07 Annuities and Insurance

Question 1

Which of the following is true of the difference between a Roth and a Traditional IRA?

A. The Roth allows the participant to write covered calls
B. The Roth is funded with non- deductible contributions
C. The Roth is utilized more by lower-income individuals
D. The Traditional is funded with non-deductible contributions

Answer 1

B. The Roth is funded with non- deductible contributions

Rationale:
The main difference between the two is that the Roth is funded with non-deductible contributions, while the traditional IRA is funded with deductible (pre-tax) contributions.

Question 2

When will an employee in a SIMPLE IRA be fully vested?

A. Immediately
B. 7 years
C. 5 years
D. 3 years

Answer 2

A. Immediately

Rationale:
Vesting has to do with employer contributions—at what point do they rightfully belong to the participant? In an IRA, it’s always the individual’s money, so he/she is immediately “vested.”


Question 3

Which of the following do mutual funds and variable annuities have in common?

A. Tax-deferred growth
B. Suitable for Traditional IRA accounts
C. Right to vote for the investment adviser
D. Current taxation of all dividends, interest capital gains

Answer 3

C. Right to vote for the investment adviser

Rationale:
Mutual funds are currently taxable while variable annuities allow the taxation to be deferred. Mutual funds are suitable for Traditional IRA accounts, but variable annuities already offer tax- deferral, making them sort of redundant for IRA investments

Question 4

Your 58-year-old client has invested a total of $30,000 into
a non-qualified variable annuity. The value of the separate account is now $68,000. If your client takes a lump-sum payout, what will be the result?

A. Taxed at long-term capital gains rates
B. 10% of growth taxed at ordinary income rates
C. 10% taxed at short-term capita gains rate, plus 10% penalty
D. Growth taxed at ordinary income, plus 10% penalty on growth portion

Answer 4

D. Growth taxed at ordinary income, plus 10% penalty on growth portion

Rationale:
You never pay capital gains rates on retirement plan distributions. Rich folks wish they could do that, especially now that their ordinary income rate could be, say, 35% vs. their capital gains rate of just 15%. But even rich folks don’t always get what they wish. Why is there a penalty? The client isn’t 59 V2 yet. Remember, though, when we talk about penalties and taxes, those only apply to the growth portion. Her cost base/contributions are tax- and penalty free on a non-qualified annuity. Always.

Question 5

Your client, who is 60 years old, has invested a total of $10,000 into a tax-qualified variable annuity. The value of the separate account is now $57,000. If your client takes a lump-sum payout, what will be the result?

A. 10% penalty on entire amount
B. Capital gains on excess over cost basis
C. Ordinary income on excess over cost basis
D. Entire contribution taxed at ordinary income rate

Answer 5

D. Entire contribution taxed at ordinary income rate

Rationale:
If it’s “tax-qualified” money, it all comes out taxed. It went in tax-free. Most annuities on the exam are “non-tax-qualified,” but, obviously, not all of them.

Question 6

Which of the following represent accurate statements that a sales representative might make to an investing client about 529 Savings Plans?

A. The beneficiary assumes control of the assets upon reaching the state’s age of majority
B. 529 Savings Plan withdrawals used for qualified educational expenses are exempt from federal income taxes
C. 529 Savings Plans are currently used for educational expenses for grades kindergarten through graduate school
D. 529 Savings Plan contributions are tax-deductible for purposes of federal income tax

Answer 6

B. 529 Savings Plan withdrawals used for qualified educational expenses are exempt from federal income taxes

Rationale:
Contributions are subject to gift taxes. which is why most people put no more than the annual exclusion into the plan. But, it’s really the states that set the maximum that can be contributed for any beneficiary. The ccrtr butions are not tax-deductible for purposes of federal income tax, but may be deductible for purposes of state taxes. The withdrawals are tax-exempt at the federal level and usually at the state level, too, but the state tax treatment needs to be checked before putting someone into the plan. It’s the Coverdell, by the way, that allows the money to be used for kindergarten through h gher education. Also in the Coverdell. the newly-turned adult assumes control of the account; in the 529 Savings Plan, Grandma might cop an” attitude and take the money back. If she’ s willing to pay the usual 10% penalty plus ordinary ncome taxes, she can do whatever she wants with the money.

Question 7

Which of the following risks does the investor retain in a fixed annuity?

A. Purchasing power risk
B. Investment risk
C. All choices listed
D. Market risk

Answer 7

A. Purchasing power risk

Rationale:
Purchasing power/constant dollar risk is the only risk to a fixed annuitant. The annuity company guarantees a minimum return, so they have the investment/market risk. They also have mortality risk because the annuitant might live to be 157 years old. That minimum guaranteed return , though, might be all the annuitant receives. So, if the annuitant keeps getting a 4% rate of return, the risk is that inflation will go higher than 4%, leaving him/her with less purchasing power at the supermarket. Wal-Mart, etc.

Question 8

Which of the following risks does the investor retain in a variable annuity?

A. All choices listed
B. Systematic risk
C. Non-systematic risk
D. Interest rate risk

Answer 8

A. All choices listed

Rationale:
A variable annuity leaves you with the same risks that a mutual fund does. The market is a big, scary, unpredictable place. Why take on that risk in a variable annuity? Because you hope your money grows faster than the rate of inflation. Unfortunately to get that possible upside, you have to take on risks that individual securities could take a hit (non-systematic), the whole market could plummet (systematic risk) or that interest rates will spike, driving down bond prices and not doing too much wonderful stuff for stocks, either.

Question 9

When must an account executive present a prospectus to a client considering the purchase of a variable annuity?

A. At the time of contract delivery
B. Before or at the time of solicitation
C. As soon as he begins to discuss the concept of variable contracts
D. Upon request

Answer 9

B. Before or at the time of solicitation

Rationale:
Deliver the prospectus either before you sit down to sell the annuity or as you sit down to sell the annuity.

Question 10

A variable annuity will make payments to the annuitant for the rest of the annuitant’s life. This is known as a:

A. Payment guarantee
B. Mortality guarantee
C. Payout guarantee
D. Lifetime guarantee

Answer 10

B. Mortality guarantee

Rationale:
They will pay him as long as he is a mortal, and they will stop paying him as soon as he is immortal. Mortality guarantee. A “payment guarantee” would be a guaranteed rate of return—that’s the realm of the fixed annuity.

Question 11

If your client wants to receive the largest monthly payout from her variable annuity, she should typically select:

A. Life only
B. Life with 15-year period certain
C. Joint and last survivor
D. Life with 20-year period certain

Answer 11

A. Life only

Rationale:
If the insurance company only has to make payments for as long as the annuitant shall live, they’ll be mighty generous. If they’re on the hook for a certain period or if they have to cover a survivor, the payouts have to be more conservative.

Question 12

How much of your client’s annuity check is subject to capital gains if he takes a lump- sum payout?

A. 10%
B. The entire growth portion
C. None
D. 10% of the growth portion

Answer 12

C. None

Rationale:
You don’t pay cap gains on retirement money. It’s always ordinary Income.

Question 13

A schoolteacher participates in a 403b plan. Over her past 20 years of service the school district has contributed $50,000 to her account, with the account valued at $92,500 at retirement. Therefore, the teacher will be taxed on:

A. $42,500.00
B. $92,500.00
C. None of the choices listed
D. $50,000.00

Answer 13

B. $92,500.00

Rationale:
It all went in tax-free, so it all gets taxed on the way out. TSA/403b = qualified plan funded with pre-tax contributions.

Question 14

A schoolteacher participates in a tax-sheltered annuity. Over her past 20 years of service the school district has contributed $50,000 to her account, with the account valued at $92,500 at retirement. Therefore, the teacher’s cost base is:

A. $42,500.00
B. $50,000.00
C. $92,500.00
D. Zero

Answer 14

D. Zero

Rationale:
There is no cost base in a 403b/TSA because the money going in hasn’t been taxed yet. You have a cost base in a non- qualified variable annuity, not a qualified retirement plan.

Question 15

A client covered under an employer’s qualified defined benefit pension plan started an IRA before tax year 1996. What is true of this situation?

A. The IRA money must be commingled with the pension money
B. The IRA must be closed under Graham-Rudman-Leach
C. The client may continue to contribute to the IRA
D. Contributions to the IRA must cease before April 15 of the following year

Answer 15

C. The client may continue to contribute to the IRA

Rationale:
Don’t assume that everything is complicated. You can always have a traditional IRA as long as you have earned income. Period. You might not get to deduct the full contribution, but that’s another matter.

Question 16

What is normally associated with a 401K plan?

A. After-tax contributions
B. Employer matching
C. Corporate bonds
D. Municipal securities

Answer 16

B. Employer matching

Rationale:
That’s the beauty of the 401K, employer matching. It’s not a requirement, but it’s a typical feature.

Question 17

What is true of a qualified, non- contributory, defined-benefit pension plan?

I. Contributions are fully taxable
II. Contributions are not taxable
III. Contributions are tax- deductible
IV. Distributions are taxable

A. II, III
B. II
C. II, III, IV
D. I

Answer 17

C. II, III, IV

Rationale:
Defined benefit plans involve tax-deductible contributions from the employer and taxable distributions to the retiree.

Question 18

A teacher has participated in a TSAfor the past 17 years, over which time her employing school district has deposited $20,000 from her paychecks. Her account is worth $37,000 at retirement. On what amount will the teacher be taxed?

A. None of the choices listed
B. $37,000.00
C. $20,000.00
D. $17,000.00

Answer 18

B. $37,000.00

Rationale:
It’s a qualified plan. The money goes in tax-free, and it all comes out taxable as ordinary Income.

Question 19

What is the main difference between an IRA and a TSA?

A. The IRA is funded with pre-tax dollars
B. Self-employed persons may participate
C. The TSA is funded with pre-tax dollars
D. Capital gains liability

Answer 19

B. Self-employed persons may participate

Rationale:
You can’t have a TSA if you’re self-employed. You have to work for a school, hospital, religious institution or other tax exempt organization. Both are funded with pre-tax dollars, and neither involves capital gains.

Question 20

When determining the 10% early distribution penalty for a qualified plan, all of the following could qualify for an exemption except:

A. The distribution is for paying medical
B. The distribution is for the first-time purchase of a vacation home
C. The distribution is for paying certain educational costs
D. The distribution is taken because of death or disability

Answer 20

B. The distribution is for the first-time purchase of a vacation home

Rationale:
It has to be a primary residence, not a vacation home or investment property.

Question 21

An account executive is meeting with the owner of a small business to discuss retirement plans for his employees. The account executive is explaining a plan for a business of any size that does not need formal IRS approval. This plan will allow large contributions to be made on behalf of highly paid employees, specifically 25% of compensation up to the current maximum. Only employer contributions will be made. The account executive is discussing a:

A. SIMPLE IRA
B. 401(k)
C. SEP IRA
D. Keogh

Answer 21

C. SEP IRA

Rationale:
Remember these basic features of the SEP-IRA, and even though it is called a Simplified Employee Pension plan, try not to confuse it with the SIMPLE IRA, which is a very similar plan only completely different.

Question 22

Under ERISA, which of the following works full-time and must be included in a qualified plan?

A. Employee who works 40 hours or more 10 weeks or more
B. Employee who works 1,000 hours In a year
C. Employee who works 500 hours in a 6-month period
D. Employee who works 50 hours or more 12 weeks consecutively

Answer 22

B. Employee who works 1,000 hours In a year

Rationale:
Just something else to memorize.

Question 23

All of the following are funded with after-tax contributions except:

A. Tax-sheltered annuity
B. State 529 Plan
C. Coverdell Plan
D. Roth IRA

Answer 23

A. Tax-sheltered annuity

Rationale:
The Coverdell, 529 plan, and the Roth don’t give a benefit on the contribution side, but if you play by their rules, the distributions are tax-free. And that’s a good thing.

Question 24

Which of the following is funded with federally non-tax- deductible contributions?

A. 529 Plans
B. Keogh
C. IRA
D. SEP-IRA

Answer 24

A. 529 Plans

Rationale:
You don’t deduct your contribution to the 529 plan on your federal returns, but when you take the money out to help fund the kid’s education, it all comes out tax-free. The Keogh, SEP, and Traditional IRA offer tax-deductible contributions, but all the money is taxed on the way out.

Question 25

After-tax contributions are accurately associated with:

A. Traditional IRA
B. SEP-IRA
C. Roth IRA
D. Keogh plan

Answer 25

C. Roth IRA

Rationale:
Roth’s are “after-tax in, tax-free out.” Unless the individual can’t abide by having the account established 5 years and attaining age 59 1/2 first, no withdrawals will be taxed or penalized. Which means if you start a Roth and liquidate the account, say, two years later, there could be taxes and penalties to pay.

Question 26

Jennifer has contributed $19,000 to a non-qualified variable annuity over the past 10 years. With the separate account now valued at $50,000, she takes a lump-sum distribution of $33,000. How much is taxed at her ordinary income rate?

A. $31,000.00
B. $16,500.00
C. $19,000.00
D. $33,000.00

Answer 26

A. $31,000.00

Rationale:
Don’t go too fast! The only part that gets taxed is the growth/earnings, of which Joann has 31K.

Question 27

Carla received a check for $850 from last month’s variable annuity payment. The AIR of the separate account is 3%. In order for Carla to receive a check of $850 next month, the Separate account must earn an annualized rate of return of:

A. Zero
B. More than the previous month’s rate of return
C. More than 3%
D. 3%

Answer 27

D. 3%

Rationale:
Whenever the separate account achieves AIR, the check stays the same, period. Never compare this month’s return to last month’s. That’s irrelevant Can you imagine if it actually worked that way? We start at 5% for January, then we need 6% in February, 7% in March, and in 10 years we’ll be needing 99% returns.

Question 28

In a variable annuity with AIR at 4%, the separate account experienced a 5% rate of return, annualized, in March and Stephanie Stevenson received a check of $500. The following month the separate account receives only a 4% rate of return; therefore, Stephanie’s check will be:

A. Less than $500
B. Post-dated
C. Exactly $500
D. More than $500

Answer 28

C. Exactly $500

Rationale:
Whenever the separate account matches AIR, the check stays the same. Don’t check will be compare this month’s return to last month’s. Compare this month’s return to AIR.

Question 29

Jill Rogers contributed $10,000 to her non-qualified variable annuity. Now that the separate account is worth $30,000, she takes a $25,000 random withdrawal, leaving her with income tax liability at her ordinary income rate on:

A. $10,000.00
B. $25,000.00
C. $20,000.00
D. $30,000.00

Answer 29

C. $20,000.00

Rationale:
There is 20K of earnings, and it will all be taxed at ordinary income rates.

Question 30

What is true of the difference between defined benefit and defined contribution plans?

A. Defined contribution plans are subject to ERISA
B. Defined benefit plans are subject to ERISA
C. Defined contribution plans pass investment risk to the participant
D. Defined contribution plans may only invest in debt securities

Answer 30

C. Defined contribution plans pass investment risk to the participant

Rationale:
If your employer only defines what goes into the plan, they wish you lots of luck with that whole retirement thing. Either type of plan is covered by ERISA, and while the defined benefit plan will invest in bonds, that’s not all they invest in.

Question 31

An individual who is not risk averse would probably not be interested in which of the following if he also had concerns about purchasing power?

A. Traditional IRA
B. Fixed annuity
C. Roth IRA
D. Variable annuity

Answer 31

B. Fixed annuity

Rationale:
Fixed annuities leave you with purchasing power/constant dollar risk, so this guy would not be interested, especially as fixed annuities are really for risk-averse investors. And he is not.

Question 32

All of the following individuals may contribute to an IRA except:

A. College student earning only $2,200 delivering pizzas
B. Woman earning $1,200 designing websites from her home
C. Woman receiving $11,000 from cash dividends paid by small-cap stocks
D. Woman receiving alimony payments

Answer 32

C. Woman receiving $11,000 from cash dividends paid by small-cap stocks

Rationale:
It has to be earned income, not portfolio or passive income.

Question 33

Which of the following is not allowed in an Individual
Retirement Arrangement?

A. Purchasing bonds in default
B. Purchasing junk bonds
C. Purchasing penny stocks
D. Purchasing securities on margin

Answer 33

D. Purchasing securities on margin

Rationale:
One, no margin in retirement plans. Two, municipal securities don’t belong in pre tax plans—their tax-free interest would end up being taxed when distributed.

Question 34

Which of the following are suitable investments for an IRA?

A. Junk Bond Mutual Fund
B. Rare coin of ancient Mexico
C. Whole life policy
D. Barry Bonds rookie card

Answer 34

A. Junk Bond Mutual Fund

Rationale:
Bet it drove you nuts having to choose “junk bond” as the right answer, but it is the right answer. They’d probably re name it the “high yield fund,” since no one in his right mind would buy a “junk bond,” especially when you’d be happy to sell him a “high-yield bond” instead. No insurance and no collectibles. U.S. minted silver and gold coins would be okay, but that’s pretty darned esoteric stuff.

Question 35

Which of the following represents an inaccurate statement of 529 Savings Plans?

A. Contributions are subject to the annual gift tax exclusion
B. The federal government establishes the maximum contributions to the account
C. The account owner does not need to be related to the beneficiary
D. Contributions are non-tax-deductible for federal taxation

Answer 35

B. The federal government establishes the maximum contributions to the account

Rationale:
The states run in the plans – in fact, the plans are considered to be municipal securities.

Question 36

An individual concerned most about inflation would least likely buy a(an):

A. Variable annuity
B. Small cap stock
C. Fixed annuity
D. Index fund

Answer 36

C. Fixed annuity

Rationale:
If you’re worried about inflation, stay away from fixed income securities. Their Income is fixed—inflation varies. If it goes above your fixed payment you’re SOL.

Question 37

Which of the following would lead you to conclude that a deferred variable annuity might be a suitable investment for a particular client?

I. Long anticipated holding period
II. High need for liquidity
III. Fully participating in employer-sponsored plan
IV. Concerned about purchasing power

A. III
B. I, II
C. II, IV
D. I, III, IV

Answer 37

D. I, III, IV

The deferred annuity has a long surrender period during which withdrawals are penalized by the annuity company. So, the investor must have a lo^g anticipated holding period and can not be relying on this money for liquidity/emergency withdrawals. For this reason, the regulators get real nervous when rep’s want to sell deferred annuities to senior citizens. Also, because annuities come with all kinds of fees, the regulators like to see that your investor is a ready maxing out her other retirement plan options before going this route.

Question 38

An account executive is meeting with the owner of a small business to discuss retirement plans for his employees. The account executive is explaining a plan in which the business would either match their employees’ contributions dollar-for- dollar up to 3% of salary or for the employees who do not contribute, a contribution of 2% of salary would be made. Since the business has no more than 100 employees and has no other retirement plan in place, this plan might be best. The account executive is discussing a:

A. SIMPLE IRA
B. 401(k)
C. SEP IRA
D. Section 457 Plan

Answer 38

A. SIMPLE IRA

Rationale:
Remember these basic characteristics of the SIMPLE IRA. If they were high earners, a SEP-IRA would allow them to save more for retirement, as it allows 25% of their compensation to be contributed. Someone being paid $20,000 a year would not be able to save much in a SEP IRA, as 25% of $20,000 is a small amount. In that case, the SIMPLE would have allowed her to save more for retirement. Another difference is that employees can contribute to a SIMPLE IRA, while for SEP-IRA’s only employ-er contributions are allowed.

Question 39

One of your customers is a married man who just passed away during the accumulation phase of a variable annuity
contract. His wife, the named beneficiary, receives a lump sum distribution. Which of the following accurately states the tax implications?

A. The wife will pay no tax provided she is at least 59 1/2 years old
B. The wife will pay ordinary income rates on the amount of the distribution
C. The wife will pay long-term capital gains rates on the amount of the distribution
D. The wife will pay ordinary income rates on any excess over basis

Answer 39

D. The wife will pay ordinary income rates on any excess over basis

Rationale:
If she receives more than her husband put In, she will pay ordinary income tax rates on that difference/excess.

Question 40

Which of the following allows for unlimited contributions?

A. Traditional IRA
B. Non-qualified variable annuity
C. Tax-qualified variable annuity
D. 529 Plan

Answer 40

B. Non-qualified variable annuity

Rationale:
The non-qualified annuity has no maximum contributions. 529 plans don’t care about the income level of the contributors, but the states set a maximum amount that may be contributed to the account.

Question 41

Which of the following is an incorrect statement concerning Traditional IRA accounts?

A. Contributions may be made in either cash or securities
B. Individuals may contribute up to age 70 1/2 if they have earned income, regardless of their income level
C. Contributions are generally tax- deductible
D. Contributions must be made in cash

Answer 41

A. Contributions may be made in either cash or securities

Rationale:
Deposits are made in cash. Once the check clears, then securities may be bought (and sold) in the account.

Question 42

One of your investing clients started an IRA seven years earlier through your broker- dealer. Recently, your client got a full-time job with benefits, including a 401K with generous matching contributions. Therefore, you would accurately advise your client that:

A. He may continue to contribute to the IRA, but any capital gains realized are taxable for the year realized
B. Whether he may contribute to the IRA depends on his income level
C. He may lose the ability to deduct his contributions to the account depending on his income level
D. No further IRA contributions are allowed

Answer 42

C. He may lose the ability to deduct his contributions to the account depending on his income level

Rationale:
As long as he has earned income, he can contribute to a Traditional IRA. He may not be able to deduct the contribution depending on his income level for the year.

Question 43

Roscoe Robertson has earned income of $329,457 this tax year. He is covered by a defined benefit pension plan at work, where he is employed as an in- house attorney. Which of the following is, therefore, an accurate statement?

A. Roscoe may contribute to a Keogh plan based on his earned income
B. Roscoe may contribute to a Roth IRA only
C. Roscoe may make tax-deductible contributions to a Traditional IRA
D. Roscoe may contribute to a Traditional IRA

Answer 43

C. Roscoe may make tax-deductible contributions to a Traditional IRA

Rationale:
He can CONTRIBUTE to a Traditional IRA, but the contribution would not be deductible. If he’s covered by an employer plan, he lost the ability to deduct his IRA contributions a few hundred thousand dollars ago. We see no self- employment income here, which knocks out the Keogh.

Question 44

Jeremiah is earning $72,500 for Tax Year 2012. Born in 1954, Jeremiah may contribute how much to his Traditional IRA?

A. $5,000
B. $6,000
C. Nothing
D. $16,500

Answer 44

B. $6,000

Rationale:
There is a catch-up provision for people 50 and older of $1,000 for Tax Year 2010. Remember that “Tax Year 2010” goes through April 15, 2011 in terms of making IRA
contributions.

Question 45

Bobbi Zimmerman is now a 74- year-old folk singer performing two shows per week for a minimum of $50 per show. Therefore, Bobbi:

A. Is precluded from contributing to her Roth IRA due to her age
B. May contribute to her Roth IRA
C. May contribute $6,000 to her
D. Is precluded from contributing to her Traditional IRA due to her income level

Answer 45

B. May contribute to her Roth IRA

Rationale:
She has earned income, so she can contribute to a Roth-
not a Traditional-IRA

Question 46

An advantage of participating in a 401k would be that:

A. They allow for higher annual contributions than Traditional IRA
B. Employers must match a minimum percentage of salary
C. Unlike contributions to a Traditional IRA, contributions to a 401K are tax-deductible
D. They allow for higher annual contributions than 403b plans

Answer 46

A. They allow for higher annual contributions than Traditional IRA

Rationale:
Maximum contributions to 401K, 403b, and 457 plans are generally the same. Matching contributions are a common feature but not a requirement for the 401K plan. Contributions are generally deductible to all of the following: 401k, 403b, 457, Traditional IRA, SIMPLE IRA, SEP-IRA, Keogh.

Question 47

Which of the following is an accurate statement of Keogh plans?

A. They are typical plans for non-profit organizations
B. They are not required to conform to ERISA standards
C. They allow for after-tax contributions only
D. They allow for higher annual contributions than 401k plans

Answer 47

D. They allow for higher annual contributions than 401k plans

Rationale:
The contributions are made pre-tax and the annual contributions are much higher than 401K (or 403b, 457 plans). They must conform to ERISA requirements, unlike SIMPLE and SEP IRAs.

Question 48

Which of the following is an inaccurate statement of the SEP-IRA?

A. Employees are immediately vested
B. Employers are not required to make contributions each year
C. Allow for higher maximum annual contributions than SIMPLE IRA
D. Employees may contribute to the plan

Answer 48

D. Employees may contribute to the plan

Rationale:
All contributions to the SEP (unlike SIMPLE and Keogh) come from the employer through payroll reduction. For high-income workers and business owners SEP IRAs allow for much higher contributions than SIMPLE IRAs.

Question 49

Which of the following is a true statement concerning qualified, non-contributory, defined-benefit pension plans?

A. The plans must conform to ERISA guidelines
B. Distributions to employee beneficiaries are taxed at long-term capital gains rates
C. Earnings in the plan are taxable each year
D. Distributions to employees are taxed at long-term capital gains rates

Answer 49

A. The plans must conform to ERISA guidelines

Rationale:
The defined benefit pension plan is DEFINITELY covered by ERISA. Distributions are taxed as ordinary income, because one never gets to pay long-term capital gains rates on retirement distributions.

Question 50

An advantage offered by the Coverdell Education Savings
Account over the 529 plan is that:

A. The maximum contribution level is higher
B. Funds may be used for educational expenses for children younger than high school age
C. The assets belong to the beneficiary at the age of majorit
D. The contributor’s income level is not a factor

Answer 50

B. Funds may be used for educational expenses for children younger than high school age

Rationale:
The main advantage of the CESA is that money can be used for elementary school through post-high school, while 529 funds are for post-high school only. Income limits do apply to the CESA (not the 529). The 529 allows much higher annual contributions compared to the $2,000 per child per-year on the CESA. The assets DO belong to the new adult in a CESA, but that’s not an advantage, as anyone with children probably knows.

Question 51

A police officer would most likely participate in:

A. A defined benefit pension plan or a 457 plan
B. A Keogh plan
C. A SIMPLE IRA
D. A Roth IRA but not a 457 plan

Answer 51

A. A defined benefit pension plan or a 457 plan

Rationale:
Policeman, fireman, and other municipal workers generally participate in defined benefit pension plans or Section 457 plans.

Question 52

Variable annuity payments to the annuitant are based on:

A. A consumer price index multiplier
B. A fixed number of units with a variable value
C. A fixed number of units with a fixed value
D. A variable number of units with a fixed value

Answer 52

B. A fixed number of units with a variable value

Rationale:
This is just another way of saying that when the individual annuitizes the contract, she receives a fixed number of annuity units, but the value of those units will vary depending on how well the “separate account” performs.

Question 53

Variable annuity payments to the annuitant fluctuate according to:

A. Changes in the CPI
B. A pre-determined actuarial value
C. Changes in the S&P 500
D. The value of securities held in the separate account

Answer 53

D. The value of securities held in the separate account

Rationale:
Actually, the answer choice should be completed with “compared to AIR.M But, you have to choose the one answer that works best, or almost works the best.

Question 54

During the accumulation phase of a variable annuity contract, how is the value of an investor’s interest in the separate account calculated?

A. Multiplying the number of annuity units owned by their then-current value
B. Multiplying the current value of an accumulation unit by the number of units owned
C. Any of these methods, if deemed “fair and reasonable” by the state insurance commissionier
D. Multiplying the number of subaccounts by an assumed interest rate

Answer 54

B. Multiplying the current value of an accumulation unit by the number of units owned

Rationale:
A question like this is hard to read, so read it carefully. Focus on the key words- accumulation unit.

Question 55

All of the following statements of periodic deferred variable annuities are false except:

A. The number of annuity units does not change
B. The annuitant waives the right to name a beneficiary
C. Monthly payouts are tied to the consumer price index
D. The number of accumulation units does not change

Answer 55

A. The number of annuity units does not change

Rationale:
Fixed NUMBER of annuity units-variable value.

Question 56

If a 60-year-old takes a lump- sum distribution from her non-qualified variable annuity, this withdrawal will:

A. Be taxed as ordinary income
B. Be taxed at long-term capital gains rates
C. Be taxed partly as ordinary income
D. Trigger gift taxes if it exceeds $13,000

Answer 56

C. Be taxed partly as ordinary income

Rationale:
The question is not 100% fair, but we assume there is some growth in the account so that at least the excess over cost basis will be taxed as ordinary income. We could never assume that it would ALL be taxed as ordinary income, since there would have to be contributions into the account, which are the cost basis.

Question 57

When an individual is saving for retirement via a variable
annuity, contributing $279 per month, she is purchasing:

A. An obligation of the annuity company’s general account
B. A variable number of annuity units
C. A variable number of accumulation units
D. A fixed number of annuity units

Answer 57

C. A variable number of accumulation units

Rationale:
The only place where the word “fixed” belongs in a variable annuity is in the phrase “fixed number of annuity units.” This individual is not in the annuity phase-she’s in the accumulation phase of the contract, buying an increasing number of accumulation units.

Question 58

Mitzy contributed $45,000 to a non-qualified variable annuity at age 54. Now, ten years later, she withdraws $20,000 with the account value at $60,000. If Mitzy is in the 25% Income tax bracket, the tax on this withdrawal would be:

A. Waived
B. $4,125
C. $3,750
D. $5,000

Answer 58

C. $3,750

Rationale:
All of the earnings are taxed first, and there is/are $15,000 taxed at 25% in this case. No penalty, as she is well past 59 1/2 years of age.

Question 59

Which of the following insurance products may be sold without a Series 6 or 7 license?

A. Closed-end funds trading in the secondary market
B. Variable annuities
C. Variable life insurance
D. Universal life insurance

Answer 59

D. Universal life insurance

Rationale:
Universal, whole, and term life insurance can be sold with only an insurance license.

Question 60

All of the following products provide death benefits except:

A. Variable annuity
B. Fixed annuity
C. Term life insurance
D. Mutual funds

Answer 60

D. Mutual funds

Rationale:
Just in case the exam writes questions this awkward . . . because it does . . . we made this one hard to read. All it’s saying is that death benefits are or may be provided on all three choices. Remember that term life insurance has no cash value. If it also had no death benefit, what would it provide?