Chapter 5 Annuity Principles and Concepts

T/F A tax-free owner, who may also be the annuitant, may change the annuity date, beneficiary, and payout option.

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What are the factors that determine the monthly income payment?

-Account value at the time of annuitization -Interest rate return -Age and gender of the annuitant -The payment option selected

Types of Annuities

-Fixed (Guaranteed) Annuity -Indexed Annuity -Variable Annuity -Qualified/Non-qualified Annuity

Control of the Contract

-Owner -Beneficiary -Annuitant

Indexed Annuity

An annuity product with interest rates that are linked to the positive performance of a related index, such as the Standard & Poor's 500 Index.

With annuities, whom names and designates?

As with life insurance, annuities may have beneficiaries named and designated by the owner prior to the annuitization or guaranteed payout period. The beneficiary may be named at receipt of the first purchase payment and may only be changed by the owner.

When does the owners rights begin?

At the time of the purchase

Which of the following annuities does not have a traditional accumulation phase? A. Periodic premium deferred B. Single premium immediate C. Single premium deferred D. Flexible premium deferred

B. Single premium immediate An immediate annuity essentially does not have an accumulation period and is used to generate immediate income. Income is generated within a year of the issue date.

All of the following factors are used to determine the monthly benefit payment of an annuity, except: A. Age of annuitant B. Annuity payment option selected C. Annuitant's medical history D. Accumulated account value

C. Annuitant's medical history The monthly annuity payment is based on several factors, including the accumulated value, interest rate, age and gender of annuitant and the payment option selected. Since there are no insurability requirements, the annuitant's medical history is not a factor.

If an annuity is purchased in December and monthly benefits begin in January of the following year, what type of annuity is it? A. Flexible Premium Tax Sheltered Annuity B. Single Premium Fixed Annuity C. Single Premium Immediate Annuity D. Variable Retirement Annuity

C. Single Premium Immediate Annuity The question addresses when the actual receipt of benefits from an annuity begins. When benefits begin within a year of the issue date, this is referred to as 'immediate'.

Jasmine has deposited $100,000 into a single premium immediate annuity. If Jasmine were to die before receiving $100,000 in payments, the balance of the $100,000 would be paid to her sister. Jasmine has selected the: A. Life Income Joint and Survivor Option B. Life Income Period Certain Option C. Joint Life Option D. Life Income with Refund Option

D. Life Income with Refund Option If Jasmine dies prior to receiving an amount equal to the total of all payments made into the annuity and the balance of that amount is refunded to a beneficiary either in a lump sum or in installments, she has chosen Life Income with Refund.

What happens if contract owner and annuitant are the same person?

During the accumulation period, if the contract owner and the annuitant are the same person and the designated beneficiary is the annuitant's spouse, the IRS code allows the spouse to assume ownership of the annuity upon the death of the annuitant. All rights of ownership are assumed to include tax deferment.

In theory, what is an annuity designed to do?

In theory, an annuity is designed to protect against outliving an individual's retirement income by providing lifetime income.

One of annuities' primary function?

One of the primary functions of an annuity is to liquidate an estate, or to pay benefits until the death of an annuitant

Tax-Deferred Growth

Since an annuity is an insurance contract, the accumulation value grows tax-deferred. Deferred annuities allow for the naming of a beneficiary to receive any policy values if the annuitant dies prior to annuitizing. Withdrawals prior to age 59 ½ are subject to income tax and generally a 10% tax penalty as well. Systematic withdrawals are allowed as a way to access the policies values without having to elect a settlement option.

In a variable annuity, when do you pay the premium, and what happens to the premium once paid?

The premium paid during the accumulation period is invested in a separate account; the underlying investment in the separate account is similar to a mutual fund.

Periodic Premium

Continuous premiums are paid into the contract. While annuities can certainly offer fixed level premiums, the most common example of a periodic premium is a flexible premium.

Premium Payment Options

-Single Premium -Periodic Premium -Flexible Premium

Annuity (Benefit) Payment Options

-Life Income (Pure or Straight Life) -Life Income Period Certain -Life Income with Refund (Installment or Cash Refund) -Life Income Joint & Survivor -Joint Life

Do you need a license for variable annuities?

Yes, both an insurance license and a securities license (FINRA) are required.

The annuity benefit or payment option requiring the greatest amount of capital per $1,000 of benefit is: A. Life Income Joint and Survivor 100% B. Life Income Joint and Survivor 75% C. Life Income Joint and Survivor 66 2/3% D. Life Income Joint and Survivor 50%

A. Life Income Joint and Survivor 100% The income benefit requiring the greatest amount of capital per $1,000 of benefit is Life Income Joint and Survivor 100%. The higher the percentage of payment for the survivor (1/2, 2/3), the greater amount of capital that is needed.

Jill wants to know how much to put into her annuity in order to receive the greatest benefit payment amount. Which of the following will provide her with the largest monthly income regardless of the settlement option selected? A. $250,000 B. $1,000,000 C. $750,000 D. $500,000

B. $1,000,000 All other factors being equal, the larger the premium deposit, the larger the benefit payment.

A Variable Annuity is different from a Fixed Annuity because it must be sold with which of the following documents? A. Regulator approved sales literature B. A prospectus C. A copy of the insurer's business formation documents D. A copy of the producer's licensing exam test score

B. A prospectus A prospectus is a disclosure document that provides the prospective buyer with information about all fees, charges, expenses, and risks. It must be provided by the producer prior to sale of the variable annuity.

Fixed (Guaranteed) Annuity

During the accumulation period, the insurer guarantees a minimum fixed interest rate. At annuitization, benefits are paid as a minimum level fixed amount. The fixed amount purchasing power decreases as the cost of living increases. The actual rate of interest created at any one time is based on the earnings rate of the insurer's general account and the insurer bears any investment risk. A life-only insurance license is required in order to sell fixed annuities in most states. Some fixed annuities offer a base interest rate plus a bonus interest rate which becomes the current rate credited into the annuity. The current rate is set by the insurance company at the time the contract is issued and is guaranteed for a specific time period.

In a variable annuity, what happens to the monthly annuity payment if the actual return is lower/equal/greater than the AIR?

If the actual return is lower than the AIR, the monthly annuity payment will be reduced. If the actual return is equal to the AIR, the monthly annuity payment will remain the same as the previous month. If the actual return is greater than the AIR, the monthly annuity payment will increase from the previous month.

Life Insurance vs Annuities

Life Insurance: -Provides benefit upon death of the insured -Creates an estate -Pays a death benefit -Protects against premature death -Owner, insured, beneficiary -Policy Annuity: -Provides steady benefit until the death of annuitant -Liquidates an Estate -Pays a living benefit -Protects against living too long -Owner, annuitant, beneficiary -Contract

Lump Sum vs. Annuitization

Lump Sum -The annuitant has the option of cashing out the annuity in a lump sum instead of electing to receive a stream of income. -There could be tax consequences and tax penalties depending upon when this occurs. Annuitization -The election to receive payments from the annuity for life, or for a specified period depending on the settlement option selected.

Annuity Payments

Once a contract is annuitized, the insurance company takes ownership of funds in the account. In return, the annuitant is entitled to a guaranteed income stream based on the terms of annuitization. Depending on the option chosen, the annuitant may be able to name a beneficiary to receive any remaining benefits available upon the annuitant's death.

What is the actual rate of interest for a fixed (guaranteed) annuity?

The actual rate of interest created at any one time is based on the earnings rate of the insurer's general account and the insurer bears any investment risk. A life-only insurance license is required in order to sell fixed annuities in most states.

Life Income (Pure or Straight Life)

The annuity benefit is payable for as long as the annuitant lives, and upon death all payments cease. This option provides the highest monthly income than any of the other options.

Joint Life

The annuity is payable to 2 or more named annuitants while both are living. Upon the death of the first annuitant, the benefits stop.

Owner

The individual who controls the contract and is responsible for making payments into the contract, as well as having all of the contractual rights in the policy, is the owner.

Annuitant

The individual whose life the contract is based upon. Upon a lifetime annuitization, payments will be made to the annuitant according to the annuitant's age, gender, settlement option selected, and dollar amount used to fund the income benefit payments.

Deferred Annuity Characteristics

-are normally purchased to defer taxes on any contract earnings. They are ideal for accumulating a retirement fund. During the accumulation period, only the contract owner can sign the request for surrender of a deferred annuity. ---During the early part of the accumulation period, the insurer normally assesses a surrender charge. -Tax-Deferred Growth

Primarily, the _________ is the person who will receive any residual contract benefits after the annuitant has died. A. Beneficiary B. Spouse C. Insurer D. Owner

A. Beneficiary The beneficiary of an annuity receives any residual contract benefits upon the death of the annuitant.

Life Income Period Certain

The annuity benefit is payable for life, or for a specified period of time, whichever is longer. ---If the annuitant lives beyond the stated period, benefits continue for life of the annuitant. ---If the annuitant dies prior to the end of the period certain, a beneficiary receives the balance of the payments for the remaining time period.

Life Income with Refund (Installment or Cash Refund)

The annuity benefit is payable for the lifetime of the annuitant. Upon death, if an annuitant has not received an amount equal to the total of all payments made into the annuity (not the growth), the balance is refunded to the beneficiary as a lump sum, cash refund, or in installments, sometimes referred to as the installment refund.

Life Income Joint & Survivor

The annuity benefit is payable in one payment to 2 or more annuitants until the last surviving annuitant dies. Upon the death of the first annuitant, survivor benefits continue, either paying the full amount or a reduced benefit, such as 2/3 or 1/2 of the original amount, until the survivor dies. Depending on which option is selected, these options may be referred to as Joint and Full Survivor, Joint and 2/3 Survivor, or Joint and ½ Survivor.

Immediate Annuities

The immediate annuity does not have an accumulation period and is used to generate immediate income within a year of the issue date.

Which of these annuity distribution options promises the largest possible payment to a single annuitant? A. Life income only B. Installment refund C. Life income with period certain D. Lump sum refund

A. Life income only A life income only option provides the largest possible payment since the insurer has no risk of paying income to a beneficiary. There is a greater possibility that the insurer will pay income beyond the life of the annuitant if any of the other options are selected.

What happens to the fixed amount of purchasing power as the cost of living increases?

The fixed amount purchasing power decreases as the cost of living increases.

Deferred Annuities

A deferred annuity will pay periodic benefits starting at some specified time in the future. Annuitization can occur at any time, but benefits from a deferred annuity are not payable for at least 1 year from the issue date.

What must a prospective buyer be provided when looking at a variable annuity? What does this document provide? When should it be provided?

A prospective buyer of a variable annuity must be provided with a document called a prospectus. The prospectus gives detailed information on the separate account available in the annuity. This information provides the contract owner the opportunity to make a better decision based on the historical performance of the separate account. The prospectus must be provided at or before the time of the sale.

Single Premium Deferred Annuity (SPDA)

A single premium (lump sum) is put into an annuity from which the annuitant will draw the benefits at some specified time in the future, more than 1 year from the issue date.

A flexible premium deferred annuity permits all of the following EXCEPT: A. A lump sum payment can be used to purchase the annuity B. Accumulated values in the account are not taxable until they are withdrawn C. Annuitization is allowed at any time after 1 year D. Scheduled and unscheduled premiums may be payable at any time prior to annuitization

A. A lump sum payment can be used to purchase the annuity A flexible premium annuity is not funded with a lump sum payment.

All of the following statements are correct regarding an annuity, EXCEPT: A. An immediate annuity must start providing income within 3 years of the first premium payment B. An annuity can be characterized by immediate or deferred income C. Annuity premiums can be made in single or periodic payments D. The accumulation value grows tax-deferred

A. An immediate annuity must start providing income within 3 years of the first premium payment An immediate annuity must start providing income within one year of the first premium payment.

How are annuities funded and sold?

Annuities are funded and sold through life insurance companies and require at least a life insurance license to sell. There is no evidence of insurability required to purchase an annuity.

Primary purpose of an annuity?

Annuities are used primarily to provide a steady stream of income to an individual typically upon retirement.

A characteristic of a fixed annuity is that the: A. Interest rate credited in the account varies based on the performance of the separate account B. Monthly income benefits are fixed and level C. Separate account has investment options D. Annuitant cannot be changed

B. Monthly income benefits are fixed and level A fixed annuity provides for a fixed level benefit payment to the annuitant when the contract is annuitized.

Flexible Premium Deferred Annuity (FPDA)

Flexible contributions may be made as often and in whatever amount the contract owner desires. However, most insurers set a minimum and a maximum amount for contributions. Benefits begin more than 1 year from the issue date.

Flexible Premium

Flexible contributions may be made as often and in whatever amount the contract owner desires. However, most insurers set a minimum and a maximum dollar amount they will accept.

Who regulates variable annuities?

Variable annuities are regulated by the SEC and State insurance departments. This annuity is considered a security, and therefore, must comply with the Federal Securities and Exchange Commission (SEC) rules as well as the state insurance laws.

Why are systematic withdrawals allowed?

Systematic withdrawals are allowed as a way to access the policies values without having to elect a settlement option.

Qualified vs Non-Qualified Annuities

Qualified -is funded with pre-tax dollars -The entire distribution from a qualified annuity (contributions and earnings) is subject to ordinary income taxes. Non-Qualified -is funded with after-tax dollars, meaning taxes on the money were paid before it goes into the annuity -Upon distribution, only the earnings are taxable as ordinary income.

How do variable annuities protect from inflation?

This protects against the purchasing power risk of a fixed payment annuity by providing income that trends toward keeping pace with inflation.

Accumulation (Pay-in) Period

The period of time from the first deposit to the start of the annuity payout is considered the accumulation period, during which taxes are deferred. ---are only found within deferred annuities, not immediate annuities. ---ends when the owner elects to annuitize, or begin to receive income payments.

Annuity income benefit payments are based on all of the following, except: A. Gender B. Education level C. Age D. Settlement option selected

B. Education level Age, gender, settlement option selected, and dollar amount used to purchase the income payment benefit are all used in determining the amount of the income benefit payment.

All of the following are true regarding annuities, except: A. They are used primarily to provide a steady stream of income B. They are similar to life insurance C. They can liquidate an estate D. They are designed to protect against outliving one's income

B. They are similar to life insurance Annuities are used primarily to provide a steady stream of income to an individual, typically upon retirement. They are designed to protect against outliving one's retirement income by providing lifetime income. And they can liquidate an estate over the lifetime of an annuitant. Although both annuities and life insurance are mortality-based products, they have opposite purposes: annuities are designed to distribute an estate, while life insurance is designed to create an estate.

When comparing life insurance to an annuity, an annuity: A. Guarantees a death benefit upon the insured's death B. Provides tax-free payments for the lifetime of a beneficiary C. Protects against the annuitant living too long D. Creates a lump sum benefit to be paid upon the annuitant's death

C. Protects against the annuitant living too long Annuities protect against an annuitant living too long by providing a stream of income the annuitant cannot outlive. Annuities do not provide tax-free payments or guarantee a death benefit. Annuities liquidate an estate and life insurance creates an estate.

K owns a variable annuity with an assumed interest rate of 4%. If the actual performance of the separate account(s) is 4%, the effect on this month's income benefit check will be such that it: A. Becomes Higher B. Becomes Lower C. Remain the Same D. All Depends on the Separate Account(s) Selected

C. Remain the Same If the actual return is lower than the AIR, the monthly annuity payment will be reduced. If the actual return is equal to the AIR, the monthly annuity payment will remain the same as the previous month. If the actual return is greater than the AIR, the monthly annuity payment will increase from the previous month.

All of the following are characteristics of a variable annuity, except: A. Designed to protect against inflation B. Premiums made into the annuity purchase accumulation units C. Each month the payment will increase, decrease, or remain the same as the previous month's payment based on the actual return as compared to the assumed interest rate (AIR) D. The separate account provides for a guaranteed minimum return

D. The separate account provides for a guaranteed minimum return A variable annuity does not provide for any minimum guarantees.

Annuity Period (Pay-Out)

The annuity period begins once the policyowner elects to convert a deferred annuity into an income benefit payment. -The settlement option selected can provide a temporary or lifetime payment. -If a lifetime benefit is selected, it is an irrevocable election. The cash values go towards paying for the income benefit.

What does the indexed annuity offer?

The contract offers safety of principal with guaranteed minimum returns. ---The safety of principal and previously locked-in interest is backed by the insurer's general account. ---The minimum guarantee can be as low as 0%, reflecting that the policy will not be adversely affected by negative stock market index performance.

Single Premium Immediate Annuity (SPIA)

A single premium (lump sum) is put into an annuity from which the annuitant may immediately begin drawing benefits (within a year of the issue date). A retirement plan rollover, savings account balances or CDs, mutual funds, deferred annuity values, or the death proceeds of a life insurance policy might be used to purchase a SPIA.

Deferred annuities are normally purchased to defer ___________. A. Withdrawals of any earnings B. Withdrawals of any principal C. Earnings on any deposits D. Taxes on any policy earnings

D. Taxes on any policy earnings Deferred annuities are normally purchased to defer taxes on any policy earnings. They are ideal for accumulating a retirement fund.

Single Premium

A lump sum payment is made into an annuity.

Beneficiary

The individual or person named in the contract to potentially receive benefits if the owner and/or annuitant die prior to annuitization or if the settlement option selected offers any residual benefit after the annuitant's death.

Is an indexed annuity a securities product? do you need a license to sell?

An indexed annuity is not a securities product and does not require an additional securities license to sell it.

Variable Annuity

Annuity payments and cash values fluctuate according to the investment experience of the separate account the contract owner has designated. -Payments are based on "units" rather than dollars. -While not guaranteed, variable annuities may act as a hedge against inflation. The contract owner bears the investment risk and receives the return earned on invested assets, less any charges assessed by the insurer and investment managers. (No Guarantee) The investment return varies according to the separate account selected based on the assumed interest rate (AIR). The premium payments made during the accumulation period may be flexible in amount and frequency limited only to the contract's provisions. Premiums purchase accumulation units of the separate account. These are similar to shares of a mutual fund. Upon annuitization, accumulation units are converted into annuity units. The number of annuity units liquidated remains level, but the unit value fluctuates, based upon the performance of the separate account.

James is nearing retirement and has accumulated $175,000 in an annuity. He wants the largest possible monthly benefit for as long as he lives. Which option should he choose? A. Joint Life B. Life Income C. Fixed Amount D. Life Income with Refund

B. Life Income The Life (Life Only or Straight Life) Income option provides the largest possible payment to the annuitant because the insurance company offers no residual values upon his death.

Harry, the annuitant of a non-qualified tax deferred annuity with $40,000 cash value chooses the Life Income with Refund Payment Option when he annuitizes the policy. After receiving $1,000 each month for 80 months, Harry suddenly dies. How much will his beneficiary, his wife Lucille, receive? A. Payments over the rest of her life B. $40,000 C. Zero D. $80,000

C. Zero A Refund Option returns the remaining unpaid principal, since Harry lived well beyond the refund (principal amount) there would be no residual values remaining on the payment option selected.

K owns a variable annuity with an assumed interest rate of 4%. If the actual performance of the separate account(s) is 5%, the effect on this month's income benefit check will be such that it: A. All Depends on the Separate Account(s) Selected B. Becomes Lower C. Remains the Same D. Becomes Higher

D. Becomes Higher If the actual return is lower than the AIR, the monthly annuity payment will be reduced. If the actual return is equal to the AIR, the monthly annuity payment will remain the same as the previous month. If the actual return is greater than the AIR, the monthly annuity payment will increase from the previous month.

Which of the following statements is TRUE regarding Fixed Annuities? A. A securities registration (license) is required in order to sell them B. Premiums are allocated to separate account(s) C. The contract owner bears the investment risk D. Upon annuitization, the annuity payments are level

D. Upon annuitization, the annuity payments are level Premiums are allocated to the insurer's general account. The insurer has the investment risk, and fixed annuities pay out a fixed level income benefit payment.