Annuity Suitability and Uses

Annuity Suitability and Uses

Annuities have many uses. They can be used purely as a means to regularly distribute a given sum of money (immediate annuities). Or, they can be used to accumulate funds on a tax-deferred basis for future use (deferred annuities). They are particularly well suited when a person needs a guaranteed stream of income payments for his or her life.

Key Points

-Potentially steep surrender charges can make deferred annuities unsuitable for seniors who are simply interested in a place to hold their savings. Also, an immediate annuity may not be suitable for someone with a limited life expectancy. -Choosing an annuity to fund a qualified plan should not be based on its tax-deferral feature since the qualified plan itself makes the growth of the funds tax-deferred, with or without the use of an annuity. -An annuity is most suitable for retirement planning purposes when the contract owner wishes to use it to provide guaranteed lifetime income. -A group annuity has the same features as an individual annuity except that it is written on a group contract basis

Structured Settlements

Annuities are used to distribute funds from the settlement of lawsuits or from the winnings of state lotteries. A person injured in an accident or by the actions of another party is often awarded a sum of money through a court settlement. In many cases, the award of a settlement amount is not made all at once. Payments over time may be required. Similarly, a state lottery board may also offer a person a choice in how they receive the winnings. For example, instead of a lump-sum amount, they can receive them in installment payments over a 10- to 20-year period. In both cases, structured settlement annuities are commonly used. This type of annuity pays out to the injured party or to the lottery winner a stream of payments over the specified period.

Annuity Contract Provisions and Riders

Deferred annuities include provisions and optional riders that give contract owners flexibility in choosing how to distribute accumulated funds. -Liquidity Provisions and Riders Some provisions and riders spell out conditions in which distributions may be made from a deferred annuity without a surrender charge. Common examples include: --charge-free withdrawals provision—Some deferred annuities permit contract owners to withdraw a specified percentage (e.g., 10 percent) of the accumulated value annually without a surrender charge. --terminal illness rider—This rider waives surrender charges if the annuitant incurs a terminal illness. In most cases, death must be expected within one year of diagnosis. --disability rider—This rider allows the contract owner to withdraw funds without a surrender charge if the owner becomes disabled and remains so for a specified period of time (usually ranging from 60 days to one year). --long-Term care rider—With this rider, the contract owner can withdraw funds without a surrender charge if confined to a nursing home. -Special Variable Annuity Riders Variable annuities (VAs) have special riders that add a guaranteed element to their withdrawal options. Common examples include: --guaranteed minimum accumulation benefit (GMAB) rider—A GMAB rider guarantees that the VA's accumulated value will be at least equal to the sum of premiums paid after a specified period of time (typically five to ten years) minus previous withdrawals. Some insurers include the ability to lock in gains in the accumulation value at that point in time, so that thereafter the guaranteed minimum accumulation value equals the sum of premiums paid plus the locked-in gains --guaranteed minimum withdrawal benefit (GMWB) rider—With this rider, the contract owner can withdraw an amount at least equal to the sum of premiums paid. Annual withdrawals are usually limited to a specified percentage (e.g., 5 to 10 percent) of total premiums paid. --guaranteed minimum income benefit (GMIB) rider—This rider provides a guaranteed minimum life income regardless of the contract's accumulated value. It adds a growth factor that assures a guaranteed minimum account value. At a specified future date, the deferred VA may be converted to an immediate annuity that provides income payments based on the greater of the guaranteed minimum account value or the actual accumulated value. --guaranteed lifetime withdrawal benefit (GLWB) rider—With this rider, the contract owner receives a lifetime income without having to convert to an immediate annuity. This rider usually lets the owner access undistributed contract values in addition to the income payments already received, though doing so will diminish income withdrawals thereafter (since the remaining account balance from which they are drawn will be decreased).

Uses of Annuities in Qualified Retirement Plans

People can use annuities as a vehicle for a qualified retirement plan. Such plans generally include IRAs, SEPs, or 403(b) plans. The employer (or, in the case of an IRA, the individual) sets up the plan. He or she may then buy a deferred annuity to fund the plan. If a deferred annuity is used to fund a qualified retirement plan, then the premiums are tax deductible by the plan owner or sponsor. Choosing an annuity to fund a qualified plan should not be based on its tax-deferral feature since the qualified plan itself makes the growth of the funds tax-deferred, with or without the use of an annuity. An annuity is most suitable for retirement planning purposes when the contract owner wishes to use it to provide guaranteed lifetime income (something other retirement planning instruments except traditional pension plans cannot do). In fact, defined benefit pension plans are required to distribute benefits in the form of lifetime annuitized payments. Pension plan administrators use the participant's accrued pension benefits to buy a single premium immediate annuity (SPIA). This type of annuity pays out lifetime income to the participant on either a joint-life or single-life basis. --403b plans= retirement plan reserved for non-profit organization and their employees. Both contribute funds into the plan. Funds are directed into individual accounts set up for each participating employee. Contributions are not taxable to the employee when they are made. Rather, they grow tax-deferred until they are distributed. Also called a tax-sheltered annuity plan (TSA)

Use Annuities to Fund Life Insurance

A common fear among annuity contract owners is that they will die shortly after income payments have commenced, leaving little for their survivors. Choosing the right settlement option is certainly one way to alleviate this concern. Another is to use a portion of the annuity income payment to purchase life insurance. At the annuitant's death, the life insurance can be used to provide the beneficiary with a potentially substantial sum of money which itself can be converted into lifetime income. One approach to this strategy is to use the taxable portion of the annuity to fund the life insurance purchase. Every annuity income payment consists partly of a tax-free return of premium and partly of taxable interest. Determining the split is done through an exclusion ratio calculation (discussed in a following lesson). Using the taxable portion of the annuity payment to fund life insurance effectively uses money that will be taxed to pay for a life insurance death benefit that is usually not income taxable --exclusion ratio= applied to each annuity payment to determine the portion that is excluded from tax.

Individual Uses of Annuities

Annuities are used most often for retirement planning purposes: -to accumulate retirement savings -to pay out retirement funds on a periodic basis for a period that can be guaranteed to last as long as they do Life annuities ensure that one's income cannot be outlived. As distribution vehicles, annuities can be structured to fit almost any payout period or term. They can even ensure that income continues for the lives of two people. Older married couples especially want this feature. All deferred annuities offer the guarantee of a death benefit, which is distributed if the owner or annuitant dies during the accumulation period. In this situation, a beneficiary receives as a death benefit no less than the amount invested in the contract. (This also applies to variable annuities, which guarantee a death benefit equal to at least the premium invested.) Because deferred annuity funds accumulate on a tax-deferred basis, it is possible that deferred annuities may realize greater net returns than comparable taxable investments (e.g., certificates of deposit). The power of compounded interest earnings plus tax deferral can produce large funds over time. Deferred annuities can be used for almost any purpose that needs future income. In addition to accumulating retirement savings, people can also use deferred annuities to fund a child's education. One way to do this is to set up an interest-only payment plan, in which interest earned on the deferred annuity is distributed but the principal remains intact. However, deferred annuities should be reserved for people who have long-term investment goals and time frames. This is because deferred annuities typically impose surrender charges on funds withdrawn during a contract's early years. In addition, withdrawals from annuities before the owner's age 59½ may be subject to a tax penalty

quiz

Question 1 The Acme Company sets up a plan that provides annuities to its employees when they retire. The individuals those annuities cover hold "certificates of participation." Which type of plan is that? 403(b) plan -group annuity fixed annuity multiple-lives annuity This is a made-up term. Question 2 The purpose for a long-term care rider with a deferred annuity contract is to Allow the annuity owner to assign the deferred annuity to a nursing home Allow tax-free withdrawals from the deferred annuity if the annuitant requires long-term care. Allow the deferred annuity to be annuitized earlier than age 65 if the annuitant requires long-term care. -Allow withdrawals from the deferred annuity without a surrender charge if the annuitant is confined to a nursing home. The long-term care rider lets annuity contract owners withdraw funds without a surrender charge if they become confined to a nursing home. Question 3 For which of the following purposes are annuities most often used? short-term savings -retirement planning estate planning income protection in the event of death People use annuities most often for retirement planning purposes: to accumulate retirement savings and/or to pay out retirement funds on a periodic basis for a period that can be guaranteed to last as long as they do. Question 4 Which of the following best typifies the use of a structured settlement annuity? Rachel wants to use a portion of her monthly annuity payment to fund a life insurance policy in which her husband is the beneficiary. -Shirley was paralyzed in a car accident, and a jury awarded her $2 million which must be paid to her over a 20 year period. Carl wants to save money in a financial product that will grow on a tax-deferred basis and, at retirement, provide him with income that he cannot outlive. Dick recently retired and wants to take his vested retirement plan money and divide it between a lump sum payment and payments made over his lifetime. A person injured in an accident or by the actions of another party is often awarded a sum of money through a court settlement. If payments are to be paid over time, a structured settlement annuity is used. Question 1 A deferred annuity would be a suitable recommendation for all the following needs EXCEPT Chris, age 43, wants to set up a non-qualified retirement savings account where the growth is tax-deferred even though the premiums are not tax deductible. Betty, age 48, received a distribution from her previous employer's retirement plan and wants to roll that money into a product that will preserve the tax benefits of the qualified money and provide her with lifetime retirement income when she retires. -Joe, age 23, wants to save money to buy a first home within 10 years. Celeste, age 48, inherits $200,000 and wants to save it somewhere that will grow tax-deferred until she retires in 20 years. Deferred annuities are suitable for IRA rollovers, and unlike other types of assets they can be used to provide guaranteed income for life at retirement. Question 2 All of the following are accurate reasons for not using deferred annuities for short-term accumulation goals EXCEPT: possible penalty tax upon distribution possible surrender charges upon distribution possible immediate taxation of gain upon distribution -possible loss of accrued interest earnings upon distribution If the annuity owner is less than age 59 ½ when a withdrawal is taken from a deferred annuity, the amount withdrawn may be subject to a 10% penalty tax Question 3 Which one of the following most correctly describes the process that occurs when a group annuity member retires? The employer buys a variable annuity, which pays the benefits promised retirees in the group contract. -An individual annuity contract is issued to the retiring member using funds from the group contract. The retiree converts his or her accumulated share of the group contract into an individual annuity. The group annuity begins paying the monthly income amount directly from the group contract. The employer does not buy a variable annuity. Question 4 After Bob and Karen won the lottery, their state lottery board offered them a choice in how to receive their winnings. Instead of a lump sum, Bob and Karen chose to receive the funds in installment payments over a 10- to 20-year period. In this case, what is the state lottery board most likely to do? -buy a structured settlement annuity from an insurance company to pay a stream of income to the lottery winners over the specified period buy a deferred annuity from an insurance company to pay the lottery winners a stream of payments over the specified period buy an equity-indexed annuity from an insurance company to pay the lottery winners a stream of payments over the specified period pay Bob and Karen a stream of payments over the specified period using state funds The board would most likely buy a structured settlement annuity from an insurance company. This type of annuity pays streams of income payments to lottery winners over specified periods.

Annuity Suitability

While they are ideal solutions for many people looking for assurance that they cannot outlive their income, annuities are not for everyone. For example, potentially steep surrender charges can make deferred annuities unsuitable for seniors who are simply interested in a place to hold their savings. Also, an immediate annuity may not be suitable for someone with a limited life expectancy. Most states have adopted regulations that require producers to determine the suitability of all annuity recommendations, especially those involving seniors. These state regulations generally follow the 2010 Suitability in Annuity Transactions Model Regulation adopted by the National Association of Insurance Commissioners (NAIC). This model regulation accomplishes the following: -It establishes a regulatory framework that makes insurers responsible for ensuring that annuity transactions are suitable, even if the insurer uses another party to supervise or monitor producer recommendations in the sale of annuities. (In other words, insurers are not exempt from suitability requirements simply because they outsource the monitoring process associated with this requirement.) -To the extent practical, it makes state annuity suitability standards consistent with the annuity suitability standards imposed by the Financial Industry Regulatory Authority (FINRA). The model regulation also requires two types of annuity suitability training for producers who sell annuities: -carrier-specific training in which insurers provide product training for any producer selling their annuity products -industry-specific training that requires producers to complete a one-time annuity training program (minimum four hours) provided by an approved education provider If your state has specific annuity training requirements, they are covered in the state law section of this course.