Variable Annuities

  1. Fixed Annuities
    Investors pay premiums to the insurance company that are invested in the company's General Account

    Insurance company is then obligated to pay a guaranteed amount of payout (typically monthly) to the annuitant based on how much was paid in

    Insurer guarantees a rate of return and as such, bears the investment risk (because the issuer is at risk, the product is not a security)

    Purchasing Power Risk: Fixed payment that the annuitant receives loses buying power over time as a result of inflation
  2. Variable Annuity
    Opportunity to keep pace with inflation, and the investor carries the risk (which is why it is considered a security); payments are invested in a separate account

    Must be sold witha prospectus and may be sold only by individuals who are both insurance licensed and securities licensed
  3. Separate Account
    Investments include: common stock, bonds, and mutual funds, with the objective of achieving growth that will match or exceed the rate of inflation

    Although guaranteed monthly income for life, the amount of monthly income received is dependent on the performance of the separate account
  4. Death Benefit Provision
    If an annuitant dies during the accumulation period, most contracts call for a death benefit to be paid to the variable annuitant's beneficiary in an amount equal to the total of all investments made plus any earnings that have accrued - if the separate account has lost money, the annuitant's beneficiary is guaranteed the return of the total invested money at minimum

    The beneficiary is liable for the ordinary income taxes on the earnings received just as if the annuitant had surrendered the annuity during the accumulation period

    No penalty for early withdrawal, even if the beneficiary is younger than 59 1/2
  5. Combination Annuity
    Advantages of both the fixed and variable annuities - investor contributes to both the general and separate accounts, which provides for guaranteed payments and inflation protection
  6. Similarity of Variable Annuities to Mutual Funds
    • 1)Separate Account
    • 2)Management and Registration: directly managed and must be registered under the Investment Company Act of 1940 as an open-end management investment company
  7. Differences between Variable Annuities and Mutual Funds
    • 2 very distinct differences:
    • 1)The Earnings on dollars invested into a variable annuity accumulate tax deffered
    • -Mutual funds periodically distribute dividends and capital gains, and all these distributions are taxable upon receipt of reinvestment
    • -In a variable annuity, these increase the value of units in the separate account and tax liability is postponed until withdrawal - if withdrawls are made before age 59 1/2, a 10% penalty is incurred
    • 2)Variable annuities offer the advantage of guaranteed lifetime income
    • -Mutual fund shareholders are offered no guarantees on income provided
  8. Single Premium Preferred Annuity
    Purchased with a lump sum, but payment of benefits is delayed until a later date selected by the annuitant
  9. Periodic Payment Deferred Annuity
    Allows investments over time; Payments of benefits on this type of annuity are always deferred until a later date selected by the annuitant
  10. Immediate Annuity
    Purchased with a lump sum, and the payout of benefits usually commences within 60 days
  11. Payout and Assumed Interest Rate (AIR)
    If annuitization is chosen, the actuarial dept of the insurance company determines the initial value for the annuity units and the amount of the first month's pmt - at this time, the AIR is established.

    AIR = conservative projection of the performance of the separate account over the estimated life of the contract (and is only relevant during the annuitization phase of the contract); the value of each annuity unit will vary each month based on the performance of the separate account.

    If Separate Account performance is GREATER THAN AIR: monthly income is more than the previous month's payment

    If Separate Account performance is EQUAL TO AIR: monthly income stays the same as the previous month's payment

    If Separate Account performance is LESS THAN AIR: monthly income is less than the previous month's payment
  12. Payout Options
    • 1)Life Income (also called life only or straight life)
    • 2)Life with period certain
    • 3)Joint life with last survivor
  13. Life Income
    Insurance compnay will pay the annuitant for life - when the annuitant dies, there are no continuing payments to a beneficiary
  14. Life with Period Certain
    To guarantee a minimum # of payments are made even if the annuitant dies - but if death occurs within the period certain, a named beneficiary receives payments for the remainder of the period
  15. Joint Life with Last Survivor
    Guarantees payments over 2 lives - often used for husbands and wives
  16. Taxation of Annuities
    Because all contributions are made with after tax dollars, considered the investor's cost basis and are not taxed at withdrawl.

    Earnings in excess of cost basis are taxed as ordinary income when withdrawn.

    Individuals under 59 1/2 are subject to a 10% penalty for early withdrawl

    Taxed using LIFO when a contract owner chooses random withdrawls over the annuity operation. If a monthly payout is chosen, each month's payment is considered partly a return of cost basis and partly earnings.
Card Set
Variable Annuities
Variable Annuities