Chapter 8

A variable annuity contract holder dies during the accumulation period. Which of the following is TRUE regarding the tax consequences? A. All proceeds are considered a return of capital. B. The growth is taxable as a capital gain to the beneficiary. C. Proceeds in excess of cost are taxable as ordinary income to the beneficiary. D. The growth above cost is not taxable if the beneficiary rolls it over into a retirement plan.

*C. Proceeds in excess of cost are taxable as ordinary income to the beneficiary.* When a variable annuity contract holder dies during the accumulation period, the proceeds in excess of cost are taxable to the beneficiary as ordinary income.

equity-indexed contracts (EICs) aka Equity Indexed Annuities (EIAS)

*EICs are contracts that combine the features of both fixed and variable annuities; however, they're not required to be registered with the SEC as securities.* An equity indexed contract offers clients a minimum guaranteed rate of return or *floor* (similar to a fixed annuity), but also offers upside potential (similar to a variable annuity/contract). The insurance company links the return of these types of contracts to an equity index, such as the S&P 500 Index. If the index performs poorly, the client will still earn the minimum guaranteed rate. On the other hand, if the index appreciates above a preset level, the investor will earn a return that exceeds the minimum guaranteed rate. Some contracts are issued with a *participation rate* which may limit the amount of the index's appreciation that the client will earn. For example, an EIC has a participation rate of 80% and the associated index's return is 10%. In this case, the investor will not share in the entire return of the index. Instead, the investor's return is capped at 8% (10 x 80%). Although these contracts offer the benefit of *tax-deferred growth*, clients may lose money when surrendering the contract in the early years since expenses, CDSCs, and premature distribution penalties often apply. The market doesn't cause the value of these investments to decline; instead, it's the impact of fees being deducted. *Suitability*: As with variable annuities, equity-indexed annuities are not suitable for all investors, particularly older investors, who may need access to their money for medical or living expenses. EIAs should *never be sold to short-term investors* since the surrender period for an equity-indexed annuity may be as long as 15 years.

Municipal Fund Securities

Although municipal fund securities constitute municipal securities, they may not have many of the features that are typically associated with traditional municipal securities. Instead, *municipal fund securities appear to have features more similar to investment company securities or variable contract products.* For instance, municipal fund securities provide investment returns and are valued based on the investment performance of an underlying pool of assets with an aggregate value that may increase or decrease from day-to-day, rather than providing interest payments (either paid currently or at maturity) at a stated rate or discount, as is the case with traditional municipal securities. In addition, unlike traditional municipal securities, municipal fund securities don't have stated par values or maturity dates and cannot be priced based on yield or dollar price. Let's examine three different forms of municipal fund securities—*local government investment pools (LGIPs), 529 college savings plans, and 529A plans.*

Expanded use of 529 plans

Although originally intended to accumulate funds to only pay for college educational expenses, the funds in 529 plans may also be used for expenses related to *elementary and secondary schools* at public, private, or religious institutions. Today, individuals are allowed to take up to $10,000 in distributions annually from their 529 plans to pay for private school tuition and books for grades K through 12—in addition to using their account proceeds for college costs. Additionally, an individual is now permitted to *withdraw up to $10,000 on a tax-free basis (a qualified withdrawal) to repay a qualified student loan as well as expenses for certain apprenticeship programs*. This is a lifetime limit that applies to the beneficiary and each of the beneficiary's siblings. you can be the donor and the beneficiary (want to make a college fund for yourself) but you must be at least 18 to be a donor

death benefits

Although variable annuities are not life insurance policies, these contracts often have an associated death benefit. Therefore, at the time of purchase, the contract owner designates a person as her beneficiary to receive this benefit in the event of her death. If the annuitant dies during the accumulation period, the beneficiary receives the greater of: 1. The sum of all the contract owner's payments into the annuity, or 2. The value of the annuity on the day of the annuitant's death For example, a person has paid a total of $50,000 into a variable annuity and designated his son as his beneficiary. If the annuitant dies one year later when the value of his annuity is $45,000, then the beneficiary receives $50,000. *Because mutual funds lack the death benefit feature, this is one reason that clients may prefer to purchase annuity contracts despite the fact that they're relatively more expensive.

annuity units

At annuitization, the insurance company converts all of the accumulation units into annuity units. Annuity units represent the accounting measurement that's used to determine the dollar amount of each payment that will be made to the annuitant. The number of annuity units represented in each payment is fixed at this time. The value of each payment that's made to the annuitant is based on a fixed number of annuity units multiplied by a fluctuating value. To calculate the annuitant's payment, the insurance company takes the following into consideration: Annuitant's age and gender Settlement (payout) option selected Annuitant's life expectancy Assumed interest rate

section 529A (ABLE) Plans

Similar to 529 college savings plans, *529 ABLE* (or simply referred to as 529A) accounts are savings accounts that are administered by the states. The 529A plan was authorized under the Achieving a Better Life Experience (ABLE) Act to supplement the support of persons who are disabled or who meet the government's definition of disabled and are receiving Social Security disability, Medicaid, or private insurance payments. In the past, if a disabled person earned more than $700 per month or had assets in excess of $2,000, he risked having to forfeit eligibility for government programs. Today, a 529A account will not impact Medicare or Social Security payments unless the current account value exceeds $100,000. Once the account value is again below the $100,000 level, federal and state aid resumes. The maximum contribution limit is $500,000. A 529A account may be opened in any state that has a nationwide ABLE program. The maximum contribution into the account is $15,000 per year and it's made on an after-tax basis at the federal level (may be pre-tax at the state level). Unlike a 529 plan, there's no five-year front loading of contributions and there may only be one 529A account per beneficiary. The earnings are *tax-free* if they're used for *qualified* expenses, including basic living expenses, education, employment support, housing, financial management, legal fees, transportation, and wellness. If the funds are used for non-qualified expenses, the earnings are subject to taxes at ordinary tax rates and a 10% tax penalty. Upon the termination of disability status or death of the beneficiary, the assets in the 529A plan are used to pay off the state Medicaid agency for any expenses that were paid out after the ABLE plan was established. The assets of the plan may also be rolled over to an eligible sibling without a taxable event. Offering documents associated with 529A plans, as well as continuing disclosure documents, are available on the MSRB's Electronic Municipal Market Access (EMMA) system. EMMA is an online repository that is maintained by the MSRB.

accumulation period

The accumulation *(pay-in)* period (also known as deposit phase) of a variable annuity begins when a person first directs her contributions to the insurance company. During the accumulation period, the value of the annuitant's investment in the separate account is calculated by using an accounting measurement that's referred to as an *accumulation unit.* Units are purchased after tax, with no tax deduction. It is *not* tax free though, it is tax-deffered until withdrawn. So its like a mutual fund in a tax-deferred wrapper, so you cant withdraw the money whenever you want like with a mutual fund. Essentially, the accumulation units are purchased at net asset value (NAV). (Also called AUV- Accumulation Unit Value). The NAV of the subaccount units is calculated using the same method that's employed by mutual funds, also at end of day with forward pricing just like mutual funds, and accumulation units are invested in separate accounts: *NAV Per Unit = Total Net Assets / Total Units Issued* The calculation is done at the end of every business day (usually at the close of trading on the exchanges). The actual price that annuitant's will pay for their units is the next calculated NAV. (This approach is referred to as *forward pricing.*) However, the value of the units will fluctuate along with the changing value of the underlying portfolios of the *separate account.* If the investments in the separate account perform well, then the units will increase in value; however, if the investments in the separate account perform poorly, then the units will decrease in value. With each investment, the insurance company first deducts the applicable commissions or other charges and then uses the remainder of the annuitant's investment (the net payment) to buy the accumulation units in the subaccounts that are selected. within the accumulation period there are three important factors: *cash surrender, loans, and death benefits*

sales charges

The prospectus for a variable annuity must clearly disclose all of the charges and expenses that are associated with the annuity. Today, the majority of companies impose a form of *contingent deferred sales charge* (also referred to as a *surrender charge or withdrawal charge*) that's similar to what's assessed on Class B mutual fund shares. (Although FINRA rules specify a maximum sales charge of 8.5% for mutual fund sales,) there's no statutory maximum sales charge on variable products. Instead, sales charges for variable annuities must be reasonable.

the Separate Account

The separate account feature is unique to variable products. As the name implies, the assets in an insurance company's separate account are segregated from the insurance company's general account (which is used for fixed annuities). It is an investment company product that must be sold by prospectus. Investments may be changed during the accumulation phase but not during the payout phase aka the annuity phase (phase 1 is accumulation phase 2 is annuity) All of the income and capital gains that are generated by the investments in the separate account are credited to the account. Also, any capital losses that are incurred by the separate account are then charged to the account; however, it's not affected by any other gains or losses that the insurance company incurs. If the insurance company becomes insolvent, its creditors may not make claims against the assets in the separate account, but they may make claims against the assets in the general account. The separate accounts of variable products are generally required to be registered as investment companies under the Investment Company Act of 1940. Within these separate accounts there are *subaccounts*

settlement payout options

There are several methods for receiving payments from an annuity. An annuitant may choose from the options described below in order to receive benefit payments from the contract. *straight-life annuity, life annuity with period certain, unit refund life annuity, and joint and last survivor life annuity*

direct or adviser sold

There are two methods by which 529 plans may be sold to customers. One is referred to as *direct-sold,* in which there's no salesperson and the plan is sold directly through the 529 savings plan's website or through the mail. The other method is *adviser-sold,* in which the plan is sold by through a broker-dealer that has entered into a signed selling agreement with the primary distributor of the 529 plan. Some states may only offer plans directly (typically to their residents), while others have selling agreements with broker-dealers and offer the plans directly. The fees that are paid may be lower in direct- sold plans, but the customer will not receive the advice of an investment professional. Obviously, adviser- sold plans offer the advice of an adviser.

two types of annuities

There are two types of annuity contracts—*fixed and variable.* With a *fixed contract,* the investor receives a *fixed rate of interest* and the investment *risk* is assumed by the *insurance company*. For this reason, *fixed contracts are not considered securities* and are governed under state insurance law only. On the other hand, *variable contracts* offer *returns that fluctuate* and the investor assumes all of the *investment risk*. *Variable contracts are considered securities* and are subject to SEC, FINRA, and state insurance regulation. As is the case with all variable products, a prospectus must be delivered prior to completing the sale of any variable annuity.

529 plan advantage

These plans allow the owner to change beneficiary once per year; however, the new beneficiary must be a family member of the previous beneficiary in order to retain federal tax benefits. The ability to change beneficiaries means that funds which were contributed to a 529 plan may leave donors' estates, but not their control. Many plans have no time limit as to when the funds must be withdrawn and the donor will authorize the payment of any future educational expenses. Additionally, twice every 12 months, account owners can adjust their holdings in a 529 plan (this was previously only allowed once every 12 months).

management fee

Each of the subaccounts will usually assess an investment management fee. This is the fee that the subaccount's investment adviser receives for managing the assets.

principal approval

Once a registered representative has collected the required information on a potential deferred variable annuity customer, this complete and correct application package and the customer's check (payable to the issuing insurance company) must be promptly forwarded to the representative's Office of Supervisory Jurisdiction for approval. Typically, once received, the approving principal at the OSJ will review the application and determine whether the proposed transaction is suitable. The broker-dealer has up to *seven business days* from its receipt of the application package to make this determination

joint and last survivor life annuity

Payments from the annuity are made to two people; when one dies the payments continue to the joint annuitant. However, upon the death of the last survivor, payments cease. For example, a grandfather establishes an annuity that will provide lifetime payments to both his son and grandson. A joint and last survivor life annuity is the best payout option for the grandfather's needs because it provides lifetime income to both persons.

An investor has annuitized a variable annuity and has realized that the payments he's receiving are falling below market return. If the investor wants to reallocate a portion of the investment portfolio within the separate account, which of the following statements is TRUE regarding this situation? A. The investor is permitted to change the allocation of the investments within the separate account. B. The investor is not permitted to change the allocation of the investments within the separate account. C. The investor can only change the allocation to a fixed-income portfolio. D. The investor can only change the allocation to an equity growth portfolio.

*A. The investor IS permitted to change the allocation of the investments within the separate account.* Although some limitations may apply, the investor is permitted to reallocate their investments within the separate account. Keep in mind, both the decision to annuitize and the chosen settlement option are final.

Which of the following statements concerning a tax-qualified annuity is TRUE? A. It has a zero cost basis and grows tax-free B. It is not subject to contribution limits C. It has a zero cost basis and grows tax-deferred D. It may be subject to tax-free distributions, if qualified

*C. It has a zero cost basis and grows tax-deferred* Tax-qualified annuities are employer-sponsored plans that are available to certain nonprofit organizations, public school, and/or state/city university/college employees. These annuities, sometimes referred to as TSAs may be placed into a 403(b) or a 501(c)(3) plan. Since these plans are *funded on a pretax basis*, contributions are *deducted* from an individual's taxable *income*. An investor's *cost basis is considered to be zero since none of the contributions have been recognized for tax purposes*. Income grows tax-deferred not tax-free. Upon distribution, every dollar is taxable as unearned ordinary income. Tax-free growth means that none of the distributions will be subject to taxation. This is not the case with these types of plans.

The main disadvantage of 529 Prepaid Tuition Plans compared to 529 Savings Plans is that: A. Distributions that are not used to pay for educational expenses are subject to a 10% tax penalty B. Qualified distributions may be used to pay for tuition, books, room and board, and other expenses C. The account owner may lose financially if the student does not attend a public school in that state D. The account owner can lock-in the beneficiary's tuition at a state college at a reduced rate

*C. The account owner may lose financially if the student does not attend a public school in that state* The main disadvantage of a prepaid tuition plan is that the investor may suffer financially if the beneficiary attends an out-of-state or private college. Unlike 529 Savings Plans, prepaid tuition plans do not have distributions. Instead, the account owner purchases credits toward tuition at a state university or college. Prepaid tuition plans generally may not be used to save money for other educational expenses such as room and board. The advantage of a prepaid tuition plan is that the investor is guaranteed a certain number of credits toward the beneficiary's tuition.

When determining the suitability of the recommendation of a 529 college savings plan, which of the following should a registered representative consider? A. Whether contributions may be restricted due to income eligibility limits B. Whether assets must be transferred to the account beneficiary at the age of majority C. The deductibility of contributions from state income taxes D. The deductibility of contributions from federal income taxes

*C. The deductibility of contributions from state income taxes* Contributions to a 529 plan are non-deductible at the federal level; however, if an investor uses his home state's plan, *contributions are often deductible for state income taxes*. If an investor uses assets from a 529 plan for qualified education expenses, the earnings are tax-free at the federal level (i.e., like a Roth IRA). Unlike an UGMA or UTMA account, 529 plan assets don't need to be transferred when the beneficiary reaches the age of majority.

life annuity with period certain

A life annuity with period certain is an option that will provide monthly or other periodic payments to the annuitant for life. However, if the client dies prior to the end of the specified period, the payments will continue to be made in either a lump-sum or in installments to a designated beneficiary until the end of the period certain. For example, an investor chooses a 15-year period certain life annuity, but dies after receiving payments for five years. The annuity company will continue to pay the named beneficiary for the remaining 10 years on the contract. However, if the investor had lived for 18 years, the annuity company's payment obligations would have continued up until his death. Since his death occurred three years after the end of the period certain, the annuity company is relieved of the obligation to make any payments to a beneficiary.

straight-life annuity

A straight-life annuity is a contract in which an annuitant receives monthly payments for as long as she lives, but this method makes no provision for a designated beneficiary. Therefore, no payments are made after the annuitant's death, even if only one payment had been made before the person's death. Remember, the *contract's death benefit ceases once the holder makes the decision to annuitize.* This payment option carries the *most risk,* but also provides the annuitant with the *highest payout* of all of the options.

administrative expenses

Administrative expenses are associated with the costs of issuing and servicing variable annuity contracts including recordkeeping, providing contract owners with information, and processing both their payments and requests for surrenders and loans.

qualified annuities

Although any person may invest in a non-qualified annuity, a tax-deferred, qualified annuity is a special type that may only be established by non-profit organizations or public school systems for their employees. The employees may set aside a portion of their income on a pre-tax basis in order to fund the annuity. The employers may also contribute to the annuity on their employees' behalf. The amount contributed by the employees is excluded from their taxable income. *Penalty upon withdrawal until you're over 59 ½ years old. Then no penalty upon withdrawal* 403-b plan* For example, a public school teacher who earns $35,000 per year has $2,000 withheld from his paycheck annually to purchase units in a tax-deferred annuity. This will result in his taxable income being only $33,000 per year. The money that the employees contribute into qualified annuities accumulates on a tax-deferred basis until the employees ultimately withdraw the funds. Since the contributions are made with pre-tax dollars, all of the payouts from the annuity are taxed as ordinary income. State and local government offer their employees 457 plans, which have qualified features

contribution limits

Although current tax law allows a tax-free gift of up to $15,000 to any one person in any given tax year, a 529 plan may be front-loaded with an initial gift of $75,000 which is treated as if it's being made over a five-year period (five contributions of $15,000 each). Individuals may contribute these same amounts to 529 plans that are maintained for more than one beneficiary. In other words, if an individual has five grandchildren, she's able to contribute $75,000 to each grandchild's 529 plan without incurring federal gift taxes. These amounts are doubled for a married couple who are funding multiple 529 plans. The total amount able to be contributed to a 529 plan is determined by the state. Most states use a total that's sufficient to pay for an undergraduate degree.

review of 1035 exchanges

Although many persons use new funds to contribute to annuities, registered representatives may also suggest moving client assets from existing contracts. Managers must be extremely vigilant when examining the validity of a proposed transfer which is typically accomplished through a 1035 Exchange. Named after IRS Section 1035, this provision permits the exchange of annuity contracts *without creating a taxable event.* A principal should determine if the proposed exchange will result in the client incurring a surrender charge, being subject to a new surrender period, losing existing benefits (e.g., death, living, or other contractual benefits), or being subject to increased fees or charges (e.g., mortality and expense fees or investment advisory fees). Additionally, a principal must document whether another exchange has been executed for the client within the preceding 36 months since this may be evidence of *churning.*

mortality risk charges

An insurance company may *not* refuse to meet the obligation of providing its annuitants with a lifetime income even if they live longer than expected. The pledge that the company makes is referred to as the *mortality guarantee.* There are two types of mortality risks that are associated with annuities. 1.) the insurance company may guarantee its annuitants that it will make payments to them for the rest of their lives. When calculating these payments, the company takes into account the annuitant's expected life span. 2.) most variable annuities also guarantee that if the contract owner dies during the annuity's accumulation phase, the company will return a certain amount of money (i.e., a death benefit) to the person who is designated as the beneficiary by the contract owner.

cash surrender

Annuitants may cancel *(surrender)* their variable annuities at any time during the accumulation period and receive the annuity's current value. Also, annuitants may instead choose to withdraw a part of their annuity's value at any time (a partial surrender). However, as described earlier, an annuitant may be required to pay *surrender charges* that are determined by how long she has held the annuity. The surrender will also result in the requirement to pay *taxes* on any increase in the value of her annuity. For variable annuities, insurance companies don't guarantee a minimum cash surrender value. Therefore, if a person surrenders her annuity, she may receive less than the total amount that she has invested.

Annuities

Annuities are *products that are sponsored by insurance companies in which investment income grows tax deferred*; they may be *fixed* or *variable* The term annuity refers to paying out An annuity is an agreement between a *contract owner* and an insurance company. The owner gives the insurance company a specific amount of money (either all at once or over time) and, in return, the company promises to provide a person (i.e., *the annuitant*) with income either immediately or at some point in the future. The contract owner may designate any person as the annuitant; however, the annuitant and the contract owner are usually the same person. Most annuitants choose to start receiving their income payments when they retire. Annuities are typically considered long-term investments which many clients use to supplement their work-sponsored retirement plans and/or their IRAs. A significant benefit offered by annuities is that the *growth in the accounts is tax-deferred*. However, two drawbacks are that purchasers of these investments often have long holding periods and they may be subject to significant surrender charges and/or tax liabilities if assets are withdrawn too quickly. From an investor's perspective, it's important to understand the different features of the contracts. The majority of annuities are *non-qualified,* which means that the contract owner invests money on an after- tax basis with the interest credited to the account accumulating on a tax-deferred basis. In other words, an annuitant is not required to pay taxes on the income or growth until she begins taking distributions or withdraws funds from the account. As is the case with retirement plans, these contracts don't generate capital events. If any portion of a withdrawal is subject to taxation, it's taxable at the same rate as the owner's ordinary income. Non-qualified annuities will form the basis of this examination of annuities.

expenses

As to be expected, insurance companies that issue variable annuities have expenses. These expenses are deducted from the investment income that's generated in the separate account. Expenses include the costs of contract administration, investment management fees, and mortality risk charges.

non-qualified annuity

Available to anybody through an insurance company or broker, you're putting in after tax dollars, contribution amount is not limited, most annuities are non-qualified. Dont have to be a specific kind of employee

College savings plans

College savings plans, which most simply recognize as 529 plans, are more similar to a 401(k) plan in that they offer mutual fund type investments that grow on a *tax-deferred basis.* Some plans offer rather limited investment choices, including aged-based portfolios that automatically adjust the asset allocation based on the beneficiary's age. These plans typically move money from stock funds to bond funds as the child grows closer to college age. Under federal law, contributions are made with *after-tax dollars,* but any earnings grow on a tax-deferred basis. Earnings in a 529 plan account are not subject to federal income tax, and in many cases are not subject to state income tax when used for the qualified higher education expenses. Qualified education expenses include those incurred for tuition and fees, room and board, as well as books, supplies, and equipment. States that offer 529 plans are responsible for determining the specific plan rules, such as allowable contributions, investment options (e.g., mutual funds), and the deductibility of contributions for state tax purposes.

subaccounts

For variable annuities, the separate accounts typically contain a variety of different underlying portfolios or subaccounts (which are similar to the fund choices that investment companies offer to their investors). You can switch between these during accumulation phase. They're like the mutual fund families. The contract owners are able to allocate their payments among these different subaccounts based on their investment objectives. Additionally, contract owners are generally allowed to transfer their money from one subaccount to another as their investment goals change. Each of the subaccounts typically corresponds to a different underlying mutual fund (or unit investment trust), such as a large-cap stock fund, a long-term bond fund, or a money-market fund. Another subaccount may have a fixed rate of return which is guaranteed by the insurance company. The value of the other underlying subaccounts will fluctuate based on changing market conditions. In a variable annuity, a contract owner who invests in any subaccount (other than the fixed-rate subaccount), assumes all of the investment risk. An insurance company doesn't guarantee a minimum rate of return for most of its variable annuity subaccounts. As a result, *market risk is the greatest risk that a variable annuity contract holder faces.* Variable annuities are classified as securities; therefore, they must be registered with the SEC and sold by prospectus. The separate accounts and underlying subaccounts must also be registered with the SEC as investment companies.

FINRA Concerns

Historically, some salespersons have sold annuities to the wrong investors and/or recommended inappropriate exchanges within contracts. Additionally, annuities often have higher expenses than similar mutual funds that could instead be placed within a retirement account. Any persons saving for retirement should normally exhaust all of their opportunities to contribute to employer-sponsored retirement plans (e.g., a 401(k) or IRA) before investing in a variable annuity. The benefit to employer-sponsored plans is that they're funded with deductible (pre-tax) contributions. Although the earnings in a non-qualified variable annuity grow on a tax-deferred basis, the contributions are made with after-tax dollars.

annuity charges and expenses

In an annuity, the entire contribution is not invested in the separate account since purchases are subject to various sales charges and fees. Registered representatives must explain each of these costs to their clients prior to effecting a sale.

Local Government Investment Pools (LGIPs)

LGIPs are *trusts that are established by state and local governments* and offer municipalities a place to invest their money. Government entities use their surplus cash to purchase interests in a trust, which invests the assets in a large portfolio of securities, according to the trust's investment objectives and state laws. Since only municipal governments and their instrumentalities may invest in LGIPs, they're *not* open to investment by the public. The purpose of LGIPs is to encourage the efficient management of the cash reserves of government entities, who otherwise have limited investment options. *LGIPs offer an investment alternative that minimizes the risk of principal loss while offering daily liquidity and a competitive rate of return.* By pooling their funds, government participants benefit from economies of scale, diversification, professional portfolio management, and liquidity.

the stages of a variable annuity

Most variable annuities involve two periods—the *accumulation and the annuity period.* In other words, there's a pay-in period as well as a pay-out period.

prepaid tuition plans (PTPs)

Prepaid tuition plans are designed to cover tuition costs at public in-state colleges and universities. The donor may pay for amounts of tuition in one lump-sum or through installment payments. Some prepaid tuition plans offer contracts for a two-year or four-year undergraduate program and can cover one to five years of tuition. Other plans may even allow for the contract to be applied to graduate school. Prepaid tuition plans are *not* considered to be municipal fund securities. In effect, these plans lock in tuition costs at today's levels and protect the saver against future cost increases. Unlike college savings plans, tuition plans are not self-directed and typically offer guaranteed returns. *Residency requirements and other limitations*: Many PTP plans require that the donor or the beneficiary be a resident of the state that offers the plan. Some plans also limit enrollment to a certain period each year and they may limit the expenses that are covered. For example, some plans may cover the costs of tuition, books and laboratory fees, but may not cover the costs of room and board. Prepaid tuition plans don't provide the donor any investment options. The price of the contract is determined prior to purchase and usually depends on the type of contract, the current grade of the beneficiary, and the current and projected cost of tuition. *transferability*: If the beneficiary of a prepaid tuition plan chooses not to attend a college covered by the plan, most plans provide for a transfer to another sibling of the original beneficiary. In some cases, age restrictions may apply. Additionally, if the sibling decides not to attend college or if the donor cancels the plan, only the original contribution will be returned and any interest earned on the plan will be lost. In fact, some plans may charge a cancellation fee.

Section 529 college savings plans

Section 529 of the IRS Code, which was amended by Congress in 1996, enabled the establishment of state-sponsored, tax-deferred, college savings vehicles. The two types of 529 plans that can be used to meet the expenses of higher education are *prepaid college tuition plans and college savings plans.*

loans

Some insurance companies allow their contract owners to borrow against the value of their annuity contracts during the accumulation period. A loan that's taken against an annuity is *not tax-free*. Instead, the IRS considers the loan to be a taxable distribution. An insurance company will usually charge interest on the loan and will therefore reduce the number of accumulation units that the client owns in relation to the amount of the loan. If the contract owner repays the loan, then the insurance company will again increase the number of accumulation units that she owns.

Variable annuities-- suitability and compliance issues

Since variable contracts *don't* provide a known amount of retirement income, these contracts are best suited for investors who can deal with the fluctuation in value and payment stream and can understand the risks inherent with equity investments. An investor's hope is that the contract will continually grow at a rate that will provide a hedge against inflation risk. Generally, *variable annuities are not suitable for senior investors*; instead, they're more appropriate for persons with *long-term* investment goals who don't anticipate needing access to their money for at least five to seven years. While variable annuity contracts have features that are similar to mutual funds, what makes them unique is that they provide *tax-deferred growth.* However, many annuities impose significant charges on investors who *surrender* their contracts early. If an annuitant withdraws funds prior to reaching the age of *59 1/2, he's required to pay taxes on any increases in the value of his annuity plus he's subject to a 10% tax penalty.* Under FINRA rules, prior to making a variable annuity recommendation, salespersons must make reasonable efforts to obtain certain client-related information, including their age, annual income, financial situation and needs, investment experience, investment objectives, and investment time horizon (since most contracts have CDSCs), the intended use of the deferred variable annuity, existing assets (including outside investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, and tax status. Best for people 30-55, looking for tax-deferred growth (not current income) and for their money to be above inflation rate (otherwise fixed would be better) ALSO best for people who have already maximized their qualified planning like 401k's and whatnot, because for those your employers match what you put in but here they don't so do those first

annuity period

The annuity *(pay-out)* period begins when an annuitant decides to receive income payments from the annuity. Prior to this point (during the accumulation period), the contract holder is permitted to surrender the annuity in exchange for its current value. However, once a person decides to annuitize, she may no longer surrender the annuity or freely withdraw money from it. Instead, she's receiving payments based on the performance of the assets in the *separate account.* At annuitization, the insurance company converts all of the accumulation units into *annuity units* which represent the dollar amount of each payment made to the annuitant

unit refund life annuity

Under a unit refund life annuity, periodic payments are made during the annuitant's lifetime. If the annuitant dies before an amount equal to the value of the annuity units is paid out, the remaining units will be paid to a designated beneficiary. This payment may be made either in a lump- sum or over a given period.

Variable annuities

Variable annuities were created to provide investors with greater protection against *inflation* than what traditional, fixed annuities can offer. The contract owner is also given a level of control over how her contributions are invested—at least during the annuity's *accumulation phase* (the period during which she's depositing funds into the annuity). Although it's only insurance companies that issue variable annuities, these *contracts are not considered forms of life insurance*. A firm that offers variable annuities must be a broker-dealer that's registered with the SEC. Also, the registered representatives who sell variable annuities must obtain a state insurance license (probably the LAH) as well as either a Series 6 or Series 7 FINRA registration. In a variable annuity, when a person decides to annuitize, she will begin to receive payouts from the annuity and, in turn, relinquish control of the principal value of the contract to the insurance company. Once the benefit payments start, the amount will vary from month-to-month depending on the performance of the investments in the *separate account* (described below). If these investments perform well, the payments to the annuitant may increase. Conversely, if they perform poorly, then the payments may decrease. For variable annuities, the insurance company doesn't guarantee a minimum rate of return. Variable annuities are not suitable for all investors. *Before considering variable annuities, investors should exhaust all of their options in saving for retirement on a pre-tax basis—such as through IRAs or 401(k) plans.

expense risk charges

When an insurance company issues a variable annuity, it usually guarantees that it will not raise its costs for administering the contract beyond a certain level (referred to as the *expense guarantee*). The expense risk charge compensates the company if the expenses incurred for administering the annuity turn out to be more than estimated.