Annuities and Variable Products Flashcards

Questions and Answers

Which of the following statements is TRUE concerning periodic payment variable annuities?

A client's number of annuity units never changes (correct)

A client's number of accumulation units never changes

The monthly payout is fixed by the inflation index

Annuity contracts never have a beneficiary

The purchaser of a variable life insurance policy bears which of the following risks?

The insurance company may increase the premiums if the investment performance of the separate account is poor

The policy may have no cash value if the separate account performance is negative (correct)

The death benefit may fall to zero due to poor market performance

The increasing cost of doing business may force the insurance company to raise expense charges against the separate account

Which annuity settlement option would provide the greatest monthly return for an individual?

Life annuity with a 10-year certain

Unit refund life annuity

Life annuity with a 20-year certain

Life annuity with a 5-year certain (correct)

A variable annuity would be MOST suitable for which of the following customers?

A client in a high tax bracket who is purchasing the annuity for his spouse's retirement needs Signup and view all the answers

A variable annuity application sent by a FINRA member does not include a principal's approval. The insurance company:

Must reject the application Signup and view all the answers

A variable life insurance policy has an AIR of 5%. The separate account recently performed at a 4% rate of return. Which of the following statements BEST describes the effect of this rate of return on the death benefit of the policy?

The death benefit will decrease, but not below the guaranteed minimum Signup and view all the answers

When engaging in a 1035 exchange an individual should be aware that:

The exchange is not a taxable event but the new annuity may come with additional restrictions Signup and view all the answers

The separate account of a variable life policy has performed poorly for some time. A client is concerned about her cash value and death benefit. Which of the following statements is TRUE?

The death benefit may decline, but not below a contractual minimum Signup and view all the answers

Alan and Marie Johnson have one child and have just purchased a home. Which of the following types of insurance is MOST appropriate for the Johnsons?

Variable universal life insurance Signup and view all the answers

A person purchases a non-qualified variable annuity and dies at the age of 57. The tax implication is:

No penalty and the difference between the amount invested and the death benefit is taxable Signup and view all the answers

An individual considering the purchase of an equity-indexed annuity should understand that:

The return over long periods of time will equal the greater of the participation rate of the underlying index or the guaranteed minimum Signup and view all the answers

A firm's suitability responsibilities for sales of variable annuities do NOT apply to recommendations in which of the following situations?

The reallocation of assets among subaccounts after the initial purchase Signup and view all the answers

Ms. Brown owns a variable annuity that has a life annuity payout option with a 20-year period certain. If Ms. Brown dies after 14 years of payments:

Future payments will continue for 6 years to a named beneficiary Signup and view all the answers

A variable annuity contract holder dies during the accumulation period. In this situation, which of the following statements is TRUE regarding the tax consequences?

Proceeds in excess of cost are taxable as ordinary income to the beneficiary Signup and view all the answers

Which of the following statements is TRUE concerning the suitability of a Section 1035 exchange?

Exchanges made within 36 months of a previous exchange are generally considered inappropriate Signup and view all the answers

If the purchaser of a non-qualified annuity dies at the age of 56, which of the following BEST describes the tax impact?

There is no penalty assessed and the difference between the amount invested and the death benefit is taxable at ordinary income tax rates Signup and view all the answers

Which of the following statements can be made about Mr. Brick's payments?

The third payment was higher than the previous month's payment Signup and view all the answers

Who is the most appropriate buyer for a variable life insurance policy?

A person with an understanding of investments who can tolerate market risk Signup and view all the answers

Which of the following statements is TRUE about variable annuities?

Payout is based on a number of annuity units, which remains fixed for the duration of the payout period Signup and view all the answers

What is the tax implication of withdrawing proceeds from a variable annuity prior to age 59 1/2?

A 10% tax penalty may apply, unless the annuitant dies or becomes disabled. Signup and view all the answers

What does Section 1035 of the Internal Revenue Code permit?

Permits the tax-free exchange of one annuity contract for another Signup and view all the answers

Which of the following choices would be most suitable for a client looking to set aside additional funds for retirement without immediate taxation on growth?

A variable annuity Signup and view all the answers

If an investor withdraws $20,000 from a non-qualified variable annuity with a tax bracket of 28%, what is their tax liability?

$2,800 Signup and view all the answers

Which expense is found in a variable annuity but not in a mutual fund?

Mortality expenses Signup and view all the answers

Which annuity settlement option provides a payout period of at least 20 years or for the annuitant's lifetime, whichever is greater?

Life annuity with period certain Signup and view all the answers

How long should investors wait between 1035 exchanges of variable contracts?

36 months Signup and view all the answers

Which payout option provides the highest payout for variable annuities?

Life annuity Signup and view all the answers

Which statement is TRUE concerning periodic payment variable annuities?

The number of a client's annuity units never changes Signup and view all the answers

An individual considering moving to the payout phase of a variable annuity should understand the payments will:

Be based on the performance of the subaccount products in the separate account Signup and view all the answers

Which of the following annuities offers the shortest surrender period to avoid sales charges?

L shares Signup and view all the answers

What is required to sell variable annuities to clients?

A life insurance license and securities registration Signup and view all the answers

Richard Smith, a variable life insurance policyholder, dies. What describes the tax consequences of his policy?

The value of the policy will be included in Richard's estate for tax purposes Signup and view all the answers

Which statement is TRUE concerning the purchase of a mutual fund and a variable annuity?

The growth fund may be purchased immediately but the variable annuity purchase must first be approved by a principal Signup and view all the answers

What is the term for recommending that a client redeem one annuity and invest in another?

Potentially acceptable if the benefits of the new annuity outweigh the possible taxes and additional charges Signup and view all the answers

Which of the following statements about an equity-indexed annuity (EIA) is NOT TRUE?

It is considered a security Signup and view all the answers

In which situation does suitability in variable annuity transactions NOT apply?

An employee's contribution to his 403(b) plan Signup and view all the answers

According to suitability rules, 1035 exchanges should occur not more frequently than once every:

36 months Signup and view all the answers

Many investors prefer to receive variable annuity payments under the straight-life payout option because this option:

Provides the maximum cash flow of all payout options Signup and view all the answers

Which statement is NOT considered misleading regarding a variable annuity communication?

Telling a client about the negative impact of an early redemption Signup and view all the answers

What happens if a variable annuity has an AIR of 4% and the separate account grew by 12%?

Will increase an annuitant's monthly payment from the annuity Signup and view all the answers

Which retirement vehicle likely provides the greatest protection of purchasing power?

Variable annuities Signup and view all the answers

Which annuity settlement option would provide the longest stream of income over the lives of two individuals?

Joint and last survivor annuity Signup and view all the answers

An investment contract that offers life insurance benefits plus participation in a portfolio of securities is called a:

Variable life insurance contract Signup and view all the answers

A person who purchases an annuity with an expectation of exchanging into another better-performing annuity after three years, should consider purchasing:

L shares Signup and view all the answers

Which factor is NOT used in determining the value of an annuity unit?

The assumed interest rate Signup and view all the answers

Which calculation describes the payout on a variable annuity?

A fixed number of annuity units multiplied by a variable dollar amount Signup and view all the answers

According to FINRA, what is the maximum sales charge on a variable annuity contract?

An amount that is fair and reasonable Signup and view all the answers

Which statement concerning a tax-qualified annuity is TRUE?

It has a zero cost basis and grows tax-deferred Signup and view all the answers

The payout on a variable annuity is based on a:

Fixed number of annuity units with a fluctuating value per unit Signup and view all the answers

An accumulation unit in a variable annuity contract is:

An accounting measure used to determine the contract owner's interest in the separate account Signup and view all the answers

Within how many days must a principal approve or disapprove an application to purchase a variable annuity?

7 business days Signup and view all the answers

What type of annuity is most suitable for a client looking for a long-term investment with guaranteed returns and a death benefit?

An equity-indexed annuity Signup and view all the answers

The fluctuations in the value of a variable annuity correspond with the fluctuations in the:

Value of the securities held in the separate account of the annuity Signup and view all the answers

Study Notes

Periodic Payment Variable Annuities

During the pay-in period, clients acquire accumulation units that convert to annuity units in the payout phase.
Monthly payouts depend on separate account performance, not fixed amounts.

Variable Life Insurance Policy Risks

Cash value can diminish to zero if the separate account performs poorly.
Death benefits can fluctuate but never drop below a guaranteed minimum.
Premiums remain constant through the policy's life.

Annuity Settlement Options

Life annuity with a 5-year certain offers the highest monthly payout.
Shorter guarantee periods result in higher payments due to increased risk to beneficiaries.

Suitability of Variable Annuities

Most suitable for clients seeking long-term tax-deferred income and not short-term needs.
Tax-qualified accounts (e.g., 401(k)) are not ideal for annuities due to existing tax-deferred benefits.

Variable Annuity Accumulation Units

Accumulation units measure ownership interest during the pay-in phase and their value fluctuates based on performance.

Annuity Application Procedures

Applications lacking principal approval must be rejected in compliance with FINRA regulations.
A principal must approve all variable annuity transactions within 7 days.

Variable Life Insurance Death Benefits

If account performance is below the AIR, the death benefit decreases but stays above a minimum level.

1035 Exchange Understanding

1035 exchanges are non-taxable; however, new contracts may impose restrictions.

Tax Implications of Nonqualified Variable Annuity Withdrawals

Early withdrawals incur a 10% penalty unless the annuitant dies or becomes disabled; only the appreciated amount is taxed as ordinary income.

Death Benefits in Variable Life Policies

Death benefits may decrease as per performance; however, they are protected by a minimum face value contract.

Variable Universal Life Insurance

Offers flexible premiums based on income; combines benefits of investment performance with life insurance coverage.

Tax Consequences for Death Before 59½

If an annuitant dies before 59½, there’s no penalty, but the taxable amount becomes the difference between contributions and death benefit.

Equity-Indexed Annuities

Returns over long periods depend on a combination of market performance and guaranteed minimums.

Variable Universal Life Cash Value

Cash value can fluctuate with account performance and is reduced by any policy loans.

Suitability Responsibilities

FINRA suitability rules don't apply to reallocations among existing subaccounts post-initial purchase.

Period Certain Annuity Payments

Beneficiaries receive remaining payments according to the period certain in case of the owner's death before the term ends.

Tax Treatment of Variable Annuity Proceeds

Death benefits exceed the invested amount taxed as ordinary income, with no penalties if the owner passes away.

Suitability of Section 1035 Exchange

Exchanges made within 36 months of a previous one are generally deemed inappropriate; must consider new contract benefits and surrender periods.

Tax Implications on Non-Qualified Annuities

If a purchaser dies before 59½, no penalty applies, but the tax comes from the difference between the invested amount and death benefit.

Retirement Savings Planning

A variable annuity is optimal for individuals who have exhausted contributions to retirement accounts and seek tax-deferred growth.

Unique Annuity Expenses

Mortality expenses are exclusive to annuities, covering death benefits; mutual funds do not include these fees.### Annuity Settlement Options
The life annuity with period certain option guarantees payouts for at least 20 years or for the annuitant's lifetime, whichever is longer.
If the annuitant dies before the end of the specified period, the beneficiary receives remaining payments or a lump sum.
A unit refund life annuity pays until the annuitant dies, with remaining units going to a beneficiary if the full contract value isn’t paid out.
A joint and last survivor life annuity continues payments until the last surviving individual passes, offering longevity in income.

Variable Annuities and Accumulation

The value of an investor’s interest in a variable annuity depends on added money and the performance of the separate account; the AIR is relevant only during the payout period.
Payments from a variable annuity in the payout phase are based on the subaccount products’ performance without guarantees of at least the cost basis.

Surrender Periods and Sales Charges

L shares offer the shortest surrender period (3 to 4 years) before sales charges are waived, while B shares typically have 7–8 years.
A principal must approve or disapprove a variable annuity purchase application within 7 business days.

Death Benefits and Tax Implications

The death benefit of a variable annuity skips the probate process but the policy value is included in the decedent’s taxable estate.
Beneficiaries might incur taxes on the amount exceeding the cost basis of the annuity.

Equity-Indexed Annuities

An equity-indexed annuity (EIA) offers a guaranteed minimum return, links returns to a stock market performance index, but is not classified as a security; its growth is tax-deferred.

1035 Exchanges and Investor Suitability

A 1035 exchange must occur no more frequently than every 36 months to avoid being deemed unsuitable due to churning.
When selecting investment options, suitability analysis includes factors like age, income, investment experience, and risk tolerance.

Payments in Variable Annuities

Payments are based on a fixed number of annuity units, which remain constant, multiplied by a variable dollar amount.
If a variable annuity’s separate account performs better than the assumed interest rate, monthly payments may increase.

Investor Characteristics for Variable Life Insurance

The best candidates for variable life insurance policies are individuals with investment knowledge and the capacity to absorb market risk; cash value fluctuates based on account performance.

Regulatory Compliance for Variable Annuities

Variable annuities must be registered with both the SEC and the State Insurance Commission while brokers must hold appropriate licenses to sell these products.

Investment Risk in Variable Annuities

Investment risk in variable annuities is borne by the customer; payments depend on separate account performance and are not guaranteed.
Straight-life payout option ceases payments upon the investor's death without further obligations from the insurer.

Key Characteristics of Annuity Units

Accumulation units represent ownership in the separate account and track the contract owner's interest.
Variable annuity payments are influenced by the value of the securities held in the separate account, reflecting market fluctuations.### 1035 Exchanges
Allows tax-free exchange of one annuity contract for another during the accumulation period.
Forbids tax-free exchanges between insurance policies, or from insurance policies to annuity contracts.
Permits tax-free transfers to life insurance policies.

Investment Risk in Annuities

Variable annuity investors assume investment risk; the annuity company does not guarantee returns.
Fixed annuities have the company assuming investment risk, guaranteeing fixed monthly payments.

Tax Liability on Withdrawals

Example: A 60-year-old investor who withdraws $20,000 from a variable annuity with $10,000 in earnings will face tax liability of $2,800 (28% tax rate on earnings).

Frequency of 1035 Exchanges

Investors should wait at least 36 months between 1035 exchanges of variable contracts for regulatory scrutiny.

Highest Payout Options

The life annuity option offers the highest cash flow since payments cease at death, with no beneficiary designated.

Licensing Requirements

Selling variable annuities requires both a life insurance license and securities registration.

Mutual Fund and Variable Annuity Purchases

Mutual funds can be purchased immediately while variable annuities require prior approval from a principal.

Switching Annuities

Switching to a new variable annuity may be acceptable if the benefits outweigh potential taxes or sales charges.

Suitability Regulations

Suitability rules do not apply to employee contributions to tax-qualified plans like 403(b).

Misleading Communications about Variable Annuities

Misleading representations include stating a variable annuity is a mutual fund or suggesting it meets short-term liquidity needs.

Annuity Unit Valuation

Annuity unit values are determined by the value of the separate account, not the assumed interest rate.

Sales Charges on Variable Annuities

No statutory maximum sales charge; must be fair and reasonable according to FINRA guidelines.

Tax Implications of Switching Annuities

Switching to another variable annuity may be considered unsuitable if it incurs deferred sales charges; however, it may not be taxable if it qualifies as a 1035 exchange.

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Test your knowledge of variable annuities with these flashcards. Understand the key concepts related to periodic payment and accumulation units. This quiz is essential for those studying financial products and annuities.