DC Variable Products in Insurance 2 — Questions and Answers
Question 1: Which of the following is a key tax advantage of a variable annuity held in a non-qualified account?
- Premiums are tax-deductible
- Investment earnings grow tax-deferred until withdrawal (Correct answer)
- All withdrawals are tax-free at any age
- The death benefit is always income-tax-free to beneficiaries
Correct answer: Investment earnings grow tax-deferred until withdrawal
Variable annuity earnings accumulate on a tax-deferred basis in non-qualified accounts—taxes are owed only when funds are distributed.
In a non-qualified variable annuity, premiums are paid with after-tax dollars, but earnings compound tax-deferred. Taxes are paid on the earnings portion at distribution as ordinary income. This is the primary tax benefit; unlike IRAs, there is no deduction for contributions. Qualified variable annuities (inside IRAs) also grow tax-deferred.
Question 2: What is a 'surrender charge' in a DC variable annuity?
- A fee charged by DISB for approving the variable annuity contract
- A penalty imposed by the insurer for withdrawals made during the surrender charge period, usually declining over time (Correct answer)
- A fee for switching between subaccounts
- A charge to convert a variable annuity to a fixed annuity
Correct answer: A penalty imposed by the insurer for withdrawals made during the surrender charge period, usually declining over time
A surrender charge is a back-end fee imposed by the insurer for early withdrawals during the surrender period, designed to recoup distribution costs.
Variable annuity surrender charges typically start at 7–10% in the first year and decrease by about 1% per year until they reach zero (e.g., a 7-year surrender period). They compensate the insurer for upfront distribution costs. DC producers must disclose surrender charges to clients as part of the suitability analysis.
Question 3: Under DC insurance law, what is the '10% free withdrawal' provision commonly found in variable annuity contracts?
- Allows the policyholder to withdraw 10% of the account value annually without a surrender charge (Correct answer)
- Requires the insurer to refund 10% of premiums paid upon cancellation
- Allows tax-free withdrawals of up to 10% per year
- Limits total withdrawals to 10% of the original premium
Correct answer: Allows the policyholder to withdraw 10% of the account value annually without a surrender charge
Most variable annuities allow policyholders to withdraw up to 10% of the account value annually without incurring the surrender charge.
The 10% free withdrawal provision gives policyholders some liquidity despite surrender charges. Each contract year, the policyholder may withdraw up to 10% (sometimes of accumulated value, sometimes of premiums paid) without triggering the surrender charge. This is an important suitability and disclosure point.
Question 4: Which of the following describes a 'guaranteed minimum death benefit' (GMDB) in a variable annuity?
- Guarantees the policy will pay the full premium back to the beneficiary, even if the account value is lower due to market losses (Correct answer)
- Guarantees the account value will never decrease
- Ensures the insurer pays a premium refund only if the annuitant lives past age 90
- Provides a guaranteed income stream regardless of account value
Correct answer: Guarantees the policy will pay the full premium back to the beneficiary, even if the account value is lower due to market losses
A GMDB ensures that beneficiaries receive at least the total premiums paid (or a stepped-up value) as a death benefit, even if market losses have reduced the account value below that amount.
The standard GMDB in variable annuities guarantees beneficiaries receive the greater of the current account value or the total premiums paid (return of premium GMDB). Enhanced GMDBs may step up the guaranteed amount to the highest annual anniversary value. This feature is a key selling point for DC clients concerned about market risk.
Question 5: In DC, an immediate variable annuity differs from a deferred variable annuity in which key way?
- Immediate variable annuities are free of surrender charges, while deferred variable annuities always have surrender charges
- Immediate variable annuities begin income payments within one year of purchase; deferred variable annuities accumulate value before annuitization (Correct answer)
- Deferred variable annuities require securities licensing; immediate variable annuities do not
- Immediate variable annuities are only available for qualified retirement accounts
Correct answer: Immediate variable annuities begin income payments within one year of purchase; deferred variable annuities accumulate value before annuitization
An immediate variable annuity (SPIA variant) converts a lump sum into variable income payments starting within one year. A deferred annuity accumulates value over an accumulation phase before annuitization.
An immediate annuity is purchased with a single premium and begins paying variable income within 12 months. A deferred variable annuity has an accumulation phase (subaccount growth, contributions) followed by an optional annuitization phase. DC producers must understand this distinction for client suitability purposes.
Question 6: Under FINRA Regulation Best Interest (Reg BI), how must DC producers approach variable annuity recommendations?
- Recommendations must be based solely on the highest commission product
- Recommendations must be in the best interest of the customer, placing the customer's interests above the producer's financial interests (Correct answer)
- Reg BI does not apply to insurance products in DC
- Producers must obtain prior DISB approval for each variable annuity recommendation
Correct answer: Recommendations must be in the best interest of the customer, placing the customer's interests above the producer's financial interests
FINRA Regulation Best Interest (Reg BI) requires broker-dealers and their registered representatives to act in the retail customer's best interest when making securities recommendations, including variable annuities.
Effective June 30, 2020, SEC's Regulation Best Interest requires broker-dealers to act in the best interest of retail customers when recommending securities, including variable annuities. This is a higher standard than mere suitability. DC variable annuity producers must document why the recommendation is in the client's best interest, considering costs and alternatives.
DC Variable Products in Insurance 2
Which of the following is a key tax advantage of a variable annuity held in a non-qualified account?