Quick Answer
"Variable" is the tell for the whole unit: variable annuities, variable life, and Variable Universal Life put money in a separate account, shift investment risk to the owner, and are securities sold by prospectus. Every other product (fixed, indexed, whole, universal) sits in the general account and leaves the risk with the insurer; term life has no cash value at all. None of these non-variable products are securities; state insurance departments regulate them instead.
The tables below put every product side by side so you can see which risk applies, who is regulated by whom, and how each type is taxed at death.
Which Insurance Products Are Securities?
| Product | Security? | Why | Regulated By |
|---|---|---|---|
| Fixed annuity | No | Guaranteed return; no investment risk to owner | State insurance dept |
| Indexed annuity | No | Guaranteed floor; no investment risk to owner | State insurance dept |
| Variable annuity | Yes | Separate account; owner bears investment risk | SEC + state insurance |
| Term life | No | No investment component | State insurance dept |
| Whole life | No | General account; guaranteed cash value | State insurance dept |
| Universal life | No | General account; guaranteed minimum rate | State insurance dept |
| Variable life | Yes | Separate account; owner bears investment risk | SEC + state insurance |
| Variable universal life | Yes | Separate account; owner bears investment risk | SEC + state insurance |
The rule: If it says "variable", it is a security. If assets are in a separate account, it is a security. If the owner bears investment risk, it is a security.
Who Bears the Investment Risk?
- Insurer bears risk: Fixed annuity, indexed annuity, whole life, universal life
- No investment risk (no cash value at all): Term life
- Policyholder/annuitant bears risk: Variable annuity, variable life, Variable Universal Life (VUL)
What Are the 1035 Exchange Rules Across Products?
- Life insurance to life insurance: allowed
- Life insurance to annuity: allowed
- Life insurance to qualified long-term care contract: allowed
- Annuity to annuity: allowed
- Annuity to qualified long-term care contract: allowed
- Long-term care to long-term care: allowed
- Annuity to life insurance: NOT allowed (must go "across or down," never "up")
- Must be the same owner on both contracts
- Must be a direct transfer between insurance companies
- Cost basis of the old contract carries over to the new contract
- Tax-free but does NOT waive surrender charges from the old contract
How Does Death Benefit Taxation Differ Between Life Insurance and Annuities?
- Life insurance death benefit: income-tax-free to beneficiaries under the tax code's life-insurance proceeds exclusion
- Annuity death benefit: gain portion is taxable as ordinary income to beneficiaries
- Life insurance death benefits may be included in the insured's taxable estate for estate tax purposes (if insured had incidents of ownership)
How Do Living-Distribution Tax Rules Differ?
- Annuity accumulation-phase withdrawals use LIFO: earnings come out first and are fully taxable, then principal returns tax-free
- Life insurance withdrawals (non-MEC) use cost recovery: basis (premiums paid) comes out first tax-free, then amounts above basis are taxable
- A life insurance policy that becomes a Modified Endowment Contract (MEC) flips to the annuity-style income-first rule, plus the 10% early-distribution tax before age 59 1/2 (no exception for the holder's death, unlike the annuity penalty)
Cross-Topic Exam Gotchas
Exam Tip: Gotchas
- Funding an IRA/401(k) with an annuity (fixed, indexed, or variable) adds no tax benefit (already tax-deferred) but adds fees and surrender charges. This is a classic unsuitable recommendation, most often tested with variable annuities because their fee load runs highest.
- All annuity gains are ordinary income at withdrawal, regardless of annuity type. No capital gains treatment is ever available, even for a variable annuity that held equity subaccounts for decades.
- Universal life is NOT a security; Variable Universal Life (VUL) IS.
- Policy loans on a non-MEC policy are not taxable when taken, but forgiven loans (on lapse) become taxable income; a MEC loan is an income-first distribution instead.
- Outstanding policy loans reduce the death benefit paid to beneficiaries.
- A 1035 exchange is tax-free but does NOT eliminate surrender charges from the old contract.
- Life insurance withdrawals recover basis first (cost recovery); annuity withdrawals take earnings first (LIFO), the opposite order.
What Should You Check on Exam Day?
- Does the product name include "variable"? That is the fastest way to confirm security status across both annuities and life insurance.
- Is the stem about a withdrawal (accumulation phase, LIFO for annuities or cost recovery for life insurance) or a payment after annuitization (exclusion ratio)?
- Is the death benefit from life insurance (generally tax-free) or an annuity (gain portion taxable)?
- Has a life insurance policy become a Modified Endowment Contract? If so, apply the annuity-style income-first rule and the 10% penalty, not cost recovery.
- Is the recommendation placing any annuity inside a tax-advantaged account? That is unsuitable regardless of annuity type.