CH. 9 annuities

Period certain

period certain income option is not based on life contingency. Instead, it guarantees benefit payments for a minimum number of years, such as 10, 15, or 20 years, regardless of when the annuitant dies. At the end of the specified term, payments cease.

Annuity

An annuity is a contract between you and an insurance company in which you make a lump sum payment or series of payments and in return obtain regular disbursements beginning either immediately or at some point in the future. An annuity is an insurance product that pays out income, and can be used as part of a retirement strategy.

A single-life annuity only has ONE

Annuitant Single-life annuities are characterized by having only one annuitant.

When does interest income for a flexible premium deferred annuity get reported for federal income taxes?

Upon receiving distributions from the contract The portion of the annuity payment that represents interest-earned is taxable. The portion that represents the return of principal is not taxed.

How do benefit payments fluctuate over time in a variable life annuity?

Reflects changes in the market value of assists in a separate account

Which of the following contracts offer deferred taxation, flexible payments, a guaranteed interest rate, and death benefits equal to the cash value?

Flexible premium fixed annuity A flexible premium fixed annuity offers flexible deposits, deferred taxation, a guaranteed minimum interest rate, and death proceeds equal to the cash value.

Joint and full survivor

The joint and full survivor option provides for payment of the annuity to two people. If either person dies, the same income payments continue to the survivor for life. When the surviving annuitant dies, no further payments are made to anyone. A full survivor option pays the same benefit amount to the survivor. A two-thirds survivor option pays two-thirds of the original joint benefit. A one-half survivor option pays one-half of the original joint benefit.

Fixed Annuities

ed annuities provide a guaranteed rate of return. During the period in which the annuitant is making payments to fund the annuity (the accumulation period), the insurer invests these payments in conservative, long-term securities (typically bonds). This allows the insurer to credit a steady interest rate to the annuity contract. The interest payable for any given year is declared in advance by the insurer and is guaranteed to be no less than a minimum specified in the contract. In this way, a fixed annuity has two interest rates: a minimum guaranteed rate and a current rate. The current rate is what the insurer credits to the annuity on a regular schedule (typically each year). The current rate will never be lower than the minimum rate, which the insurer guarantees. Under the fixed amount option, the annuitant receives a fixed payment until the contract value is exhausted, regardless of when that will be. If the annuitant dies before the contract is depleted, the beneficiary receives the remaining

403(b) plan

403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers. Individual accounts in a 403(b) plan can be any of the following types.

Which of the following is NOT an intended use of an annuity?

Create new funds upon the death of a wage-earner

cash refund option

cash refund option provides a guaranteed income to the annuitant for life. If the annuitant dies before the annuity fund (principal) is depleted, a lump-sum cash payment of the remaining balance is made to the annuitant's beneficiary. Thus, the beneficiary receives an amount equal to the beginning annuity fund less the amount of income already paid to the deceased annuitant. A cash refund option provides for payments to the annuitant for life and, if the annuitant dies before the principal fund is depleted, the remainder is to be paid in a single cash payment to the annuitant's beneficiary. Thus, the total annuity fund is guaranteed to be paid out.

Immediate annuities

An immediate annuity is designed to make its first benefit payment to the annuitant at one payment interval from the date of purchase. Since most annuities make monthly payments, an immediate annuity would typically pay its first payment one month from the purchase date. Thus, an immediate annuity lacks an accumulation period. As you might guess, immediate annuities can only be funded with a single payment and are often called single-premium immediate annuities (or SPIAs) and is intended for liquidation of a principal sum. An annuity cannot simultaneously accept periodic funding payments by the annuitant and pay out income to the annuitant.

What happens to the purchasing power of benefit payments from a fixed life annuity when the cost of living goes up?

Decreases Under a fixed life annuity, the purchasing power decreases when the cost of living goes up because the amount of benefit payments remains fixed. On the flip side, the purchasing power increases when the cost of living goes down.

Which of these annuity contract features is meant to discourage withdrawals and exchanges?

Surrender charges

The interest credited to the cash values of personally-owned non-qualified annuities is considered

Tax deferred Interest credited to the cash values of annuities is deferred until distribution. A non-qualified annuity is funded with after-tax dollars, meaning you have already paid taxes on the money before it goes into the annuity. When you take money out, only the earnings are taxable as ordinary income.

Straight life annuities

straight life income annuity option (often called a life income annuity, a pure life annuity, or a straight life annuity) pays the annuitant a guaranteed income for the annuitant's lifetime. When the annuitant dies, no further payments are made to anyone. If the annuitant dies before the annuity fund is depleted, the balance is forfeited to the insurer. This annuity guarantees protection against exhaustion of savings due to longevity. When a life annuitant outlives life expectancy, the funds for additional benefit payments will be derived primarily from funds that were not distributed to life annuitants who died before life expectancy. The straight life annuity typically pays the largest monthly benefit to a single annuitant because it is based only on life expectancy. However, it creates a risk that the annuitant may die early and forfeit much of the value of the annuity to the insurance company.

What does a fixed life annuity offer protection against?

Savings depletion due to longevity Life annuities pay an annuitant a guaranteed income for the annuitant's life.

Exclusion ratio

The exclusion ratio is simply the percentage of an investor's return that is not subject to taxes . The exclusion ratio is a percentage with a dollar amount equal to the payback on an initial investment. Any return above the exclusion ratio is subject to taxes, such as a capital gains tax.

Sarah, age 88, is a life annuitant who has lived beyond her life expectancy. The funds for additional benefit payments will be derived primarily from funds that were

not distributed to life annuitants who died before life expectancy When a life annuitant outlives life expectancy, the funds for additional benefit payments will be derived primarily from funds that were not distributed to life annuitants who died before life expectancy.

What determines how much an annuitant is paid for a variable annuity?

The market value variations of the securities backing it The amount of each variable annuity benefit paid to an annuitant varies according to the market value of the securities backing it.

An annuitant is paid $495 per month until the contract value is exhausted at some undetermined date in the future. Which type of annuity payout option is this?

Fixed amount Under the fixed amount option, the annuitant receives a fixed payment until the contract value is exhausted, regardless of when that will be. If the annuitant dies before the contract is depleted, the beneficiary receives the remainder.

Life with period certain

Also known as the life income with term-certain option, this payout approach is designed to pay the annuitant an income for life, but guarantees a definite minimum period of payments. For example, if an individual has a life and 10-year certain annuity, the individual is guaranteed payments for life or 10 years, whichever is longer. If the individual receives monthly payments for six years and then dies, the individual's beneficiary will receive the same payments for four more years. Of course, if the annuitant died after receiving monthly annuity payments for 10 or more years, the annuitant's beneficiary would receive nothing from the annuity. The life with period certain annuity option provides income to the annuitant for life but guarantees a minimum period of payments. Thus, if the annuitant dies during the specified period, benefit payments continue to the beneficiary for the remainder of the period. For example, suppose an individual has a 15-year life with period-certain annuity. The annuitant receives monthly benefit payments for 11 years and then dies. The individual's beneficiary will then receive the same payments for the remainder of the period certain (four years).

Market value adjustment

Another fixed annuity product with a market-driven aspect is the market value adjusted (MVA) annuity. Instead of having the annuity's interest rate linked to an index as with the equity-indexed annuity, an MVA annuity's interest rate is guaranteed fixed if the contract is held for the period specified in the policy. The market-value adjustment feature applies only if the contract is surrendered before the contract period expires. Otherwise, the annuity functions the same way a fixed annuity does. If a MVA annuity owner decides to surrender the contract early, a surrender charge and a market-value adjustment will apply. If interest rates decreased during the contract period, the market-value adjustment will be positive and may add to the surrender value of the contract. However, if interest rates increased over that period, the market-value adjustment will be negative, which would increase the contract's surrender charge. The effect of the market value adjustment is to shift some of the investment risk to the owner. Annuity benefit payments are a combination of principal and interest. Accordingly, they are taxed in a manner consistent with other types of income. The portion of the benefit payments that represents a return of principal (i.e., the contributions made by the annuitant) are not taxed. However, the interest earned on the declining principal is taxed as ordinary income. The result is a tax-free return of the annuitant's investment and the taxing of the balance. Though a detailed discussion of how to compute the taxable portion of an annuity payment is beyond the scope of this text, the basics are not difficult to understand. A simple formula called the exclusion ratio is used to determine the amount of annual annuity income exempt from federal income taxes. The formula is the investment in the contract divided by expected return. The owner's investment (cost basis) in the contract is the amount of money paid into the annuity (the premium). The expected return is the annual guaranteed benefit the annuitant receives multiplied by the number of years of the annuitant's life expectancy. The resulting ratio is applied to the benefit payments, allowing the annuitant to exclude from income a like-percentage from income tax.

Deferred Annuities

Deferred annuities accumulate interest earnings on a tax-deferred basis and provide income payments at some specified future date (normally within a minimum of 12 months after date of purchase). Unlike immediate annuities, deferred annuities can be funded with periodic payments over time. Periodic payment annuities are commonly called flexible premium deferred annuities (FPDAs). Deferred annuities can also be funded with single premiums, in which case they're called single-premium deferred annuities. The accumulation value of a deferred annuity is equal to the sum of premium paid plus interest earned minus expenses and withdrawals. Benefit payments are initiated after the contract becomes annuitized. Most insurers charge contract owners a back-end load for liquidating deferred annuities in the early years of the contract. These surrender charges cover the costs associated with selling and issuing contracts as well as costs associated with the insurer's need to liquidate underlying investments at a possibly inappropriate time. Many deferred annuity contracts waive the surrender charge when the annuitant dies or becomes disabled.

1035 contract exchange

Section 1035 of the Internal Revenue Code provides for tax-free exchanges of certain kinds of financial products, including annuity contracts. Recall that no gain will be recognized (meaning no gain will be taxed) if an annuity contract is exchanged for another annuity contract. The same applies when a life insurance or endowment policy is exchanged for an annuity contract. An annuity contract cannot be exchanged tax-free for a life insurance contract. This is not an acceptable exchange under Section 1035.

Variable Annuities

Annuities As with variable life insurance, variable annuities shift the investment risk from the insurer to the contract owner. If the investments supporting the contract perform well (as in a bull market), the owner will probably realize investment growth that exceeds what is possible in a fixed annuity. However, the lack of investment guarantees means that the variable annuity owner can see the value of the annuity decrease in a depressed market or in an economic recession. Variable annuities invest deferred annuity payments in an insurer's separate accounts, as opposed to an insurer's general accounts (which allow the insurer to guarantee interest in a fixed annuity). Because variable annuities are based on non-guaranteed equity investments (such as common stock), a sales representative who wants to sell such contracts must be registered with the Financial Industry Regulatory Authority (FINRA) as well as hold a state insurance license. Not only can the value of a variable annuity fluctuate in response to movements in the market, so too will the amount of annuity income fluctuate even after the contract has annuitized. It was for that reason the product was developed in the first place. In spite of inevitable dips in the amount of benefit income, the theory is that the general trend will be an increasing amount of income over time as inflation pushes up the price of stocks. Generally, this theory has held true.

Which statement is INCORRECT concerning a tax-sheltered annuity (TSA)?

Annual investment gains are included in participant's gross income The investment gains are actually deferred in a tax-sheltered annuity.

Annuitant

An annuitant is a person who collects the benefits of an annuity or pension, or named in a specialized life insurance contract. During liquidation phase of an annuity contract, the income benefits are normally payable to them. The annuitant is the beneficiary of an annuity or pension. An annuitant can be the contract holder or another person. The beneficiary receives the proceeds of the annuity contract upon the annuitant's death to shield the beneficiary from a loss of income. An annuitant is one or more individuals, or a special class of government employee who receives periodic payments for life or during a specified period of an annuity contract. The owner can name one or more annuitants. Some contracts allow the owner to name joint annuitants. An annuitant must be a natural person and cannot be a company or a trust. The annuitant is the person whose life expectancy and age insurers use to calculate the annuity payments.

What is the effect of the market value adjustment in a market value adjustment annuity?

Transfers some of the investment risk to the policyowner A Market Value Adjustment (MVA) can be attached to a deferred annuity that features fixed interest rate guarantees combined with an interest rate adjustment factor that can cause the actual crediting rates to increase or decrease in response to market. Market value adjustments found in some annuity products are meant to shift some of the investment risk to the policyowner.

Single premium

Annuities can be funded with a single lump-sum premium, in which case the principal sum is created immediately. For example, individuals nearing retirement whose financial priority is retirement income could surrender their whole life policies and use the cash value as a lump sum premium to fund an annuity.

Accumulation period

the accumulation period, contributions made by the annuitant (less a deduction for expenses) are converted to accumulation units and credited to the individual's account. The value of each accumulation unit varies depending on the value of the underlying stock investment. For example, assume that the accumulation unit is initially valued at $10 and the holder of a variable annuity makes a payment of $200. This means she has purchased 20 accumulation units. Six months later, she makes another payment of $200, but during that time, the underlying stocks have declined, and the value of the accumulation unit is $8. This means that the $200 payment will now purchase 25 accumulation units. The value of one accumulation unit is found by dividing the total value of the company's separate account by the total number of accumulation units outstanding. Thus, if a company had $20 million in its separate account, and a total of 4 million accumulation units outstanding, the value of one accumulation unit would be $5. As the value of the account rises and falls, the value of each accumulation unit rises and falls.

Periodic payments

Annuities can also be funded through a series of periodic premiums that will eventually create the annuity principal fund. At one time, it was common for insurers to require that periodic annuity premiums be fixed and level, much like insurance premiums. The purpose of this type of funding is to create a certain amount of periodic annuity income. In other words, the contract defines what premium is required to generate a specified amount for a specified period of time upon contract maturity. Today, it is more common to allow annuity owners to make flexible premium payments. A certain minimum premium may be required to purchase the annuity. After that, the owner can make premium deposits as often as is desired. With flexible premium annuities, the benefit is expressed in terms of accumulated value. For instance, a contract might specify that it will provide for guaranteed lifetime monthly payments of $5.06 per $1,000 at the annuitant's age 65. This means that a contract that has grown to $100,000 upon the annuitant's age 65 would generate $506 a month for life.

Which statement concerning a deferred annuity contract is correct?

The owner can be the beneficiary, annuitant, or neither

Equity Indexed Annuity

fairly recent innovation, equity indexed annuities (EIA) are a type of fixed annuity that offer the potential for higher credited rates of return than their traditional counterparts but also guarantee the owner's principal. The interest credited to an EIA is tied to increases in a specific equity or stock index (such as S&P 500), which results in long-term inflation protection. Underlying the contract for the duration of its term is a minimum guaranteed rate (ordinarily 3 or 4%), so a certain rate of growth is guaranteed. When increases in the index to which the annuity is linked produce gains that are greater than the minimum rate, that gain becomes the basis for the amount of interest that will be credited to the annuity. At the end of the contract's term (usually five to seven years) the annuity will be credited with the greater of the guaranteed minimum value or the indexed value.