Annuities

Annuities can protect

- consumers against outliving their money -protect consumers from the volatile nature of the stock market, unlike stocks or mutual fund accounts.

Single Premium Immediate Annuity (SPIA)

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

Factors that Determine the Amount of Each Annuity Payment

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.

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.

ABC Insurer sells a $500,000 single premium immediate annuity to four different people. Who receives the largest check?

The person with the shortest life expectancy will receive the highest annuity check. The correct answer is: 60-year old male

Assumed Interest Rate

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

While the SEC regulates the investment portion of the variable annuity, the state insurance department is responsible for

regulating the insurance portion.

accumulation phase

the pay-in period, when the contract owner makes premium payments into the annuity. During the accumulation phase, the principal (premium) earns compound interest. -Any changes to an annuity contract must be made during the accumulation period.

the SEC is responsible for regulating

the separate account of a variable annuity.

annuitization

the term describing when the annuity's total cash value is converted into income payments

only life insurance companies can offer an annuity that provides guaranteed income for life (the "survivorship factor") because

they have mortality data

Life with Period Certain Option

-"life income with term certain" 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: 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.

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.

Immediate Annuities

-Annuity payments that begin immediately after the annuity is purchased -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.

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 three factors:

-The amount of the original sum of money (the principal), -The duration of the payout period, and -The assumed interest rate.

annuitant

-The individual whose life the annuity has been issued -the person who receives the annuity payments. - must always be a natural person, but the contract owner can be any legal entity or a natural person.

What do annuities protect?

-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.

Multiple Life Annuities: Joint and Survivor Option

-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. 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.

deferred annuities

-the annuity period begins sometime in the future.

Annuities: Funding Method: 2 ways to fund the principal sum

1) Single Premium (lump sum payment) 2) Series of periodic payments paid over time

2 phases in an annuity:

1) The accumulation phase (this is when you put money in) 2)The annuity phase (this is when you get money paid back to you) Most annuities have both phases, but all annuities have the annuity phase.

Annuity Certain =

= Doesn't Guarantee Life Income

Immediate Annuities =

= Don't Have Accumulation Period

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.

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.

flexible premium deferred annuity (FPDA).

An annuity where both the premium amount and frequency of premium payments are flexible

Periodic Payments

Annuities may also be funded by periodic premiums paid over time. Premiums may be paid: Monthly, Quarterly, Semi-annually, or Annually.

Deferred annuities are frequently used to build retirement funds. examples

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.

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.

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

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.

Pure Life Payout 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. 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.

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.

There are variations of the survivior joint 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.

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. life insurers sell this because they have MORTALITY data

Annuities funded by periodic premiums may have:

Level premiums or Flexible premiums.

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.

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

Life with Guaranteed Minimum Payouts

Many consumers do not like the idea of losing all or most of their investment in their annuity, if they were to die after receiving a few payments. Insurance companies offer alternatives to the pure life payout that provide guaranteed minimum payouts.

Annuity payments are made:

Monthly, Quarterly, Semiannually or Annually.

Bail-Out Provision

NO SURRENDER CHARGE allows the annuity owner to surrender the annuity without surrender charges on conditions stated in the contract. A common example is if interest rates drop a specified amount within a specified time period.

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

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.

accumulation units and annuity units

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.

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.

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 Annuity certain

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.

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.

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.

Single 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)

Annuity Certain (Period Certain Option)

Unlike a life annuity, the annuity 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. -fixed period -fixed amount

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.

Of the following, who will receive the largest monthly annuity benefit from a $100,000 single premium immediate annuity?

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. The correct answer is: Man, age 70

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.

Under a level premium arrangement

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

At its most basic level, an annuity provides a

a guaranteed income stream for life by systematically liquidating an estate. this means a sum of money is periodically paid out to the annuitant.

Producers selling variable products must have

a securities license - series 6 or 7 - in addition to a life insurance producer license.

Deferred annuities can be purchased with

a single premium or with multiple premiums.

Fixed Amount Installment

a stipulated amount is paid to the annuitant periodically. The contract owner decides how much each payment will be, and the insurer determines how long payments will last based on the value of the annuity and assumed interest rate. Payments stop when the funds are depleted. Example: Mark has a 15-year fixed period installment annuity certain. Mark will receive payments for 15 years. Even if he is still alive after the 15 years, the payments stop. Lets say Mark has a fixed amount installment annuity certain that is valued at $100,000. Mark decides to receive the payment amount of $10,000 a year. Mark would receive paymetns for 10 years until the funds are depleted. Even if he is still alive after 10 years, the payments stop.

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.

Once selected, the payout option for an annuity

cannot be changed after payments begin.

With variable annuities, the investment risk is borne upon the

contract owner

The individual who purchases the annuity, pays the premiums, and has rights of ownership is the

contract owner 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.

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.

With fixed annuities, premiums grow at a fixed interest rate durin

during the accumulation phase

guaranteed fixed benefit amounts are paid out during

during the annuity phase.

The surrender charge is greatest, when?

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

Principal

funds that build up during the accumulation period of an annuity

The assumed interest rate is the

growth rate insurers estimate that the annuity's cash value will earn during the annuity phase.

Flexible premium annuities are appropriate for individuals who

have fluctuating incomes, or who are unable to pay for an annuity in one lump sum.

Variable Annuities

have variable interest rates and benefits. -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.

Cash Refund Option

he 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. Because the refund life annuity option provides the most guarantee, each annuity payment will be smaller than that provided by the life annuity with period certain or straight life. Keep in mind the beneficiary would have to pay income tax on the interest portion of the annuity payments, just as the annuitant would.

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 exclusion ratio

informs contract owners what portion of each annuity payment is taxable.

Premiums for a fixed annuity are invested in the

insurer's general account. This account is composed of conservative assets such as bonds.

During the accumulation period of a deferred annuity, the principal

l earns compound interest on a tax-deferred basis.

The insurer's operating expenses, though small, l

lower the annuity payment amount.

With a period certain annuity payout option, the monthly periodic benefit is based on

on the amount of the annuity upon annuitization and the length of the period certain. The annuitant's age and sex are not factors. Of the following, who will receive the largest monthly annuity benefit from a $100,000 single premium immediate annuity with 5-year period certain: Jane, age 40; Paul, age 40; or William, age 70? -each receive same amount

Fixed Period Installment

pays periodic annuity payments to the annuitant for a stipulated period of time. Based on the annuity value at annuitization and the assumed interest rate, the insurer calculates the amount of each annuity payment. Payments stop when the period ends.

The amount paid during the annuity phase is usually stated in dollars per

per $1,000 of funds in the annuity.

Premiums are paid with dollars that have already been taxed; therefore,

premiums are funded with after-tax dollars.

Annuity payments are comprised of

principal and interest.

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.

Variable annuities are considered

securities products, and as such, must be registered with the SEC.

Premiums from variable annuities are put into the insurer's _______________ and then invested in _______________

separate account, and then invested in various equity investments, such as the stock market. This account is separate from the insurer's general account.

A flexible premium arrangement

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.

In addition,_______________regulates brokers and dealers selling variable annuities.

the NASD

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.

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.

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. 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.

downside to fixed annuities

the earning potential may not be sufficient to offset the effects of inflation. A variable annuity can address this problem.

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.

annuity phase

the income or payout period when payments from the annuity are being made to the annuitant.

While the risk of investment is borne upon the

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.

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.

Insurers use _____________________ to determine when annuitants will die.

the law of large numbers The proportion of annuitants living beyond and annuitants dying before their expected life spans tends to average out.

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. males = larger benefit

The more frequent the annuity payments,

the lower the payment amount.

Upon annuitization, the annuity's__________________ is converted into income payments.

total cash value