Chapter 6

Single Premium Deferred Annuity (SPDA)

A lump sum payment is made to the insurer, and the payments to the annuitant are deferred until a specified time. The monies deposited grow tax-deferred until annuitization.

Funding Method

Funds that build up during the accumulation period of an annuity are termed principal. There are two ways to fund the principal sum: Single premium (lump sum payment) or A series of periodic payments paid over time.

Annuity Basics

Annuities are investment tools that are funded with a sum of money that is either paid in one single payment, or through multiple payments. The fund earns a rate of interest that is tax-deferred, allowing the annuity to grow in value. If the annuitant dies prior to the payout period, a "death benefit" is paid to a beneficiary in an amount equal to the funds plus interest in the annuity. The annuitant is the person who receives the annuity payments. The individual who purchases the annuity, pays the premiums, and has rights of ownership is the contract owner. The individual whose life the annuity has been issued is termed the annuitant. The annuitant is the person who receives the annuity payments. The annuitant must always be a natural person, but the contract owner can be any legal entity or a natural person. Frequently, the contract owner and the annuitant are the same person, but this is not always the case. For example, a corporation may own an annuity with an employee as the annuitant. The beneficiary is the person who receives survivor benefits if any, upon the annuitant's death.

Male = Larger Benefit Longer Anticipated Lifespan = Smaller Benefit Shorter Anticipated Lifespan = Larger Benefit

Example: Robert has twin 50 year-old sons. They also purchase immediate annuities and the monthly payments that they receive are lower than Robert's payments - because of the number of years that the payouts will be made, based on their ages, is longer than their dad's.

Loading Costs

Loading Costs: The amount of a premium payment must include a portion of the insurer's operating expenses. These operating costs that the annuity owner must contribute to via premium payments are considered loading expenses and are factored into the amount of premium payments.

Annuities may also be funded by periodic premiums paid over time.

Premiums may be paid: Monthly, Quarterly, Semi-annually, or Annually. Annuities funded by periodic premiums may have: Level premiums or Flexible premiums.

Installment Refund Option

Similar to the cash refund option, the installment refund option pays the annuitant income for life. The difference: upon the annuitant's death the beneficiary will receive the balance of annuity funds, equal to the remaining funds in the annuity, paid in installments. Example: If Tom's $100,000 installment refund annuity pays him $1,200 monthly annuity payments, then upon Tom's death, Linda will receive $1,200 monthly annuity payments until the balance of principal is disbursed.

Annuities protect against: Select one: a. The risk of prolonged life b. The risk of premature death c. The risk of accident or sickness d. The risk of disability

a

The person who owns the annuity and pays the premiums is the: Select one: a. Contract owner b. Annuitant c. Beneficiary d. Annuity

a

The value of each accumulation unit varies: Select one: a. Daily b. Monthly c. Semiannually d. Annually

a The value of each accumulation unit varies daily.

All of the following statements are true regarding the accumulation period in an annuity, EXCEPT: Select one: a. The accumulation period is the pay-in period. b. During the accumulation period, the contract owner makes premium payments into the annuity. c. During the accumulation period, the principal earns compound interest. d. Premiums are paid with pre-tax dollars.

d Premiums are paid with dollars that have already been taxed; therefore, premiums are funded with after-tax dollars.

Classification of Annuities

Annuities are classified based on their investment configuration. Annuities are either: Fixed annuities - provide a fixed guaranteed interest rate Variable annuities - provide a variable interest rate A third type of investment configuration is equity-indexed annuities.

Assumed Interest Rate

The Assumed Interest Rate: When determining premium amounts, insurers estimate an assumed interest rate that would apply to the future investment of the premiums.

How do annuities provide guaranteed income for life? Select one: a. By systematically liquidating an estate b. By paying monthly disability income benefits c. By paying a lump-sum death benefit d. None of the above

a

What is a disadvantage of fixed annuities? Select one: a. Knowing the exact amount of each annuity payment b. Potential for higher interest earnings c. Earning potential may not be enough to offset the effects of inflation d. Investment in the insurer's separate account, which has the potential for higher yields

c The downside to fixed annuities is that the earning potential may not be sufficient to offset the effects of inflation. A variable annuity can address this problem.

Which annuity payout option has a distinct beginning and ending? Select one: a. Cash b. Lump-sum c. Life annuity d. Period certain

d A period certain has a distinct beginning and ending, so if income is needed for life, a life annuity is more suitable.

Single Premium

Annuities may be funded with a single lump sum premium. This immediately creates a principal sum. Annuities funded with a single premium are either: Single Premium Immediate Annuity (SPIA) Single Premium Deferred Annuity (SPDA)

Payout Options

Similar to settlement options for life insurance policies, annuity payout options are the ways to pay out funds from an annuity. Once selected, the payout option cannot be changed after payments begin. Aside from one lump sum distribution, there are six annuity payout options: Straight life Cash refund Installment refund Life with period certain Joint and survivor Period certain You will notice some of the life insurance settlement options are the same as annuity payout options.

Owner, Annuitant and Beneficiary

The individual who purchases the annuity, pays the premiums, and has rights of ownership is the contract owner. The individual on whose life the annuity has been issued is the annuitant. The annuitant is the person who receives the annuity payments. Frequently, the contract owner and the annuitant are the same person, but this is not always the case. For example, a corporation may own an annuity with an employee as the annuitant. The annuitant must always be a natural person, but the contract owner can be any legal entity or a natural person.

Annuity General

While life insurance protects against the risk of premature death, annuities protect against the risk of living too long. The risk involved with living too long is the depletion of financial resources and savings, such as a retirement fund. At its most basic level, an annuity provides a guaranteed income stream for life by systematically liquidating an estate. Two of the most common uses of annuities are: Providing lifetime income, and Accumulating money, such as for a retirement fund.

The phase during which premiums are paid into the annuity is the: Select one: a. Annuity phase b. Accumulation phase c. Annuitization phase d. Payout period phase

b

What accounting unit is used during the annuity phase of a variable annuity? Select one: a. Accumulation unit b. Annuity unit c. Premium unit d. Contract unit

b During the annuity phase, annuity units are used in lieu of accumulation units to determine the amount of each annuity payment. The number of annuity units is fixed and is based on the contract's dollar value investment in the separate account, and how much the first annuity payment will be.

Single Premium Immediate Annuity (SPIA)

A lump sum payment is made with the insurer, and payments to the annuitant start immediately.

Consumer Protection

Annuities can protect consumers against outliving their money. In addition, annuities can protect consumers from the volatile nature of the stock market, unlike stocks or mutual fund accounts.

Income Amount and Payment Guarantee

The Income Amount and Payment Guarantee: How much lifetime income payments will be and the amount of any payment guarantees, such as a 10-year period certain, also impact the amount of premiums. High annuity premium amounts result from high-income payments and long payment guarantee periods. Example: Robert has decided that he wants to have enough money to maintain his current lifestyle when he retires. So, he purchases an annuity and has a higher than normal premium payment - because he wants his lifetime income payments to be greater. Example: John wants to guarantee his income for 10 years after he retires, so his annuity premiums are also higher than average - because of the 10-year guarantee.

Annuities are defined as: Select one: a. The creation of an estate b. The systematic liquidation of an estate c. Income replacement d. A plan to pay medical expenses

b

Which of the following is the best definition of an annuity? Select one: a. Death protection b. Cash supplement c. Systematic liquidation of an estate d. Savings account

c

Premiums for a joint and survivor life annuity are based on the annuitants': Select one: a. Ages only b. Sex only c. Ages and sex d. Ages, sex and geographic location

c Premiums for a joint and survivor life annuity are based on the ages and sex of the annuitants.

ABC Insurer sells a $500,000 single premium immediate annuity to four different people. Who receives the largest check? Select one: a. 18-year old female b. 25-year old male c. 60-year old female d. 60-year old male

d The person with the shortest life expectancy will receive the highest annuity check.

Cash Refund Option

With the cash refund option the annuitant will receive income for life, and upon the annuitant's death, the beneficiary will receive the balance of annuity funds. The beneficiary receives a lump sum payment of the balance of funds in the annuity, in an amount equal to the funds upon annuitization minus income paid to the deceased annuitant. Example: Greg (the annuitant) received $33,025 from a $50,000 cash refund annuity while alive. When he died, Cindy - his wife and the beneficiary - received $16,975 (the balance in the annuity) in a lump sum payment. Cindy will have to pay income tax on the interest portion of the annuity payment.

For which of the following annuities must an agent have a securities license in order to sell? Select one: a. Variable annuity b. Equity indexed annuity c. SPDA d. Fixed annuity

a Variable annuities are regulated as securities products. Any agent selling a variable annuity or variable life insurance policy must have a securities license in addition to a life insurance license.

What are the two types of refund life annuity payout options? Select one: a. Single life and multiple lives b. Cash refund and installment refund c. Life annuity with period certain and straight life d. Fixed period installment and fixed amount installment

b The two types of refund life annuity payout options are cash refund and installment refund.

The person who receives annuity payments is the: Select one: a. Insurer b. Contract owner c. Beneficiary d. Annuitant

d

The amount of each monthly payment for a straight life annuity is based on the annuitant's: Select one: a. Age b. Sex c. Age and sex d. Age, sex, and amount of money in the annuity upon annuitization

d For life annuities, the amount of each periodic payment is based on the annuitant's age and sex and the amount of money in the annuity upon annuitization.

This annuity is regulated as a securities product and agents selling this product must have a securities license: Select one: a. SPDA b. Equity indexed annuity c. Fixed annuity d. Variable annuity

d Variable annuities are regulated as securities products. Any agent selling a variable annuity or variable life insurance policy must have a securities license in addition to a life insurance license.

Which of the following is characteristic of fixed annuities? Select one: a. Variable interest rates during the pay-in period b. Fixed interest rates during the payout period c. Annuity payment amounts are flexible. d. Premiums are invested in the insurer's separate account.

b Interest rates are fixed during both phases of the annuity. Each payment amount is fixed, and premiums are invested in the insurer's general account.

All of the following are true of the life with period certain annuity payout option, EXCEPT: Select one: a. The annuitant is provided with guaranteed income for life. b. Payments are guaranteed for a minimum number of years. c. Any balance in the annuity fund after the period certain ends is refunded to a beneficiary. d. The life with period certain option does not guarantee the full value of the annuity will be paid out.

c Any balance in the annuity fund after the period certain ends, is retained by the insurer.

Nick is single and retired at the age of 55. He does not have any dependent family members. Nick wants to purchase an annuity that will give him the largest monthly income. What annuity would you recommend to him? Select one: a. Straight life annuity b. Life annuity with period certain c. Refund life annuity d. Joint and survivor life annuity

a The straight life annuity provides the largest amount of periodic income because it does not have any _guarantees._

Immediate Annuities = Don't Have Accumulation Period

Annuity payments that begin immediately after the annuity is purchased are immediate annuities. Unlike deferred annuities, immediate annuities do not have an accumulation period. This is because a single premium must be used for purchase, and the payout period must begin within one year. This type of annuity is called a single premium immediate annuity (SPIA) because a single premium is used to purchase the immediate annuity, and the payment period begins one payment period from the date the annuity was purchased. Example: David, who is retired, inherited some money from his grandfather. He used the money to purchase a single payment immediate annuity on February 1st specifying monthly payments. His payments began on March 1st.

The amount of each annuity payment is based on three factors:

The amount of the original sum of money (the principal), The duration of the payout period, and The assumed interest rate. With this information, it is possible for anyone to establish an annuity. However, only life insurance companies can offer an annuity that provides guaranteed income for life (the "survivorship factor") because they have mortality data.

Which of the following is not true about the impact of the annuitant's sex on the premium payments? Select one: a. Men live more dangerously so their premiums are higher. b. Women live longer than men, so their premiums are higher. c. Both of the above. d. Neither of the above.

a Men's premiums are typically lower than women's because their life expectancy is shorter. The dangers of their lifestyle may impact life insurance premiums, but do not impact the annuity premiums.

Lucas purchased an annuity for himself. He begins to receive annuity payments. If the amount of premium in the annuity has not been paid out upon his death, then his grandson will receive the balance. What type of annuity does Lucas have? Select one: a. Straight life b. Period Certain c. Cash Refund option d. Joint and survivor life

c The cash refund option is an annuity that pays for the entire life of the annuitant. If the annuitant dies before the premiums in the annuity have been paid out, then a beneficiary will receive the balance.

Alex purchases a single premium immediate annuity on March 1. If he elects monthly annuity payments, when will he receive his first annuity payment? Select one: a. March 15th b. March 31st c. April 1st d. May 1st

c With an SPIA, the first payment begins one payment period from the date the annuity was purchased. Therefore, if payments are scheduled to be made monthly, the first payment will be made one month after the annuity purchase date.

Premiums from variable annuities are put into the insurer's separate account, and then invested in various equity investments, such as the stock market. This account is separate from the insurer's general account.

Variable annuities are considered securities products, and as such, must be registered with the SEC. Furthermore; the SEC is responsible for regulating the separate account of a variable annuity. Producers selling variable products must have a securities license - series 6 or 7 - in addition to a life insurance producer license. While the SEC regulates the investment portion of the variable annuity, the state insurance department is responsible for regulating the insurance portion. In addition, the NASD regulates brokers and dealers selling variable annuities. Variable annuities are back-end loaded, meaning the insurer may charge a surrender fee if the contract owner surrenders the policy instead of annuitizing. The amount of the surrender fee is based on how long the contract was in force. Since variable annuities have variable interest rates, accumulation units and annuity units are used to account for annuity income and benefit payments. Example: Because Paul opted for a safe investment, his wife Laura thought she could take more risk. Consequently she invested in a variable annuity. With this choice, Laura chooses how (where) to invest the money - and the value of her annuity will be dependent on the performance of her investment choices.

Which of the following statements regarding the amount of each annuity payment is true? Select one: a. The younger the annuitant is, the higher the annuity payment. b. Fixed annuities have variable annuity payments. c. Variable annuities have fixed annuity payments. d. Women typically receive lower annuity payments.

d Fixed annuities (annuities with a fixed interest rate) pay fixed annuity payments, and variable annuities pay variable annuity payments. The older the annuitant is, the more likely the annuitant is to die, so the higher the annuity payment. This is the reverse logic of life insurance: the longer the annuitant is expected to live, the lower the annuity payment. Because women are expected to live longer than men, the annuity payment for women will be lower.

Equity Indexed Annuities

Equity indexed annuities are fixed annuities that provide a guaranteed minimum interest rate. Equity indexed annuities differ from traditional fixed annuities in that the current interest rate exceeding the minimum guaranteed interest rate is tied to an equity index, such as the S&P 500. Therefore, equity indexed annuities have the potential for higher returns, while providing a guaranteed principal. The guaranteed minimum interest rate is typically 3% or 4%, providing a minimum growth rate. The contract's accumulation period is between five and seven years, at which point either the guaranteed minimum value or the indexed value is credited to the account, whichever is greater. When the contract owner is ready to withdraw the funds from an equity indexed annuity, he or she can take a lump sum distribution or annuitize the contract and receive periodic payments.

Annuity Phase

The annuity phase is the income or payout period when payments from the annuity are being made to the annuitant. Annuity payments are made: Monthly, Quarterly, Semiannually or Annually. Each annuity payment is comprised of: Principal - not taxable, since it was funded with after-tax dollars Interest - taxable income

Period Certain Option = Doesn't Guarantee Life Income

Unlike a life annuity, the period certain option does not guarantee a life income. Instead, it provides income for a fixed time period, such as 10 or 15 years. An annuity certain has a distinct beginning and end, so if income is needed for life, a life annuity is more suitable. Example: Matthew's brother Mark has a 15-year period certain annuity. Mark will receive payments for 15 years. Even if he is still alive after the 15 years, the payments stop. If Matthew had lived for 20 more years, his life with period certain annuity would have paid for another 20 years or until he died. However, because he had a 10-year period certain option, once he goes beyond the 10 years - his beneficiary would get nothing.

Which annuity provides a guaranteed minimum rate of return? Select one: a. Single premium immediate annuity b. Single premium deferred annuity c. Fixed annuity d. Variable annuity

c A fixed annuity has a guaranteed minimum interest rate.

Life with Period Certain Option

The life annuity with period certain or life income with term certain option provides the annuitant with guaranteed income for life and further guarantees annuity payments for a minimum number of years, such as 10 or 20. If the annuitant dies within the period certain, the beneficiary will receive annuity payments for the remainder of the period. Any balance in the annuity fund after the period certain ends, is retained by the insurer. If the annuitant lives beyond the period certain, the beneficiary would not receive anything. While the life with period certain annuity guarantees life income to the annuitant, it does not guarantee the full value of the annuity will be paid out. It guarantees that annuity payments will be paid for at least a certain number of years. Example - shown in the diagram below: Matthew (the annuitant) has an $80,000 life with 10-year period certain annuity. The annuity pays monthly payments to Matthew (the annuitant) for 6 years until Matthew's death. Since there are 4 years remaining in the 10-year period certain, Matthew's beneficiary, Barbie, receives payments (in the same amount as Matthew received) for 4 years. At the end of 4 years, payments stop.

Which of the following statements is true regarding the taxation of premiums and interest in annuities? Select one: a. Principal (premiums) is paid with pre-tax dollars; interest is taxable income during the payout phase. b. Principal (premiums) is paid with after-tax dollars; interest is not taxable income during the payout phase. c. Principal (premiums) is paid with pre-tax dollars; interest is not taxable income during the payout phase. d. Principal (premiums) is paid with after-tax dollars; interest is taxable income during the payout phase.

d The interest portion of the payment is taxable income, but the principal portion is not taxable since it was funded with after-tax dollars.

Of the following, who will receive the largest monthly annuity benefit from a $100,000 single premium immediate annuity? Select one: a. Woman, age 40 b. Man, age 40 c. Woman, age 70 d. Man, age 70

d Women's life expectancies are longer than men's, so men will receive higher monthly annuity benefits. People in advanced ages are closer to death, so their income benefit will be larger. Therefore, the 70-year old man will receive the largest monthly annuity benefit.

Example for Above

Example: Rick purchases an annuity contract with a $30,000 purchase payment. The contract has a schedule of surrender charges beginning with 8% in the first year and declining by 1% each year thereafter. Rick is allowed to withdraw 10% of the contract value each year - free of surrender charges. In the first year, Rick decides to withdraw $10,000, or one-third of his contract value of $30,000 (assuming that his contract value has not changed because of investment performance). In this case, Rick could withdraw $3,000 (10% of contract value) free of surrender charges, but he would pay a surrender charge of 8%, or $560, on the other $7,000 withdrawn. In addition to the surrender charge, there is a 10% tax penalty for surrendering a deferred annuity before the age of 59 ½, as well as ordinary income tax that must be paid on the interest earned. Fortunately, Rick is 62 years old and will not incur the early withdrawal tax penalty.

In addition to a life insurance producer license, producers selling variable products must have a(n): Select one: a. Annuity license b. Series 6 or 7 license c. Accident and health license d. Property and casualty license

b Producers selling variable products must have a securities license _ series 6 or 7 _ in addition to a life insurance producer license.

How does an annuity work?

A sum of money is paid out in equal installments over a period of time, until the original sum of money is depleted. Since the sum of money is invested with the insurer, it will earn interest. That interest is paid out to the annuitant.

Variable Annuities

Unlike fixed annuities, variable annuities have variable interest rates and benefits. Variable annuities have the potential for greater earnings and are intended to offset the effects of inflation. Since variable interest rates are not guaranteed, the insurer cannot promise a certain dollar amount for each annuity benefit. The insurer does not cushion investment gains and losses. Instead, the annuity directly reflects investment experience. Variable annuities have the potential for immense gain, but also loss. With variable annuities, the investment risk is borne upon the contract owner.

Market Value Adjusted Annuities

Market value adjusted annuities are fixed annuities. However, if the annuity is surrendered prior to annuitization, the contract owner will incur a surrender fee and an adjustment to the surrender value will be made based on the market value. Lower interest rates have the effect of increasing the surrender value, in which case there may be no surrender charge. However, higher interest rates have the effect of decreasing the surrender value because the insurer would have continued to earn the higher interest rate had the annuity not been surrendered. In this case, a surrender charge is incurred. Market value adjusted annuities are categorized as securities, so producers selling them must have a securities license.

Surrender and Withdrawal Charges

When a contract owner partially or entirely surrenders a deferred annuity prior to annuitization, the insurer will impose a surrender charge. The purpose of the charge is to account for lost investment value the insurer relied upon. The surrender charge is greatest during the early contract years and in many cases decreases to zero after a certain number of years, such as in the 10th or 15th year. Some annuities have a free withdrawal feature that allows the contract owner to withdraw a certain amount each year (typically 10%) without incurring a surrender charge.

Marty purchases an annuity for his younger brother, Jacob. If Jacob is the person who will be receiving annuity payments, which of the following statements is true? Select one: a. Marty is the contract owner and annuitant. b. Jacob is the contract owner and annuitant. c. Marty is the annuitant and Jacob is the contract owner. d. Marty is the contract owner and Jacob is the annuitant.

d The person who purchases the annuity, pays the premiums and has all rights of ownership is the contract owner. In this example, Marty purchases the annuity, so he is the contract owner. The person whose life the annuity has been issued, and who will be receiving annuity payments, is the annuitant. In this example, the annuitant is Marty's brother, Jacob.

Insurance Aspects of Annuities ; Annuities are the opposite of life insurance.

Life insurers sell annuities because they have access to mortality data, but keep in mind that annuities are not life insurance. Annuities are the opposite of life insurance. When the annuitant dies, a death benefit is not paid. Typically, annuities pay benefits until the annuitant's death. Insurers use the law of large numbers to determine when annuitants will die. The proportion of annuitants living beyond and annuitants dying before their expected life spans tends to average out.

Annuity Units

During the annuity phase, annuity units are used in lieu of accumulation units to determine the amount of each annuity payment. The benefit amount that an annuitant receives from a variable annuity is determined by both of the following: The number of annuity units The value of annuity units The number of your annuity units is fixed at the time that you buy the income annuity contract, or when you annuitize your deferred variable annuity. While the number of units does not change, the value of each unit fluctuates to reflect the performance of the underlying investments in the separate account. That's why the income you receive from a variable annuity may differ from month to month. Determining the number of annuity units is a two-step process: First, multiply the number of accumulation units by the dollar value of each accumulation unit. This provides the dollar value of the separate account upon annuitization. Notice how accumulation units are converted into annuity units in order for variable annuity benefits to be paid out. Second, the amount of the first annuity payment is determined. This is based on the annuitant's age, sex, and payout option. The annuity payment is based on each $1,000 of value in the separate account. The first annuity payment is converted into a fixed number of annuity units by dividing it by the value of an annuity unit at that point. Example: Linda has 5,000 accumulation units. Each accumulation unit is valued at $100 at the time of annuitization, so her share of the separate account is $500,000. Based on her age, sex, and choice of payout option, the insurer determines $3 per $1,000 of value. This means that Linda's first monthly annuity payment would be $1,500 ($500,000 ÷ $1,000 = 500; $3 × 500 = $1,500 monthly payment). The value of each annuity unit at that time is $4, so Linda has 375 annuity units ($1,500 ÷ $4 = 375 annuity units). The number of annuity units Linda has will never change. If the following month the value of each annuity unit increases to $5, then Linda's monthly annuity payment would be $1,875 (375 × $5 = $1,875).

Under a level premium arrangement, a fixed premium amount is paid in installments over time until the annuity income begins.

A flexible premium arrangement is similar to a level premium annuity, except that the owner of the annuity can elect to pay varying amounts for each premium payment. The amount of each premium payment must fall within a certain minimum and maximum amount. An annuity where both the premium amount and frequency of premium payments are flexible is called a flexible premium deferred annuity (FPDA). Flexible premium annuities are appropriate for individuals who have fluctuating incomes, or who are unable to pay for an annuity in one lump sum. The major drawback of flexible premium annuities is the inability to determine the actual amount of the annuity benefit. Because the amount of each premium payment to be paid and the total amount that will be paid into the annuity is a flexible amount that depends on future premium payments, there is no way to determine the exact amount of the annuity benefit that will be received until the final premium payment is received.

Deferred Annuities

With a deferred annuity, the annuity period begins sometime in the future. Deferred annuities may be funded with: A single premium (SPDA - single premium deferred annuity) or Periodic premium payments (FPDA - flexible premium deferred annuity). Payments begin a specified number of years after purchase and can be no sooner than at least one year after purchase. Deferred annuities can be purchased with a single premium or with multiple premiums. During the accumulation period of a deferred annuity, the principal earns compound interest on a tax-deferred basis. The exclusion ratio informs contract owners what portion of each annuity payment is taxable. Deferred annuities are frequently used to build retirement funds. Example: David's brother Doug (who is employed full time) also inherited money from their grandfather. Doug opted for a single premium deferred annuity (SPDA). He chose to invest the money immediately, but to defer the payments for 10 years - thus allowing it to earn tax-deferred interest. Example: Their sister Diane, has 5 children, and lots of unplanned expenses. Therefore, she chose to invest her inherited money in a FPDA (flexible premium deferred annuity). This allows her to build her annuity over time - and vary the (dollar) amount of her premiums for her periodic payments based on the availability of her funds.

In which of the following types of annuities does the payment period begin immediately after the annuity is purchased? Select one: a. SPIA b. SPDA c. Deferred d. None of the above

a Immediate annuities are those where the payout period begins immediately after the annuity is purchased. A single premium payment is used to purchase this kind of annuity. _SPIA_ stands for single premium immediate annuity.

Accumulation Period Versus Annuity Period

There are two phases in an annuity: The accumulation phase (this is when you put money in) The annuity phase (this is when you get money paid back to you)

Variable annuities have: Select one: a. Variable interest rates and benefits b. Fixed interest rates and benefits c. Fixed premiums d. Level benefits

a Variable annuities have variable interest rates and benefits. Because the interest rates are not guaranteed, the insurer cannot promise a certain dollar amount periodic annuity benefit.

Annuitant's Sex

The Annuitant's Sex: Statistically, men do not live as long as women. Because of this fact, women will typically have to pay higher premiums than men of the same age, because women are likely to live longer, and, therefore, will require more income payments. Example: Mark and Mary are both 45 when they start their annuity accumulation phases. They both expect to begin receiving income payments at age 65. Because Mary's life expectancy is longer than Mark's - she (statistically) will receive payments for a longer period of time. Her longer life expectancy results in a higher premium.

Annuitant's Age

The Annuitant's Age: The age at which an annuitant will start receiving lifetime income payments determines the amount of an annuitant's premium payment. Example: Bonnie and Clyde are both 45 years old. Clyde (an annuitant), who will begin receiving monthly lifetime income payments of $400 upon attaining 65 years of age, will pay a lower premium than Bonnie (also an annuitant), who will begin receiving the $400 monthly income payments upon attaining 60 years of age.

Date Income Payments Begin

Annuities can be broadly categorized into two types, based on when the annuity phase (payout period) begins: Immediate and Deferred. Once the payout period begins, the annuity no longer accepts funding payments.

Dollar Cost Averaging

Dollar cost averaging is the cost of accumulation units purchased over the pay-in period. Dollar cost averaging is an investment strategy where the contract owner invests the same amount of money at regular intervals over a lengthy period of time, instead of trying to guess the market highs and lows. A program of regular investing may help smooth out the highs and lows of a volatile stock market. A variable annuity is well suited to carry out this strategy, because it allows a specified portion of your lump sum investment (typically deposited into a fixed-rate account) to be transferred tax-free on a monthly basis into equity portfolios, where you have the potential for higher returns. By ignoring short-term fluctuations, you are able to buy more units when prices are down and fewer units when prices are up, ultimately resulting in a lower average cost per unit. Dollar cost averaging replaces emotion with consistency, but does not assure a profit or protect against a loss. Investors should weigh their ability to sustain investments during periods of market downturns, and should be aware that any fixed rates offered are paid on a declining balance.

As you can see in the above diagram, a straight life income option pays principal and interest from an annuity fund for as long as the annuitant is alive. Once the annuitant dies, payments stop and any balance in the annuity fund is forfeited to the insurer. The straight life option has the fewest guarantees in place, but provides the largest periodic income payment. Fewer guarantees also mean a greater risk that the full value of the annuity may not be paid out. The straight life option is a win-lose scenario.

Example: The good news - a win - if an annuitant is alive after depleting the annuity funds, the insurer will have to pay annuity payments out-of-pocket. Example: The bad news - you lose - if an annuitant dies after receiving only one or two annuity payments, the insurer keeps the remaining balance of the annuity.

Straight Life Income Option (Life Annuity)

If no guarantee is desired, the life annuity payout option is straight life, also referred to as life only or pure life. The annuitant receives annuity payments for their entire life. Upon the annuitant's death, the annuity payments stop. The insurer retains any balance on the annuity. The balance of the annuity forfeited to the insurer is then used to pay benefits to annuitants who live longer than expected.

Joint and Survivor Option

Single life annuities provide payouts for the life of just one insured, while multiple life annuities provide payments that last for the lives of multiple annuitants. One example of a multiple life annuity is the joint and survivor annuity. A joint and survivor annuity payout option pays annuity benefits to two annuitants. If either of the two annuitants dies, payments will be made to the surviving annuitant for life. Payments stop upon the death of the surviving annuitant. With the joint and full survivor option, the same income payment is paid to the surviving annuitant. The monthly payout will be higher with a single-life annuity than a joint and survivor annuity, because the expected payment period is longer. There are variations of this option, which pay the surviving annuitant less than what was received when both annuitants were alive which include: Joint and 2/3 survivor annuity - the survivor receives 2/3 of the original annuity payments upon the death of the first annuitant Joint and 1/2 survivor annuity - the survivor receives 1/2 of the original annuity payments upon the death of the first annuitant Example: Linda and Tom are married and have a joint and 1/2 life annuity. While Tom and Linda are alive, their household receives $3,000 in monthly annuity payments. If Tom dies before Linda, Linda would begin receiving $1,500 in monthly annuity payments.

Accumulation Period

The accumulation phase is the pay-in period, when the contract owner makes premium payments into the annuity. During the accumulation phase, the principal (premium) earns compound interest. Upon annuitization, the annuity's total cash value is converted into income payments. Any changes to an annuity contract must be made during the accumulation period.

Factors that Determine the Amount of Each Annuity Payment

The amount of each annuity payment is based on the following factors: Annuity cash accumulation Payout guarantees, if any Annuity payment frequency Loading The assumed interest rate The annuitant's age The annuitant's sex The more cash value available at the time of annuitization, the larger the annuity payment Based on the payout option chosen, the benefits may be guaranteed, but these guarantees have the effect of lowering each annuity payment. The more frequent the annuity payments, the lower the payment amount. The insurer's operating expenses, though small, lower the annuity payment amount. The assumed interest rate is the growth rate insurers estimate that the annuity's cash value will earn during the annuity phase. The interest rate has the potential to increase annuity payments. Fixed annuities (annuities with a fixed interest rate) pay fixed annuity payments, and Variable annuities pay variable annuity payments. The older the annuitant, the more likely the annuitant is to die, so the higher the annuity payment.

Older = Larger Benefit

This is the reverse logic of life insurance: the longer the annuitant is expected to live, the lower the annuity payment. Because women are expected to live longer than men, the annuity payment will be lower. Example: Robert, a 75 year-old man, and Ella, his 75 year-old wife, both purchase $100,000 immediate annuities. The monthly payments that Robert receives are higher than Ella's because he is not expected to live as long as Ella. Mortality tables state that women live longer than men.

Accumulation Units

When a contract owner pays premiums into the separate account, the owner is purchasing accumulation units. The separate account has a certain total number of accumulation units. In the most basic terms, the value of each accumulation unit can be calculated by dividing the value in the separate account by the insurer's total number of accumulation units. The number of accumulation units a contract owner has directly correlates to the portion of the separate account owned by the contract owner. The value of each accumulation unit varies daily, so while the number of accumulation units a contract owner has may stay the same, the total dollar value of a contract owner's accumulation units may vary daily. Part of the premium paid is used to cover sales fees and taxes, so the net premium purchases accumulation units. Example: Tom pays $1,200 on July 1 into the separate account for his deferred variable annuity. On July 1, this amount of premium purchases 12 accumulation units, so each accumulation unit is valued at $100 on July 1. On July 2, each accumulation unit is valued at $150; however, Tom still only has 12 accumulation units even though the total value of his accumulation units has increased from $1,200 to $1,800. If Tom pays an additional $600 into the separate account on July 3, purchasing 10 accumulation units, he has a total of 22 accumulation units each unit valued at $60 on July 3. His total value in the separate account has dropped to $1,320.

Determining Annuity Premiums

When determining annuity premiums, insurers consider five important factors: The annuitant's age, The annuitant's sex, Assumed interest rate, Income amount and payment guarantee, and Loading costs.

Fixed Annuities

With fixed annuities, premiums grow at a fixed interest rate during the accumulation phase, and guaranteed fixed benefit amounts are paid out during the annuity phase. Fixed Annuities may not be sufficient to offset the effects of inflation. Based on the annuity payout option chosen, the insurer guarantees the amount of each annuity payment and the length of time that annuity payments will be paid. The downside to fixed annuities is that the earning potential may not be sufficient to offset the effects of inflation. A variable annuity can address this problem. Premiums for a fixed annuity are invested in the insurer's general account. This account is composed of conservative assets such as bonds. While the risk of investment is borne upon the insurance company, the conservative investments are relatively stable permitting the insurer to quote contract owners an interest rate and annuity payment amount with a greater degree of certainty. The amount paid during the annuity phase is usually stated in dollars per $1,000 of funds in the annuity. Fixed annuities will earn the insurer's current interest rate. However, contract owners are quoted a guaranteed minimum interest rate (around 4%) that the annuity will earn. Example: Paul chose a fixed annuity for his investment option. This means that the insurance company chooses where to invest his money, and guarantees to pay Paul a pre-determined fixed return.

What type of premium is used to purchase an immediate annuity? Select one: a. Single b. Flexible c. Level d. Increasing

a A single premium is used to purchase an immediate annuity.

Collin buys a fixed deferred annuity. Upon annuitization, he chooses the life annuity with period certain payout option. Collin will receive $3,000 each month with a 15-year certain period. If Collin dies after seven years, how much will his beneficiary receive? Select one: a. $0 b. $252,000 c. $288,000 d. $540,000

c Collin's beneficiary will receive eight years worth of $3,000 monthly annuity payments. This works out to $288,000 (15 _ 7 = 8 years remaining in the period certain. $3,000 _ 12 months per year = $36,000. $36,000 _ 8 = $288,000).

Which of the following fixed annuities has a minimum rate of return and a current rate of return that is connected to the S&P 500? Select one: a. Fixed annuity b. Market value adjusted annuity c. FPDA d. Equity indexed annuity

d An equity indexed annuity will earn a guaranteed minimum interest rate up to a current interest rate that is tied to an equity index, such as the S&P 500.