Chapter 14: Annuities and Individual Retirement Accounts

3 Major types of annuities sold today

1. Fixed annuity 2. Variable annuity 3. Equity indexed annuity

Two basic types of IRAs

1. Traditional IRA 2. Roth IRA

Single-premium deferred annuity

A deferred annuity with a lump sum

Equity-indexed annuity

A fixed, deferred annuity that allows the owner to participate in the growth of the stock market and provides downside protection against the loss of principal and prior interest earnings if the annuity is held to term

Individual annuity

A periodic payment that continues for a fixed period or for the duration of a designated life or lives 1. An annuity provides protection against the risk of excessive longevity 2. The fundamental purpose is to provide lifetime income that cannot be outlived

Spousal IRA

Allows a spouse who is not in the paid labor force or a low-earning spouse to make a fully deductive contribution to a traditional IRA

Flexible-premium annuity

Allows the owner to vary the premium payments

Traditional IRA

Allows worker to take a tax deduction for part or all of their IRA contributions 1. The investment income accumulates income tax free on a tax deferred basis 2. Distributions are taxed as ordinary income 3. The participant must have earned income during the year, and must be under age 70.5 4. For 2015, the maximum annual contribution is $5,500 or 100% of earned compensation, whichever is less; workers over 50 can contribute $5,000 5. A full deduction for IRA contributions is allowed if the worker is not an active participant in an employer's retirement plan or if the worker's modified adjusted gross income is below certain thresholds

Individual retirement account (IRA)

Allows workers with taxable compensation to make annual contributions to a retirement plan up to certain limits and receive favorable income tax treatment

Roth IRA

Another type of IRA that provides substantial tax advantages 1. The annual contribution to Roth IRA are not tax deductible 2. The investment income accumulates income tax free 3. Qualified distributions are not taxable under certain conditions

Current rate

Based on current market conditions and is guaranteed only for a limited period

Distributions from a traditional IRA before age 59.5:

Considered premature and subject to a 10% tax penalty

Life annuity with guaranteed payments

Pays a life income to the annuitant with a certain number of guaranteed payments

Installment refund option

Pays a life income to the annuitant; after the annuitant's death, payments continue to a beneficiary until they equal the purchase price

Variable annuity

Pays a lifetime income, but the income payments vary depending on common stock prices 1. The purpose is to provide an inflation hedge by maintaining the real purchasing power of the payments 2. Premiums are used to purchase accumulation units during the period prior to retirement 3. The value of an accumulation unit depends on common stock prices at the time of purchase 4. At retirement, the accumulation units are converted into annuity units 5. The number of annuity units remains constant during the liquidation period, but the value of each unit changes with common stock prices

Joint and survivor annuity

Pays benefits based on the lives of two or more annuities; the annuity income is paid until the last annuitant dies

Fixed annuity

Pays periodic income payments that are guaranteed and fixed in amount

Accumulation period

Prior to retirement, premiums are credited with interest

Guaranteed death benefit

Protects the principal against loss due to market declines

Life annuity (no refund) option

Provides a life income to the annuitant only while the annuitant remains alive

Deferred annuity

Provides income payments at some future date; most are not annuitized

Inflation-indexed annuity option

Provides periodic payments that are adjusted for inflation

Cash refund option

Similar to the installment refund, but pays the beneficiary a lump sum

Guaranteed rate

The minimum interest rate that will be credited to the fixed annuity

Participation rate

The percent of increase in the stock index that is credited to the contract

Liquidation period

The period in which funds are paid out, or annuitized

Annuitant

The person who receives the payment

Immediate annuity

Where the first payment is due one payment interval from the date of purchase