Accumulation and Annuity Phases

Variable annuities have two distinct phases: the accumulation phase (pay-in period) and the annuity phase (payout period). Understanding how each phase works, including the concepts of accumulation units, annuity units, and the Assumed Interest Rate (AIR), is essential for the Series 6 exam.

The Accumulation Phase

During the accumulation phase, the contract owner:

• Makes premium payments into the annuity
• Selects subaccount allocations
• Can transfer between subaccounts
• Owns accumulation units

Accumulation Units

Accumulation units represent the owner's proportionate ownership in the separate account during the pay-in period:

Example: If your net premium is $1,000 and an accumulation unit costs $100, you purchase 10 accumulation units.

Key characteristics:

• The number of units increases with each premium payment
• The value per unit fluctuates based on subaccount performance
• Units can be added at any time during accumulation phase
• AIR is NOT relevant during accumulation phase

Accumulation Unit Value Calculation

The value of accumulation units is determined solely by the performance of the underlying investments in the separate account:

The Annuity Phase (Annuitization)

When the owner is ready to receive income, they annuitize the contract. This converts:

• Accumulation units → Annuity units
• A pool of assets → A stream of income payments

Annuity Units

Once annuitized, the owner exchanges all accumulation units for a fixed number of annuity units:

Critical Concept: The NUMBER of annuity units is fixed at annuitization and remains constant. Only the VALUE per unit changes.

The number of annuity units received depends on:

• Total value of accumulation units at conversion
• Annuitant's age and gender
• Selected payout option (life only, period certain, etc.)
• The contract's Assumed Interest Rate (AIR)

Assumed Interest Rate (AIR)

The Assumed Interest Rate (AIR) is a benchmark rate used to:

• Calculate the initial annuity payment amount
• Determine whether future payments increase, decrease, or stay the same

Key Point: The AIR is NOT a guaranteed rate of return. It's only a measuring stick to adjust payment amounts.

How AIR Affects Payments

Exam Tip: Compare the ACTUAL return to the AIR. If the separate account earns 8% and AIR is 5%, payments increase. If it earns 3% and AIR is 5%, payments decrease.

AIR Example

Scenario: Contract has AIR of 5%. Separate account earns 4%.

• The accumulation unit value would increase (portfolio earned positive 4%)
• But the annuity unit value would DECREASE (4% actual < 5% AIR)
• Therefore, the monthly payment would decrease

This is a classic exam question! Many candidates get confused because positive returns can still lead to decreased payments if below the AIR.

Comparison: Accumulation vs. Annuity Phase

When Does Annuitization Occur?

• Voluntary: Owner chooses to begin income stream
• Mandatory: Contract may require annuitization by certain age (often 85-95)
• Irrevocable: Once annuitized, generally cannot be undone

Important: Many modern contracts allow systematic withdrawals WITHOUT annuitizing, providing more flexibility. Annuitization is typically irrevocable.

Free Look Period

Most states require a free look period of 10-30 days after receiving the contract:

• Owner can cancel for a full refund
• No surrender charges apply during free look
• Allows time to review contract terms

Summary of Key Concepts

1. Accumulation units - Variable number, value based on performance
2. Annuity units - Fixed number, value based on performance vs. AIR
3. AIR - Only matters during annuity phase, not accumulation
4. Payments increase - When actual return exceeds AIR
5. Payments decrease - When actual return is below AIR (even if positive!)