Chapter 14.1

Question 1

Annuity

Answer 1

A series of periodic payments paid to an annuitant for life usually for retirement income or can be paid to an annuitant and their beneficiary for a minimum “period certain”, like a 10 year period. Annuity contracts are issued by life insurance companies. The annuity contract holder buys the contract by paying a lump sum to the life insurance company called a “single premium” or by paying a series of installment payments called “periodic premiums”.

Question 2

Types of annuities

Answer 2

Fixed Annuity: Pays the same predetermined dollar amount each period.
Variable Annuity: Pays a fluctuating dollar amount each period. The amount paid varies based on the value of the securities in the separate account of the insurance company issuing the variable annuity contracts.

Question 3

Variable Annuities

Answer 3

Made up of an investment portfolio of mutual funds or other professionally managed securities held in a special, tax-defered account of the insurance company called the separate account. They are considered long term investments and provide a possible hedge against inflation. Some variable annuities contain a minimum guaranteed death benefit.

Question 4

Accumulation Unit

Answer 4

Used to determine the contract owner’s interest in the separate account.

• The value of these units is determined by the value of the securities in the separate account and is not determined by mortality tables.
• Earnings are tax deferred until Annuity payments begin.
• During the accumulation period, a contract owner can withdraw the cash surrender value of the contract, although penalties may be incurred.

Question 5

Annuity Unit

Answer 5

Determines the amount of each payment to the annuitant. Changes in the value are related to the value of securities in the separate account.

Question 6

Purchasing methods of variable annuities - Periodic Payment deferred annuity

Answer 6

Allows investors to make monthly, quarterly, semi-annually, or annual payments over a period of time at a fixed sale load

Question 7

Purchasing methods of variable annuities - Single Payment deferred annuity

Answer 7

Allows investors to make a lump-sum purchase and defer the receipt of payments to a later date

Question 8

Purchasing methods of variable annuities - Single Premium immediate or lump-sump purchase

Answer 8

Investors make one lump-sum purchase and immediately begin to receive benefit payments

Question 9

Payout Methods - Life Annuity

Answer 9

Investors receive regular payments until death, regardless of how long the investors live. This payout gives the investors the largest payment of all methods of payout.

Question 10

Payout Methods - Life Annuity-Period Certain

Answer 10

The investor will receive regular payments until death, but if the investor dies, payments would continue to be paid to the beneficiary for the remainder of a pre-determined period

Question 11

Payout Methods - Joint and Last Survivor Annuity

Answer 11

Regular payments are made to a couple and would continue to be paid until both persons die

Question 12

Payout Methods - Unit Refund Annuity

Answer 12

The investor or beneficiary is guaranteed the payment of a set number of units

Question 13

Payout Methods - Installments for a period certain

Answer 13

The investor receives payments for a designated period and payments are then halted whether or not the investor is still living. If the investor dies prior to installment completion, their beneficiary would receive the balance of the annuitant’s installments. This is not an “annuity” payout.

Question 14

Payout Methods - Installments for a fixed amount

Answer 14

The investor receives a fixed amount set in the contract, until the account is extinguished. This is not an “annuity” payout.

Question 15

Penalties for premature withdrawals on annuities

Answer 15

10%

Question 16

Annuitization

Answer 16

When the annuity owner selects a payout option, accumulation units are exchanged for annuity units.
-The number of annuity units that the owner receives will vary based on the payout method that they choose.
-A Variable annuity guarantees lifetime payments based on the fluctuating dollar value of the separate account, but will pay-out a fixed number of units each month.
-Prior to retirement, the contract holder must carefully choose their payout option, because once the client has converted accumulation units to annuity units, the client cannot withdraw from the program or change investments.
Annuity Units are generally valued once a month just prior to payouts
-On the annuity date, an interest rate is used to determine the payout. It’s called the Assumed Investment Rate(AIR), which is not guaranteed
-The AIR is a hurdle rate, meaning the rate the insurance company has to receive to cover their costs and profits. Any rate of return above the hurdle or AIR goes to the annuitants, therefore the annuity value will increase if the actual return exceeds the AIR

Question 17

Separate Account

Answer 17

Managed by a board of directors. The separate account can also be called a sub-account or investment account.

Question 18

The Contract Holder

Answer 18

The investor that buys the variable annuity. The contract holder:

• must receive a prospectus at the time of purchase
• must receive a statement of additional information, if the contract holder requests the information
• has a choice of investments, therefore has investment risk and is NOT protected against capital loss if the value of the separate account declines
• has a possible hedge against inflation if the annuity units keep pace with inflation
• has the right to vote for members of the board of managers and to change the investment objectives of the separate account. Proxies are sent to contract owners so they can exercise their right to vote.

Question 19

Qualified Annuity

Answer 19

Also called a tax qualified annuity. It is an annuity where the investor contributes pre-tax dollars, usually in an employer-sponsored retirement plan. Upon retirement the distributions are taxed as ordinary income

Question 20

Non-tax qualified annuity

Answer 20

After-tax dollars are contributed by an individual investor buying a contract. Upon retirement, only the excess over the amount contributed is taxable.

Question 21

Risks associated with variable annuities include:

Answer 21

• The risk that the value of the securities will not keep pace with inflation
• The risk that during recessions or depressions the value of the annuity units may decline significantly which is the investment risk
• The risk that the annuitant cannot afford a decrease in their current income during the payout period

Question 22

Who must variable annuities salespersons be registered with?

Answer 22

The state insurance department, SEC, and FINRA.

**They do not need to be registered with the state banking department

Question 23

Non-forfeiture provision on annuity contracts

Answer 23

Provides that if the contract holder stops making payments on an installment contract they will not lose claim to their previous investments

Question 24

How are dividends taxed on variable annuities?

Answer 24

They are not taxed each year, they are tax deferred

Question 25

Variable securities are considered what?

Answer 25

Securities. They are sold with a delivery of a prospectus.

Question 26

How are one time withdrawals taxed?

Answer 26

LIFO - Last in First Out

Question 27

What are sales charge breakpoints for investments in variable annuities based on?

Answer 27

The total amount invested in the annuity

Question 28

1035 Exchange

Answer 28

Allows the contract holder of a variable annuity to exchange their existing contract for a new variable annuity contract without paying any tax on the income and investment gains on their current variable annuity. Surrender charges may be incurred on the old annuity and a new surrender charge period generally begins on the date of the new annuity

**A principal of an OSJ branch office has 7 business days to approve applications for 1035 exchanges

Question 29

Bonus annuities

Answer 29

Provide an extra 3% to 5% premium credit as an incentive to buy the annuity. The benefit typically comes with higher contract costs and longer surrender period subject to surrender charges

Question 30

Equity Indexed Annuities

Answer 30

Provide annuity payments linked to a specific stock index. If the index increases, the contract holder is credited with at least part of the gain. If the index declines, the contract holder will suffer a loss but is guaranteed a minimum return

Question 31

What can variable annuities be referred to as?

Answer 31

A sub-account, and underlying account or an investment account.

**They cannot be referred to as a Mutual fund

Question 32

When purchasing a variable annuity, all of the following should be considered:

Answer 32

• The financial soundness of the issuer
• The return
• The sales charges and other fees

Question 33

RR’s who sell variable annuities must hold what?

Answer 33

Both a life insurance license and a securities license. Branch office managers need only be securities licensed if they do not participate directly in the sale.

Question 34

Variable annuities in IRA or 401k Plans

Answer 34

Generally they should not be purchased in these account types because the variable annuity earnings accrue tax-deferred, there is no benefit to buying them in a retirement account. Such a purchase would be considered suitable when a guaranteed lifetime income and guaranteed minimum death benefit are desired by the client.

Question 35

What should a RR considered when advising the client on the exchange of one variable annuity for another

Answer 35

-Should consider whether or not the exchange would benefit the client, the possibility of surrender charges, and if the client has had another exchange in the last 36 months

Question 36

Supervision and training for variable annuities

Answer 36

A member firm must have written supervisory policies and procedures in place for the supervision of variable annuity sales and must provide training to the RRs for their implementation.

Question 37

Deferred variable annuities are considered what type of investment?

Answer 37

A long-term investment. It would not be appropriate to put a senior investor into a deferred variable annuity, whereas an immediate variable annuity may be appropriate for some senior investors.

Question 38

Early withdrawals on annuities

Answer 38

Withdrawals before an investor reaches age 59.5 are generally subject to a 10% tax penalty in addition to any gain being taxed as ordinary income.

**The exception to this penalty rule would occur if the customer annuitized the annuity

Question 39

What should investors make sure they are doing first before investing in variable annuities?

Answer 39

Maximizing contributions to their before-tax retirement plans such as a 401k

Question 40

Do proceeds of variable annuities receive a “step-up” in the cost basis when the owner dies?

Answer 40

No

Question 41

Sales practices for variable annuities

Answer 41

When recommending a deferred variable annuity, an RR must know the product, know the customer, and have a reasonable basis to believe that the product is suitable for a particular customer given the customer’s circumstances and needs.

**The RR must sign a written statement about what factors were considered in making the suitability determination/recommendation and forward the statement to a registered principal of the firm for review.

Question 42

Subscription-way transactions

Answer 42

Where a RR meets with a client to discuss a security to assist the client in completing an application for the purchase of securities, such as a variable annuity, and obtains a check from the client. A member firm may hold a client’s check, for up to 7 business days from the date that an OSJ receives a complete and correct application package for the sale of the securities on a subscription-way basis provided that:

• The check is being held pending Principal review of the application package for the transaction
• The firm provides for the safeguarding of the check
• The firm has policies and procedures in place for such transactions
• The principal approves or rejects the application to purchase the securities within 7 business days after the customer signs the application
• The firm maintains a copy of the check and creates a record of the date the check was received from the customer as well as the date the check was transmitted to the issuer