Annuities for the California life exam

Eight Life-exam questions cover annuities: how they work, the parties, payout options, suitability, and California's training and senior rules.

Questions and answers, explained

All 12 questions above, with the correct answer and why it is correct. Everything here is on annuities for the california life exam.

1. A 72-year-old buys a variable annuity in California and gives no investment direction. During the 30-day cancellation period, where may the premium be invested under Insurance Code section 10127.10?

   • AIt may not be invested; it must sit in cash
   • BOnly in the insurer's general account at a guaranteed 10 percent
   • CIn any of the underlying stock funds, chosen by the agent to maximize growth during the period
   • DOnly in fixed-income investments and money-market fundsCorrect

   Why: Under section 10127.10, during a senior's 30-day cancellation period the premium for a variable life policy or variable annuity may be invested only in fixed-income investments and money-market funds unless the owner specifically directs investment in the underlying mutual funds.

   Reference Cal. Ins. Code 10127.10 — CA Life objectives II.C, II.D.1.a

2. In an annuity, whose life determines how long annuity payments are made under a life income option?

   • AThe beneficiary's, because the beneficiary receives whatever is left after the annuitant dies
   • BThe insurer's chief actuary
   • CThe annuitant'sCorrect
   • DThe agent's

   Why: The annuitant is the person whose life measures the payout under a life income option and who usually receives the payments. The owner controls the contract, and the beneficiary receives any death benefit.

   Reference CA Life objectives II.C.2

3. During which period of a deferred annuity does the owner pay premiums and the value grows tax-deferred?

   • AThe distribution (annuity) period, when the insurer pays income to the annuitant
   • BThe accumulation periodCorrect
   • CThe free look period
   • DThe grace period

   Why: A deferred annuity has an accumulation period, when premiums are paid and the value grows tax-deferred, and a distribution or annuity period, when it pays out. Interest earned is taxed only when withdrawn or paid out.

   Reference CA Life objectives II.C.1.a

4. Before recommending an annuity, what should a California agent gather about the consumer?

   • AFinancial situation, objectives, liquidity needs, risk tolerance and time horizonCorrect
   • BNothing; suitability applies only to securities
   • COnly the consumer's age and the amount available to invest, since annuities suit almost everyone
   • DThe consumer's credit score

   Why: California's annuity rules (Insurance Code 10509.910 and following) require a recommendation to be in the consumer's best interest, based on reasonable inquiry into the consumer's financial situation, insurance needs, objectives, liquidity needs, risk tolerance and time horizon, with surrender charges and penalties disclosed.

   Reference Cal. Ins. Code 10509.910 et seq. — CA Life objectives II.C

5. An indexed annuity credits interest using a 100% participation rate, a 2.5% spread (margin) and a 0% floor. The index gains 9% for the crediting term. What rate is credited?

   • A9%
   • B6.5%Correct
   • C2.5%
   • D0%

   Why: A spread, margin or asset-fee method subtracts a stated percentage from the index gain before crediting: 9% minus 2.5% equals 6.5%. Option A is the closest distractor and simply ignores the spread. A spread limits the credit differently from a cap — instead of stopping the credit at a ceiling, it takes a fixed slice off whatever the index produces, and if the index gain were less than the spread the floor would limit the credit to 0%.

   Reference CA Life objectives II.C (Annuities)

6. Which annuity payout option produces the LARGEST monthly income from a given accumulated value?

   • ALife income with a 20-year period certain
   • BJoint and 100% survivor
   • CStraight life (life only)Correct
   • DInstallment refund life income

   Why: Straight life pays the most per period because the insurer promises nothing beyond the annuitant's death; every guarantee added to a life income — a period certain, a refund feature, or a second life — must be paid for by lowering each payment. Option A is the closest distractor: a 20-year certain guarantee is expensive and cuts the payment noticeably. The trade-off is that if the annuitant dies early under straight life, no residual value is paid to anyone.

   Reference CA Life objectives II.C (Annuities)

7. Ernesto, 68, and Pilar, 66, want annuity income to continue in full for as long as either of them is alive. Which payout option meets that objective?

   • AA joint life annuity
   • BA joint and 100% survivor annuityCorrect
   • CLife income with a 10-year period certain on Ernesto's life
   • DA fixed-period annuity payable for 20 years

   Why: A joint and 100% survivor annuity pays while either annuitant lives and continues the full payment to the survivor, so neither spouse can outlive the income. Option A is the closest distractor and is its opposite: a joint life annuity stops at the FIRST death. Option C leaves Pilar with nothing after 10 years if Ernesto dies early, and option D can be exhausted while both are still alive.

   Reference CA Life objectives II.C (Annuities)

8. Under a life income with cash refund option, what does the beneficiary receive if the annuitant dies before total payments equal the amount paid for the annuity?

   • AA lump sum equal to the difference between the purchase price and the payments already madeCorrect
   • BContinued monthly payments for the beneficiary's lifetime
   • CContinued monthly installments until the remaining balance of the purchase price has been paid out
   • DNothing, because all payments cease at the annuitant's death

   Why: A cash refund option guarantees that at least the purchase price is returned, and it pays the unrecovered balance to the beneficiary in one lump sum. Option C is the closest distractor and describes the installment refund option, which guarantees the same total but continues the periodic payments until the balance is exhausted. Option D describes straight life, which carries no refund guarantee at all.

   Reference CA Life objectives II.C (Annuities)

9. Sara pays $120,000 for a nonqualified immediate annuity. Her expected return over her life expectancy is $240,000, and she receives $1,000 per month. How much of each monthly payment is excluded from her taxable income?

   • A$0
   • B$250
   • C$500Correct
   • D$1,000

   Why: The exclusion ratio is the investment in the contract divided by the expected return: $120,000 / $240,000 = 50%. Applied to the $1,000 payment, $500 is excluded as a tax-free return of her cost basis and the other $500 is taxable ordinary income. Option D is the closest misconception, treating the whole payment as a return of principal; option A treats the entire payment as taxable, which is the rule only after the basis is fully recovered.

   Reference CA Life objectives II.C (Annuities)

10. An annuitant receiving payments under a life income option lives well beyond her life expectancy and has now recovered her entire cost basis. How are her continuing payments taxed?

    • AThey remain partially excluded under the original exclusion ratio.
    • BThey are taxed as long-term capital gains.
    • CThey become fully tax-free.
    • DThey become fully taxable as ordinary income.Correct

    Why: The exclusion ratio applies only until the entire investment in the contract has been recovered tax-free; after that point every remaining payment is fully taxable ordinary income. Option A is the closest distractor, since candidates often assume the ratio applies for life, but the exclusion is capped at the cost basis. Conversely, if the annuitant dies before recovering the basis, the unrecovered amount may be deducted on the final return.

    Reference CA Life objectives II.C (Annuities)

11. Hugo, age 55, owns a nonqualified deferred annuity. He has paid $50,000 in premiums, the contract is now worth $80,000, and he takes a $20,000 withdrawal before annuitizing. Ignoring any surrender charge, what is the federal income tax result?

    • ANothing is taxable, because he withdrew less than the premiums he paid.
    • BThe full $20,000 is taxable ordinary income, plus a $2,000 penalty tax.Correct
    • C$7,500 is taxable, plus a $750 penalty tax.
    • DThe $20,000 is taxed as a long-term capital gain, with no penalty.

    Why: Withdrawals from a nonqualified deferred annuity before annuitization come out gain first under LIFO; the contract holds $30,000 of gain, so the entire $20,000 is taxable ordinary income, and because Hugo is under 59 1/2 an additional 10% penalty of $2,000 applies unless an exception is met. Option A applies the FIFO cost-basis-first rule, which governs life insurance cash values but not modern annuities. Annuity gain is always ordinary income, never capital gain.

    Reference CA Life objectives II.C (Annuities)

12. In a variable annuity, what happens at annuitization?

    • AAccumulation units convert into a fixed number of annuity units; each payment varies.Correct
    • BAccumulation units convert into a fixed dollar payment that is fully guaranteed for life.
    • CThe number of annuity units changes monthly while the unit value stays fixed.
    • DThe separate account is liquidated and the proceeds move into a fixed annuity.

    Why: During accumulation the owner buys a growing number of accumulation units; at annuitization those units are exchanged for a fixed number of annuity units, and each payment equals that fixed number times the fluctuating unit value, so income rises and falls with separate-account performance. Option C reverses the two variables, the single most tested confusion in variable annuities. Option B describes a fixed annuity payout, which some contracts offer as an alternative election.

    Reference CA Life objectives II.C (Annuities)

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• California licensing, appointments and continuing education
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• California group health insurance, COBRA and Cal-COBRA
• California's Commissioner, unfair practices and the guarantee association

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