Retirement Planning Glossary

ANNUAL RESET (ANNUAL RATCHET, CLIQUET) - Crediting methods measuring index movement over a one-year period. Positive inter­est is calculated and credited at the end of each contract year and cannot be lost if the index subsequently declines. Say that the index increased from 100 to 110 in one year and the indexed annuity had an 80 percent participation rate. The insurance company would take the 10 percent gross index gain for the year (110-100/100), apply the participation rate (10 percent index gain x 80 percent rate) and credit 8 percent interest to the annuity. But, what if in the following year the index declined back to 100? The individual would keep the 8 percent interest earned and simply receive zero interest for the down year. An annual reset structure preserves credits gains and treats negative index periods as years with zero growth.

ANNUITANT - The person, usually the annuity owner, whose life expectancy is used to calculate the income payment amount on the annuity.

ANNUITY -An annuity is a contract issued by an insurance com­pany that often serves as a type of savings plan used by individuals looking for long term growth and protection of assets chat will likely be needed within retirement.

AVERAGING - Index values may either be measured from a start point to an end point (point-to-point) or values between the scare point and end point may be averaged to determine an ending value. Index values may be averaged over the days, weeks, months, or quarters of the period.

BENEFICIARY - A beneficiary is the person designated to receive payments due upon the death of the annuity owner or the annuitant themselves.

BONUS RATE -A bonus rate is the "extra" or "additional" interest paid during the first year (the initial guarantee period), typically used as an added incentive to get consumers to select their annuity policy over another.

CALL OPTION (ALSO SEE PUT OPTION) - Gives the holder the right to buy an underlying security or index at a specified price on or before a given dare.

CAP - The maximum interest rate that will be credited to the annuity for the year or period. The cap usually refers to the maximum interest credited after applying the participation race or yield spread. If the index methodology showed a 20 percent increase with a participation rate of 60 percent and a maximum interest cap of 10 percent, the contract would credit 10 percent interest. A few annuities use a maximum gain cap instead of a maximum interest cap with the participation rare or yield spread applied to the lesser of the gain or the cap. If the index methodology showed a 20 percent increase with a participation rate of 60 percent and a maximum interest cap of 10 percent, the contract would credit 6 percent interest.

COMPOUND INTEREST - Interest is earned on both the original principal and on previously earned interest. It is more favorable than simple interest. Suppose that your original principal was $1, and your interest rate was 10 percent for five years. With simple interest, your value is ($1 + $0.10 interest each year) = $ 1.50. With compound interest, your value is ($1 x 1. 10 x 1. 10 x 1. 10 x 1.10 x 1.1 O) = $1.61. The advantage of compound interest over simple interest becomes greater as each subsequent period passes.
CREDITING METHOD (ALSO SEE METHODOLOGY) - The formula(s) used to determine the excess interest that is credited above the minimum interest guarantee.

DEATH BENEFITS - The payment the annuity owner's estate or beneficiaries will receive if he or she dies before the annuity matures. On most annuities, this is equal to the current account value. Some annuities offer an enhanced value at death via an optional rider that has a monthly or annual fee associated with it.

EXCESS INTEREST - Interest credited to the annuity contract above the minimum guaranteed interest rate. In an indexed annuity the excess interest is determined by applying a stated crediting method to a specific index or indices.

FIXED ANNUITY - A contract issued by an insurance company guaranteeing a minimum interest rate with the crediting of excess interest determined by the performance of the insurer's general account. Index annuities are fixed annuities.

FIXED DEFERRED ANNUITY - With fixed annuities, an insurance company offers a guaranteed interest rate plus safety of your principal and earnings (subject to the claims-paying ability of the insurance company). Your interest rate will be reset periodically, based on economic and other factors, but is guaranteed to never fall below a certain rate.

FREE WITHDRAWALS - Withdrawals that are free of surrender charges.

INDEX - The underlying external benchmark upon which the crediting of excess interest is based, also a measure of the prices of a group of securities.

IRA (INDIVIDUAL RETIREMENT ACCOUNT) - An IRA is a tax-advantaged personal savings plan that lets an individual set aside money for retirement. All or part of the participant's contributions may be tax deductible, depending on the type of IRA chosen and the participant's personal financial circumstances. Distributions from many employer-sponsored retirement plans may be eligible to be rolled into an IRA to continue tax-deferred growth until the funds are needed. An annuity can be used as an IRA; that is, IRA funds can be used to purchase an annuity.

IRA ROLLOVER - IRA rollover is the phrase used when an individual who has a balance in an employer-sponsored retirement plan transfers that balance into an IRA. Such an exchange, when properly handled, is a tax-advantaged transaction.

LIQUIDITY - The ease with which an asset is convertible to cash. An asset with high liquidity provides flexibility, in that the owner can easily convert it to cash at any time, but it also tends to decrease profitability.

MARKET RISK - The risk of the market value of an asset fluctuating up or down over time. In a fixed or fixed indexed annuity, the original principal and credited interest are not subject to market risk. Even if the index declines, the annuity owner would receive no less than their original principal back if they decided to cash in the policy at the end of the surrender period. Unlike a security, indexed annuities guarantee the original premium, and the premium is backed by, and is as safe as, the insurance company that issued it (subject to the claims-paying ability of the insurance company).

METHODOLOGY (ALSO SEE CREDITING METHOD) - The way that interest crediting is calculated. On fixed indexed annuities, there are a variety of different methods used to determine how index movement becomes interest credited.

MINIMUM GUARANTEED RETURN (MINIMUM INTEREST RATE) - Fixed indexed annuities typically provide a minimum guaranteed return over the life of the contract. At the time that the owner chooses to terminate the contract, the cash surrender value is compared to a second value calculated using the minimum guaranteed return and the higher of the two values is paid to the annuity owner.

OPTION -A contract which conveys to its holder the right, but not the obligation, to buy or sell something at a specified price on or before a given date. After this given date the option ceases to exist. Insurers typically buy options to provide for the excess interest potential. Options may be American style whereby they may be exercised at any time prior to the given date, or they may have to be exercised only during a specified window. Options chat may only be exercised during a specified period are European style options.

OPTION RISK - Most insurers create the potential for excess interest in an indexed annuity by buying options. Say that you could buy a share of stock for $50. If you bought the stock and it rose to $60 you could sell it and net a $10 profit. But, if the stock price fell to $40 you'd have a $10 loss. Instead of buying the actual stock, we could buy an option that gave us the right to buy the stock for $50 at any time over the next year. The cost of the option is $2. If the stock price rose co $60 we would exercise our option, buy the stock at $50 and make $10 (less the $2 cost of the option). If the price of the stock fell to $40, $30 or $10, we wouldn't use the option and it would expire. The loss is limited to $2 - the cost of the option.

PARTICIPATION RATE - The percentage of positive index movement credited to the annuity. If the index methodology determined that the index increased 10 percent and the indexed annuity participated in 60 percent of the increase, it would be said char the contract has a 60 percent participation rate. Participation rates may also be expressed as asset fees or yield spreads.

POINT-TO-POINT - A crediting method measuring index movement from an absolute initial point to the absolute end point for a period. An index had a period starting value of 100 and a period ending value of 120. A point-to-point method would record a positive index movement of 20 [120-100] or a 20 percent positive movement [(120-100)/ 100]. Point-to-point usually refers to annual periods; however the phrase is also used instead of term end point to refer to multiple year periods.

PREMIUM BONUS - A premium bonus is additional money that is credited to the accumulation account of an annuity policy under certain conditions.

PUT OPTION (ALSO SEE CALL OPTION) - Gives the holder the right to sell an underlying security or index at a specified price on or before a given date.

QUALIFIED ANNUITIES (OUALIFIED MONEY) - Qualified annuities are annuities purchased for funding an IRA, 403(6) tax-deferred annuity or other type of retirement arrangements. An IRA or qualified retirement plan provides the tax deferral. An annuity contract should be used to fund an IRA or qualified retirement plan to benefit from an annuity's features other than tax deferral, including the safety features, lifetime income payout option and death benefit protection.

REQUIRED MINIMUM DISTRIBUTION (RMD) - The amount of money that Traditional, SEP and SIMPLE IRA owners and qualified plan participants must begin distributing from their retirement accounts by 4/1 of the year after they turn 72. Subsequent RMDs must be taken by 12/31 of each year. RMD amounts must then be distributed each subsequent year. If you don't take your RMD, you'll have to pay a penalty of 50% of the RMD amount.

RETURN FLOOR - Another way of saying minimum guaranteed return.

ROTH IRA - Like other IRA accounts, the Roth IRA is simply a holding account that manages your stocks, bonds, annuities, mutual funds and CD's. However, future withdrawals (including earnings and interest) are typically tax-advantaged once the account has been open for five years and the account holder is age 59.5.

RULE OF 72 - Tells you approximately how many years it takes a sum to double at a given rate. It's handy to be able to figure out, without using a calculator, chat when you're earning a 6 percent return, for example, by dividing 6 percent into 72, you'll find chat it takes 12 years for money to double. Conversely, if you know it rook a sum twelve years to double you could divide 12 into 72 to determine the annual return (6 percent).

SIMPLE INTEREST (ALSO SEE COMPOUND INTEREST) - Interest is only earned on the principal balance.

SPLIT ANNUITY - A split annuity is the term given to an effective strategy that utilizes two or more different annuity products - one designed to generate monthly income and the other to restore the original starting principal over a set period of time.

STANDARD & POOR'S 500 (S&P 500) - The most widely used external index by fixed indexed annuities. Its objective is to be a benchmark to measure and report overall U.S. stock market performance. It includes a representative sample of 500 common stocks from companies trading on the New York Stock Exchange, American Stock Exchange, and NASDAQ National Market System. The index represents the price or market value of the underlying stocks and does not include the value of reinvested dividends of the underlying stocks.

STOCK MARKET INDEX - A report created from a type of statistical measurement that shows up or down changes in a specific financial market, usually expressed as points and as a percentage, in a number of related markets, or in an economy as a whole (i.e. S&P 500 or New York Stock Exchange).

SURRENDER CHARGE - A charge imposed for withdrawing funds or terminating an annuity contract prematurely. There is no industry standard for surrender charges, that is, each annuity produce has its own unique surrender charge schedule. The charge is usually expressed as a percentage of the amount withdrawn prematurely from the contract. The percentage tends to decline over time, ultimately becoming zero.

TRADITIONAL IRA - See IRA (Individual Retirement Account)

TERM END POINT - Crediting methods measuring index move­ments over a greater timeframe than a year or two. The opposite of an annual reset method. Also referred to as a term point-to-point method. Say that the index value was at 100 on the first day of the period. If the calculated index value was at 150 at the end of the period the positive index movement would be 50 percent (150-100/100). The company would credit a percentage of this movement as excess interest. Index movement is calculated and interest credited at the end of the term and interim movements during the period are ignored.

TERM HIGH POINT (HIGH WATER MARK) - A type of term end point structure that uses the highest anniversary index level as the end point. Say that the index value was at 100 on the first day of the period, reached a value of 160 at the end of a contract year during the period, and ended the period at 150. A term high point method would use the 160 value - the highest contract anniversary point reached during the period, as the end point and the gross index gain would be 60 percent (160-100/100). The company would then apply a participation rate to the gain.

TERM YIELD SPREAD - A type of term end point structure which calculates the total index gain for a period, computes the annual compound rate of return, deducts a yield spread from the annual rate of return and then recalculates the total index gain for the period based on the net annual rate. Say that an index increased from 100 to 200 by the end of a nine year period. This is the equivalent of an 8 percent compound annual interest rate. If the annuity had a 2 percent term yield spread this would be deducted from the annual interest rate (8 percent-2 percent) and the net rate would be credited to the contract (6 percent) for each of the nine years. Total index gain may also be computed by using the highest anniversary index level as the end point.

VARIABLE ANNUITY - A contract issued by an insurance company offering separate accounts invested in a wide variety of stocks and/or bonds. The investment risk is borne by the annuity owner. Variable annuities are considered securities and require appropriate securities registration.

1035 EXCHANGE - The 1035 exchange refers to the section of tax code that allows annuity owners the flexibility to exchange one annuity for another without incurring any immediate tax liabilities. This action is most often utilized when an annuity holder decides they want to upgrade an annuity to a more favorable one, but they do not want to activate unnecessary tax liabilities chat would typically be encountered when surrendering an existing annuity contract.

401 (K) ROLLOVER - See IRA Rollover

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