17 Free Maryland Life & Health Practice Questions: Annuities, Federal Tax and Qualified Plans (2026)
How to Use This Annuities, Federal Tax and Qualified Plans Set
This set covers three sections of the Maryland Life outline: Annuities (6.0, 9% of the Life exam, 7 items), Federal Tax Considerations for Life Insurance and Annuities (7.0, 8%, 6 items) and Qualified Plans (8.0, 3%, 2 items). On the Combo the same sections are 5% (6 items), 4% (5 items) and 2% (2 items).
The 17 questions cover the period-certain payout, fixed versus variable annuities, Section 1035 exchanges, SEP and SIMPLE IRA plans, IRA transfers and distributions, net unrealized appreciation, bail-out and nonforfeiture provisions, indexed crediting, annuity uses and suitability. Each has an answer and an explanation.
Practice Questions 1-6: Payouts, Plan Types and Transfers
These questions test the period-certain payout, the SEP, the fixed versus variable annuity, the Section 1035 exchange, SIMPLE IRA eligibility and the direct IRA transfer.
Question 1 (Chapter 4)
An annuitant elects a life income with 10-year period certain payout option from their annuity. They die after receiving 6 years of payments. What happens to the remaining payments?
- A) Payments stop; no further benefits are payable.
- B) The insurance company retains the remaining funds as a mortality gain.
- C) Payments are converted to a lump sum equal to the present value of the remaining 4 years.
- D) The beneficiary receives the remaining 4 years of payments.
Show answer & explanation
Answer: D
With a life income with period certain option, if the annuitant dies before the period certain expires, the beneficiary receives the remaining payments for the balance of the period. Here, 10 years certain minus 6 years received leaves 4 years of payments due to the beneficiary. Option A describes a pure life option. Option B is incorrect; the insurer does not retain funds as a mortality gain in this case. Option C is not standard; payments continue as installments, not a lump sum conversion unless elected.
Question 2 (Chapter 4)
Which of the following is a requirement for a plan to qualify as a Simplified Employee Pension (SEP) under IRS rules?
- A) The plan must allow employee elective deferrals.
- B) Contributions must be made exclusively by employees.
- C) The employer must make contributions to a traditional IRA set up for each eligible employee.
- D) The plan must undergo annual nondiscrimination testing like a 401(k) plan.
Show answer & explanation
Answer: C
A SEP requires the employer to contribute to a traditional IRA (or SEP-IRA) established for each eligible employee. Employees do not make elective deferrals; contributions are employer-only. Option A describes a 401(k) or SIMPLE IRA feature. Option B is incorrect; employees do not fund SEPs. Option D is false; SEPs are exempt from the annual nondiscrimination testing required for 401(k) plans.
Question 3 (Chapter 4)
Which statement accurately describes a key difference between a fixed annuity and a variable annuity regarding the investment risk and return?
- A) In a fixed annuity, the insurance company bears the investment risk and guarantees a minimum interest rate; in a variable annuity, the policyholder bears the investment risk, and returns vary based on the performance of the underlying investment options.
- B) In a fixed annuity, the policyholder bears the investment risk; in a variable annuity, the insurance company bears the investment risk.
- C) Both fixed and variable annuities guarantee a minimum rate of return, but variable annuities offer the potential for higher returns based on market indices.
- D) The insurance company declares the interest rate for both fixed and variable annuities, but variable annuities adjust the rate monthly based on bond yields.
Show answer & explanation
Answer: A
A is correct: in a fixed annuity, the insurance company invests premiums in its general account and bears the investment risk, guaranteeing a minimum interest rate; in a variable annuity, the policyholder allocates funds among separate account investment options and bears the investment risk, with returns varying based on the performance of those options. Option B is incorrect because it reverses which party bears the investment risk. Option C is incorrect because variable annuities do not guarantee a minimum rate of return, and tying returns to market indices describes an equity indexed annuity, not a variable annuity. Option D is incorrect because the insurance company does not declare a rate for variable annuities, nor do variable annuities adjust based on bond yields; their returns depend on the performance of the owner's chosen investment options.
Question 4 (Chapter 4)
Under a Section 1035 exchange, a Maryland resident exchanges an old life insurance policy for a new annuity contract. Which statement is correct about the tax treatment of this exchange?
- A) The exchange is tax-free if it meets the requirements of Section 1035, and the basis in the old policy carries over to the new annuity.
- B) The exchange is taxable to the extent the cash value of the old policy exceeds the premiums paid.
- C) The exchange triggers immediate taxation of all gains in the old policy as ordinary income.
- D) Section 1035 only allows exchanges between like-kind products, such as life insurance for life insurance or annuity for annuity.
Show answer & explanation
Answer: A
Section 1035 allows tax-free exchanges of life insurance for annuities (and vice versa) when specific requirements are met. The exchange is not a taxable event, and the cost basis (adjusted basis) from the old life insurance policy carries over to the new annuity contract. Option B is incorrect because there is no taxation of the exchange; Option C is incorrect because gains are not taxed immediately; Option D is incorrect because Section 1035 permits exchanges between life insurance and annuities, not just like-kind.
Question 5 (Chapter 4)
Which of the following is a requirement for a plan to qualify as a SIMPLE IRA plan under IRS rules?
- A) The employer must make a matching contribution of up to 3% of each employee's compensation, dollar-for-dollar.
- B) Employees must be allowed to make elective deferrals of up to 100% of their compensation, subject to annual limits.
- C) The plan must be established by a tax-exempt organization such as a school or hospital.
- D) The employer must have no more than 100 employees who earned $5,000 or more from the employer in the preceding year.
Show answer & explanation
Answer: D
To establish a SIMPLE IRA plan, the employer must have no more than 100 employees who earned $5,000 or more from the employer in the preceding year. This is an eligibility requirement. While employers must make contributions (either matching or non-elective), the specific matching formula is not a requirement for qualification—employers can choose between a matching contribution (up to 3%) or a 2% non-elective contribution. Option A describes a common employer choice but is not a strict qualification requirement; Option B is incorrect because elective deferrals are limited to IRS annual limits, not 100% of compensation; Option C is incorrect because SIMPLE IRA plans are not limited to tax-exempt organizations.
Question 6 (Chapter 4)
Under federal tax law, what is the tax treatment of a direct trustee-to-trustee transfer of funds from a traditional IRA to another traditional IRA?
- A) The transfer is tax-free and not considered a distribution, so it is not subject to tax or the 10% early withdrawal penalty.
- B) The transfer is treated as a taxable distribution and is subject to ordinary income tax.
- C) The transfer is subject to the 10% early withdrawal penalty if the account owner is under age 59½.
- D) The transfer requires mandatory 20% federal income tax withholding.
Show answer & explanation
Answer: A
A direct trustee-to-trustee transfer between IRAs is not considered a distribution and is therefore tax-free. It is not subject to income tax or the 10% early withdrawal penalty, and no tax withholding applies. This method is preferred to avoid the 60-day rollover rule and potential withholding. Option B is incorrect because it is not taxable; Option C is incorrect because no penalty applies to transfers; Option D is incorrect because withholding does not apply to direct transfers.
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Practice Questions 7-12: NUA, Contract Provisions, IRA Distributions and Crediting
The next six turn on employer securities in a lump-sum distribution, the bail-out and nonforfeiture provisions, IRA and Roth distributions and the crediting formula on an indexed annuity.
Question 7 (Chapter 4)
Which of the following statements is true regarding the federal income tax treatment of a lump-sum distribution from a qualified plan that includes employer securities, if the participant elects net unrealized appreciation (NUA) treatment?
- A) The entire distribution, including the NUA, is taxed as ordinary income in the year of distribution.
- B) The NUA portion is tax-free, and only the cost basis is subject to tax.
- C) The distribution must be rolled over to an IRA within 60 days to qualify for NUA treatment.
- D) Only the cost basis of the employer securities is taxed as ordinary income; the NUA is taxed as long-term capital gains when the securities are sold.
Show answer & explanation
Answer: D
Under NUA rules, if a lump-sum distribution from a qualified plan includes employer securities and the participant elects NUA treatment, the cost basis of the securities is taxed as ordinary income in the year of distribution. The unrealized appreciation (the difference between the fair market value and the cost basis) is not taxed at distribution but is instead taxed as long-term capital gains when the securities are eventually sold. Option A is incorrect because the NUA is not taxed as ordinary income; Option B is incorrect because the NUA is not tax-free; Option C is incorrect because NUA election does not require an IRA rollover—it is an alternative to rollover.
Question 8 (Chapter 4)
Which of the following statements accurately describes a bail-out provision in a deferred annuity contract?
- A) It allows the annuitant to increase the death benefit without evidence of insurability.
- B) It guarantees a minimum payout amount during the annuity period regardless of market performance.
- C) It requires the insurance company to annuitize the contract if the owner dies during the accumulation phase.
- D) It permits the owner to withdraw funds without surrender charges if the declared interest rate falls below a guaranteed minimum rate specified in the contract.
Show answer & explanation
Answer: D
A bail-out provision allows the owner to surrender the annuity without incurring surrender charges if the interest rate credited to the contract drops below a predetermined guaranteed minimum rate. It does not relate to death benefit increases (A), minimum payout amounts (B), or forced annuitization upon death (C).
Question 9 (Chapter 4)
A Maryland resident who is 50 years old takes a distribution from a traditional IRA to pay for qualified higher education expenses. Which statement is true regarding the taxation and penalties?
- A) The distribution is fully taxable as ordinary income and subject to a 10% premature distribution penalty.
- B) The distribution is partially tax-free as a return of contributions and subject to a 10% penalty.
- C) The distribution is fully taxable as ordinary income but exempt from the 10% premature distribution penalty.
- D) The distribution is tax-free and penalty-free because it is for education expenses.
Show answer & explanation
Answer: C
Distributions from a traditional IRA used for qualified higher-education expenses are exempt from the 10% premature-distribution penalty, but the distributed amount remains fully taxable as ordinary income (assuming the contributions were deductible) — this is a penalty exception, not a tax exception. Option A is incorrect because the penalty is waived for this exception. Option B is incorrect because a traditional IRA distribution is not treated as a partial return of contributions unless the account actually holds after-tax (nondeductible) contributions, which this question does not indicate. Option D is incorrect because the distribution is not tax-free; only the 10% penalty is waived.
Question 10 (Chapter 4)
A Maryland resident who is 60 years old takes a distribution from a Roth IRA. The account has been open for 8 years. Which statement is true regarding the taxation of this distribution?
- A) The distribution is fully taxable as ordinary income.
- B) The distribution is partially taxable, with a portion subject to capital gains tax.
- C) The distribution is tax-free because it is a qualified distribution.
- D) The distribution is subject to a 10% early withdrawal penalty.
Show answer & explanation
Answer: C
A Roth IRA distribution is qualified if made after age 59½ and after the account has been open for at least 5 years. Since the individual is 60 (>59½) and the account has been open for 8 years (>5 years), the distribution is qualified and therefore entirely tax-free and penalty-free. There is no ordinary income or capital gains tax on qualified Roth IRA distributions.
Question 11 (Chapter 4)
A Maryland resident purchases a fixed indexed annuity (also known as an equity indexed annuity) that credits interest based on the performance of the S&P 500 index, with an annual cap of 6% and a participation rate of 80%. If the S&P 500 index returns 10% for the year, what interest rate will be credited to the annuity?
- A) 8%
- B) 10%
- C) 6%
- D) 4.8%
Show answer & explanation
Answer: C
In an equity indexed annuity (EIA), the interest credited is determined by: (index gain) × (participation rate), but subject to an upper limit (cap). Here, the index return is 10%, participation rate is 80%, so 10% × 80% = 8%. However, the annual cap is 6%, so the credited interest is limited to the cap of 6%. Option A (8%) ignores the cap. Option B (10%) uses the full index return without applying the participation rate or cap. Option D (4.8%) incorrectly applies the participation rate to the cap (6% × 80% = 4.8%), which is not how the formula works.
Question 12 (Chapter 4)
A Maryland resident purchases a deferred annuity with a single premium. They are concerned about needing access to some of their funds before the annuity period begins, but also want to ensure they don't lose all their investment if they stop making payments (though they only made one). Which annuity provision would typically allow them to retain some value if they needed to fully surrender the contract prematurely?
- A) The bail-out provision.
- B) The nonforfeiture provision.
- C) The guaranteed minimum interest rate.
- D) The systematic withdrawal option.
Show answer & explanation
Answer: B
Nonforfeiture provisions in deferred annuities ensure that if the owner stops making premium payments or surrenders the contract, they will not forfeit the accumulated cash value. Instead, they can elect to receive the cash value, convert it to a reduced paid-up annuity, or take an extended term option (though less common for annuities). A bail-out provision (Option A) allows penalty-free withdrawals if interest rates fall below a certain level. A guaranteed minimum interest rate (Option C) pertains to the growth of the annuity. A systematic withdrawal option (Option D) allows partial withdrawals, but doesn't address the retention of value upon full surrender.
Practice Questions 13-17: Uses, Inherited IRAs, Employer Deductions and Suitability
The last five cover what annuities are used for, tax on an inherited IRA, the employer's deduction for a qualified plan and suitability for an older client with limited liquid savings.
Question 13 (Chapter 4)
A Maryland couple recently received a substantial lump-sum inheritance and wants to ensure it provides a steady, predictable income stream throughout their retirement years. They are also interested in potential tax-deferred growth before they begin receiving payments. Which use of annuities would be most suitable for their situation?
- A) Funding a charitable gift annuity.
- B) Establishing an education fund for their grandchildren.
- C) Providing retirement income and tax-deferred growth.
- D) Investing in a qualified retirement plan.
Show answer & explanation
Answer: C
Annuities are commonly used for lump-sum settlements, such as inheritances, to provide a guaranteed retirement income stream and offer tax-deferred growth during the accumulation phase. This aligns perfectly with the couple's stated goals. While annuities can be used for education funds (Option B) or charitable gift annuities (Option A), their primary and most common use for a large lump sum with retirement income and growth goals is described in Option C. Option D refers to qualified plans, which have specific contribution limits and rules, and may not be the most direct fit for a large, immediate lump-sum inheritance outside of those limits.
Question 14 (Chapter 4)
A Maryland resident, age 75, passes away and leaves a Traditional IRA to their non-spouse beneficiary. The beneficiary elects to take distributions over their own life expectancy. Which statement accurately describes the federal income tax treatment of these distributions?
- A) All distributions are received income tax-free by the beneficiary.
- B) Distributions are taxable to the beneficiary as ordinary income.
- C) Only the growth portion of the IRA is taxable to the beneficiary.
- D) Distributions are subject to a 10% early withdrawal penalty.
Show answer & explanation
Answer: B
When a non-spouse beneficiary inherits a Traditional IRA, the distributions they receive are generally taxable as ordinary income. The tax-deferred status of the IRA ends upon the original owner's death, and the beneficiary must take distributions according to IRS rules (e.g., 10-year rule or life expectancy for certain eligible beneficiaries). Option A is incorrect because Traditional IRA distributions are generally taxable. Option C is incorrect because the entire distribution (contributions and earnings) is taxable if the original contributions were tax-deductible. Option D is incorrect; the 10% early withdrawal penalty generally applies to the original owner for premature distributions, not to beneficiaries inheriting the IRA, although there are specific rules for beneficiaries taking distributions.
Question 15 (Chapter 4)
A small business owner in Maryland establishes a qualified retirement plan for their employees. Which of the following is a primary federal tax advantage for the employer when sponsoring a qualified plan?
- A) Employer contributions to the plan are generally tax-deductible.
- B) Employee contributions are subject to immediate taxation.
- C) Earnings within the plan are tax-exempt, not just tax-deferred.
- D) The employer can selectively choose which employees to include in the plan.
Show answer & explanation
Answer: A
A significant federal tax advantage for employers sponsoring qualified retirement plans is that their contributions to the plan (on behalf of employees) are generally tax-deductible as a business expense. This reduces the employer's taxable income. Option B is incorrect; employee pre-tax contributions are tax-deferred. Option C is incorrect; earnings grow tax-deferred, not tax-exempt (unless it's a Roth-style qualified plan feature). Option D is incorrect; qualified plans must adhere to strict non-discrimination rules regarding employee eligibility and participation, as outlined in federal law, preventing selective exclusion of employees.
Question 16 (Chapter 4)
A Maryland resident, an 80-year-old widow with limited liquid savings and a fixed social security income, is approached by a producer recommending she purchase a single premium deferred variable annuity. The annuity has a 10-year surrender charge schedule and significant investment risk. Which of the following concerns regarding annuity suitability is most relevant for a Maryland producer to address with this client?
- A) The potential for tax-deferred growth may not be realized due to her advanced age and need for immediate income.
- B) The long surrender charge period and investment risk are unsuitable for someone with limited liquid assets and a need for stable, accessible income.
- C) The variable annuity's death benefit may not be sufficient to cover her final expenses.
- D) The annuity is not a qualified plan, which means contributions will not be tax-deductible.
Show answer & explanation
Answer: B
Annuity suitability requires that the product recommended aligns with the client's financial situation, goals, and risk tolerance. For an 80-year-old widow with limited liquid assets and a fixed income, a deferred variable annuity with a long surrender period and investment risk is highly unsuitable. She needs stable, accessible income, not long-term, illiquid, and risky investments. Option A is a consequence but not the primary suitability concern. Option C is a general concern for anyone, not specific to the unsuitability here. Option D is true but irrelevant to the core suitability issue for this client's specific circumstances.
Question 17 (Chapter 4)
A Maryland couple wants to save for their grandchild's college education. They are looking for a financial product that offers tax-deferred growth on their contributions and could potentially provide a structured income stream for tuition payments when the time comes. Which use of annuities would be most appropriate for their goal?
- A) Using an annuity for lump-sum settlements.
- B) Using a deferred annuity as an education fund.
- C) Establishing a qualified retirement plan.
- D) Purchasing a single premium immediate annuity (SPIA).
Show answer & explanation
Answer: B
A deferred annuity can be an effective tool for saving for education. It offers tax-deferred growth, meaning earnings are not taxed until distributed. When the grandchild is ready for college, the accumulated funds can be withdrawn or annuitized to provide a structured income stream for tuition. Option A relates to receiving a large sum, not saving for education. Option C is for retirement savings, not typically education. Option D provides immediate income, which is not suitable for a long-term savings goal like education.
The Mistakes That Cost Marks
Applying the formula in the wrong order. On an indexed annuity the participation rate multiplies the index gain first, and the cap limits the result.
Mixing up the SEP and the SIMPLE IRA. A SEP is funded by the employer into an IRA for each eligible employee. A SIMPLE IRA allows employee elective deferrals and has an employer-size eligibility test.
Treating a direct transfer as a distribution. A trustee-to-trustee transfer between IRAs is not a distribution, so there is no tax, no early-withdrawal penalty and no withholding.
Forgetting the difference between a penalty exception and a tax exception. A penalty exception waives the 10% additional tax. The distribution can still be taxable income.
Mixing up Roth and traditional rules. Roth contributions are after-tax, and a qualified distribution after age 59½ with the account open long enough is tax-free. Traditional deferrals are pre-tax.
Confusing bail-out with nonforfeiture. A bail-out provision waives surrender charges if the credited rate falls below a stated minimum. Nonforfeiture protects the value if the owner stops paying or surrenders.
Ignoring suitability. A long surrender period and investment risk do not fit a client with limited liquid assets who needs stable, accessible income.
Your Next Step
Missed questions point to the outline section to revisit. When you are ready, preview the Maryland Life & Health course for the audio lessons and the full question bank, or go back to the free Maryland practice question hub for the other topic sets.
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