Life Insurance and Annuities
Core concepts
Candidates must separate risk classification (mortality, medical underwriting, table ratings) from product design. Term is pure protection. Whole life bundles a level premium, guaranteed cash value, guaranteed death benefit, and nonforfeiture options. Universal life separates cost of insurance from cash value and credits interest; variable products shift investment risk to the owner and require securities registration. Know the standard provisions: incontestability (usually two years), suicide, grace period, reinstatement, misstatement of age or sex, free look, and policy loan and dividend treatment. Ownership rights, irrevocable beneficiary designations, and settlement options are frequently tested.
Annuities
Annuities are accumulation and payout vehicles, not life insurance. Know fixed, indexed, and variable; immediate versus deferred; qualified versus nonqualified. In a nonqualified annuity, each payout is part gain and part return of basis-the exclusion ratio. Gains are generally taxable to the beneficiary at death, with no step-up.
Traps
"Death benefits are always income-tax-free"-not after a transfer for value or for MEC distributions. "Policy loans are taxable"-generally not while the policy remains in force. "Dividends are guaranteed"-they are a return of premium and generally not taxable until they exceed basis. "An annuity inside an IRA uses an exclusion ratio"-no; IRA distributions are fully taxable.
Rule of thumb
Exclusion ratio = investment in the contract ÷ expected return. Example: $60,000 basis and $140,000 expected return give 42.86%; on a $7,000 payment, $3,000 is excluded and $4,000 is taxable.