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Insurance Selection and Annuities - The Premium Method of Annuities

Premium Method
a. Single premium deferred annuity (SPDA) - A lump-sum immediate premium with a deferred payout period.
b. Flexible premium deferred annuity (FPDA) - Allows periodic, non- fixed contributions with a deferred payout period.
c. Single premium immediate annuity (SPIA) - Annuity begins immediately following premium paid.
d. Variable annuity - The return will vary depending on the performance of the underlying investments. The benefit could result from a single premium or flexible premium and may be an immediate or deferred annuity.

Uses
Annuities may appeal to anyone who wants a guarantee on their investment contributions without bearing the full investment risk of other investment options or growing funds on a tax-deferred basis. Unfortunately, the majority of annuity owners use them as a way to accumulate earnings then proceed to take a lump sum instead of taking advantage of the guaranteed-life-income feature.

  • Annuities can play a vital role in any situation where income is needed for only a few years or for a lifetime.
  • It is important to realize that annuities are not life insurance contracts. The principal function of a life insurance contract is to create an estate, an annuity's principal function is to liquidate an estate.

Practice Question:
Which are disadvantages of a straight life immediate fixed annuity?

I. Annuitant receives a fixed payment with no inflation hedge.
II. Annuitant cannot change the remaining value and ask for principal back.
III. Annuitant may die before the return of principal is realized, leaving nothing for the beneficiaries.
IV. Annuitant receives a guaranteed stream of income no matter how long he/she lives.

A. II & IV
B. I, II, & IV
C. VI only
D. I, II, & III
E. I, II, III, & IV

Answer: D
The annuitant receiving guaranteed income for life is an advantage. All others are disadvantages.

Taxation of Annuities
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