Insurance Chapter 7
For which of the following annuities must an agent have a securities license in order to sell?
Variable annuity
Annuity payments are made:
Monthly, Quarterly, Semiannually or Annually.
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.
contract owner
The individual who purchases the annuity, pays the premiums, and has rights of ownership.
All of the following statements regarding annuities are true, EXCEPT:
The more guarantees an annuity has, the lower the annuity payment. Life annuities provide income that an annuitant cannot outlive. The annuity certain does not guarantee life income. * Upon annuitization, cash value taken in one lump-sum is not taxable.
Two of the most common uses of annuities are:
*Providing lifetime income, and *Accumulating money, such as for a retirement fund.
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
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?
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).
The no-gain, no-loss rule (section 1035 contract) applies to annuities;
If an annuity is exchanged for another annuity, a gain (for tax purposes) is not realized. This is also true for a life insurance policy or an endowment contract exchanged for an annuity. However, an annuity cannot be exchanged for a life insurance policy.
What are the two phases of an annuity?
Pay-in phase and pay-out phase
Which of the following statements is true regarding the taxation of premiums and interest in annuities?
Principal (premiums) is paid with after-tax dollars; interest is taxable income during the payout phase.
Each annuity payment is comprised of:
Principal - not taxable, since it was funded with after-tax dollars Interest - taxable income
Nonforfeiture options are available to contract owners of all of the following, EXCEPT:
SPDA FPDA Deferred annuity *SPIA
____________ also known as _______________, are available to employees of tax-exempt nonprofit organizations and public schools.
Tax-sheltered annuities (TSA), also called Tax Deferred Annuities; An example of a TSA is a 403(b) retirement plan. The employer establishes the TSA, and contributions made by employees are not taxable. TSAs are established to provide retirement income for employees. Income payments made from the TSA are taxable at the time of distribution.
annuitant
The individual on whose life the annuity has been issued. and receives the payments.
What portion of an annuity's death benefit is taxed?
The portion that exceeds the cost-basis
Annuities are defined as:
The systematic liquidation of an estate
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.
Assumed Interest Rate:
determining premium amounts, insurers estimate an assumed interest rate that would apply to the future investment of the premiums.
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.
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.
The value of each accumulation unit varies:
daily
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.
The annuity phase is:
the income or payout period when payments from the annuity are being made to the annuitant.
Rebecca has funded her annuity with after-tax dollars. Consequently, when her annuity payments begin - there is no tax owed on her initial investment, only on the interest earned. This is considered a _________________
'non-qualified annuity'.
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.
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. *Equity-indexed annuities are fixed annuities that provide a guaranteed minimum interest rate.
Variations of joint and survivor annuity;
*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
If the contract owner chooses to surrender the deffered annuity before the payout phase begins or to stop making premium payments, two nonforfeiture options are available:
*Surrender - the entire amount of premiums paid into the annuity, minus the surrender charges and prior withdrawals, will be refunded in a lump sum or *Annuitize - the contract based on the amount of cash accumulated at that point.
Tax-deferred Growth - Cash Accumulation;
Deferred annuities grow cash value on a tax-deferred basis. This is an attractive feature, since the interest is not taxed until distribution.
___________ 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.
Dollar cost averaging; 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.
_______________ 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.
Market value adjusted annuities; Lower interest rates have the effect of increasing the surrender value, in which case there may be no surrender charge, but higher interest rates have the opposite effect. Producers selling them must have a securities license.
______________ regulates brokers and dealers selling variable annuities.
NASD
Annuities funded with a single premium are either:
Single Premium Immediate Annuity (SPIA)- A lump sum payment is made with the insurer, and payments to the annuitant start immediately. 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.
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
___________ are annuities used to fund lawsuit settlements and lottery winnings. Annuities are perfect funding tools for these situations because they liquidate a large sum of money over a period of time.
Structured settlements
All of the following are characteristics of tax-sheltered annuities, EXCEPT:
Tax-sheltered annuities are available to tax-exempt nonprofit organizations and public schools. The employer establishes the tax-sheltered annuity and contributions made by employees are non-taxable. The purpose of tax-sheltered annuities is to save money for retirement income. *Money invested in a tax-sheltered annuity is taxable upon deposit.
Loading Costs:
The amount of a premium payment must include a portion of the insurer's operating expenses.
Unlike fixed 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. invested in stock market The SEC regulates the investment portion of the variable annuity, and the state insurance department regulates the insurance portion.
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.
Premiums for a joint and survivor life annuity are based on the annuitants':
ages and sex
During the annuity phase, _________ are used in lieu of accumulation units to determine the amount of each annuity payment.
annuity units
With the ___________ the annuitant will receive income for life, and upon the annuitant's death, the beneficiary will receive the balance of annuity funds.
cash refund option; 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
What is the term attributed to the balance of a deferred annuity paid to a beneficiary if the annuitant dies during the accumulation phase of a deferred annuity?
death benifits
________________ is an option that may be purchased for retirement annuities.
guaranteed minimum withdrawal benefit (GMWB); It provides a way for annuitants to protect their retirement investments from market downturns by giving annuitants the right to withdraw a maximum percentage of their investment each year until the amount of the initial investment has been recovered. The GMWB is a popular rider in variable annuities, but is also available for fixed annuities. It must be elected upon issuance of an annuity that is purchased with a single premium (e.g., $100,000 SPDA).
Annuity payments that begin immediately after the annuity is purchased are ________.
immediate annuities *Unlike deferred annuities, immediate annuities do not have an accumulation period.
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.
A ________________ annuity payout option pays annuity benefits to two annuitants.
joint and survivor; 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.
level premium arrangement-
level premium arrangement, a fixed premium amount is paid in installments over time until the annuity income begins.
If no guarantee is desired, the life annuity payout option is ____________, also referred to as life only or pure life.
straight life; annuitant receives annuity payments for their entire life and it provides the largest periodic income payment. Upon the annuitant's death, the annuity payments stop. The insurer retains any balance on the annuity.
Qualified -
taxes are paid on the investment funds when the payout begins.
Non-qualified -
taxes are paid on the monies as earned (prior to investing in the annuity).
With deffered annuities;
the annuity period begins sometime in the future and may be funded with: *A single premium (SPDA - single premium deferred annuity) or *Periodic premium payments (FPDA - flexible premium deferred annuity
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.
_______________ have two distribution values, contingent upon whether or not the annuity is surrendered in a lump sum prior to annuitization. The contract owner may earn a higher interest rate and subsequent higher distribution value if the annuity is not surrendered prior to annuitization. The purpose of a two-tiered annuity is to provide contract owners with incentive to annuitize.
two-tiered annuities
there is a_____% tax penalty for surrendering a deferred annuity before the age of ______, as well as ordinary income tax that must be paid on the interest earned.
10%; 59 and a half
How do annuities provide guaranteed income for life?
By systematically liquidating an estate
Life Income
Depending on the payout option chosen, annuitants can receive income for their entire lives.
__________ are fixed annuities that provide a guaranteed minimum interest rate.
Equity indexed annuities; 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.
The portion of annuity benefits that is interest is taxable as ordinary income. The exclusion ratio is a simple way to determine what portion of each annuity benefit payment is taxable:
Exclusion ratio = Principal annuity fund / Annual guaranteed benefit side note; When a partial withdrawal is taken from an annuity before age 59 ½, the withdrawal is considered 100% interest, and is, therefore, taxable as ordinary income. A 10% tax penalty is applied if a distribution is received before the annuitant reaches age 59 ½.
____________ are tax-deferred annuities in which interest is tax-deferred. There are annual contribution limitations set by the Internal Revenue Service.
IRAs
All of the following are true of the life with period certain annuity payout option, EXCEPT:
The annuitant is provided with guaranteed income for life. Payments are guaranteed for a minimum number of years. The life with period certain option does not guarantee the full value of the annuity will be paid out. *Any balance in the annuity fund after the period certain ends is refunded to a beneficiary.
All of the following statements are correct, EXCEPT:
With the cash refund option, the beneficiary receives the balance of premiums plus interest minus benefits paid in a lump-sum. All annuities have an annuity period, but may not have an accumulation period. The fixed period installment annuity makes periodic payments for a set period of time. * All annuities are qualified.
A retirement income annuity is
a deferred annuity with a decreasing term life insurance rider. The rider's face amount decreases each year and falls off when the annuitant reaches retirement age and begins receiving annuity payments. Retirement Income Annuity = Deferred Annuity + Decreasing Term Rider
With _________, 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; downside to fixed annuities is that the earning potential may not be sufficient to offset the effects of inflation. 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. Invested in bonds.
Similar to the cash refund option, the_________ 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.
installment refund option
While the ___________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
life with period certain;
Unlike a life annuity, the_______ 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.
period certain
Producers selling variable products must have a ____________ in addition to a life insurance producer license.
securities license - series 6 or 7 -
