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Annuities

Accumulation and payout, immediate vs. deferred, fixed, variable, and indexed annuities, suitability, taxation, and 1035 exchanges.

Study questions and answers

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1. The period during which premiums are paid into an annuity and earnings grow tax-deferred is the:

  1. Accumulation period
  2. Annuitization period
  3. Payout period
  4. Elimination period
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A. Accumulation period
During accumulation, funds build up. During annuitization, the value is converted into a stream of payments.

2. Which statement describes an immediate annuity?

  1. It accepts flexible premiums over many years
  2. Payments must begin at age 59 1/2
  3. It is bought with a single premium and payments begin within one year
  4. It cannot provide lifetime income
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C. It is bought with a single premium and payments begin within one year
An immediate annuity is funded with a single premium and starts paying out within one year of purchase.

3. In a fixed annuity, the investment risk is borne by the:

  1. Annuitant
  2. Insurer
  3. Agent
  4. Beneficiary
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B. Insurer
The insurer guarantees the interest rate and principal, so it carries the investment risk.

4. Premiums for a variable annuity are invested in the insurer's:

  1. General account
  2. State guaranty fund
  3. Escrow account
  4. Separate account
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D. Separate account
Separate account assets are invested in subaccounts, and the owner bears the investment risk.

5. Which statement describes an indexed annuity?

  1. It invests directly in individual stocks
  2. It credits interest linked to a market index, subject to a cap or participation rate, with a minimum guarantee
  3. It offers no principal guarantee
  4. It is available only as an immediate annuity
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B. It credits interest linked to a market index, subject to a cap or participation rate, with a minimum guarantee
Indexed annuities share some market upside while protecting against loss through a guaranteed minimum.

6. Withdrawing earnings from a deferred annuity before age 59 1/2 generally results in:

  1. Ordinary income tax plus a 10% penalty
  2. Capital gains tax only
  3. No tax
  4. A 10% penalty only
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A. Ordinary income tax plus a 10% penalty
Earnings come out first and are taxed as ordinary income. A 10% penalty applies before 59 1/2 unless an exception applies.

7. The exclusion ratio is used to determine:

  1. The surrender charge on early withdrawals
  2. The death benefit owed to the beneficiary
  3. The portion of each annuity payment that is a tax-free return of principal
  4. The index cap on an indexed annuity
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C. The portion of each annuity payment that is a tax-free return of principal
Each payment is split between a tax-free return of the owner's cost basis and taxable earnings.

8. Which of the following exchanges does NOT qualify as a tax-free Section 1035 exchange?

  1. Life policy to life policy
  2. Life policy to annuity
  3. Annuity to annuity
  4. Annuity to life policy
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D. Annuity to life policy
Section 1035 allows life to life, life to annuity, and annuity to annuity. An annuity cannot be exchanged tax-free for life insurance.

9. Under a cash refund annuity, if the annuitant dies before receiving the amount paid in, the remainder is paid to the beneficiary:

  1. In installments over 10 years
  2. In a lump sum
  3. Not at all
  4. As interest only
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B. In a lump sum
A cash refund pays the balance in a lump sum. An installment refund continues payments until the balance is used up.

10. The annuitant is the person:

  1. Who guarantees the payments
  2. Who sells the annuity
  3. Who receives the death benefit
  4. Whose life expectancy is used to calculate the annuity payments
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D. Whose life expectancy is used to calculate the annuity payments
The annuitant is often, but not always, the owner.

11. A joint and survivor annuity:

  1. Continues payments to the surviving annuitant after the first death
  2. Pays a lump sum at the first death
  3. Pays only to the beneficiary
  4. Stops payments at the first death
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A. Continues payments to the surviving annuitant after the first death
Payments may continue at the full amount or a reduced amount, such as two-thirds.

12. Under a life income with period certain option, if the annuitant dies during the guaranteed period:

  1. The beneficiary receives a refund of all premiums
  2. Payments stop immediately
  3. The beneficiary receives payments for the rest of that period
  4. The insurer keeps the remaining balance
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C. The beneficiary receives payments for the rest of that period
Payments continue for life, or for the certain period if longer.

13. Surrender charges on a deferred annuity:

  1. Are imposed by the IRS
  2. Apply to withdrawals during the early years of the contract and usually decline over time
  3. Increase each year the contract is held
  4. Apply only after annuitization
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B. Apply to withdrawals during the early years of the contract and usually decline over time
Most contracts allow a free withdrawal each year, often 10% of the value.

14. During the accumulation period of a variable annuity, premiums purchase:

  1. Shares of the insurer's stock
  2. Accumulation units
  3. Term insurance
  4. Annuity units
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B. Accumulation units
At annuitization, accumulation units are converted into annuity units, which determine the payments.

15. The primary purpose of an annuity is to protect against the risk of:

  1. Market losses in a brokerage account
  2. Becoming disabled
  3. Dying too soon
  4. Outliving one's money
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D. Outliving one's money
Life insurance creates an estate. An annuity liquidates an estate in a systematic way.

16. Before recommending an annuity, a producer must have a reasonable basis to believe that the recommendation:

  1. Pays the highest commission
  2. Is approved by FINRA
  3. Is suitable for, and in the best interest of, the consumer
  4. Has the lowest surrender charge available
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C. Is suitable for, and in the best interest of, the consumer
State annuity suitability and best interest rules, based on the NAIC model, require gathering information about the consumer's finances, goals, and needs.

17. If an annuity owner dies during the accumulation period, the beneficiary's gain above the owner's cost basis is:

  1. Taxed as ordinary income
  2. Subject to a 10% penalty
  3. Taxed as a capital gain
  4. Tax free
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A. Taxed as ordinary income
Annuities do not receive a step-up in basis at death, unlike many other assets.
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