4-Hour Annuities Training Course

Transcription

1 4-Hour Annuities Training Course 2014

2 - Notice - This is a training manual and is not to be considered as legal or professional advice. If you have legal or tax questions, please consult with your Tax Attorney and/or Tax Professional/CPA Accountant This manual is up to date as of the year It contains the latest legislative regulations signed into law. The earlier legislative content is also included for the purpose of having insight and a continuing view of the history of annuity regulations in the State of California Barry Caudill, President CyberCE. Inc. P.O. Box 1876 Bullhead City, AZ CyberCE.biz 2014 CyberCE, Inc, Bullhead City, AZ Copyright 2014, All Rights Reserved

3 i Primary Uses of Annuities, Types of Annuities, & the Senior Market 4-Hour Table of Contents Introduction & Overview... 1 Background... 1 Your 4-Hr Annuity Training Course... 1 Curriculum Objective Training Goals... 2 Environment... 3 Overview... 3 Market Overview... 3 Consumer Attitudes Toward Retirement... 4 Chapter ONE... 6 Identifying and Discussing Suitability... 6 Suitability... 6 Licensing Requirements for Life-Only Agents... 6 Checklist as required by Section (e) of the CIC... 7 Insurer Responsibilities as required by Section (f)(d) and (E) of the CIC... 8 Importance of Determining Client Suitability for Annuity Sales... 8 The need for information prior to making recommendations... 8 Need for Full Contract Disclosure... 9 The Need for Complete Record Keeping Required Disclosures Life Agent's Duties Life Agent Financial Products Disclosure Chapter TWO The Primary Uses of Annuities Annuities Defined Tax-deferred Compounding The Tax-Deferred Advantage Tax-Deferred vs. Fully Taxable Tax-Deferred (after taxes) vs. Fully Taxable Fully Taxable vs. Tax-Deferred (after taxes) vs. Tax Free Tax-deferral Advantage - Long term effect of tax-deferred compounding vs. other available investment choices Income Distributions i

4 Advantages of a Split Annuity Plan Limitations The Various Settlement Options Period Certain Cash Refunds Period Certain Only Life and Period Certain Life Only with Guaranteed Minimum Option Advantages and Disadvantages of Annuitization Options Tax Ramifications of Annuitization Options Non-Qualified Qualified Minimum Required Distributions Qualified plans Retirement Plans Covered Multiple Retirement Plans IRA Penalty Calculating the MRD (Minimum Required Distribution) Exceptions to the 10% Premature Distribution Penalty Tax Annuity Advantages and Disadvantages Advantages Disadvantages Utilization of Annuities and Consumer s Retirement Goals Alternatives to Annuities Chapter THREE Introducing the Types of Annuities Annuity Types According to When Benefits are Paid Out Immediate Annuity Deferred Annuity Characteristics of the Two Types Annuity Type according to How and When Premiums are Paid Single Premium Annuities Flexible Premium Annuities Characteristics of the Two Types Annuity Type according to Investment Options Offered Variable Annuities Contract Provisions Common to Variable Annuities Variable Options Fixed options Charges and Fees Dollar Cost Averaging Annualized Interest Rate Calculations in Fixed Accounts Death Benefit Guarantees Surrender Values CIC Living Benefit Guarantees Fixed Annuities... 36

5 Contract Provisions that are Typically Common to Fixed Annuities Death Benefits Lump Sum vs. Annuitization Charges and Fees Interest Rate Strategies Interest Rate Crediting Methods Minimum Guaranteed Interest Rates Low interest Rate Market & Its Impact on Interest Rates Minimum Non-Forfeiture CIC Indexed Annuities Contract Provisions Common to Indexed Annuities Specific Term or Index Term Primary Interest Crediting Strategies Indexing Methods Combination Methods Spreads Participation Rates Cap Rates Minimum Guaranteed Interest Rate Impact of Premature Surrender Charges Distinguishing the characteristics of fixed, indexed, and variable annuities as well as distinguishing the relationship between the annuity types relating to our clients Chapter FOUR The Senior Market Market Volatility and Risk Tolerance and the Senior Client Pre-retirement vs. Post-retirement Planning Post-retirement Planning Pre-retirement Planning Financial Concerns Insurance Concerns Selling to the Senior Market The Issue of Buyer Competence Family Involvement / Power of Attorney Unique Ethics and Compliance Issues Suitability for the Senior Market Prohibited Sales Practices Selling Annuities for Medi-Cal Eligibility (Section II of SB620/Section of the CIC) Selling Annuities to Persons 65 years and older Medi-Cal Written notice for people 65 and over CIC In-Home Solicitations - Criteria In-home Meetings with Seniors- 65 years and older Required Notice Content of Written Notice Cannot Misrepresent True Content of Meeting Unnecessary Replacement... 61

6 "Unnecessary Replacement Defined" Long Term Care Sales Law-drafting, Delivering, Interpreting Legal Documents Cause for Suspension Loans Agent Beneficiaries Agent as Trustee Agent as Power of Attorney Benefits Payable to Family or Friends of Agent Penalties Appropriate Advertising to Seniors CIC Importance of Determining Client Suitability for Annuity Sales The need for information prior to making recommendations Need for Full Contract Disclosure The Need for Complete Record Keeping Required Disclosures Life Agent's Duties Elder Abuse Life Agent Financial Products Disclosure Policy Cancellation and Refunds of the CIC Replacement FREE look for persons 65 years and older (Section 786 of the CIC) FREE look for persons 60 years and younger (Section of the CIC) Attachment III Penalties... 74

7 Introduction & Overview 1 Background Section of the California Insurance Code took effect on January 1, This law requires that California resident and non-resident life agents who sell annuity products must first complete eight (8) hours of annuity training that is approved by the California Department of Insurance (CDI). In addition, the law also requires life agents who sell annuity products to satisfactorily complete an additional four hours of annuity training every two years prior to their license renewal. For resident agents, this requirement is part of, and not in addition to, their continuing education requirements. In addition, Assembly Bill (AB) 689 (Chapter 295, Statutes of 2011) Insurance Annuity Transactions became effective January 2, AB 689 adds Section (a) to the California Insurance Code which states that an insurance producer shall not solicit the sale of an annuity product unless the insurance producer has adequate knowledge of the product to recommend the annuity and the insurance producer is in compliance with the insurer s standards for product training. Insurance producers may rely on insurer-provided product-specific training standards and materials to comply with the product-specific training requirement. Please note that AB 689 does not change the annuity training requirements which are stated in Section of the California Insurance Code. The annuity product-specific training is a separate requirement from the eight and four-hour annuity training noted above. Your 4-Hr Annuity Training Course This course was designed, constructed and written to provide training annuity and continuing education for meeting the California requirements in the area of Annuities with special attention to the various types of annuities and issues specific to California in the world of accumulation through annuities with special attention to those over age 60. Your course covers all of the topics required by the California DOI that must be addressed, understood, and practiced. The training curriculum in this four-hour outline is from Section II, III, and XI of the California Department of Insurance Eight-hour Annuity Training Outline, Topics to Be Included in Eight-hour Annuity Training Course. The outline is available on CDI s website at Attachment III- Penalties-Annuity Training from the Eight-Hour Annuity Training course is also available at the end of this course. It explores the types of annuities - Fixed, Variable, and Indexed annuity categories due to the many types available in the marketplace. The Senior Market and its uniqueness is discussed along with statutes and regulations required by California for agents selling annuities in the state. We also take a look with you at reserving issues, consumer attitudes toward retirement, and the California Life and Health Insurance Guarantee Act. Besides the goal of fulfilling your special California annuity education and continuing education requirements, it is our hope that you will acquire a new and/or renewed level

8 2 of competency and insight into this highly critical area of people s financial future; that of saving and accumulating dollars for use in the future through annuities. Over time, individual s situations change with respect to their available discretionary income, tax brackets, and family situations. In addition, tax law changes, program availability, and feature modifications are constantly being reviewed, updated, and changed. Some save specifically for retirement and education. Some save for the future (retirement) exclusively, and take care of education as best they can when it occurs prior to their retirement or some combination of both. Some things are fundamental and seldom change. Accumulating funds for the future depends on money, time, a vehicle, and consistency. With so many plans and places to save or invest in, the real key for our clients is to start putting aside funds so that a retirement nest egg is available down the road. The more one puts away today, the more it grows. The higher the yield or the growth each dollar earns makes it compound faster and greater. The less taxes we pay when we put it away, the less taxes due as it grows, and the less taxes required when we take it out all allow for each dollar to work harder, grow larger, and provide for more for its intended usage. And, to the extent we have planned ahead for certain amounts to be available at specific times in the future, the more motivated we are to put aside, on a regular basis, an amount that will grow to what is needed in the future. Whether you are a newer agent or a veteran, we re confident that you will gain new insight into this critical area for Americans as well as sharpen your saw on current info and regulations pertinent to this area of your expertise. Curriculum Objective Training Goals At the conclusion of this four-hour course, our students will: Understand the primary uses and types of annuities Be aware of annuities and other financial products available to seniors Understand investment concerns of seniors Understand issues of buyer competency Understand issues of annuity product ethics and compliance

9 Environment 3 Overview Market Overview The need for saving for the future has never been so great as it is now. The retirement savings rates for Americans and Californians, alike, are at low levels and average debt levels are high. The population overall in the US and in California is aging rapidly with larger numbers of Californians than ever before being over age 65 with millions more entering their senior citizen years over the next 15 years. All of this puts more pressure on individuals, state governments, and the federal government to focus on those upcoming financial arenas. There are currently 25 million+ seniors over age 65. By 2020, there will be 75 million+ seniors over age 65 due to the baby boomer population bubble. That s just a short 15 years from now. That means that there are more millions of Americans and Californians in their 50 s than ever before in our history. The market for annuities has historically seen a bubble in sales for people in their 50 s and above. This is the time when most people must get serious about putting aside dollars so they have some level of nest egg for their retirement. Children, mortgages, education, buying things, etc. are all things that have left little or no money left over for millions to save for retirement and the needs of old age when income from working ceases. For people in their 50 s, many of these reasons to spend their money are reduced or eliminated. The kids are out of school and on their own, the mortgage is paid off or reduced considerably, the need for first time purchases of more costly things are reduced, and so on. Their discretionary dollars available are greater and the need to save and invest for their upcoming retirement is at its greatest point, as well. In addition, as time has gone by, changes in the market with respect to people s available discretionary income, tax brackets, attitudes, and family situations have evolved to where we are today. Tax laws have changed, availability of alternative retirement programs has increased, and features and benefits have been modified, revised, updated, and changed. People continue to have competing needs for saving for their retirement and their children s education. Many have to save for one goal at a time to the exclusion of the other. Interest rates are low and have maintained those lower levels for several years. This creates a market where people are looking for alternative solutions to have their money grow more quickly, even if it requires them to accept more risk than they were formerly willing to take on.

10 4 Annuities, with their capacity to offer guarantees and monthly incomes for life make them an attractive and effective tool for providing an income stream that one can count on for the long run. For this reason and all of the above previously mentioned, the demand for annuities will continue to be high and will get higher as the baby boomers continue to age toward retirement. In addition to retirement saving, many people use annuities to provide an income from the proceeds that they receive lump sum from life insurance policies and from occasional lump sums received from a business venture or a large sum received as bonuses from varied sources. In looking ahead to their retirement years, many individuals plan on Social Security and pension plans from their employers to provide needed income and funds for their retirement. However, these many times only provide for a small portion of what is needed and desired for income security at retirement. Because of this shortfall, people want to supplement these two areas with additional sources of funds at retirement. The purchase of non-qualified annuities is one way to accomplish this. Consumer Attitudes Toward Retirement Having enough money to be able to retire from work and have that money along with all other sources of income provide enough money for the rest of their lives to do and have what we and they want is the common goal of people in America as well as in California. We all want to be in a position financially to enjoy the years remaining in our lives after we stop working. We and consumers would like to have that be at a point that we choose to do so rather than have it be a time when we have to due to lack of funds or a health situation that prevents us from going to work each day. The needs and wants are the easy part. Getting there and having the money to do it is another matter. The only way for most Americans to realize this goal in life is by saving and accumulating enough dollars for use in the future toward that goal. Many individuals needlessly struggle before and after retirement. Many never attain their other financial goals simply because they were never exposed to the financial facts of life. They didn t plan to fail, but rather failed to plan. More Americans than ever before are investing in the securities markets. They are buying more stocks, bonds, and mutual funds than ever before. Numerous studies show, however, at the same time many lack the financial basics to make sound judgments in this arena. They need to learn more about what questions to ask before investing, how to evaluate financial products and professionals, and how to protect themselves in the marketplace. Some interesting facts follow that will give us a better sense and talking knowledge of the state of affairs in relation to the retirement marketplace: Few have developed financial plans to save for their important financial goals, such as retirement or their children s education. Yet those who do develop a plan, regardless of income level, consistently save more.

11 65 million households, will probably fail to realize one or more of their major life goals because they ve failed to develop a comprehensive financial plan. More than half, 55 percent, of all current workers have never even tried to figure out how much they need to save and accumulate for retirement. An alarming number of high school students (66 percent) flunked a basic economic literacy test. Among adults taking the same test, only one-third achieved a score of C or better, and nearly half (49 percent) failed. Only 5 percent of investors believe they know everything they need to know to make good investment decisions. These facts represent a tremendous opportunity for agents to see to it that their clients and their prospects are armed with the information they need to make sound financial decisions, protect their hard-earned savings, and have enough to retire when they want to, not when they have to. 5

12 Chapter ONE 6 Identifying and Discussing Suitability Suitability In recommending that individual consumers, including consumers over the age of 65, purchase or exchange an annuity, the insurance producer (or insurer where no producer is involved), must have reasonable grounds for believing that the recommendation is suitable for the individual consumer on the basis of the facts disclosed by the individual consumer as to his or her investments and other insurance products and as to his or her financial situation, needs, and objectives. Licensing Requirements for Life-Only Agents Training (section of the CIC) Every life agent who sells annuities must satisfactorily complete eight hours of training prior to soliciting individual consumers in order to sell annuities. Every life agent who sells annuities must satisfactorily complete four hours of training prior to each license renewal. For resident licensees, this requirement shall count toward the licensee's continuing education requirement, but may still result in completing more than the minimum number of continuing education hours set forth in this section. The training required by this section must be approved by the commissioner and must consist of topics related to annuities, and California law, regulations, and requirements related to annuities, prohibited sales practices, the recognition of indicators that a prospective insured may lack the short-term memory or judgment to knowingly purchase an insurance product, and fraudulent and unfair trade practices. Subject matter determined by the commissioner to be primarily intended to promote the sale or marketing of annuities will not qualify for credit towards the training requirement. Any course or seminar that is disapproved under the provisions of this section shall be presumed invalid for credit towards the training requirement of this section unless it is approved in writing by the commissioner. The training requirements set forth in this section shall not apply to nonresident agents representing an insurer that is a direct response provider. For the purposes of this section, "direct response provider" means an insurer that meets each of the following criteria: (1) The insurer does not initiate telephone contact with insureds or prospective insureds. (2) Agents of the insurer speak with insureds and prospective insureds only by telephone, and at the request of the insureds or prospective insureds.

13 (3) Agents of the insurer are assigned to speak with insureds or prospective insureds on a random basis, when contacted. (4) Agents of the insurer are salaried and do not receive commissions for sales or referrals. 7 Checklist as required by Section (e) of the CIC An insurance producer or, where no insurance producer is involved, the responsible insurer representative, must at the time of sale do all of the following: (1) Make a record of any recommendation subject to subdivision (a). (2) Obtain a customer-signed statement documenting the customer's refusal to provide suitability information, if any. (3)Obtain a customer-signed statement acknowledging that an annuity transaction is not recommended if the customer decides to enter into an annuity transaction that is not based on the insurance producer's or insurer's recommendation. (a) In recommending to a consumer the purchase of an annuity or the exchange of an annuity that results in another insurance transaction or series of insurance transactions, the insurance producer, or an insurer if no producer is involved, shall have reasonable grounds for believing that the recommendation is suitable for the consumer on the basis of the facts disclosed by the consumer as to his or her investments and other insurance products and as to his or her financial situation and needs, including the consumer's suitability information, and that there is a reasonable basis to believe all of the following: (1) The consumer has been reasonably informed of various features of the annuity, such as the potential surrender period and surrender charge, potential tax penalty if the consumer sells, exchanges, surrenders, or annuitizes the annuity, mortality and expense fees, investment advisory fees, potential charges for and features of riders, limitations on interest returns, insurance and investment components, and market risk. (2) The consumer would receive a tangible net benefit from the transaction. (3) The particular annuity as a whole, the underlying subaccounts to which funds are allocated at the time of purchase or exchange of the annuity, and riders and similar product enhancements, if any, are suitable, and in the case of an exchange or replacement, the transaction as a whole is suitable, for the particular consumer based on his or her suitability information. (4) In the case of an exchange or replacement of an annuity, the exchange or replacement is suitable, including taking into consideration all of the following: (A) Whether the consumer will incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits, such as

14 death, living, or other contractual benefits, or be subject to increased fees, investment advisory fees, or charges for riders and similar product enhancements. (B) Whether the consumer would benefit from product enhancements and improvements. (C) Whether the consumer has had another annuity exchange or replacement and, in particular, an exchange or replacement within the preceding 60 months. 8 Insurer Responsibilities as required by Section (f)(d) and (E) of the CIC The insurer must maintain procedures for review of each recommendation prior to issuance of an annuity that are designed to ensure that there is a reasonable basis to determine that a recommendation is suitable. The review procedures may apply a screening system for the purpose of identifying selected transactions for additional review and may be accomplished electronically or through other means, including, but not limited to, physical review. An electronic or other system may be designed to require additional review only of those transactions identified for additional review by the selection criteria. (E) The insurer must maintain reasonable procedures to detect recommendations that are not suitable. This may include, but is not limited to, confirmation of consumer suitability information, systematic customer surveys, interviews, confirmation letters, and programs of internal monitoring. Nothing in this subparagraph prevents an insurer from complying with this subparagraph by applying sampling procedures or by confirming suitability information after issuance or delivery of the annuity. Importance of Determining Client Suitability for Annuity Sales The importance of this suitability issue for annuity purchases to all, but for seniors in particular, is underscored and emphasized by the fact that the NAIC (National Association of Insurance Commissioners) has dealt with it in a model regulation called NAIC Senior Protection in Annuity Transactions Model Act & Regulation which was completed in October of The need for information prior to making recommendations The purpose of the NAIC regulation was to provide standards and procedures for recommendations to senior consumers that result in the purchase or exchange of an annuity so that the insurance needs and financial objectives of the seniors were appropriately addressed at the time of their purchase. It describes the duty of the producer (agent) as that of the responsibility for having reasonable grounds for believing that the annuity recommendation they make is suitable for the senior purchaser on the basis of the facts disclosed by the senior as to their investments and other insurance products as well as to their financial needs and situation.

15 It requires that a producer make reasonable efforts to obtain information concerning the senior s: Age of the Consumer Financial status of the Consumer o Income o Liquid assets o LTC Insurance in place Tax Status of the Consumer Investment objectives of the Consumer Other information considered reasonable in making the recommendation The model regulation also recognizes that some purchasers may not be willing to share the needed information in regard to determining suitability and removes the obligation should the senior or any other purchaser: Refuses to provide relevant information Decides to buy something other than that which is recommended as suitable Fails to provide complete or accurate information In an effort to achieve compliance and to further assure that suitability is seriously applied throughout the process before, during, and after the sale, the regulations regarding supervision of producers and the suitability of annuity sales are also formal parts of the model. Maintaining written procedures and conducting periodic reviews of records that are reasonably designed to assist in detecting violations and preventing violations are required for insurers, general agents and independent agencies. Since registered representatives are already required to comply with NASD suitability requirements in the sale of variable annuities, this compliance is recognized to have met the requirements of suitability under the NAIC model. The commissioner may order that the producer, general agent, independent agency, and the insurer take reasonably appropriate corrective action for the purchaser of an annuity if the regulation is violated. California has been sensitive to this issue for years prior to this NAIC regulation in its Insurance Code Title X, section instituted back in 1974 regarding suitability standards for variable annuities. Need for Full Contract Disclosure Any contract that does not provide cash surrender benefits or does not provide death benefits at least equal to the minimum non-forfeiture amount prior to the commencement of any annuity payments must include a statement in a prominent place in the contract that such benefits are not provided. CIC

16 10 The Need for Complete Record Keeping Recordkeeping of the information collected from the purchasers of annuities during the process of determining suitability of the recommendation is also highly encouraged by the NAIC act. This would allow the commissioner to be provided with appropriate information for monitoring compliance and resolving complaints. Required Disclosures Life Agent Disclosure Requirements for Sales to Elders (Attachment II) Effective in July 1, 2001, regulations referred to as Chapter 442 and 547, Statutes of 2001 (Assembly Bill 2107, Scott), strengthened the Elder Abuse and Dependent Civil Protection Act with respect to selling insurance and financial products to elders. It clarified the definition of financial abuse. The definition of "elders" is any person residing in this state that is 65 years of age or older. As of the enactment of this law in July 2001, a life agent is required to make specified disclosures about the potential consequences of entering into financial transactions related to an elder's potential eligibility for Medi-Cal coverage and prohibits a life agent from negligently misrepresenting a product based on its treatment under Medi-Cal. These disclosures and key points for all agents to have read in regard to doing business with seniors age 65 or over are found in Appendix III. This appendix is a part of this course and not just an add on. You will need to study, understand, and adhere to the content of this appendix as part of your course. There are several key pieces of valuable information and regulatory requirements included and involved in the Appendix III. Among them are a Required Medi-Cal Disclosure, sample Department of Health Services Forms, an outline of a Life Agent s Duties, definitions of Elder Abuse, a Life Agent Financial Products Disclosure, and a Notice regarding standards for Medi-Cal eligibility. To successfully, legally, and professionally operate in the age 65 and above marketplace, you need to know about and execute these forms and procedures shown in Appendix III at the end of your course. Required Medi-Cal Disclosure A life agent who offers or sells any financial product on the basis of its treatment under the Medi-Cal program must provide, in writing, the disclosure shown in Appendix III to the elder or the elder's agent. Life Agent's Duties With regard to Medicare supplement insurance and long-term care insurance, all insurers, brokers, agents, and others engaged in the business of insurance owe a policyholder or a prospective policyholder a duty of honesty, and a duty of good faith and fair dealing.

17 Conduct of an insurer, broker, or agent during the offer and sale of a policy previous to the purchase is relevant to any action alleging a breach of the duty of honesty, and a duty of good faith and fair dealing. Life Agent Financial Products Disclosure If a life agent offers to sell to an elder any life insurance or annuity product, the life agent must advise an elder or elder's agent in writing that the sale or liquidation of any stock, bond, IRA, certificate of deposit, mutual fund, annuity, or other asset to fund the purchase of this product may have tax consequences, early withdrawal penalties, or other costs or penalties as a result of the sale or liquidation, and that the elder or elder's agent may wish to consult independent legal or financial advice before selling or liquidating any assets and prior to the purchase of any life or annuity products being solicited, offered for sale, or sold. This section does not apply to a credit life insurance product. A life agent who offers for sale or sells a financial product to an elder on the basis of the product's treatment under the Medi-Cal program may not negligently misrepresent the treatment of any asset under the rules and regulations of the Medi-Cal program, as it pertains to the determination of the elder's eligibility for any program of public assistance. A life agent who offers for sale or sells any financial product on the basis of its treatment under the Medi-Cal Program must provide, in writing, the required disclosure shown in Appendix II. 11

18 Chapter TWO 12 The Primary Uses of Annuities Annuities Defined An annuity is defined as the liquidation of a principal sum to be distributed on a periodic payment basis to commence at a specific time and to continue throughout a specified period of time or for the duration of a designated life or lives. Tax-deferred Compounding The annuity owner is credited interest and/or growth depending whether it is an interest bearing fixed annuity contract or a variable annuity, respectively, and the annuity owner does not pay taxes on the earnings until they make a withdrawal or begin receiving an annuity income. In fixed annuities, in addition to the underlying guarantees, the annuity contract earns a competitive return that is very safe. Tax-deferred means postponing taxes on interest earnings until a future point in time. In the meantime, one earns interest on the money that they are not paying in taxes on the earnings. With tax-deferment, one can accumulate more money over a shorter period of time, which ultimately will provide them with a greater income. The Tax-Deferred Advantage To illustrate the increased earnings capacity of tax-deferred interest, let s compare it to fully taxable earnings. $100,000 at 6.5% will earn $6,500 of interest in a year. A 28% tax bracket means that approximately $1,820 of those earnings will be lost in taxes, leaving only $4,680 to compound the next year. If these same earnings were tax-deferred, the full $6,500 would be available to earn even more interest. The longer one can postpone taxes, the greater the overall gain. (For 3.25% example, divide below by factor of 2.) Tax-Deferred vs. Fully Taxable Certificate of Deposit Annuity Fully taxable Tax-deferred Before-tax yield: 3.25% 3.25% After-tax yield: Fed/State 1.95% 3.25% 1 year $51,950 $53,250 5 years $60,540 $68, years $73,304 $93, years $88,757 $128, years $107,734 $176,187 Difference in the Return $176,187 Accumulated in a Tax-Deferred Annuity $107,734 Accumulated in a Taxable Account The Difference: $69,214

19 13 To level the playing field in comparison for the Fully Taxable investment, we take the same tax bracket of 28% and subtract this amount from the total tax-deferred amount developed after 20 years assuming it was all taken in a lump sum. (For 3.25% example, divide below by factor of 2.) Tax-Deferred (after taxes) vs. Fully Taxable Certificate of Deposit Annuity Fully taxable Tax-deferred Before-tax yield: 3.25% 3.25% After-tax yield: 1.95% 3.25% 1 year $51,950 $53,250 5 years $60,540 $68, years $73,304 $93, years $88,757 $128, years $107,734 $176,187 28% tax $ 35,331 Balance after 28% tax $140,851 Difference in the return after tax on annuity lump sum withdrawal $176,187 $35,331 (28% of growth of $176,183)= $140,851 $107,734 Accumulated in a Taxable Account The Difference: $33,382 more in the tax-deferred annuity after taxes. To finalize our comparison and computations on taxable vs. tax-deferred vs. tax free after 20 years for the same initial investment, the summary would look like the following: $107,734 vs. $140,851 vs. $176,187, respectively Fully Taxable vs. Tax-Deferred (after taxes) vs. Tax Free Fully taxable Tax-deferred Tax Free Before-tax yield: 3.25% 3.25% 3.25% After-tax yield: 1.95% 3.25% 3.25% 20 years $107,734 $176,187 $176,187 28% tax - 20 th yr. $ 35,331 Balance after tax $107,734 $140,851 $176,187 Tax-deferral Advantage - Long term effect of tax-deferred compounding vs. other available investment choices

20 14 Many people today are using tax-deferred annuities as the foundation of their overall financial plan instead of certificates of deposit or savings accounts. Although CD s and annuities are very similar there are significant differences between the two. No taxes are payable while their money is compounding in an annuity. Their money can grow faster in a deferred annuity than in a taxable investment with a similar interest rate. This is because earnings normally lost to taxes remain in their annuity and can generate additional earnings through the effects of compounding. They can also pay a lower tax on random withdrawals because they control the tax year in which the withdrawals are made, and only pay taxes on the interest withdrawn. Tax deferral gives them control over an important expense their taxes. Any time one controls an expense, they can minimize it. The longer they can postpone this particular expense, the greater their gain when compared to the gain they would make with a fully taxable account. Later, if they decide to take a monthly income, their taxes can be less because they will be spread out over a period of years. Like Certificates of Deposits, annuities have a penalty for early surrender, however most annuity contracts have a liberal free withdrawal provision during the surrender fee period. And, if they wait until retirement to receive their annuity income, they may be in a lower tax bracket, adding to the value of the income they receive. Bank savings accounts used to accumulate money for the future also have current taxation like CDs, but generally have no penalties for withdrawals. They do generally have less interest credited than CDs. With no tax deferral, as interest earned each year, it is taxable in the year received. Principal is guaranteed in savings accounts and CD s. Mutual funds do not generally have tax-deferred growth inside them as do annuities and therefore do not enjoy the added accumulation potential of additional growth of compounding on the growth and interest available in annuities. Mutual funds also have fees for early surrender as well as annual expense loads, unless they are no load type of funds. There are no lifetime income annuity provisions in mutual funds as there are in annuities, as well. There are no guarantees of principal in mutual funds as there is in annuities. Stocks and bonds do not have the tax-deferred advantages of annuities. Growth of stocks is not taxable until liquidated and then this growth is subject to taxation at capital gains tax rates that are generally lower than regular income tax rates. They have no annuitization provisions. Bond interest is taxable in the year received and they have no annuity provisions either. Stocks have no guarantees of principal and bond have no contractual guarantees, although they are traditionally more safe than stock when it comes to safety of principal. Income Distributions Split annuities are frequently used in retirement planning to provide income as well as to keep a portion of one s money continuing to grow tax-deferred to provide cash and/or future income as a person s situation warrants. A split annuity is not an annuity policy but rather a strategy involving a combination of two annuity products; a fixed period immediate annuity and a single premium deferred annuity.

21 15 They are structured in such a way as to produce immediate tax-advantaged income for a guaranteed period of time and during the same period of time to restore their original principal at the end of that time period. It s a process by which the annuity owner "splits" his or her initial premium into two pieces. They put part of the premium into a fixed deferred annuity with a guaranteed interest rate for a given period of time, and they put the other part into an immediate annuity that pays an income for that same period of time. It is usually structured where the deferred annuity grows back at the end of the guaranteed period to the total deposit originally invested in both annuities, while receiving a guaranteed income from the immediate annuity throughout that same time period. Advantages of a Split Annuity Dependable Income: The immediate annuity can supplement one s income by providing them with a safe, predictable, and guaranteed cash flow. Depending on their income needs, the immediate annuity can generate a stream of monthly income anywhere from five to twenty years. Tax-Advantaged Income: Since a significant portion of their monthly income from the immediate annuity is considered a return of their original investment, it is taxadvantaged. In our example below, 81% of their monthly income payments would be tax-free. Tax-Deferred Growth: The deferred annuity portion of the split-annuity concept offers tax-deferred growth and earns an interest rate that historically has been higher than average CD rates. Principal Preservation: The original principal is restored at the end of the guaranteed period which allows one to start the process over again at prevailing interest rates. The funds placed in the single premium deferred annuity policy are available for emergencies with limitations. Plan Limitations The limits placed on the use of a split annuity are the issue ages of the policies, usually age 0-85 for non-qualified funds and 0-70 for qualified funds. The immediate income periods range from 3 to 20 years.

22 Example of a Split Annuity 16 $100,000 Total Funds are SPLIT Immediate Annuity $19,215 at 3.12% provides Monthly Income of $ or Annual Income $2, for 8 years of which 82% is not taxed Total Income before Taxes $23, Deferred Annuity $30,785 at 3.12% will grow to Yr. 1 $32,709 Yr. 2 $34,753 Yr. 3 $36,926 Yr. 4 $39,233 Yr. 5 $41,685 Yr. 6 $44,290 Yr. 7 $47,059 Yr. 8 $50,000 Original Principal $50,000 Please note that the illustration is based on a guaranteed interest rate of 3.15% for 8 years. Withdrawals from an annuity prior to age 59 1/2 may result in a 10% penalty tax imposed by the IRS. Annuities are not FDIC insured. The Various Settlement Options The unique feature of annuities is not found in any other investment or accumulation vehicle. That uniqueness is the fact that only an annuity can provide a stream of income that an annuitant cannot outlive. Annuities offer a variety of settlement options so the annuitant can tailor their income schedule to suit their needs. They can choose to receive payments monthly, quarterly, semiannually or annually. The payment options include the following: Life Only Payments will continue for the rest of their life. They cannot outlive their income. Upon their death, payments stop. Joint and Survivor Payments are guaranteed during the lifetime of two people. After the death of one, payments continue for the lifetime of the surviving person. They can choose to have either full payments, or a percentage they choose, to continue for the lifetime of the survivor. They can also specify a period certain, and if both individuals were to die within the period certain, payments would continue to the named beneficiary for the remainder of the period certain.

23 17 Period Certain The insurance company agrees to pay the annuity benefit for the longer of the annuitant s lifetime or a certain period of years. Most of the annuity contracts offer choices that include 5, 20, 15, or 20 years. Cash Refunds "Refund annuity" means that payments will continue for the life of the annuitant, but if death occurs, then someone will receive at least what the original amount of the funds that were in the annuity at the time of the annuitization. This makes sure that, at least, someone will receive the initial amount. This could be the annuitant or the beneficiary or both. Period Certain Only "Period Certain" means a number of years they chose. Payments will continue for the duration of the number of years they chose, and then cease. If they should die before the end of the stated number of years, their beneficiary would continue to receive the payments for the remainder of those years. Life and Period Certain Life and period certain means payments will continue for the rest of their life, but for no less than the stated number of years. If they should die before the end of the stated number of years, their beneficiary would continue to receive the payments for the remainder of those years. Life Only with Guaranteed Minimum Option Payments will continue for the rest of their life. If they should die before they have been repaid their initial investment, the balance of their initial investment will be paid in like installments to their beneficiary. Advantages and Disadvantages of Annuitization Options In annuities, an income stream that one cannot outlive gives a person the security of long-term peace of mind for that monthly payment amount. Generally, this amount is fixed and will not go down due to guaranteed nature of most annuity payment options. Variable payouts are available from a variable annuity that can fluctuate up or down depending on the performance of the sub-accounts inside the variable annuity. While the fixed nature of the annuity payment is desirable and predictable, it does not increase with the changes in interest rates or equity performance. It does not increase with inflationary trends in the costs of living. Other assets, funds, and income sources are needed to keep up with the rising costs of living. The annutization options, once chosen, generally cannot be changed to offer flexibility in continually adapting to a person s ongoing changing situation with regard to survivor benefits. These choices are made at the time of annuitization.

24 The lump sum available at the time of annuitization is forfeited to the insurance company in lieu of a monthly income stream for life. Needs for funds beyond the monthly income need to be met by other available assets beyond the monthly payments from one s annuity. If one annuitizes before their age 59½, they avoid the 10% penalty on the interest portion of their payments if the annuity period is longer than 5 years and that the annuity period chosen will be one that takes them past age 59½. The life only settlement options without guarantees to others beyond the death of the annuitant have the largest monthly payout. However, if the annuitant dies in a short period, for example, the monthly income ceases and the unpaid balance of the original annuity value goes to the insurance company. On the other hand, if the annuitant lives longer than their life expectancy, the payments continue even if the total payments far exceed the original value of their annuity before the annuitized. Non-Qualified Tax Ramifications of Annuitization Options The money that is put into an annuity is referred to as the original contribution or principal contribution. Since one already has paid taxes on this amount prior to paying it in to the annuity, it is not subject to future income taxation. The money put into an annuity earns interest or receive dividend income or capital gain distributions. These "earnings", unlike money in a savings account, mutual fund, and certificate of deposit are tax-deferred and not taxed in the year in which they are earned. The "earnings" continue to grow and compound tax free until withdrawn. The IRS eventually collects taxes on the "earnings" inside a non-qualified annuity. When one withdraws money from their annuity, the earnings, according to the IRS, are withdrawn first. The "earnings" are subject to "ordinary income taxes" in the year in which they are withdrawn. Keep in mind that capital gains and dividends earned in a variable annuity are also subject to tax as ordinary income tax rates, not capital gains and dividend tax rates. For lump sum withdrawals, either partial or full, the amount of growth in the annuity is subject to tax first and the principal is the last amount to be withdrawn and not subject to tax. Annuitization with monthly payments offers a payout method that reduces the effects of taxation as only a portion of the monthly payments is subject to taxation. This provides the least amount of taxation on the growth in a year period and adds the least amount of additional taxable income to all other income, thus keeping total income subject to the lowest marginal tax brackets possible. A part of each payment is considered a return of the amount paid in and not subject to taxation. The remainder of each monthly payment is considered to be a payment of the growth portion and is subject to taxation. This split of each monthly annuity payment is referred to as the exclusion allowance. The amount of total payments over the period 18

25 19 from one s current age to their life expectancy age is referred to as the total expected payments. To determine the percentage of each monthly payment that will be taxable, the company determines this amount by calculating what percentage the original premium is of the total expected payments. In addition, the IRS considers "Premature Distributions" on both non-qualified and qualified annuities when one withdraws their earnings (or contributions and earnings in qualified annuities) prior to becoming age of 59½. There are no penalties on these premature distributions if they are made after one is 59 ½, made on or after the death of the owner of the annuity, if the taxpayer becomes disabled, if they are a part of a series of substantially equal periodic payments (not less than annually) for the life (or life expectancy) of the taxpayer or joints lives (or joint expectancies) of the taxpayer and his or her designated beneficiary, if made under a single premium immediate annuity with a starting date no later than one year from the annuity purchase date, and if made under certain annuities issued in connection with a structured settlement agreements. In addition to the above, if a premature death occurs during the accumulation phase, the accumulated funds within the annuity may be transferred to their named beneficiaries, avoiding the expense, delay, frustration and publicity of the probate process. Like most assets, the annuity is part of one s taxable estate. Their heirs can generally choose to receive a lump sum payment, or a guaranteed monthly income. Qualified The money put into a qualified annuity earns interest or receives dividend income or capital gain distributions. These contributions are pre-tax and are subject to taxation when withdrawn. The "earnings" continue to grow and compound tax free until withdrawn. The IRS eventually collects taxes on the contributions and "earnings" in a qualified annuity. Capital gains and dividends earned in a qualified variable annuity are also subject to tax as ordinary income tax rates, not capital gains and dividend tax rates. For lump sum withdrawals, either partial or full, the amount of premiums and growth in the annuity are subject to tax. Annuitization with monthly payments is subject to taxation of the entire monthly payments. The IRS considers "Premature Distributions" on qualified annuities when one withdraws their contributions and earnings in qualified annuities) prior to becoming age of 59½. Minimum Required Distributions Qualified plans Once one has retired, they can postpone withdrawing their money from their retirement plan until they have reached the age of 70½. In the calendar year in which they turn age 70½, they must make their first withdrawal by the time they reach their actual age 70½. In future years, they are required to make a withdrawal by the end of the calendar year.

26 Retirement Plans Covered 20 If one has an IRA, 401(k), SEP-IRA, TSA or SIMPLE Plan they are required to begin minimum distributions by age 70½. Roth IRA's are NOT covered by the MRD rule. Multiple Retirement Plans If one has more than one retirement plan from which minimum required distributions must be made, they must calculate the amount required for each plan. The actual minimum distribution may be taken from one plan to satisfy the MRD. The value used to calculate the MRD is the total value of each plan as of December 31 st of the preceding year. IRA Penalty Failure to make the required distribution by the end of the calendar year results in a penalty equal to 50% of the amount of the required distribution. In addition, ordinary income taxes are due on the entire amount, as well. Calculating the MRD (Minimum Required Distribution) Calculating the MRD is easy. Take one s account balance as of December 31 of the preceding year and divide by their life expectancy years for that age forward. Account Balance Contributions - Includes all contributions made in the immediate preceding year for which the calculation is being made. Distributions - When calculating the distribution for the second year only, it is reduced by any distribution made in that year to satisfy the minimum distribution requirement for the first year. The first year distribution year is the year in which they reach age 70½. Life Expectancy Single Life Expectancy - The owner s life expectancy as set forth by IRS Joint Life Expectancy - The owner & designated beneficiary set by IRS Death of Owner - If the owner dies before distributions have begun, the remaining life expectancy of the beneficiary. Exceptions to the 10% Premature Distribution Penalty Tax The are exceptions to the premature distribution penalty tax for distributions made from traditional IRAs. Unreimbursed Medical Expenses If you and your spouse are both under age 65, on your tax return that you will file in 2014 and after, you can deduct on Schedule A, Itemized Deductions (Form 1040) only

27 21 the amount of your unreimbursed allowable medical and dental expenses that is more than 10 percent of your adjusted gross income (AGI) from Form 1040, line 38. If you or your spouse is 65 or over, you are temporarily exempt from the increase. The exemption applies to any tax year beginning after December 31, 2012, and ending before January 1, 2017, if you or your spouse attained age 65 during or before the tax year. If one is 65 or over and prior to tax year 2017, they do not have to pay the 10% tax on amounts they withdraw that are not more than the amount they paid for unreimbursed medical expenses during the year of the withdrawal, minus 7.5% of their adjusted gross income for the year of the withdrawal. For 2017 tax year and thereafter this 7.5% will be increased to 10%. Medical Insurance Even if one is under age 59½, they may not have to pay the 10% tax on amounts they withdraw from their traditional IRA during the year that are not more than the amount they paid during the year for medical insurance for themselves, their spouse, and their dependents. They will not have to pay the tax on these amounts if all four of the following conditions apply; if they lost their job, received unemployment compensation paid under any federal or state law for 12 consecutive weeks, made the withdrawals during either the year they received the unemployment compensation or the following year, and made the withdrawals no later than 60 days after they have been re-employed. Disability If one becomes disabled before they reach age 59½, any amounts they withdraw from their traditional IRA because of their disability are not subject to the 10% additional tax. They are considered disabled if they can furnish proof that they cannot do any substantial gainful activity because of their physical or mental condition. A physician must determine that their condition can be expected to result in death or to be of long continued and indefinite duration. Death If one dies before reaching 59½, the assets in their traditional IRA can be distributed to their beneficiary or to their estate without either having to pay the 10% additional tax. However, if they inherit a traditional IRA from their deceased spouse and elect to treat it as their own, any distribution they later receive before they reach age 59½ may be subject to the 10% additional tax. Higher Education Expenses If one is under age 59½, and if they paid expenses for higher education during the year, part (or all) of any withdrawal may not be subject to the 10% tax on early withdrawals. The part not subject to the tax is generally the amount that is not more than the qualified higher education expenses paid out of pocket for the year for education furnished at

28 22 an eligible educational institution. The education must be for them, their spouse, or the children or grandchildren of them or their spouse. First Home To qualify for penalty-free withdrawal treatment as a first-time homebuyer distribution, a distribution must meet the following requirements. It must be used to pay qualified acquisition costs before the close of the 120th day after the day they received it and it must be used to pay qualified acquisition costs for the main home of a first-time homebuyer who is any of the following: themselves, their spouse, their spouse's child, spouse's grandchild, and their spouse's parent or other ancestor. When added to all their prior qualified first-time homebuyer distributions, if any, the total distributions cannot be more than $10,000. If both husband and wife are first-time homebuyers they each can withdraw up to $10,000 penalty-free for a first home. Advantages Annuity Advantages and Disadvantages For persons under 60 years old, annuities provide an excellent vehicle for accumulating funds on a tax-deferred basis that allows for more growth generally than non-tax deferred savings approaches. The variety of choices from fixed to indexed to variable gives annuity purchasers a plethora of varying risk tolerant choices, as well. The ability to put aside lump sums and/or periodic payments gives annuitants a number of choices for setting aside money on a basis that is appropriate for them and their cash flow. In addition, the safety record of fixed annuities is unequaled, the interest rate received in a fixed rate annuity is guaranteed, the principal of a fixed-rate annuity is guaranteed, the reserve requirements for an annuity account are much higher than for a bank account, a policyholder can choose to change annuities contracts simply by using a 1035 tax-free exchange, generally no portion of the investment is reduced by commission charges, most allow for withdrawals for up to ten percent a year without cost, fee or penalty, an automatic guaranteed death benefit is available, and probate is generally avoided. For persons 60 years and older, the flexibility in tailoring payout options to one s situation as they move past their 60s and beyond provides opportunities for arranging suitable choices depending on their income and cash needs when they retire and have a need of continuous income for life. The favorable taxation on monthly payments improves the amount of spendable income from accumulated funds. Fixed guaranteed monthly income payments for life provide predictability and security of knowing what will be coming in on a regular basis. Variable payout options are also available from annuitizing accumulated variable annuity proceeds, as well. Annuities provide a safe place to park funds to be available for retirement income when ready and to not have the funds exposed to the ups and downs in the market if they were left in variable equity instruments.

29 Surrender Charges 23 This penalty only applies if the policyholder takes out more than the allowed free withdrawal amount of money from the contract within a set number of years. For those under age 60, the surrender charge is not an issue if they do not need to take out more than the free withdrawal amount in any year while the surrender fee period is in effect. After this period the surrender charge has not effect on their withdrawals from a contractual context. A positive in one regard for the under age 60 crowd is that those who do not surrender more than their free withdrawal amount have a better chance of getting the most earnings on their money during the accumulation period. This is because the company offsets any of its losses in their investments due to premature surrenders through the surrender fees charged to those who do, rather than spread these losses among everyone. For those over age 60, the surrender fees have no impact if they have gotten beyond the number of years that the surrender fees applied to their annuity. Again, their earnings are maximized by having surrender fees applied to others that do withdraw or surrender more than the free withdrawal amount. Disadvantages For persons under 60 years old with a good number of years to retirement, a fixed annuity may not be the ideal vehicle for accumulating funds. Equity instruments or a variable annuity may provide a better chance for additional growth when there is a long time horizon for investing money in equities historically. Withdrawal penalties of 10% prior to age 59½ could reduce available funds, if needed prior to this age. For persons 60 years and older, annuities offer many advantages not available through other financial instruments. However, if there is a death with accumulated funds still intact, the beneficiaries do not receive the step up in basis and the beneficiaries will have to pay taxes on the growth portion of the annuity as they use it for cash and income needs. Fixed, guaranteed monthly annuity payments may not keep up with inflation. Variable payouts that fluctuate with the performance of the separate accounts in a variable annuity may drop to levels that cause the annuity payment to drop to levels below the amount that is needed by the annuitant to meet their monthly commitments. And, if life income options are selected without survivor payment guarantees, the funds may be forfeited to the insurance company should an annuitant die before the value of the annuity funds originally started out with are paid out. Surrender Charges For those over age 60, annuities, in the initial several years, that are purchased close to the time that the money in the annuity might be needed to pay for critical things may

30 24 have surrender fees for partial and full withdrawals and surrenders. The fees imposed can dilute the amount of money available for annuitization subsequently desired. Utilization of Annuities and Consumer s Retirement Goals The tax-deferred accumulation advantages, unique lifetime income characteristics, and relative safety of funds in annuities gives them a preferred place in the plethora of saving and investing opportunities and products for accumulating funds for income production at retirement. Favorable tax reducing strategies afforded by annuity payments having only the growth portion of the payment each month taxed helps to reduce the diluting effects of taxes and increases the income potential during the distribution phase of annuities. Having fixed, variable, and index types of annuities allows for more of a choice in risk and reward potential choices. With so many people at varying ages and varying risk tolerances putting dollars away for retirement, there are choices available to match more closely the needs of the masses. Fixed annuities provide safety of principal with lower rates of return. Variable annuities provide little or no safety of principal, but have the potential, over time, to outperform lower interest bearing instruments. Index annuities have attempted to offer a middle of the road choice that provides safety of principal with a chance for additional interest beyond fixed annuities through an interest calculation that is based on the gains in popular indexes measuring movement within the equity markets. At the end of your previous chapter, Chapter 7, we took a look at alternative financial planning vehicles to annuities. There are certainly a wide variety of them and each one has its place and purpose as investment and savings choices for consumers actively pursuing the accumulation of money for all of the things that life has available, both before and after retirement. They all have their own particular levels of safety, potential for return, and abilities to provide income at retirement. There are many consumers who will use any and/or all of these in various combinations as they go about accumulating financial wealth for their futures and for their families after they die. Annuities will provide a place for appropriate amounts of this accumulated money at retirement, and as people approach retirement in their early 60 s, to safeguard their accumulations and to harness the lifetime income guarantees available through annuities. We will discuss in Chapter Four the advantages and disadvantages of annuities and annuitization options for those under age 60 and those over age 60. Like most things in life, there is no one absolute in anything, it seems. It depends on one s own individual situation, one s philosophy, and one s pocketbook. Developing a retirement plan and how to fund it appropriately depends on the age of an individual and the amount of time that one has to harness time and compounding of money at work. It depends on their discretionary income, tax brackets, family situations, employment status, employee benefits available, and state and federal programs.

31 25 Most adults have high expectations for retirement. Many will fail to maintain the lifestyle and standard of living to which they have become accustomed because they failed to plan and save. More than half of American workers, 55 percent, have no idea how much they will need to put aside on a regular basis to make their retirement dreams a reality. That s why it is the work of the agent that is so vital in professionally going about assisting people in learning about planning techniques, products, services, and programs available to them. This is critical to help others so they can be in a better position to make sound financial decisions for their own particular wants and needs now and into the future. Accumulating funds for the future depends upon people taking action as early as possible in their working and income earning years. Annuities are a great place for people to start with at least a portion of their money available for long-term saving. With a sound foundation of predictable savings and results, they can diversify into other things that have greater risk and greater reward potential while they are younger and have a longer investment horizon to retirement. With so many plans and places to save or invest in, the real key is to start putting aside funds so that a retirement nest egg is available down the road. The more one puts away today, the more it grows. The higher yield or growth each dollar earns makes it compound faster and greater. The less taxes we pay when we put it away, as it grows, and when we take it out allows for each dollar to work harder, grow larger, and provide for more of it s intended usage. And, to the extent we have planned ahead for certain amounts to be available at specific times in the future, the more motivated we are to put aside on a regular basis an amount that will grow to what is needed in the future. Alternatives to Annuities CD s are safe and offer current interest at various levels depending on what rates are available in the marketplace. The past several years have seen a low interest rate environment. Their interest earned each year is taxable in the year received and are, therefore, not tax deferred. Annuities offer guarantees of principal plus are tax-deferred, allowing for compounding of interest without the diluting effect of taxes on their growth. Their principal is guaranteed. CD s have no lifetime annuity payment feature. Money Markets are very short-term and interest rate driven, but have greater access to the money than do CD s. Their interest rates are typically lower than CD s due to the short-term nature of the interest rate sensitivity. Their interest earned each year is taxable like a CD. They are not seen as an ideal long-term alternative to accumulate money for retirement. They have no lifetime annuity payment feature. Savings accounts are generally positioned between CD s and money markets with taxable interest annually like CD s and money markets. Their interest is not taxdeferred, as well. They are relatively safe as to principal and interest. They have no lifetime annuity payment feature. Mutual funds are not guaranteed, nor is their growth predictable. They are subject to fluctuations in value depending on their underlying investments. Their growth is taxable in the year earned. They have many different investment options inside them to diversify the risk. This provides less chance for swings in results when investing in one stock by

32 26 itself. These are better when there is a longer time horizon available to derive performance over a period of time. Their earnings are not tax-deferred. They have no lifetime annuity payment feature. Stock growth is realized and taxed when sold. They are best for people who have a good number of years before they will need money, such as at retirement. The risk of principle is unlimited as is the potential for growth unlimited. Risk tolerant people find these desirable regardless of the downside potential. Bonds have their interest earnings taxed in the year earned and/or received and are, therefore, not tax-deferred. Like CDs, money markets, savings, and mutual funds, stocks and bonds have no lifetime income options like annuities. They have no lifetime annuity payment feature. Commodities are products that trade on a commodity exchange including foreign currencies and financial instruments and indexes. They are physical substances, such as food, grains, and metals, which are interchangeable with other products of the same type, and which investors buy or sell, usually through futures contracts. The price of the commodity is subject to supply and demand. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be. The risk downward and upward is unlimited and there are no guarantees. They are not tax-deferred. They have no lifetime annuity payment feature. Options are the right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike price) during a specified period of time. For stock options, the amount is usually 100 shares. Each option has a buyer, called the holder, and a seller, known as the writer. If the option contract is exercised, the writer is responsible for fulfilling the terms of the contract by delivering the shares to the appropriate party. In the case of a security that cannot be delivered such as an index, the contract is settled in cash. For the holder, the potential loss is limited to the price paid to acquire the option. When an option is not exercised, it expires. No shares change hands and the money spent to purchase the option is lost. For the buyer, the upside is unlimited. Options, like stocks, are therefore said to have an asymmetrical payoff pattern. For the writer, the potential loss is unlimited unless the contract is covered, meaning that the writer already owns the security underlying the option. They have no lifetime annuity payment feature. Options are used most frequently as either leverage or protection. As leverage, options allow the holder to control equity in a limited capacity for a fraction of what the shares would cost. The difference can be invested elsewhere until the option is exercised. As protection, options can guard against price fluctuations in the near term because they provide the right to acquire the underlying stock at a fixed price for a limited time. Risk is limited to the option premium (except when writing options for a security that is not already owned).

33 However, the costs of trading options (including both commissions and the bid/ask spread) is higher on a percentage basis than trading the underlying stock. In addition, options are very complex and require a great deal of observation and maintenance. Limited partnership is a business organization with one or more general partners, who manage the business and assume legal debts and obligations, and one or more limited partners, who are liable only to the extent of their investments. Limited partners also enjoy rights to the partnership's cash flow, but are not liable for company obligations. A direct participation program is a program enabling investors to receive the cash flow and tax benefits directly; often through a limited partnership. There are no guarantees and they are not tax-deferred, although there are some tax benefits associated with them. They have no lifetime annuity payment feature. Promissory notes are negotiable instruments and are transferable, signed documents that promise to pay the bearer a sum of money at a future date or on demand. Examples include checks, bills of exchange, and promissory notes. The safety of these is only as good as the ability of the person or entity to make good on the promise. Earnings are taxable in the year received and are not tax-deferred. They have no lifetime annuity payment feature. Real estate investment trusts are a corporation or trust that uses the pooled capital of many investors to purchase and manage income property (equity REIT) and/or mortgage loans (mortgage REIT). REITs are traded on major exchanges just like stocks. They are also granted special tax considerations. REITs offer several benefits over actually owning properties. First, they are highly liquid, unlike traditional real estate. Second, REITs enable sharing in non-residential properties as well, such as hotels, malls, and other commercial or industrial properties. Third, there's no minimum investment with REITs. REITs do not necessarily increase and decrease in value along with the broader market. However, they pay yields in the form of dividends no matter how the shares perform. REITs can be valued based upon fundamental measures, similar to the valuation of stocks, but different numbers tend to be important for REITs than for stocks. They have no lifetime annuity payment feature. Viatical settlements are the purchase of a terminally ill person's life insurance policy for a certain percentage of the policy's face value, also known as accelerated benefits. In some life insurance policies, benefits available before death, in such events as longterm, catastrophic or terminal illness. This benefit first became available when companies offering viatical settlements purchased the life insurance policies of terminally ill individuals from the insurance companies that issued the policies. After extracting a portion of the value of the policy for costs and profits, these companies offered the remainder of the death benefit to terminally ill policyholders. Insurance companies have different rules about how much money can be extracted and how close to death the holder must be to receive benefits early. The remainder of the value of the policy, minus interest charges, is awarded to the beneficiaries upon the death of the holder. They are also called living benefits. They have no lifetime annuity payment feature. 27

34 Chapter THREE 28 Introducing the Types of Annuities We should take an overview general look at what an annuity is and what an annuity is not here before we move on in our course. The following is a general summary of the basics when referring to an annuity. We will take a closer detailed look at all the various components and California regulations pertaining to annuities and annuity sales throughout the various chapters in your course. An annuity is defined as the liquidation of a principal sum to be distributed on a periodic payment basis to commence at a specific time and to continue throughout a specified period of time or for the duration of a designated life or lives. The Webster dictionary defines annuity as a yearly grant or allowance, or as an investment of money entitling an investor to a series of equal annual sums over a stated period. It has one basic purpose and that is to provide a series of payments over a period of time. Usually this period of time is over the lifetime of the person who is the annuitant named in the annuity policy. This is a unique feature and is not found in any other investment or accumulation vehicle. It provides a stream of income that the annuitant cannot outlive no matter how long that is. This lifetime guarantee of income is also unique as it promises to continue payments even if the payments are continued after all of the annuitant s accumulation of contributions and earnings are used up. It can be simply regarded as savings or investments made through a life insurance company. Annuities are not life insurance even though insurance companies offer them. Annuities are bought by people from a variety of providers such as an insurance agent, bank, and brokerage firms. Some people think of an annuity contract as life insurance without the extra death benefit and resulting mortality charges because there is no "net amount at risk" beyond the cash accumulation in the annuity. An annuity can also be described as a retirement planning and cash accumulation tool or vehicle. It can be viewed as having two phases: the accumulation phase and the annuitization or distribution phase. In the accumulation phase, a person gives money to an insurance or investment company over a period of time or in a lump sum, and it earns a rate of return. In the annuitization phase, the annuitant begins to withdraw regular payments (such as monthly or annually) from their contract until they die. An annuity does also have a death benefit. It is different than the one found in a life insurance policy. If an annuitant dies before they annuitize, their beneficiary receives either the current value of the annuity or the amount they paid into it, whichever is greater. For example, in a variable annuity, if a person dies when their investments are performing poorly and their account value is less than what they have paid in, their beneficiary would generally receive the amount one paid in. If their account value was greater than what they paid in, then the larger value would be paid out. Once an annuitant begins receiving monthly annuity payments, they no longer have a death benefit on their contract. For example, if they annuitize at age 65 and die at age

35 29 67, the insurance company keeps their money in their contract. However, one can buy "term certain" annuities, which guarantee that either they or their beneficiary will receive payments for a certain period of time, such as 10 to 15 years. For example, if they died three years after they began receiving payments from a 10-year term certain annuity, their beneficiary would still receive payments for the next seven years. Money in annuities grows tax-deferred. This means that the growth on one s money is not taxable until they make withdrawals or receive periodic annuity payments from their annuity. Once they receive payments, the portion of those payments that is considered their gains is taxed at their ordinary income tax rate. If one dies before they annuitize, their beneficiary pays taxes on the growth portion of the death benefit. In either case, the person who receives the money (the annuity holder or their beneficiary) is taxed at his or her ordinary income tax rate. Younger investors are sometimes see annuities as less attractive because there is a 10 percent penalty tax if they withdraw money from their annuity before age 59½ for reasons other than specific situations in the Code like death or disability, to mention a few. However, many people who have already retired and need annuity income right away many times opt for immediate annuities, which skip the accumulation phase and begin to issue payments as soon as they invest in the contract. While annuities are excellent accumulation vehicles for most people, the ideal annuity buyer is a person who has already contributed the maximum amount to their existing tax-deferred retirement plan, such as a 401(k), 403(b), or IRA. This is due to the fact that they are already building up tax-deferred money in those plans, and the fees associated with those savings vehicles usually are much lower than those of nonqualified annuities. Annuity Types According to When Benefits are Paid Out Immediate Annuity This is an annuity policy that is issued for a single lump sum premium that will give one and/or their spouse a guaranteed fixed payment. An immediate annuity begins making periodic payments to the annuitant immediately which can be usually within one year after it is purchased by the annuitant or as quickly as right after the policy is issued. Immediate annuity payments may be monthly, quarterly or annually and based on one's life expectancy or that of the annuitant and their spouse combined. Deferred Annuity A deferred annuity is one under which the annuity owner delays receiving payments until a later date after it is purchased. Money in a deferred annuity accumulates at interest (or grows based on the performance of the sub-accounts in a variable annuity) for a specific period of time before the company begins making payments to the annuitant. In effect, it delays an annuitant s income stream in lieu of accumulating interest without it s earnings being taxed until withdrawn by the owner or annuitant if the same person as the owner. Many often purchase deferred annuities during their working years in anticipation of the need for retirement income later in their lives. Most deferred annuities provide a great deal of flexibility surrounding the timing and amounts of payout benefits.

36 30 Characteristics of the Two Types The main difference between an immediate and deferred annuity is when the benefits or periodic payments (usually monthly, but not required to be monthly) are paid out to the annuitant. Annuity Type according to How and When Premiums are Paid California Insurance Code refers to annuity payments in a section of the Code where it discusses how much life insurance premiums can be paid in advance. It states: An incorporated life insurer issuing life insurance policies on the reserve basis may collect premiums in advance. Such insurers may also accept moneys for the payment of future premiums related to any policies issued by it. No such insurer may accept such moneys in an amount to exceed the sum of future unpaid premiums on any such policy, or the sum of 10 such future unpaid annual premiums on any such policy if such sum is less than the sum of future unpaid premiums on any such policy. This section shall not limit the right of such insurers to accept funds under an agreement that provides for an accumulation of such funds for the purpose of purchasing annuities at future dates. Section of the CIC Single Premium Annuities Single Premium Annuities are what their name implies a single lump sum paid to an insurance company into an annuity. The annuitant will then let the company know when they want the payments to begin and under what payment option they want it to be paid out. Single premium annuities are those where a person makes a single payment of money at the time of purchase of their annuity. In some cases, a company will consider a single premium all the money put into the annuity in the first 12 months of the contract. After the single sum paid at purchase time and over the 12 month in other cases, there are no more payments made into this type of annuity. After the single premium is paid in, the annuitant can elect to defer payment of any periodic payments (deferred annuity) or they can elect to have a periodic payment start immediately (immediate annuity). By paying in a lump sum of money, one is guaranteed to receive a series of payments over a period of time. In a deferred annuity, the amount of the payment is determined by both the current interest rate at the time one s contract is issued and by choices they make from a wide variety of payment options in the future. In an immediate annuity, once their contract is issued, their payments are fully guaranteed for the period of time they have chosen.

37 Flexible Premium Annuities 31 A flexible premium annuity is what it s name applies varying amounts of payments and varying time intervals between payments. All amounts at those intervals accumulate to build a fund to be available for payments in the future at the direction of the annuitant/owner in line with the various payout options provided by the contract. Flexible premium annuities will accept payments that are more than one single payment. These can take the form of fixed monthly, quarterly, semi-annual, or annual payments made over time while the annuitant wants to make payments into their annuity. The flexible premium annuity can also accept non-fixed irregular payments based on the minimum requirements of the specific annuity provisions they are buying. One might make regular monthly payments and change the amount if needed and/or make flexible payments in addition to regular payments as additional amounts of money come available to them at varying time throughout the year. This might be a bonus paid by an employer or an income tax refund that a person would like to add to their annuity payment for additional growth of their retirement nest egg. Characteristics of the Two Types The basic difference between single and flexible premium annuities essentially, then, is how, how much, and when a person pays money into their annuity. Annuity Type according to Investment Options Offered Variable Annuities In a variable annuity the annuity holder receives varying rates of interest and/or growth on the funds that one places into the annuity during the accumulation phase. Depending on the choice of investments during the distribution phase one can receive benefit payments from their annuity that vary in amount from month to month. Variable annuities fluctuate in their value relative to the performance of the investments inside the variable annuity, which are held by the insurance company in a separate account outside the company s general investment accounts. Variable annuities are considered securities and must be registered with the Securities and Exchange Commission. In a variable annuity, one s money is placed in selected investment options known as sub-accounts, which are similar to the various investment accounts inside mutual funds. Each sub-account has its own degree of risk, ranging from aggressive growth funds to bond funds and many others in between. The annuity owner assumes the responsibility for making the investment decisions in their variable annuity. The upside in variable annuities is that a person has the opportunity to make substantial gains depending on the performance of their investments in the varied sub-accounts.

38 32 In a variable annuity, the downside is that one can lose money if their investments in their sub-accounts chosen perform poorly. Another variable annuity downside is that there may be fees to switch one s money among sub-accounts. When one annuitizes their variable annuity, their periodic payments fluctuate depending on the performance of their investments. Some variable annuities allow for "fixed annuitization," which allows an annuity owner to receive fixed payments. The insurance or investment company recalculates their payments each year based on the performance of their investments. Basically, there are three separate elements to fees in a variable annuity; a "mortality and expense" fee, a sub-account fee, and an annual contract maintenance charge. Mortality and expense fees cover insurance expenses. These include the cost for the risk that the insurance company assumes to pay an annuitant a lifetime income stream, the death benefit payable in the event of the death of the annuity owner, and the commission paid to the agent or broker who sells the contract. The sub-account fee covers the cost of managing one s annuity investment accounts. The annual contract maintenance charge is generally a flat fee, usually around $30-$40. The average fee for a variable annuity is around 2-2½%. Contract Provisions Common to Variable Annuities To sell variable annuities agents must have a Variable Contract license and secure their FINRA Registration (Series 6 or 7, and 63) All agents selling annuities must complete the California 8-Hour Annuity Training course. Thereafter, life producer selling annuities must complete a 4-hour specifically designated annuity training course every two years prior to license renewal. Not investing in an insurance companies underlying investments (general account), because the money a person puts in to a variable annuity is invested in separate accounts, equities through the stock and bond fund choices within the contract, variable annuities are equity based investment vehicles. Many variable annuities offer more than one family of funds to choose from and within each family of funds they may choose from a variety of funds with different investment objectives. A prospectus must be given to any client in conjunction with any variable annuity review and purchase. Variable Options While many variable annuities have a dozen or more variable options for all or a portion of the overall premiums paid in, most have funds that are combinations of the following investment options: money market funds, government securities funds, bond funds, balanced (total return) funds, growth (common stock) funds, and a guaranteed fund. Variable annuity and variable life insurance products (collectively, variable insurance products" or variable products ) are being marketed and sold to a large number of investors. While variable insurance products may be appropriate investments for some investors, concerns have been raised about the sale of these products. This prompted the

39 33 staffs of the Securities and Exchange Commission ( SEC or Commission ) and NASD ( Staff ) to conduct examinations of broker-dealers that sell variable insurance products. The Financial Industry Regulatory Authority (FINRA), is the largest independent regulator for all securities firms doing business in the United States. All told, FINRA oversees nearly 4,800 brokerage firms, about 171,400 branch offices and approximately 644,000 registered securities representatives. Created in July 2007 through the consolidation of NASD and the member regulation, enforcement and arbitration functions of the New York Stock Exchange, FINRA is dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. Besides the fundamental basic investment sub-account choices (separate accounts), other types or subdivisions of these may include names such as Aggressive Growth, Growth & Income, International Stocks, Corporate Bonds, Government Bonds, High- Yield Bonds, Global & International Bonds, and Specialty Portfolios. This allows the variable annuity owner to diversify their investment portfolio to minimize risk and maximize their potential investment return. Unlike fixed annuities with guaranteed protection against loss of principal due to investment in the company s general account, the variable annuity owners principal is at risk and subject to loss in value. Variable annuities, then, are risk-based investments. Fixed options The owner of a variable annuity can transfer all or part of the value of their contract to the fixed account, sometimes called the guaranteed account. They might want to provide a safe harbor for a part or all of their funds held in their variable annuity in times of declining performance of all or one of their sub-accounts. If an owner wants to annuitize their fund values and have a guaranteed monthly lifetime income instead of a variable payout, they might transfer their money to the guaranteed fund and then elect to annuitize those funds. In essence, the variable annuity owner for a fixed dollar amount purchases a monthly income which will be paid to him/her until death. Contracts when issued include an "annuity table" stating the minimum payout guaranteed by the company based on age and sex (according to state law). From the fixed account, when the contract is annuitized, the payout will be based on the higher value of the guaranteed amount stated in the table or the current values used at that time. California Insurance Code also speaks to the fixed accounts in variable annuities during the 30-Day Free Look Period after delivery of the annuity to the client. It states, in part, that during the 30-day cancellation period, the premium for a variable annuity may be invested only in fixed-income investments and money-market funds, unless the investor specifically directs that the premium be invested in the mutual funds underlying the variable annuity contract. If the owner does not direct investments to be made outside the fixed funds during the Free Look Period, they will receive all of their initial premiums back if they cancel during the 30 days.

40 34 However, if the owner does direct that their initial premiums be invested in accounts other than the fixed accounts, then, if they cancel during the 30-day period after delivery, they will receive the value of their account as of the day of the cancellation which may or may not be similar to what they paid in initially. (Section of the CIC) Charges and Fees These fees are many times referred to as Loads and Management Fees. They can vary from contract to contract, but the basics shown below will give you a good rule of thumb as a basis for fundamental understanding. Agents should be well aware of what these fees and costs are in the different variable annuities that they have available for their clients to purchase. Administrative Fees: The issuing insurance company usually charges an Administrative Fee and a Mortality Risk Fee totaling 1.0% to 2.0% of assets - the typical fee usually is about 1.25% of assets. Contract Fees: Many companies charge a flat dollar amount varying from $20.00 to $40.00 per year. Sub-Account Fees: The charges for the operation and management of the subaccount range from.15% to 1.50% of assets Many people see these as complicated and seniors especially find these complex. Since seniors generally need their funds in safe places to be used for retirement income and medical costs, the variable annuity is rarely a suitable investment for them. Variable annuity fund values can go up and down sharply depending on what is going on in the stock market and equities in general, unless their money is in the guaranteed subaccount. Dollar Cost Averaging Many variable annuities offer an option called dollar cost averaging which provides a method for the systematic transfer of dollars from one fund to another inside the variable annuity. It is a systematic process of putting specific amounts of money into the variable annuity sub-accounts at regular intervals. This is a long-term process for investing money by an annuity owner into a variable annuity. An owner buys the same dollar amount of a sub-account each month. When an owner does this he is buying more shares of a sub-account fund shares when the market price is lower and a smaller amount of shares when the sub-account fund share price is higher. The dollar cost averaging system and approach historically has resulted in the average cost being lower than the average price over time. Returns on money invested, then, are historically higher for each dollar invested when using dollar cost averaging as the method of purchasing. This monthly regular and routine approach is in contrast to when one puts money into a variable annuity once a year or at irregular intervals in lump sum payments. Many companies provide for this investment option within their variable annuities. Initial payments go into the money market fund and are then transferred specifically and automatically into pre-selected sub-accounts that the owner had indicated originally at

41 35 the time of purchase. The owner can change the mix of sub-accounts to better match their needs for security, risk tolerance, and diversification. The process, amounts of money, and the timing of dollar cost averaging within a variable annuity are determined by the company and are part of the contract and reviewed fully in the prospectus. Agents must review all of their variable annuity contracts and be familiar with all of the information contained in the prospectuses in order to be accurate and helpful to their clients in making appropriate choices for their accumulation of money for their future. Annualized Interest Rate Calculations in Fixed Accounts To give you a good example of this interest crediting and fund transfer process as it relates to dollar cost averaging from the fixed account in a variable annuity, we provide this extract from an actual prospectus. In addition to the DCA (Dollar Cost Averaging) Program, within the Fixed Account, we may credit increased interest rates to Contract Owners under an administrative special DCA Program established at our discretion, depending on availability and state law. Under this program, the Contract Owner may pre-authorize level transfers to any of the funding options under a 6 Month, 12 Month or 24 Month program. The programs will generally have different credited interest rates. We must transfer all Purchase Payments and accrued interest on a level basis to the selected funding options in the applicable time period. Under each program, the interest will accrue only on the remaining amounts in the Special DCA Program. For example, under the 12 Month program, the interest will accrue up to 12 months only on the remaining amounts in the Special DCA Program and we must transfer all Purchase Payments and accrued interest in this program on a level basis to the selected funding options in 12 months. Death Benefit Guarantees In variable annuities, the guaranteed death benefit is at least equal to what the cash surrender benefit would have been had the person surrendered their annuity the day they died, if it is in the fixed account of the variable annuity. If funds are in the sub-accounts, most companies calculate the value of the accounts to be used in the death benefit as of the day the company receives formal notification and required paperwork regarding the death, not the day of death. As a practical matter, many companies guarantee the full amount of the premiums paid in as the minimum death benefit, regardless of whether the account value is less than the amount of premiums paid in at the time of the death. If the account value is more than the premiums paid in at the time of death, then the total value of the account is paid out as the death benefit. Some companies have riders/options, for an additional charge, that provide different approaches for enhancing death benefit payments, as well. Agents should be knowledgeable in the different ways that death benefits are paid out by the various variable annuity contracts that they sell to the public. Sample policies and prospectuses for the many VA s out there should be read and studied fully for the benefit of their customers.

42 California Insurance Codes address this issue in the following manner. The essence of this Code section is in bold type at the end of the section: Surrender Values CIC For contracts which provide cash surrender benefits, such cash surrender benefits available prior to maturity shall not be less than the present value as of the date of surrender of that portion of the maturity value of the paid-up annuity benefit which would be provided under the contract at maturity arising from considerations paid prior to the time of cash surrender reduced by the amount appropriate to reflect any prior withdrawals from or partial surrenders of the contract, such present value being calculated on the basis of an interest rate not more than 1 percent higher than the interest rate specified in the contract for accumulating the net considerations to determine such maturity value, decreased by the amount of any indebtedness to the company on the contract, including interest due and accrued, and increased by any existing additional amounts credited by the company to the contract. In no event shall any cash surrender benefit be less than the minimum non-forfeiture amount at that time. The death benefit under such contracts shall be at least equal to the cash surrender benefit. (Section of the CIC) Living Benefit Guarantees Since variable annuities are equity based and risk based by the owner, they are not seen generally as having living benefit guarantees. However, the fixed/guaranteed accounts inside of variable annuities do have contractual guarantees with regard to their principal and minimum interest guarantees for the funds placed in the guaranteed/fixed sub-accounts. Annuitizing the funds held in the fixed/guaranteed sub-accounts have living guarantees built into the various settlement options that are available in the fixed account. Generally these periodic annuity payments have lifetime guarantees of monthly income for the life of the annuitant with some guarantees of income for beneficiaries of the annuitant if the annuitant had elected options that continued payments to others after the annuitant dies. Again, it is critical for the agent to be familiar with the guarantees offered by their various variable annuities that they will be selling to others. Sample contracts and prospectuses provide the detailed information to accomplish this. 36 Fixed Annuities These are annuities that pay an interest rate, which is guaranteed for one or more years, and have surrender charges of one or more years, as well. The money one invests earns a fixed rate of interest that is guaranteed by the insurance company. The upside is that there is no risk involved. Fixed annuities offer security by having the rate of return a certain rate known in advance. The annuity owner does not take on the responsibility for making decisions about where their money is to be invested.

43 37 The downside is that one may miss out on gains and growth that they might have made beyond the fixed annuity if the stock market performs well. When one annuitizes, their payments are also fixed, which can be a blessing or a curse depending on how the market performs during the annuity distribution phase. Unlike a variable annuity, a fixed annuity does not fluctuate in value. The investments underlying the fixed annuity are owned by the insurance company as part of its general account. The insurance company guarantees the value of each annuity policy that is backed by the general assets of the company. Every fixed annuity policy contains an underlying guaranteed minimum credited interest rate. The minimum interest rate during the accumulation period may be different than the minimum interest rate during the payout period. In addition to the guaranteed underlying interest crediting rate, the annuity company usually declares a current interest rate that is higher than the minimum guaranteed rate and it is normally guaranteed for a period of time, generally one year. At the end of this period the company declares a new current credited rate. There are no up-front charges in fixed annuities. Occasionally, a one-time policy fee is charged with the application for the annuity. The insurance company makes money on these by subtracting the amount of money it is required to pay on these from the gross investment results the company earns on the annuity deposits that they invest as part of the company s general accounts. Contract Provisions that are Typically Common to Fixed Annuities Death Benefits Death benefits from a fixed annuity are generally the amount of the premiums plus guaranteed interest or the total value of the annuity funds including credited interest, if greater. Lump Sum vs. Annuitization If an annuity owner dies before their entire interest in the annuity is paid out there are certain distributions that must be made. If death occurs during the annuity payout phase, the IRS requires that the balance of the payments due must be paid out at least as fast as they would have been had the owner lived. If the owner dies during the accumulation phase, the entire amount of the proceeds must be paid out within 5 years of the owner s death. This 5-year payout, rather than a full immediate payout, could help from a tax standpoint. In a full distribution in one year, the entire amount of the growth in the annuity would be subject to tax. In the 5-year distribution, only a portion of the total growth would be subject to current income taxation in each of the 5 years. This could serve to lessen the tax bite on the amount of growth in the annuity at the time of the owner s death. If an annuitant is the owner, as well, the rules and situation from a tax point of view is similar to the owner dying above. However, if the annuitant dies during the accumulation

44 38 phase of the annuity, their beneficiary will receive the death proceeds and will be liable for the income tax on the entire amount of the growth in the annuity at the date of death. However, if the beneficiary elects within 60 days of the death of the annuitant to take a life or installment annuity settlement option on the entire amount of the death proceeds, then the entire amount of the growth portion will not be taxable in the current year. It will be treated like an annuity installment payment where only a portion of the monthly installments will be subject to taxes in each current tax year. This many times can serve to lessen the overall tax bite from an annuity death benefit payout. Charges and Fees An agent must be familiar with the ways in which companies charge administration and policy fees on their annuities. As discussed previously, most annuity policies have administrative charges of one nature or another. Some have more than one method of charging fees. Some companies charge a flat annual fee ($30, for example) to cover costs of things like statement fees and providing administrative changes as needed such as beneficiary changes or ownership changes. The fees and charges in fixed annuities are generally lower than those charged in variable annuities. The interest credited by an insurance company beyond the guaranteed interest can also be a place where a company makes up for what they need to pay expenses and provide profit to the company. They may adjust the current interest to be credited downward enough to allow for a portion of the interest to be retained by them to offset expenses that might otherwise be separately charged outright for administrative fees. Some fixed annuities may have a bail out provision. This feature allows the annuity owner to cash in their contract without surrender charges if the interest rate credited to their annuity falls below a certain predetermined level. An example of this would be a provision where the bailout rate is specified to be 1% below the current rate being credited. In this case, if the interest rate declared is more than 1% below the current interest rate, the owner of the annuity could surrender the annuity and not have to pay any of the surrender charges that are normally charged for surrender where the interest rate was above the bail out rate. This provides a measure of peace of mind for the annuity owner against wanting to move their money in dramatically falling interest rate times, but not being able to do so without incurring significant expenses in order to move their money elsewhere. Interest Rate Strategies Fixed annuities pay a current interest rate that is generally guaranteed for one or more years. A fixed annuity refers to the interest rate paid by the insurance company on the funds placed in the annuity. When a person purchases a fixed annuity they know what the current and guaranteed interest rates are and these are the types of interest rates that will be earned on their money. Fixed annuities offer security because the guaranteed rate of return is certain and sometimes the current rate for at least a number of years may be known up front. The risk for performance falls on the company issuing the annuity and the annuity holder does not have to take on the responsibility for investing the money.

45 In addition, the fixed nature of these annuities applies to the amount of the benefit to be paid out during the annuitization period, as well. Some fixed annuities offer a higher first-year interest rate that is guaranteed for one year or annual. The "base rate" is the interest rate that the company projects it will pay in the second year and thereafter, but is not guaranteed in most cases. The difference between the actual rate in the first year and the projected base rate for subsequent years is the bonus rate. Quite often, the "renewal rate" a company declares on each contract anniversary from the second year and beyond is different than the projected base rate. Some refer to these as bonus annuities. There are also annuity products where the number of years the interest rate is guaranteed is equal to the number of years the surrender charge exists or multi-year. For example, annuity products that have a 5-year guaranteed interest rate and a 5-year surrender charge are typically regarded as CD type annuities. Interest Rate Crediting Methods The methods for calculating interest to credit and pay to fixed annuity owners are generally determined by the company s Board of Directors based on the return earned on the company s investments of annuity premiums as part of the company s overall general portfolio of investments. Companies may also elect to invest annuity premiums in investments that take into account the returns that are provided through investment in financial instruments that derive their return from new money rates of return available in the investment marketplace during each year. Minimum Guaranteed Interest Rates Fixed annuities have guarantees of the principal or premiums paid in as well as a guaranteed minimum interest rate. The guaranteed rate is the minimum rate that the annuity company will contractually credit to the money held in the annuity. It guarantees this rate no matter what current interest rates and earnings potential for the company is in the financial and investment arena. Low interest Rate Market & Its Impact on Interest Rates Guaranteed Rates For years prior to the last few, these guaranteed rates in annuity contracts were typically in the 3 to 4 percent range. However, in the current environment with low interest rates in the economy being sustained over a number of years and apparently continuing without dramatic upward movement, companies have lowered these guaranteed rates in their newer contracts to the 1½% to 2½% area. Current Interest Rates This low interest rate environment has also had a significant dampening effect on current interest rates beyond the guaranteed rates being credited to both new and older 39

46 40 annuity contracts. The spread between guaranteed rates and current rates above those guaranteed rates being credited to fixed annuity owners have shrunken significantly. California legislation is much more specific in the way it deals with this subject as it relates to companies offering annuities to residents of California. Current legislation has changed and is applicable to specific dates that are here now and upcoming in To give you a better sense of the issues that the legislation regards, we have brought the Code to your text here: Minimum Non-Forfeiture CIC (a) This section shall apply to contracts issued on and after January 1, 2006, and may be applied by a company, on a contract-form-by-contract-form basis, to any contract issued on or after January 1, 2004, and before January 1, (b) The minimum values as specified in Sections , , , , and of any paid-up annuity, cash surrender, or death benefits available under an annuity contract shall be based upon minimum non-forfeiture amounts as defined in this section. (c) (c) The minimum non-forfeiture amount at any time at or prior to the commencement of any annuity payments shall be equal to an accumulation up to that time, at the rates of interest indicated in subdivision (d), of the net considerations (as hereinafter defined) paid prior to that time, decreased by the sum of all of the following: Any prior withdrawals from or partial surrenders of the contract, accumulated at the rates of interest indicated in subdivision (d). An annual contract charge of fifty dollars ($50), accumulated at the rates of interest indicated in subdivision (d). Any state premium tax paid by the company for the contract, accumulated at the rates of interest indicated in subdivision However, the minimum non-forfeiture amount may not be decreased by this amount if the premium tax is subsequently credited back to the company. The amount of any indebtedness to the company on the contract, including interest due and accrued. (d) The net considerations for a given contract year used to define the minimum nonforfeiture amount shall be an amount equal to 87.5 percent of the gross considerations credited to the contract during that contract year. (e) The interest rate used in determining minimum non-forfeiture amounts shall be an annual rate of interest determined as the lesser of 3 percent per annum and the following, which shall be specified in the contract if the interest rate will be reset: (f) The five-year Constant Maturity Treasury Rate reported by the Federal Reserve as of a date, or averaged over a period, rounded to the nearest one-twentieth of 1 percent, specified in the contract no longer than 15 months prior to the contract issue date or re-determination date under paragraph (2), reduced by 125 basis points, where the resulting rate is not less than 1 percent.

47 (g) The interest rate shall apply for an initial period and may be re-determined for additional periods. The re-determination date, basis, and period, if any, shall be stated in the contract. The basis is the date, or average over a specified period, that produces the value of the five-year Constant Maturity Treasury Rate to be used at each re-determination date. (h) During the period or term that a contract provides substantive participation in an equity indexed benefit, it may increase the reduction described in paragraph (2) of subdivision (d) by up to an additional 100 basis points to reflect the value of the equity index benefit. The present value at the contract issue date, and at each redetermination date thereafter, of the additional reduction shall not exceed the market value of the benefit. The commissioner may require a demonstration that the present value of the additional reduction does not exceed the market value of the benefit. Lacking a demonstration that is acceptable to the commissioner, the commissioner may disallow or limit the additional reduction. (i) The commissioner may adopt regulations to implement the provisions of subdivision (e) and to provide for further adjustments to the calculation of minimum nonforfeiture amounts for contracts that provide substantive participation in an equity index benefit and for other contracts with respect to which the commissioner determines adjustments are justified. Indexed Annuities Index annuities are in a unique class of annuities that use an equity index as the basis for calculating the interest that will be credited to the annuity policy. These annuities have all the guarantees of a fixed annuity contract plus the potential of stock market performance based returns with no downside risk. In an equity index annuity, one s money is invested in a fixed account and they may earn additional interest based on the performance of a particular stock index, such as the Standard & Poor's 500 Index, the Dow Jones Industrial Average, the Nasdaq Composite Index, or the Russell 2000 Index. The upside is that the annuity owner has the potential to get the best of both worlds. The owner has the opportunity to earn money based on stock performance and the stability of a fixed account. The downside is that they still essentially have a fixed annuity, and the gains they can make in the contract due to the performance of the stock index can be fairly small. When they annuitize during the distribution phase, their payments are fixed. There are generally no up-front charges in index annuities. The insurance company makes money on these by subtracting the amount of money it is required to pay on these by investing the assets in the annuities. Occasionally one may find a margin, spread, or administrative fee, but these are subtracted from the credited interest only in years where there is a positive increase in the index that creates some level of credited interest above and beyond the guaranteed interest, if any. Contract Provisions Common to Indexed Annuities An Equity Indexed Annuity (EIA), in its simplest form, is a fixed annuity product that provides current interest based on the long term potential growth of the stock market as 41

48 42 measured by the movement upward of indexes that measure the average performance of a group of stocks, such as the Standard & Poor s 500. This means that the interest rate set and credited by the insurance company at the end of each policy calculation period, usually a year, is based on the performance of an equity index. The method by which the interest rate is calculated can vary among EIA s. The percentage of the gain of the index that is used to credit interest to a person s annuity is referred to as the Participation Index Rate. An EIA is an annuity product that provides the downside guarantees of a fixed annuity. This means that once one makes a premium payment they will never have less in their account than their premium payment and that once interest has been credited to their equity index annuity, the value of their annuity will never decrease unless they make a withdrawal even if the stock market goes down. The challenge with EIA s is that they are quite different between companies in how they calculate credited interest and the approaches they take in applying the many different components that go into this unique annuity. Specific Term or Index Term The specific term or index term is the time frame over which the index-linked interest is calculated. To understand more fully the specific term an example is helpful. The S&P 500 index was at 1000 on the day one s contract was issued and at the end of the 5 year term of their contract, the S&P 500 index was The gain of 400 points represents a 40% increase. Therefore, the value of their contract would be increased by 40%. An annuity policy with an initial premium of $100,000 would be credited with $40,000 of interest 5 years later. The time periods that companies use are either the policy year, from the day the policy is issued to one year later or a specific term (index term), a period of one or more years. Primary Interest Crediting Strategies An equity-indexed annuity is different from other fixed annuities because of the way it credits interest to the annuity's value. Most fixed annuities only credit interest calculated at a rate set in the contract. Equity-indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked. The formula decides how the additional interest, if any, is calculated and credited. How much additional interest they get and when they get it depends on the features of their particular annuity. An equity-indexed annuity, like other fixed annuities, promises to pay a minimum guaranteed interest rate. The rate that will be applied will not be less than this minimum guaranteed rate even if the index-linked interest rate is lower. The value of this annuity also will not drop below a guaranteed minimum. Some company s EIA s guarantee 100% of the principal while others may guarantee 90% or 75%. They are all different. For example, many single premium annuity contracts guarantee the minimum value will never be less than 90 percent (100 percent in some contracts) of the premium paid, plus at least 3% in annual interest (less any

49 43 partial withdrawals). The insurance company will adjust the value of the annuity at the end of each index term to reflect any index increases. Two features that have the greatest effect on the amount of additional interest that may be credited to an equity-indexed annuity are the indexing method and the participation rate. It is important to understand these features and how they work together. The following describes some other equity-indexed annuity features that affect the index-linked formula. Indexing Methods One of the most confusing aspects of index annuities for consumers and agents alike is the method that companies use to calculate the interest rate that the policy will earn. The indexing method is the approach used to measure the amount of change, if any, in the index. Some of the most common indexing methods are explained more fully below. All the methods that are used essentially measure the change in the S & P 500 Index over some period of time. It is the most common of the indexes used. Other indexes that companies also use include the Nasdaq, Russell 2000, and the Dow Jones Industrial Average. In some, the annuity owner can choose which index(s) they want used to calculate their interest. In others, owners can choose how much of their money they want to have interest credited to using different indexes. Point-to-Point The index-linked interest, if any, is based on the difference between the index value at the end of the specific term and the index value at the start of the term. It ignores any fluctuations in the index during the period between the points used for calculation. Interest is added to their annuity at the end of the term. The specific term period may be one policy year or 3, 7, 12, etc. policy years. If the index annuity calculates the gain in the equity index using the point-to-point method every year and credits the interest every year during the index term, this is referred to as Annual Point to Point. If the annuity interest is calculated at the end of the index term, at the end of 5 years, for example, and uses the point to point method which looks at the index at the beginning and then only looks at the index at the end of the 5 year period to calculate and credit interest, this is referred to as Long Term Point to Point. Advantage Since interest cannot be calculated before the end of the term, use of this design may permit a higher participation rate than annuities using other designs. Disadvantage Since interest is not credited until the end of the term, typically six or seven years, they may not be able to get the index-linked interest until the end of the term.

50 Averaging 44 In some index annuities, the average of an index's value is used rather than the actual value of the index on a specified date. The index averaging may occur at the beginning, the end, or throughout the entire term of the annuity. Instead of using the percentage change over the policy year, some companies use the averaging method. They calculate the change by averaging the daily closing index values or averaging the monthly index values. Monthly averaging would have the company look at the index number each month during the year and add them together. Then, they would divide this number by 12 to derive the average index number during the year. This average would be substituted for the year-end index number and the increase from the starting point would be calculated using this number. The averaging method also tends to lower the overall rate of return of the S&P 500 Index, similar to that of a "cap" rate which sets the upper limit on what the company will credit in interest regardless of how much the index increases during the index term. In rising markets the averaging method limits the increase that would be credited to their annuity policy. Averaging at the beginning of a term protects one from buying their annuity at a high point, which would reduce the amount of interest they might earn. Averaging at the end of the term protects them against severe declines in the index and losing index-linked interest as a result. On the other hand, averaging may reduce the amount of indexlinked interest they earn when the index rises either near the start or at the end of the term. Advantage Since interest is calculated using the highest value of the index on a contract anniversary during the term, this design may credit higher interest than some other designs if the index reaches a high point early or in the middle of the term, then drops off at the end of the term. Disadvantage Interest is not credited until the end of the term. In some annuities, if they surrender their annuity before the end of the term, they may not get index-linked interest for that term. In other annuities, they may receive index-linked interest, based on the highest anniversary value to date and the annuity's vesting schedule. Also, contracts with this design may have a lower participation rate than annuities using other designs or may use a cap to limit the total amount of interest they might earn. High Water Mark This is an additional way that some companies calculate the interest to be credited on one s EIA, especially where point to point is being used over a longer period of time such as 6 years, for example. It is most helpful to annuity owners where the index value goes down at the end of their index term prior to the interest calculation.

51 45 The index-linked interest, if any, is determined by looking at the highest index value during the index term, usually on the annual anniversaries of the date they purchased their annuity. The highest level of the index during the index term is captured and used in the interest rate calculation. The interest, then, is based on the difference between this highest index value and the index value at the start of the term. Interest based on the high water mark is added to their annuity at the end of the term. This method, in essence, substitutes the high water mark during the term for the end value in the calculation process if the high water mark is, in effect, higher than the actual end value. Low Water Mark Like the high water mark concept, the low water mark method is similar, but just the opposite. It looks back at the index values during the specific term to determine what was the lowest point of the index. The index-linked interest, if any, is decided by looking at the index value at various points during the term, usually the annual anniversaries of the date they bought the annuity. The low water mark is determined and substituted for the beginning value in the percentage of change calculation, if it is lower. The interest is based on the difference between the index value at the end of the term and the lowest index value. Interest based on this calculation is added to their annuity at the end of the term, as was the high water mark method above. This calculation method is best when the value of the index goes down early after one buys their EIA and then rises back over the remainder of the index term period. Annual Resets This calculation method is often known as the Ratchet Method, as well. This method locks in the gain for a calculation period, usually each year during the index term. It can also relate to compounding of interest within the policy. Once the interest is credited, by doing a calculation each year to their policy, it becomes the total value on which the next years gain is calculated. This is in contrast to simple interest calculations that some EIA s have as their method of crediting interest. Here the interest credited is always calculated on the amount of premium paid in originally. It is not added to the principal when subsequent years interest is calculated. Agents should be aware of how each of the policies they sell handles this matter as most people are used to compounding of interest in their savings accounts and could be confused or unhappy if they find out after purchase that their interest in not compounding. Combination Methods Some policies will use the above indexing, calculating, and crediting methods separately and some may use some or all of them in combination within their policy.

52 46 Agents must review sample policies and all policy literature to know how and if each policy they sell treat these items. Spreads Companies that use this method calculate the percentage increase in the index for that policy year or term, then subtract a specific percentage (spread) from that change before crediting the interest to the owner s annuity. For example, if the gain in the S&P 500 for a policy year was 12% and the company used a spread fee of 2%, then 10% would be credited to their policy for that year. Spread fees are also called margin fees in some index annuity contracts. Participation Rates This can be viewed as a variation on the spread method. Instead of subtracting a flat percentage from the index increase before crediting the interest, the participation rate determines how much or what percentage of the increase in the index will be used to calculate index-linked interest to be credited to their policy for that year. It is generally expressed as a percentage such as 70%, 80%, or 90%. For example, if the calculated change in the index is 10% and the participation rate is 70%, the index-linked interest rate for their annuity will be 7% (10% x 70% = 7%). A company may set a different participation rate for newly issued annuities as often as each day. Therefore, the initial participation rate in their annuity will depend on when it was issued by the company. The company usually guarantees the participation rate for a specific period (from one year to the entire index term). When that period is over, the company sets a new participation rate for the next period. Some annuities guarantee that the participation rate will never be set lower than a specified minimum or higher than a specified maximum. The participation rate may vary greatly from one annuity to another and from time to time within a particular annuity. If it can be changed during one s index term, it is referred to as a moving part. Therefore, it is important for agents to know how their annuity's participation rate works with the indexing method in the index annuities that they sell.. A high participation rate may be offset by other features, such as averaging or a point-to-point indexing method. On the other hand, an insurance company may offset a lower participation rate by also offering a feature such as an annual reset indexing method. Cap Rates Some equity index annuities may put an upper limit, or cap, on the index-linked interest rate. This is the maximum rate of interest that the annuity will earn, regardless of what the increase in the index is. If an annuity contract has a 12% cap rate and the index linked interest would be calculated as 15% in a high increase year, 12% would actually be credited. Not all annuities have a cap rate.

53 While a cap limits the amount of interest one might earn each year, annuities with this feature may have other product features they want, such as annual compound interest crediting or the ability to take partial withdrawals. Also, annuities that have a cap may have a higher participation rate. Minimum Guaranteed Interest Rate Companies that issue EIA s vary in how and if they have a minimum guaranteed interest rate. Some do and some do not. The guarantees typically range from 0% to 3%, with more being in between these two. This guarantee provides some level of growth even if there is no increase in the index or a decline in the index in which there would be no interest calculated. Impact of Premature Surrender Charges Premature surrenders, either partial or full, in an equity index annuity are similar to those actions taken in other annuities. The interest is currently taxable in the year received. If under age 59½, there is a 10% penalty on the amount of interest released due to the surrender. In partial surrenders, the full amount of the interest in the entire annuity is withdrawn first and taxable, with the amount paid in being the last amount to be withdrawn not subject to tax. Distinguishing the characteristics of fixed, indexed, and variable annuities as well as distinguishing the relationship between the annuity types relating to our clients The investment options offered for fixed and indexed annuities are chosen and invested by the insurer where as the annuitant chooses the investment alternatives provided through the sub-accounts in the variable annuity. A client can choose who they want to make their investment decisions The fixed and indexed annuities have guarantees for the principal and minimum interest to be paid on these annuities. The variable annuity has no guaranteed interest rate, nor do they have a guarantee of the annuity owner s principal. A client may want to risk more to return more and has that flexibility and risk in the variable annuity. The fixed and index annuities have fixed annuity payments during the distribution phase. Variable annuity payments during the distribution phase can fluctuate depending on the performance of the sub-accounts. A client may want to have all payments be fixed or they may want to arrange to have a combination of the two types. Distinguishing the Relationship between the Annuity Types reviewed in A, B, C and How They relate to a Client In variable annuities, a client can choose who they want to make their investment decisions. In fixed annuities the company does the investing and makes those choices and takes the risk for the client. 47

54 48 In variable annuities, a client may want to risk more to return more and has that flexibility and risk in the variable annuity. That risk and reward scenario is not available in a fixed annuity. Index annuities try to bridge those alternatives of risk and reward for a client by providing a basic underlying guarantee while also providing a measure of capacity for additional reward depending on how the market indicators change over time.

55 49 Chapter FOUR The Senior Market Market Volatility and Risk Tolerance and the Senior Client In the United States and in California, life expectancy has increased dramatically in the last decade and will continue to do so due to advances in medical science, treatment, and technology. This means that a higher percentage of all age categories will be living longer than ever before. The large population bubble that is frequently referred to as the Baby Boomer Generation is 70+ million in size and has aged to where they are now in their mid 40 s and late 50 s to mid 60 s. On January 1, 2011, the first of the boomers turned 65. On December 31, 2029, the last of the boomers will turn 65. By 2020, it is estimated that there will be 75 million Americans over age 65 where there are 25 million today. By 2030 there will be 80 million as the last of the Baby Boomer bubble in population crosses the age 65 threshhold. More than any other generation, the Baby Boomers, those born between 1946 and 1964, face unique financial challenges. On average, Boomers waited longer to have children. A majority will enter retirement with ongoing financial obligations like a mortgage or funding a college education. They won t be able to rely on a lifetime pension from their employer. Many experts believe that lack of planning and poor financial education has caused many seniors to be worried about their financial health and well-being. As an agent s clients near retirement, they are often told they should have less exposure to equities and the risk of loss due to short-term volatility in the stock market. But, because inflation will continue during retirement, many financial advisors today believe that most seniors need to earmark a percentage of their portfolios for growth to help offset this inflation. Markets go up and markets go down with little predictability. Seniors can be hesitant to do that, for fear they won't be able to earn back principal lost in a market decline. But innovative approaches like the new equity index annuities may be an alternative that many of these seniors can use; because they were built to provide the potential for receiving the higher returns associated with equities without loss of principal. And, chances are good that Boomers will live longer than their parents and grandparents, thus extending the period during which they will need retirement income, compared to their predecessors. The percentage of our entire population of those who are over 65 over the next 10 to 15 years will be higher than ever before. Correspondingly, the numbers and percentages of those reaching their 70 s, 80 s, and 90 s will grow dramatically over the next 20 to 30 years. This increased number of older Americans results in an increasing number of individuals with a variety of longer-term financial needs. The opportunities for this market are much broader than just meeting monthly retirement income needs.

56 50 Many seniors, regardless of how much they have when they retire, will eventually run out of money. The American Association of Retired Persons estimates that four in 10 Americans over the age of 60 will experience poverty at some point in their later lives. One in two will experience near-poverty (income between the poverty level and 125% of this level). The risk issues for seniors are that they need to continue to have guaranteed monthly incomes that they cannot outlive, but that they also risk having those fixed incomes not able to increase in line with the increases in living costs caused by inflation. Without a plan, many retirees will learn the hard way that bad investments, unexpected medical expenses, and self-indulgences can quickly erode their life savings. Post-retirement Planning Pre-retirement vs. Post-retirement Planning Post-retirement planning does not seem to get the same level of attention as preretirement planning. Perhaps it s because the financial professional views the tools necessary to work in this market as too different, or because the need for planning is considered less urgent in the later years. Today s Boomers increasingly have the sole responsibility not only for funding and managing their own retirement accounts, but also for ensuring that their retirement savings will last the 20 or more years they could be in retirement. Immediate and deferred annuities are vehicles that can give them the peace of mind of knowing they will have income that will always be there for them. Family structures and dependent situations are changing and evolving. Today, there are a number of varying family structures. There are families with adult children at home, grandparenting families, sandwich generation families, "empty nesters" and "full nesters." These situations add additional risks for those who are dependent financially on each other. Death benefits and income streams continuing from annuitants to others after they die have all taken on greater significance and urgency. Also, as more and more people wait until older ages to have children, they can easily find themselves past age 65 with their children still at home or moving back in. The oldest Boomers are increasingly turning their attention to post-retirement planning. The younger Boomers are not far behind and will have to turn their attention to this, as well, before too long. The insurance industry and agents are compelled to be in a position to ably advise and provide expanded annuity and retirement income strategies for this huge group of Americans. Immediate annuities, also known as income annuities and payout annuities, hold definite appeal to people in this age group. They provide aging Boomers with a guaranteed stream of income they can t outlive. Given the decrease of defined-benefit pension plans, which also guarantee an income stream in retirement, it s not surprising that immediate annuity products and annuity strategies will take on added importance and increased purchase growth by an increased number of our population.

57 51 Over the last several years there has been a huge increase in annuity sales over previous years with an increasing percentage of this total increased amount going towards the purchase of immediate annuities. The traditional senior market typically has been considered the prime target for such products as annuities, long term care insurance, IRAs and Medicare supplements, just to name a few. Clients who think the end of their working life signals the end of active planning needs and investment opportunities will need to take a closer look at their post-retirement situation. Retirees need continued planning and they need capable agents to help them through it. Given the increasing longevity of our population and the acknowledgement that total return and equity participation are still very important in the later years, there are numerous opportunities to provide a valuable service to retired individuals. Pre-retirement Planning There is no denying that many people in their 50 s, 60 s and even 70 s may benefit from purchasing retirement products, annuities, long-term care, and Medicare supplements. With the exception of Medicare supplements, though, some prime targets for traditional senior products may actually be much younger. Many financial professionals are concerned by the fact that younger clients, those in their 30 s, 40 s, and 50 s, often do not have the time, energy or money to think about their senior years. This is because younger people are caught up in the tasks of advancing their careers, buying homes, and raising families. Ironically, the best time for clients to buy insurance and set aside money in financial and retirement products for their senior years is in their 30s and 40s and, some might say, in their 20s. When one couples that with the fact that many people would like to retire earlier than the traditional age of 65, it becomes clear that the market for senior products may be younger than many people think. For long-term care insurance and various types of life insurance, the obvious answer is to have them be reminded that the likelihood of their being approved for these types of insurance and for paying lower premiums depends on age and health status. Younger and healthier clients will be more likely to be approved and to pay lower premiums on life insurance. In the case of LTC insurance, older clients in their 50 s or 60 s often discover that something in their health histories will prevent them from purchasing any coverage at all, as well as the potential for being charged a higher premium. These outcomes are rarer at the younger ages. For annuities, IRAs, and other asset accumulation products, the agent s biggest ally for helping convince younger clients of the value of these products is the time value of money. Agents can point out that a small change in financial savings habits can add up to big dollars in retirement savings over the course of 25 or 30 years.

58 Financial Concerns 52 Social Security Social Security, if it s around by time the Boomers retire, will become available later in life with extended age provisions and will replace only a small percentage of their preretirement income. When created, Social Security was intended to be a supplement to an individual s personal savings, employer retirement plans, and pension plans. It has, for many, become their base retirement plan with other things becoming their retirement supplement. Retirement Plan Distributions Choosing payout options at retirement is a concern as the longer term future is not always going to look the same as it does at the time initial distribution decisions are made. Some elections are not flexible and the senior has to make their best guess as to how their future financial needs picture will unfold. Maximizing monthly income streams at retirement have to also take into account continued payments to others, such as a spouse, in the event of death of the payee of a retirement plan. Health issues at retirement can quickly change as the years go by. Flexibility needs and inflation protection needs many times require that maximum income options currently be reduced to provide for some level of security in meeting the changes that can occur in the future. There is no crystal ball to help in this area. Investing Retirement Assets Investing strategies and suitable products change their stripes when one retires. The strategies and products that were used prior to retirement in the accumulation phase are not necessarily appropriate during the distribution phase. The risk factor after retirement becomes more critical in making sure that funds are available for predictable long-term income and for shorter-term money for opportunities, desires, and emergencies. Investments also need to be reviewed for suitability at retirement. In a low interest rate environment, no longer are most clients content to convert their assets to low-yielding fixed instruments. Equities and professional money management become key considerations, both for economic reasons and with the emergence of the prudent investor standard that focuses on total return. The same is true of annuity assets, where having sufficient retirement income for life becomes a more immediate concern. Tax-deferred growth, tax-advantaged distributions and an income the client cannot outlive continue to make annuities an effective tool in retirement.

59 Insurance Concerns 53 Health For most, growing older means an increased concern and reality about deteriorating health issues. With the high cost of medical care currently and the potential for continued cost increases with advanced treatment and technology, the need to have health insurance is critical. But, the cost for Medicare Part B and Medicare supplements can be prohibitive for many with limited incomes. This leaves many vulnerable to the potential for out of pocket costs depleting income-producing assets. Fortunately, Medicare provides most at age 65 currently with basic hospitalization (Medicare A) free with physician and outpatient care (Medicare B) available at an additional cost per month ($ per month per person in 2014). Medicare supplements can be purchased privately (costs vary widely by company and by benefit levels) to provide coverage for many of the out of pocket costs not covered by part A and B to make their overall coverage more comprehensive in scope. The new Medicare prescription benefit, Part D, became available in 2006 and helped many to offset some of the cost of this growing medical necessity for millions of Americans, especially those with more low and modest incomes. A temporary interim discount prescription card was available for seniors between June 2004 and December Some discounting was available for all. Many low-income individuals received a $600 credit for their initial prescription needs with small co-pays and discounts on costs beyond the credit. It continues today with more benefits and assistance for all seniors. Long Term Care Long term care takes on new meaning upon entering retirement. At this point, clients must be much more willing to consider their own morbidity, particularly after their earned income drops. Addressing this need early in retirement, when insurability is less of an issue, is of concern and makes good sense to plan for and to take action on. In addition, the need for increased dollars to cover the elder s increased needs for assistance with activities of daily living creates the necessity for annuities that have the potential for increase benefits as well as the need for long-term care insurance. Tiered annuity benefits to offset inflation are a consideration due to the eventuality that one-half of a person's adult life could be spent in retirement. Estate Planning In addition to needing retirement products that have flexible payout options and that provide for long term care costs, seniors also need to be concerned with financial needs focused on death protection; a need often overlooked or even ignored. Planning needs in retirement are very similar to pre-retirement needs. For example, it becomes even more important for seniors to be sure they have a properly drafted will, which reflects their current situation and evolving tax laws. Dying without a will can force some very awkward property distributions, depending upon state intestacy laws. Likewise, retired individuals need to be sure they have a durable power of attorney, health care power, and living will.

60 Beneficiary designations for 401(k)s, IRAs, pension plans, deferred compensation, annuities, and life insurance should be reviewed on a regular basis to be sure they reflect the client s current situation and desires. They also need to be coordinated with any other planning tools the client has in place. Trusts are often created in the post-retirement years, to benefit grandchildren, disabled children, siblings, or parents to encourage and reward responsible behavior by family members, or to protect assets. Section 529 College Saving Plans present an excellent opportunity for estate planning by a retired couple. Large amounts of assets can be moved out of the estate, yet still remain accessible to the retirees in the event of a financial emergency. Charitable giving often becomes more urgent or attractive in later years, as clients have the discretionary assets to support their favorite organizations. Planning techniques such as charitable remainder trusts and charitable gift annuities are excellent planning tools for the retirement years. Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) accounts are still very viable options for providing for grandchildren, and often their benefits can be enhanced through the leverage and tax advantages of life insurance and annuities. Simplicity of implementation makes these techniques some of the first tools seniors should consider. Larger life insurance needs are evident as retirees begin their "end game" planning. They become much more aware of estate, capital gains, and income tax shrinkage of assets before they pass to the next generation. Estate planning is all about asset preservation. Annuities and life insurance play a key role in this area. Selling to the Senior Market Product complexity The aging of America in general and the aging of the 50 million Baby Boomers in particular has caused rapid development of products aimed at seniors facing earlier retirement and shrinking support from government resources. Doubts about the future of both Medicare and Social Security have led baby boomers to seek products, traditionally targeted for seniors, at earlier ages and in unprecedented numbers. Seniors, in general, are experiencing a changing economic world with continued low interest rates that cause fixed incomes relying on interest rates to earn rates not able to keep up with inflation. A wide range of "senior products" have emerged that are both suited to more active lifestyles and aimed at ensuring independence and financial security during retirement. With this emergence of variety in products comes increased complexity in choices that are suitable for one s particular situation. Add to this the lack of standardization among product varieties, and you have new challenges in dealing successfully with the variety and complexity of choices. 54

61 55 Surveys of seniors indicate that their primary goals during the "golden years" include not being a burden on the family, remaining physically and financially independent, and providing for spouses. Flexible products that target these various concerns are therefore on the rise. These products are built with varying degrees of diversity, flexibility and liquidity. Juggling all these facets add to the complexity facing our seniors. Seniors also need products that let them access benefits when needed. With economic uncertainties, the traditional emphasis on death has shifted to the living. Life policies with accelerated benefits riders are particularly popular because they allow insureds to receive advance payments from their death benefits during their lifetime. This adds to the further complexity in choosing from the myriad of products available. Neither Medicare nor supplemental health insurance covers many of the services needed by our elderly, such as home health care, nursing home care, and adult day care. Seniors are living longer, pension funds are shrinking, and medical costs are mounting. Seniors must plan for and develop their own contingency plans for being able to meet these needs. This carries with it varying degrees of complexity and challenge. Asset protection is also a priority for seniors. They want to leave behind as much of their hard-earned money and assets as they can to their spouses, children, and grandchildren. The tax laws and requirements to qualify for varying governmental programs like Medi-Cal make planning complicated at a time when most seniors prefer to have their live more simple. Surrender Charges This penalty only applies if the policyholder takes out more than the allowed free withdrawal amount of money from the contract within a set number of years. For those under age 60, the surrender charge is not an issue if they do not need to take out more than the free withdrawal amount in any year while the surrender fee period is in effect. After this period the surrender charge has not effect on their withdrawals from a contractual context. For those over age 60, the surrender fees have no impact if they have gotten beyond the number of years that the surrender fees applied to their annuity. Again, their earnings are maximized by having surrender fees applied to others that do withdraw or surrender more than the free withdrawal amount. The Issue of Buyer Competence Agents must be responsible for and diligent in their recognition of indicators that a prospective insured may lack the short-term memory or judgment to knowingly purchase an insurance product. The senior marketplace has the added ingredient of aging clients who have a greater likelihood that their cognitive abilities and capacities can be diminished in greater degree as the years go by. California, in recognition and responsiveness to this issue, deals with it by specific Civil Code statute. For emphasis on this subject, we have included the exact wording of the Code for your benefit and understanding.

62 56 California Civil Code 38 and A person entirely without understanding has no power to make a contract of any kind, but the person is liable for the reasonable value of things furnished to the person necessary for the support of the person or the person's family. 39. (a) A conveyance or other contract of a person of unsound mind, but not entirely without understanding, made before the incapacity of the person has been judicially determined, is subject to rescission, as provided in Chapter 2 (commencing with Section 1688) of Title 5 of Part 2 of Division 3. (b) A rebuttable presumption affecting the burden of proof that a person is of unsound mind shall exist for purposes of this section if the person is substantially unable to manage his or her own financial resources or resist fraud or undue influence. Substantial inability may not be proved solely by isolated incidents of negligence or improvidence. Suffice it to say that agents need to be even more vigilant and responsible for recognizing indicators existing with their clients and consumers, in general, that may demonstrate a lack of short-term memory or judgment when purchasing an annuity from that agent. Family Involvement / Power of Attorney It is highly encouraged for family involvement in Medicaid and health care planning. Family members should attend all attorney client meetings if appropriate. As family members are often the caregivers, they are encouraged to be trained in all health care documents and processes. Beneficiaries will be involved with planning documents because as beneficiaries they have a legal interest and right to be involved. If beneficiaries are family members, then the family will be involved with planning documents, assets, and all affairs no later than at incapacity or death. The family will also be involved with planning to the extent they are fiduciaries. Fiduciaries will obviously be involved with planning documents, because they are the ones legally named to manage affairs when others cannot. If one names family members as their fiduciaries, then their family will be deeply involved with their planning, assets, and all affairs again, no later than at incapacity or death. A financial power of attorney (also known as a general durable power of attorney) is a document, created pursuant to state and federal law, which gives financial authority for a family member to act on behalf of an individual for a period of time or at a certain time. The following kinds of financial powers of attorney: Limited power of attorney Stand alone financial power of attorney Financial power of attorney (in conjunction with a trust and a pour over will)

63 Unique Ethics and Compliance Issues 57 Even if seniors do not have personal competency issues, the senior market still has special needs and ethical treatment requirements that are unique. Many seniors today and those approaching their senior stage in life did not grow up in the computer age and are not savvy when it comes to the internet, , ebills, online banking, online investing, and complex business arrangements. Many grew up during a period of time when the number and types of insurance, savings, and investment products and options were more limited in number and simpler in scope. For many, aging brings with it an increased desire for simplicity, lack of patience, nervousness about simple things, loneliness, greater dependence on others, greater need to trust others to do things for them, and fear about things awaiting them for the remainder of their lives. For all these reasons, agents working with people in the senior marketplace have an obligation to be beyond reproach with regard to their ethical approach to this marketplace. Their level of compassion and understanding needs to be heightened. They need to enthusiastically adhere to all the California statutes and regulations in place to protect both the senior and themselves from problems arising out of financial and insurance dealings with seniors. As we have seen throughout our course to this point, there are many specific sections of the California Insurance Code and Civil Codes that speak to and directly relate to the age 60 and above marketplace. Both agents and their companies have specific requirements and obligations for adhering to these specific duties in the senior marketplace. Formal disclosures, signatures on key elements of the sales process, competency, financial prudence, professional conduct, and the Golden Rule are all pieces of the puzzle to be mastered and incorporated into all of our dealings with consumers at all ages, but especially with those age 60 and over. Suitability for the Senior Market For the benefit of all annuity purchasers in California, especially seniors over 65 years old, there are obligations and rights that agents must be aware of and adhere to in their performance of quality salesmanship and financial counseling with their clients. Seniors have an added measure of need for legislated protection since their situations have special characteristics with generally fixed incomes and the need for all their financial affairs and products purchased to be appropriate and suitable for their situation. Federal and state benefit programs like Medi-Cal, Medicare, Medicare Supplements, and Social Security are all of special significance to seniors more than any other age group in California. Income and assets of seniors greatly affect their eligibility and availability of financial, medical benefits, and long term care programs.

64 58 To protect California s seniors and others investing their hard earned money to prepare for and payout during retirement through the use of annuities, specific requirements regarding advertising, prohibited sales practices, suitability disclosure, illustrations, replacement, cancellations & free look periods, and the agent knowledge of contracts have been addressed by legislation and regulation. Prohibited Sales Practices Selling Annuities for Medi-Cal Eligibility (Section II of SB620/Section of the CIC) Many Californians have either done or been encouraged to do things financially to hide or restructure their assets to avoid having them be part of their eligibility for Medi-Cal. They may want to have their assets preserved for their children or grand children by shifting them away from themselves so that they are not available to be used appropriately within the requirements in order to be eligible for benefits under Medi-Cal. In an effort to tighten up and curb these practices by individuals themselves and by agents who might use practices that support and harbor this asset shifting, regulations and disclosure statutes were developed to incorporate in the sales process to discourage this practice. In addition to any other reasons that a sale of an individual annuity to a senior may violate any provision of law, an annuity must not be sold to a senior in a number of other situations. One of those situations is where a senior is sold or buys an annuity to rearrange their assets to look more favorably for qualifying for Medi-Cal. Selling Annuities to Persons 65 years and older Medi-Cal Selling annuities to persons 65 years and older for purpose of qualifying for Medi-Cal is prohibited if the senior's purpose in purchasing the annuity is to affect Medi-Cal eligibility and either of the following is true: If assets are equal to or less than community spouse resource allowance The purchaser's assets are equal to or less than the community spouse resource allowance established annually by the State Department of Health Services pursuant to the Medi-Cal Act (Chapter 7 (commencing with Section 14000) of Part 3 of Division 9 of the Welfare and Institutions Code). CIC Senior otherwise qualifies The senior would otherwise qualify for Medi-Cal. CIC After purchase senior or spouse does not qualify for Medi-Cal The senior's purpose in purchasing the annuity is to affect Medi-Cal eligibility and, after the purchase of the annuity, the senior or the senior's spouse would not qualify for Medi-Cal. In the event that a fixed annuity specified in subdivision (a) is issued to a senior, the issuer shall rescind the contract and refund to the purchaser all premiums, fees, any interest

65 59 earned under the terms of the contract, and costs paid for the annuity. This remedy shall be in addition to any other remedy that may be available. CIC The following is an overview of the key components in those regulations followed by the actual statute and disclosure form required in the sales process. "Elder" for purposes of this section of the disclosure law means any person residing in California who is 65 years of age or older. Informing purchasers that the sale or liquidation of any stock, bond, IRA, certificate of deposit, mutual fund, annuity, or other asset to fund the purchase of an annuity may have tax consequences. Informing the elder or elder's agent that they may wish to consult independent legal or financial advice before selling or liquidating any assets. Informing the elder that they or the agent may not negligently misrepresent the treatment of any asset under the statutes and rules and regulations of the Medi-Cal program. A life agent who offers for sale or sells any financial product on the basis of its treatment under the Medi-Cal program must provide information on this to the elder in writing. Written notice for people 65 and over CIC "Elder" for purposes of this section means any person residing in this state who is 65 years of age or older. If a life agent offers to sell to an elder any life insurance or annuity product, the life agent shall advise an elder or elder's agent in writing that the sale or liquidation of any stock, bond, IRA, certificate of deposit, mutual fund, annuity, or other asset to fund the purchase of this product may have tax consequences, early withdrawal penalties, or other costs or penalties as a result of the sale or liquidation, and that the elder or elder's agent may wish to consult independent legal or financial advice before selling or liquidating any assets and prior to the purchase of any life or annuity products being solicited, offered for sale, or sold. This section does not apply to a credit life insurance product as defined in Section A life agent who offers for sale or sells a financial product to an elder on the basis of the product's treatment under the Medi-Cal program may not negligently misrepresent the treatment of any asset under the statutes and rules and regulations of the Medi-Cal program, as it pertains to the determination of the elder's eligibility for any program of public assistance.

66 In-Home Solicitations - Criteria 60 Meeting with seniors in their own homes can be viewed as intimidating and of concern to them, especially today in light of all the crime and scam artistry that is daily shown to us on the many news shows on television. Baiting and switching in the appointment process can also be subtly done when seniors are not protected against it. To this end, California statutes require contacting and meeting with seniors to follow specific protocols to better assure them that their best interest will be taken into account. They also discourage those agents that might be open to making appointments with seniors at any costs. In-home Meetings with Seniors- 65 years and older Required Notice This section of the Code, CIC , applies to the sale, offering for sale, or generation of leads for the sale of life insurance, including annuities, to senior insureds or prospective insureds by any person. The following is the content and requirements for agents to follow when meeting with seniors in their homes. Any person who meets with a senior in the senior's home is required to deliver a notice in writing to the senior no less than 24 hours prior to that individual's initial meeting in the senior's home. If the senior has an existing insurance relationship with an agent and requests a meeting with the agent in the senior's home the same day, a notice shall be delivered to the senior prior to the meeting. CIC Content of Written Notice The notice must be in substantially the following form, with the appropriate information inserted, in 14-point type: "During this visit or a follow-up visit, you will be given a sales presentation on the following (indicate all that apply): ( ) Life insurance, including annuities ( ) Other insurance products (specify):. You have the right to have other persons present at the meeting, including family members, financial advisors or attorneys. You have the right to end the meeting at any time. You have the right to contact the Department of Insurance for information, or to file a complaint. (The notice shall include the consumer assistance telephone numbers at the department) The following individuals will be coming to your home: (list all attendees, and insurance license information, if applicable)" Cannot Misrepresent True Content of Meeting Upon contacting the senior in the senior's home, the person must, before making any statement other than a greeting, or asking the senior any other questions, state that the

67 61 purpose of the contact is to talk about insurance, or to gather information for a follow up visit to sell insurance, if that is the case, and state all of the following information: The name and titles of all persons arriving at the senior's home. The name of the insurer represented by the person, if known. Each person attending a meeting with a senior shall provide the senior with a business card or other written identification stating the person's name, business address, telephone number, and any insurance license number. The persons attending a meeting with a senior shall end all discussions and leave the home of the senior immediately after being asked to leave by the senior. A person may not solicit a sale or order for the sale of an annuity or life insurance policy at the residence of a senior, in person or by telephone, by using any plan, scheme, or ruse that misrepresents the true status or mission of the contact. Unnecessary Replacement Annuity purchasers, and seniors especially, need to be protected from agents who encourage them to replace their existing annuities with other annuities in order for the agent to earn a commission. The regulations provide for a framework in which this practice is diminished, if not ultimately eliminated. Violation of the replacement statutes also occurs if an agent uses inaccurate information and/or misrepresents the facts in order to induce an applicant to replace their existing annuity, especially those over age 65. The Code requires that clients sign off on the fact that they know if a transaction is to be a replacement. The agent must sign a statement to that fact, as well. The agent must give an applicant a Notice (shown here below) if replacement is to be executed and both the agent and the applicant must sign. The agent must submit all the signed forms and any materials used in the sales process with the application to their company. All of these things are part of the process to help insure that the replacement is warranted and that the applicant is aware of this fact and consents to the replacement. To give you a better feel and understanding of how this is presented by the California Insurance Code, we have included overviews and the wording here for you: "Unnecessary Replacement Defined" Unnecessary replacements are defined in the statutes as those where surrender fees will be charged for the existing policy when it is surrendered in order to buy a replacement policy. This is especially important when there is not a substantial possibility that the newer one will not have additional values over time to offset the surrender fee loss at the time of the replacement. Agents who sell repeated annuities to the same applicant and indicate that no replacement is involved create grounds for an infraction in the regulations and will be dealt with as such.

68 An agent is in violation of this section of the Code if the agent or their insurer recommends the replacement or conservation of an existing policy by use of a materially inaccurate presentation or comparison of an existing contract's premiums, benefits, dividends, and values. They are also in violation if they recommend that an insured 65 years of age or older purchase an unnecessary replacement annuity. CIC "Unnecessary replacement" means the sale of an annuity to replace an existing annuity that requires that the insured will pay a surrender charge for the annuity that is being replaced and that does not provide a substantial financial benefit over the life of the policy to the purchaser so that a reasonable person would believe that the purchase is unnecessary. CIC Long Term Care Sales There have also been similar schemes to sell long-term care insurance by way of seminars touted to be for the purpose of learning about retirement, Social Security, Medi-Cal, Medicare, and/or MediCaid. But, a large part of the seminars were designed to expose ways and means of getting around the rules for qualifying by redistributing assets so that one could preserve their assets for their heirs while also qualifying for MediCAL as well as for the purpose of identifying those who were candidates for longterm care policies, as well. In order for participants to know whether their assets could be rearranged, a fact find to gain knowledge about their assets had to be performed to determine the potential for qualification through asset rearrangement. This knowledge about the participant s financial holdings could then be used to recommend alternate products or strategies even if they did not have any potential for circumventing Medi-CAL rules and requirements a classic Bait and Switch. Law-drafting, Delivering, Interpreting Legal Documents These are unauthorized practices of law especially in relation to any program for annuity sales in which the insurer or agent states or infers that they possess particular expertise in the areas of law, finance or financial planning. The Business and Professional Code in California states that No person shall practice law in California unless the person is an active member of the State Bar. Business and Professions Code 6125 It further states that Any person advertising or holding himself or herself out as practicing or entitled to practice law or otherwise practicing law who is not an active member of the State Bar, or otherwise authorized pursuant to statute or court rule to practice law in this state at the time of doing so, is guilty of a misdemeanor punishable by up to one year in a county jail or by a fine of up to one thousand dollars ($1,000), or by both that fine and imprisonment. Upon a second or subsequent conviction, the person shall be confined in a county jail for not less than 90 days, except in an unusual case where the interests of justice would be served by imposition of a lesser sentence or a fine. If the court imposes only a fine or a sentence of less than 90 days for a 62

69 63 second or subsequent conviction under this subdivision, the court shall state the reasons for its sentencing choice on the record. Business and Professions Code 6126 Cause for Suspension In addition to the grounds set forth in Section 1668, the following acts shall constitute cause to suspend or revoke any permanent license issued pursuant to this chapter: SB 618 Section 4, CIC Loans Agents who might figure out a way to gain an economic benefit from their clients by having them give an agent a loan, gift, or invest in them directly or from an annuity or insurance product are in direct violation of the Code and are subject to their license being suspended or taken away. In addition they are subject to fines which were raised to $1,500. SB.618 authorizes the commissioner to suspend or revoke any permanent license issued if the licensee induces the client to make a loan or gift to or investment with the licensee, or to otherwise act in other specified ways that benefit the licensee or other people acquainted with or related to the licensee. SB The fines were raised for a violation of these provisions to $1,500. SB 618. An agent is in violation if the licensee has induced a client, whether directly or indirectly, to cosign or make a loan, make an investment, make a gift, including a testamentary gift, or provide any future benefit through a right of survivorship to the licensee, or to any of the persons which include: A person who is related to the licensee by birth, marriage, or adoption. A person who is a friend or business acquaintance of the licensee. A person who is registered as a domestic partner of the licensee. CIC Agent Beneficiaries Revocation or suspension of an agent s license can also result if the licensee has induced a client, whether directly or indirectly, to make the licensee or any of the persons listed above a beneficiary under the terms of any inter vivos or testamentary trust or the owner or beneficiary of a life insurance policy or an annuity policy. CIC Agent as Trustee Revocation of one s license is also the consequence if the agent has induced a client, whether directly or indirectly, to make the licensee, or a person who is registered as a domestic partner of the licensee, or is related to the licensee by birth, marriage, or adoption, a trustee under the terms of any inter vivos or testamentary trust. However, if the licensee is also licensed as an attorney in any state, the licensee may be made a trustee under the terms of any inter vivos or testamentary trust, provided that the licensee is not a seller of insurance to the trustor of the trust. CIC

70 64 Agent as Power of Attorney Agents cannot have a power of attorney for a client who has sold to the client or has used the power of attorney to purchase an insurance product on behalf of the client for which the licensee has received a commission. CIC Benefits Payable to Family or Friends of Agent Revocation of an agent s license can also be the remedy if the agent does any of the previous infractions listed above relative to loans, beneficiaries, trustees, and powers of attorney to the following people: A person who is related to the licensee by birth, marriage, or adoption. A person who is a friend or business acquaintance of the licensee. A person who is registered as a domestic partner of the licensee. Exceptions This section shall not apply to situations in which the client is: A person related to the licensee by birth, marriage, or adoption. A person who is registered as a domestic partner of the licensee. Penalties To put some teeth into the rule and regulations so that an added measure of protection is afforded to consumers, in general, and seniors, in specific, California has established fines, penalties and license suspensions and revocations for agents not living up to the letter of the law in selling annuities as well as all other insurance products. While we have discussed many of these throughout the appropriate sections of your course, we take a moment here to fill in some of the gaps where they might not have been addressed previously. Appropriate Advertising to Seniors CIC Any broker, agent, or other person or other entity engaged in the transactions of insurance, other than an insurer, who violates this article is liable for an administrative penalty of no less than one thousand dollars ($1,000) for the first violation. Any broker, agent, other person, or other entity engaged in the business of insurance, other than an insurer, who engages in practices prohibited by this article a second or subsequent time or who commits a knowing violation of this article, is liable for an administrative penalty of no less than five thousand dollars ($5,000) and no more than fifty thousand dollars ($50,000) for each violation. If the commissioner brings an action against a licensee pursuant to subdivision (a) or (b) and determines that the licensee may reasonably be expected to cause significant harm to seniors, the commissioner may suspend his or her license pending the outcome of the hearing described in subdivision (c) of Section 789.

71 65 Any insurer who violates this article is liable for an administrative penalty of ten thousand dollars ($10,000) for the first violation. Any insurer who violates this article with a frequency as to indicate a general business practice or commits a knowing violation of this article, is liable for an administrative penalty of no less than thirty thousand dollars ($30,000) and no more than three hundred thousand dollars ($300,000) for each violation. The commissioner may require rescission of any contract found to have been marketed, offered, or issued in violation of this article. Importance of Determining Client Suitability for Annuity Sales The importance of this suitability issue for annuity purchases to all, but for seniors in particular, is underscored and emphasized by the fact that the NAIC (National Association of Insurance Commissioners) has dealt with it in a model regulation called NAIC Senior Protection in Annuity Transactions Model Act & Regulation which was completed in October of The need for information prior to making recommendations The purpose of the NAIC regulation was to provide standards and procedures for recommendations to senior consumers that result in the purchase or exchange of an annuity so that the insurance needs and financial objectives of the seniors were appropriately addressed at the time of their purchase. It describes the duty of the producer (agent) as that of the responsibility for having reasonable grounds for believing that the annuity recommendation they make is suitable for the senior purchaser on the basis of the facts disclosed by the senior as to their investments and other insurance products as well as to their financial needs and situation. It requires that a producer make reasonable efforts to obtain information concerning the senior s: Financial status of the Consumer Income Tax status of the Consumer Liquid assets Investment objectives of the Consumer Other information considered reasonable in making the recommendation LTC Insurance in place The model regulation also recognizes that some purchasers may not be willing to share the needed information in regard to determining suitability and removes the obligation should the senior or any other purchaser: Refuses to provide relevant information Decides to buy something other than that which is recommended as suitable

72 Fails to provide complete or accurate information 66 In an effort to achieve compliance and to further assure that suitability is seriously applied throughout the process before, during, and after the sale, the regulations regarding supervision of producers and the suitability of annuity sales are also formal parts of the model. Maintaining written procedures and conducting periodic reviews of records that are reasonably designed to assist in detecting violations and preventing violations are required for insurers, general agents and independent agencies. Since registered representatives are already required to comply with NASD suitability requirements in the sale of variable annuities, this compliance is recognized to have met the requirements of suitability under the NAIC model. The commissioner may order that the producer, general agent, independent agency, and the insurer take reasonably appropriate corrective action for the purchaser of an annuity if the regulation is violated. California has been sensitive to this issue for years prior to this NAIC regulation in its Insurance Code Title X, section instituted back in 1974 regarding suitability standards for variable annuities. Need for Full Contract Disclosure Any contract that does not provide cash surrender benefits or does not provide death benefits at least equal to the minimum non-forfeiture amount prior to the commencement of any annuity payments must include a statement in a prominent place in the contract that such benefits are not provided. CIC The Need for Complete Record Keeping Recordkeeping of the information collected from the purchasers of annuities during the process of determining suitability of the recommendation is also highly encouraged by the NAIC act. This would allow the commissioner to be provided with appropriate information for monitoring compliance and resolving complaints. Required Disclosures Life Agent Disclosure Requirements for Sales to Elders (Attachment II) Effective in July 1, 2001, regulations referred to as Chapter 442 and 547, Statutes of 2001 (Assembly Bill 2107, Scott), strengthened the Elder Abuse and Dependent Civil Protection Act with respect to selling insurance and financial products to elders. It clarified the definition of financial abuse. The definition of "elders" is any person residing in this state that is 65 years of age or older. As of the enactment of this law in July 2001, a life agent is required to make specified disclosures about the potential consequences of entering into financial transactions related to an elder's potential eligibility for Medi-Cal coverage and prohibits a life agent from negligently misrepresenting a product based on its treatment under Medi-Cal.

73 67 These disclosures and key points for all agents to have read in regard to doing business with seniors age 65 or over are found in Appendix III. This appendix is a part of this course and not just an add on. You will need to study, understand, and adhere to the content of this appendix as part of your course. There are several key pieces of valuable information and regulatory requirements included and involved in the Appendix III. Among them are a Required Medi-Cal Disclosure, sample Department of Health Services Forms, an outline of a Life Agent s Duties, definitions of Elder Abuse, a Life Agent Financial Products Disclosure, and a Notice regarding standards for Medi-Cal eligibility. To successfully, legally, and professionally operate in the age 65 and above marketplace, you need to know about and execute these forms and procedures shown in Appendix III at the end of your course. Required Medi-Cal Disclosure A life agent who offers or sells any financial product on the basis of its treatment under the Medi-Cal program must provide, in writing, the disclosure shown in Appendix III to the elder or the elder's agent. Life Agent's Duties With regard to Medicare supplement insurance and long-term care insurance, all insurers, brokers, agents, and others engaged in the business of insurance owe a policyholder or a prospective policyholder a duty of honesty, and a duty of good faith and fair dealing. Conduct of an insurer, broker, or agent during the offer and sale of a policy previous to the purchase is relevant to any action alleging a breach of the duty of honesty, and a duty of good faith and fair dealing. Elder Abuse "Financial abuse" of an elder or dependent adult occurs when a person or entity does any of the following: Takes, secrets, appropriates, or retains real or personal property of an elder or dependent adult to a wrongful use or with intent to defraud, or both. Assists in taking, secreting, appropriating, or retaining real or personal property of an elder or dependent adult to a wrongful use or with intent to defraud, or both. A person or entity will be deemed to have taken, secreted, appropriated, or retained property for a wrongful use if, among other things, the person or entity takes, secrets, appropriates or retains possession of property in bad faith. A person or entity shall be deemed to have acted in bad faith if the person or entity knew or should have known that the elder or dependent

74 68 adult had the right to have the property transferred or made readily available to the elder or dependent adult or to his or her representative. A person or entity should have known of a right, if, on the basis of the information received by the person or entity or the person or entity's authorized third party, or both, it is obvious to a reasonable person that the elder or dependent adult has a right. Life Agent Financial Products Disclosure If a life agent offers to sell to an elder any life insurance or annuity product, the life agent must advise an elder or elder's agent in writing that the sale or liquidation of any stock, bond, IRA, certificate of deposit, mutual fund, annuity, or other asset to fund the purchase of this product may have tax consequences, early withdrawal penalties, or other costs or penalties as a result of the sale or liquidation, and that the elder or elder's agent may wish to consult independent legal or financial advice before selling or liquidating any assets and prior to the purchase of any life or annuity products being solicited, offered for sale, or sold. This section does not apply to a credit life insurance product. A life agent who offers for sale or sells a financial product to an elder on the basis of the product's treatment under the Medi-Cal program may not negligently misrepresent the treatment of any asset under the rules and regulations of the Medi-Cal program, as it pertains to the determination of the elder's eligibility for any program of public assistance. A life agent who offers for sale or sells any financial product on the basis of its treatment under the Medi-Cal Program must provide, in writing, the required disclosure shown in Appendix III. Policy Cancellation and Refunds The responsibility of the company includes safeguards for the consumer by including a 30-day free look cancellation / refund period, with differentiation made between and for fixed and variable annuity policies. This must be printed clearly on the policy. This is effective with policies sold 1/1/2004 with it being the provisions retroactive for policies sold after 1/1/2003. For fixed annuities, a full refund of the amount paid in must be returned if requested by the annuity owner within 30 days of receiving their contract. If not done in 30 days from the annuity owner s request, the company is liable for interest to be paid on the money from the day of the receipt of the request by the annuity owner to the date of payment of the refund to the annuity owner. For variable annuities, it is required that a customers money be held, during the 30 day period, in guaranteed instruments so that if a person exercises the cancellation in the 30 day period, they will get their initial premium back (unless the client specifically asks to have the money invested in the variable accounts) CIC Every policy of individual life insurance and every individual annuity contract that is initially delivered or issued for delivery to a senior citizen in this state on

75 69 and after July 1, 2004, must have printed on it or attached to it a notice stating that, after receipt of the policy by the owner, the policy may be returned by the owner for cancellation by delivering it or mailing it to the insurer or agent from whom it was purchased. The period of time set forth by the insurer for return of the policy by the insured shall be clearly stated on the notice and this period shall be not less than 30 days. The insured may return the policy to the insurer by mail or otherwise at any time during the period specified in the notice. During the 30-day cancellation period, the premium for a variable annuity may be invested only in fixed-income investments and money-market funds, unless the investor specifically directs that the premium be invested in the mutual funds underlying the variable annuity contract. Return of the policy within the 30-day cancellation period must have one of the following effects: (1) In the case of individual life insurance policies and variable annuity contracts for which the owner has not directed that the premium be invested in the mutual funds underlying the contract during the cancellation period, return of the policy during the cancellation period shall have the effect of voiding the policy from the beginning, and the parties shall be in the same position as if no policy had been issued. All premiums paid and any policy fee paid for the policy shall be refunded by the insurer to the owner within 30 days from the date that the insurer is notified that the owner has canceled the policy. The premium and policy fee shall be refunded by the insurer to the owner within 30 days from the date that the insurer is notified that the owner has canceled the policy. (2) In the case of a variable annuity for which the owner has directed that the premium be invested in the mutual funds underlying the contract during the 30-day cancellation period, cancellation shall entitle the owner to a refund of the account value. The account value shall be refunded by the insurer to the owner within 30 days from the date that the insurer is notified that the owner has canceled the contract. (b) This section applies to all individual policies issued or delivered to senior citizens in this state on or after January 1, All policies subject to this section which are in effect on January 1, 2003, shall be construed to be in compliance with this section, and any provision in any policy which is in conflict with this section shall be of no force or effect. (c) (3) Every individual life insurance policy and every individual annuity contract, other than variable contracts and modified guaranteed contracts, subject to this section, that is delivered or issued for delivery in this state shall have the following notice either printed on the cover page or policy jacket in 12-point bold print with one inch of space on all sides or printed on a sticker that is affixed to the cover page or policy jacket: "IMPORTANT YOU HAVE PURCHASED A LIFE INSURANCE POLICY OR ANNUITY CONTRACT. CAREFULLY REVIEW IT FOR LIMITATIONS. THIS POLICY MAY BE RETURNED WITHIN 30 DAYS FROM THE DATE YOU RECEIVED IT FOR A FULL REFUND BY

76 70 RETURNING IT TO THE INSURANCE COMPANY OR AGENT WHO SOLD YOU THIS POLICY. AFTER 30 DAYS, CANCELLATION MAY RESULT IN A SUBSTANTIAL PENALTY, KNOWN AS A SURRENDER CHARGE." The phrase "after 30 days, cancellation may result in a substantial penalty, known as a surrender charge" may be deleted if the policy does not contain those charges or penalties. Every individual variable annuity contract, variable life insurance contract, or modified guaranteed contract subject to this section, that is delivered or issued for delivery in this state, must have the following notice either printed on the cover page or policy jacket in 12-point bold print with one inch of space on all sides or printed on a sticker that is affixed to the cover page or policy jacket: "IMPORTANT YOU HAVE PURCHASED A VARIABLE ANNUITY CONTRACT (VARIABLE LIFE INSURANCE CONTRACT, OR MODIFIED GUARANTEED CONTRACT). CAREFULLY REVIEW IT FOR LIMITATIONS. THIS POLICY MAY BE RETURNED WITHIN 30 DAYS FROM THE DATE YOU RECEIVED IT. DURING THAT 30-DAY PERIOD, YOUR MONEY WILL BE PLACED IN A FIXED ACCOUNT OR MONEY-MARKET FUND, UNLESS YOU DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO UNDERLYING THE CONTRACT DURING THE 30-DAY PERIOD. IF YOU DO NOT DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO, AND IF YOU RETURN THE POLICY WITHIN THE 30-DAY PERIOD, YOU WILL BE ENTITLED TO A REFUND OF THE PREMIUM AND POLICY FEES. IF YOU DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO DURING THE 30-DAY PERIOD, AND IF YOU RETURN THE POLICY DURING THAT PERIOD, YOU WILL BE ENTITLED TO A REFUND OF THE POLICY'S ACCOUNT VALUE ON THE DAY THE POLICY IS RECEIVED BY THE INSURANCE COMPANY OR AGENT WHO SOLD YOU THIS POLICY, WHICH COULD BE LESS THAN THE PREMIUM YOU PAID FOR THE POLICY. A RETURN OF THE POLICY AFTER 30 DAYS MAY RESULT IN A SUBSTANTIAL PENALTY, KNOWN AS A SURRENDER CHARGE." The words "known as a surrender charge" may be deleted if the contract does not contain those charges. This section does not apply to life insurance policies issued in connection with a credit transaction or issued under a contractual policy-change or conversion privilege provision contained in a policy. Additionally, this section shall not apply to contributory and noncontributory employer group life insurance, contributory and noncontributory employer group annuity contracts, and group term life insurance. When an insurer, it s agent, group master policyowner, or association collects more than one month's premium from a senior citizen at the time of application or at the time of delivery of a group term life insurance policy or certificate, the insurer must provide the senior citizen a prorated refund of the premium if the senior citizen delivers a cancellation request to the insurer during the first 30 days of the policy period.

77 71 For purposes of this chapter, a senior citizen means an individual who is 60 years of age or older on the date of purchase of the policy of the CIC Companies and agents must also follow very specific timed procedures when replacing another company s annuity. And, the company whose policy is being replaced must follow specific timed responses to their client and the replacing company. This provides timely response regarding the replacement for the annuity purchaser s benefit and protection that the replacement was in the client s best interest. Replacement CIC Every life insurer that uses an agent in a life insurance or annuity sale shall do the following: (a) Require with or as part of each completed application for life insurance or annuity, a statement signed by the agent as to whether he or she knows replacement is or may be involved in the transaction. (b) Where a replacement is involved: Require from the agent with the application for life insurance or annuity: a list of all of the applicant's existing life insurance or annuity to be replaced, and a copy of the replacement notice provided the applicant pursuant to Section The existing life insurance or annuity shall be identified by name of insurer, insured, and contract number. If a number has not been assigned by the existing insurer, alternative identification, such as an application or receipt number shall be listed. Send to each existing life insurer a written communication advising of the replacement or proposed replacement and the identification information obtained pursuant to this section and a policy summary, contract summary, or ledger statement containing policy data on the proposed life insurance or annuity. Cost indices and equivalent level annual dividend figures need not be included in the policy summary or ledger statement. This written communication shall be made within three working days of the date the application is received in the replacing insurer's home or regional office, or the date the proposed policy or contract is issued, whichever is sooner. Every existing life insurer or the insurer's agent that undertakes a conservation shall, within 20 days from the date the written communication plus the materials required in subdivisions (1) and (2) are received by the existing insurer, furnish the policyowner with a policy summary for the existing life insurance or ledger statement containing policy data on the existing policy or annuity. Information relating to premiums, cash values, death benefits, and dividends, if any, shall be computed from the current policy year of the existing life insurance. The policy summary or ledger statement shall include

78 72 the amount of any outstanding indebtedness, the sum of any dividend accumulations or additions, and may include any other information that is not in violation of any regulation or statute. Cost indices and equivalent level annual dividend figures need not be included. When annuities are involved, the disclosure information shall be that in the contract summary. The replacing insurer may request the existing insurer to furnish it with a copy of the summaries or ledger statement, which shall be within five working days of the receipt of the request. The replacing insurer shall maintain evidence of the "notice regarding replacement," the policy summary, the contract summary, and any ledger statements used, and a replacement register, cross-indexed by replacing agent and existing insurer to be replaced. The existing insurer shall maintain evidence of policy summaries, contract summaries, or ledger statements used in any conservation. Evidence that all requirements were met shall be maintained for at least three years. The replacing insurer shall provide in its policy or in a separate written notice which is delivered with the policy that the applicant has a right to an unconditional refund of all premiums paid which right may be exercised within a period of 30 days commencing from the date of delivery of the policy. In the case of variable annuity contracts, variable life insurance contracts, and modified guaranteed contracts, return of the contract during the cancellation period shall entitle the owner to a refund of account value and any policy fee paid for the policy. The account value and policy fee shall be refunded by the insurer to the owner within 30 days from the date that the insurer is notified that the owner has canceled the policy. FREE look for persons 65 years and older (Section 786 of the CIC). CIC.786 All disability insurance and life insurance policies and certificates offered for sale to individuals age 65 or older in California shall provide an examination period of 30 days after the receipt of the policy or certificate for purposes of review of the contract, at which time the applicant may return the contract. The return shall void the policy or certificate from the beginning, and the parties shall be in the same position as if no contract had been issued. All premiums paid and any policy or membership fee shall be fully refunded to the applicant by the insurer or entity in a timely manner. (a) For the purposes of this section a timely manner shall be no later than 30 days after the insurer or entity issuing the policy or certificate receives the returned policy or certificate. (b) If the insurer or entity issuing the policy or certificate fails to refund all of the premiums paid, in a timely manner, then the applicant shall receive interest on the paid premium at the legal rate of interest on judgments as provided in Section of the Code of Civil Procedure. The interest shall be paid from the date the insurer or entity received the returned policy or certificate. (c) Each policy or certificate shall have a notice prominently printed in no less than 10-point uppercase type, on the cover page of the policy or certificate

79 73 and the outline of coverage, stating that the applicant has the right to return the policy or certificate within 30 days after its receipt via regular mail, and to have the full premium refunded. (d) In the event of any conflict between this section and Section with respect to life insurance, the provisions of Section shall prevail. FREE look for persons 60 years and younger (Section of the CIC). The period of time set forth by the insurer for return of the policy by the insured shall be clearly stated on the notice and this period shall be not less than 10 days nor more than 30 days.