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Risk Test 2 > Chapter 14 > Flashcards

Chapter 14 Flashcards

1
Q

What is an annuity?

A

A periodic payment that continues for a fixed period of time or for the duration of a designated life or lives.

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2
Q

When is money taxed and not taxed (simplest answer possible) when using an annuity?

A
  • Taxed before used to pay premium
  • Tax free while growing
  • Taxed when annuity payments are received.
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3
Q

Who is an annuitant?

A

The person who receives the periodic payments of whose life governs the duration of a payment.

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4
Q

What does life insurance do compared to an annuity?

A

Life insurance - creates and immediate estate and provide protection against dying too soon before sufficient financial assets can be accumulated.
Annuity - Provides protection against living too long and exhausting one’s savings while the individual is still alive.

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5
Q

What is the fundamental purpose of an annuity?

A

To provide a lifetime income that cannot be outlived.

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6
Q

What three sources do an annuity payment consist of?

A
  • Premium payments
  • Interest earnings
  • the unliquidated principal of annuitants who die early.
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7
Q

What are the three major classifications of annuities?

A
  • Fixed annuity
  • Variable annuity
  • Equity-index annuity
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8
Q

What is a fixed annuity?

A

An annuity that pays periodic income payments that are guaranteed and fixed in amount

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9
Q

What are the two interest rates in an annuity?

A

Guaranteed rate - minimum interest rate that will be credited to the fixed annuity.
Current rate - a higher rate based on current market conditions.

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10
Q

What is the liquidation period (payout period)?

A

The period immediately following the accumulation period and refers to the period in which the funds are being paid to the annuitant.

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11
Q

What are the two options available during the liquidation period regarding accumulating cash?

A

Accumulated cash can by annuitized, or

Paid to the annuitant in the form of a guaranteed lifetime income.

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12
Q

What is the downside of a fixed annuities periodic payments?

A

They generally don’t change in amount and therefore provide little or no protection against inflation.

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13
Q

What is an immediate annuity?

A

One where the first payment is due one payment interval from the date of purchase.

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14
Q

What is a deferred annuity?

A

One that provides payments at some future date.

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15
Q

What is a single-premium deferred annuity (SPIA)?

A

A deferred annuity purchase with a lump sum

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16
Q

What is a flexible premium annuity?

A

An annuity that allows the owner to vary the premium payments; there is no requirement that the owner must deposit a specified amount each year.

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17
Q

In what situations are single premium immediate annuities particularly suitable for? 6

A
  • Retirement from employment
  • Terminal funding or pension terminations (including deferred commencements)
  • Retired life buyouts
  • Structured settlements for personal injury, estate, or divorce cases.
  • Professional sports contracts.
  • Credit enhancement and loan guarantee transactions.
18
Q

What are six advantages of an immediate annuity to a retired worker?

A
  • Security
  • Simplicity
  • High Returns
  • Preferred Tax Treatment
  • Safety of Principal
  • No sales or administrative charges after initial purchase.
19
Q

What are the various annuity settlement options? 7

A
  • Cash option
  • Life annuity (no refund)
  • Life annuity with guaranteed payments (term)
  • Installment refund option
  • Lump sum (cash) refund option
  • Joint & Survivor annuity
  • Inflation-indexed annuity option
20
Q

What is a variable annuity?

A

An annuity that pays a lifetime income, but the income payments vary depending on common stock prices.

21
Q

What is the fundamental purpose of a variable annuity?

A

To provide an inflation hedge by maintaining the real purchasing power of the periodic payments during retirement.

22
Q

What are accumulation units?

A

In variable annuities, these are purchased with your premiums, their value increasing or decreasing along with the market (so you end up buying more when the market is down). At retirement, these are converted into annuity units.

23
Q

What are annuity units?

A

What accumulation units turn into at retirement. The annuitant is paid a fixed number of annuity units each month but the value will fluctuate with the market prices.

24
Q

For a variable annuity owner that dies during the accumulation phase, what is the amount paid to the beneficiary based upon?

A

The higher of two amounts:

  • The account value of the annuity, or
  • The amount of total premiums paid adjusted for any withdrawals.
25
Q

What can the enhanced benefits that can be found in variable annuities do?

A

Either:

  • guarantee the principal plus interest, or
  • periodically adjust the value of the account to lock in investment gains.
26
Q

What are some examples of enhanced benefits?

A
  • Rising-floor death benefit
  • Stepped-up benefit
  • Enhanced earning benefit
27
Q

What type of fees and expenses could an annuity contain?

A
  • Investment management charges
  • Administrative charges
  • Mortality and expenses risk charges
  • Surrender charges
28
Q

What does the Mortality and Expenses Risk Charge pay for? 3

A

1) The mortality risk associated with the guaranteed death benefit and excessive longevity.
2) A guarantee that annual expenses will not exceed a certain percentage of assets after the contract is issued
3) An allowance for profit.

29
Q

What is an Equity-Indexed Annuity?

A

A fixed, deferred annuity that allows the annuity owner to participate in the growth of the stock market and also provides downside protection against the loss of principal and prior period interest earnings if the annuity is held to term. (Reinvestment of dividends not included)

30
Q

What are the four key elements of an equity-indexed annuity?

A
  • Participation rate
  • Maximum cap rate
  • Indexing Method used
  • Guaranteed minimum value
31
Q

What is the participation rate in equity-indexed annuities?

A

The percent of the increase in the stock index credited to the contract

32
Q

What is the maximum cap rate in equity-indexed annuities?

A

An upper limit on the index-linked interest rate credited to your annuity.

33
Q

What is the indexing method in equity-indexed annuities

A

The method for crediting excess interest to the annuity. An example of this is the annual reset method in which interest earnings are calculated based on the annual change in the stock index. The index value starting point is also reset annually.

34
Q

What is the guaranteed minimum value in equity-indexed annuities?

A

A minimum value that provides downside protection against the loss of principal if the annuity is held to term. The result is a guaranteed minimum value at the end of the index period.

35
Q

What is longevity insurance?

A

A generic name for a single-premium deferred annuity that begins paying benefits only at an advanced age, typically 85. There are no cash values or death benefits in the policy.

36
Q

What is the purpose of longevity insurance?

A

To provide protection against the risk of depleting your financial assets at an advanced age.

37
Q

What are some advantages longevity insurance provides? 3

A
  • The monthly benefit kicks in at an advanced age when other financial assets are likely exhausted.
  • Compared to a traditional immediate annuity, longevity insurance is a relatively low cost annuity because the policies generally do not provide cash values or death benefits during the deferral period.
  • Longevity products can be purchased with an inflation hedge.
38
Q

What are some disadvantages of longevity insurance? 3

A
  • Your heirs will lose money if you die during the deferral period because, as stated earlier, longevity products generally do not provide death benefits.
  • Once purchased, your funds are locked up, and you do not have access to the funds in the event of an emergency.
  • The risk of possible forfeiture of the purchase price if death occurs during the deferral period, or shortly after payments begin, may make the product unappealing to risks-adverse individuals.
39
Q

What is a non-qualified annuity?

A

One that does not meet the IRC requirements for employer benefits. As such, it does not qualify for most income-tax benefits that qualified employer retirement plans receive.

40
Q

What happens to an annuity distribution that takes place before age 59 1/2?

A

It is not only taxed as ordinary income, but is subject to a 10% penalty tax.

Risk Test 2 (7 decks)

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