Chapter 8 Annuities

what are the 2 phases of a variable annuity

1. In the first phase, the customer contributes money into the annuity account. This is called the accumulation phase. As the customer contributes more, the account grows in value. Also, the account grows (or shrinks) depending on the performance of the securities in the subaccounts. 2. At a certain point, the customer must annuitize the contract and begin receiving monthly payments. This is called the annuitization phase. The monthly payments will vary depending on the performance of the investments in the customer's separate account and on the customer's choice of payment.

waiver of premium

A premium waiver is a rider on an insurance policy that waives the insured's future payments if he becomes seriously ill or disabled. This allows individuals to benefit from their insurance policy, even when they are unable to work.

early redemptions

If a customer redeems an annuity contract within seven business days of signing the contract, the broker-dealer that the sold the contract will be required to return the sales commission to the insurance company. This is to prevent representatives from signing customers who are not really serious about purchasing an annuity simply to receive additional commissions.

death benefit

If the annuitant dies during the accumulation period, before the insurance company has begun payments, if the contract so specifies, a beneficiary will receive the payments. This is called a death benefit

surrender fee

If the annuitant needs the money before the end of the surrender period, he can surrender the contract by paying a surrender fee

indexed annuities

Indexed annuities are a type of annuity that tracks an index and pays a rate of return based on the performance of that index. Indexed annuities are currently considered to be a type of fixed annuity, but may in the future be classified as securities, due to their participation in the market

units

Insurers measure the value of an annuity in units. When the investor decides to annuitize the contract, the insurance company converts accumulation units to annuity units. During the accumulation phase, the number of accumulation units will grow as the value of the account grows. After annuitization, the number of annuity units remains fixed and the value of the units varies depending on the performance of the subaccounts.

life insurance vs annuity

Like an annuity, life insurance can be a vehicle to save and grow funds. Both life insurance and annuities offer a death benefit, which is paid to a beneficiary. With an annuity, however, the beneficiary receives the original investment plus any earnings. With life insurance, the beneficiary receives the face value of the policy, which may be significantly larger than the original investment

free look period

Many variable annuities have a "free look" period, which allows customers to cancel the policy within a certain amount of time at no charge. The amount of time for the free look varies, but it is typically 10 days.

who can issue annuities?

Only insurance companies

how to receive payment in a variable annuity

Random withdrawal—the annuitant requests sums at random times • Lump sum • Monthly payments (annuitize the contract)

required minimum distributions for annuities

Regular annuities are not subject to required minimum distributions (RMDs). If the annuity is a tax-qualified annuity, also called a tax-sheltered annuity (TSA), it will be subject to required minimum distributions

1035 exchanges

Section 1035 of the Internal Revenue Code allows annuity holders to exchange one annuity contract for another without suffering any tax consequences

instead of a participation rate, what will an EIA use

Some EIAs use a spread, margin, or asset fee in addition to or instead of a participation rate. The percentage stated in the contract is subtracted from any gain in the index linked to the annuity. For example, if the index gained 10 percent and the spread, margin, or asset fee is 3.5%, then the gain in the annuity would be only 6.5 percent

bonus annuities

Some insurers offer bonus annuities, which give annuity holders bonus credits for switching to them. Bonus annuities pay out an extra 1% to 5% of what the investor contributes and can be either fixed or variable annuities. Setting up a bonus annuity requires paying a fee. In addition, bonus annuities often have exceptionally long surrender periods, so the representative and the compliance officer must make sure the investor is aware and can wait for the length of the surrender period to get his investment back

term life insurance

Temporary life insurance is known as term life insurance and is similar to paying rent. The purchaser pays premiums, which provide a guaranteed death benefit to a beneficiary if the insured dies during a specified period of time. If the insured does not die during this period, the option is available to renew the insurance policy, although renewing will be much more expensive because the insured is now at a higher risk for death. Unlike an annuity, term life insurance does not build any cash value.

life income

The amount is annuitized so that beneficiary receives a certain guaranteed amount of money over his life.

fixed amount

The amount is put into an interest bearing account, and the beneficiary receives a fixed amount over regular increments of time until the amount runs out.

fixed period

The amount is put into an interest-bearing account, and the beneficiary receives payments at regular intervals over a fixed period until the money runs out

Underlying fund expenses

The annuitant is responsible for fees and expenses related to the mutual funds that are part of the separate subaccounts of a variable annuity, which may include management fees.

stepped up death benefit

The annuitant may also select a stepped-up death benefit, which allows the annuitant to lock in a greater guaranteed minimum death benefit..The guaranteed minimum might be the account value on a particular date, which may be greater than the investments and earnings minus withdrawals. The stepped-up death benefit serves to lock in a rate and prevent possible decline of the account from affecting the amount of money an annuitant leaves to a beneficiary. However, there is an additional charge associated with this feature.

AIR

The assumed interest rate is an expected rate at which the annuitant and insurance company agree that the annuity will grow annually. This expected rate is not an actual rate but simply an "assumed" rate. Each month the AIR is compared to the account's actual return rate.

lump sum

The entire amount is paid upon death

what is the guaranteed minimum return on an EIA

The guaranteed minimum return for an EIA is typically 90 percent of the premium paid at a 3% annual interest rate. More recently, in part because of changes to state insurance laws, the guaranteed minimum return is typically at least 87.5% of the premium paid at 1 to 3 percent interest

Annuitant

The individual, called the annuitant, invests money with the insurance company, either as a lump sum or in periodic payments

life with period certain

The insurer pays the annuitant an income during his lifetime. As part of the initial contract, the annuitant chooses a "period certain" during which payments will continue even if the annuitant dies. For example, the investor may choose a period certain of 20 years. If the annuitant dies during that 20 years, his named beneficiary will receive payments for the remainder of the period. An annuitant who chooses life with period certain will receive medium-sized monthly checks.

joint life with last survivor

The insurer pays the annuitant an income during his lifetime. In addition, the annuitant names a survivor beneficiary who also will receive payments from the same account for her lifetime. Payments are made to the annuitant and the beneficiary until both have passed away. The joint life with last survivor option will have the smallest monthly checks, because payments must continue through the lives of both people.

life income

The insurer pays the annuitant an income during his lifetime. When the annuitant dies, benefits stop. Because this option is likely to be the shortest amount of time and therefore the least expensive for the insurance company, the annuitant will receive the largest monthly check with this option.

surrender period

The length of time the investor must wait before withdrawing money from the annuity without penalty is called the surrender period

general payment the beneficiary will receive

The payment the beneficiary receives will equal the total investments and any additional earnings from the annuity. If the annuity lost money, the beneficiary will receive the total invested money. The beneficiary is responsible for paying income taxes on the earnings.

surrender value

The surrender value of the account will be the value in the account at the time of surrender minus the surrender fee

tax qualified VAs

There are some annuities in which contributions are made with pre-tax dollars. These are called tax-qualified variable annuities, but are sometimes referred to as tax-sheltered annuities (TSAs). Because they are funded with money that has not yet been taxed, all of the distributions will be taxed at the annuitant's ordinary income level

what are the penalties associated with early withdrawal of a variable annuity

There is a 10% penalty on withdrawals before the age of 59 1/2. Once earnings are withdrawn, they are taxed at the client's ordinary tax rate

Administrative fees

These charges are used to cover a variety of administrative expenses and may be charged as a flat annual fee or as a percentage of account value.

Mortality and expense risk charge

This charge usually makes up around 1.25% of the annuitant's account value each year and is meant to compensate the insurance company for the risk it assumes under the contract.

where is the customer's money deposited into in a fixed annuity

into the insurance company's general acct

what risk does a fixed annuity have

purchasing power risk (inflation risk)

who bears the investment risk in a fixed annuity

the insurance company

who bears the investment risk in a variable annuity

the investor

when is the fixed annuity taxable

when it is paid out

participation rate

which is the rate at which the annuitant can participate in the returns of the index

how long will the annuitant receive payments?

for the remainder of his life

Annuities

Annuities are investment vehicles used to provide steady income to an individual after retirement, often until death. An annuity is a contract between an individual and an insurance company

what does the insurance company do?

At some agreed upon time, the insurance company begins distributing payments to the annuitant. Payments may be made monthly, in a lump sum, or irregularly, based on the wishes of the annuitant. The size of the payments depends on the amount deposited

suitability for annuities

Because annuities often have long surrender periods, they should never be sold to older clients who may need to withdraw their money before the surrender period is over. Annuities may be appropriate for clients who want to be assured of a death benefit. In addition, they allow earnings to grow tax-free, so they can be a good retirement vehicle.

prompt payment

Broker-dealers must transmit customers' annuity applications and purchase payments promptly to the insurance company that issued the annuity.

what are fixed annuities comparable to

CDs

EIA CAPS

Equity-indexed annuities also may be subject to caps on performance. If an EIA has a cap, the annuitant will not receive a return higher than the cap, even if the increase in the index return times the participation rate is higher than the cap

taxation of life insurance

FIFO method

fixed annuities

Fixed annuities pay a rate of return guaranteed by an insurance company and are not considered securities

variable life insurance

For variable life insurance contracts, insurance companies invest the premiums paid into both their general account and their separate account. In this way, variable life insurance is like a variable annuity or a mutual fund. The separate account allows the investor to select from a variety of investment choices. With this, the investor takes on some risk for the upside potential of growing the cash value of the account and the death benefit. The cash value of the account will be based solely on the performance of the subaccounts. If the subaccounts increase by 5%, the cash value will increase by 5%. The cash value is not guaranteed by the insurance company. The insurance company does provide a minimum guaranteed death benefit that comes out of the insurance company's general account. The death benefit may rise above the minimum guaranteed amount, depending on the separate account performance, but never drop below. How much the death benefit rises will be based on the performance of the separate account, but also on an assumed interest rate for the account. If the subaccount performs worse than the AIR, the death benefit will shrink.

separate acct

Funds from variable annuities are kept in accounts that are separate from the insurance company's general account, often referred to as separate accounts. Within a separate account, the investor chooses from several possible subaccounts that operate like mutual funds, If the investments in the subaccounts perform well, the periodic payments to the annuitant will be larger, but if they perform poorly, the payments will be smaller

universal life insurance

Universal life insurance is a type of whole life insurance that provides the purchaser with more flexibility in terms of the death benefit and the premiums. Universal life insurance premiums can be adjusted depending on the amount of coverage the purchaser desires, allowing her to save money if she decides she or the insured doesn't need as much coverage.

variable annuities

Variable annuities pay a variable rate of return, depending on the investments chosen by the annuitant, and are considered securities

variable universal life insurance

Variable universal life insurance is a combination of variable and universal life insurance. The policyholder is still able to invest in separate accounts as a way to grow cash value, but the monthly premiums are flexible. The individual must pay enough in premiums to keep the policy from lapsing. This amount will vary depending upon the performance of the separate account.

whole life insurance

Whole life insurance is an insurance product that has an insurance component and an investment componentThe purchaser pays set premiums, which are locked in over the life of the insured, and the insurance company guarantees a minimum amount of payout upon death. With whole life insurance, insurance companies guarantee the recipient a minimum cash value even if the recipient stops paying into the policy. Like an annuity, it protects the beneficiary in the event of the insured's death and also is a way to grow savings. The cash value of the account grows tax deferred at a minimum, guaranteed rate. Similar to how a fixed annuity operates, the insurance company draws from a general account, and if the general account does well, the cash value may grow more than the guaranteed rate. At any time, the policy owner may withdraw part of the cash value or borrow part of it.

deferred annuity

With a deferred annuity, the annuitant may not have access to funds for up to 10 years

what kinds of contributions does an investor make with a variable annuity

after tax dollars

non-qualified annuity

after tax dollars, earnings grow tax deferred, random draw use LIFO