CAS CAS Annuity Distribution and Payout Strategies 2 — Questions and Answers
Question 1: A 1035 exchange allows an annuity owner to:
- Convert a variable annuity to a fixed annuity for free
- Transfer the cash value of one annuity to another annuity tax-free (Correct answer)
- Roll over an annuity into an IRA without tax consequences
- Exchange annuity payments for a lump-sum settlement tax-free
Correct answer: Transfer the cash value of one annuity to another annuity tax-free
Under IRC Section 1035, an annuity owner can transfer the value from one annuity contract to another annuity on a tax-free basis, allowing repositioning without triggering immediate income tax on accumulated gains.
Question 2: What is 'annuitization' in the context of annuity contracts?
- Making additional premium deposits to the annuity
- Converting the contract's accumulated value into a stream of periodic income payments (Correct answer)
- Switching from one sub-account to another inside a variable annuity
- Adding a rider to guarantee lifetime income
Correct answer: Converting the contract's accumulated value into a stream of periodic income payments
Annuitization is the process of converting a deferred annuity's accumulated value into a series of regular income payments, based on the payout option selected, which may last for a lifetime or a defined period.
Question 3: The 'Last In, First Out' (LIFO) tax treatment for non-qualified annuity withdrawals means:
- The last premium paid is returned first, tax-free
- Withdrawals are considered to come from earnings first and are fully taxable until all gain is depleted (Correct answer)
- Only the most recent contributions are subject to the 10% early withdrawal penalty
- Interest earned is distributed last and therefore taxed last
Correct answer: Withdrawals are considered to come from earnings first and are fully taxable until all gain is depleted
Under LIFO rules, withdrawals from a non-qualified deferred annuity are treated as coming from earnings (gain) first, making them fully taxable as ordinary income until the entire gain is withdrawn before basis is returned.
Question 4: What is the federal income tax penalty for withdrawing from a non-qualified annuity before age 59½?
- 5% penalty on the total withdrawal amount
- 10% penalty on the taxable (gain) portion of the withdrawal (Correct answer)
- 15% penalty on all accumulated earnings
- 20% mandatory withholding on the entire withdrawal
Correct answer: 10% penalty on the taxable (gain) portion of the withdrawal
Withdrawals from a non-qualified annuity before age 59½ are subject to a 10% federal tax penalty on the taxable (earnings) portion of the withdrawal, in addition to ordinary income tax on that amount.
Question 5: When a deferred annuity owner dies before annuitization, the 'five-year rule' for non-spouse beneficiaries requires that:
- Payments must begin within five years but can last a lifetime
- The entire death benefit must be distributed within five years of the owner's death (Correct answer)
- The beneficiary must wait five years before accessing funds
- Surrender charges are waived after five years
Correct answer: The entire death benefit must be distributed within five years of the owner's death
Under the five-year rule, a non-spouse beneficiary of a non-qualified deferred annuity must take the entire death benefit distribution within five years of the original owner's death.
Question 6: Which strategy involves purchasing an immediate annuity with a portion of retirement savings to cover essential expenses while investing the rest?
- Laddering strategy
- Income flooring strategy (Correct answer)
- Systematic withdrawal plan
- Bucket strategy
Correct answer: Income flooring strategy
An income flooring strategy uses an immediate annuity to cover essential, non-discretionary expenses (the 'floor'), while the remaining assets are invested for growth and discretionary spending.
CAS CAS Annuity Distribution and Payout Strategies 2
A 1035 exchange allows an annuity owner to: