What are Annuities? Flashcards
Requirements to be a salesman of variable products
A) Possession of a valid FINRA registration
B) Affiliation with a registered broker-dealer
C) Possession of a valid life insurance license
(Because variable contracts are securities as well as insurance products, it is necessary to have a life insurance license as well as a FINRA registration. There is NO requirement to be affiliated with an investment adviser, but obviously one can’t have a FINRA registration without being affiliated with a broker-dealer.)
Fixed annuity is protected against
Longevity risk.
(Because a fixed annuity promises a fixed monthly payment for life, longevity risk is not a concern. However, the fixed payments are subject to purchasing power risk, also known as inflation risk. One other risk is that of dying after only receiving payments for several months after having chosen the life only option.)
A variable annuity has
Different investment options known as subaccounts.
(Variable annuities pay variable payments once annuitized; they do NOT guarantee a rate of return. That is why the term variable is used to describe them. Although a variable annuity may be surrendered and the cash value paid out similar to the redemption of mutual fund shares, they are NOT considered liquid investments because of the surrender charges that can run for 10 years or longer. They do offer multiple investment options through the subaccounts.)
A variable annuity annuitant bears all of the following risks except:
A) Interest rate risk
B) Market risk
C) Mortality risk
D) Inflation risk
C) Mortality risk
(The insurance company issuing the variable annuity bears mortality risk, or the danger that some annuitants will live to surpass their average life expectancy. The primary risk to the investor in a variable annuity is market risk. Although variable annuities attempt to keep up with inflation, there is no assurance that the performance of the separate account, after expenses, will do so. To the extent that the selected subaccounts contain fixed income securities, there will also be interest rate risk.)
What best describes the death benefit provision of a variable annuity?
The principal amount at death is the greater of the total of premium payments or the current market value.
(The death benefit insures that the investor will never receive back less than the original amount contributed to the account. Unlike life insurance proceeds, with annuities, anything above the cost basis is taxed as ordinary income. Receiving the benefit as a lump sum is only one of the options available to a beneficiary of a variable annuity death benefit. There are others, such as annuitizing the benefit. Although it is true that the 10% penalty for withdrawal before reaching age 59½ does not apply when the contract owner dies, that does not describe the death benefit. This is a case, as so often happens, when there is a second choice that looks good but doesn’t “hit the nail on the head” as does the correct answer.)
Current IRS regulations permit an unlimited contribution to which tax-deferred plan?
Annuity
(Nonqualified annuities offer tax deferral similar to that of qualified retirement plans. However, unlike qualified plans and IRAs, the IRS places no limitation on the amount that may be contributed.)
Client objective is monthly income that he can receive after he retires to supplement his small pension and Social Security benefits. As part of his profile, he stresses that he has had uncomfortable experiences in the past with the stock market and is not inclined to invest in anything that is based on stock market performance—and he would opt for principal protection instead. Based on the client’s profile, what would be the best recommendation?
Fixed annuity
(Though its stated return might not be as high as the other choice’s potential returns, only a fixed annuity fits the objective and risk-averse traits of this client. VAs, blue-chip mutual fund portfolios, ETFs, and ETNs are all tied to market performance in some way and have risk characteristics that would not align in terms of suitability for this client.)
A popular vehicle for saving for retirement is the variable annuity. An agent explaining the benefits of this product would probably be in violation of the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents by claiming that variable annuities offer:
Lower overall expenses than a mutual fund with similar investment objectives.
(In general, and always on the exam, variable annuity expenses are higher than those of a mutual fund with similar objectives. That doesn’t mean the fund is good and the VA bad, it is that there are guarantees and other features offered by the VA that a fund does not have and they have to be paid for.)
You have a 70-year-old client who is in excellent health. Both parents lived into their late 90s and the client is concerned about outliving her money. One product that should be considered to alleviate this concern is:
An Annuity
(One of the unique characteristics of an annuity (variable or fixed) is that it guarantees monthly payments for the life of the annuitant. Life insurance provides a death benefit, but not income. An index fund carries no guarantees.)
What is considered an advantage of annuitization?
It guarantees income that will last for the client’s lifetime.
(Annuities offer a guarantee of income that will last for a client’s lifetime. Annuitization does limit liquidity and flexibility.)
The return that will be earned over the life of a fixed annuity:
Will always be at least equal to the guaranteed minimum specified in the contract.
(Fixed annuities are what the term implies—the return is fixed for the life of the contract. In some cases, a fixed annuity may actually pay more (but never less) than the guaranteed amount. This would be true if the insurance company earned what is called “excess interest.”
Reasons why deferred variable annuities might be a suitable investment for seniors:
Potential Inflation Protection
(Variable annuities do offer potential inflation protection due to their participation in the equity market. The tradeoff is potential capital fluctuation, particularly if the portfolio selected is too aggressive. In addition, they typically carry high surrender charges.)
1035 Exchange
A 1035 exchange is a provision in the Internal Revenue Service (IRS) code allowing for a tax-free transfer of an existing annuity contract, life insurance policy, long-term care product, or endowment for another one of like kind.
A risk faced by many seniors is longevity risk. What security would be most appropriate to protect against that risk?
Variable annuity
(Longevity risk is the uncertainty that one will outlive his money. The only instrument that guarantees a payout for as long as one lives is an annuity. Because the question asks for a security, only the variable annuity is correct, otherwise the fixed annuity would also offer protection.)
The difference between a fixed annuity and a variable annuity is that the variable annuity
I. Offers a guaranteed return
II. Offers a payment that may vary in amount
III. Will always pay out more money than the fixed annuity
IV. Attempts to offer protection to the annuitant from inflation
II and IV
II. Offers a payment that may vary in amount
IV. Attempts to offer protection to the annuitant from inflation
(Variable annuities differ from fixed annuities because the payments vary and are designed to offer the annuitant protection against inflation.)
