Test Your Annuity Knowledge

Annuity Questions

1. How are annuities different from other types of insurance products?

A. Annuities do not include a death benefit
B. Annuities provide tax deferred earnings growth
C. Capital withdrawals may be taken from annuities
D. The beneficiary of the annuity is paid an uncertain amount

2. What advantage do immediate annuities have over regular bank accounts?

A. Immediate annuities provide a guaranteed rate of return
B. Immediate annuities offer payouts throughout an indefinite period of time
C. Immediate annuities provide for tax-free retirement income
D. The principal grows faster in an immediate annuity

3. Which is NOT an advantage of investing in a fixed annuity?

A. Fixed annuities provide for tax-deferred interest income
B. Fixed annuities offer triple compounding
C. There are no surrender charges if funds are withdrawn before the fixed annuity’s maturity date
D. Funds may be withdrawn from the fixed annuity before it is annuitized

4. Which type of annuity settlement option allows the withdrawal of a fixed percentage of the account value?

A. Annuitization
B. Systematic withdrawals
C. Period certain
D. Period uncertain

5. A split annuity…

A. derives its income from several investment sources
B. is a combination of a fixed annuity and a variable annuity
C. pays benefits using two different settlement options
D. is a combination of an immediate annuity and a deferred annuity

6. The most common reason individuals purchase annuity plans is…

A. to provide sufficient income to cover expenses that pension plans and other investments may not cover during retirement
B. to provide an income for a beneficiary after the death of the purchaser of the annuity
C. to replace a life insurance policy
D. as an alternative to other investment options

7. Which type of annuity provides cash payments in the event of personal injury, such as an automobile accident?

A. Fixed annuity
B. Structured settlement annuity
C. Immediate annuity
D. Equity indexed annuity

8. Which is NOT a major advantage of a fixed annuity?

A. Tax-deferred
B. Avoidance of probate
C. Guaranteed death benefit paid to a beneficiary
D. Guaranteed income for life

9. An annuity will begin to accumulate enough income to pay guaranteed retirement income in…

A. three to five years
B. seven to 10 years
C. 12 to 15 years
D. 20 or more years

10. Which type of annuity provides additional income payments if the annuitant incurs a serious health problem?

A. Accelerated annuity
B. Increasing annuity
C. Life annuity
D. Term certain annuity

11. If an individual wants to maximize retirement income and has no plans to leave any part of the annuity to a beneficiary, in what type of annuity should the individual invest?

A. Lifetime annuity
B. Equity indexed annuity
C. Straight life annuity
D. Deferred annuity

12. Which of the following is not a characteristic of an immediate annuity?

A. The minimum investment is $10,000
B. Monthly repayments and interest rates remain the same during the life of the annuity
C. Only the return of capital portion of the annuity payment is tax-free
D. The rate of interest is not guaranteed by the insurance company

13. Which annuitization method provides the annuitant a guaranteed income until death with no monies left to distribute to a beneficiary?

A. Period certain
B. Period certain plus life
C. Period uncertain
D. Lifetime income

14. Which type of annuity provides a higher rate of return when financial indexes are rising?

A. Deferred annuity
B. Equity-indexed annuity
C. Fixed deferred annuity
D. Variable deferred annuity

15. Which of the following fees and charges are not charged by a variable annuity?

A. Surrender charges
B. Administrative fees
C. Mortality and expense risk charge
D. Broker’s commission

16. What is a Section 1035 Exchange?

A. A tax-free exchange of an annuity for a mutual fund
B. A tax-free exchange of one annuity for another annuity
C. A taxable exchange of an annuity for a life insurance contract
D. None of the above

17. A variable annuity has an initial investment of $5,000. Upon the owner’s retirement, the annuity has a value of $25,000. If the owner withdraws $5,000 from the variable annuity after retirement, what amount would be considered taxable income?

A. Nothing, the initial investment was withdrawn
B. 25% of the $25,000 value
C. $2,500
D. $5,000

18. Which of the following is not an advantage of variable annuities?

A. Tax-deferred
B. Mortality guarantee
C. Fixed rate of return
D. Investment choices similar to mutual funds

19. Which is not a feature of a variable annuity contract?

A. A death benefit, if the annuitant dies during the accumulation period
B. Annuity payments are made for as long as the annuitant lives
C. Does not include a mortality and expense risk fee
D. Includes a contingent deferred sales charge

20. What happens when a variable annuity contract is annuitized?

A. Accumulation units are converted into a fixed number of annuity units
B. The annuity contract is in the accumulation phase
C. All payments have been made and the contract is canceled
D. All of the above

21. Which annuity payout option allows an annuitant to provide payments to a beneficiary until that beneficiary’s death?

A. Life only option
B. Unit refund life annuity
C. Life with period certain
D. Joint and last survivor

22. When purchasing an equity-indexed annuity, which of the following risks should be disclosed to an investor?

A. Caps that limit earnings or an increase in account value
B. Performance may not match the performance of the index
C. Surrender periods and surrender penalties
D. All of the above

23. What is the purpose of Internal Revenue Service Rule 72(t)?

A. Provides tax-free distributions from an annuity
B. Provides penalty-free distributions from an annuity
C. Determines when distributions may be made from an annuity
D. Prevents the depletion of an annuity before the end of the annuitant’s life

24. What type of institution issues annuities?

A. Insurance companies
B. Stock brokerage firms
C. Mutual fund companies
D. Banks

25. What types of investments are used to create income and growth in a variable immediate annuity?

A. Stocks and growth mutual funds
B. Certificates of deposit and stocks
C. Bonds and equity mutual funds
D. Bonds and global mutual funds

26. An annuity with period certain may be used…

A. to fund costs associated with a medical disability
B. to purchase term life insurance
C. as retirement income
D. as an inheritance for a beneficiary

27. What concept underscores an insurance company’s guarantee that the annuitant receives annuity payments until his death?

A. Cross subsidy
B. Longevity insurance
C. Benefit rider
D. Annuity population

28. Which instrument allows an annuitant to provide a beneficiary with lifetime annuity income after the annuitant’s death?

A. A separate lifetime annuity
B. A life insurance policy
C. Longevity insurance
D. A benefit rider

29. A forfeiture of an annuity contract occurs when…

A. the annuitant doesn’t pay the premiums according to the contract terms
B. the annuitant’s death occurs before the annuitant recovers the investment in the annuity
C. the beneficiary’s death occurs before the annuitant’s death
D. one annuity contract is traded for another type of annuity contract

30. What feature is shared by all types of deferred annuities?

A. Tax-deferred growth
B. Growth is from interest rate earnings only
C. A guaranteed minimum rate of return
D. Growth is from capital gains earned from investments in stocks and bonds

31. Which type of annuity has features similar to a bank Certificate of Deposit?

A. Immediate annuity
B. Variable annuity
C. Fixed annuity
D. Structured settlement annuity

32. Which type of annuity functions in a manner similar to mutual funds?

A. Immediate annuity
B. Variable annuity
C. Fixed annuity
D. Equity indexed annuity

33. Which type of guaranteed minimum death benefit ensures an annuitant receives the highest account value upon death?

A. Return of premium
B. Roll-up of premium at a particular rate
C. Greater of maximum anniversary value or particular roll-up
D. Maximum anniversary value

34. Which type of guaranteed living benefit ensures the account value of an annuity will be a certain amount at a certain future date?

A. Guaranteed minimum accumulation benefit
B. Guaranteed minimum income benefit
C. Guaranteed minimum withdrawal benefit
D. Guaranteed for life income benefit

35. How much of the total premium paid by the investor is the average commission on the sale of a deferred annuity?

A. 3%
B. 6%
C. 8%
D. 12%

36. What is the tax penalty on withdrawals from an annuity before the annuitant reaches age 59½?

A. 3%
B. 7%
C. 10%
D. 15%

37. Up to which dollar amount are annuity contracts protected against insurance company insolvency?

A. $25,000
B. $50,000
C. $100,000
D. $250,000

38. Variable annuities differ from mutual funds because they…

A. pay periodic payments for the life of the annuitant
B. have a death benefit
C. are tax-deferred
D. All of the above

39. What happens during the accumulation phase of a variable annuity?

A. Funds may not be transferred from one investment option to another
B. The annuitant may withdraw funds without incurring surrender charges
C. The annuitant makes purchase payments
D. The annuity begins to make payments to the annuitant

40. What happens during the payout phase of a variable annuity?

A. Commissions are assessed against the annuity contract
B. The death benefit amount is determined
C. The annuitant receives purchase payments and investment income
D. The frequency of payments is determined

41. A stepped-up death benefit…

A. prevents a decline in the value of the annuity account
B. allows for an additional beneficiary
C. provides for variable investment performance
D. offers increasing annuity payments

42. Under what circumstance would an annuitant elect to exchange an existing variable annuity contract for another annuity contract?

A. The other annuity contract has a larger death benefit
B. The other annuity has a longer surrender period
C. The other annuity has fewer investment choices
D. The annuitant wants a tax-free withdrawal of funds

43. A variable annuity contract with a bonus credit feature may possibly be accompanied by…

A. higher surrender charges
B. a longer surrender period
C. increased mortality and expense risk charges
D. all of the above

44. The time period in which an annuitant can terminate an annuity contract without paying a surrender charge is the…

A. Lemon law period
B. Trial period
C. Free look period
D. Preview period

45. Before purchasing a variable annuity, what must the broker making the recommendation explain to the purchaser?

A. Liquidity issues
B. Fees
C. Market risk
D. All of the above

46. Which statement best describes the condition that must exist for a tax-free exchange of one annuity contract for another?

A. An annuity contract can be exchanged for a life insurance contract
B. The annuity contract may be transferred into another annuity owned by the annuitant
C. The annuitant cannot liquidate the original contract, receive a check, then purchase a new contract
D. An insurance contract may not be exchanged for a new annuity contract

47. When making a 1035 Exchange, the investor is required to sign a form acknowledging the transfer. Which information is included in this form?

A. A comparison of costs and features of the original and proposed contracts
B. Detail of charges associated with the proposed contract
C. The amount of money to be transferred
D. The amount of commission charged on the transaction

48. What is the most complex feature of an equity-indexed annuity?

A. The calculation of the death benefit
B. The value of the underlying securities
C. The method used to calculate the gain in the index linked to the annuity
D. How future payments are determined

49. What is the guaranteed minimum return on an equity indexed annuity?

A. 90% of the premium paid at 3% interest
B. 90% of the premium paid at 1% to 3% interest
C. 87.5% of the premium paid at 4% interest
D. 87.5 % of the premium paid at 1% to 3% interest

50. Which of the following are used to compute the index linked interest rate on an equity indexed annuity?

A. Participation rates
B. Spread, margin, or asset fee
C. Interest rate caps
D. All of the above

Annuity Answers

1. Answer: B. Annuities provide tax deferred earnings growth

An annuity is an interest bearing contract between an individual (the annuitant) and a life insurance company. The annuity contract has a specified time period and provides for guaranteed periodic payments at the end of the annuity period. When an individual purchases an annuity, he makes either a lump sum payment or pays over a specified period of time. Annuities provide for tax-deferred earnings growth consisting of a death benefit and a specified amount paid to the beneficiary. Annuities do not allow for capital withdrawals. Annuities are most commonly used as a means to provide an individual with a guaranteed income after retirement.

2. Answer: D. The principal grows faster in an immediate annuity

In an immediate annuity, payments are made as soon as the funds are invested in the annuity account. Depending on the terms of the immediate annuity contract, the annuity payout may be either for a specified period of time, or for the life of the individual. Immediate annuities are used by individuals who have received a lump sum of money from a retirement account and want to reinvest those funds. The advantages of an immediate annuity over a regular bank account are that the principal amount in the annuity grows at an increased rate, and that the contract guarantees the time period in which payments are made.

3. Answer: C. There are no surrender charges if funds are withdrawn before the maturity date of the fixed annuity

Fixed annuities pay a specified rate of return for a specified period of time. The advantages of investing in a fixed annuity include:

• Interest paid on the annuity increases as interest rates rise
  
• Investors are guaranteed against loss
  
• Longer term fixed annuities have higher benefits
  
• Interest earned is tax-deferred as long as the funds remain in a fixed annuity or other tax-deferred investment
  
• Funds may be withdrawn before the fixed annuity is annuitized
  
• Triple compounding occurs because interest is earned on interest, deferred taxes, and the original premium
  

Disadvantages of fixed annuities include:

• Funds withdrawn before maturity are subject to surrender charges
  
• Funds withdrawn before age 59½ incur tax penalties
  
• Interest earned fall when interest rates fall

4. Answer: B. Systematic withdrawals

There are three types of annuity settlement options:

• Systematic withdrawals— the periodic withdrawal of funds from the annuity in the amount of a fixed percentage of the account value. This arrangement can be cancelled at any time; when an individual no longer wishes to receive periodic payments, the remaining amount may be paid in a lump sum
  
• Annuitization— a settlement option giving the annuitant the choice of receiving monthly, semi-annual or annual payments over a specified period of time
  
• Period certain—the option of receiving annuity payments over a period of five, 10, 15 or 20 years. If death occurs before the end of the annuity payment period, the remaining balance is paid to a beneficiary

5. Answer: D. A combination of an immediate annuity and a deferred annuity

A split annuity is a combination of an immediate annuity and a deferred annuity. A split annuity is funded with a single premium payment, pays a guaranteed monthly income for a period of 5, 7 or 10 years. In addition, the monies used to fund the split annuity earn interest on a tax deferred basis. Over the course of the split annuity, the earned income accumulates so that at the end of the annuity, the amount remaining in the annuity is equal to the initial investment. A split annuity is a flexible investment option that allows an individual to reevaluate their financial needs during retirement.

6. Answer: A. To provide sufficient income to cover expenses that pension plans and other investments may not cover during retirement

Annuities are often used to supplement retirement income, as they provide guaranteed payments. A company-sponsored pension plan, individual retirement plan or other investments may not be adequate to pay an individual’s needs once that person reaches retirement. Annuities provide a specified income during a specified period of time, and also provide a death benefit option so that any funds remaining in the annuity can be paid to a beneficiary.

7. Answer: B. Structured settlement annuity

Structured settlement annuities are commonly used to provide compensation for personal injury cases. They provide the injured individual or family with a regular income for a specified period of time, paid out in either annual or periodic installments. These payments are often used for medical expenses and alterations to the lifestyle (modified vehicle or special equipment) of a personal injury victim. The Internal Revenue Service, under Section 104(a) (2), excludes structured settlement payments from gross income, making them tax-free. Before purchasing a structured settlement annuity, the individual’s life expectancy and selected beneficiary should be taken into consideration.

8. Answer: C. Guaranteed death benefit paid to a beneficiary

The main advantages of a fixed annuity are deferral of income taxes, avoidance of probate, and a guaranteed income. Fixed annuities pay a guaranteed income for the life of the annuitant at regular intervals, or until a specified event (usually death) has occurred. Upon the death of the annuitant, the proceeds of the fixed annuity are paid directly to the beneficiary and are not subject to the probate process. The fixed annuity may be funded with either a single premium, or with an initial premium and ongoing premium payments. The accumulated interest income is not subject to income taxes as long as the funds are kept in the fixed annuity. Taxes are payable when funds are withdrawn from the annuity.

9. Answer: B. Seven to 10 years

An annuity normally takes between seven and ten years before it accumulates adequate interest income to fund retirement income needs, making it a long-term investment. The rule of thumb is the younger the annuitant at time of purchase, the better able the annuity will be in meeting retirement goals. A younger annuitant will also pay smaller premiums than an older annuitant for the same annuity product. Interest compounds significantly in annuities held over a long period of time prior to withdrawals. If early withdrawals are made before the annuity is annuitized, there are surrender charges and tax consequences.

10. Answer: A. Accelerated annuity

An annuity purchaser can choose from among several types of annuities, each structured to achieve different results. They are:

• Accelerated annuities— pay higher payments when the annuitant incurs a serious health condition
  
• Life annuities— provide an income for the life of the annuitant
  
• Term certain annuities— pay a specified amount of money for a specified period of time
  
• Level annuities— pay a higher income in the beginning, gradually decreasing over time, but made during the entire life of the annuitant
  
• Increasing annuities— protect the annuitant from increasing prices. The annuity payments are adjusted based on the Retail Prices Index (RPI)
  
• Investment linked annuities— invest in stocks and bonds, with annuity payments dependent on the performance of the underlying investments

11. Answer: C. Straight life annuity

When an individual needs the highest possible amount of retirement income, a straight life annuity is the best choice. Straight life annuities do not contain provisions for the transfer of benefits to a beneficiary. Lifetime annuities, a type of immediate annuity, are guaranteed to pay out for the lifetime of the annuitant. Lifetime annuities are also called lifetime income annuities, single life annuities, straight life annuities, and non-refund annuities. Most lifetime annuities have a provision that passes the income to a beneficiary when the annuitant dies; these are called reversionary or Joint and Survivor annuities.

12. Answer: D. The rate of interest is not guaranteed by the insurance company

Immediate annuities make lump sum payments over a period selected by the annuitant. The minimum investment on an immediate annuity is $10,000, which is tax-deductible. Annuity payments and the interest rate are guaranteed to remain constant over the life of the annuity contract. The amount received in annuity payments depends on the amount invested in the annuity. The annuity payments consist of two components; return of capital, and earnings. The portion paid as return of capital is tax-free, but earnings from interest are taxable.

13. Answer: D. Lifetime income

There are a variety of settlement options that are offered by annuities. Annuitization is the most popular settlement option. There are three annuitization options:

• Lifetime income— pays a specified amount on a regular basis continuing until death. Any monies left remaining in the annuity are lost because this option doesn’t provide a death benefit
  
• Period certain— guarantees to pay out the balance of the annuity account (principal invested plus accrued interest) over a specified period of time. If the annuitant’s death occurs before the end of the payout period, remaining funds are distributed to a beneficiary.
  
• Period certain plus life— provides the annuitant with a specified amount of money for a specified period of time. If the annuitant lives past the payout period, payments will continue until the annuitant’s death

14. Answer: B. Equity-indexed annuity

Deferred annuities provide a constant amount of income after retirement. Funds invested in a deferred annuity accrue interest on a tax-deferred basis. Income taxes are not incurred until the funds are withdrawn from the annuity account. There are three types of deferred annuities:

• Equity-indexed annuities— earnings are based on financial indexes, but guarantee a minimum rate of return. When the financial markets rise, the interest earned on an equity-indexed annuity is greater than the earnings on a fixed deferred annuity.
  
• Fixed deferred annuities— earn a fixed rate of interest and protect the principal from declines in the financial markets
  
• Variable deferred annuities— completely dependent on the financial markets. In poor market conditions, there is the risk of losing the principal amount invested in the annuity

15. Answer: D. Broker’s commission

Variable annuities have a number of associated fees and charges, which decrease earnings on the annuity investment. Before purchasing any annuity, the prospective annuitant should read the prospectus carefully to understand these fees.

• Surrender charges— incurred when funds in excess of the free withdrawal providing are withdrawn during the surrender charge period, which is usually between the first six and eight years on the annuity contract
  
• Mortality and expense risk charges— deducted from the annuity account by the insurance company. These charges cover insurance risk and assure the annuitant of future payments.
  
• Administrative fees— charged to cover the expenses of professionally managing the investments of the annuity. These fees cover many of the record keeping and customer service costs of the insurance company
  
• Underlying fund expenses on sub accounts— covers the costs associated with managing the securities portfolio of the annuity

16. Answer: B. A tax-free exchange of one annuity for another annuity

In order to qualify for a Section 1035 Exchange, the policyholder of an existing annuity contract must exchange that annuity contract for an equivalent new contract. The existing annuity contract must be re-invested immediately in the same type of annuity to the same annuitant in order to avoid paying taxes on any realized gains. Annuities are usually used as a means to fund a retirement. If the proceeds of the annuity are not immediately re-invested in a similar annuity, the policyholder will pay incomes taxes on the amount over the cost basis, plus a 10% penalty. Money withdrawn from an annuity after age 59½ is not taxed.

17. Answer: D. $5,000

Distributions from variable annuity investments are taxed on a LIFO (last in, first out) basis. The cost basis of a variable annuity is the amount of money originally invested, therefore, in this example, $5,000 is the cost basis and is not taxed. The money invested in the variable annuity grows on a tax-deferred basis. Earnings above the cost basis are not taxed until withdrawn from the variable annuity. In this example, $20,000 has accumulated in earnings, and is taxed as ordinary income when withdrawn from the variable annuity. For tax purposes, the earnings are considered the first monies withdrawn from a variable annuity. In this example, the first $20,000 withdrawn is taxed and the last $5,000 withdrawn is not taxed.

18. Answer: C. Fixed rate of return

A variable annuity is an insurance contract in which the value depends on the value of the underlying securities. Dividends and capital gains received from the underlying securities are re-invested in the variable annuity and grow tax-deferred. The variable annuity is taxed when money is withdrawn from the account. Variable annuities have a mortality guarantee; they pay until the end of the beneficiary’s life. In this respect, they’re similar to an insurance policy. There are several types of variable annuities that offer growth, value, or high yield. Choices of variable annuities are similar to the various types of mutual funds.

19. Answer: C. Does not include a mortality and expense risk fee

Variable annuity contracts are sold by insurance companies. A mortality and expense risk fee is assessed to cover the insurance company’s risk of increased expenses over the life of the annuity. The annuitant makes a single lump sum payment and, in turn, receives a monthly income payment that continues for the duration of his life. If the annuitant cashes in the annuity during the surrender period, the annuitant is charged a contingent deferred sales charge. If the annuitant dies during the accumulation period, the annuitant’s beneficiary receives the greater of the contract value or the amount invested in the annuity.

20. Answer: A. Accumulation units are converted into a fixed number of annuity units

An annuity contract is annuitized when it changes from the accumulation (or pay-in) phase to the distribution (or payout) phase. At this point, the accumulation units in the annuity are converted into annuity units, which are the annuitant-s holdings during the distribution phase. The number of annuity units is fixed, but the value of the annuity units varies. Accumulation units are the payments made by the annuitant and represent a proportional share of the separate account.

21. Answer: D. Joint and last survivor

The joint and last survivor option provides payments for the lifespan of the annuitant and a beneficiary. The life only option (also called straight life) makes payments over the annuitant’s life only. The unit refund life annuity guarantees that the annuitant will receive a specified number of payments, but pays remaining payments in a lump sum to a beneficiary in the event of an annuitant’s death. The life with period certain option provides payments for the greater of the annuitant’s life or a specified amount of time. If the annuitant dies before the specified amount of time, a beneficiary will receive payments during the remaining time period.

22. Answer: D. All of the above

Equity-indexed annuities guarantee a minimum specified rate of return, with higher rates of return possible when the stock index linked to the annuity increases. However, equity-indexed annuities may also place limits on how much an annuitant may earn when the stock market index rises. Limits are also placed on how much the account value may increase on an annual basis. Because of these limits, an equity-indexed annuity will not perform the same as the underlying index. Annuitants who sell an annuity during the surrender period may incur a surrender penalty. Equity-indexed annuities are tax-deferred.

23. Answer: B. Provides penalty-free distributions from an annuity

Internal Revenue Service (IRS) Rule 72(t) provides penalty-free distributions from an annuity before the annuitant reaches age 59½. These distributions are taxed at ordinary income tax rates. In order to avoid the 10% penalty for early withdrawal, the withdrawal must qualify for an exemption, which can include a disability that prevents the annuitant from working, or payments for medical expenses. Also, the annuitant must make withdrawals as a series of substantially equal periodic payments. These withdrawals must be made over a five-year period, or until the annuitant reaches age 59½, whichever comes later.

24. Answer: A. Insurance companies

Although annuities have the features of both life insurance policies and investment products, annuities are sold only by life insurance companies. These companies and their annuity contracts are regulated by the state in which the contract is sold. Since individual states are responsible for regulating life insurance companies, each state has its own requirements for which options may be made available for different types of annuities. The Internal Revenue Service defines how annuity contracts may be set up, and the tax implications of investing in an annuity contract. The Securities and Exchange Commission has regulatory authority over variable annuity companies and the Financial Industry Regulatory Authority has authority over the sale of variable annuities.

25. Answer: C. Bonds and equity mutual funds

A variable immediate annuity is a type of immediate annuity where the annuity payments are determined based on the performance of a specified group of investments, most commonly bonds and equity mutual funds. The variable immediate annuity allows an individual to allocate the invested funds from among a selection of investments. The rate of return is based on the performance of the annuity portfolio. When the value of the portfolio increases, annuity payouts will increase. When the value of the portfolio decreases, annuity payouts will decrease.

26. Answer: B. To purchase term life insurance

An annuity with period certain is an immediate annuity with a payout period for a set, specific number of years. It’s commonly used to fund an expense that has the same payment time frame, such as premiums on a term life insurance policy. An annuity with period certain is not suitable to fund retirement income because the lifespan of the annuitant may be longer than the period specified by the annuity.

27. Answer: A. Cross subsidy

Cross subsidy is known as the law of large numbers. Under this concept, an insurance company uses statistics to determine the lifespan of a population in general. In reality, some lives will be longer and some shorter. The remaining annuity funds of those individuals who do not live as long as the average population are used to fund the annuity payments of those individuals that live longer than the average expected lifespan As lifetime immediate annuities pay out until death of the annuitant, the insurance company bases its guarantee of payments on this concept. A lifetime immediate annuity is similar in nature to a defined benefit plan or pension plan. The amount the annuitant pays into the annuity is based on the expected life expectancy.

28. Answer: D. A benefit rider

A benefit rider allows an annuitant to provide a spouse or child with income after the annuitant’s death. To pay for this rider, an annuitant can opt for a decreased payment to himself, or a higher premium payment. When the annuity payments are made to a spouse, it is called a reversionary annuity or survivorship annuity. If an annuitant is in good health, the annuitant should consider opting for the highest payout option on the annuity and purchasing a life insurance policy in order to provide an income to the surviving spouse or child.

29. Answer: B. That annuitant’s death occurs before the annuitant recovers the investment in the annuity

Forfeiture occurs when the annuitant dies before having recovered the amount invested in the annuity contract. This leaves the amount paid for the annuity contract greater than the amount paid to the annuitant in the form of annuity payments. In order to avoid this type of situation, the annuitant can buy an annuity with a period certain feature, which will requires the annuity to make payments over a specified period of time. If the annuitant’s death occurs before the end of the specified time period, the remaining payments are made to the annuitant’s estate or beneficiary.

30. Answer: A. Tax-deferred growth

Deferred annuities accumulate earnings on a tax-deferred basis; earnings accrued in the account are not taxed until the funds are withdrawn. A fixed deferred annuity accumulates growth through interest rate earnings, while a variable annuity invests in stocks and bonds with the account’s value dependent on those investments’ earnings. There’s no guarantee that the account value will remain above the principal amount invested in a variable annuity. Fixed indexed annuities invest according to stock and bond indexes and provide a guaranteed minimum rate of return.

31. Answer: C. Fixed annuity

A fixed annuity provides a guaranteed rate of return during the term of the annuity contract. The rate of return on a fixed annuity is competitive with the interest rate offered by Certificates of Deposit. The rate of return offered for fixed annuities is reset by the insurance company every year on the anniversary of the initial deposit.

32. Answer: B. Variable annuity

Variable annuities allow an annuitant to invest funds in a range of options, typically mutual funds. Variable annuities provide the annuitant with a minimum rate of return even if the investments, allowing investment in the securities markets without the higher degree of risk. In addition, variable annuities give an individual an opportunity to make tax-deferred investments for retirement that are larger than the amounts set by individual retirement accounts or 401(k) plans. Variable annuities are regulated by the state in which the annuity is sold, the Securities and Exchange Commission, and the Financial Industry Regulatory Association.

33. Answer: D. Maximum anniversary value

An annuitant may choose from several guaranteed minimum death benefit options. These options are accompanied with risk charges, paid by the annuitant, that vary depending on degree of risk. The types of guaranteed minimum death benefit options include:

• Return of premium— the least risky to an insurance company and guarantees the annuitant will not have a negative return on investment
  
• Roll-up of premium at a particular rate— ensures the annuitant receives a minimum rate of return
  
• Maximum anniversary value— guarantees the annuitant will receive the highest account value, with payout determined by the account value on the anniversaries
  
• Greater of maximum anniversary value or particular roll- up— the most risky to an insurance company

34. Answer: A. Guaranteed minimum accumulation benefit

Guaranteed living benefits offer insurance coverage on annuities and can be exercised by the annuitant when the benefits are worth the most. The types of guaranteed living benefits include:

• Guaranteed minimum income benefits— guarantee that the annuitant will receive a minimum payment upon annuitization at a specified future date
  
• Guaranteed minimum accumulation benefits— guarantee that the account will have a specified value at a specified future date
  
• Guaranteed minimum withdrawal benefits— guarantee that the annuitant will receive a minimum payment at a specified future date
  
• Guaranteed for life income benefits— provide a minimum payment until the cash value of the account is zero. At this point, annuitization occurs on the guaranteed benefit amount but the payment amount is not calculated until the annuitization date

35. Answer: B. 6%

Insurance companies pay commissions to financial professionals who sell their deferred annuities. The commission is based on a percentage of the total premium paid by the investor, and it ranges from 1% to 12%, with the average being 6%. The insurance company recaptures the commissions it pays out through fees charged to the investor or from the spread in the interest rate market. In addition, if an investor cancels the annuity contract before the surrender period, he is subject to deferred back-end charges. The surrender period is normally eight years.

36. Answer: C. 10%

Any withdrawals made before age 59½ are charged a 10% tax penalty, and any gains paid to the annuitant by the annuity are taxed as ordinary income. Annuities accumulate income on a tax-deferred basis as long as the funds remain in the annuity account. Once annuity payments begin, the annuitant pays income taxes on the annuity earnings after he has recovered the initial investment. The only portion of the annuity payments that are taxable are the interest and capital gains portion of the annuity.

37. Answer: C. $100,000

In most states, annuity contracts are protected up to $100,000 if the insurance company becomes insolvent. New York, New Jersey, and Washington State provide protection up to $500,000. This protection, provided by each state’s Guaranty Association, is not insurance nor enforced by any government agency. In the event of insurance company insolvency, the Guaranty Association evaluates each annuity contract and determines how the situation should be handled; it may pay off the annuity contract or transfer it to a solvent insurance company.

38. Answer: D. All of the above

Variable annuities are typically invested in mutual funds, pegging the annuity’s value to the performance of the funds. Features of variable annuities that cause them to differ from mutual funds include:

• A stream of periodic payments for a specific period, such as 20 years, or for the life of the annuitant
  
• A death benefit that pays out to a beneficiary an amount of at least the total purchase payments
  
• Tax-deferred growth of earnings, with taxes payable when funds are withdrawn
  

39. Answer: C. The annuitant makes purchase payments

In the accumulation phase, the annuitant makes purchase payments and decides how to allocate those funds between investment options. During this phase, funds may be transferred from one investment option to another without incurring taxes on the investment income and gains, but the insurance company may charge for transfers. The annuity’s prospectus provides information about the investment options available for the variable annuity. Before selecting an investment option, an annuitant should evaluate the fund’s investment objectives and policies, management fees and other expenses, and the risks and volatility of the fund. Surrender charges may be assessed during the accumulation phase if the annuitant withdraws funds

40. Answer: C. The annuitant receives purchase payments and investment income

During the payout phase of a variable annuity, the annuitant receives the amount invested in the annuity plus investment income and gains. This payment may come in the form of either a lump sum payment or a series of payments at regular intervals. The series of payments may be made for either a specified or indefinite period of time. The amount of each payment is dependent on the payout time period selected. Once payments begin, additional funds may not be withdrawn from the annuity account.

41. Answer: A. Prevents a decline in the value of the annuity account

In a stepped up death benefit, the guaranteed minimum death benefit is usually an amount higher than the total purchase payments into the account, less any withdrawals. This is particularly true if the underlying investment options have performed well. The purpose of a stepped up death benefit is to “lock in” the investment performance, helping to prevent a possible later decline in account value, which would, in turn, decrease the annuity value remaining for a beneficiary. Insurance companies will assess a fee for this benefit, reducing the account value.

42. Answer: A. The other annuity contract has a larger death benefit

Under Section 1035 of the U.S. tax code, an annuitant may exchange an existing variable annuity contract for a new annuity contract without paying taxes on the income and investment gains in the current variable annuity. The reasons for making this type of exchange include larger death benefits, changing annuity payout options, or additional investment choices. If the exchange is made before the end of the surrender period, the insurance company will assess surrender charges. These surrender charges, along with the possibility of a higher annual fee, will reduce the rate of return on the annuity.

43. Answer: D. All of the above

The bonus credit feature of a variable annuity provides a bonus to the annuity account when the annuitant makes a purchase payment. The bonus credit may be between 1% and 5% of the purchase payment. For example, when a purchase payment is $10,000 and the bonus credit is 2%, the insurance company deposits a bonus credit of $200 to the annuity account. Variable annuities with bonus credits may have other features that can offset any gains, such as higher surrender, mortality and expense risk charges, or a longer surrender period. The bonus credit is only an advantage if the bonus credit is worth more than the increased charges assessed on the annuity.

44. Answer: C. Free look period

Variable annuity contracts have free look periods, usually of at least 10 days, giving the purchaser the option to terminate the contract free of surrender charges. The insurance company also returns any payments made into the annuity. The purpose of the free look period is to give the investor an opportunity to further review the annuity contract and determine its suitability. Before purchasing a variable annuity, an investor should review the annuity literature carefully and ask questions to determine if the annuity meets the investor’s needs.

45. Answer: D. All of the above

Before selling a variable annuity to an individual, the broker has a responsibility to explain the liquidity issues, fees, and market risk to the individual. Liquidity issues that should be explained include surrender charges and tax penalties. Fees that should be discussed include mortality and expense charges, administrative charges, and investment advisory fees. In addition, the broker must collect information from the individual including age, marital status, occupation, financial and tax status, investment objectives, and risk tolerance. This information is required so that the broker can make a determination if the variable annuity is an appropriate investment for the individual.

46. Answer: C. The annuitant cannot liquidate the original contract, receive a check, then purchase a new contract

A 1035 Exchange provides an investor with the ability to exchange an insurance contract for either a new life insurance contract or a new annuity contract. However, it only allows annuity contracts to be exchanged for other annuity contracts, not life insurance contracts. The original contract must be exchanged directly for a new contract. The investor cannot receive a check for liquidating the original contract and then apply those proceeds to the purchase of a new contract. The proceeds must be transferred directly from one contract to another by the insurance company. By taking advantage of a 1035 Exchange, the investor does not pay tax on the income and investment gains earned on the original insurance or annuity contract.

47. Answer: A. A comparison of costs and features of the original and proposed contracts

When making a 1035 Exchange, the investor and the salesperson sign a form that indicates the investor’s acknowledgement of the transaction. This form shows a comparison of the costs and features between the original contract and the proposed contract. The form also indicates issues that the investor should review when making the exchange. When considering a 1035 Exchange, the investor should determine:

• The total cost of the exchange
  
• The change in the surrender period
  
• New features of the proposed annuity contract
  
• Whether or not the cost of the features benefits the investor
  
• The amount of commission paid on the exchange

48. Answer: C. The method used to calculate the gain in the index linked to the annuity

There are several indexing methods used by the various equity-indexed annuities to determine the interest, making it difficult to compare different equity-indexed annuities. This can be a source of confusion for the investor. Before investing in an equity indexed annuity, an investor should be prepared to ask the salesperson about the features of the annuities so that the suitability of the investment is right for the investor.

49. Answer: D. 87.5 % of the premium paid at 1% to 3% interest

Changes in insurance laws have reduced the guaranteed minimum return to 87.5% of the premium paid at 1% to 3% annual interest, down from the guaranteed minimum return of 90% of the premium paid at a 3% annual interest rate in the 1990s. The guaranteed minimum return on an equity-indexed annuity is only as good as the financial strength of the insurance company that sells the annuity. If an insurance company is not able to meet its financial obligations, an investor may not receive this guaranteed minimum return. Before investing with an insurance company, the investor should research the insurance company to review the ratings of the insurance company’s financial strength.

50. Answer: D. All of the above

The index-linked gain on equity-indexed annuities is determined by the indexing features used. The most common indexing features include:
Participation rates determine the amount of the gain in the index that is credited to the annuity. If the participation rate is 80%, the annuity is credited with 80% of the gain realized by the index

Spread, margin, and asset fees are used instead of, or in addition to, the participation rate. These may reduce the gain in the index linked to the annuity. If the index realizes 10% and the fees equal 3.5%, the gain in the annuity is 6.5%

Interest rate caps set a limit on the annuity’s rate of return, which is the maximum interest rate the annuity will earn