Annuities

I Light a Cigar

I light a cigar and, as they say,

Review the scenes of another day.

In the drifting smoke, I see so much good;

I would not see sadness, if I could.

The fire lights up, as the dark drifts by.

The horses graze and the night birds cry.

Saddle horses, all as fine a string

As ever rode on the outside ring.

Horses long since gone come back to me,

Still sleek and fat and running free.

Then the night is through and the sun is high,

And fleecy clouds race across the sky.

Then I saddle and ride as we used to do,

The trail we will travel, I'll leave up to you.

We'll gather or brand, do what we may,

The call of the range is all that they say.

Then my cigar burns out, the ashes fall,

And I wake with a start to the modern call.

The noise of the truck and the smell of the car;

I leave the times that were, face the things that are.

Let's ride our top horse, make the long drive;

As long as we are living, let's be fully alive.

By Purdy J. Conrad

A Different Type of Insurance Product

As every knows, most people associate insurance with such things as death, disease or financial loss of some type. Most people do not want to deal with insurance topics and do so only because they realize it's prudent.

Annuities offer the agent an opportunity to deal in good news rather than bad. Although annuities are an insurance product, they deal with life rather than death or disability (although they may well be used to fund life during a disability).

"A Payment of Money"

Probably one of the most popular investments shown to older clients is annuities. The word annuity means "a payment of money." The insurance industry designed them to do exactly that. The deferred annuity was originally designed with income features in mind, but today they are looked at more for their ability to accumulate and less so for their ability to distribute income at a later date. It is generally felt that investment grade annuities are the best ones to use since safety is always important to the older investor.

Living Longer Than the Money

An annuity is often used as a safeguard against living too long. There is the fear on the part of retirees that they may outlive their savings. This is not an idle fear. People are living longer and longer. Most annuities have a 100 percent guarantee of principle as well as a minimum guaranteed interest rate. Normally, an annuity will pay more than that minimum guarantee. Annuities are an extremely useful estate-planning tool. Annuities are a form of capital that the individual cannot outlive, if annuitized for a lifetime income. However, these guarantees do little if enough money was not saved in the first place. A lifetime income of $100 per month will not be enough to live on. Obviously, the amount of the lifetime income needs to be sufficient to meet one's needs.

An annuity is simply a periodic fixed payment (if annuitized) for life or for a specific period of time, made to an individual or individuals by an insurance company. In the last few years, everyone from bankers to attorneys has acquired insurance licenses and are marketing annuities.

Tax-Deferred Status

Annuities have long been stressed for their tax-deferred status. That status could at some point, be changed by Congress. There have been proposals to remove the tax-deferred advantage of annuities from time to time. Should this ever happen, the effective date would most likely be the date on which the President signed the bill after passage by Congress.

Known for Their Stability

Annuities have long been noted for their stability. Finding a safe investment while still obtaining a decent interest rate is often the objective of investors. Due to the requirements the government mandated, the insurance industry came up with two safety features:

1) A guaranteed minimum interest rate built into the annuity contract, and

2) the reinsurance network.

Backed by the insurance companies' reserves, a reserve system for annuities was first introduced during the 1920s. This was the result of the United States government's use of annuities to fund government retirement plans. Unions also began the use of annuities about the same time.

The legal reserve system required then, and still requires today, that insurance companies keep enough surplus on hand to cover all cash values and annuity values that may come due at any given time. It is these reserves that enables the minimum interest rate guarantees to exist.

The reinsurance network was designed so that if there was a large run on the money in the insurance industry, no one particular company would be required to take the brunt of the loss. The insurance companies spread the risk out among all of the companies offering similar products.

Certainly much has happened since the 1920's and today we are hearing some dire predictions for the life insurance industry. However, clients are still relatively safe when investing in an insurance product. It is always best to market those products with the highest company ratings, of course. Hindsight is not much comfort when an inferior product has been used.

There is the possibility that the future will bring some changes in how commissions are paid on annuities. There is talk of spreading out the commission over the life of the annuity contract (during the surrender years, in most cases). Chances are that commissions will also become lower as companies try to stay competitive in the marketplace.

Annuity Sales Are Up

Annuity sales have nearly tripled in the last ten years. Tax deferred earnings, guaranteed interest rates, safety of principal, liquidity and freedom from probate proceedings are good reasons for looking towards annuities in record numbers. Also most annuities do not have any sales charges deducted.

Changes In Annuity Structure

As with all investments, it is possible that some changes may be mandated by Congress. The first time that annuities experienced such a change was the loss of the stepped-up cost basis (passing on all assets at death income-tax-free to the beneficiary or beneficiaries). The next loss was the ability to take out income-tax-free withdrawals on a first-in-first-out basis (usually written as FIFO) up to the amount of the total premiums paid in. This allowed an individual to first withdraw the principal rather than the interest earnings, which meant a tax savings since the principal had already been taxed. At that time, many people predicted the fall of consumer interest in annuities, but that did not come true. Consumers continued to purchase annuities. The third blow came when the Internal Revenue Service (IRS) acquired the ability to impose a 10 percent penalty on all partial withdrawals prior to the age of 59 1/2. Again, it was predicted that annuities would no longer generate consumer interest. Still consumers continued to purchase annuities, despite the 10 percent penalty for early withdrawal that was imposed by Congress.

If other legislation occurs that affects annuities, chances are that there will again be predictions of declining consumer interest. However, insurance companies report that a large number of their clients do not seem to realize that their annuities are being penalized. For example, few people report that the tax-deferred status was a major selling point. The companies are fairly certain that their agents do advise them of this fact. After all, it is a major selling point. It is likely that most consumers simply did not fully understand the concept of tax-deferred vehicles and secondly did not purchase the annuities on the basis of that feature.

Filling An Investment Need

Today's investors are a mixture of those seeking return regardless of risk down to those seeking security regardless of return. Of course, the middle of the road is usually recommended: some risk and some security with most investments falling between the two.

Annuities fill an investment need. They supply that "middle of the road" investment offering a decent return while maintaining security of principal. Annuities currently offered are second, third and even fourth generation products. They offer creativity and flexibility. There is no individual annuity contract that is right for everyone, but there are enough variations available so that every person can find the right one for them.

Checking Out the Insurance Company Offering the Annuity

The average mature buyer seems to be looking for security, not a gamble. Most agents work only with companies that they personally feel secure with. Sometimes, however, the agent may fail to see clauses in the annuities that may cause problems later on. Annuities are certainly safety-oriented products as a whole and these are simply points that an agent will want to check out as a matter of caution:

1) As with any insurance company, make sure that the company itself is financially strong. Although it is unlikely that any investor would loose even with the financial failure of the company, no agent wants to be in the middle of their clients and a failing company.

2) Check out any charges that may apply. Most annuities do not have administrative charges, but some do. These are mostly long term investments so the consumer should expect to leave their funds for a period of time. However, some companies do have much longer surrender periods than others. The severity of the surrender charges must be considered. Each agent wants to ask: how many years at what percentage? That is also a question that the consumer is likely to ask.

3) Withdrawal provisions are often thought to be guaranteed in an annuity. While most are, some are not. Typically, a yearly 10 percent free withdrawal is allowed from the second policy year on. Some may allow a withdrawal in the first year. Others may have no free withdrawal provision at all.

4) After safety, the interest rate paid is always a primary concern for consumers. While the rate should be competitive, it should never be the primary focus. When an agent has selected a particular company for a variety of reasons, it is important that they fully discuss those reasons with the consumer. Otherwise, another agent may sway the consumer with a higher interest rate, but less safety or other desired features.

5) The history of a company is one of the best indicators there is when it comes to performance. Of course, any company can change its philosophy for better or worse. Most consumers are likely to want written guarantees rather than projected expectations based on past history. Even so, it is a good indicator of future performance.

6) Annuities often carry special provisions or features. These can range from special surrender options to specific medical problems to frequent withdrawal clauses. It is important that an agent understand any features unique to his or her product.

As with all insurance or investment products, the salesperson should have thoroughly read the entire contract and understood all of its provisions.

Appreciating An Annuity For What It Is

There was a time when many agents were careful not to mention the words "life insurance" when presenting an annuity product. As a result, many people have thought that an annuity was essentially a Certificate of Deposit. The major differences were not always discussed or disclosed by the selling agent. That was unfortunate since those major differences were what made the annuity a sound investment.

Although an annuity is, in a true sense, the opposite of life insurance, it is still an insurance product. Life insurance is designed to pay at death; an annuity is designed to pay during life.

Per Stirpes

Besides the safety offered by annuities, there are estate advantages that should not be overlooked. If properly set up an annuity will eliminate the delays and costs of probate. The annuity gives the owner of the contract control of his or her annuity assets through restrictive beneficiary designations. For instance, by adding the words "per stirpes" (which is Latin for "through the blood") to the beneficiary designation, the owner's annuity will never be distributed outside of his or her own bloodline even if the beneficiary has died before the owner. "Per stirpes" is sometimes referred to as an in-law avoidance clause for this reason.

Privacy

It is always possible to restrict the ways in which a beneficiary may receive the annuity funds. It may be set up in a variety of ways, as the contract owner sees fit. Also, an often overlooked feature of an annuity is the privacy it affords. Only the insurance company and the beneficiary knows what the conditions of the contract are. This privacy benefit is available in life insurance policies as well as annuities.

Beneficiary-Designated Money

In some situations, Social Security benefits may be increased when funds are transferred to an annuity since annuity accruals are not minifying factors the way alternative investments may be. Many states also consider the annuity to represent what is called "beneficiary-designated money." Under such a definition, this investment may be much more difficult to attach in some states in the event of any future litigation which might occur. It is necessary to seek legal council in your particular state for details.

Changing Investment Avenues

We are seeing more people use annuities as an investment. Many of these investors had previously used such vehicles as mutual funds. While mutual funds have been and still are a major investment area, we are seeing older investors shy away from the risk they perceive to be there. This seems to be the case especially as investors begin to age and realize how vulnerable they are to risk.

Lipper Analytical Services of Denver, Colorado, which monitors mutual funds and variable annuity performances, stated that a review of fixed income mutual funds and equity mutual funds show that they have under performed when compared to similar groups in variable annuities. In fact, almost every major mutual fund complex is now in the variable annuity business.

Three Basic Annuity Types

There are three basic types of annuity contracts:

1) The Immediate Annuity, where one puts in a lump sum of money and then immediately begins collecting payments from it. There are variations from company to company on how this may be collected. Some annuitants may choose to collect only the interest earned while others may actually decide to annuitize and collect both interest and principal. Although payments to the annuitant may vary, typically the annuitant receives them monthly.

2) The Deferred Annuity, where one large deposit is made, but payments are postponed for some future date. As the name implies, payouts are "deferred."

3) The Accumulation Annuity, where one pays into the account on a systematic basis over a period of years. At some later date, it will provide income for retirement or other goals. The shift from accumulation to monthly payout is called annuitizing. However, the annuitant or owner may withdraw funds without actually annuiting. How much and how often may be withdrawn will depend upon the contract terms. Any withdrawals prior to annuitization would be subject to any company penalties that are stated in the contract. After the contract is annuitized, the monthly payouts based upon the terms of the contract become frozen. The contract owner can not draw anything more; just the monthly payments as stated under the terms of the annuitization. Annuities may have tax penalties if funds are withdrawn before the age of 59 1/2 in addition to any penalties imposed by the insurance company.

Money may, as stated, be withdrawn prior to annuitization. Most contracts allow 10 percent per year to be withdrawn without any penalty being imposed by the insurance company. It is not necessary to ever actually annuitize the contract. In fact, many annuitants never do. Taxes are paid on the taxable portion of the annuity, which is the interest earnings, for the year in which they are withdrawn from the annuity. Any principal withdrawn is not taxed because that money had already been taxed prior to depositing it into the annuity.

Annuity Pay-Out Options

When an annuity contract is annuitized, the insurance company determines the amount to be received in the monthly check. The amount of money that will be received is derived from a formula that uses such factors as age, principal plus interest earned and the payout option selected.

Although annuity contracts do vary, there tends to be some fairly standard options offered:

1) Single Life: For as long as the annuitant lives he or she will receive a check each month for a specified sum of money. The amount to be received each month will never change. That is why it is a "specified" amount received. This option will pay the maximum amount in comparison to the other options offered. This is the option that gambles on the longevity of life. If a person lives a long time they may collect handsomely over the years; much more than the annuitant ever paid into the annuity. If, on the other hand, their life is cut short, the insurance company will keep any balance left unpaid. No leftover funds will be distributed to any beneficiaries.

2) Joint-And-Survivor: Under this option, the insurance company will make monthly payments for as long as either of two named people live. This option is often utilized by married couples, but may be used by any two people. Both of the people's ages are considered by the insurance company when determining what the monthly payments will be set at.

3) Life-And-Installments-Certain: There are two key words here. One key word is "certain." The "certain" period of time is usually either ten or twenty years, but may be for any stated time period. This option states that should the annuitant die prior to the stated "certain" time period, payments would then continue to the beneficiary until that specified number of years has been met. On the other hand, the annuitant may receive payments longer than the "certain" period stated. The second key word is "life." The annuitant is guaranteed to be paid for his or her lifetime. Therefore, the payout is for both the "life" of the annuitant, plus a guarantee that payments will be no less than the "certain" amount of installments guaranteed under the contract.

4) Cash-Refund Annuity: If the annuitant dies before the amount invested has been paid out by the insurance company, then the remainder of the invested money, plus interest, will be paid out in monthly installments or in a lump sum to the named beneficiary or beneficiaries.

In each of these options, the insurance company pays nothing beyond the agreed period of time. To recap:

SINGLE LIFE: nothing after the death of the annuitant.

JOINT-AND-SURVIVOR: nothing after both named people have died.

LIFE-AND-INSTALLMENT CERTAIN: nothing after the death of the annuitant or until the stated time period; whichever comes last.

CASH REFUND: nothing after the full account has been paid out, whether to the annuitant or to the beneficiaries.

With all of these options, nothing beyond the terms of the contract would be paid to the estate. Remember that an annuitant could live to be extremely old and still receive monthly income, far past the amount ever paid into the annuity. Unfortunately, many people never realize that annuities, while marketed by life insurance companies, are actually the opposite of life insurance. Annuities pay in life while life insurance policies are designed to pay at death.

Annuities pay in life, while insurance policies

are designed to pay at death.

Competing With Certificates of Deposit

In the last few years we have seen a number of annuity products developed that are very much like a Certificate of Deposit or CD, as they are called. The volatility of the stock market, lowering interest rates and the mess of savings-and-loan institutions provided a perfect climate for such product development.

CD-Like Annuities

The many factors seen today often produce what is referred to as "investment stress." Simply put, investors do not trust anyone! Consequently, it has become increasingly important to develop financial portfolios that include some type of middle ground for the consumer's assets. These investment products must also provide guarantees of principal, a fairly competitive interest rate and reasonable access to the investment funds. Certainly the investment must also contain a very minimum level of risk. Insurance companies, in response to the current marketplace, have developed what is often referred to as CD-Like Annuities or CD Annuities. These annuities are a hybrid of the single premium deferred annuities (usually simply referred to as SPDA). However, the CD-like annuities give the policyholder the liquidity and rate of return most often seen with the banks. The CD-like annuities have all of the advantages of the traditional annuities, but they are different in one very important aspect: the surrender period may be as little as one year. Generally, the commissions paid on these annuities are much lower than what is paid for the traditional long-term annuities. They often tend to be marketed by banks who can offer either the CD or the CD-Like Annuity side-by-side.

Certificates of Deposit

Certificates of Deposit may also be called CDs, Time Deposits, Savings Certificates, Investment Certificates or High-Interest Passbooks. Certificates of Deposit and CDs are the most commonly used names. They are very good for the small investor or for short-term accounts.

A certificate of deposit is similar to a savings account with one notable difference: the length of the time commitment. When compared to many other investments, however, that time commitment can be relatively short.

The interest rate on a certificate of deposit is guaranteed and the entire deposit (investment) is guaranteed up to the Federal deposit insurance program limitations. This, of course, is assuming that the bank chosen is insured by either the Federal Deposit Insurance Corporation or the Federal Savings and Loan Insurance Corporation.

Certificates do carry penalties for early withdrawals just like many other investments do. In the first days, that penalty may involve a loss of principle.

It is generally recommended that certificates of deposit be staggered so that they come up for renewal at different times. In this way, the investor could cash in one of the certificates coming due, if necessary, and avoid an early withdrawal penalty.