Chapter 6 Practice Question Answers
- 1. Answer: A. With fixed annuities, contributions are deposited into the insurance company’s general account and managed by the insurance company. The insurance guarantees the payments and, therefore, is responsible for the risk. In contrast, variable annuities utilize separate accounts. Additionally, because insurance companies guarantee a rate of return on fixed annuities, they are not securities. Finally, since the insurance company is responsible for investing a fixed annuitant’s money as it sees fit, the insurance company takes on all investment risk.
- 2. Answer: C. With the last in, first out method, the IRS taxes the deferred tax dollars as early as possible. Since Mary contributed $50,000 to the account and it now has a total of $75,000, the account must have $25,000 in earnings. That $25,000 is taxed at her ordinary income rate. The remaining dollars have already been taxed.
- 3. Answer: D. An investor in a variable annuity invests his money into separate accounts; the performance of those accounts is not guaranteed by the insurance company. Because this mode of investing brings about higher risk and more diversity between several accounts, it’s more likely that a variable annuity investor—rather than a fixed annuity investor, who is guaranteed a standard rate of return and regular payments—will see increased earnings. Additionally, since variable annuities offer the potential for increased gains that can outpace inflation, they are less subject to purchasing power, or inflation risk, than fixed annuities.
- 4. Answer: A. The assumed interest rate is an expected rate that the annuitant and insurance company agree the annuity will grow at annually. This expected rate is not an actual rate but simply an “assumed” rate. The insurance company uses the AIR as a benchmark to help determine the monthly annuity payments to investors.
- 5. Answer: D. If the separate account’s rate of return i