3.2 Accumulation and Annuity Phases
Key Takeaways
Accumulation phase uses accumulation units whose value fluctuates with performance.
Annuitization converts to a fixed number of annuity units.
AIR is a benchmark that determines whether payments rise, fall, or stay flat.
Payments can decrease even with positive returns if below the AIR.
Annuitization is generally irrevocable; free look periods allow early cancellation.
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:
| If Separate Account... | Accumulation Unit Value... |
|---|---|
| Increases in value | Increases |
| Decreases in value | Decreases |
| Stays flat | Stays flat |
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
| Separate Account Performance vs. AIR | Payment Result |
|---|---|
| Performance EXCEEDS AIR | Payment INCREASES |
| Performance EQUALS AIR | Payment STAYS THE SAME |
| Performance LESS THAN AIR | Payment DECREASES |
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
| Feature | Accumulation Phase | Annuity Phase |
|---|---|---|
| Purpose | Build value | Receive income |
| Units Owned | Accumulation units | Annuity units |
| Number of Units | Increases with payments | Fixed at annuitization |
| Unit Value | Based on performance only | Based on performance vs. AIR |
| AIR Relevance | Not applicable | Determines payment changes |
| Control | Full owner control | Limited - locked into payout |
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
- Accumulation units - Variable number, value based on performance
- Annuity units - Fixed number, value based on performance vs. AIR
- AIR - Only matters during annuity phase, not accumulation
- Payments increase - When actual return exceeds AIR
- Payments decrease - When actual return is below AIR (even if positive!)
During the annuity phase, when will monthly payments increase?
When the separate account has any positive return
When the separate account return exceeds the AIR
When the number of annuity units increases
When the owner makes additional premium payments
If a variable annuity has an AIR of 5% and the separate account earns 5%, what happens to the annuity payment?
The payment increases
The payment decreases
The payment remains the same
The payment is recalculated based on new actuarial tables
At annuitization, which of the following is true about annuity units?
The number of units continues to increase with each payment received
The number of units is fixed, but the value per unit fluctuates
Both the number and value of units are guaranteed
The number of units decreases as payments are made
Sections you finish are checked off in the contents.