Chapter 10: VARIABLE PRODUCTS Flashcards
______ are similar to IRAs, in that they incur a penalty on early withdraws and pay taxes on earnings within the account.
Annuities
Although managed by a third party, __________ are not considered securities. This is due to the risk being incurred primarily by the issuer
Fixed annuities
While mutual fund investors buy shares, customers investing in ________ buy accumulation units.
While mutual fund investors buy shares, customers investing in variable annuities buy accumulation units
Accumulation units are similar to Redemption shares. In that they are based on the net asset value of the annuity and our calculated at the end of every business day.
Registered Representatives must clearly disclose that an annuity is a long-term investment since significant surrender fees may be incurred if assets are not held in the contract for a minimum prescribed.
Note
True or False. Payments received by the annuitant of a fixed annuity keep pace with inflation
False. A significant disadvantage to a fixed annuity is that the fixed-dollar payments being received by annuitant tend to not keep with inflation
True or False. Fixed annuities are subject to regulation by the SEC and FINRA
False. Since fixed annuities are not securities, these contracts are typically not subject to regulation by either the SEC or FINRA However, all annuities are governed by state insurance regulations.
Lastly, there’s no prospectus delivery requirement with fixed annuities and any person who sells them must have an insurance license
True or False. Contributions to a variable annuity are invested in the insurance companies separate account with a rate of return that’s not guaranteed. Therefore is considered a security, and must be registered with the SEC as investment companies
True
These annuities delay payments to the annuitant for an undetermined period after the date of purchase.
PREMIUMS: maybe deposited in the annuity monthly, quarterly, semi- annually, or annually
Deferred Annuities
These annuities begin payments to the annuitant one payment. After a lump-some deposit has been made to fund the annuity
- may only be funded with a single premium
Immediate annuities
Example: if the contract calls for monthly payments, these payments to the annuitant will begin one month after the date of purchase. If the contract calls for annual payments, these payments will begin one year after the date of purchase.
What is the formula calculate net asset value per unit?
Total net assets / total units issued
If the annuitant has the death benefit feature of an account
What does the beneficiary receive upon death of the decedent
The beneficiary receives the greater of either (1) the sum of all the contract owners payments to the annuity or (2) the value of the annuity on the day the annuitant dies.
An annuitant receives monthly payments for as long as she lives, but this method makes no provision for a designated beneficiary. What method of payment are they receiving
Straight-life annuity
Suppose Jane, a 65-year-old woman, purchases a life annuity with a 10-year period certain. She will receive a monthly payment (say, $1,000) for at least the next 10 years.
Jane passes away after 7 years: The remaining 3 years of payments (36 payments of $1,000 each) will go to a beneficiary named by Jane when she purchased the annuity. The beneficiary could be a spouse, child, friend, or even a charity.
What type of annuity payout option does Jane have?
Life annuity with period certain
The concept of a “unit” in this type of annuity refers to the total amount of the initial investment. If the annuitant passes away before all “units” have been paid out (i.e., before the total payout equals the initial investment), the remaining “units” will be paid out to a designated beneficiary.
What payout option for an annuity is this?
Units Refund Life Annuity
Is an option in which payments are made to two or more persons. If one person dies, the survivor continues to receive only her payments. However, upon the death of the last survivor, payments cease.
Joint and last survivor life annuity
A customer has made total contributions of $50,000 to a non-qualified variable annuity. The account currently has a value of $150,000 and the customer chooses to take a random withdrawal of $20,000. Using the lifo method, the earnings come out first; therefore the __________ is taxable as ordinary income
Entire $20,000 withdrawal is taxable ordinary income
If an investor in a non-qualified variable annuity chooses to take a lump hyphen some withdrawal the entire amount, the portion that represents earnings is taxable, while the amount equal to the Investor’s contribution is a non-taxable return of her cost basis.
Example.
A customer has made total contributions of $50,000 to a non-qualified variable annuity. The account currently has a value of $150,000 in the customer chooses to take a lump sum withdrawal of the entire amount. How would this be taxed?
The $100,000 which represents earnings is taxable ordinary income, while the remaining $50,000 is considered a non-taxable return of capital
True or False. LIFO means earnings come out first.
True
Stands for Last-in-first-Out method.
When a non-qualified contract is annuitized the annuitant begins to receive ________.
Periodic payments
For tax purposes, these periodic payments are divided into the following two parts:
- An amount that represents the original investment in the annuity
- The remainder which represents investment income
Determine the payout option:
- Periodic payments are made during the annuitant’s lifetime.
- if the annuitant dies before an amount equal to the value of the annuity units is paid out, the remaining units will be paid to a designated beneficiary. This payment may be either in a lump-sum or a given period
Unit Refund Life Annuity
Determine the payout option
- annuitant’s receive payments for life
- payments end upon the last person’s death
Joint and last survivor life annuity
The Assumed interest rate is not a minimum or guarantee - it simply used as part of the actuarial calculation.
The AIR is the rate of interest that stated in the contract and used to determine the first annuity payment. Going forward, it then becomes The Benchmark for determining subsequent payments
Note
- if separate account performance is equal to the AIR, the annuities payment will remain the same as the previous payment.
- If separate account performance exceeds the AIR, then the payment will be higher than the previous payment.
- If separate account performance is less than the AIR, the payment will be lower than the previous payment.
In a non-qualified variable annuity, the investors cost-basis represents the total amount of the contributions.
Remember contributions are made on an after-tax basis, this means only earnings upon withdrawal we taxed
Note
If an annuitant dies during the accumulation., the annuities value will be included in his estate for purposes of calculating federal estate taxes. The beneficiary, his wife, will also be required to pay ordinary income taxes on anything she receives in excess of the cost basis (earnings).
The death benefit of a variable annuity skips the probate process which is a lengthy legal process that involves settling an estate according to the terms of a will.
Note
True or False. Persons who market annuity products must hold a valid Series 6 or Series 7 registration as well as a state insurance license.
True
True or Flase. The separate accounts of variable products are generally required to be registered as investment companies under the Investment Company Act of 1940.
True
True or False. Senior investors are suitable generally speaking for variable annuities
False. Generally, variable annuities are not suitable for senior investors. Instead, they’re appropriate only for people with long-term investment goals who don’t anticipate needing access to their money for at least five to seven years
Created after IRS Section 1035, this provision permits the exchange of annuity contracts ______ creating a taxable event
Without creating a taxable event
___ shares have deferred sales charges that declined to zero in three to four years and are designed for customers who may be considering in exchange in the future
L-shares
In exchange is often viewed as inappropriate if the client has made another 10:35 deferred variable annuity transfer within the previous ____ months
36 (3 years)
Remember, although not specifically prohibited, recommending the purchase of annuity contracts within a tax-deferred account (e.g. an IRA), deserves special scrutiny since variable annuity contracts already grow tax-deferred.
Additionally, annuities generally have higher expenses than similar mutual funds that could instead be placed within a retirement account.
Note