Accumulation phase: The period during which the owner of a deferred annuity makes the initial investment and any additional contributions. The growth of the total contributions will provide the basis for future income options.
Actuary:Professionals that use statistics and mathematics to determine risk in the insurance and finance industries. In many cases actuaries determine the costs and features of insurance and annuity contracts based on risk criteria from the insurance company.
Administration Fee: An annuity fee charged by the insurance company intended to cover basic operations such as deposit and withdrawal processing and statement generation.
Annual Percentage Yield:The effective interest rate for an investment normalized to a one year annualized return. Because various investments can have different compounding terms the annual percentage yield offers a normalized interest rate that can be compared from one financial offer to another.
Annualized Returns: The average annual compound growth rate of an investment; similar to an APR. Often referred to in performance calculations to compare returns of one investment to another. Fixed annuities typically have an explicit annual interest rate while variable annuities are subject to the movement of stock and bond markets through your subaccounts. Returns from 0-9% might be realistic over time.
Sample indices annualized total returns 12/31/1992-12/31/2012: S&P 500 (US stocks) – 8.2%, MSCI EAFE (European and Asian stocks) – 6.1%, MSCI World (developed world stocks) – 6.9%, BofA ML US Treasury Index (US government bonds) – 6.1%, BofA ML US 3 Month T-Bill (cash equivalent) – 3.2%.
Source: Thomson Reuters.
Annuitization phase: The period after the full annuity balance has been exchanged for a stream of regular income payments.
Annuitant: The person or persons who receive annuity payments; typically the annuity owner.
Beneficiary: The person designated under an annuity contract to receive the death benefit payout if the contract holder dies in the accumulation phase, or to receive future income payments if the contract holder of the annuity dies during the annuitization phase.
Benefit base: A dollar amount on which an annuity’s living and death benefit payments will be based. Typically this value is not available to withdraw as a lump sum.
Brokerage Commission: The payment a broker receives for selling an annuity to an investor.
Cost Basis: The original value of an investment (usually the purchase price). This is the value used to determine capital gain, which is equal to the difference between the asset’s cost basis and the current market value. An annuity’s cost basis can be retained through a 1035 exchange.
Death Benefit: An annuity feature similar to life insurance that determines the amount of capital paid to the designated beneficiary or beneficiaries in case of premature death of the annuity owner or annuitant.
Deferred Annuity: Variable, Indexed, and Fixed annuities in the accumulation phase are all considered deferred annuities. Both the taxes and income are deferred to a later date.
Equity-indexed Annuity: A type of annuity contract that pays an interest rate on your contributions. The interest rate is determined by the annual return of a specified equity-based index.
Expense Ratios: An estimate of certain fees and expenses associated with an investment; typically presented as a percent of the investment that is paid annually by an investor. For examples of fees that are included in expense ratio calculation, see also Subaccount fees, and Mortality and Expense Fee (M&E)
Fixed Annuity: A type of annuity contract in which the insurance company pays a fixed interest rate for a set period of time. These function similar in concept to certificates of deposit.
Guaranteed Income:A term to describe an annuity feature and usually associated with optional living benefits called riders. Guaranteed income is frequently only applicable in very specific scenarios where your account has underperformed same base level of return over a longer period of time such as 5-10 years, and usually requires annuitization. Guaranteed income is different from guaranteed return or guaranteed withdrawals.
Guaranteed Withdrawals:A term to describe an annuity feature and usually associated with optional living benefits called riders. Guaranteed withdrawals permit the owner to withdrawal some guaranteed amount per year after a waiting period of a number of years and usually cannot be withdrawn as a lump sum. Guaranteed withdrawals are different from guaranteed return or guaranteed income.
Immediate Annuity: These annuities begin in the annuitization phase, which is the point the annuity owner hands the value of the contract to the insurance company in exchange for a stream of payments.
Indexing/crediting method: An annuity owner will often have to choose between multiple options for how the interest is calculated on an equity indexed annuity. Some examples are point-to-point, monthly average, annual high water mark, or monthly sum. Each type will result in slightly different interest rates over time.
Life Expectancy: An actuarial number representing the average number of years of life remaining based on an individual’s age. Some life expectancy calculators also factor in health and other details.
Living Benefit: An optional feature that can be added to a variable or indexed annuity to provide additional guarantees. Most living benefits carry a separate additional fee.
Market Value Adjustment (MVA): An adjustment to the remaining annuity value if you withdraw more than the annuity’s permitted free withdrawal. The MVA will be negative during a rising or neutral interest rate environment and positive during a declining interest rate environment.
Maturity period: the period in years until a contract will be needed/available for income. Often this is the years until retirement. Deferred annuity contracts may also have a minimum expected holding period.
Mortality and Expense Fee (M&E): A fee charged by the insurance company intended to cover the cost of death benefits and to compensate the insurance company for the risk associated with the minimum guarantees of a contract.
Non-qualified annuity: An annuity purchased outside of tax advantaged retirement plan, such as in a taxable brokerage account. These annuities are typically taxed as soon as they have matured or are surrendered.
Opportunity Cost:The cost of an investment as measured by what other investment options are forgone. The opportunity cost of investing in bonds instead of stocks is measured by the excess return that would have been received from investing in stocks instead of bonds. Since financial assets cannot be invested in everything at all times, there is an opportunity cost to any investment decision.
Participation/Index Rate: The percentage of the underlying index’s return an indexed annuity holder is allowed to capture.
Performance Cap: The maximum performance percentage allowed by an indexed annuity contract, which is typically tied to the return of a market index, such as the S&P500.
Performance Floor: The guaranteed minimum interest rate of a fixed or indexed annuity contract
Point-to-point: one type of crediting option for indexed annuities. The index price on the contract anniversary is compared to the previous year. The percent difference between the two values is the basis for the interest rate calculation. Usually a participation rate is then applied along with a cap and a floor.
Sample: Over 12 months the index has risen from 1000 to 1200 (+20%). The contract has an 80% participation rate, 2% floor, and 10% cap. After application of the participation rate (20%*80% = 16%) the interest exceeds the cap of 10% so the contract would be credited the maximum interest of 10%.
Premium: A periodic payment (specific amount and/or frequency) required to provide coverage on a given insurance plan.
Principal:The original investment amount.
Qualified annuity: An annuity purchased and held within a tax advantaged retirement plan such as a 401(k), 403(b), 457 or IRA plan. These annuities are not typically taxed until the assets are withdrawn from the tax advantaged account even if the annuity itself has matured or is surrendered.
RIA (Registered Investment Adviser):An investment adviser registered with the SEC that must adhere to a fiduciary standard of care which requires the adviser to act in a client’s best interest and disclose any conflicts of interest. RIA’s are usually compensated based on a portion of the total assets they manage for a client or by some fixed or hourly fee. Other financial professionals may still have adviser in their title but may be associated with specific companies or products and can receive compensation from commissions.
Rider: A provision that is purchased separately from the basic policy and provides additional benefits at additional cost.
Subaccount: The mutual-fund-like investment funds that are offered through a variable annuity. The subaccounts function as a menu of investment options within the contract and typically include cash, bond, and equity fund choices.
Subaccount fees: A fee charged by subaccount funds within variable annuity contracts. These fees cover the cost of research, investment decisions, and fund management for the underlying funds.
Survivor benefit:A benefit that pays to the spouse after the contract owner passes. The benefit may pay for some predetermined period of time, such as five years or for the survivors remaining life. Annuities with a survivor benefit may provide a lower income payment during contract owner’s life to compensate for the extended income paid to a surviving beneficiary.
Two-phase annuity:Most annuities sold today are two-phase annuities. Phase 1 is the accumulation phase where contributions are made and, hopefully, grown over time. Phase 2 is the distribution phase where the insurance company distributes the funds from phase 1. The phase 2 distributions can be in the form of a lump sum, regular withdrawals, or an annuitized income stream.
Variable Annuity: A variable annuity contains mutual fund like investment vehicles called subaccounts which are held within an insurance contract. Variable annuity returns are variable, i.e. they are not fixed or guaranteed. However, many variable annuities have optional benefits, called riders, which can provide various guarantees for an additional cost.