Straight Talk Q &A. about today s Variable Annuities

Transcription

1 Straight Talk Q &A about today s Variable Annuities IFS-A Ed. 02/2009

2 Individual Retirement Accounts 1. How is a variable annuity different from an Individual Retirement Account (IRA)? n This is an apples-to-oranges comparison. A variable annuity is an insurance product. An IRA is a savings arrangement defined by the Internal Revenue Code that allows consumers to save for retirement on a tax-qualified basis. An IRA, in and of itself, is not an insurance product. n With an IRA, investors can deposit funds to grow on a tax-deferred basis. An IRA is funded through those funds in a CD, mutual fund, variable annuity, or other financial product. Depending on the income level of the investor and spouse, and whether they participate in an employer retirement plan, contributions may be tax deductible. The investor must have earned income, such as wages, to make an IRA contribution and can no longer make contributions to a traditional IRA in the year he / she reaches age 70½. An unemployed or lower wage individual can also make an IRA contribution based on the earned income of his or her spouse. n Investment earnings in an IRA grow tax-deferred until the owner begins taking withdrawals. n Investors can choose a Roth IRA, which is funded with after-tax money, thus making withdrawals of principal and, potentially all gains, free from federal income taxes. The same earnings requirements apply, but contributions can continue past age 70½. n Variable annuities can be used either on a qualified basis (inside an IRA or Roth IRA governed by Internal Revenue Code sections, where premiums paid into the annuity are excluded from taxable income for the year in which it is paid) or on a non-qualified basis (purchased outside of an IRA or Roth IRA). If outside an IRA, they can t invest pre-tax. However, under both scenarios, future investment earnings are tax-deferred until withdrawals begin 2. If a consumer funds an IRA with a variable annuity, isn t that paying for an unnecessary tax deferral? n That s a common misconception. In fact, all annuities, as defined by the Internal Revenue Code, are tax-deferred (unless owned by a non-natural person such as a corporation). Hence, while annuities do include certain fees (see #7, #8, #9), investors don t pay anything extra for tax deferral because annuity earnings by statute are tax-deferred. Investors do not need to use an annuity inside an IRA to get tax deferral. n What they are paying for are the extra guarantees that only a variable annuity can provide. (See #5 & #13) TAXATION 3. Are there other tax advantages to a variable annuity? n Because of the tax-deferred nature of a variable annuity, investors can move money from one investment subaccount within their annuity to another without creating a taxable event (i.e., producing a short-term or long-term taxable gain). n If investors owned mutual funds, every time they moved money between portfolios they d potentially create a taxable event. n Investment gains in a variable annuity are tax-deferred until assets are withdrawn. 4. Since variable annuity payouts are taxed as ordinary income, not as long-term capital gains, isn t that a disadvantage? n Variable annuity payouts are taxed at ordinary income tax rates (up to 35% in 2008), not as long-term capital gains (up to 15% in 2008). n However, this may not be a disadvantage depending on people s ages and when they plan to access their money. n For example, if they only plan to access their money in retirement, when they re older and presumably in a lower tax bracket, this may not be a consideration. n Plus, during the accumulation phase of the variable annuity, when investors would typically be in a higher tax bracket, no current year taxes are paid on gains. Thus, all the money that would have been paid annually in taxes stays in the account and can continue to grow until withdrawn. n Transfers between mutual funds can potentially cause a taxable event, except in the cases of transfers among the same fund families. Transfers between variable annuity subaccounts do not cause a taxable event. n Finally, a key driver for people today may not be tax treatment, but rather the ability to create a guaranteed account value or guaranteed lifetime income stream. Only annuities provide this guarantee today. n Concerns about taxation on annuities should be discussed with a tax advisor. FEES AND CHARGES 5. Don t variable annuities have fees that other investments do not? n Yes, there are additional fees associated with variable annuities. However, these fees provide death benefits as well as income and principal guarantees not available with other investment products. Because investors are transferring their risk to the insurance company, fees are charged for this added value.

3 n Many investors may find the trade-off between higher fees and higher value to be a sensible trade-off. n Common variable annuity fees include: (See #6 & #7) - Surrender charges - if an investor withdraws more than the contract allows; - Mortality and expense charges - to fund the insurance protection in a variable annuity; - A fee for optional living benefits - to provide the guarantees an investor chooses. 6. How does the surrender charge work? n If investors withdraw money from a variable annuity within a certain period after purchase (typically within four to eight years, but sometimes as long as ten years), the insurance company may assess a surrender charge. This is also known as a contingent deferred sales charge. n Generally, the surrender charge is a percentage based on the amount withdrawn, and declines gradually over a period of several years, known as the surrender period. n For example, if a contract has an 8-year surrender schedule, a 7% charge on assets might apply in the first year, 6% in the second year, 5% in the third year, and so on until the eighth year, when the surrender charge vanishes. n Often contracts will allow clients to withdraw part of their account value each year typically 10% of their purchase payments without paying a surrender charge. n Keep in mind that variable annuities are intended for long-term retirement investing. Surrender charges help discourage short-term investing in an annuity, and allow the insurance company to have reasonable expectations for frequency of early withdrawals. 7. What are mortality and expense charges? n This charge, which is typically equal to a percentage of the account value, is collected by the insurance company for the risks it assumes under the annuity contract. n For example, this provides beneficiaries with a guaranteed minimum death benefit regardless of any investment losses. The minimum guarantee is often equal to the greater of the current account value or the initial investment, assuming no withdrawals. n The insurer provides a guaranteed lifetime income if an investor decides to annuitize the contract (convert the account value into a guaranteed stream of payments). n The mortality and expense charge also covers a portion of the company s distribution costs (costs for issuing the policies, sending trading confirmations, mailing statements, providing customer service, paying commissions, etc.). ACCESS to the Money in a variable annuity 8. If a consumer buys a variable annuity and later dies, does the insurance company keep the person s money? n No. Because of the death benefit feature, the person s beneficiary(ies) will either get the full account value or the original investment (assuming no withdrawals), whichever is higher. Many variable annuities offer additional enhanced death benefit guarantees for an extra fee. 9. Is it true that once investors purchase a variable annuity, they lose access to their money? n No. However, there are three liquidity issues investors should consider. n First, the IRS has ruled that annuities are retirement investments. In return for granting tax advantages, the government may impose a 10% penalty for withdrawals prior to age 59½. This discourages people from tapping into their annuities for nonretirement income. There are exceptions to this rule for disabled individuals and for other circumstances defined in the Internal Revenue Code. n Second, as explained earlier, the insurance company imposes a charge for some withdrawals made during the surrender period. Once this period is over, investors can access 100% of their money without paying a surrender charge. (See # 7) n Third, the insurance company lets investors withdraw up to a percentage of their account value every year, free of charge (typically 10% of purchase payments). n Please be sure you understand that variable annuities are not short-term savings vehicles. They are for people who want to accumulate retirement savings over the long term and then convert those savings into a monthly income they can t outlive. 10. Do investors have to annuitize their contracts in order to generate retirement income? n Not any more. That used to be the case a decade ago when investors had less control. They would accumulate savings within a variable annuity, then trade the entire value of the annuity for a guaranteed stream of income to last their lifetime or for a certain period of time. However, if they died, the insurance company would keep the remainder of the account value left in the policy. n Today, annuitizing isn t the only way to generate guaranteed lifetime income. Modern variable annuities with optional living benefits allow investors to withdraw money from their annuity account values for as long as they live. Even if poor investment performance

4 and/or living longer than expected deplete their account, the insurance company will continue to provide income for as long as they live. And, if they selected a joint annuity benefit, for as long as they or their spouse live. n Also, unlike annuitizing, where people relinquish control over their money, today s guaranteed income provisions give people the ability to start or stop or even to increase or decrease their income payments. retirement investing 11. Are there advantages to a variable annuity in all market cycles? n Yes, variable annuities provide a wide array of investment options. This allows investors to broadly diversify their portfolios, which may reduce risk in a bear market. n If they purchase an account-value guarantee, a minimum account value will be guaranteed (when the guarantee matures) even if they sustain poor investment performance. n If they purchase a minimum income guarantee, their future income level is guaranteed even if their account sustains poor performance. n Also, by purchasing a variable annuity with an optional account value or minimum income guarantee, investors can lock in gains in their account when the market advances. n Result: as the stock market posts positive returns, their minimum account value or income payout in the future will increase, as well. 12. Are there safe places to invest money in a variable annuity? n Typically, investing involves some degree of risk. In most variable annuities, investors can allocate their money across a variety of money market, bond, and other conservative investment options. Of course these conservative options tend not to experience the same degree of gains and losses as equities. n In addition, most variable annuities offer a selection of asset allocation portfolios that can allow investors to spread their money across a variety of different asset classes. n And, as explained in #13, purchasing a variable annuity with an optional living benefit guarantee can provide a measure of protection for an investor s money. guarantees 13. Do variable annuities provide a guaranteed return on investment? n Variable annuities do not guarantee a specific investment return, but they do offer three fundamental guarantees not available elsewhere. n The first is a death benefit guarantee. This means that after the owner dies, their beneficiary(ies) will receive no less than what he/she paid into the annuity and potentially more (assuming no withdrawals). n The second is an account value guarantee. This assures that at a certain point in the future, an investor s account will be worth at least a certain amount based on prior account performance. n The third is a minimum lifetime income guarantee. This assures that investors can withdraw a certain percentage of their account value as annual income for life. n The first guarantee is generally provided by the base variable annuity contract, as well as through optional features for an additional fee. The second and third are usually optional features that also require an additional fee. suitability 14. Should people trade their old style variable annuity for a modern version? n Trading in an older variable annuity might make sense if the new product lowers expenses and/or provides better guarantees. But before an investor replaces an existing annuity, it is important to understand what benefits might be lost, whether the current company permits the addition of newer features/benefits to the existing annuity, tax considerations, as well as whether a new surrender period will apply. This decision needs to be explored fully with a financial professional to determine if it is suitable for you. 15. How can people decide if a variable annuity is right for them? n Between the broad number of investment choices and optional guarantees available, buying the right variable annuity requires careful consideration. That s why it is important to discuss options with a financial professional.

5 Investors should consider the contract and the underlying portfolios investment objectives, risks, charges and expenses carefully before investing. This and other important information is contained in the prospectuses, which can be obtained by your Financial Professional. Please read the prospectuses carefully before investing. This material was prepared to support the promotion and marketing of variable annuities available through Prudential. Prudential, its affiliates, its distributors and their respective representatives do not provide tax, accounting or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used for the purpose of avoiding U.S. federal, state or local tax penalties. Please consult your own independent advisor as to any tax, accounting or legal statements made herein. Variable annuities are appropriate for long-term investing and designed for retirement purposes. Investment return and principal value of an investment will fluctuate so that an investor s unit values, when redeemed, may be worth more or less than their original cost. Withdrawals or surrenders may be subject to contingent deferred sales charges (CDSC). Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 59 ½, may be subject to an additional 10% federal income tax penalty. Withdrawals, for tax purposes, are deemed to be gains out first. Withdrawals can reduce the living benefit, death benefit and account value. Your needs and the suitability of an annuity product should be carefully considered before investing. When evaluating your needs, please consider other variable annuities available from Prudential Financial companies. Optional living and death benefits may not be available in every state and may not be elected in conjunction with certain optional benefits. The fees are in addition to fees and charges associated with the basic annuity. See the prospectus for more detailed information. Tax deferral is provided by an Individual Retirement Account and other qualified retirement plans. A variable annuity contract should be used to fund a qualified retirement plan to benefit from the annuity s features other than tax deferral, including lifetime income payout option, the death benefit protection, and the ability to transfer among investment options without sales or withdrawal charges. Asset allocation is a method of diversification that positions assets among major investment categories. Asset allocation can be used to manage investment risk and potentially enhance returns. However, use of asset allocation does not guarantee a profit or protect against a loss. Inclusion in asset allocation models does not indicate that any subaccount is superior to a subaccount not included in a model. Annuity contracts contain exclusions, limitations, reductions of benefits and terms for keeping them in force. Your licensed Financial Professional can provide you with costs and complete details. Variable annuities are issued by Pruco Life Insurance Company (in New York, by Pruco Life Insurance Company of New Jersey), Newark, NJ, or by Prudential Annuities Life Assurance Corporation, Shelton, CT. Prudential Annuities Distributors, Inc., Shelton, CT, distributes all. All are Prudential Financial companies and each is solely responsible for its own financial condition and contractual obligations. Wachovia Corporation is the majority owner and Prudential Financial, indirectly through subsidiaries, is a minority owner of Wachovia Securities, LLC. Prudential Annuities is a business unit of Prudential Financial. Prudential, Prudential Financial, the Rock logo and the Rock Prudential logo are registered service marks of the Prudential Insurance Company of America and its affiliates. ANNUITIES: NOT FDIC OR GOVERNMENT AGENCY INSURED MAY LOSE VALUE NOT BANK OR CREDIT UNION GUARANTEED ORD IFS-A Ed. 02/2009 [WO# 75002]