EXAM 3 REVIEW CHAPTER 10 Annuities IRAs 8 or 9 questions Individual Annuities o An annuity is a tax deferred product the premiums are paid with after tax dollars the investment income accumulates income tax free and is not taxed until benefits are paid to the annuitant o An annuity is a periodic payment that continues for a fixed period or for the duration of a designated life or lives The person who receives the payments is the annuitant o Difference between annuities and life insurance Life insurance creates an immediate estate and provides protection against dying too soon before sufficient financial assets can be accumulated whereas an annuity provides protection against the risk of excessive longevity and exhausting one s savings while the individual is still alive Fundamental purpose to provide a lifetime income that cannot be outlived Annuity payments consist of three sources 1 premium payments 2 interest earnings and 3 the unliquidated principal of annuitants who die early An annuity is the opposite of life insurance o The major types of annuities sold today include Fixed annuity pays periodic income payments that are guaranteed and fixed in amount During the accumulation period prior to retirement premiums are The guaranteed rate is the minimum interest rate that will be credited with interest credited to the fixed annuity The current rate is higher and based on current market conditions and is guaranteed only for a limited period A bonus annuity pays a higher interest rate initially o i e an investor who deposits 100 000 into an annuity with a 3 bonus would receive an additional 3000 of interest the first year The liquidation period or payout period follows the accumulation period and is the period in which funds are paid out to the annuitant or annuitized Payouts are a fixed amount Downside of fixed annuity Little or no protection against inflation Fixed annuity income payments can be paid immediately or at a future date o An immediate annuity is one where the first payment is due one payment interval from the date of purchase o A deferred annuity provides income payments at some future date and flexible premiums o A deferred annuity purchase with a lump sum is called a single premium deferred annuity o A flexible premium annuity allows the owner to vary the premium payments The fixed annuity owner has a choice of annuity settlement offers o Annuity settlement options cash can be withdrawn in a lump sum or in installments or the funds can be annuitized and paid out as life income o Most annuities are not annuitized 1 Under the cash option the funds can be withdrawn in a lump sum or in installments 2 A life annuity no refund option provides a life income to the annuitant only while the annuitant remains alive Pays highest amount of periodic income payments because of no refund features Not commonly elected option 3 A life annuity with guaranteed payments or life annuity with period certain pays a life income to the annuitant with a certain number of guaranteed payments such as 5 10 15 or 20 years An installment refund option pays a life income to the annuitant after the annuitant s death payments continue to a beneficiary until they equal the purchase price A cash refund option is similar but pays the beneficiary a lump sum A joint and survivor annuity pays benefits based on the lives of two or more annuitants The annuity income is paid until the last annuitant dies An inflation indexed annuity option provides periodic payments that are adjusted for inflation i e a 70 year old male who purchases a 100 000 immediate annuity would receive lifetime income of 757 monthly If indexed for inflation however the initial monthly payment would be about 569 or about 25 less Variable annuity pays a lifetime income but the income payments vary depending on common stock prices The purpose is to provide an inflation hedge by maintaining the real purchasing power of the payments Premiums are used to purchase accumulation units during the period prior to retirement o i e assume the accumulation unit is initially valued at 1 and the annuitant makes a monthly premium payment of 100 During thw first month 100 accumulation units are purchased If commone stock prices increase during the second month and the accumulation rises to 1 10 about 91 accumulation units can be purchased If the stock price increases during the second month and the accumulation unit declines to 0 90 111 accumulation units can be purchased Therefore accumulation units are purchased over a long period of time in both rising and falling markets At retirement the accumulation units are converted into annuity units o What is an Annuity Unit It is an accumulation unit a sub account of the retiree s total accumulated annuity These units represent a fixed share of ownership of the insurer s accounts portfolio When an insured person changes from accumulating wealth to spending it they draw on their saving While saving the insured party has made periodic payments to their life insurance company to purchase shares of ownership of a very large portfolio managed by the insurer When the insured wants to start taking money out they convert their total accumulated savings to start paying them in income So the insured person purchases annuity units with the money that was formerly being saved as accumulation units Equity indexed annuity 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 interest earnings if the annuity is held to term Key elements o Participation rate percent of increase in the stock index credited to the contract o Maimum cap rate or cap maximum rate of interest the annuity will earn the annuity o Indexing method method for crediting excess interest to o Guaranteed minimum value for terms longer than one year provides downside protection against the loss of principal if the annuity is held to term Types of Annuities declines o A guaranteed death benefit protects the principal against loss due to market o Typically if the annuitant dies before retirement the amount paid to the beneficiary will be the higher of two accounts the amount invested in the contract or the value of the account at the time of death o Some variable annuities pay enhanced death benefits either 1 guarantee the principal contributions made plus interest or 2 periodicially adjust the vlue of the account to lock in
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