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Difficulty: MediumAnnuities and Insurance-Based Products

An investor is evaluating the features and taxation rules of a non-qualified deferred variable annuity contract during its accumulation phase. Which of the following statements regarding this contract are correct?

  1. Investment growth within the separate account subaccounts accumulates on a tax-deferred basis until distributions begin.Answer
  2. The contract owner bears the investment risk associated with the performance of the chosen underlying subaccounts.Answer
  3. C
    Surrender charges assessed by the insurance company for early withdrawal serve as the official 10%10\% IRS early withdrawal tax penalty.
  4. D
    Principal invested in variable annuity subaccounts is fully backed and insured up to $250,000\$250,000 by the Federal Deposit Insurance Corporation (FDIC).

Answer

Tax-deferred accumulation growth and investment risk bearing by the contract owner are correct statements.
Growth within separate account subaccounts accumulates tax-deferred during the accumulation phase, and contract owners bear all market risk because subaccount values fluctuate based on investment returns.

Step-by-Step Solution

1
Assess tax treatment during the accumulation phase of a non-qualified variable annuity.
Growth within separate account subaccounts is tax-deferred.
Internal Revenue Code rules allow investment returns in deferred annuities to compound tax-free prior to withdrawal.
2
Determine investment risk responsibility in variable subaccounts.
The investor bears investment risk.
Subaccount performance depends on underlying portfolio returns, unlike fixed annuities where the insurer guarantees principal and return.
3
Distinguish between insurer surrender fees and IRS tax penalties.
Surrender charges and IRS penalties are separate charges.
Surrender fees compensate the insurer for early contract cancellation, while the IRS 10%10\% penalty is a federal tax penalty on early taxable withdrawals.
4
Evaluate federal deposit insurance applicability to variable annuity subaccounts.
FDIC insurance does not cover variable annuity contract values.
FDIC coverage applies only to deposit accounts at insured banking institutions, not securities or insurance products.

Key Concept

Variable annuity tax deferral, separate account market risk, surrender charge mechanics, and deposit protection boundaries
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Topics

Annuities and Insurance-Based Products

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