Life and Health - Chapter 5 - Annuities

Premium Payment Options - Fixed Premium

Fixed premiums are scheduled as to time and amount, such as $100 per month, and cannot fluctuate.

Annuity Classifications are based on:

-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)

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.

Deferred Annuity - 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 - 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.

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.

Nonforfeiture Provisions - Surrender Charges

When a contract is fully surrendered, any surrender charges will lessen the contract payout. This is also referred to as a back-end load. Surrender charges diminish over a stated number of years, set by the insurer, until they disappear.

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

Annuity Payment Option - 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. An annuity guaranteed to pay out for a specific number of years (such as a typical, state lottery prize) is called a fixed period. If the periodic amount is specified, but not the number of payments needed to pay out (liquidate) the sum in question, then the annuity certain is called a fixed amount. Both forms are often used in settlement options.

Annuity Payment Option - 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.

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.

Fixed/Flexible Premium Deferred Annuity (FPDA)

Fixed or flexible premiums are made as installments and are either schedule as to time and amount, or can fluctuate. Benefits begin more than 1 year from the issue date.

What is "fixed" in a fixed annuity? The annuitant The interest crediting rate The beneficiary The investment option in the separate account

The interest crediting rate The "fixed" portion of a fixed annuity is the interest crediting rate, which may change at the discretion of the insurance company, but not less than the guaranteed minimum. A fixed annuity also promises a fixed payment to the annuitant when the contract is annuitized.

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.

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.

Premium Payment Options - Periodic Premium

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

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.

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.

While life insurance may accumulate money that a person could use in retirement, none promise the same long term benefit of a non-qualified annuity, which is ________________. A stream of income the annuitant cannot outlive Tax-free payments for the lifetime of a beneficiary Tax-free money for college education or other qualified expenses Tax-deferred growth of principal

A stream of income the annuitant cannot outlive Although both annuities and life insurance offer tax-deferred growth of principal, the long term benefit of an annuity is the lifetime income stream available at any time to the annuitant.

Nonforfeiture Provisions

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.

Concept of an Annuity

Annuities are used primarily to provide a steady stream of income to an individual typically upon retirement. In theory, an annuity is designed to protect against outliving an individual's retirement income by providing lifetime income. One of the primary functions of an annuity is to liquidate an estate, or to pay benefits until the death of an annuitant. In direct comparison to life insurance, an annuity could be referred to as the opposite of a life insurance policy. Annuities are funded and sold through life insurance companies and require at least a life insurance license to sell.

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 Option - 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.

Deferred Annuity Characteristics

Deferred annuities 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.

Which of these annuity distribution options promises the largest possible payment to a single annuitant? Life income only Life income with period certain Installment refund Lump sum refund

Life income only Because the insurance company has no way of knowing how long the annuitant will live, and because the contract is created for the benefit of the annuitant, a life only option provides the largest possible payment. The insurance company is at greater risk of paying more than the principal value at the time of annuitization, so it pays a larger amount based on the life expectancy of the annuitant.

Annuity Period - Annuitization

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

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.

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.

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.

Variable Annuity

Variable annuities are regulated by the SEC, FINRA, and State insurance departments. Annuity payments and cash values fluctuate according to the investment experience of the separate account the contract owner has designated. Payments are based on "units" rather than dollars. While not guaranteed, variable annuities may act as a hedge against inflation. This protects against the purchasing power risk of a fixed payment annuity by providing income that trends toward keeping pace with inflation. The contract owner bears the investment risk and receives the return earned on invested assets, less any charges assessed by the insurer and investment managers. There is no guaranteed return. The premium paid during the accumulation period is invested in separate account; the underlying investment in the separate account is similar to a mutual fund. The investment return varies according to the separate account selected based on the assumed interest rate (AIR). If the actual return is lower than the AIR, the monthly annuity payment will be reduced. If the actual return is equal to the AIR, the monthly annuity payment will remain the same as the previous month. If the actual return is greater than the AIR, the monthly annuity payment will increase from the previous month. Both an insurance license and a securities license (FINRA) are required. This annuity is considered a security, and therefore, must comply with the Federal Securities and Exchange Commission (SEC) rules as well as the state insurance laws. A prospective buyer of a variable annuity must be provided with a document called a prospectus. The prospectus gives detailed information on the separate account available in the annuity. This information provides the contract owner the opportunity to make a better decision based on the historical performance of the separate account. The prospectus must be provided at or before the time of the sale. The premium payments made during the accumulation period may be flexible in amount and frequency limited only to the contract's provisions. Premiums purchase accumulation units of the separate account. These are similar to shares of a mutual fund. Upon annuitization, accumulation units are converted into annuity units. The number of annuity units liquidated remains level, but the unit value fluctuates, based upon the performance of the separate account.

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 Payment Option - 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.

Control of the 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.

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.

Qualified vs. Nonqualified 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. 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.

Annuity Payment Option - 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 Uses

Before determining the use of an annuity, it is important to determine the 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.

Premium Payment Options - Single Premium

A lump sum payment is made into an annuity

Types of Annuities - Indexed (or Equity Indexed) Annuity

An 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.

Annuity Payment Option - 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,

Business Uses of Annuities - Employer sponsored qualified retirement plans

-Annuities are usually purchased by individuals. They may also be purchased as part of a structured corporate pension plan referred to as a Group Annuity. A Group Annuity is a contract between the insurer and the employer and is set up for eligible employees. Each employee receives a certificate. This is a defined benefit plan under IRS rules. -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. -Corporate owned annuities lose the tax-deferral aspect of the policy and interest or gains are taxable as income in the year earned. -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 of 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 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.

A contract that is designed to accumulate value over time with the intent to distribute the funds over the lifetime of an individual is called _________________. Whole life insurance Variable life insurance An endowment An annuity

An annuity Annuities are designed to liquidate accumulated assets rather than to create a sum of money as a direct benefit for another person. When an annuity is not already annuitized, it is subject to state insurance nonforfeiture laws, and the contract value must be paid to a beneficiary, to the owner, or to the owner's estate following the death of the annuitant.

Annuity (Benefit) Payment Options

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.

What is different about a corporate owned nonqualified annuity compared to an individually owned nonqualified annuity? It earns a rate of interest limited by the IRC Interest or gains are taxable as income in the year earned It does not provide a death benefit guarantee of principal to the beneficiary Interest or gains are taxable as capital gains, not ordinary income

Interest or gains are taxable as income in the year earned Corporate owned annuities must be associated with a qualified retirement plan for the corporation to avoid current income taxation. There are no interest rate limitations for annuities in the IRC. All annuities provide a death benefit guarantee prior to annuitization; a corporate owner of an annuity will name itself as the beneficiary.

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 Scheduled and unscheduled additions of principal at any time prior to annuitization Limited partial surrenders each year not subject to a surrender charge Annuitization at any time. A deferred annuity may not be annuitized as long as there is a surrender charge applicable to the principal value

Payments to the annuitant beginning within one month of the issuance of the contract By definition, a flexible premium annuity allows the addition of more principal value at any time prior to annuitization of the contract. An annuity that begins payments to the annuitant within one month of policy issue is a Single Premium Immediate Annuity ("SPIA").

Control of the 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.

Annuity Period - 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.

Control 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 annuitization or if the settlement option selected offers any residual benefit after the annuitant's death. As with life insurance, annuities may have beneficiaries named and designated by the owner prior to the annuitization or guaranteed payout period. The beneficiary may be named at receipt of the first purchase payment and may only be changed by the owner. The owner's rights begin at the time of purchase. An owner, who may also be the annuitant, may change the annuity date, beneficiary, and payout option. During the accumulation period, if the contract owner and the annuitant are the same person and the designated beneficiary is the annuitant's spouse, the IRS code allows the spouse to assume ownership of the annuity upon the death of the annuitant. All rights of ownership are assumed to include tax deferment.

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.

A "Joint and ½ Survivor" distribution option means which of the following statements is correct? The annuitant receives a full share of the annuity payment each month, and the beneficiary receives a one-half share of the payment The annuitant receives a full share of the annuity payment and the spouse receives an additional one-half of that There are two annuitants named in the policy and each contributes one-half of the monthly premium or the lump sum that establishes the annuity When one of the joint annuitants dies, the survivor's continuing payments will be one-half of the total payment both were receiving

When one of the joint annuitants dies, the survivor's continuing payments will be one-half of the total payment both were receiving A Joint and ½ Survivor annuity pays half of the total payment two or more annuitants were receiving when the contract was first annuitized. Payments continue until the last surviving annuitant has died.