What are annuities?
They are products sponsored by insurance companies in which investment income grows tax-deferred. They may be fixed or variable.
Fixed annuity: who takes the investment risk, is it a security, what account is it in, what type of portfolio does it hold, and is it a good inflation hedge?
- Investment risk: insurance company
- Security: no
- Account: general
- Portfolio: safe, secure, and predictable investments
- Inflation hedge: poor
Variable annuity: who takes the investment risk, is it a security, what account is it in, what type of portfolio does it hold, and is it a good inflation hedge?
- Investment risk: annuitant
- Security: yes
- Account: separate
- Portfolio: many different sub accounts that meet investor objectives
- Inflation hedge: better
What is the separate account?
- It is an investment product regulated under the investment company act of 1940
- It is registered with the SEC
- It must be sold with a prospectus
- Investments may be changed in it during the accumulation phase
What are some examples of separate accounts?
- SP 500 Index subaccount
- High yield corporate bond
- aggressive growth
- special situations
What is the tax situation during the accumulation phase?
- Units are purchased after-tax with no deduction
- Investment income is tax-deferred until withdrawn
- During this phase, the account is valued in terms of accumulation units
What is the AUV?
Accumulation Unit Value (similar to a NAV) which is the price to buy into a variable annuity. It is calculated at the end of the business day.
How do withdrawals work during the accumulation phase?
- Annuitants may choose to take withdrawals. They control the timing and ammount.
- Only the earning portion is taxable
What is a premature withdrawal from an annuity?
- Withdrawal before 59.5 years
- 10% penalty
- The gross is added to taxable income
How do you take a loan against an annuity?
You can take it against the accumulated value, but it is taxable and interest is charged (by reducing the number of accumulation units)
What happens if you die during the accumulation phase?
- If you die, the beneficiary is paid the greater of: the total contributions or the current value
- Any amount above the cost basis (contributions) is taxable
What happens during the annuitization phase?
- Accumulation units are converted into a fixed number of annuity units.
- This is based on age/gender, life expectancy, payout option selected, and value of the separate account
- Payout = annuity units * value
What are the 4 payout options for an annuity? Describe them.
- Straight life: annuitant receives payments for life, but family gets nothing (highest payout, highest risk)
- Life annuity with period certain: Payments are made to the annuitant for life or to the beneficiary if the annuitant dies for a specified minimum number of years
- Joint and last survivor annuity: Payments are made as long as one annuitant is living (1 of 2 spouses)
- Unit refund life annuity: Annuitant receives an amount at least equal to original investment (paid to beneficiary)
What is a qualified annuity?
- 403B is an example
- Only offered to employees of tax-exempt organizations or public schools
- Deductible (pre-tax) contributions, which results in zero cost basis
- Contribution amount is limited
What is a non-qualified annuity?
- Available to any person through insurance company or broker-dealer
- Non-deductible contributions
- Unlimited contributions
What is a 457 plan?
Offered by state/local governments to employees--has features of a qualified annuity.
What is the target audience of an annuity?
- 30-55 years
- Tax deferred growth or to offset inflation
- Persons who have maximized qualified plan contributions
Who should not get an annuity?
- Senior citizens/people needing immediate tax benefits
- Investors with short time horizons
What is a 1035 exchange? What is the concern?
1035 is a rollover to a new annuity. Customer must benefit and the RR must have their recommendation signed and approved by the principal.
What is a 529?
- Funded with after-tax dollars, this grows tax-deferred but can be removed tax-free for education.
- Transfers from state to state
What is the max contribution to a 529?
- $15k per person per year to avoid the gift tax
- Doubled for married couples
- You can front load 5 years of contributions
529 Maximum withdrawal for K-12?
What is a 529 ABLE?
This is a 529 plan for disabled people who are receiving SS disability, Medicaid, or private insurance payments.