Bảo hiểm - Chapter 14: Annuities and individual retirement accounts

Chapter 14Annuities and Individual Retirement AccountsAgendaIndividual AnnuitiesTypes of AnnuitiesTaxation of Individual AnnuitiesIndividual Retirement AccountsIndividual AnnuitiesAn annuity is a periodic payment that continues for a fixed period or for the duration of a designated life or livesThe person who receives the payments is the annuitantAn annuity provides protection against the risk of excessive longevityThe fundamental purpose of an annuity is to provide a lifetime income that cannot be outlivedThe major types of annuities sold today include:Fixed annuityVariable annuityEquity-indexed annuityExhibit 14.1 How Tax Deferral WorksFixed AnnuitiesA fixed annuity pays periodic income payments that are guaranteed and fixed in amountDuring the accumulation period prior to retirement, premiums are credited with interestThe guaranteed rate is the minimum interest rate that will be credited to the fixed annuityThe current rate is based on current market conditions, and is guaranteed only for a limited periodA bonus annuity pays a higher interest rate initiallyThe liquidation period is the period in which funds are paid out, or annuitizedFixed AnnuitiesFixed annuity income payments can be paid immediately, or at a future date:An immediate annuity is one where the first payment is due one payment interval from the date of purchaseProvides a guaranteed lifetime income that cannot be outlivedA deferred annuity provides income payments at some future dateA deferred annuity purchase with a lump sum is called a single-premium deferred annuityA flexible-premium annuity allows the owner to vary the premium paymentsFixed AnnuitiesThe annuity owner has a choice of annuity settlement offersMost annuities are not annuitizedUnder the cash option, the funds can be withdrawn in a lump sum or in installmentsA life annuity option provides a life income to the annuitant only while the annuitant remains aliveA life annuity with guaranteed payments pays a life income to the annuitant with a certain number of guaranteed payments Fixed AnnuitiesAn installment refund option pays a life income to the annuitantIf the annuitant dies before receiving the total income payments, the payments continue to a beneficiaryA cash refund option is similar, but pays the beneficiary a lump sumA joint-and-survivor annuity pays benefits based on the lives of two or more annuitants. The annuity income is paid until the last annuitant diesAn inflation-indexed annuity option provides periodic payments that are adjusted for inflationVariable AnnuitiesA variable annuity pays a lifetime income, but the income payments vary depending on common stock pricesThe purpose is to provide an inflation hedge by maintaining the real purchasing power of the paymentsPremiums are used to purchase accumulation units during the period prior to retirement The value of an accumulation unit depends on common stock prices at the time of purchaseAt retirement, the accumulation units are converted into annuity units The number of annuity units remains constant during the liquidation period, but the value of each unit changes with common stock pricesExhibit 14.2 Examples of Monthly Income Annuity Payments from an Immediate Annuity, $250,000 Purchase Price, Male, Age 67Variable AnnuitiesA guaranteed death benefit protects the principal against loss due to market declinesTypically, if the annuitant dies before retirement, the amount paid to the beneficiary will be the higher of two amounts: the amount invested in the contract or the value of the account at the time of deathSome variable annuities pay enhanced death benefits Some contracts guarantee the principalSome contracts periodically adjust the value of the account to lock in investment gains. Examples include:A rising-floor death benefitA stepped-up benefitAn enhanced earning benefitVariable AnnuitiesVariable annuities contain the following fees and expenses:Investment management charge, for brokerage servicesAdministrative charge, for paperwork, etc.Mortality and expense risk charge, to pay forThe mortality risk associated with the death benefitA guarantee on the maximum annual expensesAn allowance for profit Surrender charge, if annuity is surrendered in the early years of the contractTotal fees and expenses in most variable annuities are highExhibit 14.3 Three Low-Cost Variable AnnuitiesEquity-Indexed AnnuitiesAn equity-indexed annuity is a fixed, deferred annuity that:allows the owner to participate in the growth of the stock marketA cap specifies the maximum percentage of gain that is credited to the contract provides downside protection against the loss of principal and prior interest earnings if the annuity is held to termThe participation rate is the percent of increase in the stock index that is credited to the contractInsurers use different indexing methods to credit excess interest to the annuity Equity-indexed annuities with terms longer than one year have a guaranteed minimum value at the end of the index periodTaxation of Individual AnnuitiesAn individual annuity purchased from a commercial insurer is a nonqualified annuityIt does not meet IRS code requirementsIt does not quality for most income tax benefitsPremiums are not tax deductibleInvestment income is tax deferredThe net cost of annuity payments is recovered income-tax free over the payment period, but the amount that exceeds the net cost is taxable as ordinary incomeTaxation of Individual AnnuitiesAn exclusion ratio is used to determine the taxable and nontaxable portions of the paymentsAnnuities can be attractive to investors who have made maximum contributions to other tax-advantaged plansIndividual Retirement AccountsAn individual retirement account (IRA) allows workers with taxable compensation to make annual contributions to a retirement plan up to certain limits and receive favorable income-tax treatmentTwo basic types of IRAs are:Traditional IRARoth IRATraditional IRAA traditional IRA allows workers to take a tax deduction for part or all of their IRA contributionsThe investment income accumulates income-tax free on a tax-deferred basisDistributions are taxed as ordinary incomeThe participant must have earned income during the year, and must be under age 70½For 2009, the maximum annual contribution is $5000 or 100 percent of earned compensation, whichever is lessWorkers over 50 can contribute up to $6000A full deduction for IRA contributions is allowed if:The worker is not an active participant in an employer’s retirement planThe worker’s modified adjusted gross income is below certain thresholds Traditional IRAThe full IRA tax deduction is gradually phased out as a person’s modified gross income increasesTaxpayers with incomes that exceed the phase-out limits can contribute to a nondeductible IRA A spousal IRA allows a spouse who is not in the paid labor force, or a low-earning spouse to make a fully deductible contribution to a traditional IRAFor 2009, the maximum annual IRA deduction for a spouse who is not an active participant is $5000 ($6000 if over 50)Distributions from a traditional IRA before age 59½ are considered an early withdrawal, and subject to a 10% tax penalty unless certain conditions apply, e.g., death or disabilityTraditional IRADistributions from traditional IRAs are treated as ordinary incomeAny nondeductible contributions are received income-tax freeA formula is used to compute the taxable and nontaxable portions of each distributionFor 2009, the required minimum distribution rules were temporarily waivedTraditional IRAs can be established at a bank, mutual fund, stock brokerage firm, or insurerThe IRA can be set up as either:An individual retirement accountAn individual retirement annuityIRA contributions can be invested in a variety of investmentsAn IRA rollover account is an account established with funds distributed from another retirement planRoth IRAA Roth IRA is another type of IRA that provides substantial tax advantagesThe annual contributions to a Roth IRA are not tax deductible The investment income accumulates income-tax freeQualified distributions are not taxable under certain conditionsContributions can be made after age 70½ Roth IRAs have generous income limitsA traditional IRA can be converted to a Roth IRAExhibit 14.4 Comparison of a Traditional IRA with a Roth IRAInsight 14.4 Retirement Income Calculator