Book 2, Unit 2, Annuities

Equity Indexed Annuities (EIA) have several features that affect actual returns an owner receives including:

1. participation rate 2. interest rate caps 3. spread or administrative fee 4. High water mark

annuities are considered for clients who want:

1. tax deferred growth 2. Retirement income or an income stream that cannot be outlived 3. freedom from investing and managing retirement assets 4. Replacement or alternative to an individual retirement account If safety of principal is paramount or a retiree is extremely risk averse, a fixed annuity may be recommended

annuities are subject to a....

10% early distribution penalty unless an exception applies

Deferred income annuities

AKA longevity annuities, guarantee income for life or a certain period of time. One unique characteristic of these annuities is that future income start dates are chosen at contract issuance (up to age 85) Annuitization rates are established at the time of the initial premium payment or subsequent premium payments

Protecting persons against unintentional payment of excess longevity annuity premiums for QLACs

Individuals who inadvertently exceed the 25% or 125k limits on premium payments are allowed to correct the excess without disqualifying the purchase

annuities utilize

LIFO (last in first out). Earnings are withdrawn first and subject to income tax. nontaxable basis is withdrawn last

guaranteed minimum withdrawal benefit (GMWB) rider

NOT GUARANTEED FOR THE LIFE of the contact owner. The owner can make systematic withdrawals over a specified period and be assured of receiving at least a return of premium or the benefit base, regardless of the annuity contract's investment performance

maximum age at commencement of income for QLAC

QLAC contract must provide that distributions under the contract commence not later than a specified annuity starting date stated in the contract Specified annuity starting date must be no later than the first day of the month following the employee's attainment of age 85

maximum allowed investment for QLAC

a 401(k) or similar plan, or IRA, may allow plan participants to use up to 25% of their account balance or 125k, whichever is less, to buy a QLAC without concern about noncompliance with the age 70.5 minimum distribution requirements

Allowing return of premium (ROP) death benefit for QLAC

a longevity annuity in a plan or IRA can now provide that, if buying retirees die before or age the age when the annuity begins making payments (i.e. annuitization), the premiums they paid by have not yet received will be returned to their accounts and can be paid to beneficiaries

Because a variable annuity is both a security and and insurance product, a financial planner needs two licenses WHICH ARE...

a securities license and a state variable insurance license

two stages of an annuity are:

accumulation stage and the distribution stage

free withdrawals

allows contract owner to withdraw up to a stipulated amount - usually 10% of the contract's accumulated value - every year without incurring surrender charges *** Does not alter tax consequences. Annuity withdrawals are subject to income taxation and a 10% penalty if taken before the owner reaches age 59.5 Never any income tax consequences or tax penalties on the basis portion of any withdrawals

flexible premium annuity

allows the insured the option to vary the premium deposits over a designated period of time

guaranteed lifetime withdrawal benefit (GLWB) rider

an optional rider guaranteeing that the owner of a variable annuity can make certain systematic withdrawals for life and be assured of receiving a guaranteed amount of income, regardless of the annuity contract's investment performance Owner can withdraw up to a specific percentage of a protected value each year for life, even if the contract value drops to 0

single premium immediate annuity (SPIA)

annuity in which the first annuity payment is made one scheduled interval from its purchase date Purchased using a single lump-sum payment and is used when a retirement plan participant wishes to transfer investment risk and payment responsibility to an insurance company

for annuities issued after August 13, 1982,....

any withdrawals during the accumulation stage are taxable to the extent there are earnings in the contract (LIFO)

joint and survivor annuity

based on the lives of two or more annuitants, usually the annuitant and spouse. Annuity payments are made until the last of the two annuitants dies

an exchange of an annuity contract for a life insurance policy cannot...

be accomplished tax free. This is because the life insurance policy is taxed more favorably (notably the tax-free nature of the policy's death benefit) than an annuity

annuity

categorized according to the time when the benefit payments begin (immediate or deferred), by the method of premium payment (flexible or single premium), or by the form of annuity payment (fixed or variable)

variable annuity prospectus

contains, but is not limited to, all of the variable annuity's investment choices, fees, expenses, investment objectives, investment strategies, risks, performance, and pricing for each investment choice Financial planners are REQUIRED to provide a prospectus at the point of solicitation

participation rate

determines how much of the increase in the value of the underlying index will be used to compute the interest rate that is credited to the owner Ex: participation rate = 80% and index increases 10%, calculation is 0.8 x 0.1 = 0.08 x 100 = 8%

Fixed annuity exclusion ratio

determines the nontaxable portion of each annuity payment indicated by the formula: Investment in the contract / Expected return

variable annuity suitability

financial planner must follow two FINRA rules to ensure that they do not open themselves up to possible litigation or arbitration if a client files a complaint

annuity payments beyond projected life expectancy are...

fully taxable unless the annuity payments began on or before December 31, 1986

life annuity with period certain

guarantees that a minimum number of payments will be paid or the annuitant will have income for life, whichever is greater The longer the guarantee or period certain, the less the monthly payout will be for the annuitant

surrender charge

imposed when the full value of the annuity contract is surrendered (lump-sum withdrawal) or when funds exceeding the free withdrawal amount (partial withdrawal) are withdrawn Many surrender charges reduce over time

crisis wavers

in the event of a specified occurrence, a person may draw on some of the money without a penalty being incurred

spread or administrative fee

index-linked interest for some EIAs is determined by subtracting a percentage from any gain in the index. ***Can range as high as 3%

twisting

inducing a policyowner with one company to lapse, forfeit, or surrender a life insurance or annuity policy for the purpose of taking out a policy through another company

guaranteed minimum income benefit (GMIB) rider

insurance company guarantees that the owner can eventually annuitize a certain minimum guaranteed income base, regardless of how poorly the contract's subaccounts perform Useful for more conservative investors

qualified longevity annuity contract (QLAC)

insurance option that ensures retirees have a stream of regular income throughout their advanced years QLACs are a typed of deferred income annuity

variable annuity exclusion reatio

investment in the contract / annuitant's life

taxation of annuities during the accumulation stage

investment income by an annuity (the earnings) during its accumulation stage is tax-deferred to the owner ***ONE MAJOR EXCEPTION TO THE RULE-> annuity oowned by a corporation or non-natural person (nonqualified defered or executive compensation plan), the earnings are currently taxable as ordinary income

Guaranteed minimum accumulation benefit (GMAB) rider

living benefit rider guaranteeing that the owner of a variable annuity will receive at least a return of principal, in a lump sum, after a specified waiting period ***used for when contract is worth less than a guaranteed minimum value. Insurer will make a one-time contribution to bring contract up to the guaranteed value

Bonus annuity contracts generally have...

longer surrender charge periods and may have higher annual management fees

joint and survivor annuity settlement option is the...

mandatory form of payment for a qualified plan participants who is entitled to receive a pension at retirement Provides surviving spouse at least 50% but no more than 100% of the benefit Known as a QJSA

bonus annuity

may offer a bonus in the form of a credit which may be added to the initial premium (investment). Insurance companies offer bonuses to give potential annuity clients an incentive to choose a particular annuity product

variable annuity

offers a variable or uncertain amount of payment over a given period based on the performance of subaccounts, which are professionally managed portfolios of debt and equity securities rate of return of a variable annuity depends on the performance of the assets within the subaccounts in which the annuity is invested

fixed annuity

pays a specified (or fixed) interest rate over a given period and provides more security of principal than a variable annuity, but it does not take advantage of market conditions Funds are held in an insurance company's general account and the insurance company bears all of the investment risk Fixed annuity is designed for a conservative investor more concerned with safety of principal than keeping up with the market

superannuiation

possibility of running out of money during a financial life Lump-sum payment has participant assume the risk of superannuation

churning

practice by which policy values in an existing life insurance policy or annuity contract are used to purchase another policy or contract with that same insurer for the purpose of earning additional premiums or commissions with an objectively reasonable basis for believing that the new policy will result in an actual and demonstrable benefit

straight (single) life annuity

provides a lifetime income to the owner/annuitant regardless of how long he lives If an annuitant is fortunate enough to outlive their anticipated life expectancy, he has made a wise distribution choice This offers highest monthly amount because the annuity provides no guarantees beyond the annuitant's death

IRS code section 1035

provides an exchange of an existing insurance based contract without having to pay taxes on any gain in the original contract

deferred annuity

provides income at some future date and is purchased either with a single premium or periodic level premiums Deferred, nonqualified annuity is purchased with after-tax dollars and often used to provide for retirement income MOST POPULAR is a deferred, variable annuity to provide variable income at the owner's retirement, potentially providing inflation protection during the relatively long investment period

1035 exchange

provides postponement of taxes resulting from an exchange of: 1. two life insurance contracts 2. a life insurance contract for an endowment or an annuity contract 3. two annuity contracts 4. an endowment insurance contract for an annuity contract 5. two endowment insurance contracts (if new contract provides for regular payments beginning on a date no later than the date payments would have begun under the contract that was exchanged) In addition, life insurance, annuity, or endowment contracts can be exhcnaged for a tax qualified long-term care insurance policy

single premium annuity

purchased with a single lump sum. Proceeds or benefits from a qualified retirement plan are often used to purchase an immediate, single premium, fixed annuity

accumulation unit

quantity of measurement for the purpose of determining the annuity owner's interest in a separate account

installment refund annuity

similar to a life annuity with period certain, except the insurance company promises to continue periodic payments after the annuitant has died until the sum of all payments equals the purchase price of the annuity There is also a cash refund form of this option, meaning the unpaid balance is paid in a lump sum to a named beneficiary or beneficiaries at the annuitant's death

interest rate caps

some EIXs establish a maximum interest rate that the annuity can earn

if annuity is a qualified annuity,

some or all of the annuity distribution (both principal and earnings) are taxed as ordinary income once received

Equity-indexed annuity (EIA)

specialized type of annuity whereby the insurance company credits the contract owner with a return that is based on changes in an equity index (like S&P 500) Insurance company typically guarantees a minimum return (floor) After the accumulation period, the insurance company makes periodic payments to the owner/annuitant under the terms of the contract (similar to other annuity contracts)

Initial bonus percentage or initial bonus amount is...

the actual bonus paid by the insurer, generally, at inception of the annuity contract, and may be expressed as a percentage of the initial premium or a specific dollar amount, and must be stated in the annuity contract

High water mark

this indexing method credits index-linked interest on the basis of any increase in the index value from the index level at the beginning of the annuity's term to the highest index value at various points during the annuity's term, usually an annual anniversary from when the owner first purchased the annuity

Unsuitable annuity practices include:

twisting and churning

When are EIAs suitable?

when a client wants to participate in the equities market without bearing the investment risk of a variable annuity

Allowing more flexibility in issuing QLACs

when the contract is issued, the contract (or rider or endorsement with respect to that contract) must state that the contract is intended to be a QLAC