17 Free Virginia Life, Annuities & Health Practice Questions: Annuities, Federal Tax and Qualified Plans (2026)
How to Use This Set
This set draws on three sections of Prometric's Series 11-01 outline: Annuities (section 6.0, 6%, 8 of the 140 scored items), Federal Tax Considerations for Life Insurance and Annuities (section 7.0, 2%, 3 items) and Qualified Plans (section 8.0, 2%, 3 items). The annuity section is the larger block; the two tax and plan sections are small, but their rules are mechanical, so they are points you can win with a little drilling.
Several questions here also test Virginia's annuity suitability regulation and its market value adjustment provisions. Commit to an answer before opening the explanation. These 17 questions come from LanePrep's Virginia L&H quiz bank.
Practice Questions 1-6: Suitability, Market Value Adjustments and Rollovers
Whether a recommendation fits the client's time horizon, how an MVA moves the surrender value and what different distributions and transfers do for tax.
Question 1 (Chapter 5)
A Virginia insurance producer recommends a fixed indexed annuity to a 70-year-old client who intends to use the funds for potential long-term care expenses within the next 3-5 years. The annuity has a 10-year surrender charge schedule and a market value adjustment (MVA) feature. Under 14VAC5-45 (Suitability in Annuity Transactions), which factor makes this recommendation most likely unsuitable?
- A) The surrender charge period exceeds the client's anticipated liquidity need horizon.
- B) The client's age exceeds 65, triggering enhanced suitability requirements.
- C) Fixed indexed annuities are prohibited for Virginia residents over age 65.
- D) The MVA feature violates Virginia's nonforfeiture law for annuities.
Show answer & explanation
Answer: A
14VAC5-45 requires producers to have reasonable grounds for believing the annuity is suitable based on the consumer's financial situation, needs, and objectives — including liquidity needs. A 10-year surrender charge period conflicts with a 3-5 year liquidity horizon, making the product unsuitable. Option B is incorrect: age 65+ triggers additional disclosure duties but does not automatically make a recommendation unsuitable. Option C is false; no such prohibition exists. Option D is incorrect: MVAs are permitted under §§ 38.2-107.1 and 3113.1 if properly disclosed.
Question 2 (Chapter 5)
A Virginia insurance producer sells a variable annuity to a client. The client asks about the 'market value adjustment' (MVA) feature described in the prospectus. Under Virginia law (§§ 38.2-107.1, 3113.1), which statement about MVAs is correct?
- A) MVAs are prohibited on variable annuities in Virginia.
- B) MVAs apply only during the first 5 contract years.
- C) An MVA guarantees the surrender value will never be less than total premiums paid.
- D) An MVA adjusts the surrender value based on changes in interest rates since purchase, and may increase or decrease the value.
Show answer & explanation
Answer: D
A market value adjustment (MVA) modifies the surrender value of an annuity (typically fixed or indexed) based on the difference between the interest rate environment at purchase and at surrender. If rates have risen, the MVA reduces the surrender value; if rates have fallen, it may increase the value. This is authorized under §§ 38.2-107.1 and 3113.1. Option A is incorrect — MVAs are not prohibited on variable annuities, though they are more common on fixed/indexed products. Option B is false — MVA periods vary by contract. Option C is false — MVAs can reduce surrender value below premiums paid.
Question 3 (Chapter 5)
A 50-year-old Virginia resident receives a lump-sum distribution of $100,000 from her employer's qualified profit-sharing plan. She rolls over $80,000 directly to a traditional IRA and takes $20,000 as a cash distribution. Assuming no exceptions apply, what are the federal income tax consequences of the $20,000 cash distribution?
- A) The $20,000 is fully taxable as ordinary income and subject to a 10% early withdrawal penalty.
- B) The entire $20,000 is tax-free as a return of after-tax contributions.
- C) Only the earnings portion of the $20,000 is taxable; the contribution portion is tax-free.
- D) The $20,000 is taxed as capital gain at long-term capital gains rates.
Show answer & explanation
Answer: A
A cash distribution from a qualified plan that is not rolled over is fully taxable as ordinary income in the year received. Since the recipient is under age 59½ and no exception applies, a 10% early withdrawal penalty also applies. Option B is incorrect because qualified plan distributions are not treated as a return of after-tax contributions unless after-tax contributions were made (and even then, only that portion is tax-free). Option C is incorrect because qualified plan distributions do not use an exclusion ratio; the entire amount is taxable as ordinary income. Option D is incorrect because distributions from qualified plans are taxed as ordinary income, not capital gains.
Question 4 (Chapter 5)
A Virginia resident owns a non-qualified deferred annuity with a cost basis of $80,000 and a current value of $120,000. The owner, age 58, takes a partial withdrawal of $20,000. How is this withdrawal taxed for federal income tax purposes?
- A) The entire $20,000 is taxable as ordinary income.
- B) The withdrawal is tax-free return of basis up to $20,000.
- C) $13,333 is taxable as ordinary income; $6,667 is tax-free return of basis.
- D) The withdrawal is subject to a 10% early distribution penalty plus ordinary income tax on the full amount.
Show answer & explanation
Answer: A
Under the 'last-in, first-out' (LIFO) rule for non-qualified annuities (IRC §72(e)), withdrawals before annuitization are treated as coming from earnings first. The annuity has $40,000 of gain ($120,000 - $80,000). The $20,000 withdrawal comes entirely from earnings and is fully taxable as ordinary income. Option B incorrectly applies FIFO (cost recovery) which applies to life insurance surrenders, not annuity withdrawals. Option C describes the exclusion ratio method, which applies only during the annuity phase, not pre-annuitization withdrawals. Option D is incorrect because the 10% penalty (IRC §72(q)) applies only to the taxable portion, not the full amount, and the owner is under 59½ so the penalty would apply to the $20,000 taxable portion — but the question asks how the withdrawal is taxed, not the penalty.
Question 5 (Chapter 5)
A Virginia resident, age 50, receives a distribution of $10,000 from a Roth IRA. The Roth IRA has been open for 3 years, and the distribution consists entirely of earnings. Assuming no exceptions apply, what are the federal income tax consequences?
- A) The distribution is fully taxable as ordinary income and subject to a 10% early withdrawal penalty.
- B) The distribution is entirely tax-free because it comes from a Roth IRA.
- C) The distribution is fully taxable as ordinary income but not subject to the 10% penalty because the account owner is over 59½.
- D) The distribution is tax-free as a return of after-tax contributions, but earnings would be taxable if distributed.
Show answer & explanation
Answer: A
For a Roth IRA distribution to be qualified (tax-free and penalty-free), the account must be open for at least 5 years, and the distribution must be made after age 59½, due to death, disability, or for a first-time home purchase (subject to limits). Here, the account has been open for only 3 years, so the 5-year rule is not met. The distribution consists of earnings, which are therefore taxable as ordinary income. Since the account owner is under 59½ and no exception applies, a 10% early withdrawal penalty also applies. Option B is incorrect because the 5-year rule is not satisfied. Option C is incorrect because the owner is 50, not over 59½. Option D incorrectly states the distribution is tax-free; earnings distributed before the 5-year rule is met are taxable.
Question 6 (Chapter 5)
A 52-year-old Virginia resident receives a non-taxable transfer of $40,000 from an old employer's 401(k) plan to a new employer's 401(k) plan via a direct trustee-to-trustee transfer. Which statement is correct regarding this transaction?
- A) The transfer is treated as a taxable distribution subject to 20% mandatory withholding.
- B) The transfer must be completed within 60 days to avoid taxation.
- C) The transfer is not a taxable event and avoids mandatory withholding.
- D) The transfer creates a basis in the new 401(k) equal to the amount transferred.
Show answer & explanation
Answer: C
A direct trustee-to-trustee transfer between qualified plans (such as 401(k) to 401(k)) is not a taxable distribution, is not subject to the 60-day rollover rule, and avoids the 20% mandatory federal income tax withholding that applies to indirect rollovers. Option A is incorrect because there is no taxation or withholding. Option B applies only to indirect rollovers. Option D is incorrect because basis rules for pre-tax contributions do not apply in this way; the amount transferred increases the account balance but does not create a separate basis for after-tax contributions unless the funds were after-tax.
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Practice Questions 7-12: Employer Plans, Annuity Parties and Taxation at Surrender
Which plan allows the biggest deductible contribution, who the annuitant and owner are, and how cost basis and ownership decide the tax.
Question 7 (Chapter 5)
A 50-year-old Virginia business owner establishes a profit-sharing plan. The plan document specifies that contributions are discretionary and based on annual profits. In a profitable year, the employer contributes 15% of each eligible employee's compensation. Which statement about this plan is correct?
- A) The plan is a 401(k) plan because it allows employee deferrals.
- B) Employer contributions are limited to 10% of compensation under profit-sharing plans.
- C) Employees must make deferrals to receive employer contributions in a profit-sharing plan.
- D) The plan qualifies as a profit-sharing plan under IRC § 401(a), and employer contributions are tax-deductible up to 25% of compensation.
Show answer & explanation
Answer: D
Profit-sharing plans are a type of qualified plan under IRC § 401(a). Employer contributions are discretionary and tax-deductible, subject to limits (generally 25% of compensation for the plan overall). Option A is incorrect because profit-sharing plans do not require employee deferrals (those are 401(k) features). Option B is false; the limit is higher. Option C is incorrect; employer contributions can be made regardless of employee deferrals.
Question 8 (Chapter 5)
A Virginia insurance producer is discussing a variable annuity with a client. The client wants to understand how the death benefit works. Which statement accurately describes the standard death benefit provision in a variable annuity contract?
- A) The death benefit is always equal to the current account value, regardless of market performance.
- B) The death benefit is guaranteed to increase by a fixed percentage each year, independent of the underlying investments.
- C) The death benefit is only payable if the annuitant dies during the accumulation period; no benefit is payable if death occurs during the annuity period.
- D) The death benefit is the greater of the current account value or the total premiums paid, less any prior withdrawals.
Show answer & explanation
Answer: D
The standard death benefit in a variable annuity is typically the greater of the current account value or the total premiums paid (minus any withdrawals). This provides protection against market downturns. Option A is incorrect because the death benefit is not always the account value; it can be higher if the account value has declined. Option B is incorrect because the death benefit is not guaranteed to increase by a fixed percentage; it depends on premiums and withdrawals. Option C is incorrect because many variable annuities provide a death benefit during the annuity period, often based on the present value of remaining payments or a minimum guarantee.
Question 9 (Chapter 5)
A 55-year-old Virginia resident, Mr. Miller, purchases a deferred annuity. He names his 25-year-old daughter, Sarah, as the person whose life expectancy will determine the amount of the periodic income payments, but Mr. Miller retains all rights to make withdrawals or change the beneficiary. In this scenario, who is the annuitant?
- A) Sarah
- B) Mr. Miller
- C) Both Mr. Miller and Sarah
- D) The insurance company
Show answer & explanation
Answer: A
The annuitant is the natural person whose life is used as the measuring scale for determining the benefits to be paid under the contract. While Mr. Miller is the owner (holding the rights), Sarah is the annuitant because her life expectancy dictates the payout.
Question 10 (Chapter 5)
A Virginia policyowner surrenders a whole life policy for its $50,000 cash value. Over the years, the owner paid $35,000 in total premiums and received $5,000 in policy dividends in cash. According to the federal cost recovery rule, what is the taxable amount of the surrender?
- A) $15,000
- B) $50,000
- C) $20,000
- D) $0, because life insurance proceeds are never taxed
Show answer & explanation
Answer: C
The cost basis is total premiums paid ($35,000) minus dividends received ($5,000), which equals $30,000. The taxable amount is the surrender value ($50,000) minus the cost basis ($30,000), resulting in $20,000 of taxable gain.
Question 11 (Chapter 5)
A Virginia corporation purchases an annuity to fund a future obligation to a key executive. How is the interest earned during the accumulation phase of this corporate-owned annuity treated for federal tax purposes?
- A) It is tax-deferred until the executive retires
- B) It is tax-exempt if the corporation is a C-Corp
- C) It is currently taxable to the corporation as ordinary income
- D) It is taxed at the lower capital gains rate
Show answer & explanation
Answer: C
Generally, annuities owned by 'non-natural persons' (corporations) do not enjoy tax-deferred growth. The annual interest gains are taxable as current income to the entity.
Question 12 (Chapter 5)
A Virginia resident, Mrs. Gable, purchases a deferred annuity to fund her grandson's college education. She names herself as the owner, her grandson as the annuitant, and her daughter as the beneficiary. During the accumulation period, who has the right to surrender the contract for its cash value?
- A) The grandson, because he is the annuitant
- B) The daughter, because she is the beneficiary
- C) Mrs. Gable and the grandson must both sign for a surrender
- D) Mrs. Gable, because she is the owner
Show answer & explanation
Answer: D
In an annuity contract, the owner (Mrs. Gable) holds all the contractual rights, including the right to surrender the policy, name the beneficiary, and make withdrawals. The annuitant is the person whose life expectancy is used to calculate the payout, but they do not necessarily have ownership rights.
Practice Questions 13-17: Estate Inclusion, Annuitization, MVAs and Suitability Information
Incidents of ownership, what happens to units at annuitization, the direction of an MVA when rates rise and the profile a producer must gather.
Question 13 (Chapter 5)
Mr. Harrison, a Virginia resident, owns a $500,000 whole life policy on his own life. He names his wife as the beneficiary. At his death, the $500,000 death benefit is paid to his wife. How is this amount treated for Federal Estate Tax purposes?
- A) It is excluded from his gross estate because it was paid to a named beneficiary
- B) Only the cash value is included in his gross estate
- C) The full $500,000 is included in his gross estate because he held 'incidents of ownership'
- D) It is taxed as ordinary income to the estate
Show answer & explanation
Answer: C
Under federal tax law, if the insured holds any 'incidents of ownership' (such as the right to change the beneficiary or borrow against the cash value) at the time of death, the full death benefit is included in the insured's gross estate for estate tax calculation purposes.
Question 14 (Chapter 5)
In a variable annuity, what occurs at the moment of 'annuitization'?
- A) The insurer guarantees a fixed interest rate for the life of the contract
- B) Accumulation units are converted into a fixed number of annuity units
- C) The owner must pay a 10% surrender charge
- D) The contract is converted into a term life insurance policy
Show answer & explanation
Answer: B
Upon annuitization of a variable annuity, the accumulation units are converted into a fixed number of 'annuity units.' While the number of units remains fixed, the dollar value of each unit fluctuates based on the performance of the sub-accounts.
Question 15 (Chapter 5)
A Virginia resident owns a Modified Guaranteed Annuity (MVA) under § 38.2-3113.1. The contract was purchased when the prevailing interest rates were 4%. If the owner decides to surrender the contract early when the prevailing market interest rates have risen to 6%, what is the likely impact of the Market Value Adjustment?
- A) The surrender value will be adjusted upward to reflect the higher market rates.
- B) The surrender value will be adjusted downward because market rates have increased.
- C) The adjustment only applies if the owner chooses a life income option rather than a cash surrender.
- D) Virginia law prohibits downward adjustments on MVAs for resident consumers.
Show answer & explanation
Answer: B
Under Virginia Code § 38.2-3113.1, a Market Value Adjustment (MVA) feature shifts some investment risk to the owner. If an owner surrenders the contract when interest rates are higher than when the contract was issued, the insurer typically applies a downward adjustment to the value. Conversely, if rates had fallen, the value would likely be adjusted upward.
Question 16 (Chapter 5)
Under Virginia Administrative Code 14VAC5-45-40, which of the following is NOT explicitly listed as 'consumer profile information' that a producer must make reasonable efforts to obtain before recommending an annuity?
- A) Financial time horizon and liquidity needs
- B) The consumer's medical history and current prescriptions
- C) Intended use of the annuity and risk tolerance
- D) Tax status and annual income
Show answer & explanation
Answer: B
Virginia's suitability regulation (14VAC5-45) requires producers to collect financial and personal data to ensure an annuity fits the client's needs. This includes income, tax status, investment objectives, and liquidity needs. Medical history is generally relevant for life insurance underwriting or long-term care, but it is not a standard component of the 'consumer profile information' for annuity suitability.
Question 17 (Chapter 5)
From a functional standpoint, how does an annuity differ from a life insurance policy in terms of the risk it addresses?
- A) Life insurance protects against longevity risk; annuities protect against premature death.
- B) Life insurance creates an estate; annuities liquidate an estate over a period of time.
- C) Annuities provide a tax-free death benefit; life insurance provides tax-deferred growth.
- D) Annuities are only sold by banks; life insurance is only sold by insurance companies.
Show answer & explanation
Answer: B
Life insurance is designed to create an immediate estate upon the death of the insured (protecting against premature death). An annuity is designed to systematically liquidate a sum of money over a period of time, often to provide income for life (protecting against the risk of outliving one's money, or longevity risk).
The Mistakes That Cost Marks
Confusing owner and annuitant. The owner holds the contract rights, including surrender and naming the beneficiary. The annuitant is the person whose life is the measuring life for the payout.
Getting the MVA direction backwards. If rates have risen since purchase, a market value adjustment typically reduces the surrender value. If they have fallen, it may increase it.
Forgetting the cost basis. On surrender, the taxable gain is the proceeds minus the cost basis, and the basis is premiums paid less dividends received in cash.
Treating a direct transfer like a distribution. A trustee-to-trustee transfer is not a taxable event and avoids the mandatory withholding that applies to an indirect rollover.
Missing the non-natural owner rule. Annuities owned by corporations generally do not receive tax-deferred growth.
Ignoring the 59½ and five-year tests on a Roth. Earnings are tax-free and penalty-free only for a qualified distribution.
Forgetting incidents of ownership. An insured who holds incidents of ownership at death has the full death benefit included in the gross estate.
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