Annuities Flashcards
Concepts & Characteristics of Annuities
Annuities are mainly designed to provide a lifetime payment to an individual and are commonly used in retirement planning. Life insurance pays for an unexpected early death, annuities pay beyond the mortality tables for as long as the insured lives. Under the contract, an individual (annuitant) makes deposits (premiums) to the insurance company. This is during the accumulation phase. During accumulation all interest (or gains) earned is tax-deferred. The annuity phase (annuity period) begins when the insurance company systematically pays to the annuitant the value of the accumulated funds plus all deferred interest, either for life or certain time periods, selected by the annuitant.
Fixed Annuities
These have a minimum guaranteed rate of return. The insurance company may pay more than the stated guaranteed amount. The insurance company assumes the investment risk. Payout is a fixed dollar amount.
Variable Annuities
Returns on the account are based on investments in a separate account (securities) portfolio selected by the annuitant. A Prospectus is provided to the customer at the time of application which contains a list of the investment funds offered (stock, bond, and money market managed funds). The prospectus describes the investment objectives and policies of the separate account. The applicant selects the portfolio (managed funds) preferred. The variable return on the annuity depends upon the performance of the underlying securities held in the portfolio. The investor assumes the investment risk. The producer must have Series 6 (or 7) & 63 securities licenses to offer this product. Payout is based on units instead of a fixed dollar amount. The idea is that a positive securities market (over time) will provide increased benefits in the future, to offset inflation.
Indexed Annuity
These have some of the characteristics of a fixed annuity and some of the characteristics of a variable annuity. The annuity is tied to a securities index (e.g., S&P 500 Composite Stock Price Index). Contracts can have a minimum guaranteed interest rate, or “Floor” (maybe 0%). Return (if any) is calculated over an “index term”, which is simply a given time period.
Annuity - Single Premium
One lump sun finds the annuity. May be an immediate or deferred annuity.
Annuity - Flexible Premium
A flexible premium (deferred) annuity is an annuity that is intended to be funded by a series of payments, typically monthly. Flexible premiums may only fund a deferred annuity. Normally there is a designated period of payments into the account, before annuitization begins. Flexible premium annuities may also allow additional money to be added in addition to the periodic premiums.
Annuity Payments - Immediate Annuity
Funded by a single premium. Benefits begin immediately following the first income period specified in the policy (typically 30 days)
Annuity Payments - Deferred Annuity
Purchased with a single premium or installments (flexible premiums) over a period of time. benefits begin at a later date (ex. 55, or 60)
Policies that are surrendered in the early years may be subject to contract surrender charges.
Tax Treatments of Annuities
For the INVESTOR, all interest and capital gains are reinvested back into the account. All taxes on the annuities will be deferred until the time of payout.
At withdrawal, the interest and gain is taxed as ordinary income. A portion of each payment is considered gains and therefore taxed.
The IRS takes an early withdrawal penalty of 10% on the accumulated interest of the fund if all or a portion of the fund is withdrawn in a lump sum before age 59 1/2. The annuitant may actually annuitize the funds prior to age 59 1/2 without the IRS penalty. The penalty will not apply if the annuitant becomes disabled or dies.
During the accumulation phase, in case of death, benefits go to the beneficiary and are taxable to the beneficiary for only the amount of interest and gains accumulated, not on the principal or cost basis.
Annuity Payout Options - 1. Life Annuity (straight life annuity)
Pays the annuitant an income for life. Upon death, payments cease and the company’s obligations ends. This pays the highest monthly payout.
Annuity Payout Options - 2. Life Annuity Period Certain
Pays the annuitant an income for life and guarantees payments for a minimum period (stated in the contract). If the annuitant dies during the period certain, benefits are paid to a named beneficiary to the end of the guaranteed period.
Annuity Payout Options - 3. Cash Refund Life Annuity (Installment Refund Annuity)
Pays the annuitant an income for life. Upon death, the beneficiary receives the accumulated value at annuitization, less the total of payments received by the annuitant.
Annuity Payout Options - 4. Joint & Survivor Annuities
Pays an income for life for more than one annuitant. All annuitants must die before payments cease.
Survivor Life Annuity: Pays first to the principal annuitant. If the principal annuitant dies, the survivor annuitant receives 2/3 the benefit.
Joint Life Annuity: Equal payments for more than one annuitant. If one dies, the survivor(s) receives those benefits.
