Insurance Ch - 8 Flashcards
The two features of an equity indexed annuity contract that have the greatest effect on the amount of additional interest that may be credited to the contract are: ??
- The indexing methods specified in the contract
- The participation rate
ANNUITIES
* One of the common goals for most Americans is to live comfortably
in retirement – generally requires two components: ??
- Annuities are used to: ????
ANNUITIES
* One of the common goals for most Americans is to live comfortably
in retirement – generally requires two components:
- Accumulation of assets
- Reliable source of income
- Annuities are used to:
Provide income streams for retirees
Accumulate assets on a tax-deferred basis
NOTE: most annuities are not annuitized
RETIREMENT ISSUES
- Retirement Life Expectancy: The period between retirement and
death - This period has increased due to: ??
RETIREMENT ISSUES
- Retirement Life Expectancy:
The period between retirement and death - This period has increased due to:
earlier retirement and
extended life expectancy - Inflation: The increase in the general price level of goods and
services
RETIREMENT BENEFITS
- Historically, individuals received Social Security retirement benefits
and a fixed pension during retirement.
RETIREMENT BENEFITS
- Historically, individuals received Social Security retirement benefits
and a fixed pension during retirement. - Pension payments are generally made from retirement plans
known as defined benefit plans.
-Defined benefit plans pay a fixed amount of income to
retirement workers, typically for life. - In 1985, there were about 170,000 defined benefit plans. In 2019,
there were fewer than 47,000 defined benefit plans.
DEFINED CONTRIBUTION VS. DEFINED BENEFIT PLANS
DEFINED CONTRIBUTION VS . DEFINED BENEFIT PLANS
- Defined contribution plans do not promise any particular income
benefit in retirement. - In 1985, there were about 460,000 defined contribution plans. In
2019, there were more than 680,000 defined contribution plans. - With longer life expectancies and less income from defined benefit
plans, it is important for many individuals to mitigate the risk of
superannuation
CHARACTERISTICS OF ANNUITIES (1 OF 2)
CHARACTERISTICS OF ANNUITIES (1 OF 2)
- An annuity is a contract that is designed to provide a specific
income that is payable at stated intervals for a specified period of
time. - Traditionally, individuals receive fixed annuities from:
– Employer defined benefit plans
– Government retirement plans
—Insurance companies - Individuals can purchase commercial annuities; these are not
uniform in any respect.
CHARACTERISTICS OF ANNUITIES (2 OF 2)
- Annuities can be characterized based on several factors: ?
CHARACTERISTICS OF ANNUITIES (2 OF 2)
- Annuities can be characterized based on several factors:
–Type of payout
– Frequency and flexibility of premium
– The timing of when income is payable
– Tax considerations and funding vehicles
- Annuities have two distinct phases:
– Accumulation phase
– Annuitization phase (not all annuities are annuitized)
ANNUITIES: ADVANTAGES AND DISADVANTAGES
ANNUITIES: ADVANTAGES AND DISADVANTAGES
Advantages :_______________________________
Lifetime income
Structure of income can be based on single or multiple lives
Eliminates Superannuation risk and purchasing power
May provide protection from creditors
earnings oare tax -deferred
Disadvantages:______________________________
Complex
Cost and fees reduce returns
once funds are exchanges for annuity they are no longer avaialbe to heirs
Taxable benefits consist of Ordinary Income as opposed to cap gains for qualifying dividends,
PARTIES TO AN ANNUITY CONTRACT
- There are generally four parties to an annuity contract: ?
PARTIES TO AN ANNUITY CONTRACT
- There are generally four parties to an annuity contract:
- Annuitant
- Beneficiary
- Owner
- Insurance company
ANNUITY FEATURES (1 OF 2)
Annuity Payout Period
Immediate vs. Deferred
ANNUITY FEATURES (1 OF 2)
Annuity Payout Period
* May provide payments for a fixed term such as 20 years (term
certain) or for an indefinite term such as the lifetime of the annuitant
(life annuity).
Immediate vs. Deferred
* Immediate Annuity: Created when the contract owner trades a
sum of money in return for a stream of income that begins
immediately.
- Deferred Annuity: Does not begin distributions immediately but
waits until some future time to start payments.
ANNUITY FEATURES (2 OF 2)
Flexible Premium vs. Single Premium
ANNUITY FEATURES (2 OF 2)
Flexible Premium vs. Single Premium
- Flexible: Allows the insured the option to vary premium deposits
over time - Single: Annuity purchased with a single lump sum
Earnings - Fixed: Invest in less risky investments and will guarantee returns
for a period of time - Variable: Have a wider array of investment choices, including
equity investments
ANNUITY BENEFIT OPTIONS (1 OF 2)
- Single life annuities
- Term certain (Guaranteed Minimum Payment)
ANNUITY BENEFIT OPTIONS (1 OF 2)
- Single life annuities
–Straight or pure life annuities
– Installment refund annuities
–Cash refund annuities
–Life with term certain annuities
- Term certain (Guaranteed Minimum Payment)
ANNUITY BENEFIT OPTIONS (2 OF 2)
- ## Joint and survivor life annuities
ANNUITY BENEFIT OPTIONS (2 OF 2)
- Joint and survivor life annuities
–Payments are made over the lives of two or more annuitants
and continue until the last annuitant dies
– Commonly used to provide income for married couples
– Survivor may receive 100%, 75%, or 50% of the joint amount
TYPES OF ANNUITY CONTRACTS
Fixed Annuity
Variable Annuity
Equity Indexed Annuity
TYPES OF ANNUITY CONTRACTS
Fixed Annuity
* Most conservative
* Principal protection
* mitigates the risk of superannuation
Variable Annuity
* Allows for participation in equity markets
* Higher costs and fees
Equity Indexed Annuity
* Guaranteed minimum rate
* Earnings based on some type of index
FIXED ANNUITY
FIXED ANNUITY
- Most conservative
- Provides full principal protection combined with a guaranteed rate of return
– Initial rate
–Renewal rate
VARIABLE ANNUITY (1 OF 2)
Features
VARIABLE ANNUITY (1 OF 2)
Features
* Tax deferred earnings
* Avoid income tax when one investment in the annuity contract is
sold and replaced with another investment (transfer among
subaccounts)
* Death benefit protection options
* Living benefit protection options
* Lifetime income options
VARIABLE ANNUITY (2 OF 2)
Prospectus
VARIABLE ANNUITY (2 OF 2)
Prospectus
* A disclosure document provided to purchasers of variable annuities
that contains important information about the contract, such as:
– Fees and charges
– Investment options and objectives
– Risks
– Death benefit options
–Living benefits
–Annuity income options
VARIABLE ANNUITY FEES ( 1 OF 3)
VARIABLE ANNUITY FEES (1 OF 3)
- Mortality and expense risk charges
* Insurance risks
* Cover the risks of annuitant living too long
* 1.15% to 1.85% (115 to 185 bps) annually - Administrative and Distribution Fees
* Costs associated with servicing and distributing the annuity
* 0% to 0.35% (0 to 35 bps) annually - Annual Fee
* Record keeping and administration
* $30 to $50
* Regularly waived
VARIABLE ANNUITY FEES (2 OF 3)
VARIABLE ANNUITY FEES (2 OF 3)
- Subaccount Fees and Expenses
- Charged to the investment subaccounts inside the annuity
and include investment management fees - $0.7% to 2.5% (70 to 250 bps) annually
- Surrender Charges
* Known as contingent deferred sales charges (CDSCs)
- Typically, a percentage (7% to 9%) of the amount withdrawn in
excess of a 10% free withdrawal amount and declines over time - Does not apply if the annuity is annuitized
VARIABLE ANNUITY FEES ( 3 OF 3)
Variable annuities are offered by share class:
VARIABLE ANNUITY FEES (3 OF 3)
Variable annuities are offered by share class:
- B shares typically have a 6- to 8- year period of surrender charges.
- L shares have a 3- to 4- year surrender charge period for each
contribution. - C shares have no surrender charge.
- B shares typically have slightly lower fees.
Note: There is generally a direct link between the CDSC and the
commission the broker receives as part of the sale
VARIABLE ANNUITY FEES: EXAMPLE
- Elmer purchases a variable annuity contract with a $100,000
purchase payment. The contract has a schedule of surrender
charges, beginning with a 7% charge in the first year, and declining
by 1% each year. In addition, he is allowed to withdraw 10% of the
contract value each year free of surrender charges. In the first year,
Elmer decides to withdraw $50,000, or one-half of his contract value
of $100,000 assuming the contract value has not increased or
decreased because of investment performance).
VARIABLE ANNUITY FEES: EXAMPLE
- Elmer purchases a variable annuity contract with a $100,000
purchase payment. The contract has a schedule of surrender
charges, beginning with a 7% charge in the first year, and declining
by 1% each year. In addition, he is allowed to withdraw 10% of the
contract value each year free of surrender charges. In the first year,
Elmer decides to withdraw $50,000, or one-half of his contract value
of $100,000 assuming the contract value has not increased or
decreased because of investment performance).
In this case, Elmer could withdraw $10,000 (10% of contract value) free of surrender
charges, but he would pay a surrender charge of 7%, or $2,800, on
the other $40,000 withdrawn
GUARANTEED LIVING BENEFIT RIDERS
Basic Types of Living Benefits:
GUARANTEED LIVING BENEFIT RIDERS
Basic Types of Living Benefits:
- The guaranteed minimum accumulation benefit (GMAB)
- The guaranteed minimum income benefit (GMIB)
- The guaranteed minimum withdrawal benefit (GMWB)
EQUITY-INDEXED ANNUITIES
EQUITY-INDEXED ANNUITIES
- Fixed annuities that earn interest or provide benefits that are linked
to an external equity reference or an equity index. - One of the most commonly used indices for annuity products is the
Standard & Poors 500 composite stock price index (S&P 500). - Credit interest using a formula based on changes in the index to
which annuity is linked. - Two Features that affect the amount of interest credited:
1. Indexing methods specified in the contract
2. Participation rate
INDEXING METHOD
I
INDEXING METHOD
Indexing Method
1. The annual reset (ratcheting) method
* Compares the index value at the end of the contract year with
the index value at the beginning of the contract year
- The high watermark method
* Compares the value of the index at various points during the
term (usually on anniversary dates) - The point-to-point method
* Based on the difference between an index value at the end of the
term compared with the index value at the start of the term
EQUITY-INDEXED ANNUITY KEY TERMS
- Index Term:
- Participation Rate:
- Cap Rate:
- Floor Crediting Rate:
EQUITY-INDEXED ANNUITY KEY TERMS
- Index Term: Period over which index-linked interest is calculated,
ranging from 1 to 10 years, with 6 to 7 being the most common. - Participation Rate: Determines how much of the increase in the
index will be used to calculate the index-linked interest. - Cap Rate: Some indexed annuities impose an upper limit on the
index-linked rate. - Floor Crediting Rate: Minimum index-linked interest rate that will
be credited to the contract in a given period.
EQUITY-INDEXED ANNUITY: EXAMPLE
- Homer buys an equity-indexed annuity that has:
–A guaranteed minimum rate of 2%
– A participation rate of 75%
– A maximum rate of 9% - On the day Homer purchases his annuity, the S&P 500 index is
1800.
EQUITY-INDEXED ANNUITY: EXAMPLE
- Homer buys an equity-indexed annuity that has:
– A guaranteed minimum rate of 2%
– A participation rate of 75%
–A maximum rate of 9%
________________________________________________________________ - On the day Homer purchases his annuity, the S&P 500 index is
1800. - One year later the index is 2050, an increase of 13.88%.
- 75% participation rate x 13.88% = 10.42%; however, Homer’s
annuity will be credited with the maximum rate of 9%. - If the S&P 500 instead had a return of -7.3%, Homer would be
credited with the minimum rate of 2%
ADVANTAGES OF ANNUITY CONTRACTS
ADVANTAGES OF ANNUITY CONTRACTS
- Opportunity to defer income taxation
- The ability to rebalance the portfolio inside a variable annuity
contract without incurring any immediate income taxation on asset
sales - Annuities are protected from creditors in some states
DISADVANTAGES OF ANNUITY CONTRACTS
DISADVANTAGES OF ANNUITY CONTRACTS
* Complexity
* Costs and fees
* Tax consequences
TAXATION OF ANNUITIES (1 OF 3)
Income Taxation
TAXATION OF ANNUITIES (1 OF 3)
Income Taxation
- Distributions taken from an annuity BEFORE annuitizing:
– Included in the taxpayer’s gross income until all of the
gain in the contract has been distributed
– Further distributions are treated as tax-free returns of basis
– Follow a LIFO approach to income reporting
– Annuities issued prior to August 14, 1982 receive FIFO
treatment
– Taxable distributions of earnings are subject to 10% early
withdrawal penalty if the account holder is under the age 59½
TAXATION OF ANNUITIES (2 OF 3)
TAXATION OF ANNUITIES (2 OF 3)
- If the annuitant/owner is a high-income taxpayer and the annuity
distribution is not made through an IRA or qualified plan, a 3.8%
Medicare surtax will apply. - Annuities purchased with pre-tax dollars typically do not have any
basis for income tax purposes.
– 401(k) plans and deductible traditional IRAs
– All distributions are taxable as ordinary income
– The 3.8% Medicare surtax does not apply
TAXATION OF ANNUITIES (3 OF 3)
Income Taxation
TAXATION OF ANNUITIES (3 OF 3)
Income Taxation
- Each annuity payment received from a non-qualified annuity uses
an exclusion ratio to split the tax treatment into two pieces:
–A tax-free return of basis
– Taxable income - The exclusion amount for a variable annuity is determined by
dividing the after-tax investment in the contract by the number of
years of expected payout. - Once the investment in the contract has been fully recovered, all
payments will be fully taxable as ordinary income.
TAXATION OF ANNUITIES: EXAMPLE 1
- Hope purchased an annuity contract 10 years ago for $100,000.
The current value of the annuity is $175,000. Hope decides to
withdraw $100,000 from the contract
TAXATION OF ANNUITIES: EXAMPLE 1
- Hope purchased an annuity contract 10 years ago for $100,000.
The current value of the annuity is $175,000. Hope decides to
withdraw $100,000 from the contract
Total Withdrawal = $ 75,0000 GAINS
$ 100,000 BASIS
TAXATION OF ANNUITIES: EXAMPLE 2
- Ira has always been a planner and very methodical about his
finances. Twenty years ago, he purchased a deferred variable
annuity that is now worth $1 million. Unfortunately for Ira, he
stepped on a piece of glass and the wound got infected. The
infection went untreated, and he died.
TAXATION OF ANNUITIES: EXAMPLE 2
- Ira has always been a planner and very methodical about his
finances. Twenty years ago, he purchased a deferred variable
annuity that is now worth $1 million. Unfortunately for Ira, he
stepped on a piece of glass and the wound got infected. The
infection went untreated, and he died. - The value of the annuity, which was not annuitized, is included in
his gross estate, but does not go through the probate estate since it
has a named beneficiary
ANNUITY BENEFICIARY DISTRIBUTIONS
ANNUITY BENEFICIARY DISTRIBUTIONS
- To the extent that there is gain in the contract, the beneficiary will
report the gain as income. - If there is substantial gain in the contract, the beneficiary may
choose to distribute over several tax years.
– Over his or her life expectancy
–Distributed within five years after the owner’s death
– Surviving spouse of the owner can treat the annuity as his or own.
– When the beneficiary is not an individual, the five-year rule applies
USES OF ANNUITIES: LONGEVITY INSURANCE (1 OF 2)
- Cost of longevity annuity contracts are very reasonable for two
reasons: ??
USES OF ANNUITIES: LONGEVITY INSURANCE (1 OF 2)
- Cost of longevity annuity contracts are very reasonable for two
reasons:
–The contract is purchased at or before retirement, and
payments do not generally begin until age 85.
– More than half of those purchasing longevity annuities will not
receive any payments
USES OF ANNUITIES: LONGEVITY INSURANCE (2 OF 2)
USES OF ANNUITIES: LONGEVITY INSURANCE (2 OF 2)
- Qualified Longevity Annuity Contract (QLAC) purchased inside
of a qualified retirement plan or IRA will not be considered when
calculating required minimum distributions. - To be considered a QLAC, the premium must not exceed the lesser
of 25 percent of the account balance or $155,000 in 2023 and
$145,000 for 2022.
– The contract must be specified to be a longevity annuity contract
at issuance
USES OF ANNUITIES STRUCTURED SETTLEMENTS
USES OF ANNUITIES: STRUCTURED SETTLEMENTS
- An agreement under which someone who is entitled to receive a
large lump-sum payment of money decided, instead, to accept
periodic sums of money. - If payments are a result of physical injury, the payments received by
the injured party are tax-free
STRUCTURED SETTLEMENTS AND THE SECONDARY MARKET
STRUCTURED SETTLEMENTS AND THE SECONDARY MARKET
- Sometimes secondary market annuities are called pre-owned
annuities or in-force annuities. - These annuities can be purchased from the original owner at a
discount or from a third party, and the stream of income is assigned
to the purchaser. - Both sellers and buyers of annuities should conduct substantial due
diligence prior to entering into this type of transaction
STRUCTURED SETTLEMENTS AND THE SECONDARY MARKET: EXAMPLE (1 OF 2)
STRUCTURED SETTLEMENTS AND THE SECONDARY MARKET: EXAMPLE (1 OF 2)
- Wilma is injured by Betty in an automobile accident. The claim is
not settled and ultimately goes to court. Wilma wins the case and
settlement money is offered to pay Wilma either a lump-sum
payment or a structured settlement making payments over Wilma’s
lifetime. Wilma, who is now unable to work, accepts the structured
settlement annuity. The court order specifies that Wilma shall
receive $2,000 per month for life, with a 20- year guaranteed
payment period. Neither Wilma nor the court want Betty or Betty’s
auto insurance company to pay the annuity.
-Therefore, Betty’s
insurance company purchases an annuity from a major life
insurance carrier to pay the annuity of $2,000 per month with a 20-
year guarantee.
-Betty’s auto insurance company is the owner of the
policy, the life insurance company is the issuer, and Wilma is the
payee
STRUCTURED SETTLEMENTS AND THE SECONDARY MARKET: EXAMPLE (2 OF 2)
STRUCTURED SETTLEMENTS AND THE SECONDARY MARKET: EXAMPLE (2 OF 2)
- Five years into the annuity, Wilma needs money, and because she
does not work, she decides to sell some or all of her annuity
payments in return for a lump-sum payment.
-Wilma sells the annuity at an 8.5% discount rate and receives $203,000 from the structured settlement company.
-The structured settlement company then re-offers the annuity for $253,000 (equating to a yield of approximately 5%) over the term of the annuity.
-The yield is substantially higher than the yield on CDs or treasuries. A similar 15-year guaranteed annuity of $2,000 per month might cost
$300,000 and yield 2.5%
THE IMPORTANCE OF COMPANY CREDIT RATING
).
THE IMPORTANCE OF COMPANY CREDIT RATING
- The financial stability of the company issuing the annuity contract is
of major concern to contract holders and should be a consideration
in determining which annuity contract to purchase. - Several rating agencies assess the financial strength of insurance
companies issuing annuity contracts. These include A.M. Best (with
a rating scale from A++ to S), S&P (with a rating scale of AAA to R),
and Moody’s (with a rating scale from Aaa to C).
DEFAULT RISK FOR ANNUITIES
DEFAULT RISK FOR ANNUITIES
- All states have guarantee funds run by the state insurance
commission that act as the payor of last resort in the case of an
insurance company failure. - While a few insurance companies have failed, no annuity contract
holder in the United States has been deprived of promised
payments to date
Annual Reset Method -
Annual Reset Method -
The index-linked interest crediting rate is determined each year by comparing the index value at the end of the contract year with the index value at the beginning of the contract year. Interest is then added to the annuity each year during the term
Annuitization
Annuitization -
The time when annuity funds are exchanged for a stream of income guaranteed for a period of time.
Annuitized
Annuitized -
The time whe
n regular, periodic (such as monthly or annual) payments begin for life or for a specified period of time in excess of one year.
Cap Rate
Cap Rate -
Some indexed annuities impose an upper limit on the index-linked interest rate.
Cash Refund Annuity -
Cash Refund Annuity -
Guarantees that the annuitant or the annuitant’s family will receive the premium payments made to purchase the annuity, but instead of continuing to make periodic payments until there is a full recovery of the premium, the balance is paid in cash at the annuitant’s death.
Equity-Indexed Annuities
Equity-Indexed Annuities -
Have characteristics of both fixed and variable annuities, either immediate or deferred, that earn interest or provide benefits that are linked to an external equity reference or an equity index.
Floor Crediting Rate -
Floor Crediting Rate
- An indexed annuity is the minimum index-linked interest rate that will be credited to the contract in a given period
Guarantee Funds -
Guarantee Funds -
Run by the state insurance commission, they act as the payor of last resort in the case of an insurance company failure.
High Watermark Approach -
High Watermark Approach -
Determining index-linked interest is accomplished by comparing the value of the index at various points during the term (usually on anniversary dates)
immediate Annuity -
immediate Annuity -
An instrument created when the contract owner trades a sum of money in return for a stream of income that begins immediately.
Index Term -
Index Term -
The period over which index-linked interest is calculated for equity-indexed annuities
Indexing Method -
Indexing Method -
The approach used to measure the amount of change, if any, in the index. Some common indexing methods include: (1) the annual reset (ratcheting) approach, (2) the high watermark approach, and (3) the point-to-point approach
Initial Rate
Initial Rate -
The first rate of interest that is earned under a fixed annuities contract and is guaranteed for a specified period of time.
Installment Refund Annuity -
Installment Refund Annuity -
special type of term certain annuity whereby the insurer promises to continue periodic annuity payments after the annuitant has died until the sum of all annuity payments made equals the purchase price of the annuity
IRD Assets -
IRD Assets -
Assets that have a deferred income tax liability that was not paid prior to the date of the owner’s death.
Longevity Insurance
Longevity Insurance
- A sophisticated name for a deferred annuity purchased by an individual at or before retirement that will not begin to make payments until that person reaches an advanced age.
Participation Rate -
Participation Rate -
Determines how much of the increase in the index will be used to calculate the index-linked interest.
Pooling of Risk -
Pooling of Risk -
Spreading of risk among a large number of similar contributors to the pool. Protection is provided to the entire pool of contributors. With annuities, the risk that is being spread is the risk of outliving retirement funds, or superannuation.
Risk-Based Capital -
Risk-Based Capital -
The investment risk assessment undertaken by the insurance company in investing the money backing up the annuity pool.
Secondary Market Annuities -
Secondary Market Annuities -
Called pre-owned annuities or in-force annuities. These annuities can be purchased from the original owner at a discount or from a third party, in which the stream of income is assigned to the purchaser. These typically offer a rate of return or yield that is well above the yield available on standard fixed annuities, immediate annuities, or even bonds of a similar credit quality.
Straight or Pure Life Annuity -
Straight or Pure Life Annuity -
An annuity that provides a stream of income to the annuitant for life.
Superannuation -
Superannuation -
The risk of running out of money before death due to long life and can be mitigated by using annuities.
Is a loss allowed on an Annuity ?
With the surrender of an annuity for a loss,
the owner can take a loss that does not include the surrender charge. Thus, option b is not correct. It is not a capital loss. Taking the loss as an ordinary loss is more aggressive, but there is some authority for the position.
Which of the following statements about annuities is not correct?
A., Term certain and joint life terms are not mutually exclusive.
B. Variable annuities can be invested in subaccounts that invest in fixed income securities.
C. The annuity benefit payment for a 20-year term certain will be more than the annuity payment for a single life annuity with a 20-year term certain option for an annuitant whose life expectancy is 20 years.
D. All annuities are subject to minimum distribution rules.
distribution rules
Which of the following statements about annuities is not correct?
Option a is a true statement as the options can be combined.
Option b is a true statement as the annuity owner chooses to invest in a variety of subaccount types, including fixed income.
Option c is a true statement as the insurance company is more likely to pay more with the life annuity term certain combined option.
Option d is false - only qualified annuities are subject to minimum distribution rules
Variable Annuity
Variable Annuity
The value of both the accumulation units and the annuity units fluctuates
Annuities can help lessen superannuation (risk of outliving funds) and purchasing power (if the annuity is variable). An annuity does not reduce the likelihood of dying (mortality)
Saul purchased a life insurance policy with a face value of $100,000. Unfortunately for Saul, and his wife, Rhea, he died racing “import cars.” At the time of death, the life insurance policy had a cash value of $40,000. The beneficiary was his wife. Rhea, who has a life expectancy of 40 years, decided to take the single life annuity option with the life insurance proceeds. This option will pay her $500 per month for the rest of her life. How much of the monthly payment is taxable?
Saul purchased a life insurance policy with a face value of $100,000. Unfortunately for Saul, and his wife, Rhea, he died racing “import cars.” At the time of death, the life insurance policy had a cash value of $40,000. The beneficiary was his wife. Rhea, who has a life expectancy of 40 years, decided to take the single life annuity option with the life insurance proceeds. This option will pay her $500 per month for the rest of her life. How much of the monthly payment is taxable?
__________________________________________________________
Exclusion ratio = investment ÷ expected payments = $100,000 ÷ (40 years x 12 months x $500) = 41.7%.
Inclusion ratio = 1 - exclusion ratio = 58.3%
Taxable amount = $500 x 58.3% or $292
Hugh purchased a single premium annuity for $200,000. The annuity pays him $1,000 per month. If his life expectancy was 20 years when he purchased it, how much of each payment is not subject to tax?
Hugh purchased a single premium annuity for $200,000. The annuity pays him $1,000 per month. If his life expectancy was 20 years when he purchased it, how much of each payment is not subject to tax?
__________________________________________
Exclusion ratio = $200,000 ÷ (20 years x 12 month x $1,000) = 83.33%
Taxable portion = 1- exclusion ratio = 17.67%
Non-taxable portion of the payment = $833
Mason, who is now 70 years old, was a diligent saver during his working years and accumulated $100,000 at age 60. He used his savings to purchase a single premium annuity, which pays him $1,000 per month. If his life expectancy was 25 years when he purchased it,
how much of each payment is subject to tax?
Mason, who is now 70 years old, was a diligent saver during his working years and accumulated $100,000 at age 60. He used his savings to purchase a single premium annuity, which pays him $1,000 per month. If his life expectancy was 25 years when he purchased it,
how much of each payment is subject to tax?
____________________________________
Exclusion ratio = $100,000 / (25 years x 12 month x $1,000) = 33.33%
Taxable portion = 1- exclusion ratio = 66.67%
Taxable portion of the payment = $667
All of the following are requirements for Qualified Longevity Annuity Contracts (QLACs), EXCEPT?
A> A maximum of $145,000 (in 2022) may be used to purchase the QLAC.
B. A QLAC is purchased in an IRA or defined contribution retirement plan.
IC. n order to be qualified, a QLAC must be annuitized no later than age 85.
D. In order to be qualified, a QLAC must be a variable a
All of the following are requirements for Qualified Longevity Annuity Contracts (QLACs), EXCEPT?
A. A maximum of $145,000 (in 2022) may be used to purchase the QLAC.
B. A QLAC is purchased in an IRA or defined contribution retirement plan.
C. In order to be qualified, a QLAC must be annuitized no later than age 85.
D. In order to be qualified, a QLAC must be a variable a
______________________________________________
In order to be qualified, a QLAC must be a variable annuity.Rationale
Variable and indexed annuities are not permitted to be QLACs. All of the other statements are true regarding the rules for Qualified Longevity Annuity Contracts.
TYPES OF ANNUITIES TEST
ANNUITY - “ so you don’t outlive your money”, creates income stream cannot outlive.
- Flexible premium (fluctuating income)- pay whenever
- Immediate annuity -LUMPSUM, THEN PAY IMMEDIATELY
- Deferred annuity -DEFER INCOME TO FUTURE
- Pure life annuity (max. periodic payout, no bequests
guaranteed) -LIFE ONLY, ZERO TO BENEFICIARY - Guaranteed minimums
- Refund annuity -RECEIVING INCOME, THEN DIE, BENEF GET REMAINING OF VALUE.
- Joint and survivor
Cody decided to purchase a variable annuity and invested $50,000. He made a few poor investment decisions and the market dropped. Like many investors, he decided to sell when the value was low. He surrendered the annuity and received $27,000, after the $3,000 surrender fee. Which of the following is true?
Take an ordinary loss of $20,000.
Rationale
With the surrender of an annuity for a loss, the owner can take a loss that does not include the surrender charge. Thus, option b is not correct. It is not a capital loss. Taking the loss as an ordinary loss is more aggressive, but there is some authority for the position.
INVESTED $50,000
-$3,000 SURRENDER FEE
-27,000 SURRENDER VALUE
$20,000 GAIN
Mason, who is now 70 years old, was a diligent saver during his working years and accumulated $100,000 at age 60. He used his savings to purchase a single premium annuity, which pays him $1,000 per month. If his life expectancy was 25 years when he purchased it, how much of each payment is subject to tax?
$667.
Rationale
Exclusion ratio = $100,000
———————————————— = 33.33% NOT
(25 years x 12 month x $1,000) TAXABLE
Taxable portion = 1- exclusion ratio = 66.67%
Taxable portion of the payment = $667
When determining the percentage of an annuity income that is not taxable, the investment in the annuity is divided by the total of the expected payments to be received. What is this quotient is called?
The exclusion ratio.
Rationale
The exclusion ratio equals the owner’s investment in the annuity contract divided
by the expected return on the annuity.
The resulting percentage is multiplied by the distribution, or payment, received to calculate the portion of the payment that is NOT TAXABLE
Hugh purchased a single premium annuity for $200,000. The annuity pays him $1,000 per month. If his life expectancy was 20 years when he purchased it, how much of each payment is not subject to tax?
$833.
Rationale
Exclusion ratio = $200,000 ÷ (20 years x 12 month x $1,000) = 83.33%
Taxable portion = 1- exclusion ratio = 17.67%
Non-taxable portion of the payment = $833
Saul purchased a life insurance policy with a face value of $100,000. Unfortunately for Saul, and his wife, Rhea, he died racing “import cars.” At the time of death, the life insurance policy had a cash value of $40,000. The beneficiary was his wife. Rhea, who has a life expectancy of 40 years, decided to take the single life annuity option with the life insurance proceeds. This option will pay her $500 per month for the rest of her life. How much of the monthly payment is taxable?
292.
Rationale
Exclusion ratio = investment ÷ expected payments = $100,000 ÷ (40 years x 12 months x $500) = 41.7%.
Inclusion ratio = 1 - exclusion ratio = 58.3%
Taxable amount = $500 x 58.3% or $292
