XCEL Chapter 7: Annuities

Two funding methods when funding annuity:

1. Single Payment - Lump Sum 2. Periodic Payments (Flexible Premiums) - Installments paid over a period of time

Equity indexed annuity

A type of fixed annuity that offers the potential for a higher return than a standard fixed annuity. They are sometimes tied to the Standard and Poor's 500 or the Composite Stock Price Index.

Investment configuration

Annuities can also be defined by their investment configuration, which will determine the amount of income the benefits pay. The two types of annuity classifications are fixed annuities and variable annuities.

Income tax treatment of annuity benefits

Annuity benefit payments consist of principal and interest. The portion of annuity benefits that consists of principal (premiums paid into the annuity during the accumulation period) are not taxed and is sometimes called the owner's "cost basis". The portion of the annuity benefits that is interest earned on the principal is taxable as ordinary income. Interest income must be reported for federal income tax purposes upon receiving distributions or income benefits from the contract.

Single-life annuities

Characterized by having only one annuitant.

Fixed annuity v. Variable annuity

Fixed Annuity: Provide a guaranteed rate of return. Fixed annuities credit interest at a rate no lower than the contract guaranteed rate. Variable Annuity: Doesn't provide a guaranteed rate of return, because of the investment risk. * Accumulation Units: In a variable annuity, the value of the accumulation units varies depending on the value of the stock investment that is a part of a variable annuity. * Annuity Units: At the time the variable annuity is to be paid out to the annuitant, the accumulations are converted into annuity units. These payouts can vary from month to month depending on the investment results. The number of units doesn't change, but the value does.

Tax-sheltered annuities

Limited exclusively for employees of religious, charity, or educational groups. * Also called 403(b) plans * Accumulation payments often come from voluntary salary reductions * The annuitant may have an individual account contract

Accumulation period v. annuity period

Most annuities have two phases, the accumulation period and the annuity period. * Accumulation Period: The pay-in period, where the contract owner makes the purchase payments. * Annuity Period: This is also called the liquidation period, annuitization period, or pay- out period. This is the time when the money that has accrued during the accumulation period is paid-out in the form of payments to the annuitant.

Cash refund payout option

Pays a guaranteed income to the annuitant for life. If the annuitant dies before all the money is gone, a lump-sum cash payment of the remaining funds are paid out to the annuitant's beneficiary.

Installment refund payout option

Pays a guaranteed income to the annuitant for life. If the annuitant dies before the money is gone, the beneficiary will continue to receive the same monthly installment payments.

Immediate annuities

Purchased with a single lump sum payment, and will start providing income payments within the first year, but usually starting 30 days from the purchase date. It's purpose is to provide for liquidation of a principle sum. * Commonly used to structure the payment of liability insurance settlements, lottery winnings, and other large sums * This type of annuity is usually called a Single Premium Immediate Annuity (SPIA)

Fixed amount option

Under the fixed amount option, the annuitant receives a fixed payment until the contract value is exhausted, regardless of when that will be. If the annuitant dies before the contract is depleted, the beneficiary receives the remainder.

Beneficiary

The beneficiary is the person who receives survivor benefits upon the annuitant's death.

Annuitant

The income benefits distributed at regular intervals during the liquidation phase of an annuity contract are normally payable to the annuitant.

Contract owner

The individual who purchases the annuity pays the premiums and has rights of ownership.* An owner may be the annuitant, the beneficiary, or neither

Suitability of annuity sales for senior customers

When making recommendations to a senior consumer regarding the purchase or exchange of an annuity, an agent must have reasonable grounds for believing that this recommendation is suitable for the senior consumer. This recommendation should be based on the facts disclosed by the senior consumer. It should include an evaluation of his investments and other insurance products along with his financial situation and needs.

Function of annuities

While life insurance protects against the risk of premature death, annuities protect against the risk of living too long.

Qualified annuity plans

a tax-deferred arrangement established by an employer to provide retirement benefits for employees.

1035 exchange

applies to annuities. If an annuity is exchanged for another annuity, a gain (for tax purposes) is not realized. This is also true for a life insurance policy or an endowment contract exchanged for an annuity. However, an annuity cannot be exchanged for a life insurance policy.

Annuities

are ways of providing a stream of income for a guaranteed period of time. * Simply stated, an annuity is started with a large sum of money that will be paid out in installments over a period of time or until the money is all gone. * The monthly amount of benefit an annuitant receives is based on factors such as: principle amount, rate of interest the annuity earns, and length of payout period.

Life with period certain payout option (life income w/ term certain)

designed to pay the annuitant guaranteed payments for the life of the annuitant or for a specific period of time for the beneficiary. Benefit payments will continue for a minimum # of years regardless of when the annuitant dies. * Joint and Full Survivor Payout Option: Pays out the annuity to 2+ people until the last annuitant dies. * Joint and two-thirds survivor: Survivor will have payments reduced to two-thirds of the original payment. * Joint and one-half survivor: Survivor will have payments reduced to one-half of the original payment. Period Certain Payout Option: Pays guaranteed income payments for a certain period of time, such as 10/20 years, whether or not the annuitant is living.

Partial withdrawal

is taken from an annuity before age 59 1/2 the withdrawal is considered 100% interest, and is therefore taxable as ordinary income. A 10% tax penalty is applied if a distribution is received before the annuitant reaches age 59 1/2. After this age, withdrawals do not incur the 10% penalty tax but are taxable as ordinary income.

Straight life income payout option

pays the annuitant a guaranteed income for the annuitant's lifetime. When the annuitant dies, no further payments are made to anyone. This offers protection against exhaustion of savings due to longevity.

Deferred annuities

will start providing income payments after the first year. Deferred annuities are usually purchased with either a single lump sum payment known as a Single Premium Deferred Annuity (SPDA) or from monthly payments known as Flexible Premium Deferred Annuity (FPDA).