Insurance-Based Products Synthesis
SEC Registration vs. State-Only Regulation
| 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.
Investment Risk: Who Bears It
- Insurer bears risk: Fixed annuity, indexed annuity, term life, whole life, universal life
- Policyholder/annuitant bears risk: Variable annuity, variable life, Variable Universal Life (VUL)
1035 Exchanges (Tax-Free Direct Transfers)
- 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
Tax Treatment: Death Benefit Distinction
- Life insurance death benefit: income-tax-free to beneficiaries (Internal Revenue Code (IRC) Section 101(a))
- 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)
Cross-Topic Exam Gotchas
Exam Tip: Gotchas
- Funding an IRA/401(k) with a variable annuity adds no tax benefit (already tax-deferred) but adds fees and surrender charges. This is a classic unsuitable recommendation.
- Variable annuity gains are always ordinary income at withdrawal, with no capital gains treatment regardless of what the subaccounts hold.
- Universal life is NOT a security; Variable Universal Life (VUL) IS.
- Policy loans are not taxable when taken, but forgiven loans (on lapse) become taxable income.
- 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.