceases when that person dies. A life annuity-period certain continues to a beneficiary if the person dies prior to the end of the "certain period." For example, if a life annuity -10 year period certain is purchased, and the purchaser dies after the 3rd year, the annuity continues to pay to a beneficiary for another 7 years. Choice B is wrong because payments will continue beyond the stated period if the annuitant is still alive. A life annuity is always the most aggressive payment option (it gives the highest monthly payment) due to the risk of premature death during the annuity phase which would result in cessation of all payments. It has no minimum guaranteed payment period. Because of the minimum guaranteed payment period offered by a period certain annuity, the monthly payment amount is lower than a simple life annuity (since the insurance company must pay for a minimum guaranteed time period).

Which statement is TRUE regarding a life annuity?

The shorter the expected annuity period, the larger the monthly payment The shorter the time period to "expected death" when the separate account is annuitized, the larger the monthly payment will be; conversely the longer the time period to "expected death" when the separate account is annuitized, the smaller the monthly payment will be. Regarding annuity payment options, this must be looked at from the standpoint of the insurance company, that has a large pool of annuitants to cover. The insurance company can afford to pay a larger payment to those persons who it expects will be paid for the shortest time period; it will make smaller monthly payments when it expects to pay for a longer time period. A life annuity lasts only for that person's life - this is the shortest expected period of the annuity payment options. A life annuity with period certain continues to pay for a fixed time period if the person dies early; a joint and last survivor annuity pays a spouse when one person dies; a unit refund annuity pays a lump sum if a person dies early.

A variable annuity is a(n):

non-exempt security under the Securities Act of 1933 because the purchaser bears the investment risk Variable annuities differ from other products sold by insurance companies in that the purchaser bears the investment risk; as opposed to the insurance company bearing the investment risk. For example, if an insurance company achieves poor investment results, this does not affect the amount of death benefit that one gets from a traditional insurance policy; if the separate investment account funding a variable annuity achieves poor investment results, the annuity payment will drop. Because the purchaser bears the investment risk in a variable annuity contract, these are defined by the SEC as a non-exempt security that must be registered and sold with a prospectus.

An annuitized account in a variable annuity is most similar to:

pension payments Once a variable annuity separate account interest is "annuitized," the holder gets a fixed number of annuity units. Each month, the holder gets a payment equal to the fixed number of units x the unit value (which varies based upon the performance of the underlying investments). The payments continue for life. Thus, an annuitized account is most similar to pension payments.

The "death benefit" associated with a variable annuity contract means that if the contract holder dies:

prior to annuitization, the amount invested in the contract is returned to a beneficiary The "death benefit" of a variable annuity contract is not really much of one. If the contract holder dies prior to annuitization, the insurance company pays the greater of current NAV or the amount invested to a beneficiary. If the contract holder dies after annuitization, there is no more "death benefit."