Ohio Life & Health Insurance Prelicensing Online Course Unit 6 6.0 Annuities, Variable Products, and Federal Tax Considerations 6.1 Annuities Key Facts 1. Annuities are, in one way, the opposite of Life Insurance: Life Insurance creates an estate, and annuities systematically liquidate an amount of money over a period of time. 2. There are four parties to an annuity; insurer, owner, annuitant, and beneficiary. 3. Annuity contracts must contain nonforfeiture provisions for example, cash or a paid-up annuity. 4. Annuities grow tax-deferred during the accumulation phase. 5. Withdrawals are taken from the interest first and then the principal (LIFO). 6. Annuities owned by corporations do not qualify for tax-deferral during the accumulation phase 7. The accumulation period is during the pay-in phase, whereas the annuity period is the pay-out phase 8. An SPIA is purchased with one payment and the payout begins usually within 30 days. 9. An FPDA is purchased with periodic payments and the pay-out phase is deferred until a later time. 10. When buying an FPDA, Ohio requires a form to be signed by the owner stating that it has been disclosed that the payout will begin at some point in the future. 11. Surrender charges are assessed by an insurer if withdrawals are taken within the early years of the annuity. After a period of time (for example, eight years), there are no further surrender charges. 12. A Joint Annuity pays benefits until the first dies. 13. A Joint and Survivorship Life Annuity pays until the second dies. 14. Annuities are usually set up to pay for life. You cannot outlive the income from a Life annuity. 15. Fixed Annuities guarantee a fixed rate of return and are backed by the Guaranty Fund. The assets are in the company s general account. 16. An Equity Indexed Annuity has the assets linked to the S&P 500 Index, with a minimum guarantee of principal and a modest minimum interest rate. 17. Market Value Annuities pay a specific interest rate to maturity, and pay payout more or less if surrendered prior to maturity depending upon the current interest rate. 18. Personal uses for annuities include: IRAs, retirement income, education funds, lump-sum law suits, and lottery winnings. 19. If you die during the Accumulation Period of an annuity, the account value will be paid to your beneficiary or to your estate. 20. A Life Income Annuity (Straight or Pure Life Annuity) has no beneficiary, and is the most risky. 21. A Refund Annuity has the least amount of risk. 22. A period certain feature has a guaranteed minimum time frame when payments are guaranteed. For example, a 10-Year Certain guarantees that 120 monthly payments will be paid to someone. 23. The premium for a $100,000 Immediate Annuity is $100,000, regardless of the client s age, health, sex, etc. It is the pay out that depends on these factors. 24. Group Annuity benefits may be adjusted by the insurance company if it finds that the annuitant Ohio L & H Insurance Prelicensing Online Course Page 1 of 6
has misstated sex, age, length of service, salary, or any other fact determining the amount of benefits to be paid out. 25. Variable Annuities are often used in small pension plans such as an SEP. 26. Most annuities are used for retirement purposes. 27. Annuity tables are different than mortality tables since there is no insurance protection. 28. Annuities are often used as an alternative to Life Insurance settlement options. 29. When a partial surrender occurs from an annuity, the interest portion is received first (LIFO), and is taxable. After that, the principle is taken. There may also be a 10% penalty if the annuitant is under 59½. 30. At the annuitization of an annuity, the proceeds are a combination of tax-free and taxable money. The tax-free portion is calculated by dividing the amount that is expected to be received over a lifetime divided into the amount that was paid over the life of the annuity. This is called the annuity exclusion ratio. 31. Upon surrender, the portion received that exceeds the amount paid in (cost basis), is taxable at ordinary income rates. 32. A Bailout Annuity contract states that if the interest rate drops at a renewal date more than a specified percentage, the owner has the right to cash-in the annuity and not pay a surrender charge. Taxes still apply to any growth taken at that time. 33. A medical bailout occurs when the owner is confined to a nursing home or is diagnosed with a terminal illness. Ohio L & H Insurance Prelicensing Online Course Page 2 of 6
6.2 Variable Products Key Facts 1. The cash value of either an annuity or a Variable Life must be determined no less frequently than monthly. The death benefit of a Variable Life must be determined at least annually. 2. For the test, think of VLI as Variable Whole Life. 3. Variable Life contracts must contain nonforfeiture provisions and provisions for reinstatement. 4. Individual Variable Life Insurance policies that require a payment of a scheduled premium require a 31-day grace period. 5. Variable Life Insurance policies or annuities must contain procedures to be followed to determine the dollar amount of the benefits to be paid. 6. Client funds invested in a Variable Life contract or Variable Annuity must be kept in the insurance company s separate account, which is similar to a mutual fund. 7. Variable products have no guarantees and are not backed by the Guaranty Fund. (You cannot guarantee a variable!) 8. The NASD enforces securities regulations for its members. 9. Variable Life and Variable Universal Life have a 45-day free look starting from the date of the application (Federal law), or ten days from the date of delivery (Ohio law), whichever takes the longest time. 10. The client may skip, reduce, or increase premiums on a Variable Universal Life policy. The policy will not lapse as long as there is enough cash value to cover the next expense deductions. If there is not enough cash to pay the monthly expenses, a 61-day grace period begins upon the mailing of a notice from the company to the policy owner. 11. A Variable Whole Life policy must have a 31-day grace period, since the premiums are required to be paid to keep the policy in force. 12. A Variable Life policy must have a provision permitting the policy owner to reinstate the policy within two years of lapse. 13. Variable Whole Life allows the client to self-direct the investment category, not to choose individual stocks or bonds to be put into the account. 14. Investing in Variable products is considered a hedge against inflation. 15. Variable life agents do not have to be registered with the New York Stock Exchange (NYSE). They do have to be registered with Financial Industry Regulatory Authority (FINRA) and have a securities series 6 or 7 license. 16. The SEC is a federal agency that regulates securities. 17. FINRA is a self regulatory authority and is not a governmental agency. 18. The Securities Act of 1933 requires a prospectus be given to a prospect at the time of the initial discussion about the purchase of a Variable Life/Annuity. 19. The Securities Act of 1934 regulates the actions of sales representatives. 20. The Investment Company Act of 1940 regulates companies who invest money for clients. It controls the separate accounts and the amount of the sales charges. 21. Variable Life (VLI) has a required level premium whereas Variable Universal Life has a flexible premium. 22. Variable Life (VLI) has a guaranteed minimum death benefit it increases/decreases as the value of the account changes. 23. The Variable Universal Life death benefit fluctuates with the gains/losses of the account, however, not on a dollar for dollar basis. Many VULs have a guaranteed death benefit as well. 24. During the annuity (pay out) phase, benefits are based on the earning compared to the Assumed Interest Rate (AIR). Ohio L & H Insurance Prelicensing Online Course Page 3 of 6
25. The agent is required to determine the suitability of prospect when selling variable product. 26. A VLI is called a bundled product whereas the VUL is unbundled. 27. A front-load Variable takes the sales charges at the beginning of the contract. 28. A back-load Variable takes a charge when the product is surrendered. The amount is usually determined by how long the product has been in force. 29. The death benefit payment for many annuities is stepped up every few years. 30. Know the three forfeiture options for a Whole Life insurance policy. 31. Know the six settlement options for a Variable Annuity. Also note the differences between the fixed and variable annuity settlement options. 32. Ohio charges a premium tax on annuities and is paid by the company, not the premium payor. Ohio L & H Insurance Prelicensing Online Course Page 4 of 6
6.3 Federal Tax Consideration Key Facts 1. Dividends paid by a stock company to stockholders are taxable in the year received. 2. The cash value of a Life policy accumulates income tax free. 3. Cost basis is defined as premiums paid with after-tax dollars. 4. Policy loans do not trigger a taxable event unless the policy is an MEC and there is a gain over the product. 5. Any interest included in any settlement option is taxable. 6. Life Insurance death benefits are included in the deceased s estate if the decedent had any incidents of ownership. 7. If the interest option is selected, the interest paid is subject to taxation. On the test, interest always means taxable income. 8. Premiums paid for individual Life Insurance are not tax deductible, but the proceeds are not taxable if left to a beneficiary. This is true of Key Person insurance as well. 9. A Modified Endowment Contract (MEC) occurs if the values in the policy accumulate faster than a seven-pay Life policy. 10. Modified Endowment Contracts are classified that way for the life of the contract. 11. Modified Endowment Contracts have a 10% penalty for premature distributions if proceeds are taken before age 59½. 12. For both Life Insurance and annuities upon cash surrender, amounts received in excess of premiums paid are income taxable as ordinary income. 13. Upon death, amounts paid to beneficiaries are usually income tax free. 14. Death benefits paid to the beneficiaries are income tax free on Universal Life. 15. Section 1035 allows for the deferral of taxation when a Life policy is exchanged for another Life policy, endowment, or annuity. 16. An endowment can be exchanged for another endowment or annuity and qualify as a 1035. 17. An annuity can be exchanged for another annuity and qualify as a 1035 exchange, but must be on the same annuitant. 18. A SEP-IRA (also known as a 408 plan) is an employer-sponsored IRA. 19. IRA contributions may be tax deductible even though the client is an active participant in another qualified plan, if single or married couple income is below a certain level. 20. IRAs may be funded with annuities. 21. Anyone with earned income, including alimony, may contribute to an IRA, up to 100% of earned income or $5,000 in 2012) per year, whichever is LESS. For a married couple filing jointly, the amount is $$10,000 in 2012 per year. 22. IRA contributions may be tax deductible even though the client is an active participant in another qualified plan, but there is a phase out of the deductions at income levels which are adjusted over the years. 23. The IRS limits amounts contributed to qualified plans. 24. Children cannot have an IRA unless they have earned income. 25. IRAs cannot use Life Insurance as a funding instrument. Effective September 2007, new TSA s (403b) plans cannot use Life Insurance as a funding instrument. 26. When money is taken from any qualified plan or an IRA, the proceeds will be fully taxable at ordinary rates since the money paid in was not taxed at that time and all growth was tax deferred. There will be an additional 10% penalty if the money is taken before the age of 59½, except: Ohio L & H Insurance Prelicensing Online Course Page 5 of 6
$10,000 for a first-time homebuyer. Death or disability. To pay qualified medical expenses. The 7½% floor does not have to be met. At death, proceeds in excess of the cost basis from an annuity are income taxable to the beneficiary. To pay for qualified higher education expenses. If the employee takes annuitization at the life income levels of distribution, prior to 59½. 27. Roth IRAs allow non-deductible contributions and limits them to $5,000 per-year in 2012 for an individual, and $10,000 in 2012 for a married couple filing a joint return. 28. Proceeds coming from a Roth IRA are tax free if the account has been maintained at least five years and any of these events applies: $10,000 for a first-time homebuyer. Qualified higher education expenses. Death or disability. To pay qualified medical expenses. The 7½% floor does not have to be met. Owner is 59½ or older. 29. A rollover can be made once in a 12-month period and must be completed within a 60-day period. 30. Distributions from a qualified pension or profit sharing plan are subject to a 20% withholding, if the money is given to the individual. 31. The 20% withholding can be avoided if the distribution is sent by a direct transfer from the former employer to the insurance company that issues the annuity as an IRA rollover. 32. If 100% of the funds are not rolled over, the amount not rolled over is subject to tax and, if done before age 59½, is subject to the 10% penalty. 33. IRA assets can be transferred without limit in a 12-month period as long as the owner has the funds transferred directly from one trustee to another trustee. 34. Education IRA (Coverdell Education Savings Account) has a $2,000 per-year limit on contributions and the growth is tax deferred. The money can be taken to pay eligible education expenses. 35. To be a qualified plan, a plan must meet ERISA standards. Money paid into such plans is put in with pre-tax dollars, and grows tax-deferred until taken. 36. A 403(b) Tax Sheltered Annuity (TSA) is for employees of non-profits companies, churches, and schoolteachers. The money is taken from the paycheck as a salary reduction program. 37. A 457 plan is similar to a 403(b) plan, but is for public employees such as state workers, police, and firefighters. 38. Vesting means the employee has met the requirements allowing full ownership of all employer contributions. 39. A Defined Benefit plan states how much will be paid to the retired employee at retirement. 40. A Defined Contribution plan states how much will be contributed to the employees account each year. 41. A 401(k) plan is a salary reduction plan and is a form of a Defined Contribution plan. 42. The catch-up provision for anyone age 50 or over allows that an additional $1,000 can be contributed to an IRA and a Roth-IRA each year. 43. The catch-up provision for 403(b) and 401(k) plans allows anyone age 50 or over to contribute an additional $5,000 per year. Ohio L & H Insurance Prelicensing Online Course Page 6 of 6