Lesson 7: Annuities Flashcards
Life Expectancy: Longer Retirement =
Exposure to:
-Longevity risk (also known as superannuation) - the risk of outliving one’s financial resources.
-Purchasing power risk from inflation – the increase in the general price level of goods and services.
Annuities
- 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
- Less Defined benefit plans and now there are more defined contribution plans (like 401K)….introduction of annuities
Annuities:
- Provide income streams for retirees
- Accumulate assets on a tax-deferred basis
Fixed Annuity (example question)
- mitigates the risk of superannuation
- still subject to loss of purchasing power (Inflation), they can be either immediate or deferred, can be for a single life, joint life, or for a guaranteed term
Characteristics of Annuities
Annuities can be characterized based on several factors:
Length of payout (fixed or variable)
Frequency and flexibility or premium (single premium or flexible premium)
The timing of when income is payable (immediate or deferred)
Tax considerations and funding vehicle
Annuities have two distinct phases:
Accumulation phase
Annuitization (not all annuities are annuitized)
Parties to Annuity Contract
Owner - owns contract and names annuitant and bene
Annuitant - person whose life contract is dependent
Beneficiary - who receives the death benefit
Annuity Features
Annuity Payout Period: may be fixed (such as 20 years term certain) or indefinite term such as lifetime (life annuity)
Immediate vs. Deferred:
- Immediate=trades sum of money in return for stream of money that begins immediately
- Deferred=not immediate, waits to future time to start payments
Flexible Vs Single Premium:
- Flexible=vary premium deposits over time
- Single=single lump sum, maximizes income but steep up front cost
Earnings:
Fixed= less risky investments, guaranteed returns for period of time
Variable=wider array of investment choices, like equity
Annuity Benefit Options
Single Life = paid for single lifetime, can be combined with other payout options
Joint Life = funds paid over 2 lives (100% joint and survivor, 75% joint and survivor, 66% joint and survivor, 50% joint and survivor)
Term Certain = funds paid for specified period of time
Options = single life and joint life can be combined with term certain or premium refund
Advantages and Disadvantages of Annuities
Advantages: lifetime income, can be based on single or multiple lives, eliminates superannuation risk, may provide protection from creditors, earnings are tax deferred, invest. options allow for fixed or variable
Disadvantages: complex, costs and fees, funds no longer avail. for bequests/other needs, tax bene consists of OI (no cap gains)
Example:
Scott is retiring and is concerned about the risk of running out of money during retirement. He will receive Social Security benefits, but they are not large enough to cover his basic financial needs.
He was advised to consider an annuity, which appears to have many advantages. However, he does not want to run the risk of exchanging a large sum of money and then only receiving a few payments if he were to unexpectedly die shortly after purchasing the annuity.
Given his fear, he might consider an installment refund annuity, a cash refund annuity or a term certain annuity. Either of these options will “guarantee” a minimum amount of income from the annuity, but they will all have lower payments than a straight or pure life annuity.
Installment Refund Annuity: if the annuitant does not get payment equivalent to the price paid on the contribution, the beneficiary receives the difference in monthly installments (def. from google) - over period of time
Cash Refund Annuity: the annuity holder’s beneficiary receives a lump sum ^^^same but lump sum
Term Certain Annuity: A term certain annuity is an insurance product that guarantees a periodic payment of a predetermined amount for a fixed term
Types of Annuities (Fixed, Variable, Equity Indexed)
Fixed: most conservative, full principal protection with guaranteed rate of return…prem paid earned int. rate…once inital int. rate expires, renewal rate in effect
Variable: tax deferred earnings, avoid income tax on buy/sells within contract (transfer among subaccounts), DB protection options, living benefit protection options, lifetime income options ***control of investments with contract holder…potential higher returns, invest. risk
Equity Indexed: Immediate or deferred, earn interest or provide benefits linked to an external equity reference or equity index (most common S&P) ….credit int. based on index, composite between variable and fixed…little downside and modest upside potential
Fees Associated With Variable Annuities
Mortality and Expense Risk Charges: cover risk of annuitant living too long
Admin/Distr. Fees: servicing and distributing the annuity
Annual Fee: recordkeeping and administration
Subaccount Fee and Expenses: include investment management fees
Surrender Charges: CDSC…% of amount withdrawn…first year typically 7-9%…declines over time
Variable Annuity Share Classes and Surrender Charges
***classes with lower surrender charges also tend to have lower broker’s commissions
B Shares: 6-8 year period of surrender charges and slightly lower fees
L Share: 3-4 year surrender charge period for each contribution
C Share: no surrender charge
Guaranteed Living Benefit Riders
-in VA, want upside but wary of risks…GLB increase the premium but add downside protection
Guaranteed Min. Accumulation Benefit (GMAB):
Guarantees that for a specified period of time (typically 7-10 years), an investor’s contract value will be at least equal to a certain minimum percentage (usually 100%) of the amount invested regardless of investment performance.
Guaranteed Min. Income Benefit (GMIB):
Designed to provide the investor with a minimum amount of lifetime income during retirement, regardless of investment performance.
The contract guarantees an income stream based on a minimum benefit base.
The benefit base initially equals the initial investment but will increase over time.
Generally, investors must wait for a period of time (often ten years) before annuitizing.
The rider guarantees the income even if the benefit base goes to zero.
Guaranteed Min. Withdrawal (GMWB):
Guarantees that a certain percentage (usually 5-7%) of the amount invested can be withdrawn annually until the entire amount is completely recovered, regardless of the investment performance of the underlying asset base.
If the underlying investments perform well, then there are additional funds in the policy at the end of the withdrawal period.
If the underlying investments perform poorly or if the account value drops to zero, the investor can still continue to take withdrawals until the full amount of the original investment is recovered.
There is often a step-up feature that permits the investor to lock in a higher benefit base if the underlying investments perform well.
Equity Indexed Annuities
-experience returns based on an equity index, such as the S&P 500…don’t simply follow index…only some upside, but most designed to never lose value
Index Term: period index-linked interest
Part. Rate: how much of the increase in the index will be used to calculate the index-linked interest
Cap. Rate: Some imposed an upper limit on rate
Floor Crediting Rate: Minimum index-linked interest rate that will be credited to the contract in a given period
Equity Indexed Annuities: Indexing Methods
Annual Reset Method: Comparing the index value at the end of the contract year with the index value at the beginning of the contract year, interest earned is locked in and the index value is reset at the end of each year…Future decreases in the index will not affect the interest already earned
Water Mark Method: Comparing the value of the index at various points during the term (usually on anniversary dates)…int credited based on highest index value and value at start of term
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 …allows for higher participation rate
