Case Analysis & Practical Application Flashcards

A self-employed client, age 52, contributes to a SEP-IRA and now wants to add annuity coverage. He invests $80,000 in a fixed annuity inside the SEP-IRA. How are his future distributions taxed?

Answer: Entirely as ordinary income because contributions were pre-tax

Distributions from a qualified annuity inside a SEP-IRA are fully taxable as ordinary income because all contributions were made with pre-tax dollars and no cost basis was established.

A prospect is comparing a 5% fixed annuity to a bank CD also yielding 5%. What is the most significant advantage the fixed annuity holds for a high-income investor?

Answer: Annuity interest compounds tax-deferred while CD interest is taxed annually

Tax deferral on annuity earnings means the full 5% compounds without annual tax drag, producing a higher after-tax accumulation than a CD taxed each year.

A client has $1.2 million in a variable annuity purchased 20 years ago for $400,000. She dies before annuitizing. Her daughter is the beneficiary. What is the tax consequence to the daughter?

Answer: The $800,000 gain is taxable as ordinary income to the daughter

Non-qualified annuity death benefits do not receive a stepped-up basis; the $800,000 of deferred gains is taxable as ordinary income to the beneficiary.

A 60-year-old client is in poor health and expects to live no more than 5 years. He wants maximum income now. Which SPIA payout option produces the highest monthly payment for him?

Answer: Life only

Life-only provides the highest monthly payout because the insurer retains all remaining value at death, with no period-certain or refund provision reducing the payment.

An advisor is documenting suitability for a $250,000 fixed indexed annuity recommendation. Which client characteristic most strongly supports the suitability of this product?

Answer: The client is 58, has a 10+ year time horizon, and prioritizes principal protection with upside potential

A 58-year-old with a long horizon who values downside protection and some index participation matches the core design of a fixed indexed annuity.

A variable annuity subaccount lost 30% last year. The contract has an annual reset death benefit guarantee equal to the highest anniversary value. The current contract value is $140,000 and the highest prior anniversary value was $200,000. What death benefit will the insurer pay if the owner dies now?

Answer: $200,000

The annual reset (ratchet) death benefit locks in the highest anniversary value, so the insurer must pay $200,000 even though the current contract value is only $140,000.

A client converts a $500,000 non-qualified annuity with a $200,000 cost basis into lifetime income payments using an exclusion ratio. What portion of each payment is tax-free?

Answer: 40% (cost basis divided by expected return)

The exclusion ratio is cost basis divided by expected return ($200K ÷ $500K = 40%), so 40% of each payment is a tax-free return of basis and 60% is ordinary income.