SERIES 7 - Unit 9
ne of your customers purchased a fixed premium variable life insurance policy five years ago. The face value of the policy is $2 million and the current cash value is $107,237. The customer calls you and asks about taking a policy loan. Although the exact details are in the prospectus, you know that the minimum amount that could be borrowed is A) $1,500,000.00. B) $96,513.30. C) $107,237.00. D) $80,427.75.
D) $80,427.75. Explanation Once a variable life insurance policy has been in effect for at least three years, the policy must allow for a policy loan equal to a minimum of 75% of the current cash value. LO 9.e
Once a variable annuity has been annuitized A) each annuity unit's value and the number of annuity units vary with time. B) each annuity unit's value is fixed, but the number of annuity units varies with time. C) the number of annuity units is fixed, and their value remains fixed. D) each annuity unit's value varies with time, but the number of annuity units is fixed.
D) each annuity unit's value varies with time, but the number of annuity units is fixed. Explanation During the payout period, payments are based on a fixed number of annuity units established when the contract was annuitized. The value of an annuity unit varies from month to month according to the performance of the separate account, in comparison to the assumed interest rate. LO 9.c
A 38-year-old investor places $25,000 into a qualified single premium deferred variable annuity. Twenty-two years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $18,000. B) $16,450. C) $25,200. D) $11,750.
A) $18,000. Explanation Because this is a qualified annuity, the entire withdrawal is taxable. The surrender value of $72,000 has a cost basis of $0.00. That $72,000 is taxed at the marginal rate of 25%. Because the investor is older than 59½ (38 + 22 = 60), there is no additional 10% penalty tax. Effectively, this is a 25% tax on $72,000. LO 9.d
A 38-year-old investor places $25,000 into a single premium qualified deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor withdraws $50,000. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $12.500. B) $17,500. C) $16,450. D) $11,750.
B) $17,500. Explanation Because this is a qualified annuity, the entire withdrawal is taxable. In this case, it is all $50,000. That $50,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is younger than 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $50,000. LO 9.d
All of the following investment strategies offer either fully or partially tax-deductible contributions to individuals who meet eligibility requirements except A) IRAs. B) variable annuities. C) defined contribution plans. D) Keogh plans.
B) variable annuities. Explanation Contributions to a nonqualified variable annuity are not tax deductible. Contributions to an IRA may be tax deductible, depending on the individual's earnings and participation in a company-sponsored qualified retirement plan. Please note that all annuities are non-qualified unless something in the question indicates otherwise. For example, if the question deals with annuities in a 403(b) plan, it must be qualified. LO 9.d
All of the following statements about variable annuities are true except A) the number of annuity units becomes fixed when the contract is annuitized. B) such an annuity is designed to combat inflation risk. C) the rate of return is determined by the underlying portfolio's value. D) a minimum rate of return is guaranteed.
D) a minimum rate of return is guaranteed. Explanation The return on a variable annuity is not guaranteed; it is determined by the underlying portfolio's value. Variable annuities are designed to combat inflation risk. The number of annuity units becomes fixed when the contract is annuitized; it is the value of each unit that fluctuates. LO 9.c
Although there are general suitability rules that always apply, FINRA's Rule 2330 on variable annuity suitability specifies that, to be considered suitable, there is a reasonable basis to believe that the customer has been informed—in general terms—of various features of A) deferred annuities of all types. B) single premium variable annuities. C) immediate variable annuities. D) deferred variable annuities.
D) deferred variable annuities. Explanation FINRA's primary suitability concern is with deferred variable annuities. That does not mean there are no requirements for being careful with the others, it is just that most of the violations have involved the deferred VA. LO 9.e
When a person is calculating cost basis for a nonqualified variable annuity, the person is using A) the pretax dollars contributed. B) the earnings in excess of dollars contributed. C) the dollars contributed minus any gains at the time of payout. D) the after-tax dollars contributed.
D) the after-tax dollars contributed. Explanation For a nonqualified variable annuity, cost basis for the annuitant would use the after-tax dollars contributed. LO 9.d
FINRA Rule 2330 states: no member or person associated with a member shall recommend to any customer the exchange of a deferred variable annuity unless such member or person associated with a member has a reasonable basis to believe the exchange suitable, taking into consideration whether A) the customer's health has declined since the purchase of the initial annuity. B) the new annuity has a higher assumed interest rate. C) the customer is at least 59½ and will not be subject to the 10% tax penalty. D) the customer has had another deferred variable annuity exchange within the preceding 36 months.
D) the customer has had another deferred variable annuity exchange within the preceding 36 months. Explanation FINRA Rule 2330 specifies the suitability conditions surrounding the recommended exchange of an existing deferred variable annuity contract for a new one. Included in the list of considerations is determining if the customer has made another variable annuity exchange within the previous 36 months. Unlike life insurance, where the insured's health is important, there are no health questions on an annuity application. It is safe to assume that any annuity exchange will be done under the provisions of Section 1035. This means there are no tax consequences. The assumed interest rate is for internal purposes; it is not a differentiator when deciding which variable contract to purchase. LO 9.e
The holder of a variable annuity receives the largest monthly payments under which of the following payout options? A) Life annuity B) Life annuity with period certain C) Joint and last survivor annuity D) Joint tenants annuity
A) Life annuity Explanation Life annuity has the largest payout because less risk is assumed by the insurance company; there is no beneficiary in the event the annuitant dies. LO 9.b
Which of the following statements regarding variable annuities are true? The number of accumulation units is always fixed throughout the accumulation period. The number of accumulation units can rise during the accumulation period. The number of annuity units is fixed at the time of annuitization. The number of annuity units rises once annuitization begins. A) I and IV B) I and III C) II and III D) II and IV
) II and III Explanation The number of variable annuity accumulation units can rise during the accumulation period when additional units are being purchased. When a variable annuity contract is annuitized, the number of annuity units is fixed. LO 9.c
For a retired person, which of the following investments would provide the greatest protection against inflation? A) Corporate bonds B) Variable annuities C) Fixed annuities D) Municipal bonds
B) Variable annuities Explanation Fixed-income instruments, like bonds and fixed annuities, are subject to purchasing power risk. Variable annuities provide protection from inflation because their monthly income can increase depending on the separate account's performance. LO 9.a
An investor purchased a single premium deferred variable annuity 20 years ago. The premium deposit was $50,000. The account is now worth $200,000 and the investor is still working. When does the investor have to begin taking required minimum distributions? A) At age 72 or when no longer working, whichever is later B) At age 59½ C) Never with a nonqualified annuity D) At age 72
C) Never with a nonqualified annuity Explanation On the exam, unless stated to the contrary, every annuity is nonqualified. One of the benefits of nonqualified annuities is that there is no age at withdrawals must commence. In general, earnings withdrawn prior to age 59½ are subject to the additional 10% penalty on top of tax at ordinary rates. LO 9.d
It would generally be considered unsuitable for a registered representative to recommend a Section 1035 exchange of a deferred variable annuity contract if there had been one in the previous A) 36 months. B) 12 months. C) 30 months. D) 24 months.
A) 36 months. Explanation Among other requirements, FINRA Rule 2330 covers the suitability of a deferred annuity exchange under Section 1035 for a particular customer. Suitability considerations include, among other factors, whether the customer would incur a surrender charge, be subject to a new surrender period, lose existing benefits, be subject to increased fees or charges, and if the customer has had another exchange within the preceding 36 months. LO 9.e
Your customer owns a variable annuity contract. The assumed interest rate (AIR) stated in the contract is 5%. In January, the realized rate of return in the separate account was 7%, and she received a check in February based on this return for $200. In February, the rate of return was 10%, and she received a check in March for $210. For her April check to be $210, what rate of return would the separate account have to earn in March? A) 5% B) 7% C) 3% D) 10%
A) 5% Explanation Each month's payout depends on the actual earnings compared to the AIR. If the actual rate of return equals the assumed interest rate, the check will stay the same. We don't compare one month's return to another's; we compare the actual to the assumed. If the actual is higher, the following month's check goes up. If the actual is lower, the following month's check goes down. And, as stated earlier, if the actual equals the assumed, there is no change. LO 9.c
Which of the following must be registered as investment companies under the Investment Company Act of 1940? Closed-end investment companies Separate accounts of insurance companies offering variable products Variable annuity contracts Variable life insurance policies A) I and II B) III and IV C) I and IV D) II and III
A) I and II Explanation Under the Investment Company Act of 1940, face amount certificate companies, unit investment trusts, open- and closed-end management companies, and separate accounts of insurance companies used to fund variable annuity and variable life contracts must register with the SEC as investment companies. Note that the separate account is registered as an investment company, not the variable contract. LO 9.a
Which of the following characteristics is not shared by both a mutual fund and a variable annuity's separate account? A) The payout plans provide the client income for life. B) The investment portfolio is managed professionally. C) The client assumes the investment risk. D) The client may vote for the board of directors or board of managers.
A) The payout plans provide the client income for life. Explanation Only variable annuities have payout plans that provide the client income for life. LO 9.a
If a 42-year-old customer has been depositing money in a variable annuity for five years, and he plans to stop investing but has no intention of withdrawing any funds for at least 20 years, he is holding A) accumulation units. B) annuity units. C) accumulation shares. D) mutual fund units.
A) accumulation units. Explanation The customer, in the accumulation stage of the annuity, is holding accumulation units. The value of the customer's account is converted into annuity units if and when the customer decides to annuitize the contract. LO 9.c
An 18-year-old, unmarried high school student sought a safe investment for a $30,000 bequest until after she graduated from college. Her intent was to use the funds for the down payment on a house after graduation. Her agent recommended she choose a variable annuity as a safe haven for the funds. This recommendation is unsuitable because A) her situation exposes her to surrender charges and early withdrawal penalties. B) withdrawal of her cost basis is tax free. C) an 18-year-old can't own a variable annuity. D) the investment grows tax deferred.
A) her situation exposes her to surrender charges and early withdrawal penalties. Explanation The funds are not liquid due to the surrender fees, and there is also a 10% penalty on withdrawals of earnings before age 59½. LO 9.d
With regard to a variable annuity, all of the following may vary except A) number of annuity units. B) value of annuity units. C) value of accumulation units. D) number of accumulation units.
A) number of annuity units. Explanation During the accumulation phase, the number of accumulation units will increase as additional money is invested. When the contract is annuitized, the annuitant is credited with a fixed number of annuity units. Once annuitized, the number of annuity units does not vary. The value of accumulation and annuity units varies with the investment performance of the separate account. LO 9.c
A variable annuity's separate account is: used for the investment of funds paid by contract holders. used to escrow late or otherwise delinquent premium payments. required to be located off of the company's premises. regulated under both securities and insurance laws. A) I and III B) II and III C) II and IV D) I and IV
D) I and IV Explanation The separate account is used for both variable life insurance and variable annuity investments. The nature of the securities invested in—bonds and growth stocks—makes it necessary that sales representatives and their principals be licensed in securities as well as insurance. LO 9.a
An individual purchases a variable life insurance policy. Under federal law, the individual is entitled to a complete refund of all premiums paid if the request is made within A) the first 30 days after the policy was delivered to the owner. B) 45 days from the execution of the application, or for 10 days from the time the owner receives the policy, whichever is longer. C) the first 24 months after the policy was delivered to the owner. D) 10 days from the execution of the application, or for 45 days from the time the owner receives the policy, whichever is longer.
B) 45 days from the execution of the application, or for 10 days from the time the owner receives the policy, whichever is longer. Explanation The Investment Company Act of 1940 specifies a free-look period for the purchaser of a variable life insurance policy. That period is the longer of 45 days after the execution of the application or 10 days after the actual policy is delivered to the owner. The 24 months is the minimum time limit for the exchange of the variable policy into another form of permanent insurance. LO 9.e
A 45-year-old client of yours receives an inheritance of $100,000 and wishes to invest it without having to worry about any taxes being due until she reaches age 68. In addition, the client would like to have some protection against inflation. Which of the following would be the most appropriate recommendation? A) An immediate variable annuity B) A single premium deferred variable annuity C) An S&P 500 index fund D) A single premium variable life insurance policy
B) A single premium deferred variable annuity Explanation There are two benefits to the deferred variable annuity. The first is that taxes on all earnings are deferred until withdrawal. The second is that, if the proper separate account subaccounts are selected, there is potential inflation protection. An index fund will meet the second objective, but, even though index funds tend to be tax efficient, there will be certainly be dividend distributions from an S&P 500 index fund and possibly some capital gains as well. An immediate variable annuity begins payout immediately, so taxes start immediately as well. Variable life will never be an answer to a question unless the question describes a need for life insurance coverage—it cannot be sold strictly as an investment. LO 9.b
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. What product guarantees that she will receive monthly payments for life, no matter how long that will be? A) A 30-year term policy B) An annuity C) An index fund D) Whole life insurance
B) An annuity Explanation One of the unique characteristics of an annuity (variable or fixed) is that it guarantees monthly payments for the life of the annuitant. Life insurance provides a death benefit, but not income. An index fund carries no guarantees. LO 9.a
A registered representative explaining variable annuities to a customer would be correct in stating that a variable annuity guarantees an earnings rate of return. a variable annuity does not guarantee an earnings rate of return. a variable annuity guarantees payments for life. a variable annuity does not guarantee payments for life. A) I and III B) II and III C) II and IV D) I and IV
B) II and III Explanation A variable annuity does not guarantee an earnings rate because earnings will depend on the performance of the separate account. However, it does guarantee payments for life (mortality). LO 9.a
A registered representative with ABC Securities has recently become aware of a new variable annuity. As tax time is approaching, the representative decides to recommend the variable annuity to all of her customers as an attractive addition to their portfolios. The representative should recommend the variable annuity to all of her clients because the tax advantage almost always results in a greater return. recommend the variable annuity to those clients whose needs and objectives match the investment. recommend the variable annuity to all of her clients because of the performance potential of the subaccounts. not recommend the investment to all of her clients in spite of the tax advantages and additional features. A) I and IV B) II and IV C) II and III D) I and III
B) II and IV Explanation Recommendations may be made only when it is suitable for the customer's needs. Therefore, she would not recommend the variable annuity to all because some of them may not be able to benefit from those tax advantages. LO 9.d
A registered representative's customer is speaking of a variable life insurance contract she owns. She makes several statements regarding the contract. Which of the following is not an accurate statement concerning a variable life insurance contract? A) There is no guarantee regarding the investment results of the separate account. B) The death benefit can never be more than the guaranteed benefit. C) The portion of the premium invested in the insurance company's general account is used to provide for the minimum guaranteed amount of the death benefit. D) The policy provides a minimum guaranteed death benefit.
B) The death benefit can never be more than the guaranteed benefit. Explanation The minimum guaranteed death benefit is provided by that portion of the payment invested in the insurance company's general account. The remainder of the premium is invested in the separate account. While there is no guarantee on how investments in the separate account will perform, depending on its investment performance, the separate account could provide for a larger death benefit than the minimum guaranteed amount. LO 9.a
A customer has a nonqualified variable annuity. Once the contract is annuitized, monthly payments to the customer are A) 100% taxable. B) partially a tax-free return of capital and partially taxable. C) 100% tax deferred. D) 100% tax free.
B) partially a tax-free return of capital and partially taxable. Explanation The investor has already paid tax on the contributions, but the earnings have grown tax deferred. When the annuitization option is selected, each payment represents both capital and earnings. The money paid in will be returned tax free, but the earnings portion will be taxed as ordinary income. LO 9.d
One of your customers owns a single premium deferred variable annuity policy. The customer has been discussing a policy offered by a different insurance company that has a wider selection of investment portfolios. Should the customer elect to engage in a Section 1035 policy exchange, A) principal approval of any sale or exchange (including a 1035 exchange) must be obtained within three business days. B) principal approval of any sale or exchange (including a 1035 exchange) must be obtained within seven business days. C) the customer will not be able to add any additional funds to the new policy. D) you need to explain that any earnings on the exchanged policy will be subject to tax at ordinary income rates plus a 10% penalty if the customer is not at least 59 ½. Explanation
B) principal approval of any sale or exchange (including a 1035 exchange) must be obtained within seven business days. FINRA Rule 2330 requires a registered principal to review and determine whether to approve a customer's application for a deferred variable annuity before sending the application to the issuing insurance company. This must occur no later than seven business days after the broker-dealer receives a complete and correct application. It makes no difference if this is an initial sale or, as is the case in this question, an exchange (which is a purchase of a new policy using the proceeds of an old one). When done properly, there are no taxes or penalties with a Section 1035 exchange. Even though the old policy was purchased in a single premium, there is generally no problem with adding money when making an exchange. ** This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback. LO 9.e
An important feature of scheduled premium variable life insurance policies is that A) purchasers must understand that there are no guarantees with these policies. B) the death benefit can never fall below the guaranteed minimum amount. C) better than expected performance of the separate account can lead to reduced premiums. D) the cash value can never fall below the guaranteed minimum amount.
B) the death benefit can never fall below the guaranteed minimum amount. Explanation Scheduled (fixed) premium variable life always has a guaranteed death benefit. Cash values cannot be guaranteed, only the death benefit. Better than expected performance of the separate account will lead to increased cash values, but it will not affect the premiums. LO 9.a
A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty-two years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $18,000. B) $16,450. C) $11,750. D) $25,200.
C) $11,750. Explanation Only the deferred growth is taxable. In this case, it is the difference between the surrender value of $72,000 and the cost basis of $25,000. That $47,000 is taxed at the marginal rate of 25%. Because the investor is older than 59½ (38 + 22 = 60), there is no additional 10% penalty tax. Effectively, this is a 25% tax on $47,000. LO 9.d
A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $25,200. B) $18,000. C) $16,450. D) $11,750.
C) $16,450. Explanation Only the deferred growth is taxable. In this case, it is the difference between the surrender value of $72,000 and the cost basis of $25,000. That $47,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is younger than 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $47,000. LO 9.d
A 38-year-old investor places $25,000 into a qualified single premium deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $18,000. B) $11,750. C) $25,200. D) $16,450.
C) $25,200. Explanation Because this is a qualified annuity, the entire withdrawal is taxable. The surrender value of $72,000 has a cost basis of $0.00. That $72,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is younger than 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $72,000. LO 9.d
A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor withdraws $25,000. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $6,250. B) $0.00 C) $8,750 D) $17,500.
C) $8,750 Explanation Only the deferred growth is taxable on a LIFO (last-in, first-out) basis. In this case, it is the amount of the withdrawal in excess of the cost of $25,000. Using LIFO, all of the withdrawal is part of the $47,000 in earnings that have been generated. That $25,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is under 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $25,000. Remember, all annuities are nonqualified unless stated otherwise in the question. LO 9.d
A customer who has contributed to an IRA and an employer matching 401(k) plan continuously for many years, wants to purchase an annuity contract to add additional monthly income once retired. Given that all of the current retirement investments are subject to market risk, the customer wants these new funds to have no market risk exposure. One of the following options would achieve that objective, but a suitability discussion regarding its risk should also occur. Which option is it? A) Fixed-annuity contract with a discussion regarding timing risk B) Variable annuity (VA) contract with a discussion regarding interest rate risk C) Fixed-annuity contract with a discussion regarding purchasing power risk D) Variable annuity contract with a discussion regarding legislative risk
C) Fixed-annuity contract with a discussion regarding purchasing power risk Explanation A VA with its investments in the separate account subject to market risk would not align with the customer's objective. Therefore, only a fixed annuity could be considered as suitable. However, a discussion should occur regarding the risks that are associated with a fixed annuity: purchasing power risk. The fixed payment that the annuitant receives loses purchasing power over time as a result of inflation. LO 9.a
A prospectus for a variable annuity contract must provide full and fair disclosure. is required by the Securities Act of 1933. must be filed with FINRA. must precede every sales presentation. A) II and IV B) III and IV C) I and II D) I and III
C) I and II Explanation A variable annuity is a security and must be registered with the SEC, not FINRA. As part of the registration requirements, a prospectus must be filed and distributed to prospective investors. The time of distribution of the prospectus can be before the sales presentation or at the same time as the presentation. It is incorrect to state that it must precede every sales presentation. LO 9.a
Many life insurance companies offer variable products. Determining benefits usually depends on the actual performance of the selected separate account subaccount(s) compare to an assumed interest rate (AIR). Which of the following statements reflects that determination? Actual performance compared to the AIR affects the cash value of a variable life insurance policy Actual performance compared to the AIR affects the death benefit of a variable life insurance policy Actual performance compared to the AIR affects the value of an accumulation unit of a variable annuity Actual performance compared to the AIR affects the value of an annuity unit of a variable annuity A) I and IV B) I and III C) II and IV D) II and III
C) II and IV Explanation When the actual performance of the separate account exceeds the AIR, the death benefit of a variable life insurance policy will increase. When the performance is less than the AIR, the death benefit reduces, but never below the guaranteed minimum. There is no assumed interest rate for the cash value. That is, the insurance company makes no projections as to its growth. With variable annuities, it is the annuity unit where the performance versus the AIR is important. In order to set up lifetime payments, the insurance company makes certain assumptions about returns. If the returns are higher, the value of the annuity (payout) unit increases and vice-versa. During the accumulation period, there are no assumptions; the insurance company never projects how much the money will grow. LO 9.c
One of the specific concerns that the regulators have with variable annuities is sales personnel recommending that an investor switch from an existing contract to a new one. It would generally raise a "red flag" if the customer A) elects to make the exchange under the provisions of IRS Section 1035. B) has had another deferred variable annuity exchange within the preceding 60 months. C) has had another deferred variable annuity exchange within the preceding 36 months. D) has had another deferred annuity exchange within the preceding 36 months.
C) has had another deferred variable annuity exchange within the preceding 36 months. Explanation FINRA Rule 2330 frowns on recommending the exchange of one deferred variable annuity for another within a period of 36 months. This only applies to deferred variable annuities. When an exchange takes place, it is generally under the provisions of IRS Section 1035 - no red flag raised there. LO 9.e
Bob Smith, who is in his 40s, has just become covered by an extremely generous defined benefit retirement plan at his company. He has decided he no longer needs his variable annuity for retirement purposes and wants to use the money for a trip to Africa. Over the past 10 years, he has invested $60,000 in the annuity, and its net value is now $80,000. If Bob should go ahead and surrender the annuity, the tax consequences will be A) ordinary income tax on $60,000 and a $6,000 penalty. B) capital gains tax on $60,000 and a $6,000 penalty. C) ordinary income tax on $20,000 and a $2,000 penalty. D) capital gains tax on $20,000 and a $2,000 penalty.
C) ordinary income tax on $20,000 and a $2,000 penalty. Explanation If an annuity is cashed in, the growth and accumulation portion of its value ($20,000 in this case) is taxable as ordinary income. If the annuitant is under the age of 59½, he must also pay a 10% penalty on the growth withdrawn, a penalty of $2,000 in this case. LO 9.d
An investor begins a periodic payment deferred variable annuity purchase program. One respect in which this differs from purchasing a mutual fund is that A) there is a minimum guaranteed return with the variable annuity, while there are no guarantees with the mutual fund. B) the variable annuity contract will generally have lower expenses than the mutual fund. C) the investor in the variable annuity contract reports no taxable consequences during the accumulation period. D) the mutual fund will generally have a surrender charge for early withdrawal and variable annuities only charge for surrender when annuitizing.
C) the investor in the variable annuity contract reports no taxable consequences during the accumulation period. Explanation One of the features of annuities is the tax deferral of all earnings until the money is withdrawn. Mutual fund distributions are taxable when received. On the other hand, when the annuity accumulation is withdrawn, everything above the cost basis is taxed as ordinary income (10% penalty if younger than 59½)—there is never any capital gains treatment with annuities. Variable annuities invariably have higher expense ratios than mutual funds with similar portfolios. Surrender charges are found with annuities. Do not confuse those with the conditional deferred sales charge (CDSC) applied to certain mutual fund share classes. LO 9.d
A 58-year-old investor owns a single premium deferred variable annuity with a current value of $500,000. The original investment was $150,000 and the contract has a death benefit provision. If this investor wished to exchange this policy for one offered by a competing company, A) the investor would be liable for ordinary income taxes on $350,000. B) the tax-free exchange privilege applies only when the exchange is within the same insurance company. C) using a 1035 exchange would avoid any current taxation. D) the investor would be liable for ordinary income taxes plus the 10% penalty on $350,000.
C) using a 1035 exchange would avoid any current taxation. Explanation Section 1035 of the Internal Revenue Code permits the exchange of an annuity to another annuity, whether issued by the same or a competing company, with the tax-deferral on earnings continuing. These exchanges can also be made from an insurance policy to an annuity, but not from an annuity to an insurance policy. LO 9.d
FINRA Rule 2330, which deals with members' responsibilities regarding variable annuities, applies under which of the following circumstances? The initial purchase of a deferred variable annuity. The initial purchase of an immediate variable annuity. The initial subaccount allocations. The initial subaccount reallocations. A) I, II, and III B) II and IV C) I, II, III, and IV D) I and III
D) I and III Explanation This rule applies to recommended purchases and exchanges of deferred (not immediate) variable annuities and recommended initial subaccount allocations (there is no such thing as initial reallocations). On the other hand, this rule does not apply to reallocations among subaccounts made or to funds paid after the initial purchase or exchange of a deferred variable annuity. LO 9.e
If your customer invests in a variable annuity and chooses to annuitize at age 65, which of the following statements are true? She will receive the annuity's entire value in a lump-sum payment. She may choose to receive monthly payments for the rest of her life. The accumulation unit's value is used to calculate the total value of the account. The annuity unit's value represents a guaranteed return. A) II and IV B) I and IV C) I and III D) II and III
D) II and III Explanation When a variable contract is annuitized (distributed in regular payments, not as a lump sum), the number of accumulation units is multiplied by the unit value to arrive at the account's current value. An annuity factor is taken from the annuity table, which considers, for example, the investor's sex and age. This factor is used to establish the dollar amount of the first annuity payment. Future annuity payments will vary according to the separate account's performance. LO 9.c
An accumulation unit in a variable annuity contract is A) an accounting measure used to determine payments to the owner of the variable annuity. B) fixed in value until the holder retires. C) none of these. D) an accounting measure used to determine the contract owner's interest in the separate account.
D) an accounting measure used to determine the contract owner's interest in the separate account. Explanation When money is deposited into the annuity, it is purchasing accumulation units. LO 9.b
