Annuities and Federal Tax Considerations

Vocabulary flashcards covering the principles, phases, payout options, and tax considerations of annuities and retirement plans based on the lecture notes.

Annuity

A contract issued by a life insurance company designed to provide a steady stream of income, primarily to protect against outliving one's retirement savings.

Contract Owner

The person who purchases and owns the annuity contract, holding all rights such as naming the annuitant and beneficiary and determining when to annuitize.

Annuitant

The natural person whose life expectancy is used to determine distributions from the annuity; they are the individual who receives the lifetime payments.

Beneficiary

The person named in the contract to receive benefits if the owner or annuitant dies before annuitization or if the selected payout option offers residual benefits.

Accumulation Period

Also known as the pay-in phase, this is the time beginning with the initial premium payment during which money is paid in and grows on a tax-deferred basis.

Immediate Annuity (SPIA)

An annuity purchased with a single premium where income payments begin within one year of the date the contract was purchased.

Deferred Annuity

An annuity that begins paying benefits at a specified time in the future, at least one year after the issue date, often funded by a Single Premium (SPDA) or Flexible Premiums (FPDA).

Nonforfeiture Provision

A right given to the owner to the accumulation value in the contract if they surrender a deferred annuity during the accumulation period.

Surrender Charges

Also known as a back-end load, these are charges set by the insurer that diminish over time and are meant to discourage early surrender of an annuity.

Bailout Provision

An escape clause that allows the owner to surrender the contract without surrender charges if the current interest rate drops below a predetermined amount.

Annuitization

The process of converting the accumulated value into a stream of periodic income payments, marking the end of the accumulation period and the start of the annuity period.

Annuity Period

The pay-out or liquidation phase when the stream of income payments begins and the insurance company takes ownership of the funds.

Pure Life (Straight Life)

A payout option where income payments continue for the annuitant's life but any remaining balance at death is forfeited to the insurance company.

Life Income with Period Certain

An option providing guaranteed payments for life; if the annuitant dies before a specified time, the beneficiary receives income for the remaining balance of those years.

Life Income with Refund

An option guaranteeing income for life that pays any remaining principal value to a beneficiary upon the annuitant's death, either as a lump sum (cash refund) or installments.

Fixed Annuity

A product where the insurer assumes investment risk, offering a guaranteed minimum rate of return and level benefit payments from the general account.

Variable Annuity

An annuity funded by a separate account where the contract owner bears the investment risk, and values fluctuate based on the performance of subaccounts.

Indexed (Equity Indexed) Annuity

A fixed annuity offering a minimum guaranteed interest rate combined with an interest rate linked to the performance of a stock market index like the Standard & Poor’s 500 Index.

Market Value Adjusted (MVA) Annuity

A fixed annuity featuring interest rate guarantees for a specific period, where surrender values are adjusted upward or downward based on current interest rates.

Cost Basis

The owner's after-tax investment in a policy or annuity, representing the net out-of-pocket premium payments for tax purposes.

7-Pay Test

A test that limits the total amount paid into a life insurance policy during the first $7$ years to prevent it from being classified as a Modified Endowment Contract (MEC).

Modified Endowment Contract (MEC)

A life insurance policy that fails the 7-pay test, resulting in the loss of certain tax advantages and the imposition of a $10\%$ penalty on gains withdrawn prior to age $59\frac{1}{2}$.

Section 1035 Exchange

A provision allowing for the tax-free exchange of an existing life insurance policy or annuity for another, provided they meet IRS-approved criteria.

Exclusion Ratio

The calculation used to determine the percentage of an annuity payment that is considered a return of principal and is not subject to taxation.

Required Minimum Distribution (RMD)

The mandatory annual withdrawal from certain retirement plans that must begin by April 1st of the year after an individual reaches age $73$, to avoid a $25\%$ penalty.

ERISA (Employee Retirement Income Security Act)

A federal law setting minimum standards for pension plans in the private industry, requiring factors like non-discrimination and vesting.

Tax-Sheltered Annuity (TSA)

A qualified annuity plan for employees of public schools under Section $403(b)$ and certain nonprofit organizations under Section $501(c)(3)$.