Chapter 9: Annuities

Annuities versus Life Insurance

Annuities are not life insurance contracts, an annuity's principal function is to liquidate an estate by the periodic payment of money out of the contract.

Date Annuity Income Payments Begin

Annuities can be classified by the date in which the income payments to the annuitant begin. Depending on the contract, annuity payments can begin immeadiately, or they can be deferred to a future date.

Annuity Units

the payments from an annuity are expressed in these units. The value of one annuity can and does vary from month to month, depending on investment results.

Market Value Adjusted Annuities

Another fixed annuity product with a market driven aspect is the market value adjusted (MVA) annuity. Instead of having the annuity's interest rate linked to an index as with the equity indexes annuity, and MVA annuity's interest rate is guaranteed fixed if the contract is held for the period of specified in the policy. If an MVA annuity owner decides to surrender the contract early, a surrender charge and a market value adjustment will apply. The effect of the market value adjustment is to shift some of the investment risk to the owner. However the interest earned on the declining principal is taxed as ordinary income. A simple formula called the exclusion ratio is used to determine the amount of annual annuity income exempt from federal income taxes. The owners investment (cost basis) in the contract is the amount of money paid into the annuity (the premium). Deferred annuities accumulate interest earnings on a tax- deferred basis. While no taxes are imposed on the annuity during the accumulation phase, taxes are imposed when the contract begins to pay its benefits.

Cash Refund Option

A cash refund option provides a guaranteed income to the annuitant for life. If the annuitant dies before the annuith fund (principal) is depleted, a lump sum cash payment of the remaining balance is made to the annuitants beneficary.

Qualified Annuity Plans

A tax deferred arrangement established by an employer to provide retirement benefits for employees. It's also known as the 403 (b) plan or 501 (c) (3) plan because it was made possible by those sections of the tax code. For many years, the federal government, through its tax laws has encouraged specified non profit, charitable, educational, and religious organizations to set aside funds for their employees retirement. Upon retirement, payments received by employees from the accumulated savings in tax/ sheltered annuities are treated as ordinary income.

1035 Contract Exchange

A tax-free exchange of one annuity contract for another, one life insurance policy for another, or one life insurance policy for an annuity. The contracts do not have to be issued by the same company

Annuity Investments and Senior Citizens

An agent is required to make reasonable efforts to obtain information concerning the seniors financial status, tax status and risk tolerance, among other specified information relevant to determining suitably.

Structured settlement

An arrangement by which the claim is paid in installments rather than in one lump sum settlement.

Immediate Annuities

An immeadiate annuity is designed to make its first benefit payment to the annuitant at one payment interval from the date of purchase. Since most annuties make monthly payments, an immediate annuity would typically pay its first payment one month from the purchase date. Thus, an immeadiate annuity lacks and accumulation period. As you might guess, immediate annuties can only be funded with a single payment and are often called single premium immediate annuties (or SPIAS) and is intended for liquidation of a prinicpal sum. An annuity cannot simultaneously accept periodic funding payments by the annuitant and pay out income to the annuitant.

Annuity Payout Options

Annuitants have various income payout options to specify the way in which an annuity fund is to be paid out. There are a number of annuity income options available: Straight life income, Cash Refund, Installment Refund, Life with Period Certain, Joint and Survivor, Fixed Amount and Period Certain.

Annuity Basics

Annuity is a cash contract with an insurance company that includes a free - look period as well as nonforfeiture benefits. The accumulation period is that time during which funds are being paid into the annuity. The payout or annuity period refers to the point at which the annuity ceases to be an accumulation vechile and begins to generate benefit payments on a regular basis. The death of an annuity contract will generally trigger a payout to the beneficary, a spouse as beneficary may continue the contract with deferred taxation as contingent owner. The accumalation period of an annuity normally may continue after the purchase payments cease. The payout or liquidation period refers to the point at which the annuity ceases to be an accumulation vechile and begins to generate benefit payments at regular intervals. Funding Method: Single lump sum payment or periodic payments over time Date annuity benefit payments begin: Immediately or deffered until a future date Investment Configuration: A fixed (guaranteed) rate of return or a variable (non guaranteed) rate of return Payout Period: A specified number of years, or for life, or a combination of both

Periodic Payments

Annuties can also be funded through a series of periodic premiums that will eventually create the annuity principal fund. At one time, it was common for insurers to require that periodic annuity premiums be fixed and level much like insurance premiums. Today it is more common to allow annuity owners to make flexible premium payments.

Single Premium

Annuties can be funded with a single lump-sum premium, in which case the prinicipal sum is created immeadiately. For example, individuals nearing retirement whose financial priority is retirement income could surrender their whole life policies and use the cash value as a lump sum premium to fund an annuity.

Surrender Charges

Are used to discourage withdrawls and exchanges in an annuity

Fixed Annuities

Fixed annuities provide a guaranteed rate of return, when converted to a payout mode, fixed annuities provide a guaranteed fixed benefit amount to the annuitant. However, since the benefit amount is fixed, annuitants may see the purchasing power of their income payments to decline over the years due to inflation.

Installment Refund Option

Like the cash refund, the installment refund option guarantees that the total annuity fund will be paid to the annuitant or the annuitants beneficary. The diffrence is that under the installment option, the fund remaining at the annuitants death is paid to the beneficary as annuity payments not as a single lump sum. Under either the cash,refund, or installment refund option, if the annuitant lives to recieve payment equal to the principal amount, no future payments will be made to the beneficary.

Straight Life Income Option

Pays the annutianr a guaranteed income for the annuitant's lifetime. When the annutiant dies, no further payments are made to anyone. If the annuitant dies before the annuith fund is depleted, the balance is forfeited to the insurer. The straight life annuity typically pays the largest monthly benefit to a single annuitant because it is based only on life expectancy. However it creates a risk that the annuitant may die early and forfeit much of the value of the annuity to the insurance company.

Joint and Full Survivor Option

The joint and full survivor option provides for payment of the annuity to two people. If either person dies, the same income payments continue to be survivor for life. When the surviving annuitant dies, no further payments are made to anyone.

Period Certain Option

The period certain option is not based on life contingency. Instead it guarantees benefit payments for a minimum number of years, such as 10, 15 or 20 years, regardless of when the annuitant dies.

Individual Uses

The principal use of an annuity is to provide income for retirement. They can be used for other purposes as well like college funds etc.

Temporary Annuity Certain

Under a temporary annuity certain, the payments are guaranteed to be made for a specified number of years. Since this Income is guaranteed, if the annuitant dies before receiving payments for the full specified period of time, the annuitants beneficiary will receive the payments for the remaining number of years.

Fixed Amount Option

Under the fixed amount option, the annuitant recieves a fixed payment until the contract value js exhausted, regardless of when that will be. If the annuitant dies before the contract is depleted, the beneficary recieves the remainder. T

Investment Configuration

allows for a fixed (guaranteed) rate of return or a variable (nonguaranteed) rate of return.

Accumulation Units

A variable annuity contract owner's interest in the separate account prior to annuitization.

Funding Method

An annuity begins with a sum of money called the prinicipal sum. Annuity principal is created or (funded) in one of two ways. 1.) Immeadiately with a single premium or 2.) Over time with a series of peridoic premiums.

Life With Period Certain Option

annuity option that is designed to pay the annuitant an income for life but guarantees a definite minimum period of payments(ex:life and 10yr contract and they die after 6 years their beneficiary still gets paid for 4 years)

Equity Indexed Annuities

type of fixed annuity that offer the potential for higher credited rates of return than their traditional counterparts but also guarantee the owners principal. There is a minimum guaranteed rate(3-4%) so a certain rate of growth is guaranteed. Designed to bridge the gap between fixed and variable annuities. The interest credited to an EIA is tied to increase in a specific equity or stock index which results in long term inflation protection.

Deferred Annuities

Deferred annuties accumulate interest earnings on a tax-deferred basis and provide income payments at some specified future date (normally with a minimum of 12 months after date of purchase). Unlike immediate annuties, deferred annuties can be funded with periodic payments over time. The accumulation value of a deferred annuity is equal to the sum of premium paid plus interest earned minus expenses and withdrawals. Benefit payments are intiated after the contract becomes annutized. Most insurers charge contract owners a back end load for liquidating deferred annuties in the early years of the contract. These surender charges cover the costs associated with selling and issuing contracts as well as costs associated with the insurers need to liquidate underlying investments at a possibly inappropriate time. Many deferred annuity contracts waive the surrender charge when the annuitant dies or becomes disabled. Additionally some annuity owners may offer a "bailout provision" which allows the annuity owner to surrender the annuity without surrender charges if interest rates fall below a stated level within a specified time period.

Purpose and Function

The main reason for purchasimg an annuity is to provide future economic security. An annuity is a mathematical concept that is quite simple in it's most basic application. Start with a lump sum of money, then pay it out in equal installments over a period of time until the orginal find is exhausted. That is the basic principle behind an annuity, an annuity is simply a vechile for lidquidating a sum of money. The sum of money that has not yet been paid out is earning interest and that interest is also passed on to the income recipent (the annuitant). Anyone can provide an annuity. By knowing the original sum of money (the principal), the length of the payout period, and the interest rate of the annuity earns, it is a fairly simple process to calculate the payment amount.

Variable Annuities

Variable annuities shift the investment risk from the insurer to the contract owner. Variable annuities invest deferred annuity payments in an insurer's separate accounts, as opposed to an insurer's general accounts. Because variable annuities are based on non-guaranteed equity investments such as a common stock, a sales representative who wants to sell such contracts must be registered with the financial industry's Regulatory Authority (FINRA) as well as hold a stare insurance license. Not only can the value of a variable annuity fluctuate in response to movements in the market, so too will the amount of annuity income, fluctuate even after the contract has annutizied.