The Financial Advisor Guide to Understanding Annuities Self Study Course # 21

Transcription

1 The Financial Advisor Guide to Understanding Annuities Self Study Course # 21

2 OVERVIEW Like most Canadians, your clients and prospects have many important decisions in planning for retirement. These have likely included investing in a Registered Retirement Savings Plan (RRSP) along with other savings products to build a nest egg for the time when they are no longer in the work force. After many years of hard work, it is now time to turn their savings into retirement income. The choices to invest for retirement are: Annuities. Registered Retirement Income Funds. Life Income Funds. Any combination of the above. Although retirement income needs and objectives are unique to each person, there are certain key factors everyone must consider. Retirement factors that should be considered for your clients and prospects: Maximizing their income potential. Ensuring that they have the flexibility to adjust their income to changing needs. Managing their taxable income. INTRODUCTION Your clients and prospects have saved a lifetime for a comfortable retirement and now it is time to decide what should be done with their accumulated capital to provide the best income. Most people find that an annuity, Registered Retirement Income Fund (RRIF), or Life Income Fund (LIF) best meets their retirement income needs. The choice however depends on individual needs. It is a tough decision and one, which should not be taken lightly. This course will take an in-depth look at annuities. Before a Financial Services professional, can market retirement products, there must be a basic understanding. There are so many products on the market today for policyowners to invest in that we must know what the best products are so we can pass this on to our clients and prospects. 2

3 The term annuity is used in finance theory (Finance theory is the field that deals with investment making decisions and the concept of the time value of money.)to refer to any terminating stream of fixed payments over a specified period of time. This usage is most commonly seen in academic discussions of finance, usually in connection with the valuation of the stream of payments, taking into account time value of money concepts. An annuity contract is a financial product, typically offered by a financial institution, that may accumulate value and take a current value and pay it out over a period of years. These contracts are regulated by various jurisdictions and this has led to the term being focused on different features in different parts of the world. WHAT IS AN ANNUITY? An annuity is like a mortgage payment in reverse. Instead of borrowing money, you are investing money with a financial institution like an insurance company, bank or trust company. With a simple, one-time deposit, the institution will make regular income payments to you that contain both interest and principal. But, unlike a mortgage that ends after a specific period, annuity payments can continue for the rest of your life, no matter how long you live. People with various needs and financial goals choose annuities. Some examples of people who typically purchase annuities include those who: require a dependable stream of income for life, require a dependable income for a specific time period, are not interested in making on-going investment decisions and want a simple investment, don't want to worry about outliving their income, or want to diversify their investment portfolio. This investment can be purchased with any of the following: proceeds from Registered Retirement Savings Plans (RRSP), proceeds from Registered Pension Plans (RPP), proceeds from Deferred Profit Sharing Plans (DPSP), proceeds from Guaranteed Investment Certificates (GIC) or savings accounts, proceeds from the sales of real estate, or proceeds from Canada Savings Bonds (CSB). 3

4 HOW ANNUITIES WORK Life annuities are based on the principle of risk sharing. Life insurance companies do not know how long each person will live, so they rate prospective policyholders with what is called mortality tables. These are a base for calculating cost per thousand dollars of a life insurance policy. Each year people grow older, so the chances of dying become larger. These tables can tell how many members of the group will be alive at the end of each chronological age. Every year Canadians tend to live longer because of many reasons, one of them being the advance of medical technology and good lifestyles. Choosing an insurance company that uses the most current mortality tables will insure that your clients are receiving the cheapest premium rates. Insurance companies are not required to go back to old policyholders when new mortality tables come which would reduce their premiums. They will continue year after year to charge at the old mortality table. In other words the older a person is, the closer they are to death so the income from an annuity will be more than the younger person. The Life Insurance Company, banks and trust companies may issue an annuity contract, but it differs from a life insurance contract. With life insurance, the risk of dying too soon is insured. With annuities, the risk of living too long is insured against. Probability of surviving beyond age 90 Present Age Males Female in in in in in in in in in in 100 Statistics Canada is projecting that by 2026, between 30% and 41% of the population will be in the 55 or older age group. 4

5 HOW ARE INCOMES DETERMINED? Insurance companies fund their annuities by matching long-term investments with longterm annuity liabilities. When determining life annuity incomes, a number of factors are considered: Interest. Mortality. Expense rates. The annuity option chosen. The amount of the funds. When the first payment is to start. Annuity certain incomes are influenced by the same factors, with the exception of mortality rates. HOW ARE ANNUITY PREMIUMS INVESTED? Deferred annuities have an accumulation period during which a single premium or a series of premiums invested will grow. A deferred annuity can be looked at as a vehicle to save money for retirement by using an insurance company s facilities. Essential there are two types of deferred annuities: A regular deferred annuity. A true deferred annuity. Regular deferred annuity This will most likely resemble a term deposit. Premiums are collected and invested into the annuity, left to accrue in the selected investment option until such time that the annuitant wants to withdraw any proceeds or have them converted into an income payment. True deferred annuity This type of deferred annuity will have both the amount and the starting date of future income payments specified contractually at the time that the single premium is deposited. Income payment will start at some time in the future. 5

6 WHEN CAN ANNUITY PAYMENTS START? As we have mentioned previously, life annuities and annuities certain can be either: Immediate annuities Deferred annuities Immediate annuities With immediate annuities, the income payments to the client usually start exactly one installment period after the insurance company receives the funds. For example, if the funds were submitted to the insurance company on June 1, 2002, the first monthly payment to the client would be July 1, If the payments were to be annual, then the first payment would commence on Jun 1, Deferred annuities With a deferred annuity, the income commences more than one installment frequency after the funds are received. Usually this commencement date is a number of years in the future. For any annuities using RRSP funds, Canada Revenue Agency (CRA) stipulates that the contract must mature before the end of the year in which the annuitant becomes age 71. This means that the application must be signed, any transfer of funds completed and other requirements submitted before the end of the 71 st birth year. Annuitants must receive one entire year of payments in the year that they reach age 70. With some companies, deferred annuities are totally locked-in contracts with no cash values, surrender options or alternate income commencement dates. No changes of any kind are permitted after the policy is issued. If the annuitant dies during the deferred period, the beneficiary or estate may receive the premium with or without interest to the date of death. This choice of death benefit must be elected at issue. This cost of the death benefit will have some impact on the amount of the income. TYPES OF ANNUITY CONTRACTS Many factors should be considered when looking at annuities. Some of these factors are age, health, lifestyle, income needs and income provisions for a spouse and other dependents. 6

7 There are two main types of annuity contracts that will provide variations within each: Term certain annuities. Life annuities. TERM CERTAIN ANNUITY Other names for this type of annuity are annuity certain and fixed term annuity. These types of annuities will pay the annuitant a periodic income for a specific period. This payment can be for 5, 10 or 20 years, or over a period that will end with a specific age, such as 90. Term certain annuities are always based on only one annuitant. If the annuitant dies within the specified period, any remaining income payments continue to be paid to the beneficiary. The remaining proceeds can also be commuted and paid to the beneficiary in a single payment. If this option is chosen, then the present value of the balance of the guaranteed income payment is used. A term certain annuity can be purchased with either a single sum or premium, with the income payments beginning immediately. Quite simply, the income will begin at the end of the first interval after the initial purchase. The payments received can be monthly, quarterly, bi-annually or annually as directed by the annuitant. This type of annuity can also be issued on a deferred basis, with the first income payment not being paid to the annuitant until after specific number of years, or until they reach a specific age. A deferred annuity may be purchased with either a single sum or with premiums over a specified period. When RRSP funds are used, the annuity must run to age 90 (or the annuitant can take a term certain which runs to their spouse s age 90, if the spouse is younger). Once the period expires, the contract terminates. Life insurance companies and trust companies can issue term certain annuity contracts. LIFE ANNUITIES Life annuity payments are for the lifetime of the annuitant. Payments will stop as soon as the annuitant dies (if there is no guarantee period). A guaranteed period of any length (as short as on year and to a maximum of age 90 if using RRSP funds) may be stipulated. 7

8 The annuitant s estate (unless a beneficiary has been designated) will receive the remainder of the payments during the guaranteed period should the annuitant die during the period. Unless the beneficiary is the spouse, and RRSP funds are being used, any remaining guaranteed payments must be commuted. The most common type of life annuity is the straight life annuity that will pay a guaranteed income for life, but makes no provision for the return of any unused premium after death. As long as the annuitant is alive, the insurance company will make any contractual payments to them. If the annuitant lives longer than expected, then the insurance company makes up any shortfall. Life annuities can be arranged so that some unused premiums can be returned to the beneficiary after the annuitant s death. We will cover this later on in the course. Just like term certain annuities, all life annuities may be ether immediate or deferred annuities. An immediate annuity is bought with a single premium to pay the income immediately. A deferred annuity is bought with a single premium or a series of premiums to pay an income that will start at a specified future date. Insured Annuities An Insured Single Life Annuity is the unique concept of purchasing a single premium prescribed life annuity with little or no guarantee period to generate income for a person's lifetime. This kind of annuity on its own does not provide any estate benefit but it produces the largest amount of monthly income of all the forms of life annuities. For estate purposes, the annuitant uses some of the income from the annuity to purchase a permanent life insurance policy, normally for the amount of the annuity. The insured single life prescribed annuity ensures the annuitant a high after-tax income during his/her lifetime and the insurance protects the annuitant's capital while providing an estate benefit for his/her spouse or children. Compared with traditional income-generating investments, insured annuities offer distinct advantages even when compared with the most conservative of investment vehicles. 8

9 For example, many seniors keep a large portion of their investments in monthly interest term deposits. The advantage being that their capital is secure and the investment provides a regular income based on prevailing interest rates. Insured Single Life Annuities can be purchased with amounts as little as $10,000. Generally, the older you are, the better the income from this kind of annuity. The most benefit is received from a non-registered prescribed annuity because of the preferential tax treatment given to the income received. The following illustration shows the resulting annual after tax income for a male, age 65, non-smoker in a 40% tax bracket received from the equivalent of a 5 year non-registered term deposit receiving 4% interest compared to a non-registered life insured annuity. Annuity and life insurance figures are calculated as of June Totals are rounded to the nearest dollar. Description Term Deposit Insured Annuity Deposit: $100,000 $100,000 Annual Gross Income: $4,000 $7,135 Taxable Portion: $4,000 $1,641 40%: $1,600 $656 Annual Net Income: $2,400 $6,479 Cost of $100,000 insurance: 0 $3,025 Annual Net Income: $2,400 $3,454 Main types of Life Annuities Life annuity with no guarantee Annuity income from this type of annuity is the most basic. This type of annuity provides a regular income for as long as the annuitant is alive. Any payments will cease with the last regular payment preceding the annuitant s death and nothing further will be paid. Life annuities with no guarantee will pay the highest amount of income per $1000 of purchase price. This is because the insurer does not have to pay any guaranteed income to the beneficiaries of the annuitant who die younger than their life expectancy. This form of annuity would appeal to any prospects and clients who desire the highest income, and have no dependents to support. 9

10 Life annuity with a guarantee These types of annuities provide a level income payable for as long as the annuitant lives and provides that if the annuitant dies before the end of the guarantee period, the income continues to any named beneficiary for the balance of the guaranteed period. If RRSP funds are used, and the beneficiary is not the spouse, then the commuted value of the remaining payments will be payable in a lump sum. Life annuities with a guarantee will pay a lower income than a straight life annuity because the insurer is obligated by contract to pay out a specified number of payments regardless of when the annuitant dies. Increasing life annuity This type of annuity will provide a unique advantage of income increasing at a fixed rate compounded annually, as long as the annuitant lives. This can result in a built in inflation protection factor. It can also contain a guaranteed period for payout as described above. In the past Canada Customs Revenue Agency has restricted the increase to 4% annually if RRSP funds were being used. Joint and last survivor with no guaranteed period This form of annuity will provide a level income during the lifetime of two annuitants. On the death of the first annuitant, the income continues in full to the survivor and ceases on the second death. No death benefits are payable to the estate after the second death occurs. This is the common arrangement for a husband and wife, but other variations of annuitants can be arranged. Joint and last survivor annuity with a guaranteed period In some cases, if the premium to purchase a joint and last survivor annuity is substantial enough, a guaranteed period might be selected. This annuity will provide a level income while both annuitants are alive. If both pass away before the end of the guarantee period, the installments continue to the named beneficiary for the remainder of the period. If RRSP funds are used, then a lump sum settlement is done. Joint and last survivor with income reducing This annuity provides a level income while both annuitants are alive. The income reduces on the first death, or at the end of the guarantee period, whichever occurs later. 10

11 The reduction can be up to any percentage of the original income. The most common plans will provide for a reduction to 50% - 66%. If both annuitants die during the guarantee peiod, the full income is paid to the beneficiary until the guarantee peiod expires. If RRSP funds are used, a lump sum settlement will be made after the second death. Increasing joint and last survivor annuity This type of annuity arrangement will provide the advantage of increasing the income at a fixed rate of interest compounded annually as long as either annuitant lives. This can result in a built in inflation protector. It may also include a guaranteed period as previously discussed. The above annuities are by far the most common forms of income payment. Some are used more than others. Other Annuity Options (will vary with company) Installment refund annuity This type of contract is the same as the life annuity with a guaranteed number of payments. The only difference is that the total amount to be paid out under any guaranteed period will be equal to the purchase price. Integrated annuity This type of annuity will provide level income that takes into account the Old Age Security payments that the annuitant might receive at a future date. The income received from the annuity before age 65 will be higher by the amount of the monthly income expected from OAS. At age 65, OAS begins and the annuity income reduces by a comparable amount, resulting in a level income to the annuitant. Cash refund annuity This annuity will provide a life income to the annuitant. If the annuitant dies before receiving any annuity payments equal to the purchase price, the difference between the purchase price and the total amount received will be paid in a lump sum to either a named beneficiary or the annuitant s estate. 11

12 Impaired annuity An impaired annuity will pay more to those individuals who have serious health problems that will shorten their life expectancy. Examples of these health problems could be a history of serious coronary or circulatory disorders. Normally there is a minimum premium required to buy this type of annuity. Your prospect or client must supply a physician s letter to the underwriters, who will use this as the basis for determining the life expectancy. For example, if the underwriters decide that your 65-year-old client has a life expectancy of six or seven years, an older age could be used to determine the actual payout. This way, your client will receive more income, since the annuity payment depends on the age of the annuitant. If a long guarantee period is requested, any additional income due to poor health is reduced, as the guarantee period may exceed the life expectancy and the income will be related more to the guarantee period that to the life expectancy. Likewise, if a joint and last survivor is requested and only one is in very poor health, there will unlikely be additional income since the income will be related to the life expectancy of the healthy annuitant. Commutable annuities Before the Federal legislation change passed in December of 1986, many companies only allowed commutation of guaranteed payments only on death of the annuitant. After the change, the following annuities now offer an enhanced commutable feature: Single life annuity, guaranteed to 90. Joint and last survivor annuity, guaranteed to 90. Annuity certain to 90. If any of the above types of annuities are purchased with registered funds to provide an immediate and level income, the annuitant has the option to make a full or partial withdrawal of future income benefits at any time. A surrender charge may apply only to those annuitants who exercise this option. For the clients who are reluctant to lock their money into an annuity and want the option of cashing it in may be interested in taking advantage of this commutable feature. 12

13 Variable (non-level) income payments (for life) annuities Under this type of annuity contract, variable annuities are bought by the purchase price buying a given number of units in an investment fund. The values of these funds are determined by the market value of the assets in the fund. These funds are usually valued on a daily basis. Variable annuities are designed to keep up with inflation, based on the theory that over the long run, many prices of common stocks are expected to keep pace with consumer prices. This has not been evident in recent years, especially with the investment in the Technology markets. The purchaser assumes any investment risk, which is contrary to all the other annuities. Variable contracts This form of life insurance contract provides for the reserves, or part of it, to be held in a separate fund (Segregated Funds) of the insurance company. There has to be two separate elements in order to be a variable contract: An insurance element protection in the event of death or an annuity option in event of surviving to plan maturity. A reserve, which can vary depending on the performance of a segregated fund (equity element). If these contracts contain a guarantee at death and maturity, then they are exempt from any laws that govern securities. With the recent changes in Federal legislation in regards to the reserving of Segregated Funds, all guarantees should be looked at, as they will differ depending on the company you do business with. Settlement options The same basic settlement options are available as in guaranteed annuities, however a few additional options are available: Deposit Option Fixed Period or Fixed Guarantee Period Life Annuity with no Guaranteed Period Life Annuity with a Minimum Guaranteed Pay Period (10, 15, 20 years) Joint, Last Survivor Annuity, payable to the second death 13

14 A Variable Annuity Option Payment where the dollar amount of each payment is linked to the changing value of the units. The units in turn are based on the value of the segregated fund. The duration of the payments whether Lifetime, Guaranteed for a minimum of 10 years or Term Certain Annuity will be guaranteed. In good market times the dollar value of the payment will be higher than in poor market times. WHO ARE THE PARTIES TO AN ANNUITY CONTRACT? The four parties to an annuity contract are: The insurer The contract owner The annuitant The beneficiary There are always four parties, although one person may fulfill more than one role. The insurer No matter who sold the annuity, the contract agreement is always between the policyholder and the insurance company. The insurance company is the insurer. The annuity contract contains assurances and the terms of agreement. It also stipulates what can and cannot be done. These would include additional investing, withdrawals, cancellations, penalties, and of course, the guarantees. An agent or broker will need to understand each annuity contract sold by the different insurance companies that they deal with. Products differ and the need to understand those differences is important for the agent as well as the policyholder. The contract owner The policyowner is the contract owner. It is their money; they decide among the different options offered. An agent needs to be aware of the options offered to give a wellrounded view of what is available. The policyholder has the right and the ability to add more money (if the allowed by the insurance company or the annuity contract selected), terminate the annuity, and withdraw a portion or all the money and to change beneficiaries or the annuitant. The changing of beneficiaries and/or annuitants requires an approval from the insurer along with the required papers to be filled out. The contract owner can be an individual, a couple, a trust or a corporation. The one requirement is that the owner must be an adult. A minor can be named as long as there is a guardian or custodian listed. 14

15 The contract owner (policyholder) controls the investment. They can decide to gift or will a partial amount of the entire sum to anyone or any entity at any time. The annuitant The annuitant is similar to the insured of a life insurance policy. If the annuitant is not also the policyowner, they have no say in the contract, cannot make withdrawals, change names or terminate the contract. The annuity will remain in force until the contract owner makes a change or the annuitant dies. Like an insurance policy, when you purchase it on someone else, which is the insured, the annuitant must also sign the annuity contract. Some annuity applications do not require the annuitant's signature. Most companies allow the contract owner to change the annuitant at any time with a stipulation that the new annuitant has been alive when the contract was first written. Changing the annuitant is not as easy as changing a beneficiary. The insurance company must approve of the change first. If the new annuitant is young, the change may be made quite easily. If the new annuitant is older, mortality risks come in to play and the change may not be as easy. In any case, a contract owner who wants to change annuitants must follow the procedures the insurance company indicates. The beneficiary Simply stated, the beneficiary is waiting for the death of the annuitant. This is the only way the beneficiary can prosper. Like the annuitant, (if not also the policyholder) the beneficiary has no say or control in the management of the policy. Whereas the annuitant must be a person, not an organization. The beneficiaries can be trusts, corporations or partnerships as the beneficiaries, as well as friends, children, relatives or spouses. The annuity contract can name multiple beneficiaries. For instance, Tom, the annuity contract owner, could specify that his wife receive 50 percent of the proceeds. The Heart & Stroke Fund might receive 30 percent and the remaining 20 percent could go to Pro-Seminars International. One owner must be "primary" and the other "contingent" unless the insurer will permit co-ownership. Many companies no longer permit co-ownerships as they used to. This is because of so many legal problems - especially in divorces. Companies do not want to get dragged into such things. 15

16 The same is also true for annuitants. While it is still possible to find insurers that allow co-annuitants, most prefer a single annuitant due to legal problems. Most applications do not even show a line for co-annuitants, but insurers may still allow it if asked to do so. The annuity contract can have two contract owners, such as a husband and wife. Then the annuitant can be either the husband or wife or both. This would protect the couple's assets in case one of them died. This is one area where total understanding of how the annuity works is crucial. If any other beneficiary were listed, for instance, a child or charity, the surviving spouse would not receive the money. The contract owners need to have this well thought out so the annuity will meet the goals intended. Beneficiary designations may be set up with a primary beneficiary (the spouse) and a contingent beneficiary - the children. A single person can thus hold multiple titles. Tom could name himself as the annuitant and beneficiary as well as being the contract owner. If Tom elected to name himself as the contract owner and the annuitant, and then a loved one or entity as the beneficiary, he would still have complete control of the annuity. Upon Tom's death, the proceeds would pass on to the intended beneficiaries or heirs. Tom would also retain the capability of changing the beneficiaries if he elected to. It must be noted that while Alan would have the right to name himself as the annuitant and the beneficiary, it would not make sense to do so in any way. One of the advantages of the annuity is avoiding probate. Naming him as the annuitant and the beneficiary would nullify this advantage by reverting the money to the estate, which would pass through probate, and all the expenses incurred or go to a contingent beneficiary. WHICH ANNUITY IS BEST? The type of annuity that is chosen by the policyholder should depend on the following: four factors: 1. Time Horizon 2. Other Owned Investments 3. Goals & Objectives 4. Risk Level 16

17 1. Time Horizon is when the policyholder plans on using the investment proceeds. The longer the policyholder is willing to live with an investment, the more they should concentrate on equity building products. Though not an insurance product, it has been proven that stocks have outperformed bonds in every decade. 2. Other Investments should be considered when looking at annuity investing. If the policyholders have no other investments, a variable annuity may be too risky for them and their future income levels. On the other hand, they may feel they can invest well enough to better their income. One thing to keep in mind is that things can change in the marketplace -- suddenly. Diversification has always been a fundamental in successful investing. If the policyholders' investments are tied up in debt instruments, they should look at equity options within a variable annuity. 3. Goal and Objectives would include how much the policyholder wants for retirement, sending a child or children through college or just to buy a house in a few years. Whatever the policyholder's goal may be, it is important to turn these into dollar objectives - something that can be attained. We can all dream, but once a goal is set, it may be easier for one to plan and meet that goal. Once this has been established, and the policyholder knows their existing holdings, then comes the step of calculating how to attain that figure (goal). 4. Risk Level is what the policyholders accept in certain investments. This level can go up or down depending on the investment chosen. A policyholder needs to be comfortable with the risk levels of the investments they choose. This means they need to be aware of them to begin with. THE ANNUITIZATION PROCESS Annuitizing may be simply defined as "contracting for a series of payments from an annuity. It provides an even distribution of both principal and interest over a period of time (if that is the type of annuity chosen). Annuitization only subjects a portion of the amount withdrawn for that year for taxation. 17

18 There are three risks involved: 1. That the annuitant dies too early and/or selects the guarantee and does not receive back from the insurance company what they could have. 2. Once annuitization has been selected and the insurance company issues the contract and the policyholder has cashed the first cheque, there is no turning back. The amount of the cheque in a fixed annuity will be the same each month for the duration of the annuity. 3. If inflation increases at five percent a year, the dollars that the policyholder receives from the annuity will purchase five percent less each year than the policyholder receives from the annuity contract. This decrease in purchasing power will constitute a reduction in one's standard of living each year. This can be a major risk for retirees. Annuitization is a process that the contract owner chooses to do. As previously mentioned, the contract owner can choose to have the cheques issued monthly, quarterly or annually. The amount of the annuity cheques will depend on the following four factors: 1. The competitiveness of the insurance company. 2. The level of current interest rates. 3. The amount of principal that is to be annuitized. 4. The duration of the withdrawals. 1. Competition between insurance companies can benefit the policyholder greatly. The interest rate that companies will often differ. The same is true with annuitization. Some insurance companies may offer very attractive yields during the accumulation period but poor returns during annuitization (distribution). As competitiveness will vary from company to company. Shopping around for the insurance company that offers the best interest rates is an obvious chore, but one may not realize that insurance companies vary also in the returns they hand out during distribution (annuitization). When a person is initially shopping for an annuity contract, this may be a factor to consider. A person could also decide to change insurance companies when they go to annuitize. Whichever they choose, knowing there are options available can be very advantageous. 18

19 2. Current interest rates have an affect on the payout amount for obvious reasons. The amount of the cheques received upon annuitization of a fixed-rate annuity contract will be level; it will not go up or down with the interest rates, the stock market or the economy. When the policyholder decides to annuitize all or part of the investment, the amount of the cheque will depend on the current interest rates. If the insurance company can take the policyholder's money and invest it in a conservative manner, and it results in a high return to the company, a large portion of this could be passed on to the policyholder. The insurance company or contract may give policyholder the choice to annuitize a portion of the annuity contract. However, this choice may not be wise because the insurance company may not be giving competitive interest rates for this service. It may sound as if the ongoing return is based on what happens to the invested funds later on; this is not true. The amount of the cheque will always stay level. 3. The amount of principal that is going to be annuitized depends on how much the policyholder decides to annuitize. The larger the amount of the capital that is to be returned to the policyholder, plus accumulating interest on the still to be dispersed amounts, the greater each cheque will be. 4. The period of annuitization is the period of time, or duration, in which the contract owner wants the cheques to be received. For instance, a contract owner could choose a five-year period. What makes the duration a little tricky in that annuitization does not necessarily have to be for a specific number of years. Many people annuitize for three, five or ten years or longer period. Others want an income stream that will last for the remainder of their life, or during the lifetime of two people. In deciding whether or not to annuitize or take lump sum cash disbursements, the first steps to consider are: The amount of the payout. What the lump sum cash disbursement could be used for. How much would be left to invest net after taxes. 19

20 Why would a policyholder want to annuitize? They may be forced to do so if it was the only way to provide a sufficient income for the family's survival. Of course, a policyholder would find it preferable to have a sufficient pension income, social security income and personal assets to prevent them from having to annuitize. Annuitization puts the income at risk of being eaten up by inflation, having the principal forfeited to an insurance company because of premature death and it eliminates the possibility of changing the contract to suit the policyholder's future needs. The decision to annuitize can be an emotional one. It may be wise for the policyholder to seek objective counsel from a CA, a financial advisor, attorney and of course, trusted insurance agents. Annuity management is structured so that the professional manager or investment team overseeing the annuity is a specialist. The portfolio managers do not talk to clients or do anything else that might interfere with the job they are hired to do. These professionals are highly skilled and trained. They focus on a certain segment of the marketplace. This is in contrast to the stockbrokers, financial planners, accountants and so on that have a great disadvantage in that they are busy trying to do several things. They are going to meetings, talking to clients, trying to get new accounts, learning about new investments, reading about tax law changes and/or handling some administrative task. It is true that people have lost money in most types of mutual funds and variable annuities. To a certain degree, the losses and profits incurred are due to the management. The point of this is not to lay blame or discredit a profession, but to stress where the safety is for the policyholder. In contrast, portfolio managers concentrate on overseeing the annuity. The second has many duties that can pull their attention away from proper investing. The reserve requirements for an annuity account are much higher than for a bank account. For every dollar the policyholder puts into the annuity, the insurance company must set aside over a dollar in reserves. The insurance company can only use these excess reserves to settle the withdrawals and redemption of annuity owners. The money cannot be used to settle insurance claims, pay overhead, settle bad debts, or take care of any other non-related annuity item. 20