Annuity Principles and Concepts Session Five Lesson Two. Annuity (Benefit) Payment Options

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1 Annuity Principles and Concepts Session Five Lesson Two Annuity (Benefit) Payment Options Life Contingency Options - How Income Payments Can Be Made To The Annuitant. Pure Life versus Life with Guaranteed Minimum Pure Life - Guarantees payments to the annuitant for life while paying the highest monthly income to the annuitant for the lifetime of the annuitant. Payment stops at death with no death benefits. If annuitant dies before complete payout of accumulated principal and interest, the remainder is retained in its entirety by the company insuring the annuity. Example: A person has $100,000 pure life annuity. At age 65 the annuitant s annuity phase (payout) begins. The annuitant receives 14 months of income payments then dies unexpectedly. The remainder of the principal and interest is retained by the insurer. Annuitant s Death Insurer Payout Began Payout Stops Retains the Age 65 Age 66 balance of funds Life with Guaranteed Minimum - These options guarantees payments to the annuitant for life, however, in the event of the premature death of the annuitant will guarantee a return of some of the principal and interest to a beneficiary of the death benefits. Example: A person has a $100,000 life annuity with guaranteed minimum. At age 65 the annuitant s annuity phase (payout) begins. The annuitant receives 14 months of income payments then dies unexpectedly. The income payments would go to the annuitant s beneficiary for a specified period according to the annuity contract. Annuitant s Death Beneficiary Payout Began Payout Continues Receives income Age 65 Age 66 payments according to the contract Session Five: Annuity Principles and Concepts 4

2 There are three types of guaranteed minimum: 1. Life With Period Certain Option - Payments guaranteed for the lifetime of the annuitant with a specified period of payments that are guaranteed. If annuitant dies, survivor receives the annuity payment for the balance of the chosen specified time period. Example: A person has a life income with 15 years certain option that would provide the annuitant with an income for as long as they live. The annuitant dies after 5 years. The beneficiary would receive annuitant s payments for 10 years. Annuitant Beneficiary Payout to $$$$$ Dies $$$$$$$$ Receives income Annuitant Received income for 10 years for 5 years 2. Cash Refund Option - When the annuitant dies, the beneficiary receives the annuity s original amount less the payments already paid. Guarantees return of the unpaid annuity amount, no guarantee to pay any interest. Example: Annuitant Beneficiary Payout to $$$$$$ Dies $$$$$ Receives annuitant before receiving Lump-sum all payments payment 3. Installment Refund Option - When the annuitant dies before recovering the sum of the premium payments plus the accumulated interest, beneficiary would continue to receive guaranteed installments until entire accumulated amount is paid out. Example: Annuitant Beneficiary Payout to $$$$$$ Dies $$$$$$ Receives income annuitant before receiving payments according all installments to the contract Session Five: Annuity Principles and Concepts 5

3 Single Life Annuities versus Multiple Life Annuities Single Life - Covers one annuitant. Multiple Life - Covers two or more annuitants. The two types of multiple life annuities are: 1. Joint Life Annuity Two or more annuitants receive payments until death of one of the annuitants, then the payout stops. Example: Husband and his wife receive $1,000 monthly for a Joint Life annuity. Husband dies, payout stops with death of either annuitant. Payout Monthly Husband and Wife $1,000 Death of Either Annuitant Payout stops 2. Joint and Survivor Annuity - Pays the annuity income to two or more annuitants. After the death of the first annuitant payments continue until the last annuitant has died. The following are two types: Joint and Full Survivor - The survivor s annuity payments remains the same upon death of the first. Example: Husband and wife receive $1,000 income monthly from a Joint and Full Survivor annuity. Wife dies; husband continues to receive $1,000. Payout stops at death of both annuitants. Death of 1 st Annuitant Payout Monthly Full payout continues $1,000 to surviving annuitant Joint and One-half Survivor - The survivor receives half of the original benefit amount upon death of the first annuitant. Example: Husband and wife receives $1,000 income monthly from a Joint and One-half Survivor annuity. Wife dies, husband receives ½ of the original benefit. Husband s total monthly income from their annuity would be $500. Payout stops at death of both annuitants. Death of 1 st Annuitant Payout Monthly ½ Payout - $500 $1,000 goes to surviving annuitant Session Five: Annuity Principles and Concepts 6

4 Annuities Certain Period Certain Option For a Fixed Period - Not Based on Life Contingency Pays for a specific time period only, such as 10, 15, 20 years. Period Certain Option For A Fixed Amount - Not Based on Life Contingency Pays until a certain fixed amount is liquidated. Annuity Products Fixed Annuities - Guarantees the interest rate paid on the premiums invested and provides payments that do not vary from one to another. General Account Assets - Premiums are pooled into this account by the insurer for investing, usually in conservative, low risk investments. This allows the insurer to guarantee a certain rate of interest. The annuitant guaranteed an amount they will receive during their annuity period. Disadvantage is that purchasing power may decrease because of inflation. Interest Rate Guarantees Minimum versus Current - The insurer gives the annuitant a guaranteed interest rate based on the minimum rate in the annuity or the current interest rate, the higher of the two. The current rate is usually adjusted each year. If interest rates drop below the guaranteed minimum rate in the annuity the insurer is required to pay the policy s guaranteed rate. Level Benefit Payment Amount - In a fixed rate annuity, the income benefit paid is a level, guaranteed amount. Equity Indexed Annuities - Has a guaranteed minimum interest rate, however, usually earn a higher interest rate than a fixed annuity since they are often linked to an Index like the Standard & Poor s 500. As the Index rate increases, the Indexed Annuity growth rate increases. Does not require a NASD License. Participation Rate Maximum Rate (Ceiling) Minimum Rate (Floor) Administration Charge Market Value Adjusted Annuities - Fixed Maturity Option Market value adjusted to current interest rates on withdrawal. May be more or less, depending on interest rates. Session Five: Annuity Principles and Concepts 7

5 Uses of Annuities Normally used for retirement income, however annuities may be used to accumulate cash for other purposes. Lump-sum Settlements - A lump sum payment may be made to the annuitant including all accumulated interest and would become taxable immediately. If this is done prior to annuitant reaching the age of 59 ½ a 10% tax penalty may also be imposed on the taxable portion of the settlement. Qualified Retirement Plans - Pension plan contributions of the employer and employee have to be invested in a financial asset such as an annuity that meets the IRS guidelines for qualified retirement plans. Group versus Individual Annuities Group Annuities - Tax Shelter Annuity (TSA) - Also known as a 403(b) plan or a 501(c)(3) plan, because it was made possible by those sections of the Internal Revenue Code. Employer uses a defined benefit plan to buy an annuity fund for employees as a whole. Contributions are tax deductible business expense; Earnings accumulate tax deferred; Employees do not have to pay personal income tax on the employer contributions; Pay taxes when distribution begins on employer contribution plus earnings. Individual Annuities - Each person has an annuity that is individually issued and owned. Personal Uses Individual Retirement Annuities (IRAs) Tax-qualified annuities may be used to accumulate funds on a tax-deferred basis for retirement in an Individual Retirement Account (IRA) (are subject to maximum IRA contributions). Tax-deferred Growth - Earnings on a tax-deferred annuity grow tax deferred. Taxable upon surrender / distribution. Retirement Income To provide income for retirement purposes. Education Funds - Savings for education expenses of the annuitant, tax-deferred. Sometimes called Modified College Savings Plan. Interest Only Income - Leave principal in the annuity, payout of interest only. Using Tax Advantage of Exclusion Ratio - To fund purchase of other insurance. Exclusion Ratio - A method for determining the taxable portion of the benefits received in the payout period. Session Five: Annuity Principles and Concepts 8

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