Unit 9 Insurance Company Products
Fixed Annuity
(NOT a security) Investors pay premiums to the insurance company. Insurance company is then obligated to pay a guaranteed payout (typically monthly). Insurer guarantees a rate of return but this payment remains fixed throughout lifetime. The insurance risk is assumed by the company because they must pay guaranteed rate even if they don't earn it. Mortality Expense risk: also assume the risk that person will outlive life expectancy. Purchasing power risk assumed by customer: don't know if payment will keep up with inflation. Equity Index Annuities: are fixed annuities and only require insurance license to sell.
The Separate Account
- Classified as an open-end investment company. - Valuation of SA: Valued at NAV and take out any expenses. Any money comes in, new units are issued.
Pay Out (income distribution phase) if annuitized
- Creates a systematic distribution contract. Calculate how much to pay out over the expected life time of the annuitant (straight life, joint life). - Number of annuity units is fixed. - Payout depends on: Sex of Annuitant, Acount Value, Age, Payout Option (SAAPI) -The older you are the bigger the payout.
Taxation of death benefit to beneficiary
- In a life insurance policy the death benefit is not taxable when paid to a named beneficiary but it is taxable to the estate of the insured.
Random Withdrawals
- Not pulling out full lump sum. -LIFO (earnings come out first before principal) and subject to income tax. -10% penalty if under 59.5
Pay In (accumulation phase)
- Number of accumulation units remains the same unless additional purchases are made bc Sa does not distribute capital gains. All dividends paid/gains received remains inside the separate account. Therefore no ongoing taxes but taxed when money gets withdrawn.
If Contract is annuitized (what is the taxation)
- The earnings portion is taxed and the principal portion is not taxed. The return of principal is called the exclusion ratio.
Lump-Sum Withdrawals
-Taxed as income only. No long term capital gains of an annuity. -10% penalty on earnings if under age 59.5
A prospectus for a variable annuity contract
A variable annuity is a security and must be registered with the SEC, not FINRA. As part of the registration requirements, a prospectus must be filed and distributed to prospective investors. The time of distribution of the prospectus can be before the sales presentation or at the same time as the presentation. It is incorrect to state that it must precede every sales presentation.
Variable Death Benefit
Adjusted annually
Policy Loans
Available with variable life insurance, policy in force for at least three years. At least 75% of cash value must be made available. Any outstanding loan will be deducted from the death benefit.
Annuity Taxation
Based on cost-basis vs earnings. Cost Basis is deposits are earnings grow tax deferred so long as it stays in the annuity.
Guarantees/Ratings of Variable life/annuity
Based on the claims-paying ability of the issuing life insurance company. The insurance company's ratings for financial strength do not guarantee performance of the separate account and underlying investment options.
A 38-year-old investor places $25,000 into a single premium qualified deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor withdraws $50,000. If the investor is in the 25% marginal income tax bracket, the total tax liability is
Because this is a qualified annuity, the entire withdrawal is taxable. In this case, it is all $50,000. That $50,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is younger than 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $50,000.
Combination Annuity
Combines features of both fixed and variable annuities. Investments are divided between the insurance companies general account for a fixed return and the separate account for a variable return. Allows investors to limit their risk by trading away potential upside.
Rules of Advertising variable annuities and life policies
Communication must clearly state the type of product. For Example, it is not compliant to call the product a variable product in the communication, it must be called a variable annuity or life, it s also okay to include the proprietary names, "sunshine variable annuity"
Annuity
Contract between an individual and a life insurance company, usually purchased for retirement income. An investor, the annuitant, pays the premium in one lump sum or periodic payments. At a future date, the annuitant can either elect to surrender the policy and receive one lump-sum payout or begin receiving regular income distributions the continue for life.
Most important suitability rule about life insurance
Do NOT recommend unless there is a stated need.
Suitability of Life Insurance
Do not reccommend unless need for life insurance is specified. They will spell it out on test. The applicant must be comfortable with a separate account and that cash value is not guaranteed. Must understand that variable death benefit will be adjusted annually. They have been informed of the features of deferred variable annuities and surrender charges.
For a retired person, which of the following investments would provide the greatest protection against inflation? Muni Bonds Corp Bonds Fixed Annuity Variable Annuity
Fixed-income instruments, like bonds and fixed annuities, are subject to purchasing power risk. Variable annuities provide protection from inflation because their monthly income can increase depending on the separate account's performance.
Variable Life Insurance
Has a fixed, scheduled premium but differs from whole life insurance in that the premiums paid are split. One part going to insurance company to guarantee a minimum death benefit. The balance of the premium is placed in the separate account and represents the cash value of the policy.
1035 Exchange
IRS allows tax-free transfer of cash values between 2 LIKE policies (i.e. Life to Life, Annuity to Annuity, or Life to Annuity). Tax free as long as nothing taken out. Cant do an annuity to a life insurance because if you had variable annuity with lots of gains, then payouts in life insurance payouts are taxed free and not fair. Needs to be considered suitable. Cannot do annuity to life insurance policy.
Annuity death benefits
If annuitant dies during the accumulation period it is included in their estate. Proceeds to beneficiary in excess of cost basis are taxed as income.
guaranteed death benefit
If investor dies during the accumulation period, the beneficiary will receive the greater of the current value of the account or the amount invested. Therefore the estate is assured of getting back at least the original investment.
Taxation of cash value growth
In a life insurance policy, it is not taxable, but if you surrender the policy for its cash value, the growth over the premiums paid is taxable.
Universal Variable Life insurance can only be sold by
Individuals with insurance and securities licenses
Sales Charges of Variable Annuities
Level or contingent deferred sales charge (CDSC) must be reasonable and not excessive. Combination Annuities: Characteristics of both fixed and variable. Minimum fixed payout + a variable payout.
sales charge variable annuity
Level or contingent deferred sales charge, must be reasonable.
can Loans on the cash value of variable life insurance be taken out
May be taken against the cash value of a policy, and they are not taxable to the policy holder. If a loan is outstanding at the time of death, the death benefit paid is reduced by the loan amount.
Death benefit in variable life
Minimum death benefit is guaranteed, and does not change. The cash value and the current death benefit will grow based on the separate account's performance.
Assumed Interest Rate (AIR)
Minimum rate of return necessary to provide the level death benefit. It is determined by the insurance company's actuaries and is stated in the policy contract. It is simply a target not a projection. If the separate account greater to the AIR, these extra earnings are reflected in an increase in death benefit and cash value. If returns are equal (there is no change in death benefit).If SA returns less the contracts death benefit will decrease. This is the performance benchmark for the separate account. Always based on prior month not on value when started.
Annuity Suitability
Most suitable for persons nearing retirement that wish to save as much as possible (50+) However, if a younger person has contributed the maximum to all available tax qualified retirement plans, after-tax contributions to an annuity may be appropriate
Finra Rule 2320
No maximum sales charge on VA's Must be a life insurance need Must be comfortable with sep account must understand variable death benefit.
On April 15, 2016, your client purchased a variable life insurance policy with a death benefit of $450,000. The November 2019 statement showed a cash value of $28,000. If the client wanted to borrow as much as possible, the insurance company would have to allow a loan of at least
Once a variable life policy is in force for a minimum of three years (this one is a bit longer than that), there is a requirement to make the loan provision available. At the three-year mark, that minimum becomes 75% of the computed cash value. Seventy-five percent of cash value of $28,000 is $21,000.
One of the features of variable insurance products is the ability to withdraw money from the policies. Which of the following statements is correct?
One advantage to withdrawing cash value from a variable life insurance policy is that it receives FIFO treatment. That means there is no tax until the withdrawal reaches the cost basis (premiums paid) of the policy. With annuities, the taxation is LIFO. Therefore, the first money withdrawn is taxable. In addition, if the policyowner is not yet 59, the 10% penalty applies. **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.
Variable Annuities
Premium Paid by investor goes into separate account (not hands of insurance company), the separate fund is a type of open end fund (purchases units not shares) and its returns are based on the market. Investment risk is assumed by the investor, mortality risk belongs to insurance company. Securities and insurance license required to sell. If contract is annualized, there is a variable pay out to customer based on separate account performance.
Single Payment Deferred Annuity
Premium buys accumulation units (buy annuity, but dont annuitize right away, ex 50 year old, and then retire at 70)
Single Payment Immediate Annuity
Premium buys annuity units (ex: at Retirement, put it to work right away to have income adjusted with inflation)
Premiums Fixed or Not
Premiums are fixed in a variable life contract, and flexible in a universal variable life contract.
Periodic Payment Deferred Only
Premiums buy accumulation units. Obviously cannot do periodic immediate.
life insurance
Provides payment to beneficiaries who were named by the insured person. Based on insured health, age and sex. Whole life: insurance is designated to last until at least age 100 or the death of the insured. Term Life: insurance is a protection for a specified period. Provides pure protection and is the least expensive form of life insurance. Does not build cash values.
Greatest Risk of a fixed annuity
Purchasing Power Risk
Purchasing Annuities
Single Premium: One lump sum payment (can be deferred (SPDA buys accumulation units) investment or immediate (SPIA buys units). Periodic Payment: Deferred only, premiums buy accumulation units. Periodic payments of annuities not possible.
A customer has contributed $1,000 a year for 10 years to his tax-deferred nonqualified variable annuity. The value of the separate account is now $30,000. If the customer takes a withdrawal of $10,000, what are the tax consequences?
The $30,000 contract value represents $10,000 of contributions and $20,000 of earnings. When a partial withdrawal is made from an annuity, the earnings are considered to be taken out first for tax purposes (or last-in, first-out). Therefore, ordinary income taxes will apply to the entire $10,000. In addition, if the customer is not at least 59½, there will be an additional tax penalty of 10%.
1035 Exchange with Senior
There is special caution with 1035 exchange and seniors because of an surrender charges with insurance companies.
What happens to accumulation units when a variable annuity is annuitized
They become annuity units, they number of annuity units is fixed.
premium deferred variable annuity
Think about LIFO
FINRA Rule 2330
This FINRA rule applies to purchases and sales of deferred variable annuities and initial allocations to the separate account. It does not apply to fixed annuities or variable life insurance. Because it only deals with the purchase or sale or initial allocations, a client with a deferred variable annuity wishing to change the separate account allocation does not come under the rule.
Your 65-year-old client owns a nonqualified variable annuity. He originally invested $29,000 four years ago, and it now has a value of $39,000. If your client, who is in the 28% tax bracket, makes a lump-sum withdrawal of $15,000, what tax liability results from the withdrawal?
This annuity is nonqualified, which means the client has paid for it with after-tax dollars and has a basis equal to the original $29,000 investment. Consequently, the client pays taxes only on the growth portion of the withdrawal ($10,000). The tax on this is $2,800 ($10,000 × 28%). Because the client is older than age 59½, she does not pay 10% premature distribution penalty tax
When are surrender charges in a variable annuity the highest
When the investor first enters the contract with the insurance company and then will decline over time.
Settlement Options of Annuities
When you decide to annuitize, need to think about settlement options. Life Annuity/Straight Life: One person's life time to have a payout. When one life ends payments stop. From insurance company this is most certain. Life w Period Certain: One person's life but a minimum amount of time included to send to beneficiary. Ex: 5 year period, if you die in year 4 beneficiary will get payments for 1 extra year. Lower payments than straight life because of higher risk. Joint W Last Survivor: Married Couples, payments continue so long as both people alive. When one person dies spouse gets it. Lowers payment than life with period certain because of 2 people. Unit Cash Refund: Minimum number of dollars paid out. Whatever value of portfolio that went in at annuitization, insurance company will make payments until principal has been paid out completely.
When a rep reccommends replacing a variable annuity what should the rep consider
Whether they have replaced another variable annuity in the preceding 36 months.
Surrender Charge
a fee that may be imposed on any money withdrawn from an annuity
Tax sheltered annuity
a savings plan where pre-tax money is deposited to earn interest over a period of time (available in 403b plans). Investors cost basis is 0, therefore with any withdrawal everything is taxed as ordinary income.
Guaranteed Minimum Income Benefit
features that an investor can purchase for their annuity contract that ensures they will receive a minimum level of payments, regardless of the sub account's performance.
Equity Indexed Annuity
is 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. key term: FIXED.
Characteristics to consider in Variable Annuity Payout
s - sex a- accout value a - age of annuitant p - payout option selected i - investment returns vs assumed interest rate.
RMD with annuities
there are none.
