Series 66 Chapter 15

A customer has a nonqualified variable annuity. Once the contract is annuitized, monthly payments to the customer are A) partially a tax-free return of capital and partially taxable B) 100% taxable C) 100% tax deferred D) 100% tax free

A

Flexible premium payments are a feature of A) universal variable life B) whole life C) variable life D) term life

A

Surrender charges may cause a reduction to all of the following EXCEPT A) the death benefit of a variable life insurance policy B) the liquidation value of a variable annuity C) the cash value of a variable life insurance policy D) the redemption value of Class B mutual fund shares

A Surrender charges never apply in the case of a death benefit. There may be a surrender charge in the case of early surrender of a variable annuity, taking out the cash value of a variable life policy, or redemption of Class B (back-end load) mutual fund shares.

A variable annuity has A) different investment options known as subaccounts B) a high degree of liquidity C) fixed payments once it has been annuitized D) a guaranteed rate of return

A Variable annuities pay variable payments once annuitized, do not guarantee a rate of return, and are not considered liquid investments; they do offer multiple investment options through the subaccounts.

Current IRS regulations permit an unlimited contribution to which of the following tax-deferred plans? A) SEP IRA B) Annuity C) Roth IRA D) 401(k)

B

The death benefit of a variable life policy must be calculated at least A) semiannually B) annually C) weekly D) monthly

B

The value of a variable annuity during the accumulation period is determined by A) the number of accumulation units owned multiplied by the number of payments made into the account B) the number of accumulation units owned multiplied by the value of each unit C) the total payments made by the evaluation date D) the value of the securities in the general account of the insurance company

B

A 35-year-old client purchases a variable life insurance policy. Under current regulations, the maximum sales charge permitted over the life of the policy is A) 8.5% per premium payment B) 9% C) 8.5% of total premiums over the life of the plan D) 9% per premium payment

B A variable life insurance plan may charge a maximum sales charge of 9% over a period not to exceed 20 years.

If a client wishes to purchase a life insurance policy that doesn't invest in the market, but allows the holder to pay additional premium if desired, the recommendation is A) term life. B) universal life. C) index annuity. D) variable life.

B Universal life (not universal variable life) does not invest in the market through a separate account. That is only true of life insurance policies using the word "variable." These policies are frequently overfunded (premium over the required amount is paid-in by the policyowner). Term life cannot be overfunded and annuities of any type are not life insurance policies.

According to federal law, an insurance company under the provisions of the Investment Company Act of 1940 must allow a variable life policyholder the option to convert the policy into a whole life contract for a period of A) 12 months B) 18 months C) 24 months D) 45 days

C

In a scheduled premium variable life insurance policy, the insured is guaranteed A) nothing. B) positive return. C) cash value. D) minimum guaranteed death benefit.

D

The difference between a fixed annuity and a variable annuity is that the variable annuity offers a guaranteed return offers a payment that may vary in amount will always pay out more money than the fixed annuity attempts to offer protection to the annuitant from inflation

2, 4

Which of the following is designed primarily as a retirement vehicle to help protect contract owners from a decline in purchasing power? A) Variable annuities B) Flexible premium fixed annuity C) Retirement income life insurance D) Life-paid-up-at-age-65 life insurance

A

One way in which universal life and variable life are similar is that both A) permit loans against the cash value B) are considered securities C) have flexible premiums D) have a fixed minimum cash value

A As long as the policy has cash value, loans are permitted. Neither of these has a fixed minimum cash value, and only universal life has flexible premiums. Only variable life is considered a security.

The return that will be earned over the life of a fixed annuity A) is tied to an investment index such as the Standard & Poor's 500 B) will always be at least equal to the guaranteed minimum specified in the contract C) is tied to a portfolio of common stocks selected by the annuity owner D) may decrease over time due to the increase in surrender charges

B

Which of these features are common to both variable annuities and scheduled premium variable life insurance? Income earned in the separate account is tax deferred. Separate account performance below the AIR causes a reduction in cash value. Fixed contributions are required. Contract owners have voting rights.

1, 4

Which of the following types of life insurance has premiums that increase each time the policy is renewed, and no cash value buildup? A) Universal life B) Ordinary whole life C) Variable life D) Term

D A term policy provides life insurance only with no savings element. Upon renewal, the rates are higher as you age.

A variable annuity annuitant bears all of the following risks EXCEPT A) market risk B) inflationary risk C) interest rate risk D) mortality risk

D The insurance company issuing the variable annuity bears mortality risk, or the danger that some annuitants will live to surpass their average life expectancy. The investor in a variable annuity bears inflationary risk, market risk, and interest rate risk.

Marianne has a fixed-premium variable life policy in which the separate account has been performing extremely well, and the face value has been increasing as a result of the investment performance. However, recently the separate account performance has been negative. If this continues, the face value could decrease A) to the original face value B) to 50% of the original face value C) to 0 D) to the original face value minus any future negative performance

A The face value in an insurance policy is the death benefit. In a variable life policy, the face value will fluctuate with the separate account's performance, but it will never decrease below the original minimum face value.

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

B

A 47-year-old investor purchases a single premium deferred variable annuity from the ABC Insurance Company with an initial premium payment of $25,000. Six years later, a 1035 exchange is made to an annuity offered by the XYZ Insurance Company when the value of the account is $35,000. Seven years later, the account has a current value of $50,000 and the investor withdraws $20,000. The tax consequence of this withdrawal is A) no tax until the withdrawal exceeds $25,000. B) ordinary income tax on $15,000. C) ordinary income tax on $20,000. D) ordinary income tax on $20,000 plus a 10% penalty.

C

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 the required minimum distribution rules B) taxed as capital gain C) taxed as ordinary income D) subject to a 10% penalty unless annuitized

C

If an index annuity has a participation rate of 80%, it means A) the investor's account will participate in 80% of the gains and losses of the index. B) the investor's account will never be less than 80% of the initial investment. C) the investor's account will be credited with 80% of the growth of the index. D) the investor's account will be charged with 80% of the amount lost by the index.

C

A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk? A) REIT B) Fixed annuity C) Variable annuity D) Common stock

C Longevity risk is the uncertainty that one will outlive his money. The only instrument that guarantees a payout for as long as one lives is an annuity. Because the question asks for a security, only the variable annuity is correct, otherwise the fixed annuity would also offer protection.

All of the following statements regarding universal life insurance are correct EXCEPT A) may include a minimum guaranteed interest rate B) offers the policyowner exceptional flexibility in adjusting the premiums, cash value, and death benefit C) premiums are fixed for the life of the policy D) there are two death benefit options

C The single most distinguishing characteristic of universal life is the fact that premiums are flexible and not fixed.

A 35 year-old client indicates that he needs $500,000 of life insurance coverage for the next 20 years. The lowest out-of-pocket cost would be if he purchased A) a 20-pay life policy B) variable annuity with an extended death benefit C) a whole life policy D) a 20-year level term policy

D

A client has been contributing to a periodic payment annuity for 20 years. The M&E charge is 1.25% per year. What happens to that charge when the client annuitizes at attained age 68? A) It continues B) It increases because the client's mortality risk is higher at the older age C) It continues but at a reduced rate D) It ceases

D

Your 55-year-old client owns a nonqualified variable annuity. He originally invested $50,000 4 years ago. The annuity has grown to a value of $60,000. If the client, who is in a 30% tax bracket, makes a random withdrawal of $15,000, what will he pay to the IRS? A) $3,000.00 B) $4,500.00 C) $0.00 D) $4,000.00

D

Which of the following is guaranteed by a variable life policy? A) Policy loans after the policy has been in effect for at least 24 months B) Cash value C) Minimum separate account performance D) Minimum death benefit

D A variable life policy has a minimum guaranteed death benefit, but there is no minimum guaranteed cash value. There is no performance guarantee on separate accounts, and policy loans are required after the policy has been in effect for at least 3 years (36 months).

Which of the following is not an annuity purchase option? A) Periodic payment deferred annuity B) Single premium immediate annuity C) Single premium deferred annuity D) Periodic payment immediate annuity

D With an immediate annuity, payout begins immediately (generally within 30-60 days). As such, the concept of making purchases while receiving payout is illogical and is, therefore, not permitted as an option.

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

1, 4

A fixed-premium variable life insurance contract offers a guaranteed maximum death benefit a guaranteed minimum death benefit a guaranteed cash value a cash value that fluctuates according to the contract's performance

2, 4

A client needs funds for an unexpected medical emergency. If the client takes out a loan against the cash value of his life insurance policy and does not pay it back, the insurance company can do which of the following? A) Reduce the death benefit when the client dies B) Cancel the policy C) Increase the premium amortized over the life of the policy D) Reduce the cash value at the next anniversary

A

A customer in his 20s, who is not risk averse, is in the market for life insurance. His main worry is that what looks like a generous death benefit today may not be sufficient for a beneficiary 40 or 50 years from now. An investment adviser representative might consider recommending A) variable life insurance B) term life insurance C) an aggressive, long-term strategy of investment in small-cap stocks D) whole life insurance with the option of purchasing additional coverage

A

A life insurance policy where the premium increases each time the policy is renewed while the face amount remains level is A) renewable level term B) increasing term C) variable universal D) decreasing term

A

You have a 70-year-old client who is in excellent health. Both parents lived into their late 90s and the client is concerned about outliving her money. One product that should be considered to alleviate this concern is A) a 30-year term policy. B) whole life insurance. C) an annuity. D) an index fund.

C

The owner of a fixed annuity is protected against A) longevity risk. B) purchasing power risk. C) inflation risk. D) loss of money due to early death.

A

A policyowner could surrender a whole life insurance policy and choose from all the following EXCEPT A) transferring the policy to another person B) purchasing a reduced coverage whole life policy C) taking the cash value D) purchasing an extended term life policy

A Life insurance policies are nontransferrable. Upon surrender, the cash value may be taken or used to purchase extended term insurance or a reduced value, paid-up, whole life policy.

Which of the following best describes the death benefit provision of a variable annuity? A) The principal amount at death is the greater of the total of premium payments or the current market value. B) If death should occur before age 59½, the 10% early withdrawal penalty does not apply. C) Upon death, the beneficiary will receive the benefit as a lump sum. D) Upon death, the proceeds pass to the beneficiary free of federal income tax.

A The death benefit insures that the investor will never receive back less than the original amount contributed to the account. Unlike life insurance proceeds, with annuities, anything above the cost basis is taxed as ordinary income. Receiving the benefit as a lump sum is only one of the options available to a beneficiary of a variable annuity death benefit. There are others, such as annuitizing the benefit.

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

A This question is looking for a feature found in universal life that is not generally found in other forms of life insurance, i.e, something special. 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. Therefore, being able to borrow against the cash value is nothing special. Many forms of life insurance have surrender charges for early termination.

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) decline. B) be volatile. C) remain steady. D) change its objective.

B

Thirty years ago, an investor deposited $100,000 into a single premium deferred variable annuity. Today, the value of the accumulation units is $1.5 million. The investor is ready to annuitize and wishes to maximize monthly payments to be received. You would suggest which of the following settlement options? A) Joint and survivor B) Straight life C) Life with 10 years certain D) Life with 20 years certain

B

An individual purchased a variable life insurance policy 10 years ago. The policy has a $500,000 face amount which has grown to $525,000 due to the performance of the selected separate account subaccounts. Three years ago, the insured borrowed $50,000 against the policy which has never been repaid. The effect of this is that the total death benefit today is A) $525,000. B) $475,000. C) $450,000. D) $500,000.

B The death benefit of a variable life insurance policy is the current face amount ($525,000) or the guaranteed minimum, whichever is greater, less any outstanding loans ($50,000).

All of the following statements are features of a straight life, fixed, single-premium immediate annuity except A) payments do not increase with inflation. B) the annuitant may die before a return of the principal is realized. C) the income level may drop if the underlying investments go down in value. D) payments stop when the annuitant dies.

C Payments from a straight life, fixed, single-premium immediate annuity are fixed and are not dependent on underlying investments. However, as fixed payments, they do not offer inflation protection. As a straight life annuity, payments cease at the death of the annuitant. Because there is no minimum payout period, early death could result in total payments being less than the amount of the invested principal.

A popular vehicle for saving for retirement is the variable annuity. An agent explaining the benefits of this product would probably be in violation of the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents by claiming that variable annuities offer A) tax deferral on earnings until withdrawn from the account B) the choice of a large number of different subaccounts with varying objectives C) the ability to exchange funds between subaccounts without incurring a tax liability under IRS Code Section 1035 D) lower overall expenses than a mutual fund with similar investment objectives

D

In a scheduled premium variable life insurance policy, the insured is guaranteed A) cash value. B) positive return. C) nothing. D) minimum guarantee death benefit.

D

Which of the following statements is TRUE concerning variable life separate account valuation? A) Unit values are computed weekly and cash values are computed monthly. B) Unit values are computed monthly and cash values are computed weekly. C) Unit values are computed monthly and cash values are computed daily. D) Unit values are computed daily and cash values are computed monthly.

D Unit values are computed each day. Policy cash values are a monthly computation.

Which of the following statements are TRUE of a variable annuity? The number of annuity units is fixed when payout begins. The value of accumulation units is fixed at purchase. The monthly annuity payment is a variable amount. The annuity payments are not subject to income taxes.

1, 3

A 68-year-old individual, who purchased a single premium immediate fixed annuity, elected monthly payments for life with a 10-year certain settlement option. If the individual lives to the age of 80, A) monthly payments will continue until death. B) monthly payments will remain fixed until age 78 and then reduce until death. C) monthly payments will continue to the beneficiary(s) for 10 years after the annuitant's death. D) monthly payments will cease at age 78.

A

A client has invested $25,000 into a variable annuity which has grown to $150,000 over the accumulation period. At age 60, the account is liquidated. The tax treatment of the withdrawal would be A) ordinary income tax on $125,000. B) ordinary income tax on $125,000 with a 10% tax penalty. C) partly ordinary income and partly capital gains depending on the length of time the variable annuity was in force. D) capital gains tax on $125,000.

A

Which of the following is indicative of the primary difference between variable life insurance and straight whole life insurance? A) Way in which the cash values are invested B) Tax treatment of the death proceeds C) Amount of insurance that can be issued D) Cost of the insurance

A

You have a 37-year-old client whose wife has just given birth to triplets. Because of the added responsibilities, he wants to maximize the amount of life insurance he can acquire. Which of the following types of insurance will give him the greatest amount of coverage for the lowest initial premium? A) Universal life B) Variable life C) Whole life D) Annual renewable term

D

In a scheduled premium variable life insurance policy, which of the following are guaranteed? A) The right to exchange the policy for a permanent form of insurance with comparable benefits within the first 24 months of issue, as long as the insured passes a new physical examination B) The ability to borrow a maximum of 75% of the cash value once the policy has been in force at least 3 years C) A minimum cash value D) A minimum death benefit

D 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, but no physical is required. The 75% cash value loan is a minimum, not a maximum, and applies after the 3rd year of coverage.

Which of the following insurance company products is likely to have the longest time for which a surrender charge will be levied? A) Variable annuity B) Whole life insurance C) Class B shares D) Bonus annuity

D One of the characteristics of bonus annuities is that their surrender charges tend to be higher for a longer time than other insurance company products. When you see Class B shares on the exam, it will be referring to mutual funds, not insurance company products.

If a customer assumes the risk involved with her variable annuity, what does this mean? She is not assured of the return of her invested principal. The underlying portfolio is primarily common stocks, which have no guaranteed return. As an investor, she can be held liable for the debts incurred by the insurance company.

1, 2 The annuitant bears the investment risk in a variable annuity. This means that the portfolio is not guaranteed to return a specified rate, and the principal invested will also fluctuate in value according to the securities held in the separate account portfolio.

With an annuity, taxes on earned dividends, interest, and capital gains are paid annually until the owner withdraws money from the contract. random withdrawals are taxed on a LIFO basis. money invested in a nonqualified annuity represents the investor's cost basis. upon withdrawal, the amount exceeding the investor's cost basis is taxed as ordinary income.

2, 3, 4

A customer has invested a total of $10,000 in a nonqualified deferred annuity through a payroll deduction plan offered by the school system where he works. The annuity contract is currently valued at $16,000, and he plans to retire. On what amount will the customer be taxed if he chooses a lump-sum withdrawal? A) He will not owe taxes because the annuity was nonqualified. B) $6,000.00 C) $16,000.00 D) $10,000.00

B

A 45-year-old investor takes a lump-sum distribution from a nonqualified variable annuity. How is the distribution taxed? The entire amount is taxed as ordinary income. The growth portion is taxed as ordinary income. The growth portion is taxed as a capital gain. The growth portion is subject to a 10% penalty.

2, 4

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

A Scheduled (fixed) premium variable life premiums are fixed. It is universal life that has flexible premiums.

A customer has contributed $1,000 a year for 10 years to his tax-deferred nonqualified variable annuity. The value of the separate account is now $30,000. If the customer takes a withdrawal of $10,000, what are the tax consequences? A) The entire $10,000 is taxable as ordinary income. B) There is no tax because the withdrawal is considered return of capital. C) Two-thirds of the withdrawal is taxable as ordinary income. D) Any tax due is deferred.

A The $30,000 contract value represents $10,000 of contributions and $20,000 of earnings. When a partial withdrawal is made from an annuity, the earnings are considered to be taken out first for tax purposes (or LIFO). Therefore, ordinary income taxes will apply to the entire $10,000. In addition, if the customer is not at least 59½, there will be a tax penalty of an additional 10%.

A 54-year-old individual invests $25,000 into a nonqualified single premium deferred variable annuity. Five years later, with an account value of $35,000, the investor engages in a Section 1035 exchange into a variable annuity issued by a different insurance company. Four years later, with an account value of $50,000, the investor withdraws $20,000. The tax consequence of the withdrawal is A) $20,000 of ordinary income. B) $15,000 of ordinary income, $5,000 of long-term capital gain. C) $20,000 of ordinary income plus a 10% penalty tax. D) $15,000 of ordinary income, $5,000 nontaxable return of principal.

A A partial withdrawal from a nonqualified annuity is taxed on a LIFO basis. That is, the last money in (assumed to be earnings), is the first money out. The cost basis is the original $25,000. The 1035 exchange merely carried that cost basis over and resulted in no current tax on the $10,000 of earnings. When $20,000 is withdrawn, all of it represents the earnings and that is taxed as ordinary income. There is never capital gains taxation on an annuity and there is no 10% penalty tax because this investor is older than 59½ at the time of the withdrawal.

An investor purchases a single premium deferred index annuity with an initial premium of $200,000. Soon after the purchase, the investor receives a statement from the insurance company showing an initial balance of $210,000. The most likely reason for the $10,000 increase is A) the insurance agent's commission was added to the account. B) the insurance company paid a dividend. C) this is a bonus annuity. D) the underlying index has had outstanding performance.

C It is not uncommon to find index annuities offering a bonus added to the premium. In this case, the bonus appears to be 5%. There are no dividends on index annuities and rebating commissions is prohibited.

If your 60-year-old customer purchases a nonqualified variable annuity and withdraws some of her funds before the contract is annuitized, what are the consequences of this action? A) Capital gains tax on earnings exceeding basis B) 10% penalty plus payment of ordinary income tax on all funds withdrawn C) 10% penalty plus payment of ordinary income tax on all funds withdrawn exceeding basis D) Ordinary income tax on earnings exceeding basis

D

Which of the following is not a type of life insurance policy? A) Endowment policy B) Term to 65 policy C) Universal life policy D) Variable annuity policy

D Although a variable annuity may have a death benefit provision, it is not considered a life insurance policy. One key to that is, among other things, there is no health questionnaire when purchasing an annuity. Perhaps you have never heard of an endowment policy (it is not mentioned in the LEM). This type of situation may come up on the actual exam where one of the choices is something unfamiliar to you. Don't let that cause you to lose your focus. Annuities are issued by life insurance companies, but they are not life insurance policies, so select the correct answer and move on.

The main benefit that variable life insurance has over whole life insurance is A) a lower sales charge B) an adjustable premium C) the availability of policy loans D) the potential for a higher cash value and death benefit

D Premiums of variable life insurance policyholders are invested in the insurer's separate account. This allows the policyholder the opportunity (though there are no guarantees) to enjoy significant returns and substantially higher cash values than are obtainable through a whole life policy.

A client has purchased a nonqualified variable annuity from a commercial insurance company. Before the contract is annuitized, your client, currently age 60, withdraws some funds for personal purposes. What is the taxable consequence of this withdrawal to your client? A) Capital gains taxation on the earnings withdrawn in excess of the owner's basis B) A 10% penalty plus the payment of ordinary income tax on funds withdrawn in excess of the owner's basis C) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis D) A 10% penalty plus the payment of ordinary income tax on all of the funds withdrawn

C

A customer purchased a variable annuity from an agent 5 years ago with an initial investment of $200,000. The annuity's surrender fee will expire in year 7, which coincides with the customer's anticipated need for the funds. In the 5th year of the contract, the value of the annuity increased from $300,000 to $375,000. The agent notices that the general market is on the decline and recommends she enter a 1035 exchange of the variable contract for another, thus increasing her death benefit and locking it in at a higher minimum. This recommendation is A) unsuitable because of surrender fees B) unsuitable unless the customer agrees with the recommendation C) suitable because of the increased death benefit D) suitable because 1035 exchanges have no adverse tax consequences

A

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) The entire amount is nontaxable. B) $9,000 is taxable; $6,000 is nontaxable. C) $6,500 is nontaxable; $8,500 is taxable. D) The entire amount is taxable.

B

John owns a nonqualified, tax-deferred annuity. When he retires, what will be the tax consequences of his annuity payments? A) His annuity payments are tax free. B) His annuity payments are partly taxable and partly tax-free return of capital. C) His annuity payments are partly taxable as capital gain and partly taxable as ordinary income. D) His annuity payments are all taxable as ordinary income.

B

One of the major financial decisions to be made by a family is the amount and type of life insurance to purchase. The form of insurance that offers flexible premiums without a fixed cash value is A) whole life. B) universal life C) variable life. D) term life.

B

An investor purchases a single premium deferred index annuity with a 6% bonus feature. The premium was $100,000. The annuity has an 80% participation rate with a 10% cap. If the underlying index increased by 15%, the account's value at the end of the year would be closest to A) $116,600. B) $118,720. C) $110,000. D) $116,000.

A The 6% bonus means that the client's initial payment is increased by 6%. That means the account shows a starting balance of $106,000. Although the index increased by 15% and the participation rate of 80% would be a 12% growth rate, the cap of 10% comes into play. That makes the calculation: $106,000 x 110% or $116,600.

One of the features of an index annuity is the ability for the principal value to increase based on the performance of the specified index. Which of the following is NOT used as a method to compute the amount of interest to be credited to the account? A) Point to point B) Participation rate C) Annual reset D) High-water mark

B

Your client purchased an index annuity from you last year with an investment of $100,000. The particular index tied to this product had an annual return of -4%. If the participation rate is 90% with a cap of 5% and no annual minimum guarantee, the value of the account would be A) $103,600. B) $100,000. C) $96,400. D) $96,000.

B Please note that the return is negative (-4%). An index annuity does not participate in losses of the index, only gains. With no gain, and no guaranteed annual minimum, the account value remains at $100,000.

Juliette, a math teacher in the local high school, owns a qualified, tax-deferred annuity. When she retires, what will be the tax consequences of her annuity payments? A) Her annuity payments are tax free. B) Her annuity payments are partly taxable and partly tax-free return of capital. C) Her annuity payments are partly taxable as capital gain and partly taxable as ordinary income. D) Her annuity payments are all taxable as ordinary income.

D

When discussing the purchase of a scheduled premium variable life insurance policy with a client, it would be CORRECT to state that A) if a policy loan exceeds the policy cash value, the deficiency must be remedied within 10 business days to keep the policy from lapsing B) premiums will vary based upon performance of the separate account 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 Surrender of the contract requires the insurance company to pay out its cash value. The death benefit is calculated annually (not semiannually) with the cash value being figured monthly. There is no time requirement to remedy a cash value deficiency. Scheduled premium means fixed premium, one that does not change. It is the cash value and the death benefit that will be affected by the performance of the separate account.

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

B 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.

When a customer wants income from an annuity and chooses the option of life with 20-year period certain, how will distributions be taxed? A) As ordinary income based on an exclusion ratio B) As capital gains based on LIFO accounting C) As capital gains based on an exclusion ratio D) As ordinary income based on LIFO accounting

A Life with 20-year period certain is an annuitization option. When an annuity is annuitized, ordinary income taxes are paid based on an exclusion ratio (cost basis divided by expected return = how much of the distribution is a return of cost basis (the original principal invested), and not subject to income taxes). Testing note: Unless the question specifically mentions that the annuity is qualified, or gives you a clue, such as it is in a 403(b) plan, the annuity is always nonqualified.

A terminally ill client wishing to access a portion of the cash value in his whole life insurance policy while still providing a death benefit for his beneficiaries could do so by A) surrendering the policy for its cash value B) converting it into a term policy C) selling the policy in a viatical settlement D) taking out a policy loan

D

Which of the following statements concerning universal life insurance are CORRECT? Universal life has flexible premiums. Universal life is based on the assumption that level annual premiums are to be paid throughout the insured's life. The death benefit can fluctuate, but never below the guaranteed minimum face amount. Cash values can fluctuate and may even fall to zero.

1, 4 Universal life features flexible premiums that add to the cash value account, although there are no guarantees and the cash value can disappear if insufficient premiums are paid. There is no guaranteed minimum death benefit as there is with fixed (scheduled) premium variable life. The assumption that level annual premiums are to be paid throughout the insured's life is associated only with ordinary whole life and scheduled premium variable life policies.

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) a minimum death benefit C) a minimum cash value D) the ability to borrow at least 75% of the cash value after the policy has been in force at least 3 years

C 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.

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

C 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 one annuity for another on a tax-free basis under the provisions of Section 1035 of the Internal Revenue Code. When the annuitant dies, neither she nor her estate are subject to income tax; any tax due is levied against the beneficiary.

Which of the following is considered an advantage of annuitization? A) A fixed, level periodic payment tends to lose buying power over time due to inflation. B) Payments under a variable annuity could be reduced if there is a declining market. C) Once annuitized, the client's draw from the annuity is limited to the annuity payment. D) It guarantees income that will last for the client's lifetime.

D

In general, when describing the characteristics of equity index annuities and variable annuities, each of the following would be a true statement EXCEPT A) only the variable annuity is considered a security B) both are issued by life insurance companies C) only the EIA has a minimum guaranteed return D) both offer an opportunity for unlimited gain

D EIAs almost always come with a cap rate, a ceiling beyond which earnings cannot be credited to the investor's account. There is, theoretically, no limit as to how much one could earn with a variable annuity. Both are issued by life insurance companies, and only the EIA offers a guaranteed floor (minimum return). Based on court rulings in effect at this time, the equity index annuity is not considered a security.

Among the reasons to consider investing in a variable annuity would be all of the following EXCEPT A) a guaranteed death benefit for death before annuitization B) capital gains treatment on any realized gains upon withdrawal C) avoiding probate upon the death of the investor D) basically, no limit on the amount that can be contributed

B In return for granting tax deferral on all gains in the account, the IRS taxes everything over the investor's cost basis as ordinary income. There is never a capital gain with a variable annuity. Some insurance companies will place a limit on the amount that may be invested, especially for older clients, but unlike IRS rules on retirement plans, this is strictly a company-by-company decision, not a law. Variable annuities are generally sold with a death benefit provision guaranteeing that the beneficiary will receive the higher of the amount invested or the current value of the account. Because there is a specifically named beneficiary, annuities do not go through the probate process.

Your client has $50,000 to invest. His objective is monthly income that he can receive after he retires to supplement his small pension and Social Security benefits. As part of his profile, he stresses that he has had uncomfortable experiences in the past with the stock market and is not inclined to invest in anything that is based on stock market performance—and he would opt for principal protection instead. Based on the client's profile, which of the following would be the best recommendation? A) Mutual fund portfolio consisting of blue-chip stocks B) Fixed annuity C) Variable annuity D) Exchange-traded fund (ETF) or exchange-traded note (ETN)

B

Which of the following would be a difference between a universal life insurance policy and a scheduled premium variable life insurance policy? A) There is a minimum guaranteed return on the variable life, while there is no guaranteed return on the universal. B) Premiums on a scheduled premium variable life policy are fixed, while those on a universal life policy are flexible. C) There is a greater choice of separate account subaccounts in the universal life policy. D) The universal life policy will generally outperform the variable life policy during a period of falling interest rates and rising stock prices.

B A major difference between these two insurance programs is the payment of premiums. Scheduled premium is just another way of saying fixed premium. In a universal life policy, including universal variable life, the premiums are flexible. There is no choice of separate account subaccounts for universal life. Universal life is designed to benefit from periods of high interest rates, not falling ones. Finally, universal life policies have a minimum guaranteed interest rate; no such guarantee applies to variable life.

A widowed customer with no children has a portfolio invested in mutual funds valued at $250,000. The portfolio generates a monthly income of $1,600, an amount that exceeds her living expenses by $300. The investment portfolio is her sole source of income. Her agent recommends she sell $30,000 worth of her mutual funds and purchase a deferred variable annuity to take advantage of the tax deferral and death benefit features. This recommendation is A) suitable because it provides tax deferral features B) unsuitable C) suitable because it offers a growth opportunity with a death benefit for a portion of her holdings D) suitable because it provides diversification

B The customer has no need for the death benefit (she has no immediate survivors) or tax deferral features (with $19,200 in annual income, there are virtually no income taxes due) of a variable annuity, so this transaction is unsuitable. Finally, she would be replacing income generating assets with one that does not offer immediate income and that could reduce her income cushion to an uncomfortable margin of safety.

An individual is deciding between a flexible premium variable life contract and a scheduled premium variable life contract. If she is concerned about maintaining a minimum death benefit for estate liquidity needs, she should choose A) the flexible premium policy because the contract's face amount cannot be less than a predetermined percentage of cash value B) the flexible premium policy because earnings of the contract directly affect the face value of the policy and earnings can never be negative C) the scheduled premium policy because earnings do not affect the contract's face amount D) the scheduled premium policy because the contract is issued with a minimum guaranteed face amount

D A scheduled premium variable life contract is issued with a guaranteed minimum death benefit. If the individual is concerned about having the minimum guarantee, you should recommend the scheduled contract.

A client who purchased a variable life insurance policy 15 months ago has suffered a stroke. In addition, he has developed adult onset diabetes. When receiving treatment for the stroke, he was diagnosed with lung cancer. He has decided to convert his variable policy to a whole life policy. Which of the following statements is CORRECT? He will not be able to convert to a whole life insurance policy because his health has deteriorated to such a severe level. The new policy will bear the same issue date and age as the original policy. The face amount must remain the same. The premium will be rated because his health has taken a marked turn for the worse.

2, 3 Variable life insurance offers a unique conversion policy. Anytime during the first 24 months after policy issue, the policy may be exchanged for a whole life policy (or some similar form of permanent insurance if the company doesn't offer whole life) using the age and medical condition at issue, regardless of the insured's current health. However, the face amount cannot be changed from its original amount.

Annuity companies offer a variety of purchase options to owners. Which of the following definitions regarding these annuity options is NOT true? A) An accumulation annuity allows the investor to accumulate funds in a separate account prior to investment in an annuity. B) A periodic payment deferred annuity allows a person to make periodic payments over time; the contract holder can invest money on a monthly, quarterly, or annual basis. C) A single premium deferred annuity is a lump sum investment, with payment of benefits deferred until the annuitant elects to receive them. D) An immediate annuity allows an investor to deposit a lump sum with the insurance company; payout of the annuitant's benefits starts immediately (usually within 60 days).

A Accumulation does not refer to a purchase option. The pay-in period for an annuity is known as the accumulation stage. A single premium deferred annuity is an annuity with a lump-sum investment, with payment of benefits deferred until the annuitant elects to receive them. Periodic payment deferred annuities allow a person to make periodic payments over time. Immediate annuities allow an investor to deposit a lump sum, with the insurance company payout of the annuitant's benefits starting immediately (usually within 60 days).

An agent has 4 clients who have purchased variable annuities, all of who are about to enter the annuitization phase. Client 1 purchased a single premium deferred annuity 20 years ago with a premium of $30,000. Client 2 purchased a single premium deferred annuity 10 years ago with a premium of $50,000. Client 3 purchased a periodic payment annuity 15 years ago and has made monthly premium payments totaling $60,000. Each of these 3 annuities has a current surrender value of $100,000. Client 4 just purchased an immediate annuity with a premium of $100,000. Assuming that all of these clients are of the same sex and the same age, when the annuity payout begins, which of the clients will receive the lowest amount of taxable income? A) Client 4 B) Client 3 C) Client 2 D) Client 1

A When it comes to taxation on annuitization, each payment consists of a combination of income and return of principal, how much of which depends on the exclusion ratio. In the case of Client 4, with an immediate annuity, it is unlikely that there is much in the way of income - almost all of the monthly payout will represent a nontaxable return of principal. Each of the other clients has tax-deferred income ranging from Client 1's $70,000 to Client 3's $40,000. When using the exclusion ratio to determine how much is income and how much is return of principal, Client 1 will have the greatest amount of taxable income followed by Client 2 and then Client 3.

Concerning index annuities and their method of crediting interest, which of the following is TRUE? A) Point to point offers the best return when the market has had a single drastic decline during the period. B) Annual reset offers the best return regardless of market fluctuations. C) High-water mark with look back offers the best return during periods of high volatility. D) On average, annual reset has a higher participation rate than point to point.

C Using the annual high-water mark with look back will generally result in the highest return during periods of high volatility. The reason is because under this method, the highest anniversary value is used to determine the gain. In a volatile market, there is likely to be a high spike sometime during the period and that is the value used. The problem with point to point when there is a single drastic decline during the period is that the decline might occur at or just prior to the annual crediting computation. Annual reset does ignore the daily market fluctuations, but if the index is lower at the end of the year, there is nothing credited. In reality, annual reset has a lower participation rate than point to point.

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) Because only insurance companies issue variable annuities, they are not considered securities. D) It is possible to receive distributions from an annuity before age 59½ without incurring tax penalties.

D 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.

One of your customers owns an index annuity. The percentage of the index's return the insurance company credits to the annuity is determined by A) the annuity reset rate B) the CDSC C) the cap rate D) the participation rate

D Virtually all index annuities have a specified participation rate, the percentage of the index's earnings that will be credited to the account. For example, if the index returned 8% and the participation rate is 80%, the customer's account will be credited with 6.4%. Not all index annuities have a cap rate, but even then, the cap rate only takes effect when the credited earnings exceed the cap. For example, if the cap in our example was 5%, that is what the customer would receive. It is important to read the questions carefully. The cap rate puts an upper limit on the amount credited, but it is the participation rate that specifies the percentage of the return that will be credited.

Life insurance is generally purchased to replace the lost income of the insured. A client wishing to purchase a policy with a level death benefit and level premium for as long as the premiums are paid would choose A) a universal life policy. B) a decreasing term policy. C) a 5-year renewable term policy. D) a whole life policy.

D Whole life insurance is permanent insurance with a level premium and a level death benefit. The renewable term policy may have a level death benefit, but every 5 years, the premium will increase. Universal life has flexible premiums and, depending on the option chosen, the death benefit can increase.