Chapter 14 - IRAs and Annuities

Question 1

Tax Benefits of a Roth vs Traditional IRA:

Answer 1

Roth IRA: Tax Free
Traditional IRA: Tax Deferred

Question 2

Age requirements of a Roth vs Traditional IRA:

Answer 2

Roth IRA: None
Traditional IRA: None

Question 3

Income Requirements for a Roth vs Traditional IRA:

Answer 3

Roth IRA: Single: <$144,000 , Married: <$244,000
Traditional IRA: None

Question 4

Withdrawal Taxes for Roth vs Traditional IRA:

Answer 4

Roth: None
Traditional: Yes

Question 5

Early Withdrawal penalties for Roth vs Traditional IRA:

Answer 5

Roth: None on contributions, 10% on earnings
Traditional: Under 59 ½ y/o, 10% penalty + income taxes

Question 6

Required minimum distribution for Roth vs Traditional IRA:

Answer 6

Roth: Yes, beginning at age 72
Traditional: Yes, beginning at age 72

Question 7

Max Yearly Contribution to Roth vs Traditional IRA:

Answer 7

Roth: $6,000
Traditional: $6,000

Question 8

What is a spousal IRA?

Answer 8

• For a nonworking spouse, can be Roth or traditional
• Must be married and file joint income taxes
• IRAs can not be held jointly

Question 9

What is an IRA rollover?

Answer 9

• Used for rollovers from previous employer’s 401(k)
• Must rollover within 60 days of distribution
• Better to have direct transfer

Question 10

What is a backdoor Roth IRA and how does it work?

Answer 10

A strategy to work around the yearly income limits by the IRS

• Convert funds from your traditional IRA to a roth IRA
• Pay taxes when you convert
• No limit on how much money you can convert
• Can do the same trustee transfer
• You are paying taxes on your retirement savings now instead of later
• You need to wait 5 years to bypass before withdrawing from the now roth IRA

Question 11

What is the three-legged stool approach to retirement planning?

Answer 11

Retirement Income Security
Supported by:
Social Security
Employer Sponsored Plans
Personal Savings

Question 12

What is the primary reason annuities are purchased for?

Answer 12

• The primary reason that annuities are purchased is to supply retirement income. An annuity is the opposite of life insurance that pays when you die.
• An annuity pays while you are alive.

Question 13

An Annuity is an Appropriate Risk Management Tool For:

Answer 13

• Retiring couple ensure a certain level of income throughout their retirement years
• Death of a single parent life insurance settlement to support very young children
• Newly widowed individual needs to withdraw from savings to maintain a certain standard of living

Question 14

3 Elements That Make Up A Payment to an Annuitant (person receiving payments):

Answer 14

1. Interest earnings
2. Partial liquidation of principal
3. Survivorship benefit – for contracts
   guaranteeing payments for as long
   as an annuitant lives

Question 15

What is a fixed annuity?

Answer 15

• Benefit is expressed in terms of a stated dollar amount based on a guaranteed rate of return
• Benefit may be higher than the minimum amount guaranteed in the contract if interest earnings, expenses and /or mortality experience is better than what is assumed

Question 16

What is a variable annuity?

Answer 16

• The annuity unit fluctuates with the performance of a specified portfolio of investments
• May not be best suited for needs of retirees because they need a predictable income flow

Question 17

What is the purpose of a variable annuity?

Answer 17

-Purpose is to provide an inflation hedge by maintaining real purchasing power

Question 18

Annuity payments may be:

Answer 18

• Only during the lifetime of the
  annuitant
• Guarantee a certain number of
  payments
• Based on 2 or more lives

Question 19

What are the types of annuities?

Answer 19

1. Annuity Certain
2. Straight Life Annuity
3. Joint & Survivor Annuity

Question 20

What is an Annuity Certain?

Answer 20

Payable for a specified period of time without regard to death or life of the annuitant

Question 21

What is a Straight Life Annuity?

Answer 21

Annuity that pays benefits only during the lifetime of the annuitant

Question 22

What type of annuity pays the highest amount of lifetime income for each dollar spent?

Answer 22

Straight life annuity
- Suitable for person who needs maximum lifetime income & has no dependents or has provided for them through other means
- The older an annuitant is when benefits begin, the greater
the size of the payments

Question 23

What is a joint & survivor annuity?

Answer 23

Based on the lives of 2 or more annuitants
* Annuity payments will continue as long as either annuitant is alive
* Some contracts pay the full amount, some contracts pay ⅔ or ½ of the original amount when the first annuitant dies

Question 24

What is an immediate annuity?

Answer 24

Benefits begin as soon as the annuity is purchased

Question 25

What is a deferred annuity?

Answer 25

Benefits are deferred until some time in the future; a particular time may or may not be specified

Question 26

What is an equity-indexed annuity?

Answer 26

The insurance company credits you with a return that is based on the performance of a stock-market index such as the S&P 500

Question 27

What is the annuity exclusion ratio?

Answer 27

The fraction of each annuity payment that can be excluded from income taxation

Question 28

How do you calculate the annuity exclusion ratio?

Answer 28

Original Investment / Total Annuity Benefits to be Received = % excluded from taxation

Question 29

Investors can invest in a wide variety of annuities and can also use different annuity settlement options to meet specific retirement needs. For each of the following retirement objectives, identify either (1) a specific annuity or (2) an annuity settlement option that can be used to meet the objective. Treat each situation separately. A) Jose, age 35, is a sales representative and plans to retire at age 67. His monthly income varies. He would like to invest in an annuity that allows him to change the frequency and amount of premium payments.

Answer 29

Jose should purchase a flexible premium deferred annuity, which allows changes in the frequency and amount of premium payments. The flexible premium annuity can be either a fixed annuity or a variable annuity.

Question 30

Investors can invest in a wide variety of annuities and can also use different annuity settlement options to meet specific retirement needs. For each of the following retirement objectives, identify either (1) a specific annuity or (2) an annuity settlement option that can be used to meet the objective. Treat each situation separately. B) Nancy, age 67, plans to retire in six months. She has $200,000 in a savings account. She would like to receive lifetime monthly income that is guaranteed.

Answer 30

Nancy should purchase a fixed annuity and select a life income annuity option that guarantees her a lifetime income regardless of how long she lives. Depending on her needs and objectives, the life income option can be selected with a certain number of guaranteed payments.

Question 31

Investors can invest in a wide variety of annuities and can also use different annuity settlement options to meet specific retirement needs. For each of the following retirement objectives, identify either (1) a specific annuity or (2) an annuity settlement option that can be used to meet the objective. Treat each situation separately. C) Jennifer, age 63, plans to retire in 90 days. She has $100,000 to invest in an annuity and would like to receive lifetime monthly income to supplement her Social Security benefits. However, she is concerned that she might die before she receives back the amount invested.

Answer 31

Jennifer should select a life annuity income option with either an installment refund feature or a cash refund feature. Under the installment refund option, if the annuitant dies before receiving total income payments equal to the purchase price of the annuity, the payments continue to a designated beneficiary until they equal the purchase price. Under the cash refund option, if the annuitant dies before receiving total payments equal to the purchase price of the annuity, the balance is paid in a lump sum to the beneficiary.

Question 32

Investors can invest in a wide variety of annuities and can also use different annuity settlement options to meet specific retirement needs. For each of the following retirement objectives, identify either (1) a specific annuity or (2) an annuity settlement option that can be used to meet the objective. Treat each situation separately. D) Fred, age 70, recently retired and has $50,000 to invest for additional income. He wants the retirement benefits to be protected against the risk of inflation.

Answer 32

Fred should purchase a variable annuity, which is designed to provide an inflation hedge after retirement.

Question 33

Investors can invest in a wide variety of annuities and can also use different annuity settlement options to meet specific retirement needs. For each of the following retirement objectives, identify either (1) a specific annuity or (2) an annuity settlement option that can be used to meet the objective. Treat each situation separately. E) Janice, age 75, is a widow with no dependents who needs additional retirement income. She has $25,000 to invest in an annuity. She wants to receive the maximum amount of monthly annuity income possible.

Answer 33

Janice could consider the life annuity option with no refund. No additional payments are made after the annuitant dies. A life income option with no refund pays the highest amount of periodic income payments because it has no refund feature. However, because of the risk of forfeiting the unpaid principal, if death occurs early is not appealing, relatively few annuity purchasers elect this option. However, the amount of funds in this case is limited ($25,000). Because of the small amount available, a substantial amount of income cannot be generated. As an alternative, she could have the funds paid out over a specified period of years based on her life expectancy.

Question 34

Investors can invest in a wide variety of annuities and can also use different annuity settlement options to meet specific retirement needs. For each of the following retirement objectives, identify either (1) a specific annuity or (2) an annuity settlement option that can be used to meet the objective. Treat each situation separately. F) Kathy, age 32, would like to invest in the stock market, but she is conservative and risk averse. She would like to participate in any stock market gains, but she also wants to protect her principal against loss.

Answer 34

Kathy could consider a fixed-indexed annuity. A fixed-indexed annuity is a fixed, deferred annuity that allows the annuity owner to participate in the growth of the stock market and also provides downside protection against the loss of principal and prior interest if the annuity is held to term.

Question 35

What are the "3 stupid annuity moves" as detailed in the WSJ article?

Answer 35

No. 1: Choosing the wrong kind of annuity No. 2: Not considering a deferred annuity No. 3: Not choosing your insurer carefully Consider alternatives, too