Variable Annuities Lecture Review

Flashcards covering the vocabulary and concepts of variable annuities, including phases, risks, annuitization structures, and taxation rules.

Variable annuities

Non-qualified retirement plans used to provide lifetime income in retirement that allow unlimited contributions and make payments that fluctuate until death.

Premium payments

The contributions made to an annuity contract, which can be provided as periodic payments or as a lump sum.

Immediate annuity

An annuity where retirement income begins soon after the insurance company receives a lump sum payment.

Annuity bonus

A credit offered by some insurance companies toward the initially funded contract, often as a match to the initial premium payment.

Deferred annuities

Annuities designed to build value over time through an accumulation period before income begins.

Accumulation phase

The period when money is contributed and invested into a separate account before entering the distribution phase.

Separate account

An account kept distinct from the insurance company’s general assets and capital where an investor’s contributions are held and invested.

Accumulation units

A way to measure an investor’s interest in the separate account and track their basis during the accumulation phase.

Death benefit

A guarantee during the accumulation phase where a beneficiary receives the greater of the owner's basis or the current account value if the owner dies before annuitizing.

Mortality risk

The cost an insurance company faces when an account owner dies earlier than expected during the accumulation phase.

Expense risk

The risk that the insurance company’s operating costs, such as unexpected claims or regulatory costs, will rise.

M&E charges

Charges that average around $1.25\%$ annually to compensate insurers for mortality risk and expense risk.

Distribution phase

The phase when an investor begins taking money out of a variable annuity, either through a lump sum, withdrawals, or annuitization.

Annuitization

The process of giving up control and ownership of the separate account to the insurance company in exchange for guaranteed monthly payments for life.

Annuity units

The fixed number of units that accumulation units convert into at the time of annuitization; their value fluctuates based on separate account performance.

LIFO (Last In, First Out)

An IRS rule for non-annuitized distributions where growth is distributed and taxed first before the after-tax contributions (basis).

Exclusion ratio basis

A pro-rata taxation method for annuitized payments where each payment includes a portion of taxable growth and a portion of tax-free return of basis.

Assumed Interest Rate (AIR)

A conservative estimate of the separate account's projected growth used to determine if monthly payouts increase or decrease.

Straight life annuitization

An annuitization structure that pays the investor for life but stops payments and allows the insurer to keep remaining assets upon the investor's death.

Longevity risk

The risk to the insurance company that an investor lives longer than expected, requiring the insurer to continue payments for life.

Life with period certain annuitization

A structure that pays for life but guarantees payments to a beneficiary for a remaining set duration (such as $10$ years) if the investor dies early.

Joint with last survivor annuitization

A structure primarily used by married couples that pays two account owners until both have died.

Annuitant

The person, typically the original account owner, who receives the annuity payments.

Unit refund annuitization

A structure that pays for life and ensures the beneficiary receives any unrecovered basis as a lump sum or schedule if the annuitant dies early.

Qualified annuity

An annuity funded with pre-tax money rolled over from another qualified plan where all future withdrawals are fully taxable as ordinary income.

RMDs (Required Minimum Distributions)

Distributions that must start at age $73$ for qualified annuities, though they are not required for non-qualified annuities.