EXAMFX Annuity Concepts and Uses 3 — Questions and Answers
Question 1: Under IRC Section 72, the exclusion ratio applied to annuity payments determines:
- The maximum annual contribution allowed
- What portion of each payment represents a tax-free return of cost basis (Correct answer)
- The penalty for early withdrawal
- The maximum death benefit payable
Correct answer: What portion of each payment represents a tax-free return of cost basis
The exclusion ratio divides the investment in the contract by the expected return, identifying the non-taxable portion of each payment.
Question 2: Which type of annuity is most appropriate for a retiree who wants guaranteed income but is concerned about outliving savings?
- Single-premium deferred annuity
- Immediate life annuity (Correct answer)
- Flexible-premium deferred annuity
- Modified endowment contract
Correct answer: Immediate life annuity
An immediate life annuity begins income right away and continues for the annuitant's lifetime, directly addressing longevity risk.
Question 3: The 'free look' provision in an annuity contract allows the buyer to:
- Surrender the contract for a full refund within a specified period after delivery (Correct answer)
- Transfer funds between subaccounts without charge
- Skip premium payments during financial hardship
- Name multiple annuitants on one contract
Correct answer: Surrender the contract for a full refund within a specified period after delivery
The free-look period, typically 10–30 days, lets the buyer cancel the contract and receive a full refund if not satisfied.
Question 4: When a non-qualified annuity is surrendered before age 59½ and the owner receives a taxable gain, the IRS imposes a:
- 10% premature distribution penalty in addition to ordinary income tax (Correct answer)
- 20% flat withholding tax only
- 5% excise tax on the entire account value
- No penalty if the policy has been held more than three years
Correct answer: 10% premature distribution penalty in addition to ordinary income tax
Taxable distributions from non-qualified annuities before age 59½ are subject to a 10% early withdrawal penalty plus ordinary income tax on the gain.
Question 5: A joint and 100% survivor annuity option means:
- Payments are reduced by 50% after the first annuitant dies
- The full payment amount continues to the surviving annuitant for life (Correct answer)
- Income stops upon the death of either annuitant
- Payments are paid to a trust for 100 years
Correct answer: The full payment amount continues to the surviving annuitant for life
With 100% joint and survivor, the surviving annuitant receives the same payment amount that was being paid when both were living.
Question 6: An annuity owner changes the contract's beneficiary. Who must approve this change?
- The current beneficiary
- The annuitant if different from the owner
- The owner alone, provided no irrevocable beneficiary is designated (Correct answer)
- The state insurance department
Correct answer: The owner alone, provided no irrevocable beneficiary is designated
The owner controls beneficiary designations; no approval is needed unless an irrevocable beneficiary was previously named.
Question 7: Which feature distinguishes a variable annuity from a fixed annuity?
- Variable annuities are not regulated by the SEC
- The accumulation value in a variable annuity fluctuates based on subaccount performance (Correct answer)
- Variable annuities never have surrender charges
- Variable annuities always guarantee a minimum interest rate
Correct answer: The accumulation value in a variable annuity fluctuates based on subaccount performance
Variable annuity values depend on the performance of chosen subaccounts, meaning the account value can rise or fall.
EXAMFX Annuity Concepts and Uses 3
Under IRC Section 72, the exclusion ratio applied to annuity payments determines: