Chapter 5 - Annuities

Nonforfeiture Provisions: Surrender Charges (or Back-End Load)

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.

Deferred annuity

A deferred annuity will pay periodic benefits starting at some specified time in the future; income benefits begin more than 1 year from the issue date. They are normally purchased to defer taxes on any contract earnings. They are ideal for accumulating a retirement fund. During the accumulation period, only the contract owner can sign the request for surrender of a deferred annuity. During the early part of the accumulation period, the insurer normally assesses a surrender charge.

The Annuity Period (Pay-Out/Liquidation): Annuitization

The election to receive payments from the annuity for life, or for a specified period depending on the settlement option selected.

Annuity

A contract that is designed to protect against outliving retirement income by providing a stream income to a designated person. Can be referred to as liquidation of an estate

Premium Payment Options: Single Premium

A lump sum payment is made into an annuity

Fixed Period Annuity Certain

An annuity guaranteed to pay out for a specific number of years (such as a typical, state lottery prize). Often used in settlement options.

Premium Payment Options: Periodic Premium

Continuous premiums paid into the contract. The most common example of a periodic premium is a flexible premium.

Tax-Deferred Growth

Since an annuity is an insurance contract, the accumulation value grows tax deferred. Deferred annuities allow for the naming of a beneficiary to receive any policy values if the annuitant dies prior to annuitizing. Withdrawals prior to age 59 ½ are subject to income tax and generally a 10% tax penalty as well. Systematic withdrawals are allowed as a way to access the policies values without having to elect a settlement option.

Personal Uses of Annuities: Retirement fund accumulation

A deferred annuity that is held outside an IRA allows for the accumulation of earnings on a tax-deferred basis. The earnings may come from current or guaranteed interest credits, excess interest credits linked to the performance of a stock index, or from separate account investment performance. The premiums paid-in are not eligible for a tax deduction. An IRA annuity may allow for all or part of the premiums paid to be tax deductible. Since an annuity is already tax-deferred, having it held inside an IRA account does not provide any additional tax deferral benefit

Qualified Annuities

A qualified annuity is funded with pre-tax dollars, meaning the contribution itself could qualify for a tax deduction, lowering taxable income. The entire distribution from a qualified annuity (contributions and earnings) is subject to ordinary income taxes.

Nonforfeiture Provisions of Deferred Fixed Annuities

An annuity owner will not lose the value accumulated up to the point where they stopped paying into the contract. Nonforfeiture provisions give the owner the rights to the accumulation in the contract. The owner has the right to surrender the contract during the accumulation period. Remember, these provisions only apply to deferred annuities since immediate annuities do not have an accumulation period.

Insurance Aspects of an Annuity

Annuities are insurance products based on a mortality table. If a life contingency settlement option is chosen, the insurance company guarantees to provide an income benefit payment as long as the annuitant lives (for example, life only or joint and survivor). Actuarial assumptions based off of the law of large numbers allow this to occur.

Flexible Premium Deferred Annuity (FPDA)

Flexible contributions may be made as often and in whatever amount the contract owner desires. However, most insurers set a minimum and a maximum amount for contributions. Benefits begin more than 1 year from the issue date.

Annuity Payments

Once a contract is annuitized, the insurance company takes ownership of funds in the account. In return, the annuitant is entitled to a guaranteed income stream based on the terms of annuitization. Depending on the option chosen, the annuitant may be able to name a beneficiary to receive any remaining benefits available upon the annuitant's death. Annuity income is based on annuity tables which are similar to mortality tables used for life insurance. Other factors that determine the income include the accumulation amount, interest rate return, age and gender of the annuitant, and the payment option selected.

Annuity Uses/ Suitability of the Product to the Intended Purchaser

Suitability describes the steps that must be taken by a producer to ensure that an annuity is addressing a prospective owner's needs and financial objectives at the time of the sale. Additional factors used when determining suitability include the age, income, risk tolerance, and potential use of the annuity.

Accumulation (Pay-In) 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. Accumulation periods are found within deferred annuities.

Annuity Payment Options: Annuity Certain

Annuity benefit payments are received for a specified period of time or a specified amount of periodic income. If the annuitant dies with time remaining on the period certain or a balance is left in the account, the named beneficiary receives the balance of the payments.

Annuity Payment Options: 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.

Annuity Payment Options: 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.

The Annuity Period (Pay-Out/Liquidation): Lump Sum

The annuitant has the option of cashing out the annuity in a lump sum instead of electing to receive a stream of income. There could be tax consequences and tax penalties depending upon when this occurs.

Nonforfeiture Provisions: 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.

Premium Payment Options: Flexible Premium

Flexible contributions may be made as often and in whatever amount the contract owner desires. However, most insurers set a minimum and a maximum dollar amount they will accept.

Death Benefits

In addition to providing a guaranteed income benefit payout for life, an annuity also has another guarantee if the annuitant dies prior to annuitizing the contract. In this case, the policy has a named beneficiary, just like a life insurance policy, whereby the insurer pays out an amount equal to the premiums paid or the account value, whichever is greater.

Personal Uses of Annuities: Lump sum structured settlements

Lump sum payments from lawsuits, lottery winnings, or an inheritance can be used to purchase a structured settlement in the form of an annuity. The annuity can then be used to provide guaranteed lifetime income to the annuitant.

Types of Annuities: Indexed (or Equity Indexed) Annuity

A fixed annuity product with interest rates that are linked to the positive performance of a stock market related (equity) index, such as the Standard & Poor's 500 Index. The contract owner enjoys safety of principal and some guaranteed minimum returns. The safety of principal and previously locked-in interest is backed by the insurer's general account. The minimum guarantee can be as low as 0% reflecting that the policy will not be adversely affected by negative stock market index performance. These contracts typically have a fixed account from which funds are transferred into the index selected. They also tend to have higher surrender charges and longer surrender charge periods.

Personal Uses of Annuities: Education Funding

An annuity can provide funds to help offset the costs of a college education. Using a systematic withdrawal or a settlement option will provide for an income stream to help meet or offset some of the expenses incurred.

Fixed Amount Annuity Certain

An annuity where the periodic amount is specified but not the number of payments needed to pay out (liquidate) the sum in question. Often used in settlement options.

Annuity Payment Options: Life Income Joint & Survivor

Annuity is payable to 2 annuitants (in one check) while both are living. Upon the 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 ½ Survivor,

Nonforfeiture Provisions: Waiver

Annuity surrender charges are generally waived if the annuitant is hospitalized for an extended period, placed in a nursing facility for at least 30 days, becomes disabled, or dies.

The Annuity Period (Pay-Out/Liquidation)

The annuitization period begins once the policyowner elects to convert a deferred annuity into an income benefit payment. The settlement option selected can provide a temporary or lifetime payment. If a lifetime benefit is selected, in most cases it is an irrevocable election. The cash values go towards paying for the income benefit.

Annuity Payment Options: Life Income with Refund (Installment or Cash Refund)

Annuity is payable for the lifetime of annuitant. 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 as a lump sum, or cash refund, or in installments, sometimes referred to as the installment refund.

Annuity Contract: 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. An owner, who may also be the annuitant, may change the annuity date, beneficiary, and payout option.

Annuity Contract: 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.

Single Premium Deferred Annuity (SPDA)

A single premium (lump sum) is put into an annuity from which the annuitant will draw the benefits at some specified time in the future, more than 1 year from the issue date.

Types of Annuities: Fixed (Guaranteed) Annuity

During the accumulation period, the insurer guarantees a minimum fixed interest rate. At annuitization benefits are paid as a minimum level fixed amount. The fixed amount purchasing power decreases as the cost of living increases. The actual rate of interest created at any one time is based on the earnings rate of the insurer's general account and the insurer bears any investment risk. Only a life insurance license is required in order to sell fixed annuities in most states. Some fixed annuities offer a base interest rate plus a bonus interest rate which becomes the current rate credited into the annuity. The current rate is set by the insurance company at the time the contract is issued and is guaranteed for a specific time period.

Annuity Classifications are based on: (List four)

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

Non-qualified Annuities

A non-qualified annuity is funded with after-tax dollars, meaning taxes on the money were paid before it goes into the annuity. Upon distribution, only the earnings are taxable as ordinary income.

Single Premium Immediate Annuity (SPIA)

A single premium (lump sum) is put into an annuity from which the annuitant may immediately begin drawing benefits (within a year of the issue date). A retirement plan rollover, savings account balances or CDs, mutual funds, deferred annuity values, or the death proceeds of a life insurance policy might be used to purchase a SPIA.

Personal Uses of Annuities: Purchase other insurance

Annuities can be used as a funding vehicle for insurance premiums for which the consumer may have a need. If an annuity has a large amount of tax deferred earnings then, upon death, the beneficiary will receive the payout and be responsible for paying income taxes according to his/her tax bracket. This may force him/her into a higher tax bracket overall. Instead the annuity can be used either through systematic withdrawals or a settlement option to buy life insurance which will pay out a death benefit income tax free to the beneficiary.

Annuity Payment Options: 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 than any of the other options.

Personal Uses of Annuities: Retirement income

The funds accumulated inside an annuity can be used to fund all or part of a consumer's retirement income. The accumulated funds can be used to purchase a settlement option which can provide for a lifetime income stream or an income stream that can end prior to the annuitant's death. The income received will be tax-free as far as the portion of the payment is counted as a return of premium while the balance would be taxable as ordinary income. If premiums were deductible, then the entire income received would be subject to tax. The only exception is if the income comes from a Roth IRA annuity whereby the income stream would be tax-free under certain qualifying situations. A Guaranteed minimum withdrawal benefit (GMWB) is an optional benefit that can be purchased to help annuitants protect their retirement income from a down market. This option allows the annuitant to withdraw a maximum percentage each year until the initial investment has been paid out.

Immediate annuity

The immediate annuity does not have an accumulation period and is used to generate immediate income within a year of the issue date

Annuity Contract: Beneficiary

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

Types of Annuities: Market-Value Adjustment (Adjusted) Annuity

This is an annuity product that features fixed interest rate guarantees combined with an interest rate adjustment factor that can cause the surrender value to fluctuate in response to market conditions. Upon withdrawal, the MVA will add or deduct an amount from the annuity or the withdrawal amount. If the interest rates on which the MVA is based are higher than when the annuity was purchased, the MVA will likely be negative, meaning an additional amount may be deducted from either the annuity or the withdrawal amount. If the interest rates on which the MVA is based are lower than when the annuity was purchased, the MVA will likely be positive, meaning money may be added to either the annuity or to the withdrawal amount.

Nonforfeiture Provisions: 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 ½ years of age. This discourages withdrawals. The tax penalty does not apply if premature distributions occur due to the death or disability of the contract owner.

Personal Uses of Annuities: Long-term care benefits

Today's annuities may offer riders which will help offset some of the costs associated with providing long-term care. As with most riders there is an additional cost associated with it. A few companies offer a combination deferred annuity and long-term-care policy that allows for the leverage of single premiums 3-to-1 or 2-to-1. For example, a $100,000 single premium deferred annuity could pay up to $200,000-300,000 in long-term-care benefits. Generally the annuity values must be used then if needed the long-term care benefit kicks-in. The annuity funds used for long-term-care costs are tax-free.