Transcript Nontradtional life insruance

Annuities
 Objectives
 Identify the characteristics, features, and usage of deferred
annuities
 Identify the characteristics, features, and usage of immediate
annuities
 Understand how to calculate immediate annuity payments.
 Understand how to calculate the exclusion ratio for immediate
annuity payments.
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Annuities: Introduction
 What is the risk that you “insure” with an annuity?
 Risk Of Old Age
 … basically, the risk of outliving income/wealth
 The annuity product transfers this risk to an
insurer
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What is an annuity?
 Financial Definition: A Stream Of Payments
Through Time
 “Contracts providing for the systematic
liquidation principal and interest in the form of
a series of payments over a period of time”
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Insurers separate an annuity into
two phases:
Accumulation
Investor makes cash payments to the
insurance company. The money
remains invested with the insurance
company and is periodically credited
with some growth factor
Payout
The insurance company agrees
to pay the owner a specified
amount periodically, beginning
on a specified date.
 Annuities may be deferred or immediate
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 An immediate annuity has no accumulation phase
Types of Annuities – just the basics
 Immediate annuity: Payout begins within one year of the date the contract is
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established
Deferred annuity: Payout begins more than one year of the date the contract is
established
Life annuity: Payouts will continue as long as the annuitant lives
Fixed period annuity: Company promises a payout for a fixed or guaranteed
period of time, independent of the survival of the annuitant
Combination of life and fixed period payout: for example, the greater of ten years
for the life of the annuitant
Fixed annuity: Invested in the general fixed account of the insurance company
Variable annuity: Invested in the separately managed sub-accounts selected by
the annuity owner
 Additional features
 Guaranteed death benefits
 Living benefits - company guaranteed benefits for owners or beneficiaries
 That would be higher than actual investment performance would provide
for
Variable annuitization
 Payments fluctuate depending on the investment performance of the
underlying sub-accounts
Taxation of Annuities
 Taxation is governed by IRC section 72
 Accumulation phase
 Growth is tax deferred
 Withdrawals during this phase are taxed on a LIFO basis
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Withdrawals are considered to be withdrawals of growth first
and principal second
 Payout phase
 A portion of each payout is considered a return of principal
 A portion of each payout is considered interest or growth
 Calculation of those portions (the exclusion ratio) depends
on the principal invested, the period of the payout and an
internal growth factor for the payout period
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Taxation - Details
 An “exclusion ratio” is used to determine the amount that is taxed vs.
the amount that is exempt from taxation.
Exclusionratio 
Investm entin the contract
Expectedreturn
 Applies to each annuity payment equally throughout the payout phase
 Example – Male aged 70 pays $12,000 for the annuity. His expected return
throughout the payout phase is $19,200.
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The exclusion ratio is 62.50%
 If the monthly payment is $100, then
 $62.50 is considered a return of principal
 $37.50 is considered taxable income
 Once the entire investment in the contract has been recovered, then
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100% of each annuity payment received is taxable income
Taxation - Details
 The expected return is the total amount the annuity owner should receive
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Payments specified x life expectancy (or term certain if elected)
 Life expectancy based on IRS Table V (single lives) or Table VI ( joint
lives)
 If annuitant dies before receiving the full amount guaranteed under a
refund or period certain annuity
 Balanced received will not be taxed (unless it exceeds the investment in the
contract)
 For joint and survivor annuities
 Surviving owner excludes from income the same percentage of each
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payment that was excludible by the first annuitant
 An income tax deduction may be available to the survivor owner to the
extent inclusion of the annuity in the estate of the first annuitant generated
an estate tax (IRD)
Taxation - Details
 Partial withdrawals are subject to income tax, e.g., if the owner makes
a partial withdrawal and takes a reduced annuity
 If the owner takes a partial withdrawal & chooses same payments for
different term
 To the extent cash value exceeds investment in the contract, gain will be
realized in the form of a taxable withdrawal of interest
 Variable Annuities
 No tax will be paid until the earlier of
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Surrender of the contract
 Withdrawals from the contract
 Time that payments commence from the annuity
 To obtain annuity treatment the underlying investments must be
adequately diversified under IRS regulations
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Taxation - Details
 A different exclusion ratio is applied to variable annuities:
Exclusion ratio 
Investm entin the contract
# yearsof expectedreturn
 Example:
 Male aged 65 purchases variable annuity for $20,000
 Life expectancy of 20 years (Based on Table V)
 He can exclude $1,000 from each payment ($20,000 / 20)
 Assume at age 70 he receives only $200 ($800 less than his
excludible amount)
 Assume at age 70 his life expectancy is 16 years
 He can add $50 ($800/16) to his $1,000 excludible amount
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Taxation - Details
 If the annuitant dies before payments received equal cost
 A loss deduction allowed for the amount of un-recovered investment, as an
itemized deduction
 Amounts payable under a deferred annuity at the death of annuitant
 Partially taxable as ordinary income to the beneficiary
 Equal to excess of death benefit over gross premiums
 Dividends, loans, cash withdrawals and other amounts that are taken
out before the annuity starting date are taxed as ordinary income to
extend the cash value exceeds the investment in the contract
 LIFO basis
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Taxation - Details
 Premature Distributions are subject to ordinary income tax plus a 10%
penalty tax
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Tax applies to amount of distribution included in income
 Penalty for premature distributions does not apply to:
 Payments that are part of a substantial equal periodic payments made for
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life
Payments on or after age 59½
Payments made on account of contracts owner disability
Payments from qualified retirement plans and IRA’s
Payments to beneficiary after death of annuitant
Distributions under an immediate annuity contract
Annuity purchased on the termination of certain qualified employer
retirement plans
Payments allocable to investment in the contract before August 14th, 1982
Taxation - Details
 If annuitant dies before annuity starting date
 Cash value must be distributed within 5 years of death or
 Used within one year to provide for a life annuity or installments payments
not longer than the beneficiaries life expectancy
 If spouse is the beneficiary, spouse can elect to become the new owner of
the contract instead
 If an annuity contract is transferred by gift, tax deferral allowed on the
inside build-up is terminated
 Tax-free build-up is allowed only to “natural persons”
 For non-natural persons – income is treated as ordinary income in the year
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received
 Some exceptions include annuities received by the executor of a decedent,
annuities held by a qualified retirement plan or IRA, Annuities purchased by
an employer on termination of a qualified plan
When should one consider using
an annuity?
 When a person wants a retirement income that cannot be
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outlived
When an individual wants a retirement income higher than
their other conservative investments and is willing to have
principal liquidated
To avoid probate and pass a large sum of money by contract
to an heir and reduce the possibility of a will contest
When tax deferred growth is desired for an investment
When an investor wants to be free of the responsibility of
investing and managing assets
As a supplement to an IRA
Fixed or Variable?
Variable:
Fixed:
 Safety of principal
is paramount
 Investor wants to
guarantee a level
of interest
 Investor desires a
conservative
complement to
other investments
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 Investor wants more control over
the investments and is willing to
bear the risk
 Investor is looking for potentially
increasing retirement income
 Investor wants to be invested in
variable sub-accounts, but also
desires some aspect of risk
management
 Guaranteed death benefits /
living benefits
Advantages of Annuities
 Guarantees of safety, interest rates and lifelong income
 Protects and preserves person’s cash reserves
 Allows investment in the market while moderating risk
 Client can “time” the receipt of income and shift it into lower tax
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bracket years
An annuity paying the same rate of interest as a taxable
investment will result in a higher effective yield
Underlying guarantees in variable annuities allow client to take
on greater risk in the underlying investment options (equities,
small market capitalizations, high yield bonds etc.) while still
maintaining a reasonable risk exposure
Adjusted Gross Income (AGI) may be reduced in years where the
annuity is held without withdrawals
Lower taxable income may be recognized during the payout
phase, due to partial recovery of basis associated with each payment
Disadvantages of Annuities
 Receipt of lump sum could result in a significant tax burden
 Income averaging may not be available
 Cash flow received may not keep pace with inflation
 A 10% penalty tax imposed on withdrawals prior to age 59 ½
 Growth in corporate-owned annuities is subject to taxation
 Liquidation in the early years
 Management, maintenance fees could prove expensive
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Management fees and mortality charges could run from 1% to
2&1/2% of the value of the contract
 Back end surrender charges
 Investment earnings are taxed at owner’s ordinary income tax
rate
 Regardless of the source or nature of the return
 Returns associated with long term capital appreciation do not enjoy
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the capital gains tax rate
Deferred Annuities
 Goal: Long-Term, Tax-Deferred Savings
 Premium types
 Investment
 Single (SPDA)
 Ongoing (FPA)
 Regular
 Flexible
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Timely Advice from Consumer
Reports
 The fixed-dollar, deferred annuity offers safety of
principal and, often, outstanding long-term
guaranteed rates that could be very valuable over
15 or 20 years, should market-interest rates go
down. (If market-interest rates go up, the
insurance company would probably credit higher
rates.)
 It is the only investment that can provide, at your
option, the security of a monthly payment for life,
regardless of how long you live. These features
make annuities a good way to save for retirement.
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Types Of Deferred Annuities
 Fixed
 No Acquisition Charge
 Investment growth based on interest earnings
 Mortality Charge
 Other Charges
 Variable
 No Acquisition Charge
 Multiple investment options
 Investment growth based on investment choices and
performance
 Mortality Charge
 Other Charges
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Deferred Sales Charges
Beginning of
Year
1
2
3
4
5
6
7
8
9
10
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Value
$25,000
$24,645
$24,556
$24,728
$25,163
$25,873
$26,877
$28,205
$29,897
$31,691
Investment
Earnings
$1,500
$1,479
$1,473
$1,484
$1,510
$1,552
$1,613
$1,692
$1,794
$1,901
Ending
Value
$26,500
$26,124
$26,030
$26,212
$26,673
$27,425
$28,489
$29,897
$31,691
$33,592
Deferred
Ending
Sales
Value if
Charge
Surrendered
($1,855)
$24,645
($1,567)
$24,556
($1,301)
$24,728
($1,048)
$25,163
($800)
$25,873
($549)
$26,877
($285)
$28,205
$0
$29,897
$0
$31,691
$0
$33,592
The Life Insurance Business
(Sources of Income in 1975)
Health
Insurance
Premiums
24%
Investment
Income
21%
Other Income
4%
Life Insurance
Premiums
38%
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Annuity
Considerations
13%
The Life Insurance Business
(Sources of Income in 2004)
Health
Insurance
Premiums
16%
Investment
Income
25%
Life Insurance
Premiums
17%
Other Income
5%
Annuity
Considerations
37%
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Disability Insurance and Annuities
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Sales Of Individual Annuities By
Distribution Channels
Source: LIMRA International and the
Insurance Information Institute
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Variable Annuity Net Assets by
Investment Objective
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Sales of Variable Annuities, by
producer type
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Net Assets of Variable Annuities,
(1997-2006), in $billions
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Individual Annuity Considerations
(1997-2003)
Variable
$250.00
Fixed
Total
$ billion
$200.00
$150.00
$100.00
$50.00
$0.00
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1997
1998
1999
2000
2001
2002
2003
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Life Expectancy and the Need to
Save
U.S. Life Expectancy
(National Center for Health Statistics, 2005)
80
Number of Years
75
70
65
60
55
50
45
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1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
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Retirement Supports: 3 Legged
Stool (U.S. Model)
Retirement Income
Security
Social
Security
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Personal
Savings
Employer Sponsored
Retirement Plans
Tax-Deferred Savings Benefits
Investment= $25,000
I=6%
Tax Rate= 28%
Two Options
•Pay yearly tax on
investment gain
FV=$71,966
•Defer tax on
investment gain
FV=$107,297$23,043 = $84,254
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Examples of Surrender Charge and Rate Differences
Product
Years Base Bonus Current C Yield G Yield
Rate
Description
G'td Rate Rate Rate
to Surrender
Surrender Charges Last 15 Years
Company
National Western Life
Confidence Flex 85
1 Years 3.5
Surrender Charges Last 10 Years
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11.5
0.77
3.57%
RBC Insurance
Value Master
1 Years 5.3
0
5.3
5.30
3.23%
Allianz Life
Accumulator Bonus Maxxx Elite Annuity (50k)
1 Years
10
14
5.00
2.75%
Lincoln Benefit Life
Jefferson Pilot Life
SureHorizion Choice 1
1 Years 4
JPF Classic 10
7 Years 3.8
Surrender Charges Last 7 Years
2
3
6
6.8
4.20
4.10
3.30%
3.26%
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National Integrity Life Insurance SPDA Series II (1) GRO
1 Years 5.3
0
5.3
5.30
2.04%
Presidential Life
4 Years 4.7
0
4.7
4.70
3.97%
1
4.05
3.25
2.01%
Classic SPDA I
Surrender Charges Last 5 Years
The Standard Insurance
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Principal Growth Annuity 5
Source: http://www.annuityadvantage.com
1 Years 3.05
Withdrawals
 Partial Surrender
 Cash Out
 Annuitize
 Purchase Immediate Annuity
 Taxation:
 Prior To 59 ½
 After 59 ½
 Partial Surrender
 Full Surrender
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Flexible Premium Deferred Annuity:
Constant Funding
Year
1
2
3
4
5
10
30
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Annual
Premium
1000
1000
1000
1000
1000
1000
1000
Current Rate= 8%
Current
Surrender
Cash Value
Value
1083
909
2255
1962
3523
3171
4897
4554
6384
6129
15878
15878
128645
128645
Guaranteed Rate= 3.5%
Current
Surrender
Cash Value
Value
1035
869
2106
1832
3215
2893
4362
4057
5550
5328
12142
12142
53429
53429
Immediate Annuities
 Payment For Life
 Types
 Single Life, No Refund
 Period Certain
 Joint & Survivor
 Variable Payout Based On Earnings
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Effect of Gender and Age on
Immediate Annuity Payments
Monthly income per $1000 of deposit
Age
55
60
65
70
Male
$7.78
8.29
9.06
10.19
Can you explain these patterns?
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Female
$7.35
7.73
8.29
9.12
Nonparticipating Immediate
Annuity Rates (Male)
Age
55
60
65
70
75
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Straight
Life
$7.78
$8.29
$9.06
$10.19
$12.85
10 Years
Certain
$5.14
$5.68
$6.35
$7.00
$8.07
20 Years
Certain
$4.79
$5.10
$5.38
$5.56
$5.72
Cash
Refund
$4.85
$5.30
$5.88
$6.65
$7.68
How are Immediate Annuities
Used?
 Retirement Benefits
 Supplemental Benefits
 Legal Awards (Structured Settlements)
 Parent/Handicapped Child
 Private Annuities
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Using Deferred Annuities in
Retirement Plans
Retirement Plan
Deferred
Annuity
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No Additional
Tax Benefits
Alternatives to Annuities
 Municipal bond funds
 Income exempt from federal and some state income taxes
 Money can be withdrawn without tax penalty
 Disadvantage
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Lack of guaranteed return
 Potential for capital losses if interest rates rise and bonds sold before
maturity
 Single Premium Life Insurance
 Tax free death benefit
 Tax deferred growth of cash surrender values
 Withdrawals & loans subject to LIFO taxation and 10% penalty if distribution
occurred before age 59 ½
Annuity Fees and Acquisition Costs
 Fees and acquisition costs
 Investment management fees
 Typically from .25% to about 1%
 Administrative expense and mortality risk charge
 Typically from a low of about .5% to as high as 2%
 Annual maintenance charge
 Typically $25 to $100
 Charges per fund exchange
 Usually less than $10
 Some companies permit a limited number of charge-free exchanges per
year
 Maximum surrender charge
 Varies from company to company
 Generally phases out over a number of years
Selecting the Best Annuity
 Compare costs and features in a spreadsheet
 Fixed annuities – compare the total outlay with the total
annual annuity payments
 Variable annuities – evaluate the total returns for the
variable annuity sub-accounts over multiple time periods
 Morningstar and Lipper Analytical Services Inc.
 Compare the relative financial strength of the company to
other similar companies
 Rating agencies - A.M. Best / Moody’s/ Standard & Poor’s
Suitability
 In June 2008, Florida passed into law the “John and Patricia
Seibel Act”.
 The Act amends state laws with regard to the sale of annuities to
senior consumers.
 The Act outlines standards agents must meet to evaluate and
determine suitability
 Objective measures, vs. previous “reasonable” standard
 More details in writing; comparisons and disclosures
 New Requirements for corrective action and penalties
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Disability Insurance and Annuities
RMI4115