Chapter 11- Basics of Life Insurance and Variable Annuities

Question 1

Life insurance premiums and Taxes

Answer 1

Life insurance is typically paid with after tax dollars and is not tax deductible

Question 2

Examples of Life insurance policies

Answer 2

Term

Whole Life
Variable Life
Universal Life
variable universal insurance

Question 3

Greatest risk with variable life and variable universal insurance is…

Answer 3

Market risk

These products invest in the securities market

Question 4

Annuities are a suitable investment for investors with an objective of

Answer 4

Long term capital appreciation

Question 5

Annuities are issued by

Answer 5

Life insurance companies

Question 6

Annuities buy a contract by either…

Answer 6

Paying a lump sump, called a single premium”

or

by paying a series of installment payments, called “periodic premiums”

Question 7

Fixed annuities vs variable annuities

Answer 7

Fixed will pay the same amount each month, insurance company bears investment risk

variable will vary how much it pays month by month depending on how the underlying securities are preforming. The annuitant (customer) will bear the investment risk

Question 8

Variable Annuities defined

Answer 8

Made up of an investment portfolio of mutual funds or other professionally managed securities held in a separate account

Two types of units
Accumulation units
and annuity units

Some contain a minimum guaranteed death benefit

Question 9

Accumulation units

Answer 9

generated during pay in period and used to determine the owners interest in the account

Question 10

Annuity Units

Answer 10

determine the amount of each payment to the annuitant

Changes in the value are related to the value of the securities in the account

Question 11

Annuitization

Answer 11

This is the switch between paying in and being paid out

when annuity owner selects a payout option, accumulation units are exchanged for annuity units

Question 12

The investor that buys the annuity is also referred to as

Answer 12

the contract holder

or

the annuity holder

Question 13

The contract hold must be given…

Answer 13

A prospectus at the time of purchase
receive a statement of additional information if requested by the contract holder
has a choice of investment options therefore is not protected against investment risk

Question 14

Variable annuities are generally not considered…

Answer 14

insurance. they are considered a securities product even though they are sold by insurance companies

They are registered and regulated under the Securities Act of 1933

Question 15

Tax- Qualified Annuity

Answer 15

Investor contributes pre-tax dollars and upon retirement the distributions are taxed as ordinary income

Typical of an employer sponsored plan, especially 403(b) plans

Question 16

Non-Tax qualified annuity

Answer 16

The investor contributes after tax dollars

Upon retirement only the excess over the amount contributed is taxable (partly a return of capital and partial taxed as ordinary income)

Question 17

Risks of variable annuities

Answer 17

Risk they don’t keep up with inflation (inflation risk)
Risk during depression or recession that the value of annuity credits will decline significantly (investment risk)
The risk the annuitant can not afford a decrease in their current income during the payout period

Question 18

Non-forfeiture provisions in annuity contracts

Answer 18

generally in most contracts, states that if the contract holder stops making payments on the installment contract they will not lose claim to their previous investments

Question 19

Variable annuities, dividends and taxes

Answer 19

Variable annuities are not taxed on dividends each year. They are only taxed once the contract is annuitized
True for tax and non-tax qualified accounts

Question 20

One time withdrawals and taxes on annuities

Answer 20

The tax treatment is “Last in First out”
Earnings are taken out before contributions
Since it is considered a retirement account, any earnings taken out before 59 1/2 will also have a 10% penalty tax

A surrender charge could also be applied by the insurance company

Question 21

Bonus Annuities

Answer 21

These have extra 3-5% premium credits.

this typically comes with higher contract prices and/or longer surrender periods subject to surrender charges

Question 22

Equity Indexed Annuities

Answer 22

Linked to a specific index (ie. S&P500)
if index increases contract holder is credited with part of the gain (but generally has a cap)
If the index declines may suffer a loss but there is typically a guaranteed minimum return 3%

Question 23

Variable Annuities cost basis at death

Answer 23

Proceeds of an annuity do not receive a step up in cost basis as the death of the owner

Question 24

If you have an annuity in an IRA you must

Answer 24

start withdrawing RMDs at 72 regardless of the possible surrender charges or annuitization charges

Question 25

Senior investors and annuities suitability

Answer 25

A deferred variable annuity would usually not be suitable for a senior investor since it typically takes 6 to 8 years to avoid surrender charges.

But an immediate variable annuity could be suitable since payments would begin immediately

Question 26

Before suggesting a variable annuity an advisor should have sure that the investor is …

Answer 26

Maxing out their before tax retirement plans such as their IRAs and 401(k)s