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Flashcards in Chapter 13 Part 8 Deck (20)
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Finally, people saving for retirement should normally exhaust all their opportunities to

contribute to an employer-sponsored retirement plan, such as a 401(k) or an iRA, before investing in a variable annuity. Contributions to 401(k) plans and regular IrAs are usually tax-deductible. Although the earnings in a variable annuity grow on a tax-deferred basis, the investor's contributions are made with after-tax dollars


The prospectus for a variable annuity must clearly disclose

all the sales charges and expenses associated with the annuity. While there is no numerical cap on how much the company can charge the client for a variable annuity, all the sales charges and other expenses added together must be reasonable.


An insurance company may deduct sales charges from the contract owner's payments. however, the majority of companies today have a type of

contingent deferred sales charge (CDSC), usually referred to as a surrender charge. If a contract owner withdraws money from a variable annuity within 5 to 10 years after purchase, the company deducts a certain percentage of his investment. Usually, the surrender charge declines the longer the investor owns the contract. Naturally, the company that issues the annuity has other expenses besides sales charges. These expenses are deducted from the investment income generated by the separate account and include investment management fees, mortality risk charges, expense risk charges, and administrative fees


During the accumulation period,

the contract owner makes payments to the company and the value of the annuity grows (accumulates) on a taxdeferred basis. The company first deducts any applicable charges from the owner's premium payments. The remainder (the net payment) is then used to purchase accumulation units in the subaccounts that he selects. The owner buys these accumulation units at their net asset value (NAV), which is calculated in the same way as the NAV of a mutual fund. The NAV of each accumulation unit is usually calculated every business day and will fluctuate along with the value of the underlying portfolio


The contract owner may cancel (surrender) his annuity at any time during the accumulation period in return for

its cash surrender value. She may also withdraw part of its value at any time (a partial surrender). Depending on how long an investor has owned an annuity, the owner may need to pay surrender charges, taxes on the income, and a tax penalty if she is under age 59.5. The system used for taxing income is last-in, first-out (LIFO). In other words, the earnings are
taxed first on surrender


Although variable annuities are not life insurance policies, they often have a

death benefit. If the contract owner dies during the accumulation period, the beneficiary will receive the greater of either (1) the sum of all the contract owner's net payments into the annuity, or (2) the value of the annuity on the day the owner dies


The annuity period begins when (and it) the contract owner decides to

start receiving income payments from the contract. Up until this point, the contract owner is permitted to surrender the annuity at any time in exchange for its current cash value. Generally, once the annuity period begins, the owner may no longer surrender the annuity or withdraw money from it. Also, there is no death benefit once the contract begins the payout (annuitization) phase


When the contract owner decides to annuitize, the company converts accumulation units into

annuity units. Annuity units are the accounting measurement used to determine the amount of each payment to the annuitant. The number of annuity units that is used to calculate
each payment is fixed at this time. The company calculates the annuitant's first payment by taking into consideration the following factors: Annuitant's age and sex, Settlement (payout) option selected, Life expectancy, Assumed Interest Rate


Assumed Interest Rate (AIR)

rate of interest stated in the annuity contract that is used to determine the size of the annuitant's payments. The AIR is NOT the same thing as a minimum guaranteed rate of return and an IA representative should never imply that it is. The annuitant's subsequent payments will depend on the relationship between the AIr and the actual performance of the separate account. lf the investment performance of the separate account is the same as the AIR, the annuitant's payment will remain the same. If the separate account performs better than the AIR, then his payment will increase. If the separate account performs worse than the AIR, the payment will decrease


Straight-Life Annuity

With this option, the annuitant receives monthly payments for as long as he lives. The payments stop when the annuitant dies since no beneficiary may be named on the contract.
This option gives the annuitant the highest periodic payment of all the options available. The risk for the annuitant is that if he dies shortly after annuitizing the contract, the company will retain the majority of the annuity's value. This option is best for people who are still relatively young, in good health, and have no heirs


Life Annuity with Period Certain

The annuitant receives payments for her lifetime. However, if the annuitant dies before the encl of the guaranteed period (e.g., 10 years), the beneficiary continues to receive the payments for the remainder of that period. If the annuitant dies after this period ends, the beneficiary receives nothing


Unit Refund Life Annuity

The annuitant receives payments for her lifetime. however, if the annuitant dies before receiving a specific number of payments, her beneficiary will receive the remainder of the payments as scheduled or as a lump sum


Joint and Last Survivor Annuity

This is a popular option for married couples. The insurance company agrees to make payments to two people. If one person dies, the survivor continues to receive payments until death.


The beneficimy of a variable annuity, however, docs not receive the benefit of a stepped-up cost basis. Instead, the beneficiary's cost basis is the

same as the amount the original owner invested


Equity-Indexed Annuity

linked to the performance of an underlying stock index


The company that issues the equity-indexed annuity guarantees a

mininmum rate of return (as in a fixed annuity), but the annuity's ultimate return will vary depending on the performance of the index to which it is linked. The investor's risk is more limited, but so are her potential returns


Clients need to underntand that an equity-indexed annuity is never going to return

as much as the underlying index-this reality is what investors must accept to receive the contract's guarantees. The guaranteed minimum return is usually 87 .5% of the investor's premiums plus a 1% to 3% annual interest rate, provided the investor does not surrender the annuity prematurely


Many companies use a participation rate to calculate the contract owner's return. The annuity is credited with a

certain percentage of the index's gain.


Some companies use a spread, margin, or asset fee. A specified percentage is

subtracted from whatever gains the index achieves. If the S&P grows 10% and the spread/margin/asset fee is 3.5%, then only 6.5% is credited to the annuity. A company may use one of these fees in place of, or in addition to, a participation rate


Other EIAs put a cap on the amount of interest the annuity can

earn. If the S&P 500 gains 10% and the interest rate cap is 8%, the most the annuity will earn is 8%

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