Series 7 -Chapter 12-Variable Annuities
Which acts are variable annuities regulated by?
-Act of 1933 -Act of 1934 -Investment Act of 1940 -Investment Advisers Act of 1940
variable life insurance
-form of permanent life insurance -protects beneficiary int he event of the policy holder's death -invest in the premiums paid in both the general and separate accounts
Who are riders not suitable for?
anyone not anticipating a lengthy retirement
What are the two types of annuities?
fixed and variable
what advantage do variable annuities offer?
guaranteed lifetime income
Which type of license is needed to sell fixed annuities?
insurance license, NOT securities license
Who bears the investment risk for fixed annuities?
insurer
Which types of annuity options pays the largest amount?
life options -no beneficiaries -the greater risk the greater the reward
Variable annuities are similar to what?
mutual funds
Are annuities assumed to qualified or nonqualifed unless otherwise stated?
nonqualified
add later? mutual fund vs variable annuity chart
pg 480
What are two payment specification that variable annuity contracts should consider?
-Guaranteed Minimum Withdrawal Benefits (GMWBs) -Lifetime Withdrawal Benefit (LWB)/ Lifetime Income
who are variable annuities suitable for?
-supplemental income for retirement -being able to fund the contract with cash -anyone who all other retirement savings vehicles are able to be made to as this is supplemental income (IRA, 401 (k)s
Life Income
-the insurance company will pay the annuitant for life -when annuitant dies, there are no continuing payments to a beneficiary
What is another name for Lifetime Withdrawal Benefit
Lifetime Income
LWB
Lifetime Withdrawal Benefit
What makes annuities unique from other securities?
guarantees it offers
What is the monthly in a separate account dependent upon?
he performance of the separate account (either increases or decreases)
when are contributions to annuities not made with after-tax dollars?
if the annuity is part of an employee-sponsored (qualified) retirement plan or held in an IRA
Who guarantees the rate of return for fixed annuities?
insurer
When is the AIR relevant?
only relevant during the annuity phase of the contract
What does it mean to annuitize the contract?
receive monthly income
what is the primary purpose for purchasing variable annuities?
the insurance features of the contract
What are the penalties of early withdraws from annuities?
withdrawals before age 59 1/2 are subject to the 10% early withdrawal penalty and ordinary income tax on the earnings portion of the withdrawal
Fixed Annuity Characteristics
-Payments made with after-tax dollars -payments are invested in the general account -portfolio of fixed-income securities/real estate -insurer assumes investment risk -not a security -guaranteed rate of return -fixed administrative expenses -income guaranteed for life -monthly payment never falls below guaranteed minimum -subject to purchasing power risk -subject to insurance regulation
Assumed Interest Rate
-a conservative projection of the performance of the separate account over the estimated life of the contract
Accumulation/Annuity Units
-a contract owner's interest in the separate account -vary in value based on the separate account's performance - the number of accumulation units varies as additional investments purchase additional units - the number of annuity units received stays fixed once the contract has been annuitized -the number of accumulation units are used to calculate the number of annuity units
Annuity
-a life insurance company product designed to provide supplemental retirement income
Periodic Payment Deferred Annuity
-allows investments over time; payments of benefits on -this type of annuity are always deferred until a later date selected by the annuitant
How does the death benefit never become less than the minimum guaranteed amount invested in the separate account?
-anything that is considered guaranteed in the variable life insurance's separate account is partially funded by the premium in the general account -any portion of the premium need to guarantee the minimum is invested in the separate account
seperate account
-consists of the purchasers' funds pooled together -invested in a diversified portfolio of stocks, bonds and mutual funds -investors own a proportionate share of these securities
Joint Life with Last Survivor
-guarantees payments over two lives (often used for husbands and wives) -if one spouse were to die first, the other spouse would continue to receive payments for as long as they live
Annuity Distribution (how the investor can withdraw funds)
-investor can withdraw the funds: -randomly -in a lump sum -annuitize the contract (receive monthly income)
which type of annuity option is most likely to provide the smallest monthly income?
Joint Life with Last Survivor -monthly income is guaranteed on two lives
What other type of insurance product has a separate account?
Variable universal life policies
What is the objective of the separate account?
achieving growth that will match or exceed the rate of inflation
AIR
assumed interest rate
When does the annuitant have to select their annuity payout option?
at the time of annuitization
how to earnings on dollars invested in variable annuities accumulate?
tax differed
Who assumes investment risk with variable annuities?
the annuitant (investor)
anything that is considered guaranteed in the variable life insurance's separate account is partially funded by?
the premium in the general account
Immediate Annuity
-is purchased with a lump sum -the payout of benefits usually commences within 60 days
Annuitization
-when the annuitant begins to take income from the account -the value of the accumulation units is converted into a fixed number of annuity units -the annuity units are then liquidated to provide monthly income guaranteed for life of the annuitant
wavier of premium (riders)
the premium will be forgotten or waived under conditions relating to an insurance becoming totally disabled
why are fixed annuities subject to purchasing power risk?
the significant risk of fixed annuities as the fixed payment that the annuitant receives loses buying power over time as a result of inflation
Fixed Annuity
-investors pay premiums to the insurance company that are invested in the company's general account -insurance company is then obligated to pay a guaranteed amount of payout (typically monthly) to the annuitant based on how much was paid in
Which type of annuity is considered a security?
variable annuity
Which type of licenses are needed to sell variable annuities?
-because of the risk, both an insurance and securities license
Annuity Taxation
-contributions are made with after-tax dollars -these already-taxed dollars are considered the investor's cost basis and are not taxed when withdrawn -earnings in excess of the cost basis are taxed as ordinary income when withdrawn as required by the IRS -LIFO (last in, first out) applies to random withdrawals option -after earnings is completely withdrawn, there is no additional taxation because the cost basis has already been taxed
Guaranteed Minimum Withdrawal Benefit
-guarantees regular period payment (monthly, quarterly, annually) but only until the insurance company has paid back the amount equal to the principal amount account value or until the end of the contract term -"lifetime" period payment is not guaranteed
Death Benefit Provision
-if an annuitant dies during the accumulation period, most contracts call for a death benefit to be paid to the variable annuitant's benficiary in an amount equal to the total of all the investments made plus any earnings that have accrued -if account lost money, guaranteed the return of the total invested money at a minimum -beneficiary will be liable for the ordinary income taxes on the earnings received -NO penalty for early withdrawal -normal income taxes on money earned in the account
Relationship between AIR, account performance and monthly income
-if separate account performance is greater than AIR, the monthly income is more than the previous month's payment -if separate account performance is equal to the AIR, the monthly income stays the same as the previous month's payment -if separate account performance is less than AIR, the monthly income is less than the previous month's payment
What are fixed annuities subject to?
-insurance regulation -power risk
Single Premium Deferred Annuity
-is purchased with a lump sum, but payment of benefits -is delayed until a later date selected by annuitant
Life with Period Certain
-to guarantee that a minimum number of payments are made even if the annuitant dies -contract will specifically allow the choice of a period of 10 or 20 years -guaranteed monthly income for life with this option, but if death occurs within the period certain -a named beneficiary receives payments for the remainder of the period
variable life insurance (separate account)
-investment options include common stock, bonds, money market instruments. investment risk to the insured is assumed in order to achieve some protection against inflation risk for their death benefit -cash value fluctuates with the performance of the account and is not guaranteed -instead, a minimum guaranteed benefit is provided, which never falls below the minimum guaranteed amount (but can rise above it) -any portion of the premium need to guarantee the minimum is invested in the separate account
Are variable annuities considered investment securities?
no. they should only be presented as insurance products not investments
which types of investments are appropriate for separate account portfolios?
-common stocks -bonds -mutual funds
Payout Options
-life income (also called life only or straight life) -life with period certain -joint life with last survivor
how are mutual funds and variable annuities similar?
-may have diversified portfolios of common stock -are managed by full-time professionals give investors voting rights
Variable Annuity
-offers the opportunity to keep pace with inflation -because of this advantage the investor assumes the investment risk
what is the only type of taxation on annuities and retirement plans
-ordinary tax -answers with capital gains taxation is wrong
Annuity Phase
-payout phase
who aren't variable annuities suitable for?
-not preservation of capital -cashing out existing life insurance policy or annuity is considered abusive -refinancing a home or withdrawing equity from a home to fund a purchase -anyone who might need a lump sum of cash invested in the variable annuity at a later time for any reason (buying a home, college education, upcoming expenses) -anyone with low risk tolerance or wary of the stock market. separate account funds are used to invest in a diversified portfolios -prefer tax-favored accounts (IRAs) as withdrawals from variable annuities are tax differed
Variable Annuity Characteristics
-payments made with after-tax dollars -payments are invested in the separate account -portfolio of equity, debt, or mutual funds -is a security -return depends on separate account performance -fixed administrative expenses -income guaranteed for life -monthly payments may fluctuate up or down -typically protects against purchasing power risk -subject to insurance and securities regulation -no maximum sales load -Unit value (pricing) calculated once per business day -share value depends on performance of separate account -Separate Account Manger receives fee
Combination Annuity
-receive the advantages of both fixed and variable annuities -contribute to botht the general and separate accounts
Accumulation Phase
-the growth phase
What does the term annuity specifically refer to?
-the term specifically refers to a stream of income payments guaranteed for life
Separate Account
-this account is separated from the general funds of the insurer because it is invested differently -consists of the purchasers' funds pooled together and invested in a diversified portfolio
wavier of premium (qualified plans)
-under qualified plans, contributions used to purchase wavier premium benefits are taxable to the plan participant and must be includein gross income in the year which they were paid
what are the two most significantly different features between mutual funds and variable annuities?
1. earnings on dollars invested in a variable annuity are tax differed -mutual fund dividends and capital gains are taxable upon receipt or reinvestment. For annuitants, instead of being paid directly, the value units increase in the separate account and only taxed when withdrawn 2. variable annuities offer the guaranteed income advantage to some extent depending on how the contract is set up -Mutual fund holder aren't offered any income guarantees
GMWBs
Guaranteed Minimum Withdrawal Benefit
What are the other names for life income?
life only or straight life
