Understanding Annuities

With the number of defined benefit pension plans decreasing, and changes to Social Security, individuals are finding that more of the retirement savings responsibility has fallen on them. As a result, individuals are looking at a variety of alternatives for their retirement savings. Annuities are becoming more and more popular as one of those alternatives.

Agenda What is an Annuity Types of Annuities Deferred Annuities Immediate Annuities Qualified vs Non-Qualified Parties to an Annuity Death and Distribution Taxation of Annuities Why Annuities

What is an Annuity By definition: An annuity is a series of equal payments at regular intervals It is a contract issued by an insurance company. For a purchase payment or series of payments, the company can at some point in time provide a series a payments for a period of time as agreed upon in the contract. Today, annuities have evolved from a simple series of payments into a robust market of growth and income vehicles

Types of Annuities Deferred Immediate Fixed Fixed Index Variable Deferred Income

Types of Annuities 2 Phases to An Annuity Contract Accumulation Phase Deferred Annuity Income Phase Income (Immediate) Annuity

Types of annuities Annuities can be Deferred or Immediate A Deferred Annuity is one in which payments begin more than 1 year after issue An Immediate Annuity is one in which payments begin within 1 year of issue

Types of annuities A Deferred Annuity may be purchased with a single premium payment or with a series or flexible payments. By definition, Immediate Annuities are purchased with a single premium payment.

Deferred Annuities Fixed Variable Fixed Index

Fixed Annuities Interest Crediting Liquidity Riders Charges

Fixed Annuities interest crediting Provides a Minimum Guaranteed Rate Provides a Specified Rate for a Set Period of Time After Specified Period a Renewal Rate is Declared at the Guaranteed Minimum Rate or Greater The Insurance Company bears the Risk for the Performance of the Account

Fixed annuity liquidity options Full Surrender Partial Withdrawal Systematic Withdrawal Provides a specified amount at regular intervals until the account value is exhausted Withdrawals not subject to surrender charges May offer a percentage that can be withdrawn without incurring any surrender charges Annuitization

Fixed Annuity Riders Bonus Living Benefit Rider Guaranteed Withdrawal Benefit* *Rider charges may apply

Fixed Annuities: Charges Surrender Charges – In the early years of the contract Generally a percentage of premiums paid In general declines each year May be contract based or premium based withdrawals made in excess of any free withdrawal amount. Generally not applied to annuitization, or systematic withdrawal* Market Value Adjustment – In addition to the surrender charge May increase or decrease the surrender charge amount Increase if prevailing interest rates are higher than when contract issued Decrease if prevailing interest rates are lower than when contract issued Contract Fee – A flat dollar amount that may be charged annually Premium Tax- A tax some states charge on annuities. Insurance company may charge contract at issue, annuitization or at death of the contract owner, or surrender *Provided the systematic withdrawal is within the free withdrawal amount

Who Purchases Fixed Annuities CD Type Saver Conservative – Risk Averse Wants to know exactly what they will earn

Variable Annuities A Hybrid between an Insurance Product and an Investment Product Investment Options Features and Benefits Optional Riders

Variable annuities Features Investment Options Investment Strategies Death Benefit Optional Riders Share Classes Liquidity Options Fees and Expenses

Variable Annuities features Performance Based on Underlying Investment Options May Have a Fixed Account Tax Free Switches between Investment Options Investment Strategies Death Benefits Optional Features Share Classes Charges and Fees

VA Investment Options Offers a Wide Variety of Investment Options known as Subaccounts May be similar to a mutual fund offering But you are not investing directly in that fund May include managed portfolios, exchange-traded funds, index or index linked portfolios among other strategies The investor bears all the risk for the underlying performance May also offer a fixed account Exchanges between subaccounts and or the fixed account are tax free

VA Investment strategies Dollar Cost Averaging Portfolio Rebalancing Interest Sweep

VA Dollar Cost Averaging Involves Periodic Investments into the Annuity Over Time Investment Amount remains the same Underlying Share Price Fluctuates Average Price Per Share will be lower than if you tried to “time” the market But more when the price is low, buy less when price is high

VA Portfolio Rebalancing At specified points in time, the contract will automatically rebalance to a set asset allocation. In rebalancing, the contract will automatically sell in those subaccounts that are “high” and purchase in the subaccounts that are “low”

Va interest sweep If the contract offers a fixed account, monthly any interest earned in the fixed account will be swept from the fixed account and invested in one or some of the investment accounts, dollar cost averaging into the account(s)

VA Death Benefits Basic – Will return the greater of the contract value or premiums invested in the event of death Enhanced – will lock in some gains of the contract at specified times to pay in the event of death, or will guarantee a specific growth rate on premiums to be paid only in the event of death

VA optional features / riders Guaranteed Withdrawal Benefit (GWB) Guaranteed Minimum Accumulation Benefit (GMAB) Guaranteed Minimum Income Benefit (GMIB) Long Term Care Rider Terminal Illness Rider May be selected for an additional cost

VA GWB May be a lifetime withdrawal benefit Guarantee a return of purchase payments over a specified number of years or over the life time of the owner or lifetimes of the owner and spouse through a series of withdrawals Withdrawals in excess of the guarantee may impact the guarantee May limit investment options

VA GMAB Guarantees the return of purchase payments or a higher stepped up value at the end of a specified waiting period regardless of investment performance If contract value is below the amount, the contract value will be increased At the end of the specified period, rider may be renewed, if not renewed contract value becomes subject to market risk Contract may limit investment options

VA GMiB Guarantees a lifetime income stream when the contract is annuitized after a specified waiting period Income amount is the greater of a specified compounded rate, or a contract value at a specified point in time – current amount, highest anniversary value etc. Must be annuitized Regular annuitization may produce a higher income stream May limit investment options

VA Long Term Care Rider A Long Term Care rider will accelerate the death benefit to pay for long-term care. Benefits can be used for home health care, assisted living, a nursing home, adult day care or other qualifying services.

VA Terminal Illness Rider Also called an Accelerated Death Benefit Rider Provides access to the owner to access all or a portion of the death benefit for varipous expenses in the even the owner is diagnosed with a terminal illness May define the life expectancy timeframe

VA Share Classes Many variable annuities will offer varying fee and surrender charges known as share classes. Agent compensation arrangement may also vary based on share class. B – Generally lower cost and in general offer a longer surrender charge period (generally 7+ years) L – A shorter surrender charge with higher fees. (Generally 3 – 4 years) C – Generally fully liquid. Highest contract fees Bonus – If a bonus on premium deposits (May limit to first 12 months), surrender charge will be long (8-9+ years), and high charges which in effect recoup the bonus over time

Va liquidity options Full Surrender Partial Withdrawal Systematic Withdrawal Provides a specified amount at regular intervals until the account value is exhausted Free Withdrawal May offer a percentage that can be withdrawn without incurring any surrender charges Annuitization May be fixed or variable

va Charges Mortality and Expense Risk Charge- Compensates the insurance company for the insurance risks and other costs it assumes under the annuity contract. This charge is deducted from the value of the subaccounts. Administrative and Distribution Fees – Covers the costs associated with the servicing and distributing the annuity

Va charges Contract Maintenance Fee –An annual flat fee charged for record keeping and administrative purposes Underlying Subaccount Fees and Expenses – A fee charged to the subaccounts. Includes the management fees that are paid to the investment adviser responsible for making investment decisions affecting the subaccouts

VA Charges Contingent Deferred Sales Charge – An early termination charge when the annuity is surrender during the early years of the contract. Generally a percentage of the amount withdrawn and declines over time Optional Rider Charges – Some of the optional riders if selected may have separate charges associated with them.

Who Purchases variable annuities Willing to take More Risk in Exchange for the Opportunity for More Return

Fixed Index Annuities Features Crediting Strategies Riders Liquidity Options Bonuses Fees and Expenses

Fixed Index Annuities FIAs are a combination of many of the desired features or both Fixed and Variable Annuities: Potential Growth Based on the Performance of an Index Protection from Market Losses Guarantee of Principal May be subject to surrender charges Locked in Interest Earnings at Various Points in Time Provide a Hedge Against Inflation Interest is typically capped or subject to a margin

Fixed index annuities Crediting Strategies FIA Riders Liquidity Options Bonuses Fees and Expenses

How FIAs Work Definitions: Market Index Indexing Method Index Term Participation Rate Cap Rate Spread Rate (Margin Rate) Floor Uncapped Strategy

Definition: Market Index An index that measures the price changes of a large, overall market, such as the S&P 500.

Definition: Indexing Method The calculation applied to the change in the index to determine the interest crediting rate applied to the annuity. . If the Index has no increase or suffers a loss, the interest crediting will be zero. Dividends are excluded. Examples: A Point to Point Monthly Sum Monthly or Daily Averaging Annual Reset (Ratchet) High Water Mark

Definition: Index Term The period over which index change is measured and the index-linked interest is calculated and credited to the annuity.

Definition: Participation Rate The participation rate determines how much of the increase in the index will be credited to the annuity. It is expressed as a percentage – for example 60%. If the increase in the index is 10%, 6% will be credited

Definition: Cap Rate The Cap Rate is the maximum amount of interest the annuity can earn. Example: Change in Index = 10% Participation Rate = 60% Cap Rate = 5% Amount credited to the annuity = 5%

Definition: Spread Rate The Spread or Margin rate is an amount of interest that is subtracted from the change in Index. This fee may also be called an administrative fee and can be used separately or in conjunction to a cap or participation rate. Example: Change in Index = 10% Spread = 2% Amount Credited to the Annuity: 8%

Definition: Floor A contract may provide a floor. This is the minimum guaranteed interest rate that will be credited to the annuity. The floor is based on the claims paying ability of the issuing insurance company.

Definition: Uncapped Strategy This is a new type of strategy where there is no cap on the change in index rate paid. Often to participate in this type of strategy, the insurance company will require a specified amount to be invested in a fixed account.

FIA Interest Crediting Strategies Point to Point Monthly Sum Monthly or Daily Averaging Annual Reset (Ratchet) High Water Mark

Point to Point The change in the index is calculated from two points in time. Any change is impacted by any participation, cap or spread rate. The change is then credited to the annuity at the end of the crediting period and sets a new value for the annuity. Can be an Annual Point to Point or a Term End Point. A Term End Point is the same as an Annual Point to Point with the interest change credited after the end of a certain term typically 3 – 10 years.

Example: Point to Point

Monthly Sum The change in the index is calculated each month and both positive (impacted by participation rate, cap rate or spread rate) and negative changes (not reduced by cap rate) are added up at the end of the term. If the sum is positive, it will be credited to the annuity at the end of the term. If the change is negative, no interest is credited, but the annuity value is not reduced.

Example: Monthly Sum

Monthly or Daily Averaging The value of the index is recorded on a daily or monthly basis, and the index-linked interest is calculated as the difference between the average of the daily or monthly values over the course of the term and the index value at the start of the term, subject to participation rate, cap rate and or spread rate.

Example: Monthly or Daily Averaging

High Water Mark The index value is recorded at various times over the course of the term (usually on annual anniversaries). Interest is then based on the difference between the highest index value and the index value at the start of the term. Interest is credited at the end of the term.

Example High Watermark

FIA Riders Death Benefit Long Term Care Guaranteed Lifetime Withdrawal Benefit

Riders: Death Benefit Basic – Pays full account value at death Enhanced Annual Increase – Guarantees death benefit grows by a specified percentage each year regardless of performance May combine an income stream with Annual Increase

Riders: Long Term Care Provides the flexibility of having access to a portion of the annuity’s principal to pay for long term care expenses without any applicable surrender charges.

Riders: Guaranteed Lifetime Withdrawal Benefit Provides an annual withdrawal throughout the owner’s lifetime, without the need to annuitize the contract Payments continue even if account value decreases or is zero

FIA liquidity options Full Surrender Partial Withdrawal Systematic Withdrawal Provides a specified amount at regular intervals until the account value is exhausted Free Withdrawal May offer a percentage that can be withdrawn without incurring any surrender charges Annuitization

Liquidity: Annuitization Annuitization: A systematic liquidation of principal and interest. Life Only Life and Period Certain Life and Refund Joint Life Options Period Certain

Bonuses Premium Guaranteed Lifetime Withdrawal Benefit Annuitization

Fees and Expenses Surrender Charges Market Value Adjustment Optional Benefit Charges Margin, Spread or Administrative Fee Maintenance Fee

Fees: Margin, Spread, Administrative The Spread or Margin rate is an amount of interest that is subtracted from the change in Index. The key difference between a Spread and other types of fees is that a Spread is not charged to a policy if there is not enough crediting performance in the contract to cover the cost of the spread. A Spread may also be called an “Administrative Fee” and can be used separately or in conjunction to a cap or participation rate.

Immediate Annuities Fixed – Pays a Fixed Dollar Amount Variable – Pays a fixed number of units. Actual dollar amount received varies by value of a unit

Annuitization Options Fixed Period Life Only Life and Period Certain Life and Refund Feature Joint Life

Annuitization: Period Certain Will pay the entire amount of the contract over a set period of time regardless of whether or not the annuitant lives to the end of the term. If the annuitant dies prior to the end of the term, the balance of payments will be made to a designated beneficiary.

Annuitization: Life Only Payments are made as long as the annuitant is alive. At death payments cease. No guarantees. Pays the highest income amount.

Annuitization: Life and Period Certain Payments will be made for a specified time or for the annuitant’s lifetime, whichever is longer. If the annuitant dies prior to the specified time person, payments will continue to a designated beneficiary until the specified period is over.

Annuitization: Life and Refund Payments will be made for the life of the annuitant. If the annuitant dies before the original premium has been paid out, the balance will be paid to a designated beneficiary. Can be lump sum or installments depending on the contract options.

Annuitization: Joint Life Payments will be calculated and made over 2 lives. The amount paid to the survivor may be 100% , 67% or 50%. May also add a guarantee such as period certain or refund if contract offers.

Deferred Income Annuities Annuitizes at a Future Point in Time Provides a future annuitization amount today for an income in the future. Future payout amount is guaranteed Similar to what a defined benefit plan does Risk is on the Insurance Company to provide the future amount

Tax status of Annuities Qualified Non-Qualified

Types of Annuities: Qualified Receiving Special Tax Treatment Under Code Sections: 401 403 408 457 In general purchased with pre-tax money

Types of Annuities: Non-Qualified NOT receiving Special Tax Treatment Under Code Sections 401,403,408,457 Purchased with After Tax Dollars

Parties to an annuity Insurance Company Owner Annuitant Beneficiary

Parties: Insurance Company Issues the Contract Responsible for any contractual guarantees Allocated premium as instructed or prescribed Provides all contract information

Parties: Owner The “Boss” of the Contract Makes all the Decisions Regarding the Annuity Names the Annuitant and Beneficiary

Parties: Annuitant The Annuitant is the Life Upon Which Benefits are Calculated May or May not be the Owner

Parties: Beneficiary Receives any Proceeds in the Event of the Owner’s (and some times, Annuitant’s)Death In general can be changed at any time

Death and Distribution Before Annuitization After Annuitization

D&D Before Annuitization Spouse Beneficiary Can step in as the new owner Non-Spouse Beneficiary Entire value of the contract must be distributed within 5 years of death Within 1 year of death may begin a lifetime income stream

D&D After Annuitization Once the contract has been annuitized, the annuitization option will dictate what if any death benefit is payable

Annuities: Taxation The Power of Tax Deferral Basic Rules: Deferred Annuities TEFRA Immediate Annuities Qualified Non-Qualified

Tax Deferral Annuities are not taxed until they are removed from the contract* Therefore the deposit earns interest, the interest grows interest and the money that would have gone to taxed earns interest It will grow faster than in a taxable vehicle Once money is withdrawn, ordinary income taxes are accessed on any money that was not previously taxed In addition to taxes, a 10% premature distribution penalty tax may apply to the taxable portion of the distribution * The annuity will become immediately taxable if it is assigned as collateral, owned by a non-natural person (exceptions apply) or another prohibited transaction applies – See IRC Sec. 72)

Qualified vs Non-Qualified A qualified annuity is generally taxed with pre-tax money. Therefore all withdrawals would generally taxable. Any after tax deposits would not be taxed. In the case of a Roth IRA, if the rules are followed, withdrawals may come out tax free In addition to Ordinary Income Taxes a 10% federal tax penalty may apply

Qualified 10% Penalty 72(t) In addition to Ordinary Income Taxes, a 10% penalty may apply unless: Owner attains age 59 ½ Owner dies Owner becomes disabled Payment is part of a Series of Substantially Equal Periodic Payments Owner is age 55 and separated from service (Qualified employer plan) Qualifying Medical Expenses Payments to an alternate payee under a QDRO Health Insurance Premiums if Unemployed Higher Education Expenses First Time Home Purchase

Qualified vs non-qualified Non-Qualified Annuities are purchased with after tax money. The amount of the withdrawal that represents after tax money is not taxed In addition to Ordinary Income Taxes, a 10% federal tax penalty may apply

Non-Qualified 10% penalty In addition to Ordinary Income Taxes, a 10% penalty may apply unless: Owner attains age 59 ½ Owner dies Owner becomes disabled Payment is part of a Series of Substantially Equal Periodic Payments Immediate Annuity

TEFRA August 13, 1982 Created LIFO – Last In, First Out Interest comes out first Once all interest is out, Investment comes out

Immediate Annuity Taxation A systematic liquidation of principal and interest Part of each payment is principal, part is interest Qualified – Generally all taxable Non-Qualified – Determine Exclusion Ratio That portion that represents after tax investment in contract and is not taxable Formula: Investment in the Contract Expected Return

Why Annuities Benefits Who Purchases Annuities

Annuity benefits Tax Deferred Growth An Income Stream Guaranteed for Life* Various Living and Death Benefit Features * If a life contingent option is chosen. All guarantees are based on the financial strength and claims paying ability of the issuing insurance company.

Who Buys Annuities Information provided by: 2013 Survey of Owners of Individual Annuity Contracts Conducted by: The Gallup Organization Matthew Greenwald & Associates For: The Committee of Annuity Insurers

Buyer Demographics Average age at purchase: 51 Average current age: 70 86% purchased prior to age 65 Average current age: 70 51% Female 65% Retired

Buyer Occupations Support Staff: 12% Blue Collar / Service Worker: 14% Foremen or Manager: 15% Business Owner or Company Officer: 15% Professional (Physician, Attorney, Teacher): 34%

Why Purchase 90% Safety 86% Tax Deferral 87% Guarantees

Annuity Uses 84% Retirement Income 87% Financial Cushion for Living Too Long 79% Avoid Being a Burden to Children 73% Financial Protection for Investments 73% Emergency Fund in the Event of Catastrophic Illness or Nursing Home Care Need

4 Steps for Presentation Success Use Comparison Selling Use terms that your client will understand and give them a frame of reference Explain the Advantages Understand your client’s needs and demonstrate how the annuity can be a solution Handle Objections Before You Get Them Full transparency, help your client understand your product Close the sale!