Chapter 5 Flashcards
REITs
Organized as Trusts Subchapter M (receive 75% from real estate and distribute 90% or more of its taxable income to its shareholders. Owners hold undivided interest Trade on exchanges and OTC Not investment companies Pass through of gains only Negative correlation to stock market Dividends are taxed as ordinary income
Long term debt
Capital Debt, funded debt at least 5 years.
Secured Bonds
Asset has been pledged as security (collateral) for the loan, the bond is said do be secured. Mortgage bonds, equipment trust certificates, collateral trust certificates (stock market).
High Yield Bonds
BB or Ba and lower. Subject to more price volatility than BBB, Baa or higher (investment grade).
Exchange Traded Funds
Invests in specific indexes such as the S&P 500. Any class of asset that has a published index around can be made into an ETF so there are some for real estate and commodities as well. Trades like stock on exchanges, can be purchased on margin, and sold short. Expenses are typically lower than Mutual Funds, but due to commissions, they may not be competitive with a no-load index fund for the small investor making periodic dollar cost averaging.
Annuity
A contract between an individiual and a life insurance company, usually for the retirement income. It may be established by individuals looking for tax-deferred income or by corporations to serve as an employee retirement plan.
Fixed
Variable
Combination
Fixed Annuity
Guarantees a Minimum rate of return. When individuals elect to begin receiving income, the payout is determined by the account’s value and annuitant’s life expactancy. A fixed annuity payment remains constant throughout the annuitant’s life. It’s an insurance product, risk is purchasing power because inflation.
Variable Annuities
Reduce inflation risk, money deposited is placed in a separate account. Frequently invested in stock portfolios, which has a better chance of keeping with inflation than fixed-income investments. Payouts vary considerably. Investor bears the risk this is the security. Salespeople must be registered with FINRA and SEC.
Combination Annuities
Guaranteed Payments as well as payments that keep pace with inflation.
Fixed Annuities
Guaranteed Fixed Payments Guaranteed Interest Rate Investment risk by insurance company Portfolio of fixed-income securities General Account Vulnerable to inflation Insurance Regulation
Variable Annuities
Variable Payments Variable Rate of Return Investment Risk by annuitant portfolio of equities, debt, money market instruments. Separate Account Resistant to Inflation Insurance and Securities Regulation
Accumulation Stage
Pay in period
Contract terms are flexible. Investor who misses periodic payment is in no danger. Contract holder can terminate at any time during the accumulation stage, although the contract holder is likely to incur surrender charges on amounts withdrawn in the first 5-10 years after issuance of the contract. To discourage this, they allow loans. Accumulation Units
Annuitizing
Converts to accumulation to payout. Accumulation units become annuity units. It’s a measure of value. The number of annuity units does not change, but it’s value does fluctuate. Individual’s age sex, and assumed interest risk. Accumulated value.
Variable Annuity Payments
Life Annuity/Straight Life/ Pure Life
Life Annuity with Period Certain
Joint Life with last survivor.
Determined initially by mortality tables and the value of an annuitant’s account. Variable Annuity plans do not guarantee a payment amount because the insurance company cannot guarantee. Future values are determined by the annuity unit’s fluctuating value. Annuity Units *Current Value.
Taxation of Annuities
Contributions that are not part of an employer-sponsored retirement plan are made with after tax dollars. Anything above cost basis is taxed as ordinary income.
Random withdrawals are taxed as LIFO method. Earnings in this case. Subject to 10% early penalty if withdrawn before 59 1//2 except for disability or death, or life income option plan with fixed payments.
Advantages to Variable Annuities
Tax Deferred Growth
Guaranteed Death Benefit - the beneficiary will receive the greater of the current market value or total invested during accumulation phase. At least original investment.
Guaranteed Life time income. Protects against longevity risk.
IRS section 1035 Transfers. You can transfer to another annuity without tax consequences. But they may be a surrender charge. Unlike mutual funds that exchanges constitute a taxable event.
No age 70 1/2 Restrictions. Investor can delay withdrawals like in ROTH IRA’s.
Choice of separate account objectives - some companies offer 25-300 different subaccounts or more.
No probate
Fees are substantially higher than that of a mutual fund. All earnings taxed as ordinary income. Withdrawals before age 59 1/2 will incur a 10% penalty. Surrender charges ( deferred sales charges)
Carry same risks than mutual funds.
Equity Indexed Annuities
Credits based on performance of a particular stock index such as the S&P 500. Credited with 80-90% with a cap. Otherwise may receive a minimum 3%. Issuer also levies margin, spread, administrative fees, also a minimum perio that must elapse before the guarantee goes into effect. Early withdrawal penalties up to 15 years. Not regulated as securities.
Life Insurance
A life insurance Policy is a contract between an insurance company and an individiual that is designed to provide financial compensation to the named beneficiaries in the event of the insured's death. Term Insurance Whole Life Insurance Universal life Variable life
Term Insurance
Pure Protection
Least Expensive. Pay benefit only if insured dies during the term of coverage.
Do not accumulate cash value.
Whole Life Insurance
Permanent Cash Value Insurance provides protection for a whole life. Coverage begins on date of issue and continues to the date of the insured’s death, provided premiums are paid. Benefit Payable is the face amount of the policy set at issuance. Premium and benefit are fixed.
Cash Values - increases each year the policy is kept in force. Low risk of investments such as real estate, mortgage loans, bonds. Guaranteed cash value of general account. It cannot be forfeited. Can cash in for this benefit at any time. Policy loan - paid with interest. If death before, any indebtness will reduce the amount of the policy accordingly-it will be substracted from death benefit.
WLI - guaranteed death benefit, guaranteed cash value.
Universal Life
Pay higher interest rates than Cash Value of WLI, 8, 10, 12. Also provide greater flexibility because they allow policy owners to adjust the death benefits and/or premium payments.
Premium payments are separated first being paid towards insurance protection, with the remaining balance being used to build the cash value. Policyowner may increase or decrease death benefit (insurability requirements)
Premium payments changed
Interest earned by the cash account will vary, subject to a guaranteed minimum.
Universal Life Interest Rates
Current Annual Rate - varies with market
Contract rate - minimum guaranteed interest rate, and policy never pays less than this amount.
Universal Life Death Benefits
Option 1 - Death benefit equal to face value, as policy cash value increases, net death decreases. WLI.
Option 2 - increasing death benefit equal to the policy’s face amount plus the cash account. LTI and Cash Value.
Universal Life Policy Loans
If a loan is taken, it is subject to interest, and if unpaid, both the interest and the loan amount will reduce the face amount of the policy. Some permit a cash withdrawal . This is not treated as a loan and will only reduce the cash value not the death benefit. Payment of it is treated as a premium payment. Flexible payments, guaranteed return. lapse could occur if no payments.