Chapter 12

Which two of the following are likely to be included in variable annuity subaccounts, but not in the general account of an insurance company?
I. Corporate bonds
II. mutual funds
III. ETFs
IV. U.S. Treasury securities

II & III: The separate account of the insurer that provides variable products offers growth opportunities for purchasers. Equity products like mutual fund and ETF subaccounts are found in separate accounts but not in the insurer's general account.

Which two of the following statements explain the annuitization of a variable annuity contract?

I. The number of accumulation units continue to grow
II. The number of annuity units is fixed
III. Annuity units are liquidated to provide monthly income
IV. The investments are transferred to the insurer's general account

II & III: When a variable annuity is annuitized, the number of annuity units is fixed and no more accumulation units can be purchased. Annuity units are liquidated to pay the monthly income benefit the annuity provides.

Variable annuities are most suitable for an investor with which of the following objectives?

A. Long-term savings and protection from loss of principal

B. Desire for growth to ensure income that lasts for life

C. Tax deferred growth to meet long-term savings objectives
D. A low cost investment option that provides access to many different investment options with a low minimum investment

B. Variable annuities are best suited to individuals who are planning for retirement. They typically have higher charges when compared to other investment options because of the guarantees they deliver. Tax-deferred growth can be achieved in other types of retirement plans. Fixed annuities protect against loss of principal, but may lose purchasing power.

A variable annuity calculates the value of its separate account units:

Daily

Weekly

Monthly

Annually

Daily

When the investment management of the insurer passes the responsibility of management to subaccount fund managers, the separate account must be registered as____

unit investment trust

When the assets of the separate account of an insurance company are managed by the insurance company's investment company, the account is registered as an ______

open end investment company

An insurance company's separate account is not directly managed by its investment managers. This separate account is

A. Registered as a unit investment trust under the Investment Company Act of 1940

B. registered as an open end investment company under the Investment Act of 1940

C. B. registered as a closed end investment company under the Investment Act of 1940

D. not registered under the Investment Act of 1940

A. When the investment management of the insurer passes the responsibility of management to subaccount fund managers, the separate account must be registered as a unit investment trust. When the assets of the separate account of an insurance company are managed by the insurance company's investment company, the account is registered as an open end investment company.

Judy started a 529 plan for her daughter three years ago. If she earns $2,000 on its investments this year, how is this amount treated for income tax purposes now, assuming she does not plan to start taking distributions for college expenses for several more years?

A. It is currently taxable as ordinary income

B. It is currently taxable as capital gains

C. It is always tax-free

D. It is tax-deferred until distribution

D. Investment earnings accumulate on a tax-deferred basis in 529 plans. There is no IRS reporting until distributions are made. Then, distributions used for qualified education expenses are tax-free.

ABLE Accounts

ABLE accounts are a type of municipal fund security designed to help ease the financial strain of individuals with disabilities by permitting the opening of tax-free savings accounts that can cover certain qualified expenses.

Contributions to the plan are always after-tax and the

investments in the plan grow tax-free.

Distributions for qualified expenses such as housing, transportation, and wellness services is tax-free.

Which two of the following statements are true regarding variable annuity surrender charges?

I. They can apply for a period of no more than 5 years
II. They are usually a level charge for the period of years during which they apply
III. They are similar to mutual fund contingent deferred sales charges
IV. When an existing variable annuity contract is exchanged for a new annuity, a new surrender charge period is likely

III & IV: Variable annuity surrender charges commonly apply for periods of 6 - 10 years. They are similar to CDSCs (contingent deferred sales charges) charged by mutual funds, and decline over the period of years during which they apply. It is important that individuals understand that a new surrender charge period is likely to apply when annuity contracts are exchanged.

If Paul makes a $5,000 contribution to his Roth IRA, how much will it reduce his taxable income?

Zero

Depends on tax bracet

$2,000

$5,000

zero- Roth contributions are always made with after-tax dollars. They do not reduce the taxable income that owners must report.

What is the minimum level of matching an employer can choose in a 401(k)?

Zero

10% of deferrals

20% of deferrals

30% of deferrals

zero- Employers always have the option or whether or not to match, and what part of deferrals to match.

Elizabeth has one Roth IRA, which she started at age 50. She is now age 62 and wants to distribute $10,000 for retirement income. What is the tax consequence of her distribution?

A. All $10,000 is tax-free and there is no 10% penalty

B. Only the earnings portion is taxable and there is no 10% penalty

C. Only the earnings portion is taxable, and there is a 10% penalty

D. The full $10,000 is taxable and there is a 10% penalty

A. This is a qualified distribution. She has met both requirements: five-year holding period and after age 59 ½. The withdrawal is tax-free and there is no penalty.

A Roth IRA holder, aged 50, wishes to make a withdrawal from his account opened 3 years ago due to a recent disability. Which of the following statements is true?

A. The withdrawal will be subject to income taxes but no penalty.

B. Both taxes and penalties will be assessed on any withdrawals.

C. The withdrawal will be exempt from income taxes and penalties.

D. A penalty will be assessed on the withdrawal but there would be no tax liability incurred.

A/ Withdrawals before age 59.5 may be made penalty-free from a Roth IRA for various reasons. Eligible reasons include death of the account owner, disability, first time home purchase, qualified education expenses, as well as major medical expenses). Note that in this situation the earnings in the plan are subject to taxes unless the plan has been opened for at least five years.

All of the following statements about accumulation units are true EXCEPT

A. They represent an interest in the separate account of an insurer

B. They fluctuate in value relative to the performance of the investments in the general account

C. The number of accumulation units an investor owns can change

D. They are converted to annuity units when an investor begins to take income from an annuity

B. Accumulation units represent an ownership interest in the separate account, and fluctuate in value based on the performance of the underlying subaccounts. They are converted to annuity units when the annuity owner begins to take income, or annuitize, the contract.

What types of contributions may employers make to a 401(k)?

A. Matching only

B. Profit-sharing only

C. Defined benefit only

D. Matching or profit-sharing

D. Employers have the option of matching all or part of each employee's deferrals, in addition to any profit-sharing contributions they might make.

The dollar contribution limits in Roth IRAs are

A. The same as in Traditional IRAs

B. Higher than in Traditional IRAs

C. Lower than in Traditional IRAs

D. Unrelated to the limits in Traditional IRAs

A.

The dollar limits on annual contributions to Traditional and Roth IRAs are the same. This is true for both regular and catch-up contributions.

Helen opened a Roth IRA last year and wants to know what part of this year's contributions she can deduct. The answer is

She can deduct 100%

It depends on her income

It depends on her age

She can't deduct any amount

D. She can't deduct any amount

Roth contributions are always made with after-tax dollars and are never tax-deductible.

1035 Exchange

allows an investor to transfer from one variable annuity to another with no tax consequences. Note that surrender charges may still apply

Guaranteed Investment Contract

insurance contract that functions like a time deposit. An investor agrees to deposit cash with the insurance company for a fixed period and in return the insurance company provides them with a guaranteed rate of interest as well as the return of principalpal.

fixed annuity

contract between an individual and an insurance company that is used to supplement retirement savings and guarantees the owner a fixed rate of return for life

variable annuity

contract between an individual and insurance company that is used to supplement retirement savings and provide the owner with variable returns over their lifetime based on the market performance of the portfolio

vesting schedule

specifies when participants have ownership rights to employer contributions

non-qualified corporate retirement plan

does not meet ERISA guidelines and only has after-tax contributions

qualified corporate retirement plan

meets ERISA guidelines

pre-tax contributions (money is invested in plan before taxes are paid on those funds)

investments grow tax-deferred (not taxed each year)

A registered representative would be least likely to recommend a variable annuity to an individual who

A. is not covered by an employer retirement plan.

B. has reached their maximum contribution level in their other retirement plans.

C. is currently unemployed and is carrying significant monthly expenses.

D. is a college graduate with no student loan debt, and is currently employed

C. A variable annuity would not be suitable for an individual who has significant cash needs and in unable to set aside funds today for retirement.

Jack takes a $10,000 distribution from his 529 plan and uses none of the money for qualified educational expenses. $8,000 is basis and $2,000 is earnings. What penalty will he owe, in addition to regular income tax?

A. None

B. $200

C. $500

D. $800

B. He will owe a 10% penalty on the taxable portion of the distribution the $2,000 of earnings. 100% of earnings is taxable because he has no qualified educational expenses. The penalty is $200.

accumulation units

Accumulation units represent an ownership interest in the separate account, and fluctuate in value based on the performance of the underlying subaccounts. They are converted to annuity units when the annuity owner begins to take income, or annuitize, the contract.

separate account

Separate accounts are investment accounts used by insurance companies where the money from a variable annuity owner's premiums is invested to earn returns based on market performance.

The maximum amount of money that may be deposited each year into a Coverdell Education Savings Account is

$2,000 per beneficiary.

$6,000 per beneficiary.

$24,000 total for all Coverdell ESA’s owned by the individual
unlimited

$2000 per beneficiary

Coverdell Education Savings Account

funds used for qualified education expenses, contributions limited to $2000 per beneficiary per year and only for families below a certain income level

after-tax contributions

tax-free growth

What is the penalty for failure to take a Required Minimum Distribution (RMD) from a Traditional IRA?

A. Forfeiture of IRA earnings for one year

B. 2% of the IRA's value

C. 25% of the under-withdrawal amount
D. 50% of the under-withdrawal amount

C. Failure to take an RMD subjects the account owner or beneficiary to a 25% federal excise tax on the under-distribution amount.

In a 401(k), which amounts represent pre-tax money for the employee?

A. Employer contributions only

B. Elective deferrals only

C. Both employer contributions and elective deferrals

D. Neither employer contributions nor elective deferrals

c. All employer contributions and the participant's own elective deferrals are made with pre-tax money.

elective deferrals ( contributions through salary reduction)

Which withdrawals from a Traditional IRA are not fully taxable?

Those made after age 59½

Those taken for bona fide retirement income

Those representing a return of non-deductible (after-tax) contributions

Those representing a plan loan

C. Earnings accumulate in a Traditional IRA on a tax-deferred (post-tax) basis, and withdrawals are fully taxable, unless they represent a return of non-deductible contributions. Withdrawals made before age 59 ½ may be subject to an additional 10% penalty.

Alex has three Traditional IRAs. He is single and earns a salary of $90,000. He can contribute up to the annual dollar limit to

A. Each Traditional IRA

B. Any two Traditional IRAs

C. Only one Traditional IRA

D. All of his Traditional IRAs, in the aggregate

D. If an individual has several Traditional IRAs, the contribution limits apply to all, in the aggregate. Contributions may be made to any, as long as the total doesn't exceed the annual dollar limit.

Walter, age 40, wants to sell his home and buy a new one right away, using his Traditional IRA to make the down payment. As a homebuyer, can he qualify for an exception to the 10% penalty on Traditional IRA withdrawals before age 59 ½?

A. no he is too young

B. no he is not a first time home buyer

C. only if the new home costs more than his current home

D. Yes in any case

B. This exception is only available to a first-time homebuyer. The new home is considered a first home if neither the IRA owner nor a spouse had an interest in a main home in the two years before the home's purchase. He would have to wait at least two years between transactions to qualify.

Nonqualified withdrawals from Section 529 College Savings Plans are subject to which of the following?

A. Full federal and state income taxation on the entire amount of the distribution

B. Full federal and state income taxation on the entire amount of the distribution plus a 10% penalty tax

C. Full federal and state income taxation on the entire amount of the distribution that is attributable to earnings

D. Full federal and state income taxation on the entire amount of the distribution that is attributable to earnings, plus a 10% penalty tax on this amount

D. Nonqualified withdrawals from Section 529 College Savings Plans are subject to full federal and state income taxation on the entire amount of the distribution that is attributable to earnings, plus a 10% penalty tax on this amount. Because the contributions to these accounts are made with after tax dollars, only the earning are subject to taxation and the penalty.

Who is eligible to have an ABLE account?

A. Anyone under the age of 19

B. Anyone who was diagnosed with a disability prior to age 26

B. ABLE accounts are tax-advantaged savings account owned by and used for the benefit of persons diagnosed with a disability prior to age 26. Note that an individual does not need to be under the age of 26 to have an ABLE account, instead their disability must have been diagnosed prior to age 26.

non-deductible contributions

not taxable (tax-free)) no 10% penalty if 59 ½ +

Traditional IRA

Traditional IRA's allow for pre-tax contributions, tax-deferred earnings and growth, and distributions which are taxed as ordinary income.

Profit sharing

Employers may make profit-sharing contributions to 401(k) plans. Profit-sharing contributions are a percentage of compensation, for all eligible employees. They are determined on an annual basis and can be as low as zero for any given year.

A customer chooses to begin monthly income payments from a qualified annuity. The payments received will be

A. Fully taxable

B. Partially taxable

C. Tax deferred

D. Tax free

A. The purchase payments made into a qualified annuity have not been taxed. Both the portion of each payment that represents purchase payments and the amount that represents earnings will be taxed as ordinary income

Helen opened a Roth IRA last year and wants to know what part of this year's contributions she can deduct. The answer is

A. She can deduct 100%

B. It depends on her income

C. It depends on her age

D. She can't deduct any amount

D. Roth contributions are always made with after-tax dollars and are never tax-deductible.

A non-qualified variable annuity contract is one where an investor

A. Contributes pre-tax dollars and must pay tax on all subsequent distributions from the contract

B. Contributes after-tax dollars and must pay tax on all subsequent distributions from the contract

C. Contributes after-tax dollars and must pay tax on any growth on the invested funds

D. Contributes pre-tax dollars and must pay tax on any growth on the invested funds

C. A non-qualified variable annuity is funded with after-tax dollars and these contributions then grow on a tax-deferred basis. When an individual receives distributions from this annuity, they will be subject to regular taxation on any growth of the invested funds. In contrast, a qualified variable annuity is funded with pre-tax dollars, and all distributions from the contract are fully taxable to the investor.

An owner of a nonqualified variable annuity age 56, wishes to surrender her contract. Surrender charges no longer apply.
What are the tax consequences of cashing in the contract?

I. The 10% early withdrawal penalty applies
II. The 10% early withdrawal penalty does not apply because the contract is out of its surrender charge period
III. Gains in the contract are taxable as ordinary income
IV. Gains in the contract are taxable as capital gains

I & III:

I & IV:

II & III:

II & IV

I and III: A penalty of 10% applies on withdrawals prior to age 59 1/2 on top of the tax that applies to the contract gains. The gains in the contract are taxed as ordinary income.

If an individual makes pre-tax contributions to their Traditional IRA, it grows _______ and all distributions are fully taxed as________

tax-deferred___ ordinary income

If an individual makes after-tax contributions to their Traditional IRA, it grows _______ and only the ______ are taxable as ordinary income

tax-deferred earnings (growth)

Separate account:

If actively managed, it must be registered as a mutual fund under the Investment Company Act of 1940

It is mostly invested in variable products which are designed to offer growth to owners, equities such as common stock, mutual funds and equity ETF’s

Units in the account fluctuate in value based on the performance of the underlying assets

529 Plans College Savings Plan

used for qualified higher educational expense, the beneficiary does not need to be related to the owner of the account, and there are no age requirements for the beneficiary.

Diego is a single person, age 75, who has an income of $25,000 from Social Security, $15,000 from investment interest, and $3,000 from part-time work. What is the maximum contribution he can make to a Roth IRA?

Zero

$3,000

$5,500

$5,500 plus catch-up

$3000- Contributions can be made to Roth IRAs at any age, provided the worker has compensation that does not exceed the MAGI threshold. The contribution is limited to 100% of compensation from active work ? not passive sources such as Social Security or investments.

Tim is a single person covered by a retirement plan at work. He is told by his accountant that only part of his Traditional IRA contribution is deductible this year. Why is this true?

A. His income level falls in a particular range

B. He contributed more than the maximum allowed

C. His IRA is over-funded

D. He did not earn enough taxable income

A. For those covered by a retirement plan at work, their income level determines whether a Traditional IRA contribution is fully deductible, partially deductible or non-deductible. If their income level falls in a certain range, the contribution is partially deductible.

Judy started a 529 plan for her daughter three years ago. If she earns $2,000 on its investments this year, how is this amount treated for income tax purposes now, assuming she does not plan to start taking distributions for college expenses for several more years?

A. It is currently taxable as ordinary income

B. It is currently taxable as capital gains

C. It is always tax-free

D. It is tax-deferred until distribution

D. Investment earnings accumulate on a tax-deferred basis in 529 plans. There is no IRS reporting until distributions are made. Then, distributions used for qualified education expenses are tax-free.

Which of the following may be suitable for an investor who wants guaranteed income for life that begins 10 years from now and continues for life?

A. An immediate life only annuity

B. An immediate annuity with 10 year period certain

C. A deferred life only annuity

D. A deferred annuity with a 10 year period certain

C. In a deferred annuity, payments begin in the future. They will last for the life of the annuitant only if a life only option is selected.

What type of money is contributed to a 529 plan, for federal income tax purposes?

A. Pre-tax

B. Post-tax

C. It depends on state of residence

B. All money contributed to a 529 plan is post-tax for federal purposes. However, some states offer income tax deductions, for state income tax purposes.

All of the following statements about annuity units are true EXCEPT

A. They represent an interest in the separate account of an insurer

B. They fluctuate in value relative to the performance of the investments in the separate account

C. The number of annuity units an investor owns can increase

D.The value of the annuity units can impact the amount of income received by a annuitant

C. Annuity units are associated with the payout phase of a variable annuity contract. At that time the number of annuity units are fixed, and are then liquidated to provide monthly income that is guaranteed for life. The value of annuity units fluctuates based on the performance of the separate account.

Which of the following account titles would a married couple have for titling their Traditional IRA brokerage account(s)?

A) One joint account held for both spouses, JTWROS

B) One trust account held for both spouses in joint name

C) One joint account held for both spouses, community property

D) Two accounts in their individual name

D) All IRA accounts are in individual name ? not joint name. Each account holder may name his/her beneficiary and change the beneficiary at any time

For purposes of calculating the Required Minimum Distribution (RMD) from a Traditional IRA, which life expectancy factors are used?

A. Social Security's Period Life Table

B. The life insurance industry's standard mortality table

C. IRS tables

C. IRS tables- The denominator of the RMD calculation is a life expectancy factor taken from a set of three IRS tables. Most IRA owners use the IRS's Single Life Expectancy Table

Samantha, age 81, is required to take a $12,000 RMD from her Traditional IRA. However, she makes a mistake and only distributes $8,000. Does she owe an excise tax?

A. No, because she withdrew more than half of the required amount

B. Not if the mistake is inadvertent

C. Yes, she owes $1,000

D. She owes $400

C. Failure to take an RMD subjects the account owner or beneficiary to a 25% federal excise tax on the under-distribution amount. In this case, the under-distribution is $4,000 and the tax is $1,000.