Checkpoint Exam U15

Among the reasons why deferred variable annuities might not be a suitable investment for seniors is all of the following EXCEPT A) potential inflation protection B) potential capital fluctuation C) improper subaccount selection D) surrender charges

A) potential inflation protection Variable annuities do offer potential inflation protection due to their participation in the equity market. The tradeoff is potential capital fluctuation, particularly if the portfolio selected is too aggressive. In addition, they typically carry high surrender charges. U15LO1

An owner of an equity index annuity would be wise to use the high-water crediting method if the underlying index was expected to A) remain steady. B) be volatile. C) change its objective. D) decline.

B) be volatile An advantage of the high-water crediting method is that the interest is calculated using the highest value of the index during the term. Therefore, in a volatile market, where prices are going up and down, it picks up the highest price. U15LO3

Which of the following statements regarding nonqualified annuities is CORRECT? A) Because taxes on earnings are deferred, all money withdrawn will be subject to income tax when received. B) The exclusion ratio applies to accumulation units only. C) It is possible to receive distributions from an annuity before age 59½ without incurring tax penalties. D) Because only insurance companies issue variable annuities, they are not considered securities.

C) It is possible to receive distributions from an annuity before age 59½ without incurring tax penalties. Nonqualified annuities, fixed or variable, are those where contributions are made with after-tax dollars. Withdrawals due to death or disability or taking substantially equal annuity distributions over the life of the insured can begin before age 59½ without being subject to a tax penalty. The exclusion ratio only applies during the payout period. Even though taxes on earnings are deferred, that portion of the withdrawal that represents a return of principal on a nonqualified annuity is not subject to tax or penalty. U15LO5

All of the following statements regarding scheduled premium variable life insurance are correct EXCEPT A) premiums are determined based on the age and sex of the insured B) once selected, the policy owner may change payment modes C) better than anticipated results in the separate account could lead to a reduction in annual premium D) the policy owner has the right to change the selection of subaccounts

C) better than anticipated results in the separate account could lead to a reduction in annual premium Scheduled (fixed) premium variable life premiums are fixed. It is universal life that has flexible premiums. U15LO7

Alix purchased a single premium deferred fixed annuity over 10 years ago. She would be subject to taxation on the deferred earnings which of these cases? A) When she dies B) If she enters into a Section 1035 exchange C) When the earnings are credited to her account D) When the earnings are withdrawn

D) When the earnings are withdrawn Earnings from any deferred annuity are taxed when withdrawn using the LIFO (last-in, first-out) method. A major advantage of a deferred annuity is that all earnings during the deferral period are tax deferred. A special feature available to certain insurance company products, including annuities, is the ability to exchange 1 annuity for another on a tax-free basis under the provisions of Section 1035. When the annuitant dies, neither she nor her estate are subject to income tax; any tax due is levied against the beneficiary. U15LO4

A 64-year-old woman wishes to withdraw funds from her nonqualified single premium deferred variable annuity purchased a number of years ago. The withdrawal would be A) subject to a 10% penalty unless annuitized B) taxed as capital gain C) subject to the required minimum distribution rules D) taxed as ordinary income

D) taxed as ordinary income Yes, I know that only the portion of the withdrawal that exceeds the cost basis is subject to tax, but what else are you going to pick here? Sometimes you have to go with the best choice, even if it isn't the most accurate. U15LO5

When discussing the purchase of a scheduled premium variable life insurance policy with a client, it would be CORRECT to state that A) premiums will vary based upon the performance of the separate account B) you will receive a statement of your death benefit no less frequently than semiannually C) by surrendering the policy, its cash value may be obtained D) if a policy loan exceeds the policy cash value, the deficiency must be remedied within 10 business days to keep the policy from lapsing

C) by surrendering the policy, its cash value may be obtained Surrender of the contract requires the insurance company to pay out its cash value. Death benefit is adjusted annually. U15LO7

Bob, age 60, has invested $17,000 in his nonqualified variable annuity over the years. The total value has reached $26,000. He wishes to withdraw $15,000 to send his son to college. What is his tax consequence on the withdrawal? A) $9,000 is taxable; $6,000 is nontaxable. B) The entire amount is nontaxable. C) The entire amount is taxable. D) $6,500 is nontaxable; $8,500 is taxable.

A) $9,000 is taxable; $6,000 is nontaxable. Because this is a nonqualified plan, the $17,000 invested is after-tax dollars. Under the Tax Code, the taxable portion is considered to be withdrawn first in any lump-sum distribution. Therefore, the first dollars withdrawn are all taxable until the amount of withdrawal meets or exceeds the growth in the account. Because Bob is over 59½, there is no 10% tax penalty on his withdrawals. U15LO5

An owner of an annuitized annuity can do all of the following EXCEPT A) receive the benefits for life with a certain minimum period of time guaranteed. B) receive the benefits on a monthly basis until the time of death. C) receive monthly payments for a defined period and then 2 years later change the contract to payment for life D) have a joint life with last survivor clause, with payments paid, until the death of the last survivor.

C) receive monthly payments for a defined period and then 2 years later change the contract to payment for life The contract is annuitized when the investor converts from the accumulation (pay-in) stage to the distribution (payout) stage. Once that happens, the owner no longer has control over the asset. All payout decisions must be selected in advance because they cannot be changed. U15LO4

Among the special characteristics of a universal life insurance policy is A) that policyowners may borrow against the cash value B) death benefits may increase above the initial face amount C) the policy may be overfunded D) early termination could lead to surrender charges

C) the policy may be overfunded In the case of universal life, the policyowner is permitted to pay in an amount in excess of the stated premiums (one of the reasons universal life is known as flexible premium life). The IRS puts limits on the amount of the overfunding before certain tax advantages are lost, but that is beyond the scope of the exam. Not only universal life, but variable life as well, has the possibility of increased death benefits. In fact, some whole life policies allow policy dividends to be used to increase the death benefit. Permanent forms of insurance policies, including whole life, universal life, and variable life, permit loans against the cash value. Many forms of life insurance have surrender charges for early termination. U15LO6

An individual purchasing a flexible premium variable life contract should know which of the following? I. Timing and amount of premiums generally are discretionary. II. The death benefit will generally be higher than that of a comparable whole life policy. III. The face amount is fixed at the beginning of the contract. IV. The performance of the separate account directly affects the policy's cash value. A) II and IV B) I and IV C) I and III D) II and III

B) I and IV A flexible premium policy allows the insured to determine the amount and timing of premium payments, provided minimums are met. Depending on the policy, the face amount (death benefit) is recalculated each year. It is intended that the death benefit receive some inflation protection, but this cannot be guaranteed. If separate account performance causes the cash value to drop below an amount necessary to maintain the policy in force, the policy lapses unless the requisite amount is received within 31 days. U15LO7

Larry purchased a deferred annuity and, at age 65, annuitized the product under a life with 15-year certain option. His spouse, Linda, is the beneficiary. Which of the following statements is CORRECT? A) Payments would be made to Larry until he is 80, then to Linda for the remainder of her life. B) Payments would be made to Larry until he is 80, then cease. C) Payments would be made to Larry until his death, then to Linda for another 15 years. D) Payments would be made to Larry as long as he lives, and then to Linda, should Larry die prior to reaching age 80.

D) Payments would be made to Larry as long as he lives, and then to Linda, should Larry die prior to reaching age 80. Larry selected the life with 15-year certain option. This pays Larry for his life, regardless of how long, but continues to pay his beneficiary (Linda) if he dies before the end of 15 years. That is the 15-year certain part. U15LO4

In a scheduled premium variable life insurance policy, all of the following are guaranteed EXCEPT A) the right to exchange the policy for a permanent form of insurance, regardless of health, within the first 24 months B) the ability to borrow at least 75% of the cash value after the policy has been in force at least 3 years C) a minimum death benefit D) a minimum cash value

D) a minimum cash value In a variable life insurance policy, a minimum death benefit is guaranteed, but no cash value is guaranteed. There is a contract exchange privilege during the first 24 months allowing the conversion of the variable policy to a comparable form of permanent insurance and the 75% cash value loan minimum applies after the 3rd year of coverage. U15LO7

When discussing the purchase of a scheduled premium variable life insurance policy with a client, it would be CORRECT to state that A) premiums will vary based upon performance of the separate account B) if a policy loan exceeds the policy cash value, the deficiency must be remedied within 10 business days to keep the policy from lapsing C) you will receive a statement of your death benefit no less frequently than semiannually D) by surrendering the policy, its cash value may be obtained

D) by surrendering the policy, its cash value may be obtained Surrender of the contract requires the insurance company to pay out its cash value. Death benefit is adjusted annually. U15LO6

Variable annuities A) may invest only in money market mutual funds B) generally provide more security of principal than fixed annuities C) provide a guaranteed minimum annuity payout D) may have 20 or more subaccount investment options

D) may have 20 or more subaccount investment options Some variable annuity separate accounts have 50 or more subaccounts to choose from. There are no guarantees as far as the amount of payout; that is why it is called a variable annuity. U15LO1