THE FINANCIAL ADVISORS GUIDE TO ANNUITIES & SUITABILITY

201 Pages·2014·1.08 MB·English

by  Best 14

THE FINANCIAL ADVISORS
GUIDE TO ANNUITIES
& SUITABILITY PRACTICES
(2014 Edition)

Researched and Written by:
Edward J. Barrett
CFP, ChFC, CLU, CEBS, RPA, CRPS, CRPC
Disclaimer

This course is designed as an educational program for financial
professionals. EJB Financial Press is not engaged in rendering legal or other
professional advice and the reader should consult legal counsel as
appropriate.

We have tried to provide you with the most accurate and useful information
possible. However, one thing is certain and that is change. The content of
this publication may be affected by changes in law and in industry practice,
and as a result, information contained in this publication may become
outdated. This material should in no way be used as an original source of
authority on legal and/or tax matters.

Laws and regulations cited in this publication have been edited and
summarized for the sake of clarity.

Names used in this publication are fictional and have no relationship to any
person living or dead.

This presentation is for educational purposes only. The information
contained within this presentation is for internal use only and is not intended
for you to discuss or share with clients or prospects. Financial professionals
are reminded that they cannot provide clients with tax advice and should
have clients consult their tax advisor before making tax-related investment
decisions.

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About The Author

Edward J. Barrett CFP®, ChFC®, CLU, CEBS®, RPA, CRPS, CRPC®, began his career in
the financial and insurance services back in 1978 with IDS Financial Services, becoming a
leading financial advisor and top district sales manager in Boston, Massachusetts. In 1986,
Mr. Barrett joined Merrill Lynch in Boston as an estate and business-planning specialist
working with over 400 financial advisors and their clients throughout the New England
region assisting in the sale of insurance products.

In 1992, after leaving Merrill Lynch and moving to Florida, Mr. Barrett founded The Barrett
Companies Inc., Broker Educational Sales & Training Inc., Wealth Preservation Planning
Associates and The Life Settlement Advisory Group Inc.

Mr. Barrett is a qualifying member of the Million Dollar Round Table, Qualifying
Member Court of the Table® and Top of the Table® producer. He holds the Certified
Financial Planner designation CFP®, Chartered Financial Consultant (ChFC), Chartered
Life Underwriter (CLU), Certified Employee Benefit Specialist (CEBS), Retirement
Planning Associate (RPA), Chartered Retirement Planning Counselor (CRPC) and the
Chartered Retirement Plans Specialist (CRPS).

About EJB Financial Press

EJB Financial Press, Inc. (www.ejbfinpress.com) was founded in 2004, by Mr. Barrett to
provide advanced educational and training manuals approved for correspondence continuing
education credits for insurance agents, financial advisors, accountants and attorneys
throughout the country.

Broker Educational Sales & Training Inc.

Broker Educational Sales & Training Inc. (BEST) is a nationally approved provider of
continuing education and advanced training programs to the mutual fund, insurance and
financial services industry.

For more information visit our website at: www.bestonlinecourses.com. Or call us at 800-
345-5669.

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Table of Contents

About The Author ............................................................................................................. 3
CHAPTER 1 UNDERSTANDING ANNUITIES ....................................................... 13
Overview ....................................................................................................................... 13
Annuities in the United States....................................................................................... 13
Annuity Sales ............................................................................................................. 14
Annuity Buyers .......................................................................................................... 15
Primary Uses of Annuities ............................................................................................ 16
Annuity Outlook ........................................................................................................... 16
Review Questions ......................................................................................................... 17
CHAPTER 2 ANNUITY BASICS ............................................................................... 19
Overview ....................................................................................................................... 19
Classification of Annuities ............................................................................................ 19
Purchase Option ......................................................................................................... 20
Date Income Payments Begin ....................................................................................... 20
Deferred Annuities ..................................................................................................... 21
Immediate Annuities .................................................................................................. 22
Deferred Income Annuity .......................................................................................... 23
Investment Options ....................................................................................................... 23
Income Payout Options ................................................................................................. 24
Straight (Single) Life Income Option ........................................................................ 24
Cash Refund ............................................................................................................... 24
Installment Refund Option ........................................................................................ 25
Life with Period Certain Option ................................................................................ 25
Joint and Full Survivor Option .................................................................................. 25
Period Certain ............................................................................................................ 25
Review Questions ......................................................................................................... 27
CHAPTER 3 FIXED ANNUITIES ............................................................................. 29
Overview ....................................................................................................................... 29
Fixed Annuity Sales ...................................................................................................... 29
Types of Fixed Annuities .............................................................................................. 30
Crediting Rates of Interest ............................................................................................ 31
Non-forfeiture Interest Rate ....................................................................................... 31
Current Rate of Interest ............................................................................................. 31
Portfolio Rate ............................................................................................................. 33
New Money Rate ....................................................................................................... 34
Calculating the Rate ................................................................................................... 35
Trends ........................................................................................................................ 35
Interest Rate Projections ............................................................................................ 35
Bonus Annuities ......................................................................................................... 35
Two-Tiered Annuities ................................................................................................ 36
Fixed Annuity Fees and Expenses ................................................................................ 36
Contract Charge ......................................................................................................... 36
Interest Spread ........................................................................................................... 37
Surrender Charges ..................................................................................................... 37
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Disadvantages of Fixed Annuities ................................................................................ 37
Fixed Annuitization: Calculating Fixed Annuity Payments ........................................ 37
Review Questions ......................................................................................................... 39
CHAPTER 4 VARIABLE ANNUITIES ...................................................................... 41
Overview ....................................................................................................................... 41
Variable Annuity Defined ............................................................................................. 41
The VA Market .......................................................................................................... 41
VA Product Features .................................................................................................. 43
Separate Accounts ..................................................................................................... 43
Investment Options .................................................................................................... 43
Accumulation Units ................................................................................................... 44
VA Charges and Fees .................................................................................................... 46
Mortality and Expense (M&E) Charge ...................................................................... 46
Management (Fund Expense) Fees ............................................................................ 46
Contract (Account) Maintenance Fees ...................................................................... 47
Summary of Above Fees ........................................................................................... 47
Surrender Fees ........................................................................................................... 48
VA Sales Charges ...................................................................................................... 49
Premium Tax ................................................................................................................. 50
Investment Features ...................................................................................................... 50
Dollar Cost Averaging ............................................................................................... 51
Fund Transfers ........................................................................................................... 52
Asset Allocation ......................................................................................................... 52
Asset Rebalancing ..................................................................................................... 52
Guaranteed Minimum Death Benefit ............................................................................ 53
Enhanced Death Benefits ........................................................................................... 53
Contract Anniversary, Or “Ratchet” .......................................................................... 53
Initial Purchase Payment with Interest or Rising Floor ............................................. 54
Enhanced Earnings Benefits ...................................................................................... 54
Guaranteed Living Benefit (GLB) Riders ..................................................................... 55
Guaranteed Minimum Income Benefit (GMIB) ........................................................... 55
GMIB Features and Benefits ..................................................................................... 56
GMIB Caveats ........................................................................................................... 56
GMIB Client Suitability ............................................................................................ 57
Guaranteed Minimum Account Balance (GMAB) ....................................................... 57
GMAB Example ........................................................................................................ 57
GMAB Caveats .......................................................................................................... 57
GMAB Client Suitability ........................................................................................... 58
Guaranteed Minimum Withdrawal Benefit (GMWB) .................................................. 58
GMWB Example ....................................................................................................... 58
GMWB Caveats ......................................................................................................... 59
GMWB Client Suitability .......................................................................................... 59
Guaranteed Minimum Withdrawal Benefit for Lifetime .............................................. 59
GMWBL Features and Benefits ................................................................................ 60
GMWBL Client Suitability ........................................................................................ 61
Treatment of Withdrawals ............................................................................................ 61
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Recent Innovations and Trends of GLBs ...................................................................... 62
Outlook for Variable Annuities .................................................................................... 62
Variable Annuitization: Calculating Variable Annuity Income Payouts ..................... 63
Annuity Units ............................................................................................................. 64
Assumed Interest Rate (AIR) ..................................................................................... 65
Review Questions ......................................................................................................... 67
CHAPTER 5 INDEX ANNUITIES .............................................................................. 69
Overview ....................................................................................................................... 69
Index Annuity Defined ................................................................................................. 69
Index Annuity Market ................................................................................................... 69
Profile of an IA Buyer................................................................................................... 71
IA Basic Terms and Provisions..................................................................................... 71
Index Period ............................................................................................................... 71
Participation Rate ....................................................................................................... 71
Cap Rate ..................................................................................................................... 72
Spreads or Margins .................................................................................................... 72
No-Loss Provision ..................................................................................................... 73
Guaranteed Minimum Account Value ....................................................................... 73
Liquidity .................................................................................................................... 74
Fees and Expenses ..................................................................................................... 74
Surrender Charges ..................................................................................................... 74
Interest Calculation .................................................................................................... 75
Exclusion of Dividends .............................................................................................. 75
Crediting Interest .......................................................................................................... 75
Interest Crediting Methods ........................................................................................... 76
Point-to-Point ............................................................................................................. 76
High Water Mark (Term High Point) ........................................................................ 78
Annual Reset (Ratchet) .............................................................................................. 79
Averaging ...................................................................................................................... 79
Other Interest Crediting Methods ................................................................................. 80
Multiple (Blended) Indices ........................................................................................ 80
Monthly Cap (Monthly Point-to-Point) ..................................................................... 80
Binary, Non-Negative (Trigger) Annual Reset ......................................................... 81
Bond-Linked Interest with Base ................................................................................ 81
Hurdle ........................................................................................................................ 81
Annual Fixed Rate with Equity Component .............................................................. 81
Rainbow Method ....................................................................................................... 82
Index Annuity Waivers and Riders ............................................................................... 83
Types of Riders .......................................................................................................... 84
IAs with Bonuses .......................................................................................................... 84
Regulation of IAs .......................................................................................................... 85
Review Questions ......................................................................................................... 87
CHAPTER 6 ANNUITY TAX LAWS ........................................................................ 89
Overview ....................................................................................................................... 89
Annuity Defined for Tax Purposes? ............................................................................. 89
Premiums ...................................................................................................................... 89
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IRC § 72: Tax-Deferral ................................................................................................ 90
IRC § 72(a) ................................................................................................................ 90
IRC § 72(b): Exclusion Ratio Rule ........................................................................... 90
IRC § 72(c)(4): Annuity Starting Date ..................................................................... 91
IRC § 72(e): Lifetime Distributions ......................................................................... 92
IRC § 72(e)(4)(A): Loans and Assignments ............................................................. 92
IRC § 72(e)(4)(c): Gift of the Annuity Contract ...................................................... 93
IRC § 72(e)(5)(E) Gain in the Contract .................................................................... 93
IRC §72(e)(11)(A)(ii) Aggregation Rules ................................................................. 93
IRC § 72(t)(1): Additional 10% Penalty Tax on Early Distribution ........................ 94
IRC § 72(q)(1): Premature Distribution 10% Penalty Tax ....................................... 95
IRC § 72(s): Death Distribution Rules at Death of the Holder ................................. 96
IRC § 72(u): Non-Natural Person Rule .................................................................... 98
IRC § 72(u)(4): Defines an Immediate Annuity ....................................................... 99
IRC Section 165: Claiming a Loss ............................................................................... 99
IRC Section 7702B(e)(1) ............................................................................................ 100
IRC § 1035: Tax-Free Exchanges .............................................................................. 101
IRC § 1035 Requirements ....................................................................................... 101
Partial IRC § 1035 Exchanges ................................................................................. 102
Revenue Ruling 2003-76 ......................................................................................... 103
IRS Revenue Procedure 2008-24 ............................................................................. 104
The New IRC Section 1035(a)(4) ............................................................................ 104
PLR 201330016 Inherited Annuity 1035 Exchange ................................................ 105
Partial Annuitization of NQ Annuity Contracts .......................................................... 106
IRC § 2039: Estate Tax Inclusion .............................................................................. 107
IRC § 691(c) Income in Respect of a Decedent (IRD) ............................................... 107
Calculating the IRD Deduction ............................................................................... 108
Disclaimers With Regards to Tax and Legal Issues ................................................... 109
Review Questions ....................................................................................................... 110
CHAPTER 7 PARTIES TO THE CONTRACT ..................................................... 111
Overview ..................................................................................................................... 111
The Owner .................................................................................................................. 111
Rights of the Owner ................................................................................................. 111
Changing the Annuitant ........................................................................................... 111
Duration of Ownership ............................................................................................ 112
Purchaser, Others as Owner ..................................................................................... 112
Taxation of Owner ................................................................................................... 112
Death of Owner: Required Distribution ................................................................. 113
Spousal Exception ................................................................................................... 113
The Annuitant ............................................................................................................. 113
A Natural Person ...................................................................................................... 113
Role of the Annuitant ............................................................................................... 114
Naming Joint Annuitants/Co-Annuitants ................................................................ 114
Taxation of Annuitant .............................................................................................. 114
Death of Annuitant .................................................................................................. 115
The Beneficiary ........................................................................................................... 115
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Death Benefit ........................................................................................................... 115
Whose Death Triggers the Death Benefit ................................................................ 116
Changing the Beneficiary ........................................................................................ 116
Designated Beneficiary ............................................................................................ 116
Spouse or Children as Beneficiaries ........................................................................ 116
Non-Natural Person as Beneficiary ......................................................................... 117
Multiple Beneficiaries ............................................................................................. 117
Taxation of Beneficiary ........................................................................................... 117
Death of Beneficiary ................................................................................................ 118
Insurance Company .................................................................................................... 118
Collecting and Investing the Premium .................................................................... 118
Paying the Guaranteed Death Benefit ...................................................................... 119
Paying the Guaranteed Income Option .................................................................... 119
Insurance Rating Services ........................................................................................... 119
A.M. Best ................................................................................................................. 119
Moody’s ................................................................................................................... 120
Duff & Phelps .......................................................................................................... 120
Standard & Poor’s .................................................................................................... 120
Weiss Research ........................................................................................................ 121
State Guaranty Associations ....................................................................................... 122
Coverage .................................................................................................................. 123
Member Assessments .............................................................................................. 123
Review Questions ....................................................................................................... 125
CHAPTER 8 STRUCTURING THE CONTRACT ................................................ 127
Overview ..................................................................................................................... 127
Structuring the Contract .............................................................................................. 127
Annuity Contract Forms ............................................................................................. 128
Owner-Driven .......................................................................................................... 128
Annuitant-Driven Contract ...................................................................................... 128
Joint Annuitants/Co-Annuitants .................................................................................. 128
Contingent Annuitants ............................................................................................. 129
The Death Benefit ....................................................................................................... 129
Death after the Annuity Starting Date ........................................................................ 130
Review Questions ....................................................................................................... 151
CHAPTER 9 SUITABILITY OF ANNUITIES ....................................................... 153
Overview ..................................................................................................................... 153
NAIC Suitability Model .............................................................................................. 153
Senior Protection in Annuity Transactions Model Regulation ................................ 153
2010 NAIC Suitability in Annuity Transactions Model Regulation .......................... 154
Determining Suitability ........................................................................................... 155
Systems of Supervision and Training ...................................................................... 157
FINRA Compliance ................................................................................................. 157
VA Regulation under the Federal Securities Laws ..................................................... 158
Securities Act of 1933 ............................................................................................. 158
Securities Act of 1934 ............................................................................................. 159
Investment Company Act of 1940 ........................................................................... 159
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Regulation of Fees and Charges .............................................................................. 160
FINRA Regulation of VA ........................................................................................... 160
FINRA Rule 2821 .................................................................................................... 160
FINRA Rule 2330 .................................................................................................... 163
FINRA Rule 2111 .................................................................................................... 163
FINRA Rule 2090: Know Your Customer .............................................................. 164
SEC Approves Consolidated FINRA Rules ............................................................ 164
Effective Date .......................................................................................................... 164
Benefits of Maintaining Suitability Standards ............................................................ 165
Avoid Market Conduct Trouble ............................................................................... 165
Increased Client Satisfaction ................................................................................... 165
A WIN-WIN-WIN Solution .................................................................................... 165
Review Questions ....................................................................................................... 166
CHAPTER 10 ANNUITIES INSIDE QUALIFIED RETIREMENT PLANS ...... 167
Overview ..................................................................................................................... 167
Background ................................................................................................................. 167
Congressional Mandate ........................................................................................... 167
Annuities in an IRA .................................................................................................... 168
Advantages of Annuities inside a Qualified Retirement Plan .................................... 169
RMD Rule Requirements on Variable Annuity Contracts ......................................... 170
Actuarial Present Value Defined ............................................................................. 171
RMD Calculation under the New Rules .................................................................. 171
Safe Harbor Rules .................................................................................................... 171
Example: Calculating RMD under New Rules ....................................................... 172
New Proposed Treasury Regulation – Longevity Contracts ....................................... 173
Review Questions ....................................................................................................... 174
CHAPTER 11 UNFAIR MARKETING PRACTICES ........................................... 175
Overview ..................................................................................................................... 175
Misrepresentation ........................................................................................................ 175
Fraud ........................................................................................................................... 175
Altering Applications .................................................................................................. 175
Premium Theft ............................................................................................................ 176
False or Misleading Advertising ................................................................................. 176
Defamation .................................................................................................................. 176
Boycott, Coercion, Intimidation ................................................................................. 176
Twisting ...................................................................................................................... 177
Churning ..................................................................................................................... 177
Discrimination............................................................................................................. 177
Rebating ...................................................................................................................... 177
Use of Senior Specific Certifications and Designations ............................................. 178
Annuity Disclosure Model Regulation ....................................................................... 179
Variable Annuities ................................................................................................... 180
Recordkeeping ......................................................................................................... 180
Review Questions ....................................................................................................... 181
CHAPTER 12 ANTI-MONEY LAUNDERING ...................................................... 183
Overview ..................................................................................................................... 183
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