Series 7 STC Variable Products (Ch. 10) Flashcards
After making payments into a variable annuity for the last 20 years, the contract owner decides to annuitize and selects a straight-life payout. Which of the following statements is TRUE?
The investment risk is assumed by the insurance company.
The payout will be taxed on a last-in, first-out (LIFO) basis.
The annuitant’s payments are guaranteed to remain the same by the insurance company.
The annuitant’s payments are not guaranteed.
The annuitant’s payments are not guaranteed.
Unlike a fixed annuity, in a variable annuity, all funds are managed in the separate account and the owner assumes the investment risk. The dollar amount of the annuity payments is dependent on the performance of the separate account, relative to the assumed interest rate (AIR). When an investor annuitizes, payments are taxed proportionately according to the contributions and appreciation. A portion of each payment is considered taxable earnings, while another portion of each payment is a tax-free return of principal. If an investor withdraws money without annuitizing, the payment will be taxed on a LIFO basis (i.e., earnings first).
A variable annuity has an AIR of 4%. This past year, the separate account grew at a rate of 12%. The appreciation in the separate account:
Will be taxed to the investor during the accumulation period as ordinary income
Is taxable only to the separate account
Will increase an annuitant’s monthly payment from the annuity
Will have no effect on the investor because the investor is guaranteed only a 4% payment increase during the year
Will increase an annuitant’s monthly payment from the annuity
If the separate account of a variable annuity grows at a greater rate than the AIR, monthly payments from the annuity will increase. Keep in mind, appreciation in the value of securities held in a separate account is not taxable until the gain is realized in a sale.
A 65-year-old retired investor decides to surrender a non-qualified variable annuity that she had purchased 10 years ago. Her total contributions are $10,000 and, at the time of surrender, she receives a lump-sum payment of $16,000. How is the distribution taxed?
$6,000 is taxed as ordinary income and $10,000 is returned to her as a tax-free return of her cost basis.
$6,000 is taxed as long-term capital gain and $10,000 is returned to her as a tax-free return of her cost basis.
$10,000 is taxed as ordinary income and $6,000 is taxed as a capital gain.
$16,000 is taxed as ordinary income.
$6,000 is taxed as ordinary income and $10,000 is returned to her as a tax-free return of her cost basis.
Contributions to non-qualified variable annuities are made in after-tax dollars. Since the contributions have already been taxed, they represent the annuitant’s cost basis in the plan (i.e., $10,000 in this question) and are not taxable at withdrawal. Any amount that exceeds the cost basis (i.e., $6,000 in this question) is taxed as ordinary income, regardless of the holding period.
A 67-year-old man owns 3,250 accumulation units of a variable annuity that are each valued at $7.70. He wants to retire and begin receiving benefit payments each month for life. All of the following are used to determine the number of annuity units he would have, EXCEPT his:
Age
Health
Gender
Choice of Payout Option
Health
When a client wants to receive benefit payments from an annuity, he must exchange his accumulation units for annuity units. The factors considered are the annuitant’s age, gender, value of the accumulation units held, the payout option selected, and the assumed interest rate. However, the health of the annuitant is not taken into consideration.
Which of the following statements is TRUE of an insurance company fixed account, but NOT TRUE of a separate account?
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A
It provides a return that fluctuates with the performance of a portfolio of risky investments, often available as a subaccount in a variable product.
The insurance company absorbs investment risk.
C
It’s registered under the Investment Company Act of 1940.
D
Its manager must be a registered investment adviser.
The insurance company absorbs investment risk.
The returns on the fixed account of an insurance company are guaranteed by the company. However, there’s no guarantee on the returns of a separate account for a variable product and the purchaser assumes the investment risk. Only separate accounts, not fixed accounts, are registered with the SEC. Managers of separate accounts, not fixed accounts, must be registered with the SEC as investment advisers.
An annuitant receives payments under a variable annuity for a number of years. At his death, his widow receives a lump-sum payment. The annuity was a:
Variable life annuity
Variable joint and last survivor annuity
Variable unit refund annuity
20-year endowment annuity
Variable unit refund annuity
An annuity in which the beneficiary receives a lump-sum payment upon the death of the annuitant to reflect the value of the remaining annuity units is referred to as a unit refund annuity.
Which of the following statements is TRUE regarding variable annuities?
The account’s value is dependent on the return of the underlying securities that are chosen by the annuitant.
Withdrawals that exceed the premiums invested are taxed at the long-term capital gains rate.
The account’s value is based on the performance of an investment index and subject to a participation or cap rate.
The annuity cannot be purchased within a qualified retirement plan.
The account’s value is dependent on the return of the underlying securities that are chosen by the annuitant.
The value of a variable annuity’s accumulation units is calculated based on:
The unit value at the opening of the market
The unit value at 12:00 p.m. on that business day
The unit value at the close of the market
The average price of the units over the course of the day
The unit value at the close of the market
Which of the following statements is NOT TRUE regarding an equity-indexed annuity (EIA)?
It offers a guaranteed minimum rate of return.
It provides a return that’s based on the performance of a stock market index.
It must be registered as a security.
It provides tax-deferred growth.
It must be registered as a security
Equity-indexed annuities (EIAs) are a type of fixed annuity that provide a guaranteed minimum rate of return (unlike variable annuities), but may potentially provide a greater rate of return. An EIA’s return is tied to the performance of a stock market index to which it’s linked. As with standard annuities, they also provide tax-deferred growth. However, EIAs are not currently considered securities; instead, they’re categorized as a life insurance product.
(26533)
A non-qualified variable annuity investor contributed a total of $60,000 and later died while still in the accumulation period. At the time of his death, value of the annuity was $70,000. To what amount is his named beneficiary entitled?
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$70,000, of which $10,000 is taxed as ordinary income.
$70,000, of which $10,000 is taxed as a long-term capital gain.
$70,000, and the entire amount is taxed as ordinary income.
$70,000 and the entire amount is tax-free
$70,000, of which $10,000 is taxed as ordinary income.
If an annuitant dies during the accumulation (pay-in) period, the death benefit provisions stipulate that the named beneficiary will receive the greater of the account value at time of death or the total investment. When an annuitant dies, the death benefit avoids probate and any benefit above the cost basis ($10,000 in this question), is taxed as ordinary income to the beneficiary. If the cost basis ($60,000 in this question) is greater than the accumulated value, the beneficiary receives the cost basis tax-free.
A client has a variable annuity with an assumed interest rate of 5% and she received a first benefit check of $115. The separate account rate of return between the first and second month was 8% and the client received a second check for $125. What was the actual rate of return of the separate account between the second and third month if the client’s third check was also for $125?
5%
More than 5% but less than 8%
8%
More than 8%
5%
The amount of a benefit check that’s received by an annuitant is based on the relationship of the assumed interest rate (AIR) and the actual performance of the separate account. If the performance of the separate account equals the AIR, the benefit payment will be the same as the last payment. If it’s higher than the AIR, the benefit payment will increase. If the performance is lower than the AIR, the benefit payment will be lower. In this question, the client received a first check of $115. In the subsequent payment period, the separate account experienced a growth rate of 8%, which yielded a payment of $125. As expected, since the actual growth rate of the separate account (8%) was greater than the AIR (5%), the benefit payment increased. In order to receive a $125 payment for the third payment period, the separate account must experience a growth rate that’s equal to the AIR. Therefore, this growth rate must be 5%.
An individual has decided to cash out a variable annuity to which he’s been contributing for several years. How is the distribution taxed?
Entirely as ordinary income
As a long-term capital gain
The portion representing earnings is taxed as ordinary income, while the invested amount is considered a return of capital and is not taxed
The distribution is tax-free
The portion representing earnings is taxed as ordinary income, while the invested amount is considered a return of capital and is not taxed
If the owner of a non-qualified variable annuity dies during the accumulation period, which of the following is TRUE regarding the tax consequences?
All proceeds are considered a return of principal.
The growth is taxable to the beneficiary as a long-term capital gain.
The proceeds in excess of the cost basis are taxable to the beneficiary as ordinary income.
If the beneficiary delays distribution until reaching the age of 73, the proceeds exceeding the cost basis are not taxable.
The proceeds in excess of the cost basis are taxable to the beneficiary as ordinary income.
A single father owns a variable annuity and has selected a life annuity with a 20-year period certain payout option. He has selected his son as his beneficiary. If the father dies after receiving 22 years of payments:
Future payments will be made to the beneficiary for 20 years
Future payments will be made to the beneficiary for two years
Future payments will be made to the beneficiary for his life
No additional payments will be made
No additional payments will be made
Since the father’s death occurred two years after the end of the period certain, the insurance company is relieved of making additional payments to his beneficiary. However, if the father had died after year 10, payments would have continued to his beneficiary for the remaining 10 years of the contract.
A person who invests in an annuity with a fluctuating stream of income is MOST concerned with the performance of the insurance company’s:
General account
Separate account
Auditors
Sales force
Separate account
The performance of a variable annuity is related to the performance of the separate account. The insurance company’s general account backs the company’s fixed annuities and traditional (guaranteed) insurance products.
When comparing mutual fund shares and variable annuity accumulation units, which of the following statements is TRUE of both?
There’s a daily valuation of fund assets and separate accounts.
Tax liability on shares or units is always deferred until payout, withdrawal, or surrender.
Both offer death benefit provisions.
Both require investor approval prior to distributing investment income.
There’s a daily valuation of fund assets and separate accounts.
The values of both mutual fund shares and the accumulation units of a variable annuity are calculated daily. To change the investment objective of a fund or subaccount, a majority vote of the shareholders or annuitants is required; however, the investment adviser is given authority over distributions. Only annuities provide investors with a death benefit. Mutual fund shareholders must pay taxes on their distributions in the year in which they’re received. Only annuitants are able to defer their tax liability until payout, withdrawal, or surrender.
A person who invests in a fixed annuity is MOST concerned with the performance of the insurance company’s:
General account
Separate account
Auditors
Sales force
General account
What determines the current value of a variable annuity during the pay-in period?
The number of shares multiplied by the per share value
The number of annuity units
The number of accumulation units multiplied by the per unit value
The number of annuity units multiplied by the per unit value
The number of accumulation units multiplied by the per unit value
During the pay-in period, the value of a variable annuity is determined by the number of accumulation units multiplied by the per unit value. When an investor annuitizes (begins the pay-out phase), the accumulation units are converted into annuity units.
