FINRA Investment Companies and Variable Products 2 — Questions and Answers
Question 1: An investor holding accumulation units in a variable annuity's separate account has:
- A guaranteed minimum return on their investment
- A proportional interest in the separate account whose value fluctuates with investment performance (Correct answer)
- A fixed monthly income that cannot change in amount
- A direct claim against the insurance company's general account
Correct answer: A proportional interest in the separate account whose value fluctuates with investment performance
Accumulation units represent the investor's proportional ownership in the separate account, and their value changes daily based on the performance of the selected subaccounts.
Question 2: Withdrawals from a non-qualified variable annuity taken before age 59½ are generally subject to:
- Only ordinary income tax on all amounts withdrawn
- Ordinary income tax on earnings plus a 10% IRS early withdrawal penalty on the taxable portion (Correct answer)
- A flat 20% withholding tax on the entire withdrawal amount
- No tax consequences if the contract has been held for more than five years
Correct answer: Ordinary income tax on earnings plus a 10% IRS early withdrawal penalty on the taxable portion
Withdrawals of earnings from a non-qualified variable annuity before age 59½ are taxed as ordinary income and subject to a 10% IRS penalty tax, similar to other tax-deferred accounts.
Question 3: Under SEC Rule 12b-1, a mutual fund is permitted to use fund assets to pay for:
- Portfolio management and advisory fees
- Distribution and marketing expenses including sales commissions (Correct answer)
- Custodian and safekeeping fees
- Transfer agent recordkeeping costs
Correct answer: Distribution and marketing expenses including sales commissions
Rule 12b-1 specifically authorizes mutual funds to use fund assets to pay for distribution-related costs, such as advertising, marketing materials, and dealer commissions.
Question 4: How do exchange-traded funds (ETFs) primarily differ from traditional open-end mutual funds?
- ETFs can only invest in domestic equity securities
- ETFs trade on stock exchanges throughout the day at market-determined prices (Correct answer)
- ETFs have higher minimum initial investment requirements than mutual funds
- ETFs are exempt from SEC registration and reporting requirements
Correct answer: ETFs trade on stock exchanges throughout the day at market-determined prices
Unlike mutual funds that price once daily at NAV after market close, ETFs trade continuously on exchanges at prices set by supply and demand throughout the trading session.
Question 5: During the payout (annuitization) phase of a variable annuity, which of the following statements is correct?
- The number of annuity units received increases each year to offset inflation
- The number of annuity units is fixed, but the dollar value of each payment fluctuates (Correct answer)
- The annuitant receives a guaranteed fixed dollar payment for life
- The insurance company's general account bears all investment risk during payout
Correct answer: The number of annuity units is fixed, but the dollar value of each payment fluctuates
Once annuitized, the number of annuity units paid each period is fixed; however, the dollar amount varies based on subaccount performance relative to the assumed interest rate (AIR).
Question 6: Which mutual fund share class typically carries the highest total annual expense ratio due to level ongoing 12b-1 fees that never convert to a lower-cost class?
- Class A shares
- Class B shares
- Class C shares (Correct answer)
- Institutional shares
Correct answer: Class C shares
Class C shares charge level 12b-1 fees (often 1% annually) indefinitely without converting to Class A shares, making them the most expensive over long holding periods.
Question 7: Under FINRA Rule 2341, what is the maximum 12b-1 fee a fund may charge annually and still be marketed as a 'no-load' fund?
- 0.10% of average net assets
- 0.25% of average net assets (Correct answer)
- 0.75% of average net assets
- 1.00% of average net assets
Correct answer: 0.25% of average net assets
FINRA Rule 2341 provides that a fund may call itself 'no-load' only if its 12b-1 service/distribution fee does not exceed 0.25% of average net assets annually.
FINRA Investment Companies and Variable Products 2
An investor holding accumulation units in a variable annuity's separate account has: