The annuity principle

Correct answer: Outliving one's money

An annuity protects against living too long. A life contingent payout turns a sum of money into income the annuitant cannot outlive, which is why the annuity is described as the mirror image of life insurance, which protects against dying too soon.

Correct answer: Life insurance creates an estate, while an annuity liquidates one

Life insurance creates an immediate estate at death for survivors. An annuity systematically liquidates an estate, paying out principal and interest over a period, often the annuitant's lifetime.

Correct answer: Annuitant

The annuitant is the life on which payments depend. The owner is often, but not always, the same person.

Correct answer: Return of principal, interest, and survivorship benefits

A life annuity payment combines a return of the annuitant's own principal, interest on the unpaid balance, and survivorship benefits contributed by members of the pool who died earlier than expected.

Correct answer: Survivorship benefits

Survivorship benefits, also called mortality credits, are the funds released by early deaths in the pool that support continued payments to survivors.

Correct answer: Within 12 months of purchase

An immediate annuity is one in which payments start within 12 months of the date of purchase; it is purchased with a single premium.

Correct answer: Payments stop at death with no guaranteed minimum, so more of the premium can go to lifetime income

A straight life annuity provides no refund or guaranteed minimum; the insurer can therefore pay more per month. Adding a period certain buys a guarantee for a beneficiary, which raises the cost of each dollar of income.

Correct answer: Accumulation phase

During the accumulation phase, premiums are paid in and earn interest or investment returns on a tax-deferred basis. The annuity (payout) phase follows when the owner annuitizes.

Correct answer: Converts the accumulated value into a stream of income payments

To annuitize is to convert the accumulation account into an income stream; it marks the move from the accumulation phase to the payout phase.

Correct answer: The man with the heart condition receives a higher payment, because he is expected to collect for fewer years

Annuity underwriting runs opposite to life insurance underwriting. A shorter life expectancy means the insurer expects to pay for fewer years, so persons with shorter-than-average life expectancy may qualify for higher payments when the insurer considers health status.

Correct answer: Payments stop, and nothing further is paid

A straight life annuity pays only for the annuitant's lifetime. With no period certain or refund feature, payments cease at death, and the remaining funds support other annuitants in the pool.

Correct answer: Are not scheduled to begin for at least 12 months

In a deferred annuity, periodic income payments are not scheduled to commence for at least 12 months; they are deferred to a maturity date or an earlier date the owner selects.

Correct answer: How many members of the group will be alive each year, though not which ones

The law of large numbers lets the insurer forecast the group's mortality with reasonable accuracy. It does not need to know any individual's date of death; early deaths and long lives balance out across the pool.

Correct answer: Owner and annuitant; Lisa is the beneficiary

Frank purchased and controls the contract (owner), and payments are measured by his life (annuitant). Lisa, who receives any remaining amount at his death, is the beneficiary.

Correct answer: Transfers longevity risk to an insurer that pools many lives

With systematic withdrawals, the retiree bears the risk of outliving her savings. A life contingent annuity transfers that longevity risk to the insurer, which can absorb it by pooling many annuitants.

Correct answer: Use mortality tables to protect against the opposite risk, living too long instead of dying too soon

Both products rest on mortality tables and pooling, but they protect against opposite risks: life insurance against premature death, annuities against longevity.

Correct answer: The woman's will be lower, because women have a longer life expectancy

Gender is a pricing factor for life contingent income. Because women live longer on average, the insurer expects to pay a woman for more years, so the same premium buys a smaller monthly payment.

Correct answer: Provide a steady stream of income during retirement

The goal of most annuities is to provide a steady stream of income during retirement for a specified period or for the remainder of one or more lives.

Correct answer: The periodic payments for the remaining 6 years of the certain period

A life annuity with period certain pays for the greater of the annuitant's lifetime or the specified period. If the annuitant dies before the period ends, the beneficiary receives the payments for the remainder of it.

Correct answer: $40,000

Under a refund feature, if the annuitant dies before the payments made equal the premium paid, the excess of the premium over payments received is paid to the beneficiary: $100,000 minus $60,000 is $40,000.

Correct answer: A healthy single client with no dependents who wants the most income per dollar

Straight life pays the highest income per dollar of premium but nothing after death. That suits a healthy person with no one to provide for, who expects to live long enough to benefit and does not need a guarantee for heirs.

Correct answer: The insurance company

Under a life contingent option, the insurer must keep paying for as long as the annuitant lives. The insurer has assumed the longevity risk and manages it through pooling.

Correct answer: Both annuitants have died

A joint and survivor annuity has two annuitants, usually spouses, and payments continue until the death of both. The survivor's payment may continue at 100% or be reduced, for example to 50%, 66.67% or 75%.

Correct answer: A 67-year-old retiree who fears her savings will run out before she dies

An annuity addresses longevity, the risk of outliving one's money. Every other client's need arises from a premature death, which is the risk life insurance covers.

Correct answer: Period certain annuity

A period certain annuity pays for a specified time only, such as 5, 10 or 20 years, and income ceases at the end of the period whether or not the annuitant is alive. It is not life contingent, so it provides no longevity protection.

Correct answer: It is excluded from gross income under the exclusion ratio

Under 26 U.S.C. § 72(b)(1), the portion of each annuity payment that bears the same ratio to the payment as the investment in the contract bears to the expected return is excluded from gross income. That is the return of principal; the interest and survivorship portion is taxable.

Correct answer: An immediate life annuity

An annuity systematically liquidates an estate, paying principal and interest on a schedule calculated to last the annuitant's lifetime. An immediate life annuity starts this payout within 12 months.

Correct answer: The maturity date stated in the contract or, if earlier, a date selected by the owner

In a deferred annuity, periodic payments are deferred until a maturity date stated in the contract or, if earlier, a date selected by the owner.

Correct answer: Poor health makes life insurance more costly, but may increase the payments from a life annuity

Because the products cover opposite risks, underwriting runs in opposite directions. Poor health increases the expected cost of a death benefit but decreases the expected number of annuity payments, so an insurer that considers health may pay more.

Correct answer: Liquidation phase

The payout phase, also called the annuity or liquidation phase, is when the owner has annuitized and the value is paid out as income.

Correct answer: The accumulation phase

Sofia is still paying premiums and building value with no income being paid, so the contract is in the accumulation phase. It will move to the payout (annuitization or liquidation) phase when she annuitizes.

Correct answer: Owner

The owner, or contract holder, purchases the annuity, pays the premium and controls the contract. The owner is often, but not necessarily, also the annuitant.

Correct answer: Those funds become survivorship benefits that make higher lifetime payments possible; a period certain or refund feature can guarantee a minimum return for a lower payment

Under straight life, funds of early decedents stay in the pool and support survivors, which is why straight life pays the most income. A client who wants a minimum return can add a period certain or refund feature, accepting lower payments.

Correct answer: A lump-sum payment or a series of payments

An annuity is a contract in which the purchaser agrees to make a lump sum payment or a series of payments in return for regular disbursements.

Correct answer: Annuitants who live the longest receive the most in total payments, partly funded by those who die early

Each member receives the same periodic payment for life, so total payments depend on how long each lives. Long-lived annuitants collect more than they paid, funded in part by survivorship benefits from those who die early.

Correct answer: Buying an immediate annuity at least sufficient to cover her basic living expenses

The DFS advises that a person concerned with the risk of outliving financial resources might consider purchasing an immediate annuity at least in an amount sufficient to cover basic living expenses; a life contingent income option provides longevity protection.