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