In a variable annuity, the annuitant bears the investment risk, whereas in a fixed annuity, the insurer bears the risk.
Who bears the investment risk?
A 401(k) plan is a type of retirement savings plan that does not guarantee a precise sum when you retire. The employee or the company (or both) contribute to the employee’s individual account in these programs. The employee is responsible for the investment risks.
Who bears all of the investment risk in a fixed annuity quizlet?
“The insurer” is the correct response. A fixed annuity’s investment risk is borne by the insurance provider. Even if the underlying assets underperform the guaranteed rate, the insurance company guarantees the annuitant’s principal as well as a certain minimum rate of return.
Does a fixed annuity have risk?
Are Annuities a High or Low-Risk Investment? Annuities have a low risk profile when compared to other investments such as equities and bonds. In the correct circumstances, their fixed rates and guaranteed income make them safe.
What are investment risks?
Investment risk is defined as the possibility or likelihood of losses occurring in relation to the projected return on a given investment. When making an investment, most investors perceive lower risk to be preferable. The less risky the investment, the more profitable it is.
What are high risk investments?
The best approach to think about risk is in terms of the likelihood of an investment underperforming or losing a significant amount of money. A high-risk investment is one in which the odds of underperformance or the loss of some or all of the investment are greater than usual. These investment possibilities frequently give investors the chance to earn higher returns in exchange for taking on more risk.
Alternative investments, which include many high-risk investment opportunities but not all, are used to balance a portfolio and introduce assets that have little to no market correlation.
Who bears the investment risk in variable life insurance products?
Whole life insurance is a type of permanent life insurance that provides a guaranteed death payout. Whole life insurance provides beneficiaries with insurance coverage while gradually reducing the insurer’s commitment as the policyholder’s cash value grows. The cash value accrues interest at a predefined rate set by the insurer.
Universal life insurance is similar to whole life insurance in that it provides policyholders with adjustable death benefits and flexible premiums, allowing them to use the cash value to pay for premiums. There is still a guaranteed death payment, but with universal life, the interest earned on the cash value is variable, whereas with whole life, it is fixed.
Variable universal life insurance (VUL) is similar to universal life insurance in that it offers variable premiums, but it differs in that it has different asset alternatives. You can choose the assets you want to invest your premiums in with a variable universal life insurance policy, and there is no guaranteed minimum death benefit or guaranteed cash value.
What is the difference between a fixed annuity and a variable annuity quizlet?
Fixed annuities guarantee that the contract will be credited with a minimum rate of interest, ensuring the owner’s principal. The owner’s premiums are invested in nonguaranteed investment subaccounts in variable annuities.
How does an indexed annuity differ from a fixed annuity?
The most significant distinction between fixed annuities and fixed indexed annuities is the method by which insurance companies compute interest. A fixed annuity guarantees an interest rate for a set period of time. If the rate of return is too low or the surrender period has expired, you can switch your annuity for another without incurring any tax implications. The new contract would then have a new surrender term.
If the stock market performs well, a fixed indexed annuity provides a guaranteed interest rate as well as additional returns. However, there is usually a higher surrender price, and the technique for calculating returns can be somewhat complicated.
Long-term contracts
Annuities are long-term contracts that last anywhere from three to twenty years, and they come with penalties if you violate them. Annuities typically allow for penalty-free withdrawals. Penalties will be imposed if an annuitant withdraws more than the permissible amount.
What are the disadvantages of fixed annuities?
1) Teaser Rates & Limited Returns
Although fixed annuity returns are assured, they are typically low.
In fact, increasing returns by establishing a moderately safe bond portfolio is usually not difficult.
Many insurers will also add “teaser rates” in their fixed annuities.
This means they’ll guarantee a high rate of return for a brief time before lowering it after a few years.
Unless you backed out of the policy, you’d be stuck with the same poor return from then on.
2) Fees, Commissions, and Fees, Fees, Fees, Fees, Fees, Fees, Fees,
Fees are embedded into all annuity policies, reducing your return.
Fixed annuities, on the other hand, are typically significantly less expensive than their more intricate cousins (index and variable annuities).
The following are the charges you’ll face:
Surrender charge: Most insurance include a surrender charge of some sort.
This indicates that the insurance provider will charge you a price if you surrender the coverage within a particular time frame.
The closer you get to the conclusion of this term, the lower your surrender charges are likely to be.
In annuities, there are also mortality and expenditure charges, as well as administrative fees.
These fees are frequently “baked in” to the interest rate you get on your account balance with fixed annuities.
If a policy pays 4% in returns but charges 1% in annual fees, your net returns will be 3% every year.
Finally, annuities are typically sold as commission-based products.
That implies that if you opt to buy from an advisor or insurance salesperson who recommends a product, they may receive a commission.
While a commission isn’t deducted from your account balance (it’s paid by the insurance company), it does mean you should consider this relationship.
While the majority of specialists are trustworthy individuals who sincerely want to assist you, others will go to any length to collect the commission.
3) Lack of adaptability
Without mentioning financial flexibility, no list of fixed annuity benefits and drawbacks would be complete.
There is an accumulating period and a withdrawal phase in all annuities.
When you buy an insurance, the accumulating period begins.
Your account balance will increase at the stated rate of interest, and the accumulation period will finish when you opt to take income from the insurance, and the withdrawal period will begin.
You have some policy flexibility during the accumulation phase.
In the event of an emergency, you can surrender the coverage and withdraw the remaining funds.
Surrender fees and penalties for early withdrawal may apply (some of which can be avoided if you swap policies in a 1035 exchange).
If you truly need to, you can opt out of the contract and get most of your money back.
You won’t have the same freedom once the withdrawal period starts.
The insurance provider will pay your monthly income, but you will not be able to cash out the policy in the event of an emergency.
Your major investment is owned by the insurance provider.
Only the income stream is yours.
4) Inflation Protection with a Limit
When you start taking money from a standard fixed annuity, you’ll get a predetermined monthly payment.
The issue for retirees is that inflation will gradually increase their cost of living.
This will add up over the course of a 30-year retirement.
Let’s imagine you have a fixed annuity that pays you $1000 each month and inflation is 2% every year during your retirement.
Your monthly annuity payments will only be worth $552.07 in today’s dollars in 30 years.
Keep in mind that annuities come in a variety of shapes and sizes.
In addition, there are several products on the market today that provide inflation protection, which means that your monthly income payments will rise in tandem with inflation over time.
The disadvantage is that inflation protection is usually very expensive.
If a regular fixed annuity pays you $1000 each month for the rest of your life, an inflation-protected fixed annuity might only pay you $750 at first.
As a result, fixed annuities offer only a limited level of inflation protection.
5) Loss of Basis Step Up
After you die, your beneficiaries will get a step up in basis on most of your assets, such as real estate or stocks and bonds.
Assume you hold Microsoft stock, which you purchased for $20 a share many years ago.
Since then, Microsoft has appreciated and split numerous times.
If you sold your shares today, you’d have to pay tax on the long-term capital gains — the difference between the sale price and the purchase price (your basis).
When you die, your beneficiaries’ basis is reset.
Instead of inheriting your cost basis from years ago, your beneficiaries will receive a market price basis at the time of your death.
This is known as a step up in basis, and it lowers their tax obligation if they chose to sell their inheritance.
This can be extremely advantageous in terms of estate planning.
There is no such step up in basis with fixed annuities (or annuities in general).
Any profits you make from a fixed annuity are taxable.
Worse, the beneficiary will be taxed as ordinary income and will not be eligible for long-term capital gains relief.
Where are fixed annuities invested?
Fixed annuity rates are determined by the yield generated by the life insurance company’s investment portfolio, which is generally comprised of high-quality corporate and government bonds. The insurance company is thereafter responsible for paying whatever rate the annuity contract guaranteed. Variable annuities, on the other hand, allow the annuity owner to choose the underlying investments, assuming much of the investment risk.
