Chapter 5 - Annuity Principles and Concepts

Indexed Annuities

Fixed annuities that provide interest rates linked to a stock indexed

What is different about a corporate owned nonqualified annuity compared to an individually owned nonqualified annuity?

Interest or gains are taxable as income in the year earned

Tax Penalty

To discourage the use of annuities as short-term tax shelters, a 10% penalty tax is levied against any premature withdrawals prior to 59.5 years of age.

Surrender Charges

When a contract is fully surrendered, any surrender charges will lessen the contract payout. Surrender charges diminish over a stated number of years, set by the insurer, until they disappear.

Immediate annuity

does not have an accumulation period and is used to generate immediate income. Income is generated within 1 year from issue date.

Annuity Period

The funds are liquidated over time to provide a guaranteed stream of income.

Annuitization Benefit Calculation

When it is time to annuitize the contract and begin the distribution phase, it is important to have a basic understanding of what insurance companies must use to calculate the benefits to be paid.

Annuity Classifications are based on:

- Method of premium payment(single, flexible, and periodic) - Funding (Fixed v. variable) - When income benefits are payable (immediate vs. deferred) - the payout option selected (Life only vs. Annuity certain)

Fixed annuities

Money deposited is held in the insurers general account. A guaranteed minimum interest is paid by the insurance company. Fixed level income stream Purchasing power decreases as cost of living increases

A flexible premium deferred annuity permits all of the following EXCEPT:

Payments to the annuitant beginning within one month of the issuance of the contract.

Beneficiary

The individual or person named in the contract to potentially receive benefits if the owner and or annuitant die prior to annuitiziation or if the settlement option selected offers any residual benefit after the annuitant's death.

Owner

The individual who controls the contract and is responsible for making payments into the contract as well as having all of the contractual rights in the policy is the owner

Single Premium (Single Premium Immediate Annuity) (SPIA)

lump sum in which the annuity is funded all at once with one premium payment.

Periodic Payments(Flexible Premium Deferred Annuity)(FPDA)

paid into the account over time but typically monthly

Annuitization

point in time when the accumulation period ends and payments begin.

Deferred annuity

will pay periodic benefits starting at some specified time in the future; benefits begin more than 1 year from issue date.

Test Tip : the following affect annuity payouts

- Older = Greater benefit - Male = Greater benefit -Shorter Life Expectancy = greater benefit - Longer life expectancy = lower benefit

During the accumulation phase of a single premium deferred annuity, the policyowner may not do which of these?

Add additional money to the principal value of the contract.

Market-Value Adjusted Annuity

Adjusts interest based on bond returns

Annuitant

The individual whose life the contract is based upon. Upon a lifetime annuitization, payments will be made to the annuitant based upon the annuitant's age, gender, settlement option selected, and dollar amount used to fund the income benefit payments.

Life Income with Refund (Installment or Cash Refund)

Upon death, if an annuitant has not received an amount equal to the total of all payments made into the annuity(not the growth), the balance is refunded to the beneficiary either lump sum, or cash refund, or in installments, sometimes referred to as the installment refund. NOTE: This is the only life payment option that guarantees the balance of all premiums paid into the annuity to be paid out.

Annuities - Lightning Facts

1. Annuities offer the potential of lifetime income. When annuitized, an annuity will provide payments for the lifetime of the annuitant. 2. The fundamental purpose of an annuity is to systematically liquidate a sum of money over time in order to provide a source of income the annuitant cannot outlive. 3. Annuities are funded and sold through life insurance companies 4. Annuities have an owner and a beneficiary, as in life insurance. The annuitant is the person whose life expectancy the annuity payments are based on. Death of the annuitant prior to annuitization triggers payment of the annuity value to the beneficiary. 5. The owner's rights begin at the time of purchase. This includes naming and changing the beneficiary, changing the annuity date and payout option. 6. Annuities have two "phases or "periods": Accumulation and Annuity/Payout (or liquidation). The accumulation phase is when premiums are paid into the annuity; in the Annuity/Payout phase, no new premiums may be paid into the contract because payments are now being made from the contract. 7. Annuities are purchased with one of 3 payments options: single premium, periodic premium, and flexible premium. 8. An annuity purchased with a lump sum of money with no additional money to be added later is called a single premium annuity. Annuities funded with multiple payments are called "periodic" premium annuities. 9. Single premium annuity may be an immediate annuity, with payments beginning within 1 year of purchase or a deferred annuity, with payments beginning more than one year after the purchase. A periodic premium annuity, by definition, is a deferred annuity. 11. A qualified annuity hold retirement plan assets which are made with pre-tax dollars. 100% of the annuity distributions are taxable as income. 12. Nonqualified annuities are funded with after-tax money and the contributions will not be taxed when withdrawn. Only the gains are taxable as income. 13. b/c annuities are regarded as a form of retirement savings, a 10% penalty tax is imposed on all distributions of gains if the owner is under age 59.5. 15. A long term care provision may be offered to help offset long term care costs. Some companies offer a combination annuity and long term care policy. 16. Annuities provide a death benefit to the beneficiary of the contract prior to annuitization. The insurer will pay an amount equal to premiums paid or the account value, whichever is greater. 17. if the owner chooses to annuitize the contract, the choice of distribution option is irrevocable--once selected it may not be terminate or change to another option. 18. A life only (or life income only) distribution provides the largest possible monthly payment. The annuitant will receive a periodic payment for as long as he or she survives. 19. Life income with period certain is a minimum guaranteed distribution. If the annuitant dies before the end of the guarantee period, the remaining number of monthly payments will be paid to the annuitant's beneficiary. 20. Life income with refund distribution options includes both a lump sum cash refund and an installment refund. If the annuitant dies before all principal value has been distributed, the annuitant's beneficiary will receive the balance in a one-time payment (lump sum) or as a continuing series of payments (installment refund) until all principal and interest have been distributed. 21. A joint life annuity stops payment when the first annuitant dies. It may be an appropriate choice in a situation where there is adequate life insurance to provide continuing income to a surviving annuitant, and the reason for annuitizing is simply the current income stream. 22. The joint life distribution provides the largest payment based on the joint life expectancy. 23. Distributions from a joint-and-survivor annuity will be smaller than from a joint-life annuity, but will continue to the surviving annuitants for the remainder or his or her lifetime. 24. At the first death of a joint-and-survivor, the continuing payments to the surviving annuitant(s) may be the same (joint and full) or may be reduced by 1/3(joint and two-thirds) or 1/2 (joint and one-half) of the payment that was originally being received. 25. Fixed amount or fixed period annuities (Annuity Certain) are not lifetime distribution guarantees. A fixed period option will determine the number of payments, and a fixed amount option will determine the payout amount. When the final payment has been made, the contract ends. 26. Annuities are classified broadly into fixed and variable types. Indexed annuities are a form of fixed rate annuities. 27. A fixed annuity guarantees a minimum rate of interest but the actual interest rate credited is controlled by the insurance company. 28. A fixed annuity will also provide a fixed, unchanging payment to the annuitant when the contract is annuitized. 29. Payments to the annuitant in a variable annuity can be higher or lower from one period to the next depending on the assumed interest rate (AIR) as compared to the actual performance of the separate account. 30. An indexed annuity ties the interest crediting rate to a known stock index, such as the Standard & Poor's. 31. Variable annuities permit the policyowner to direct the cash accumulation into one or more mutual fund like subaccounts that range from very conservative to highly aggressive. 32. The subaccounts are direct investments in market based securities, and there is no guarantee of principal or interest to the policyowner. 33. Variable annuities are registered securities. They are offered by prospectus, and may only be marketed by an insurance produer who is both life and securities licensed. 34. Market-value adjusted annuities feature fixed rate guarantees combined with an interest rate adjustment factor that can cause the surrender value to fluctuate. 35. Annuities may be used to hold a variety of cash assets from inheritances, life insurance proceeds, personal injury settlements, retirement account assets, college endowment funds, and long term savings for use by a retied person, or a a trust fund for a child. 36. Individual or group annuities may be used to formally or informally fund employee benefit plans such as retirement funds, deferred comepnsation plans, or to structure liability settlement payments. 37. Corporate owned annuities lose the tax deferral aspect of the policy

What must an insurance producer have in order to market variable annuities?

A securities license as a variable contracts and investment company representative in addition to a life agent license

Concept of an Annuity

Annuities are used primarily to provide a steady stream of lifetime income to an individual typically upon retirement.

Life Income (Pure or Straight Life)

Annuity is payable for as long as the annuitant lives, and upon death all payments cease. This option provides the highest monthly income.

What is "fixed" in a fixed annuity?

The interest crediting rate

Accumulation (Pay-In) Period - Contribution Period

The period of time from the first deposit to the selection of a settlement option is considered the accumulation period, during which taxes are deferred

Joint Life

Annuity is payable to 2 or more named annuitants while both are living. Upon the death of the first annuitant, the benefits stop.

Test Tip: Know that the following factors are used to determine annuity pay-out benefits:

- the dollar amount in the account - The assumed interest rate the company expects to earn - age and gender -life expectancy -the number of installments to be paid out - the settlement option and any guarantees offered in the payout

Life Income Period Certain

Annuity is payable for life, or for a specified period of time, whichever is longer. If the annuitant lives beyond the stated period, benefits continue for life of the annuitant. If the annuitant dies prior to the end of the period certain a beneficiary receives the balance of the payments for the remaining time period.

Life Income Joint & Survivor

Annuity is payable to 2 annuitants (in one check) while both are living. Upon death of the first annuitant, survivor benefits continue, either paying the full amount or reduced to 2/3 or 1/2 for the survivor's income until the survivor dies. Depending on which option is selected, these options may be referred to as Joint and Full Survivor, Joint and 2/3 Survivor, or Joint and 1/2 Survivor.

Employer Sponsored Qualified Retirement Plans

Annuities for the most part are purchased by individuals. They may be used, however, for a corporate pension plan. The annuity is considered a Group Deferred Annuity with each employee receiving a certificate. - Corporations may use annuities to provide pensions for employees, funding nonqualified deferred compensation plans or qualified retirement plans, and even to structure payments from liability settlements, known as structured settlements. - coportation owned annuities lose the tax-deferral aspect of the policy - Annuities may be used as a nonqualified savings plan or as a qualified retirement plan. When nonqualified, annuity contributions are limited only to the extent that the insurance company has the right to limit the amount it is willing to accept for deposit at any one time. if used as a qualified or other type or retirement plan, contributions are limited according to the type of plan by the Internal Revenue Code. - annuities can be used simply as funding vehicles or can be used to provide benefits that other investments cannot, such as, a guaranteed minimum death benefit a guaranteed minimum interest rate, an income benefit payment that cannot be outlived, or other various benefits and riders.

Bailout Provision (Escape Clause)

During the accumulation period, some contracts also offer a "bailout" provision that allows the owner to withdraw money from the annuity without surrender charges if the crediting rate falls by more than a specific amount. This will enable the policy owner to consider other savings and investment options.