Chaper 3 -- Analyzing Suitability

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1 Chaper 3 -- Analyzing Suitability Multiple Choice Identify the choice that best completes the statement or answers the question. When you have answered all of the questions, click the Check Your Work button to review the correct responses. When you finish,use the Back button on your browser to return to the study text.. 1. The difference between accumulating capital using an equity indexed annuity versus a variable annuity invested in an indexed subaccount is: a. the indexed subaccount may go down in value, the equity indexed annuity will not b. the investor in the indexed subaccount is credited with full market movements, the equity indexed annuity is not c. the indexed subaccount will receive dividend income from its passively managed portfolio, the equity indexed annuity will not are true 2. Which of the following risks is a possible reason that fixed deferred annuities will not fulfill a client s objective of conservation of principal? a. interest rate risk b. legislative risk c. credit risk d. market risk 3. What is the greatest risk facing investors who seek conservation of principal? a. tax risk b. purchasing power risk c. interest rate risk d. opportunity risk 4. Which of the following investment factors prompted tightening of state laws on annuity disclosures and suitablity analysis? a. tax deferral b. liquidity c. creditor protection d. estate planning 5. Which of the following affect the liquidity of an investment in annuities a. surrender charges b. up front sales charges c. contract charges 6. To determine whether the tax deferral offered by annuity contracts provides a greater benefit to an investor than a comparable taxable investment depends on: a. the investor s current tax rate b. the investor s tax rate at the time of withdrawal c. the length of the investment period 7. Which of the following factors has an impact on an investor s investment horizon?

2 a. tax penalties for premature withdrawals b. financial needs c. surrender charges 8. In Florida, which of the following are protected from claims of the client s creditors? a. investments held by the client s IRA b. death benefits paid by the client s annuity or life insurance to the client s beneficiaries c. the principal balance in the client s deferred variable annuity 9. The basic net worth equation is: a. assets minus debts b. income minus expenses c. assets minus expenses d. income minus debts 10. Before recommending an annuity to a client, an advisor should consider the client s existing: a. annuity holdings b. financial needs c. income and expenses 11. An advisor should consider all of the following when proposing an exchange of annuity contracts EXCEPT: a. the new surrender period b. fees and charges on the old and new contracts c. commission payout on the new contract d. investment options, if a variable annuity is proposed 12. All of the following could negatively affect a client who exchanges an annuity contract for another EXCEPT: a. loss of grandfathered rights b. income taxes owed on the exchange c. extended surrender period d. higher fees and charges 13. When compared with an investment in a corporate bond of comparable quality, which of the following is true of a fixed deferred annuity? a. the fixed annuity will offer a higher rate of return than the bond b. the fixed annuity offers the investor a possibility of gain if interest rates fall c. the investor will be guaranteed return of total investment if interest rates rise d. the fixed annuity may be subject to penalties due to premature withdrawal 14. An elderly client is concerned with his Social Security benefits being taxed. Which of the following sources of income are included in determining the taxability of those benefits? a. interest earned on corporate bonds b. deferred income earned on fixed annuities c. both a and b d. neither a nor b 15. Which of the following investments will NOT benefit from dividend payments paid on S&P 500 stocks? a. a variable annuity invested in an indexed subaccount based on the S&P 500 index b. an indexed mutual fund based on the S&P 500 index c. SPDR shares, an exchange traded fund based on the S&P 500 index d. an equity indexed annuity based on the S&P 500 index

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4 Chaper 3 -- Analyzing Suitability Answer Section MULTIPLE CHOICE -- pager references to Safeguarding3web.pdf 1. ANS: D page 3 All of these are critical distinctions between indexed annuities and variable annuities invested in indexed subaccounts ( indexed fund or exchange-traded index shares) 2. ANS: C page 2 Fixed deferred annuities, with their guarantee of principal and guaranteed rates of return, are ideal investments for investors seeking conservation of principal. They are not subject to interest rate risk or market risk, and legislative risk is minimal. The primary risk for fixed annuity investors is that the insurer backing the contract may become insolvent (and that risk, historically, is small). 3. ANS: B page 2 In order to truly conserve one s wealth, one s investments must keep pace with inflation. 4. ANS: B page 2 The illiquidity of many annuity contracts, especially as it affects elderly clients, motivated teh legislature to tighten state laws on determining suitability of sales of these contracts. 5. ANS: A page 2 Lengthy surrender charges lock investors into annuity contracts. The other charges may have negative impacts on the investors, but they do not affect the ability of the investor to access hiw or her capital. 6. ANS: D page 2 Tax deferral is of more benefit to clients in higher current tax bracket. It is also of more benefit if the investor projects taking distributions from the annuity when the investor s tax bracket is lower. Tax deferral allows for triple compounding (earnings on initial principal, earnings on past earnings, and earnings on monies that would have been paid in taxes) -- and that benefits the investor the longer that compounding occurs. Another factor that needs to be considered, is the tax treatment of the taxable investment alternative. Perhaps paying taxes at a lower capital gains rate would offset the effects of triple compounding that is eventually taxed at ordinary income. 7. ANS: B page 2 The primary factors in setting an investor s investment horizon is the investor s age and the investor s financial needs. Factors such as tax penalties and surrender charges may affect whether an annuity is a suitable investment for an investor given the investors investment horizon, but they are not factors in setting that horizon. 8. ANS: D page 2 Florida law is rather generous in protecting clients from their creditors claims. The clients creditors cannot collect assets held in retirement accounts, cash values of life insurance or annuity contracts, and death benefits paid to the client s beneficiaries. Creditors of the beneficiaries cannot attach the death benefits as long as the insurance or annuity company holds the funds. 9. ANS: A page 1

5 Net worth is found by subtracting debts (liabilities) from assets. 10. ANS: D page 1 Advisors should consider all of their clients existing financial needs, investment objectives, financial situation (income, expenses, assets and liabilities), and current holdings, including annuity contracts. 11. ANS: C page 3 Recommendations should be based on the best interests of the client, not the salesperson. 12. ANS: B page 3 An exchange of contracts can negatively impact a client in many ways -- but Section 1035 allows for exchanges tax-free. 13. ANS: D page 3 The rates of return on medium term corporate bonds and newly-issued fixed annuities will be comparable. The bond s value will increase if interest rates fall; the fixed annuity s value will not. The fixed annuity will not fall in value due to interest rate increases, i.e., the principal value of the annuity is guaranteed, the bond s market value is not -- but the investor may not be able to recoup her entire investment due to surrender charges or tax penalties on premature withdrawals. 14. ANS: A page 3 The deferred income earned from annuities is not included in the calculation of taxes on Social Security benefits, or in the calculation of the Alternative Minimum Tax. Interest earned from corporate bonds, CDs, and savings accounts is. 15. ANS: D page 3 Indexed mutual funds, exchange traded funds, and indexed variable annuity subaccounts all invest in the index s component common stocks -- and will receive dividends paid on those stocks. Equity indexed annuities are backed by indexed option contracts, not the actual stocks, and therefore only participate in the changing value of the index, not in dividend payments from the component stocks.

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