1 1 Introduction Page ID: Introduction As we begin this course on Annuity Riders and Suitability of Transactions, it may be beneficial to review some of the basics about annuities. Fundamentally, annuities are insurance company products that are designed to systematically liquidate a sum of money, or an estate, through a series of periodic payments that the annuitant cannot outlive. This happens when the annuity contract has been annuitized. There is no other product in the financial services arena that is designed, or has the ability, to make this promise. Today, folks are being offered opportunities to purchase annuities by their life insurance agents and financial advisers, their banks and credit unions, even some of their mutual fund companies and roadside assistance motor clubs. If it weren t for the fact that annuity sales are overseen by state insurance regulators, we would probably find annuities being sold on the shelves of discount superstores. No matter who it is that s offering the product, or where or how they are being marketed, annuities are only obtained from life insurance companies. Annuities are not the same as life insurance, but they are an insurance product. In fact, annuities could be described as the exact opposite of life insurance like heads or tails of a coin. Life insurance is understood as a product that creates an immediate estate when a person dies, and annuities are designed, as we ve said, to liquidate an estate during a person s lifetime. Annuities are broadly classified in several ways. Let s take a quick look at these classifications. Qualified Versus Nonqualified
2 2 Page ID: Qualified Versus Nonqualified First, annuities are either qualified or nonqualified. Qualified annuities are those that hold retirement plan assets money contributed to a person s pension plan, 401(k), 403(b), or IRA as an example and are all funded with pretax dollars from a person s earned income. In other words, the contribution is deductible prior to computing taxes. Nonqualified annuities are funded with after-tax dollars, which could come from earned income, but could also come from unearned sources such as life insurance proceeds, inherited money, or as the result of a settlement from an injury or other legal claim. The proceeds from the sale of real estate, stocks, bonds, or mutual funds, even lottery or gambling winnings, could be used to purchase a nonqualified annuity. Whether qualified or nonqualified, the interest earned or the stock market gains (or losses) enjoy certain privileges under the Internal Revenue Code (IRC). Perhaps the most important of these is that earnings grow income tax deferred in the same manner as any retirement plan. Also, distributions from annuities are governed under many of the same restrictions that apply to retirement accounts. Page ID: Qualified Versus Nonqualified (cont.) When distributions are taken from an annuity, there will be an income tax liability on any portion of the distribution that represents a gain over the cost basis. Qualified annuities will be taxed on 100% of the distributed funds because no income tax was paid on the contributions. In other words, a qualified annuity has no cost basis. This is exactly the same as any other qualified retirement account. Distributions of principal from nonqualified annuities, however, are not taxable, but the IRC requires that unless the distributions are being made in the form of a series of substantially equal payments based on the life expectancy of the annuitant, all taxable gains will be distributed before any non-taxable principal is received: last in, first out, or LIFO. This assures the government that it will receive its share of income tax first. Page ID: Activity
3 3 Please reference the online course to view this activity. Immediate Versus Deferred Page ID: Immediate Versus Deferred Distributions from annuities are either going to be immediate or deferred. An immediate annuity makes its first payment sometime within the first 12 months after it is funded, commonly within one modal period (e.g., month, quarter, semester, annual). A deferred annuity is one that is not intended to be annuitized for many years at least eight to ten years or more into the future. A nonqualified annuity is never required to be annuitized. Even a qualified annuity may not have to be annuitized during the lifetime of the owner/annuitant, as long as any required withdrawals are taken. Page ID: Activity Please reference the online course to view this activity. Fixed Versus Indexed Annuities Page ID: Fixed Versus Indexed Annuities Originally, all annuities were fixed annuities. Consumers today have a wide variety of fixed annuities from which to choose. These contracts promise a minimum fixed rate of interest set by the insurance company when the contract is issued. The interest rate can be changed, up or down from time to time, but those changes are at the sole discretion of the insurance company. The insurance company is never required to offer a greater rate of return than the minimum guarantee, and it
4 4 cannot credit less. Some insurance companies offer an initial interest bonus in the first year or a special interest bonus after 10 years. When annuitized, a fixed annuity provides a fixed payment, which exposes the annuitant to purchasing power risk, the primary hazard of inflation. Page ID: Fixed Versus Indexed Annuities (cont.) Fixed indexed annuities (FIA) offer the attraction of a variable interest rate based on the performance of a stock market index (such as the S&P 500 Index) or another unmanaged index (such as the LIBOR bank rate index). However, there is no direct investment in the index or any stock market, and the index rate is not under the control of the insurance company (both fixed annuities and FIAs are general account products of the insurance company). FIAs offer contract owners the opportunity for greater tax-deferred appreciation compared to fixed annuities. Page ID: Fixed Versus Indexed Annuities (cont.) With the FIA, there is excellent upside potential in a rising market environment, but it is not unlimited due to the rate cap and participation rate limitations in the contract. Because it is a type of fixed annuity, the FIA also guarantees a minimum interest rate (0% is a guarantee). It may also be said that indexed annuities offer downside protection against the loss of principal or accumulated value because of the minimum interest rate guarantee. Depending on contract design, when annuitized, many FIAs offer the potential for increasing periodic payments based on the performance of the benchmark index. Given the lackluster performance of the US stock markets over the past 10 years, there is little wonder why FIAs have become very popular during this same time period. We will cover FIAs in more detail a bit later. Page ID: Fixed Versus Indexed Annuities (cont.) One final point needs to be clear. Because neither the fixed nor FIA annuities are securities, there is
5 5 no requirement for an agent to also be registered as a representative of a broker/dealer to offer them. The only license requirement is that of insurance agent. Variable Annuities Page ID: Variable Annuities Variable annuities (VAs) offer sophisticated individuals with prior investment experience the opportunity for stock market-based rates of return with unlimited upside potential and the advantage of tax-deferred earnings. However, because a VA represents direct participation in the stock markets, there is no guarantee of principal and no guaranteed interest rate. In fact, a VA may lose value; although highly unlikely, it could lose all of its value. Unlike fixed or indexed annuities, the contract value is held in the insurer s separate account, earmarked for the owner and protected from the claims of creditors. The separate account comprises a variety of subaccounts that range from very conservative to highly aggressive, and contract owners should be encouraged to create a diversified portfolio to minimize the risk of loss while attempting to obtain the best rate of return. Page ID: Variable Annuities (cont.) VAs are complex, and the products are not suitable for all persons. During the accumulation period, owners must manage the annuity for the best possible return consistent with their risk tolerance. Portfolios should be rebalanced periodically, investment choices reevaluated from time to time, and changed as needed. When the owner s management activity results in positive returns, the VA is said to be providing a hedge against inflation. Additionally, after annuitization, separate account performance directly affects the periodic payment. Positive returns in the separate account may result in a larger payment, but negative (or insufficient positive) returns will cause the periodic payment to decrease which can result in shrinking payments that could take many months of consistent and higher-than-expected returns to overcome. Page ID:
6 6 Activity Please reference the online course to view this activity. Combination Annuities Page ID: Combination Annuities Combination annuities are a blend of fixed and variable annuity components in a single contract. The variable component needs to be properly managed. When the contract is annuitized, the fixed component establishes a base from which the monthly payment will be established, and the variable component, through proper management, continues to provide its potential hedge against inflation, which is the primary appeal/selling point of VAs. Both VAs and combination annuities offer the advantage of tax-free transfers of funds from one subaccount to another. Page ID: Activity Please reference the online course to view this activity. Comparing Annuities to Life Insurance Page ID: Comparing Annuities to Life Insurance
7 7 Annuities are not life insurance, but they are an insurance product. Whether they are fixed, indexed, or variable, the insurance producer (and registered representative when VAs are involved) must remember that, as insurance products, annuities should never be marketed as investments. The various states insurance codes, as well as the rules of both the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), make it clear that variable insurance products are insurance products first, and they have an investment component that other products do not. Life insurance is a product designed to leave money to persons the insured leaves behind when the insured dies. That money may be left for the direct benefit of the beneficiaries or it may be intended to pay taxes and other expenses of the decedent in order to preserve his accumulated assets or estate. If a life insurance contract has cash value, any growth or gains are tax deferred, and the owner of the policy has access to the cash value through policy loans (or withdrawals in some contracts) prior to the death of the insured. When the death benefit is paid, it is generally received by the beneficiary tax free. The value of the life insurance proceeds is includable in the owner s estate for estate tax purposes. Page ID: Comparing Annuities to Life Insurance (cont.) Annuities are products designed to benefit living annuitants by providing income throughout their lifetime. That income will be fully or partially taxable. An additional benefit, owing to its life insurance roots, is that the annuity value may be passed to a beneficiary if the owner dies before the contract is annuitized. However, unlike life insurance, that death benefit is not always tax free (in fact, it is rarely entirely tax free). Any amount the beneficiary receives in excess of the cost basis will be taxable to the beneficiary as ordinary income. Proceeds from a qualified annuity, because it has no cost basis, will be fully taxable to the beneficiary. Perhaps the best way to describe the difference between life insurance and annuities is to understand the difference in the owner s objective; life insurance is designed to protect against the financial turmoil when a person dies too soon. Annuities are designed to protect against the financial turmoil of living too long. Together, they address two basic aspects of life not living long enough to reach financial independence and living so long as to deplete all the money one has saved. Page ID: Activity Please reference the online course to view this activity.
8 8 Comparing Annuities to Retirement Plans Page ID: Comparing Annuities to Retirement Plans It is unlawful to market life insurance contracts as either a retirement plan or a retirement product. Insurance companies have paid multimillion dollar fines for allowing or encouraging such marketing activities by their agents, and agents have been sanctioned. Annuities, however, are commonly considered and may be marketed as retirement products, not plans. They are typically used to accumulate or hold additional funds specifically for one s later years. Indeed, annuities are increasingly being used to convert accumulated investment assets or other liquidated assets such as homes, personal property, or businesses into a source of lifetime income that the assets themselves would not otherwise provide. Unless an annuity is specifically being used to hold retirement plan assets, it is still not permissible to call it a retirement plan. Many insurance companies decline new applications for nonqualified annuities when the owner is not (1) fully funding any qualified retirement plans available to her, (2) using the annuity for a structured settlement from a personal injury lawsuit, or (3) using the annuity as the holding mechanism for a cash windfall, such as an inheritance. Page ID: Comparing Annuities to Retirement Plans (cont.) Unlike qualified retirement plans, with a nonqualified annuity (1) there is no limit to the amount of money one may contribute (other than amounts exceeding the maximum the insurance company will accept without prior approval), (2) there are no income restrictions that limit one s ability to contribute, (3) there are no age limits on contributions (although most insurance companies will not accept new applications from persons over age 84 who are not already clients of the company), (4) contributions may come from any source, including passive income or income in respect of a decedent (e.g., life insurance, inheritance, or retirement plan distributions), and (5) there is generally no requirement to ever annuitize. For those persons who are fully funding all qualified plans available to them, annuities usually represent the best, and perhaps only, option for obtaining additional tax-deferred growth on their savings.
9 9 Page ID: Comparing Annuities to Retirement Plans (cont.) From a taxation perspective, annuities and most retirement plans share a number of common characteristics. Once money is contributed to the annuity, it grows income tax deferred, like a retirement plan. If it is a VA, whether qualified or nonqualified, transfers between subaccounts to maintain or change the portfolio s asset allocation are not considered a sale and are not subject to capital gains tax. Distributions from both annuities and retirement plans are taxed as ordinary income. Once money has been paid into the annuity, there is virtually no way to access that money without an income tax liability. Like retirement plans, certain withdrawals prior to age 59½ are subject to a 10% penalty tax (the only escapes in annuities are the death or disability of the owner). All withdrawals must come from gains (earnings) first (LIFO), making those withdrawals taxable. Generally, the only way to obtain money from an annuity without an income tax liability is when a nonqualified VA has lost value and is now worth less than its cost basis. Withdrawals in that situation would not be taxable, and it would generally not create a deductible capital loss. And as has been said, the beneficiary of an annuity will incur a tax liability on any gains over the annuitant s cost basis the beneficiary receives. Special distribution and tax rules apply when the beneficiary is the spouse of the decedent. Page ID: Comparing Annuities to Retirement Plans (cont.) If the annuity is qualified, the owner/annuitant will be subject to Required Minimum Distributions (RMDs). Beginning at age 70½ (technically, by April 1 of the year following the year one turns age 70½), the owner may need to withdraw funds from the annuity to satisfy his RMD amount for the year (the value of all qualified plans are aggregated to determine the RMD; however, withdrawals may come from any one or more of the plans). It does not matter whether a person needs the money or not; failure to take the RMD in whole or in part results in a 50% penalty tax on the undistributed amount. However, when a qualified annuity has been annuitized, the RMD rules do not apply because the payments represent a series of substantially equal amounts based on the annuitant s life expectancy and the IRS distribution tables, and they are already generating income tax liabilities.
10 10 Page ID: Comparing Annuities to Retirement Plans (cont.) The singular exception to all of this is an annuity that holds Roth retirement account assets (Roth 401(k), Roth 403(b), or Roth IRA). Because Roth accounts are not subject to the age 70½ rule, distributions are not required, and the annuity is never required to be annuitized. When the owner/annuitant dies, a beneficiary will receive the annuity tax free, along with the ability to withdraw the proceeds both penalty and income tax free, regardless of the annuitant s age. As the beneficiary, a spouse may continue the Roth IRA as his or her own and may contribute earned income every year with no requirement to ever take any distributions. If the beneficiary is not the spouse, then certain minimum withdrawals will be required based on life expectancy, but this favors younger beneficiaries, and the account may continue to grow in value. Without ever annuitizing, it may be passed on repeatedly to other beneficiaries in future generations until the account is depleted, providing tax-free income for multiple lives. Many life insurance producers are unaware of this, and it is a seldom exploited, yet perfectly lawful, use of qualified annuities. Page ID: Activity Please reference the online course to view this activity. Introduction Page ID: Introduction Before going further, it is important to understand and remember that although annuities may offer many features that are similar to true investments, such as mutual funds or exchange-traded funds, they are first, and foremost, insurance contracts. Even variable annuities cannot be marketed exclusively as an investment; while they may have an investment component, they are not
11 11 investments alone. Comparison of Fixed Annuities to CD s and Other Fixed Savings Vehicles Page ID: Comparison of Fixed Annuities to CDs and Other Fixed Savings Vehicles Many conservative savers choose to hold a significant portion of their savings in fixed income vehicles, such as certificates of deposit (CDs) and corporate and municipal bonds. With the exception of municipal bonds, these savers are exposed to annual taxation on their interest income. Over time, taxes erode the value of their savings, as does the negative effect of inflation on their purchasing power because the returns are fixed. By virtue of their tax-deferred growth, annuities offer an attractive alternative to these taxable products, even when the returns are fixed. One of the factors that may influence a person s choice of bank CDs is the FDIC insurance protection, currently a maximum of $250,000 per person, per institution. However, in exchange for this protection, accountholders currently receive very poor rates of return. In the current economic environment, at the end of 2011, the average rate for a five-year CD in the United States was only 1.61%! 1 By comparison, the non-seasonally adjusted all items inflation rate was 3.4%. 2 A person in the 25% marginal tax bracket would have an after-tax return of just 1.21% and would lose more than 2% in purchasing power as a result of locking his money in a safe CD. The tax-deferred growth of annuities allows the accumulated value to surpass that of the CD, and at the end of December 2011, a number of fixed, multiyear guaranteed fixed annuities (MYGA) were offering a five-year rate of 3.6%, 6% more than the current inflation rate and triple the after-tax rate of the average CD. 3 1 Accessed at on December 31, Accessed at on December 31, Accessed at on December 31, Page ID: Comparison of Fixed Annuities to CDs and Other Fixed Savings Vehicles (cont.)
12 12 While it is true that there is no FDIC coverage for annuities, each state does have a Life Insurance Guarantee Association that offers limited protection for annuity benefits and cash values. However, each state s insurance laws also prohibit discussing the protection afforded by the Guarantee Association prior to delivering the contract to the client. You can find information about your state s Guarantee Association and its statutory coverage through the National Organization of Life & Health Insurance Guaranty Association s Website. (http://www.nolhga.com/policyholderinfo /main.cfm/location/ga) Fixed annuities, when suitable for the prospect or client and presented properly, offer the most conservative savers an attractive and reasonably secure alternative to today s very low-yielding bank account options. For those clients whose attitude toward risk is a bit less conservative, they may find the features and benefits of a fixed indexed annuity a more suitable alternative to traditional or even Multi Year Guarantee Annuity (MYGA) fixed annuities. Page ID: Activity Please reference the online course to view this activity. Comparison of FIAs to Index Mutual Funds/ETFs Page ID: Comparison of FIAs to Index Mutual Funds/ETFs An FIA is an attractive variation on fixed annuities that may be of interest to all but the most conservative prospects. Offering a minimum interest rate guarantee, perhaps equal to or greater than average CD rates, FIAs offer the advantage of growth based on the performance of a benchmark index, such as the S&P 500. Insurance producers sometimes market FIAs (and equity-indexed life insurance) inappropriately by claiming they provide all the upside of the market with none of the downside. Statements such as this are inaccurate and misleading and should never be used in the sales process. FIAs closely resemble index mutual funds and exchange-traded index funds (ETFs) but with one critical difference: policyholders do not directly invest in the stock market, as is the case with ETFs, through their indexed annuities. Like fixed annuities, FIAs are general account insurance products, and only the insurance company bears the interest rate risk of its promises to policyowners. FIAs
13 13 typically change the interest crediting on a point-to-point basis, and the policyowner may select from monthly, annual, or other frequencies that may be available, or the insurer may use a more complex market value adjusted (MVA) approach that does not actually value the contract until a withdrawal is made or the contract is annuitized. The insurance company must determine how it will cover its liability to policyowners, and it may choose to invest its policy reserves in ETFs or other securities. Page ID: Comparison of FIAs to Index Mutual Funds/ETFs (cont.) To the policyowner, if the benchmark index has risen since the last measurement, the interest crediting rate will increase during the next measurement period. The upside in an FIA, however, is not unlimited. It may be subject to a participation rate of less than 100% and will always include a rate cap. The participation rate is the percentage of the index gain that will be credited to the contract. If the index gained 10% in one year, an 80% participation rate would set the next year s interest crediting rate at 8%. Rate caps limit the insurance company s exposure to a rapidly advancing market. If the index gained 20%, the 80% participation rate would entitle the contract to be credited with 16% interest, but a 12% rate cap limits the crediting rate to a maximum of 12%. Not that this is anything to be upset about, but it s not the same as getting all the upside of the market, as people would in their index mutual fund or ETF there are no upside limitations in true investment products. But investment products are also subject to negative returns Page ID: Comparison of FIAs to Index Mutual Funds/ETFs (cont.) The stock markets are not a one-way vertical ride. Markets do go into periods of decline, and when the index declines, FIA interest crediting rates will also, but they ll never fall below the minimum guarantee. There is downside protection with a 0% interest guarantee the cash accumulation will never decline because market returns are negative (any usual policy expenses will continue to be deducted), but 0% offers no growth at all. Many FIAs do offer a 1% or 2% minimum guarantee, but the tradeoff may come in the form of reduced participation rates or rate caps. In comparison, mutual funds and ETFs cannot offer their investors any protection from a declining market, and investors can lose value as a result. A true advantage of FIAs to either mutual funds or ETFs is the protection of the minimum interest guarantee. In the period, annual market declines of 40% or more in some of the major stock indexes happened in some years. Mutual fund and ETF investors might require many years of positive growth to overcome one bad year; losing 40% in one year and earning 100% the next does
14 14 not mean you are 60% ahead of where you were two years ago. The FIA owner would not suffer that same fate; they might not have any growth, but they will not suffer any loss. The disadvantage to the FIA owner is the combination of the participation rate and rate caps that can limit the growth potential. Seeking the best of both for your client will minimize the difference between the actual annuity growth and the true market performance. Page ID: Activity Please reference the online course to view this activity. Comparison of Variable Annuities to Stocks, Bonds, Mutual Funds/ETFs Page ID: Comparison of Variable Annuities to Stocks, Bonds, Mutual Funds/ETFs For the more sophisticated client in particular, one who has prior experience with investing and managing her portfolio variable annuities offer the advantage over stocks, bonds, mutual funds, and ETFs of income tax deferral that cannot be obtained outside a retirement account. For the more affluent client, who has maximized all of his qualified retirement plan contributions and has no additional need for life insurance, VAs offer the one remaining choice for saving money on a tax-deferred basis without using any of that money to pay for the cost of life insurance that would happen in a variable life insurance or variable universal life insurance product. In any variable insurance product (annuities or life insurance), the product s cash accumulation is in the insurance company s separate account. It is not available to pay company operating expenses, nor is it available to creditors of the insurance company or those of the policyowner. The separate account is registered with the SEC and invests that money through a variety of subaccounts that closely resemble mutual funds. The subaccounts are also registered with the SEC and regulated as management investment companies. Policyowners are responsible for determining their risk tolerance and apportioning their cash accumulation among the available options to create a well-allocated portfolio. They bear all the investment risk in the performance of their chosen subaccounts. They could enjoy phenomenal gains and have to endure spectacular declines, sometimes in the same day, week, month, or year! It s easy to talk about the positive aspects of a rising stock market and what that means in terms of
15 15 tax-deferred growth. Page ID: Comparison of Variable Annuities to Stocks, Bonds, Mutual Funds/ETFs (cont.) However, there are also no guarantees in a basic VA contract. Although highly unlikely, the policyowner could potentially lose her entire account value. That is a disadvantage that cannot be overlooked, and it cannot be left unsaid when marketing a VA. The good news is this is no different than stocks, bonds, mutual funds, or an ETF. However, VAs do have some layers of fees and expenses that mutual funds do not, and this, too, is a disadvantage that must be discussed. In addition, VAs are not covered by state life insurance guarantee associations, so don t even think about failing to mention that when you deliver the policy! For your clients who understand the dynamics of the stock and bond markets, are aware of the world economic situation, and have the time and temperament to manage their portfolio, a VA may be just what they are looking for when it comes to minimizing their current taxable income. No other product can do what a VA can do for them. Page ID: Activity Please reference the online course to view this activity. Introduction Page ID: Introduction
16 16 Just as with life insurance, a basic contract only covers the most common needs of most policyowners. Each owner s situation is unique, and there simply are no one-size-fits-all insurance contracts. Insurance companies recognize this, and they offer riders and endorsements that allow the contract to be customized to a limited extent and more closely meet the client s needs. The good news is this: if a client wants something that the insurance company is not currently offering, the client is free to propose his need to the insurance company. If the insurance company sees a way to provide the benefit and make a profit, it can create a new rider or endorsement to meet that need. Each of the riders we explore next have been developed on the basis of actual client needs or what the insurance company perceives client needs might include. In reviewing some of the most common riders available in the insurance marketplace today, understand that not all riders are offered by all insurance companies, and slight variations occur from one company to another in the title or language of the riders. The cost of each rider, if any, also varies from one company to another. It is your responsibility as an insurance producer and registered representative to fully familiarize yourself with the products and riders you have available to market to your clients and to market those products accurately. Page ID: Introduction (cont.) The National Association of Insurance Commissioners s (NAIC) new Suitability of Annuity Transactions Model Regulation is now in effect in all states, and it demands that insurance companies document the fact that employees have been trained in their specific annuity product(s) they market before they may begin marketing them. Many states place additional emphasis on dealings with seniors because they are the main target of annuity sales and because they have only a limited opportunity, if any, to recover from the financial effects of a poorly made decision. A number of states require that seniors be given a scope of appointment notice at least 24 hours in advance of any insurance sales meeting that will take place in their home. Finally, all annuity benefits, including those described in any rider, are solely dependent on the claims-paying ability of the insurance company that issues the contract. Various Riders Commonly Available for Annuities Page ID: Cost-of-Living Adjustment (COLA)
17 17 Annuity COLA riders are similar to those seen in life insurance and disability income policies. Policyowners may designate a specific amount of simple or compound increase in their periodic payment that applies after the contract has been annuitized. Selectable amounts range from 2% to 6% or more but will reduce the amount of the initial payment based on life expectancy compared to a contract without the rider. This rider may only be available with a single premium immediate annuity. Page ID: Cash (or Installment) Refund If not offered as a standard distribution option in the contract, this rider allows the beneficiary to select a lump sum or periodic payment of remaining annuity value if the annuitant dies prior to collecting the full cost basis/purchase price in the contract. Installment payments will include interest until the principal has been fully returned, at which time payments end. Page ID: Impaired Risk (Medically Underwritten) Often overlooked by agents, an impaired risk rider allows an annuitant to be medically underwritten to determine life expectancy in comparison to annuity mortality tables. This only applies to single premium immediate annuities. If life expectancy is confirmed as being shorter than that of a standard risk, annuitants may obtain a larger payment for the amount of their purchase premium or the same payment as a standard risk would receive, but with a smaller purchase premium. Page ID: Commuted Payout This rider permits a lifetime income benefit to be paid to the annuitant, but it also offers limited opportunities to withdraw additional money from the contract. The opportunity to withdraw these lump sums may be limited to a single amount in the first year or two of the contract, to a maximum amount per withdrawal and maximum withdrawal amount, or to a percentage of the purchase
18 18 premium. Page ID: Guaranteed Minimum Accumulation Benefit (GMAB) This rider is seen only in deferred variable annuities and establishes a benchmark value for the contract if held a certain number of years (commonly five or ten). A GMAB typically restores the value of the annuity to the original purchase premium (less any withdrawals) if the actual value is lower due to market performance. Some variations of this rider guarantee to double the purchase premium (less any withdrawals) at the end of 10 years if the actual cash accumulation is less than that amount. If the standard contract does not include a cash accumulation step-up or lock-in provision, this rider may add that benefit to the contract beyond the valuation guarantee date. Page ID: Guaranteed Minimum Withdrawal Benefit (GMWB) This rider is also only seen in deferred variable annuities. It permits the owner to withdraw 100% (or more) of the original purchase premium over the life of the contract. Withdrawals under this rider are usually limited to a specific percentage of the purchase premium, such as 5%, 8%, 10%, or more per year. It guarantees that the owner will be able to obtain the full original value of the contract even if the separate account performance causes the cash accumulation to decline below the purchase premium. Page ID: Guaranteed Minimum Income Benefit (GMIB) Seen in both fixed indexed annuities and variable annuities, this rider guarantees an annuity income based on a hypothetical interest rate (conservative, such as 5% to 7%) over a specific period of time or on a fixed percentage of the initial purchase premium (such as 5% or 10%), neither of which affects, or is affected by, the actual contract cash accumulation. The annuity income, however, is always based on the greater of the actual accumulation value or the rider benefit as calculated. Some
19 19 FIAs are offering annual preannuitization rollups of 10% to 14% of the purchase premium in years 1 8 or 1 10, which can double (or more) the purchase premium s value for the purpose of establishing a higher minimum income level at annuitization if the actual cash value is lower. Page ID: Guaranteed Lifetime Withdrawal Benefit (GLWB) One of the more commonly offered riders in fixed indexed and variable annuities, this rider allows the annuitant to receive a lifetime income without annuitizing the contract. In addition to the lifetime benefit, the rider usually includes a provision that allows the owner to make unscheduled withdrawals up to the cash value of the contract (both the income payments and withdrawals reduce the available cash accumulation). Income payments will continue beyond the depletion of the cash accumulation for the lifetime of the annuitant. GLWB riders may include a refund of remaining cash accumulation if the annuitant dies before receiving the full value of the contract. Page ID: Long-Term Care Increasingly being seen in both deferred annuities and life insurance, this rider permits the use of up to 100% of a non-annuitized annuity s cash accumulation value without surrender or excess withdrawal charges when the annuitant satisfies the conditions for being classified as disabled under a tax-qualified LTC policy (disabled in two or more of the six activities of daily living or a diagnosis of Alzheimer s disease or other cognitive impairment). Benefit usage will be limited to a certain number of dollars per day. (Note: Since 2010, the IRC also permits the use of the 1035 Exchange privilege to exchange annuities or life insurance for a standalone LTC policy. The annuity cost basis and actual cash value transfers to a LTC policy on a tax-deferred basis, and the benefits are not taxable when used to pay for qualified LTC expenses. The LTC policy must provide for a cash accumulation/nonforfeiture value in the contract. If the LTC contract is later surrendered or distributed following the death of the insured, any distributed gain in excess of cost basis is taxable to the beneficiary as ordinary income. There are only a few such LTC policies currently available for 1035 Exchanges.) Page ID:
20 20 Disability Income/Unemployment Available with most deferred annuities, this rider permits withdrawals without surrender charges if the annuitant is disabled. There is usually an elimination period of six months to one year before the annuity cash accumulation may be accessed under the terms of the rider. Some riders extend the benefit to those who are unemployed for at least six months (and receiving unemployment benefits). Page ID: Terminal (or Critical) Illness This rider is now commonly included at no cost with most deferred annuities, and it permits withdrawal of up to 100% of the accumulated value without a surrender charge when the owner is diagnosed with a terminal illness that is expected to result in death within 12 months. Actual hospital admission or home confinement is not required. Page ID: Activity Please reference the online course to view this activity. Recommending Riders Page ID: Recommending Riders Before recommending any annuity or rider, it is now incumbent on all producers to perform a proper analysis of the consumer s situation and needs. This is not a cursory event or process; it should not be a casual discussion between the producer and the customer merely to see how much money is