Variable Annuities

Annuity units

the fixed number of units upon which the pay-out from a fixed or variable annuity is calculated. The number of annuity units is fixed when the accumulation units are annuitized.

During the accumulation phase of a variable annuity contract, reinvested: I dividends and interest are tax deferred II capital gains are tax deferred III dividends and interest are taxable IV capital gains are taxable A. I and II only B. III and IV only C. I and IV only D. II and III only

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

An "accumulation unit" of a variable annuity contract is a(n): A. share of common stock representing an interest in the underlying portfolio B. accounting measure of the owner's interest in the separate account C. accounting measure of the annuity amount to be received by the owner D. share of beneficial interest in a fixed portfolio

B. An accumulation unit is an accounting measure used for valuing a variable annuity holder's interest in the separate account.

Which of the following are purchase and payout options for variable annuity contracts? I Lump sum payment; Immediate annuity II Lump sum payment; Deferred annuity III Periodic payments; Immediate annuity IV Periodic payments; Deferred annuity A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

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

A registered representative that wishes to recommend a variable annuity to a customer must make reasonable efforts to obtain the customer's: I intended use of the variable annuity II investment time horizon III existing assets including insurance holdings IV liquidity needs A. I and II only B. III and IV only C. I, II, III only D. I, II, III, IV

D. Consider this to be a learning question. To recommend a variable annuity, the representative should make reasonable efforts to obtain the customer's age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred annuity, investment time horizon, existing assets including life insurance, liquidity needs, liquid net worth, risk tolerance, tax status and any other information that is needed to make a recommendation to the customer. Just to make sure this happens, FINRA requires that the representative sign a statement that this was done.

The "death benefit" associated with a variable annuity contract means that if the contract holder dies: A. prior to annuitization, the amount invested in the contract is returned to a beneficiary B. after annuitization, the amount invested in the contract is returned to a beneficiary C. prior to annuitization, the insurance company will make a lump sum payment to complete the terms of the contract D. after annuitization, the insurance company will pay for the insured's burial expenses

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

A customer who buys a variable life policy is most susceptible to: A. purchasing power risk B. market risk C. default risk D. exchange rate risk

B. The premium paid in a variable life policy is invested in a separate account that buys shares of a designated mutual fund. If the mutual fund does poorly, the account will not build cash value as quickly and the amount of coverage provided will not grow as rapidly. If the NAV of the mutual fund declines, the coverage amount can actually decline (though not below a minimum stated coverage amount). So the main risk is market risk. Default risk is associated with investing in bonds - it is the same as credit risk. Purchasing power risk is inflation risk - and because the separate account is typically invested in equity mutual funds, where companies can raise prices if there is inflation, this risk is minimized. Finally, exchange rate risk is associated with making investments denominated in foreign currencies.

Which of the following statements are TRUE regarding mutual funds and variable annuities that are in the accumulation phase? I Distributions to mutual fund shareholders are taxable to the holder in the year the distribution is made II Distributions to mutual fund shareholders are tax deferred III Distributions to variable annuity holders are taxable to the holder in the year the distribution is made IV Distributions to variable annuity holders are tax deferred A. I and III B. I and IV C. II and III D. II and IV

B. When a mutual fund distribution is made, tax liability arises, Thus, the distribution is taxable in the year the distribution is received. Dividends and capital gains in variable annuity separate accounts build tax deferred; no tax is due until the holder is retired and commences withdrawals.

Which of the following statements are TRUE for both mutual funds and variable annuities? I Asset appreciation is untaxed for both II Dividend and capital gains distributions are taxable each year for both III Both have portfolios that are managed IV Both are regulated by the Investment Company Act of 1940 A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

C. Both variable annuities and mutual funds are regulated under the Investment Company Act of 1940; have managed portfolios; and asset appreciation is untaxed. Mutual fund asset appreciation is taxable only when a capital gains distribution is made. Dividend and capital gain distributions made by variable annuity separate accounts must be reinvested and are tax deferred. Dividend and capital gain distributions from other investment companies do not have to be reinvested and are always taxable, whether reinvested or not.

Which of the following statements is (are) TRUE regarding variable annuity contracts? I The principal amount is guaranteed prior to annuitization by the insurance company that issues the contract II The principal amount is guaranteed after annuitization by the insurance company that issues the contract III The contract holder loses control of the principal amount prior to annuitization IV The contract holder loses control of the principal amount after annuitization A. I and III only B. II and IV only C. IV only D. I, II, III, IV

C. In a variable annuity contract, the principal amount is never guaranteed. The principal value may increase or decrease, depending on the performance of the separate account. The "investment risk" is borne by the contract holder, not the insurance company. Regarding the statement about the contract holder "losing control of the principal," this relates to the contract holder's ability to change the terms of the payout from the contract. Prior to annuitization, the contract holder is allowed to change his payout option, thus he has control over how the principal will be disbursed. However, once the contract is "annuitized," the contract holder cannot change the payout option - he or she loses control over the principal. (Please note that the term "losing control over the principal" does not refer to how the investment manager decides to invest the funds in the separate account.)

Which annuity payout option usually results in the largest periodic payment? A. Unit Refund Annuity B. Joint and Last Survivor Annuity C. Life Annuity D. Life Annuity-Period Certain

C. The shorter the expected annuity period, the larger the payment. A life annuity lasts only for that person's life - this is the shortest expected period of those given. A life annuity with period certain continues to pay for a fixed time period if the person dies early; a joint and last survivor annuity pays a spouse when one person dies; a unit refund annuity pays a lump sum if a person dies early.

Which of the following statements are TRUE for both mutual funds and variable annuities that are in the accumulation phase? I Distributions are taxable to the holder in the year the distribution is made II The underlying portfolios are managed III The Investment Company Act of 1940 is the regulating legislation IV The return to investors is dependent on the performance of the securities in the underlying portfolio A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

C. The underlying portfolios of mutual funds and variable annuities are both "managed," since separate accounts buy the shares of management companies. Both are regulated by the Investment Company Act of 1940, and have investors carry "investment risk" and corresponding gain potential. Dividends and capital gains in variable annuity separate accounts build tax deferred; mutual funds distributions are taxable. When a mutual fund distribution is made, tax liability arises. This is not the case with separate account distributions which must be reinvested.

A customer buys a variable annuity and elects a payout option of Life Income with a 20 year period certain. This means that payments will continue for: A. the annuitant's life, not to exceed 20 years B. the annuitant's life, but if he dies before 20 years elapse, payments continue to his heir(s) C. the life of the annuitant and then cease D. 20 years to the annuitant or beneficiary

B. An annuity payout option of Life-with Period Certain means that the annuity continues for the customer's life, but if he dies before the "period certain" (20 years in this case) is completed, payments will continue to a beneficiary until the 20 year period is completed.

If the actual interest rate earned in the separate account underlying a variable annuity contract is lower than the "AIR," the annuity payment: A. will increase B. will decrease C. is unaffected D. is fixed at a minimum amount

B. The "AIR" is the "Assumed Interest Rate." This is used as an illustration of the annuity payment that will be received if the separate account grows at the AIR. If the assets grow at an interest rate that is higher than the AIR, then the annuity payment will increase. Conversely, if the assets grow at an interest rate that is lower than the AIR, then the annuity payment will decrease.

Payments into a variable annuity contract are deposited to the insurance company's: A. general account B. special account C. separate account D. special memorandum account

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

To sell a variable annuity, what license(s) is (are) needed? A. Series 6 only B. Series 7 only C. Series 6 or Series 7 D. Series 6 or Series 7 plus a state insurance license

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

Which of the following statements are TRUE regarding the "AIR" stated in a variable annuity prospectus? I The AIR is an aggressive illustration of an interest rate for the annuity II The AIR is a conservative illustration of an interest rate for the annuity III The AIR is the minimum guaranteed rate of return IV The AIR is not a guaranteed rate of return A. I and III B. I and IV C. II and III D. II and IV

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

Investment risk in a variable annuity contract is carried by the: A. purchaser B. issuer C. custodian D. manager

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

What will change the cash value of a variable life policy? A. Changes in expenses B. Changes in market value C. Changes in death benefit D. Changes in beneficiary

B. Any "variable" product, either a variable annuity or variable life insurance, takes the premium and invests it in a designated separate account, also called a subaccount, that invests in a specified mutual fund. The performance of the mutual fund builds cash value in a variable life policy. This cash value build can be borrowed from the policy. If the cash value grows to more than the death benefit and has not been borrowed, then the policy will pay the higher cash value on death.

A variable annuity is a(n): I security regulated under the Investment Company Act of 1940 II insurance product that is not regulated under the Investment Company Act of 1940 III security that must be sold with a prospectus IV insurance product that has no prospectus requirement A. I and III B. I and IV C. II and III D. II and IV

A. Variable annuities differ from other products sold by insurance companies in that the purchaser bears the investment risk; as opposed to the insurance company bearing the investment risk. For example, if an insurance company achieves poor investment results, this does not affect the amount of death benefit that one gets from a traditional insurance policy; if the separate investment account funding a variable annuity achieves poor investment results, the annuity payment will drop. Because the purchaser bears the investment risk in a variable annuity contract, these are defined by the SEC as a non-exempt security that must be registered and sold with a prospectus. Because these are structured as participating unit trusts, variable annuities are regulated under the Investment Company Act of 1940.

When comparing fixed annuities to variable annuities, which statements are TRUE? I A fixed annuity account grows at a guaranteed rate II A variable annuity account grows at a guaranteed rate III Fixed annuities are subject to investment risk IV Variable annuities are subject to investment risk A. I and III B. I and IV C. II and III D. II and IV

B. Fixed annuity premiums are invested in an insurance company's general account and grow at a guaranteed rate (which is usually fairly low). There is no investment risk. At retirement, the customer receives a fixed periodic payment for life. Variable annuity premiums are invested in an insurance company "separate account" which buys shares of a designated mutual fund. The account grows based on the performance of the underlying mutual fund, so the investor is subject to investment risk.

An "annuity unit" of a variable annuity contract is a(n): A. share of common stock representing an interest in the underlying portfolio B. accounting measure of the owner's interest in the separate account C. accounting measure of the annuity amount to be received by the owner D. share of beneficial interest in a fixed portfolio

C. Once a variable annuity contract is annuitized, accumulation units are converted to annuity units. These determine the annuity payments to be made.

During the accumulation phase of a variable annuity: A. payments can be made into the plan; but distributions may not be taken from the plan B. distributions may be taken from the plan; but payments may not be made into the plan C. both payments may be made into the plan; and distributions may be taken from the plan D. neither payments may be made into the plan; nor distributions may be taken from the plan

A. During the accumulation phase of a variable annuity contract, money can be paid into the plan; but distributions cannot be taken. When distributions commence in the annuity phase, no more monies can be paid into the plan. Thus, the accumulation phase allows payments to be made into the plan; but distributions cannot be taken out of the plan.

AIR

abbreviation for "Assumed Interest Rate," the annual rate of return used in the prospectus of variable annuity that illustrates the compounding effect of contributions over the life of the contract and the resultant value of the annuity at retirement. The AIR is conservatively presented for illustrative purposes only; it is not a guaranteed rate of return.

Which statements are TRUE regarding the annuitization of a variable annuity contract? I A Life Annuity payout option may be elected by the policy holder II Life Annuity-Period Certain is the preferred payout option III The number of annuity units is fixed; the annuity payment may vary IV The annuity payment is fixed; the number of annuity units may vary A. I and III B. II and III C. I and IV D. II and IV

A. Variable annuity contracts allow the holder to elect a payout option that meets that person's individual requirements. The statement that a life annuity-period certain is a preferred payout option is erroneous - the choice of payout method depends on the needs of the annuitant. Once the contract is annuitized, the number of annuity units is fixed. However, the value of each unit varies with the performance of the underlying securities, hence the monthly annuity payment may vary

Variable annuity contracts: I have the issuer bear the investment risk II have the purchaser bear the investment risk III are non-exempt securities IV are exempt securities A. I and III B. I and IV C. II and III D. II and IV

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

All of the following are variable annuity payment options EXCEPT: A. Life Annuity B. Life Annuity with Period Certain C. Joint and Last Survivor D. Joint Tenants with Rights of Survivorship

D. Annuity payment options include a life annuity; life annuity with a period certain (which pays for a minimum guaranteed period, regardless); and a joint and last survivor annuity (which covers 2 lifespans, such as both a husband and wife). Joint tenants with rights of survivorship is an ownership option for a joint account, where each tenant 100% owns the account (typical for a husband and wife).

Variable annuity

a unit trust form of an investment company where an insurance company sells an annuity in which the amount of the periodic payments to the investor (called the annuitant) will vary with the value of the mutual funds held in the underlying portfolio. The underlying portfolio is termed the "separate account," since these investments are segregated from the insurance company's general investment account. These are redeemable securities that do not trade. Variable annuities are a non-exempt security under the Securities Act of 1933 and must be sold with a prospectus