RAA Advanced Professional Practice 3 — Questions and Answers
Question 1: A client owns a non-qualified annuity and takes a partial withdrawal. How is the withdrawal taxed under LIFO rules?
- Return of principal first, then earnings
- Earnings first, then return of principal (Correct answer)
- Pro-rata allocation between earnings and principal
- No tax until full surrender
Correct answer: Earnings first, then return of principal
Non-qualified annuity withdrawals are taxed under LIFO (last in, first out), meaning earnings come out first and are fully taxable as ordinary income before principal is returned.
Question 2: Which of the following best describes the 'best interest' standard under the SEC's Regulation Best Interest (Reg BI) as it applies to variable annuity recommendations?
- Producers must recommend the cheapest available product
- Recommendations must be in the client's best interest, considering costs, risks, and alternatives (Correct answer)
- Any licensed producer may recommend any annuity product
- Suitability is determined solely by the client's stated risk tolerance
Correct answer: Recommendations must be in the client's best interest, considering costs, risks, and alternatives
Reg BI requires broker-dealers to act in the retail customer's best interest, weighing product costs, risks, rewards, and reasonably available alternatives before recommending a variable annuity.
Question 3: A client dies during the accumulation phase of a deferred annuity. The named beneficiary is the client's spouse. What is the most favorable tax treatment available?
- Spousal continuation of the contract (Correct answer)
- Lump-sum distribution subject to ordinary income tax
- 5-year rule distribution
- Annuitization over the spouse's lifetime
Correct answer: Spousal continuation of the contract
A surviving spouse beneficiary may elect spousal continuation, assuming ownership of the contract and maintaining tax deferral as if they were the original owner.
Question 4: Which strategy uses an annuity inside an irrevocable trust to fund a charitable gift while providing the grantor an income stream?
- Charitable remainder annuity trust (CRAT) (Correct answer)
- Grantor retained annuity trust (GRAT)
- Qualified personal residence trust (QPRT)
- Intentionally defective grantor trust (IDGT)
Correct answer: Charitable remainder annuity trust (CRAT)
A CRAT pays a fixed annuity to the income beneficiary for life or a term, with the remainder passing to charity, providing a charitable deduction and income stream.
Question 5: A producer sells an annuity and fails to disclose a material surrender charge. Under most state insurance regulations, this omission could result in:
- A higher commission on the next sale
- License suspension, fines, and possible rescission of the contract (Correct answer)
- A mandatory continuing education requirement only
- No penalty if the client signed the application
Correct answer: License suspension, fines, and possible rescission of the contract
Failure to disclose material contract terms such as surrender charges constitutes a deceptive trade practice, exposing the producer to license suspension, regulatory fines, and contract rescission.
Question 6: In the context of annuity suitability, 'accumulation value' refers to:
- The death benefit paid to beneficiaries
- The total premiums paid minus withdrawals
- The policy's current contract value before any surrender charges (Correct answer)
- The guaranteed minimum income benefit base
Correct answer: The policy's current contract value before any surrender charges
Accumulation value (or account value) is the current dollar value of the annuity contract before deducting any applicable surrender charges.
Question 7: A client converts a deferred annuity into a stream of payments. This process is called:
- Annuitization (Correct answer)
- Surrender
- 1035 exchange
- Laddering
Correct answer: Annuitization
Annuitization is the process of converting an annuity's accumulated value into a series of periodic income payments according to a chosen payout option.
RAA Advanced Professional Practice 3
A client owns a non-qualified annuity and takes a partial withdrawal.
How is the withdrawal taxed under LIFO rules?