Chapter 11- Basics of Life Insurance and Variable Annuities Flashcards
Life insurance premiums and Taxes
Life insurance is typically paid with after tax dollars and is not tax deductible
Examples of Life insurance policies
Term
Whole Life
Variable Life
Universal Life
variable universal insurance
Greatest risk with variable life and variable universal insurance is…
Market risk
These products invest in the securities market
Annuities are a suitable investment for investors with an objective of
Long term capital appreciation
Annuities are issued by
Life insurance companies
Annuities buy a contract by either…
Paying a lump sump, called a single premium”
or
by paying a series of installment payments, called “periodic premiums”
Fixed annuities vs variable annuities
Fixed will pay the same amount each month, insurance company bears investment risk
variable will vary how much it pays month by month depending on how the underlying securities are preforming. The annuitant (customer) will bear the investment risk
Variable Annuities defined
Made up of an investment portfolio of mutual funds or other professionally managed securities held in a separate account
Two types of units
Accumulation units
and annuity units
Some contain a minimum guaranteed death benefit
Accumulation units
generated during pay in period and used to determine the owners interest in the account
Annuity Units
determine the amount of each payment to the annuitant
Changes in the value are related to the value of the securities in the account
Annuitization
This is the switch between paying in and being paid out
when annuity owner selects a payout option, accumulation units are exchanged for annuity units
The investor that buys the annuity is also referred to as
the contract holder
or
the annuity holder
The contract hold must be given…
A prospectus at the time of purchase
receive a statement of additional information if requested by the contract holder
has a choice of investment options therefore is not protected against investment risk
Variable annuities are generally not considered…
insurance. they are considered a securities product even though they are sold by insurance companies
They are registered and regulated under the Securities Act of 1933
Tax- Qualified Annuity
Investor contributes pre-tax dollars and upon retirement the distributions are taxed as ordinary income
Typical of an employer sponsored plan, especially 403(b) plans
Non-Tax qualified annuity
The investor contributes after tax dollars
Upon retirement only the excess over the amount contributed is taxable (partly a return of capital and partial taxed as ordinary income)
Risks of variable annuities
Risk they don’t keep up with inflation (inflation risk)
Risk during depression or recession that the value of annuity credits will decline significantly (investment risk)
The risk the annuitant can not afford a decrease in their current income during the payout period
Non-forfeiture provisions in annuity contracts
generally in most contracts, states that if the contract holder stops making payments on the installment contract they will not lose claim to their previous investments
Variable annuities, dividends and taxes
Variable annuities are not taxed on dividends each year. They are only taxed once the contract is annuitized
True for tax and non-tax qualified accounts
One time withdrawals and taxes on annuities
The tax treatment is “Last in First out”
Earnings are taken out before contributions
Since it is considered a retirement account, any earnings taken out before 59 1/2 will also have a 10% penalty tax
A surrender charge could also be applied by the insurance company
Bonus Annuities
These have extra 3-5% premium credits.
this typically comes with higher contract prices and/or longer surrender periods subject to surrender charges
Equity Indexed Annuities
Linked to a specific index (ie. S&P500)
if index increases contract holder is credited with part of the gain (but generally has a cap)
If the index declines may suffer a loss but there is typically a guaranteed minimum return 3%
Variable Annuities cost basis at death
Proceeds of an annuity do not receive a step up in cost basis as the death of the owner
If you have an annuity in an IRA you must
start withdrawing RMDs at 72 regardless of the possible surrender charges or annuitization charges
Senior investors and annuities suitability
A deferred variable annuity would usually not be suitable for a senior investor since it typically takes 6 to 8 years to avoid surrender charges.
But an immediate variable annuity could be suitable since payments would begin immediately
Before suggesting a variable annuity an advisor should have sure that the investor is …
Maxing out their before tax retirement plans such as their IRAs and 401(k)s
