Insurance Prelicensing Chapter 5 - Annuities
Annuity Classifications
- Method of premium payment (single, flexible, and periodic) - Funding (fixed vs. variable) - When income benefits are payable (Immediate vs. Deferred) - The payout option selected (Life only vs. Annuity Certain) - Number of lives covered (single vs. joint)
Qualified vs. Nonqualified Annuities
A qualified annuity is funded with pre-tax dollars. The entire distribution from a qualified annuity (contributions and earnings) is subject to ordinary income taxes. A non-qualified annuity 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.
Single Premium Immediate Annuity (SPIA): Define, examples of investments used to purchase a 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.
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.
Tax treatment of accumulation value growth in an annuity; explain early withdrawals from annuity
Accumulation value in annuity grows tax deferred Withdrawals prior to age 59.5 subject to income tax and 10% tax penalty (unless contract owner dies or becomes disabled).
Nonforfeiture Provisions
An annuity owner will not lose the value accumulated up to the point where they stopped paying into the contract. Nonforfeiture provisions give the owner the rights to the accumulation in the contract. The owner has the right to surrender the contract during the accumulation period. These provisions only apply to deferred annuities since immediate annuities do not have an accumulation period.
Indexed (or equity indexed) annuities
An annuity product with interest rates that are linked to the positive performance of a stock market related (equity) index, such as the Standard & Poor's 500 Index. Provides safety of principal and some guaranteed minimum returns. Tend to have higher surrender charges and longer surrender charge periods.
When are annuity surrender charges generally waived?
Annuitant is hospitalized for extended period, placed in nursing facility for 30+ days, becomes disabled, or dies.
Annuity Certain
Annuity benefits received for specified period of time or for specified amount of periodic income. If annuitant dies with time remaining in period or with balance remaining, bene receives balance of payments.
Life Income Period Certain (Annuity Payment Option)
Annuity 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, specified beneficiary receives the balance of the payments for the remaining time period.
Life Income Joint and Survivor (Annuity Payment Option)
Annuity is payable to 2 annuitants (in one check) while both are living. Upon the death of the first annuitant, survivor benefits continue, either paying the full amount or reduced to 2/3 or 1/2 for the survivor's income 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,
Joint Life (Annuity Payment Option)
Annuity is payable to 2 or more named annuitants while both are living. Upon the death of the first annuitant, the benefits stop.
Life Income (Pure or Straight Life) (Annuity Payment Option)
Annuity pays out as long as annuitant lives - payments cease upon death. Provides highest monthly income of all options
Variable Annuity
Annuity that has a varying rate of return based on the mutual funds in which one has invested
Surrender Charge
Charge imposed on surrender of annuity contract that lessens the contract payout. AKA back-end load. Diminish over a specified # of years within accumulation period until they disappear.
Bailout Provision (Escape Clause)
During the accumulation period, some contracts also offer a "bailout" provision that allows the owner to withdraw money from the annuity without surrender charges if the crediting rate falls by more than a specific amount. This will enable the policy owner to consider other savings and investment options.
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 the insurer bears any investment risk - only a life 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 issue and is guaranteed for a specific time period
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.
Death benefit of an annuity
If annuitant dies prior to annuitization of contract, insurer pays out an amount equal to premiums paid or account value (whichever is greater) to designated beneficiary
Relationship between separate account, assumed interest rate (AIR), and resulting monthly annuity payments
If investment return of chosen separate account is higher than AIR, monthly annuity payment will increase from previous month; if investment return is lower than AIR, then annuity payment will be lower than previous month
Immediate and Deferred Annuities
Immediate Annuity - The immediate annuity does not have an accumulation period and is used to generate immediate income within a year of the issue date. Deferred Annuity - A deferred annuity will pay periodic benefits starting at some specified time in the future; benefits begin more than 1 year from the issue date.
Owner, annuitant, and beneficiary
Owner: The individual who controls the contract, is responsible for making payments into the contract, and has all of the contractual rights in the policy. Annuitant: Individual whose life the contract is based upon. Upon lifetime annuitization, payments made to annuitant based on age, gender, settlement option selected, and $ amount used to fund income benefit payments. Beneficiary: Individual named in contract to potentially receive benefits if owner and/or annuitant die prior to annuitization or if selected settlement option offers residual benefit after annuitant's death.
Relationship between amount of premium paid in VAs, accumulation/annuity units, annuity payments, and separate account performance
Premium payment amounts are flexible, limited only by contract provisions. Premiums purchase accumulation units, which are converted to annuity units upon annuitization (both are similar to mutual fund shares). Number of annuity units liquidated to fund each monthly payment remains level, but value of each unit fluctuates, based on performance of separate account.
Uses for Annuities
Purchase Other Insurance: Annuities can be used to fund premium payments for insurance. Buying life insurance can be used to help beneficiary avoid paying income taxes on annuity earnings. Education funding Retirement Fund Accumulation: Deferred annuity that is held outside an IRA allows for accumulation of earnings on tax-deferred basis. While annuity premiums are normally not tax deductible, having an IRA annuity may allow for all or part of premiums paid to be tax deductible. Retirement Income Long-term Care Benefits: Many annuities offer long-term care riders Lump Sum Structured Settlements - lump sum payments from lawsuits, lottery winnings, or inheritance can be used to purchase structured settlement in form of annuity
Premium Payment Options
Single Premium — A lump sum payment is made into an annuity. Periodic Premium — Continuous premiums paid into the contract. 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.
What happens to an annuity when the owner/annuitant (same person) dies during the accumulation period and the spouse is the beneficiary?
Spouse may assume ownership of annuity upon owner/annuitant's death
The Annuity Period (Pay-Out/Liquidation)
The annuitization 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, in most cases it is an irrevocable election. The cash values go towards paying for the income benefit.
Accumulation (Pay-In) Period
The period of time from the first deposit to the selection of a settlement option is considered the accumulation period, during which taxes are deferred. Accumulation periods are found within deferred annuities.
Market-Value Adjustment (Adjusted) Annuity
This is an annuity product that features fixed interest rate guarantees combined with an interest rate adjustment factor that can cause the surrender value to fluctuate in response to market conditions. Upon withdrawal, the market-value adjustment (MVA) will add or deduct an amount from the annuity or the withdrawal amount. If the interest rates on which the MVA is based are higher than when the annuity was purchased, the MVA will likely be negative, meaning an additional amount may be deducted from either the annuity or the withdrawal amount. If the interest rates on which the MVA is based are lower than when the annuity was purchased, the MVA will likely be positive, meaning money may be added to either the annuity or to the withdrawal amount.
Why are deferred annuities usually purchased?
To deter taxes on any contract earnings. They are ideal for accumulating a retirement fund.
What is the primary use of an annuity?
To provide a steady stream of income to an individual, typically upon retirement. Designed to protect against outliving an individual's retirement savings.
Group Annuity
a contract between the insurer and the employer and is set up for eligible employees - each employee receives a certificate - this is a defined benefit plan under IRS rules - Corporate retirement plans may purchase annuities to fund their employees' retirement benefits
Life Income with Refund (Installment or Cash Refund) (Annuity Payment Option)
annuity is payable for the lifetime of annuitant. Upon death, if annuitant has not received an amt equal to the total of all payments made into annuity, the balance is refunded to beneficiary either as lump sum or in installments (AKA the installment refund).