CLU Annuities and Retirement Planning 1 — Questions and Answers
Question 1: What is the primary purpose of an annuity in the context of retirement planning?
- To provide a lump-sum death benefit to heirs
- To convert accumulated assets into a guaranteed stream of income (Correct answer)
- To fund a life insurance policy on a tax-deferred basis
- To maximize short-term investment returns
Correct answer: To convert accumulated assets into a guaranteed stream of income
An annuity's core function is to liquidate a principal sum into periodic income payments, providing protection against outliving one's assets (longevity risk).
Question 2: Which phase of an annuity contract is characterized by the owner making premium payments and the contract value growing tax-deferred?
- Annuitization phase
- Distribution phase
- Accumulation phase (Correct answer)
- Surrender phase
Correct answer: Accumulation phase
During the accumulation phase, the contract owner pays premiums and the account value grows on a tax-deferred basis until the annuity is annuitized or surrendered.
Question 3: Under the annuity exclusion ratio, what portion of each annuity payment received is excludable from gross income?
- The entire payment until the investment in the contract is recovered
- A proportionate amount representing the after-tax investment in the contract (Correct answer)
- Only the gain portion of each payment
- None — all annuity payments are fully taxable
Correct answer: A proportionate amount representing the after-tax investment in the contract
The exclusion ratio (investment in contract ÷ expected return) determines the nontaxable portion of each payment, representing the pro-rata recovery of the owner's after-tax cost basis.
Question 4: What is a 'straight life annuity' payout option?
- Payments for a guaranteed period regardless of survival
- Payments for the annuitant's lifetime with no refund at death (Correct answer)
- Payments to the annuitant and then to a named survivor
- Payments that adjust annually for inflation
Correct answer: Payments for the annuitant's lifetime with no refund at death
A straight life (life-only) annuity pays income for the annuitant's entire lifetime but ceases at death with no remaining benefit to heirs, providing the highest per-payment amount.
Question 5: How are withdrawals from a nonqualified deferred annuity taxed prior to annuitization?
- First-in, first-out (FIFO) — cost basis withdrawn first, then gain
- Last-in, first-out (LIFO) — gain withdrawn first, then cost basis (Correct answer)
- Ratably between gain and basis on each withdrawal
- Always as return of capital only
Correct answer: Last-in, first-out (LIFO) — gain withdrawn first, then cost basis
Under IRC Section 72(e), pre-annuitization withdrawals from nonqualified deferred annuities are taxed LIFO — gain is deemed distributed first, making withdrawals fully taxable until all gain is exhausted.
Question 6: Which annuity type credits interest based on the performance of an external market index while protecting against negative index returns?
- Variable annuity
- Fixed annuity
- Fixed indexed annuity (Correct answer)
- Immediate annuity
Correct answer: Fixed indexed annuity
A fixed indexed annuity (FIA) links interest crediting to an external index like the S&P 500 but includes a floor (usually 0%) that prevents negative returns, offering upside potential with downside protection.
CLU Annuities and Retirement Planning 1
What is the primary purpose of an annuity in the context of retirement planning?