Chapter 20: Annuities

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Chapter 20Annuities IRAs

• I. Individual Annuities a periodic payment
  that continues for a certain period or a lifetime
  of an annuitant.
• A. Annuity principle (not principal) risk
  of excessive longevity is pooled into a group.
  Payments are made out of
• Principle you put up
• Interest on principle earned
• Principle not used by others in the pool because
  they die early. (See exhibit 202)

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Chapter 20Annuities IRAs
B. Types of annuities 1. Fixed annuity During
liquidation period, the guaranteed payment
amount is fixed. During the Accumulation
period principle accumulates at a fixed rate of
interest but can be a single premium or a
series of premiums even a flexible premium
annuity a. Payment of benefits can start
immediately or be a deferred annuity. b.
Annuity settlement options cash lump sum of
all principle or installments for a certain
period or life time.annuitized or can be life
with guaranteed minimum no. of payments to
beneficiaries. - can have a joint survivor
annuity.

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Chapter 20Annuities IRAs

B. 2. Variable annuity pays up to lifetime
income but payments vary with stock prices.
a. Basic characteristics premiums invested
in common stocks monthly payment varies with
stock prices b. Guaranteed death benefit
if annuitant dies before liquidation period,
beneficiary receives the amount invested or the
value of the account which ever is greater. c.
Fees and expenses for 1. investment
management and 2. surrender charges and 3.
administrative fees and 4. mortality fees
associated with guaranteed death benefit and
excessive longevity. d. Investment
performance- like a mutual fund
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Chapter 20Annuities IRAs

I. 3. Equity-indexed annuity is fixed and
deferred but allows for participation in the
upside potential of stock market but a floor in
Principal. 1. Participation rate -
of the whole gain over the period of time of
the stock index 2. Cap on the
maximum percentage of gain max gain over the
period if stock market soarsprincipal amount of
annuity rises by only the cap rate.
3. Indexing method what market index its tied
to 4. Guaranteed minimum value even
if stock market falls drastically over the
accumulation period.
Dr. Pratt Finance 330 Louisiana Tech University
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Chapter 20Annuities IRAs

• Taxation of Individual Annuities
• 10 tax penalty if withdrawn before age 59.5
• Premiums not tax deductible, but interest income
  not taxed until received
• Best to take advantage of 401-k etc before using
  Deferred annuity. Also universal
• Life products may be better because they dont
  have the rule about 59.5 years of age

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Chapter 20Annuities IRAs

III. Individual Retirement Accounts annual
contributions of 3000 for retirement (4000 in
2005) A. Traditional IRA 1.
Eligibility requirements must have earned
income not just transfer payments, must be less
than 70.5 years old 2. Annual contribution
limits spousal IRA 6000 (8000 in 2005) 3.
Income tax deduction of traditional IRA
contributions even if making a contrib. to a
company sponsored retirement plan IF income is lt
64,000 for married couple filing jointly. 4.
Special phase-out rule for spouses 5. New tax
credit - 1000 extra tax credit if low income
(30,000 for couples)
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Chapter 20Annuities IRAs
6. Withdrawal of funds 10 penalty tax (extra)
for early withdrawal before 59.5see exceptions
on page 407. 7. Taxation of
distributions start drawingstart paying tax on
all distributions (principal plus interest).
8. Establishing a traditional IRA bank,
insurance company, brokerage firm, SL acts as
trustee 9. IRA investments CDs
stocks, mutual funds, gold coins, real estate is
more difficult. 10. IRA
rollover account from one retirement account
(say you cashed in your 401 k when you leave
employment) to an IRA created for the
purpose----make sure you dont receive the funds
directly constructive receipt

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Chapter 20Annuities IRAs

B. Roth IRA annual contributions NOT tax
deductible BUT draws or distributions are not
taxable (neither princ or interest!!!!!)
1. Income limits married filing jointly up
to 150,000 2. Conversion to a Roth
IRA if income is less than 100,000 per year can
convert existing traditional IRA.
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Chapter 20Review Questions at end of Chapter

Dr. Pratt Finance 330 Louisiana Tech University