Types of Annuities

• Annuities are products that are sponsored by insurance companies in which investment income grows tax-deferred; they may be fixed or variable 

The Separate Account

• An investment company product
  • Regulated under the Investment Company Act of 1940
  • Registered with the SEC
• Must be sold by prospectus
• Investments may be changed during accumulation phase

The Accumulation Phase – Phase 1

• Also referred to as the Pay-in Period of Deposit Phase
  • During this phase, account is valued in terms of “accumulation units”
    • Units are purchased after-tax, no deduction
    • Investment income is tax-deferred until withdrawn
  • The purchase price is referred to as the accumulation unit value (AUV); similar to a mutual fund’s NAV
    • Unit value is calculated at the end of the business day (using forward pricing that’s similar to mutual funds)
  • Accumulation units are invested in separate accounts 

The Separate Account and its Subaccounts

Receiving Benefits – Withdrawals

• While still in the accumulation phase

• Annuitants may choose to take withdrawals from their annuity
  • Annuitants control the timing and amount of their withdrawals
  • Earnings are withdrawn first and taxable
• Premature withdrawals
  • Withdrawals of earnings prior to age 59 ½ are subject to a 10% penalty
  • The gross amount is also added to taxable income

Death During Accumulation Phase

• If the annuitant dies during the accumulation phase, the payout to the beneficiary will represent
• The greater of
  • The total contributions made or
  • The current value of the contract
• Amount above cost basis could be taxable (no penalty though)

Matching

• Money is deposited into the general account
  • Fixed annuity
• The investor determines where the money is deposited
  • Variable annuity
• The investor assumes the investment risk
  • Variable annuity
• The insurance company assumes the investment risk
  • Fixed annuity

The Annuity Phase – Phase 2

• Also referred to as the Payout, Withdrawal, or Annuitization Phase
  • When receiving benefits at annuitization, accumulation units are converted into a fixed number of annuity units
  • Unit value is based on:
    • Age and gender of the contact holder
    • Life expectancy
    • Payout options elected
    • Value of the separate account
  • Payout is established by multiplying the fixed number of annuity units by the fluctuating value

Payout Options

• Straight Life Annuity
  • Annuitant receives payments for life
    • Highest possible payout with highest risk
  • No beneficiary payments (if you pass away)
• Life Annuity with Period Certain
  • Payments are made to annuitant for life or to beneficiary (in the case of annuitant’s death) for specified minimum number of years
  • If 10 years, beneficiary would receive up to 10 years of annuities, but won’t get anything if you die at 13 years
• Joint and Last Survivor Annuity
  • Payments are made for life so long as one annuitant is living (two individuals regardless of age)
• Unit Refund Life Annuity
  • Annuitant receives an amount at least equal to his original  investment
    • At death, any remaining amount is paid to a beneficiary 

Annuity Charges and Expenses

• Like mutual funds, annuities have charges and expenses that are not invested in the separate account, including:
  • Sales charge – there is no maximum; they must be fair and reasonable
  • Expenses – insurance companies deduct various expenses from the investment income, such as:
    • Management fee – adviser’s fee for making investment decisions in the separate account
    • Expense risk charges – charged if expenses are greater than estimated
    • Administrative expenses – cost of issuing and servicing contracts
    • Mortality risk charges – a guarantee that annuitants will be paid for life even if they live beyond life expectancies 

Qualified versus Non-Qualified Annuities

• Qualified
  • Offered to employees of tax-exempt organizations of public schools
    • 403 b Plan
  • Deductible (pre-tax) contributions, which results in a zero-cost basis
  • Contribution amount is limited
• Non-Qualified
  • Available to any person through either an insurance company or broker-dealer
  • Non-deductible (after-tax) contributions, which establishes the basis
  • Contribution amount is NOT limited
• State and Local Governments offer their employees 457 plans, which have qualified features

Qualified versus Non-Qualified 

• A 62-year old retired individual had contributed $10,000 into an annuity. This year,she received a lump-sum payment from the annuity of $16,000. How is the distribution taxed?

• If you had chosen to withdraw this item as an annuity, you would do a ratio. $10,000/$16,000.

Equity Indexed Annuities (EAIs)

• EIAs are similar to:
  • Fixed annuities since they offer a guaranteed minimum return
  • Variable annuities since they offer returns which vary (based on index performance)
• Investor’s return:
  • If the index performs poorly, the investor will still earn the minimum guaranteed rate
  • If the index performs above a preset level, the investor will earn a return that exceeds the minimum guaranteed rate
    • Some contracts are issued with a participation rate which limits the amount of the index’s appreciation that the client will earn 

Annuity Suitability Issues

• Target audience:
  • Generally for investors within the age range of 30 to 55
  • Persons seeking tax-deferred growth or to offset inflation
  • Persons who have maximized qualified plan contributions
• Unsuitable for:
  • Senior citizens of persons who are seeking immediate tax benefits
  • Investors with short investment time horizons
  • Not liquid
• Concerns with 1035 Exchanges:
  • Customers must benefit from the new annuity
  • Any benefits potentially lost in the exchange
  • Whether the RR recommending the exchange has signed off and the application was approved by principal 

Matching

• Equity indexed annuity
  • Provides a potential return above a guaranteed minimum amount
• 1035 exchange
  • Allows for movement from one annuity to another without a taxable event
• Qualified annuity
  • Distributions are fully taxable
• Mortality risk expenses
  • Guarantees payments for life regardless of life expectancies 
• Straight life annuity
  • Settlement option with the greatest risk 

Municipal Fund Securities

• Local government Investment Pools (LGIPs)
  • Created by state and local governments to provide municipal entities a place to invest funds
  • Government entities purchase interest in the trust (LGIP)
  • Provides safety and diversification
  • Not open to the public
• Prepaid TuitionPlans
  • A type of college savings plan
  • Purchaser buys college tuition credits
    • Locks in tuition costs at current levels
    • Protects against future cost increases
  • Not self-directed
• 529 Plans
  • Primarily a type of college savings plan
  • Account owner chooses a plan, but may alter the investment direction

529 Plans:

• Funded with after-tax dollars; investment grows tax-deferred
• Money invested in one state’s plan may be used in another state
• To avoid gift tax, the maximum contribution is $17,000 per person, per year (doubled for married couples)
  • The plan allows for front-loading five years of contributions ($85,000 per person or $170,000 for married couples)
• A federal tax exemption is provided to the beneficiary for qualified withdrawals
  • College tuition, books and supplies, room and board, a maximum withdrawal of $10,000 per year for tuition and books for grade K-12 and up to $10,000 (lifetime limit) to repay a qualified student loan or expenses related to certain apprenticeship programs
    • You can’t do it for a car lease, be careful of gray areas (bus, train tickets are fine)
• As a registered person, should you first recommend with your customer who wants to open a 529 plan, they should invest in the state they are a resident of
  • TRUE, YES (even if you don’t go to college in that state)
• Can the donor (person contributing the money) also be the beneficiary
  • YES

529 Plans and 529 ABLE Plans

• 529 plans may be direct-sold or adviser-sold:
• Direct Sold
  • Involves no salesperson; instead, the plan is sold directly through the 529 savings plan’s website or through the mail
• Adviser-sold 
  • The plan is sold through a broker-dealer that has entered into a selling agreement with the primary distributor of the 529 plan
• 529 ABLE (529A) Plans (Achieving a Better Life Experience)
  • Available to individuals who are disabled and are receiving Social Security Disability, Medicaid, or private insurance payments
    • Maximum contribution is $17,000 per year (no front-loading)
    • Disability payments continue if account value doesn’t exceed $100,000
    • Distributions are tax-free if used to pay qualified expenses
  • Has to be age 26 or under that they’re disabled

You want to start a 529 Plan for someone If they’re 21 and have bi-polar disease, can you do it?

• Yes

529 Plan (funded with after-tax contributions)