Posts Tagged ‘Financial’

Anti Money Laundering (AML) Definition: Its History and How It Works

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Anti Money Laundering (AML) Definition: Its History and How It Works

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What Is Anti Money Laundering (AML)?

Anti money laundering (AML) refers to the web of laws, regulations, and procedures aimed at uncovering efforts to disguise illicit funds as legitimate income. Money laundering seeks to conceal crimes ranging from small-time tax evasion and drug trafficking to public corruption and the financing of groups designated as terrorist organizations.

AML legislation was a response to the growth of the financial industry, the lifting of international capital controls and the growing ease of conducting complex chains of financial transactions.

A high-level United Nations panel has estimated annual money laundering flows at $1.6 trillion, accounting for 2.7% of global GDP in 2020.

Key Takeaways

  • Anti Money Laundering (AML) efforts seek to make it harder to hide profits from crime.
  • Criminals use money laundering to make illicit funds appear to have a legitimate origin.
  • AML regulations require financial institutions to develop sophisticated customer due diligence plans to assess money laundering risks and detect suspicious transactions.

What’s Anti-Money Laundering?

Understanding Anti Money Laundering (AML)

AML regulations in the U.S. have expanded from the 1970 Bank Secrecy Act’s requirement that banks report cash deposits of more than $10,000 to a complex regulatory framework requiring financial institutions to conduct due diligence on customers and to seek out and report suspicious transactions. The European Union and other jurisdictions have adopted similar measures.

Know Your Customer

For banks, compliance starts with verifying the identity of new clients, a process sometimes called Know Your Customer (KYC). In addition to establishing the customer’s identity, banks are required to understand the nature of a client’s activity and verify deposited funds are from a legitimate source.

The KYC process also requires banks and brokers to screen new customers against lists of crime suspects, individuals and companies under economic sanctions, and “politically exposed persons”—foreign public officials, their family members and close associates.

Money laundering can be divided into three steps:

  • Deposit of illicit funds into the financial system
  • Transactions designed to conceal the illicit origin of the funds, known as “layering”
  • Use of laundered funds to acquire real estate, financial instruments or commercial investments

The KYC process aims to stop such schemes at the first deposit window.

Customer Due Diligence

Customer due diligence is integral to the KYC process, for example by ensuring the information a potential customer provides is accurate and legitimate. But it is also a constant process extending to customers old and new, and their transactions.

Customer due diligence requires ongoing assessment of the risk of money laundering posed by each client and the use of that risk-based approach to conduct closer due diligence for those identified as higher non-compliance risks. That includes identifying customers as they are added to sanctions and other AML lists.

According to the U.S. Treasury’s Financial Crimes Enforcement Network, the four core requirements of customer due diligence in the U.S. are:

  • Identifying and verifying the customer’s identity
  • Identifying and verifying the identity of beneficial owners with a stake of 25% or more in a company opening an account
  • Understanding the nature and purpose of customer relationships to develop customer risk profiles
  • Conducting ongoing monitoring to identify and report suspicious transactions and update customer information 

Customer due diligence seeks to detect money laundering strategies including layering and structuring, also known as “smurfing”—the breaking up of large money laundering transactions into smaller ones to evade reporting limits and avoid scrutiny.

One rule in place to foil layering is the AML holding period, which requires deposits to remain in an account for a minimum of five trading days before they can be transferred elsewhere.

Financial institutions are required to develop and implement a written AML compliance policy, which much be approved in writing by a member of senior management and overseen by a designated AML compliance officer. These programs must specify “risk-based procedures for conducting ongoing customer due diligence” and conduct “ongoing monitoring to identify and report suspicious transactions.”

Some AML requirements apply to individuals as well as financial institutions. Notably, U.S. residents are required to report receipts of more than $10,000 in cash to the Internal Revenue Service on IRS Form 8300. The requirement extends to multiple related payments within 24 hours or multiple related transactions within 12 months totaling more than $10,000.

History of Anti Money Laundering

Efforts to police illicit gains have a history stretching back centuries, while the term “money laundering” is only about 100 years old and in wide use for less than 50.

The first major piece of U.S. AML legislation was the 1970 Bank Secrecy Act, passed in part to thwart organized crime. In addition to requiring banks to report cash deposits of more than $10,000, the legislation also required banks to identify individuals conducting transactions and to maintain records of transactions. The U.S. Supreme Court upheld the Bank Secrecy Act’s constitutionality in 1974, the same year “money laundering” entered wide use amid the Watergate scandal.

Additional legislation passed in the 1980s amid increased efforts to fight drug trafficking, in the 1990s to expand financial monitoring and in the 2000s to cut off funding for terrorist organizations.

Anti-money laundering assumed greater global prominence in 1989, when a group of countries and international organizations formed the Financial Action Task Force (FATF). Its mission is to devise international standards to prevent money laundering and promote their adoption. In October 2001, following the 9/11 terrorist attacks, FATF expanded its mandate to include combating terrorist financing.

Another important organization in the fight against money laundering is the International Monetary Fund (IMF). Like the FATF, the IMF has pressed its member countries to comply with international standards to thwart terrorist financing.

The United Nations included AML provisions in its 1998 Vienna Convention addressing drug trafficking, the 2001 Palermo Convention against international organized crime and the 2005 Merida Convention against corruption.

The Anti-Money Laundering Act of 2020, passed in early 2021, was the most sweeping overhaul of U.S. AML regulations since the Patriot Act of 2001. The 2021 legislation included the Corporate Transparency Act, which made it harder to use shell companies to evade anti-money laundering and economic sanctions measures.

The legislation also subjected cryptocurrency exchanges as well as arts and antiquities dealers to the same customer due diligence requirements as financial institutions.

What Are Some Ways That Money Is Laundered?

Money launderers often funnel illicit funds through associates’ cash-generating businesses, or by inflating invoices in shell company transactions. Layering transactions are money transfers designed to disguise the source of illicit funds. Structuring, or smurfing, refers to the practice of breaking up a large transfer into smaller ones to evade reporting limits and AML scrutiny.

Can Money Laundering Be Stopped?

Given estimated annual flows approaching 3% of global economic output, increasingly aggressive AML enforcement can at best aim to contain money laundering rather than stop it entirely. Money launderers never seem to run short of money or accomplices, though AML measures certainly make their lives harder.

What’s the Difference Between AML, CDD and KYC?

Anti-money laundering (AML) is the broad category of the laws, rules and procedures aimed at deterring money laundering, while customer due diligence (CDD) describes the scrutiny financial institutions (and others) are required to perform to thwart, identify and report violations. Know your client (KYC) rules apply customer due diligence to the task of screening and verifying prospective clients.

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What They Are, Types, and How They Work

Written by admin. Posted in A, Financial Terms Dictionary

What They Are, Types, and How They Work

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Investopedia / Ryan Oakley


What Is an Annuity?

The term “annuity” refers to an insurance contract issued and distributed by financial institutions with the intention of paying out invested funds in a fixed income stream in the future. Investors invest in or purchase annuities with monthly premiums or lump-sum payments. The holding institution issues a stream of payments in the future for a specified period of time or for the remainder of the annuitant’s life. Annuities are mainly used for retirement purposes and help individuals address the risk of outliving their savings.

Key Takeaways

  • Annuities are financial products that offer a guaranteed income stream, usually for retirees.
  • The accumulation phase is the first stage of an annuity, whereby investors fund the product with either a lump sum or periodic payments.
  • The annuitant begins receiving payments after the annuitization period for a fixed period or for the rest of their life.
  • Annuities can be structured into different kinds of instruments, which gives investors flexibility.
  • These products can be categorized into immediate and deferred annuities and may be structured as fixed or variable.

How an Annuity Works

Annuities are designed to provide a steady cash flow for people during their retirement years and to alleviate the fears of outliving their assets. Since these assets may not be enough to sustain their standard of living, some investors may turn to an insurance company or other financial institution to purchase an annuity contract.

As such, these financial products are appropriate for investors, who are referred to as annuitants, who want stable, guaranteed retirement income. Because invested cash is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs to use this financial product.

An annuity goes through several different phases and periods. These are called:

  • The accumulation phase, the period of time when an annuity is being funded and before payouts begin. Any money invested in the annuity grows on a tax-deferred basis during this stage.
  • The annuitization phase, which kicks in once payments commence.

These financial products can be immediate or deferred. Immediate annuities are often purchased by people of any age who have received a large lump sum of money, such as a settlement or lottery win, and who prefer to exchange it for cash flows into the future. Deferred annuities are structured to grow on a tax-deferred basis and provide annuitants with guaranteed income that begins on a date they specify.

Annuities often come with complicated tax considerations, so it’s important to understand how they work. As with any other financial product, be sure to consult with a professional before you purchase an annuity contract.

Annuity products are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Agents or brokers selling annuities need to hold a state-issued life insurance license, and also a securities license in the case of variable annuities. These agents or brokers typically earn a commission based on the notional value of the annuity contract.

Special Considerations

Annuities usually have a surrender period. Annuitants cannot make withdrawals during this time, which may span several years, without paying a surrender charge or fee. Investors must consider their financial requirements during this time period. For example, if a major event requires significant amounts of cash, such as a wedding, then it might be a good idea to evaluate whether the investor can afford to make requisite annuity payments.

Contracts also have an income rider that ensures a fixed income after the annuity kicks in. There are two questions that investors should ask when they consider income riders:

  1. At what age do they need the income? Depending on the duration of the annuity, the payment terms and interest rates may vary.
  2. What are the fees associated with the income rider? While there are some organizations that offer the income rider free of charge, most have fees associated with this service.

Many insurance companies will allow recipients to withdraw up to 10% of their account value without paying a surrender fee. However, if you withdraw more than that, you may end up paying a penalty, even if the surrender period has already lapsed. There are also tax implications for withdrawals before age 59 and a half.

Because of the potentially high cost of withdrawals, some hard-up annuitants may opt to sell their annuity payments instead. This is similar to borrowing against any other income stream: the annuitant receives a lump sum, and in exchange gives up their right to some (or all) of their future annuity payments.

Individuals who invest in annuities cannot outlive their income stream, which hedges longevity risk. So long as the purchaser understands that they are trading a liquid lump sum for a guaranteed series of cash flows, the product is appropriate. Some purchasers hope to cash out an annuity in the future at a profit, however, this is not the intended use of the product.

Types of Annuities

Annuities can be structured according to a wide array of details and factors, such as the duration of time that payments from the annuity can be guaranteed to continue. As mentioned above, annuities can be created so that payments continue so long as either the annuitant or their spouse (if survivorship benefit is elected) is alive. Alternatively, annuities can be structured to pay out funds for a fixed amount of time, such as 20 years, regardless of how long the annuitant lives.

Immediate and Deferred Annuities

Annuities can begin immediately upon deposit of a lump sum, or they can be structured as deferred benefits. The immediate payment annuity begins paying immediately after the annuitant deposits a lump sum. Deferred income annuities, on the other hand, don’t begin paying out after the initial investment. Instead, the client specifies an age at which they would like to begin receiving payments from the insurance company.

Depending on the type of annuity you choose, the annuity may or may not be able to recover some of the principal invested in the account. In the case of a straight, lifetime payout, there is no refund of the principal–the payments simply continue until the beneficiary dies. If the annuity is set for a fixed period of time, the recipient may be entitled to a refund of any remaining principal–or their heirs, if the annuitant has deceased.

Fixed and Variable Annuities

Annuities can be structured generally as either fixed or variable:

  • Fixed annuities provide regular periodic payments to the annuitant.
  • Variable annuities allow the owner to receive larger future payments if investments of the annuity fund do well and smaller payments if its investments do poorly, which provides for less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund’s investments.

While variable annuities carry some market risk and the potential to lose principal, riders and features can be added to annuity contracts—usually for an extra cost. This allows them to function as hybrid fixed-variable annuities. Contract owners can benefit from upside portfolio potential while enjoying the protection of a guaranteed lifetime minimum withdrawal benefit if the portfolio drops in value.

Other riders may be purchased to add a death benefit to the agreement or to accelerate payouts if the annuity holder is diagnosed with a terminal illness. The cost of living rider is another common rider that will adjust the annual base cash flows for inflation based on changes in the consumer price index (CPI).

Criticism of Annuities

One criticism of annuities is that they are illiquid. Deposits into annuity contracts are typically locked up for a period of time, known as the surrender period, where the annuitant would incur a penalty if all or part of that money were touched.

These periods can last anywhere from two to more than 10 years, depending on the particular product. Surrender fees can start out at 10% or more and the penalty typically declines annually over the surrender period.

Annuities vs. Life Insurance

Life insurance companies and investment companies are the two primary types of financial institutions offering annuity products. For life insurance companies, annuities are a natural hedge for their insurance products. Life insurance is bought to deal with mortality risk, which is the risk of dying prematurely. Policyholders pay an annual premium to the insurance company that will pay out a lump sum upon their death.

If the policyholder dies prematurely, the insurer pays out the death benefit at a net loss to the company. Actuarial science and claims experience allow these insurance companies to price their policies so that on average insurance purchasers will live long enough so that the insurer earns a profit. In many cases, the cash value inside of permanent life insurance policies can be exchanged via a 1035 exchange for an annuity product without any tax implications.

Annuities, on the other hand, deal with longevity risk, or the risk of outliving one’s assets. The risk to the issuer of the annuity is that annuity holders will survive to outlive their initial investment. Annuity issuers may hedge longevity risk by selling annuities to customers with a higher risk of premature death.

Example of an Annuity

A life insurance policy is an example of a fixed annuity in which an individual pays a fixed amount each month for a pre-determined time period (typically 59.5 years) and receives a fixed income stream during their retirement years.

An example of an immediate annuity is when an individual pays a single premium, say $200,000, to an insurance company and receives monthly payments, say $5,000, for a fixed time period afterward. The payout amount for immediate annuities depends on market conditions and interest rates.

Annuities can be a beneficial part of a retirement plan, but annuities are complex financial vehicles. Because of their complexity, many employers don’t offer them as part of an employee’s retirement portfolio.

However, the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law by President Donald Trump in late December 2019, loosens the rules on how employers can select annuity providers and includes annuity options within 401(k) or 403(b) investment plans. The easement of these rules may trigger more annuity options open to qualified employees in the near future.

Who Buys Annuities?

Annuities are appropriate financial products for individuals seeking stable, guaranteed retirement income. Because the lump sum put into the annuity is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs to use this financial product. Annuity holders cannot outlive their income stream, which hedges longevity risk.

What Is a Non-Qualified Annuity?

Annuities can be purchased with either pre-tax or after-tax dollars. A non-qualified annuity is one that has been purchased with after-tax dollars. A qualified annuity is one that has been purchased with pre-tax dollars. Qualified plans include 401(k) plans and 403(b) plans. Only the earnings of a non-qualified annuity are taxed at the time of withdrawal, not the contributions, as they are after-tax money.

What Is an Annuity Fund?

An annuity fund is the investment portfolio in which an annuity holder’s funds are invested. The annuity fund earns returns, which correlate to the payout that an annuity holder receives. When an individual buys an annuity from an insurance company, they pay a premium. The premium is invested by the insurance company into an investment vehicle that contains stocks, bonds, and other securities, which is the annuity fund.

What Is the Surrender Period?

The surrender period is the amount of time an investor must wait before they can withdraw funds from an annuity without facing a penalty. Withdrawals made before the end of the surrender period can result in a surrender charge, which is essentially a deferred sales fee. This period generally spans several years. Investors can incur a significant penalty if they withdraw the invested amount before the surrender period is over.

What Are Common Types of Annuities?

Annuities are generally structured as either fixed or variable instruments. Fixed annuities provide regular periodic payments to the annuitant and are often used in retirement planning. Variable annuities allow the owner to receive larger future payments if investments of the annuity fund do well and smaller payments if its investments do poorly. This provides for less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund’s investments.

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Arbitration

Written by admin. Posted in A, Financial Terms Dictionary

Arbitration

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What Is Arbitration?

Arbitration is a mechanism for resolving disputes between investors and brokers, or between brokers. It is overseen by the Financial Industry Regulatory Authority (FINRA), and the decisions are final and binding. Arbitration is distinct from mediation, in which parties negotiate to reach a voluntary settlement, and decisions are not binding unless all parties agree to them.

Arbitration is not the same as filing an investor complaint, in which an investor alleges wrongdoing on the part of a broker, but has no specific dispute with that broker, for which the investor seeks damages.

How Arbitration Works

In practical terms, arbitration is similar to a lawsuit but may be preferable for all parties due to the lower costs and time commitments involved.

Key Takeaways

  • Arbitration is not the same as filing an investor complaint.
  • Arbitration could be preferable than a lawsuit due to the lower costs and time commitments for all parties involved.
  • Disputes involving less than $50,000 do not require in-person hearings.
  • For disputes ranging from $50,000 to $100,000, require an in-person hearing with a single arbitrator.

When an investor or broker has a specific dispute with a broker that is registered with FINRA, they may file a claim with FINRA that states the alleged misconduct and the amount of money they are seeking in damages.

FINRA will appoint a panel of three financial industry professionals who, unless the injured party requests otherwise, will not be employed in the securities industry. This is intended to eliminate bias, but if one of the parties suspects that a member of the panel is biased, they may request a change.

Arbitration Hearings

For disputes involving less than $50,000, in-person hearings are not considered necessary; rather, both parties submit written materials to a single arbitrator who decides the case. For disputes ranging from $50,000 to $100,000, in-person hearings with a single arbitrator are the most common.

For disputes over $100,000, in-person hearings with three arbitrators are standard. A majority of the three-arbitrator panel (that is, two people) is necessary for a decision. Arbitrators are not required to explain their decision.

Parties filing for arbitration may represent themselves, or they may hire an attorney. In general, arbitration panels are less formalistic than the court system, so investors have a reasonable chance of being successful even when representing themselves.

There are fees associated with filing for arbitration, not to mention the time and travel expenses involved, which investors should consider when pursuing this option.

Special Considerations

Arbitration panels do not necessarily award the full amount sought in a dispute. For example, if an investor files a claim against his or her broker for $38,000, the panel may decide in the investor’s favor, but only award $10,000.

Arbitration decisions are binding and not subject to appeal, except under very limited circumstances. FINRA’s mediation process, on the other hand, is not binding unless both parties agree to the settlement.

The Public Investors Arbitration Bar Association has criticized FINRA for lack of diversity on its arbitration panels and lax safeguards against bias and conflicts of interest. The regulator has argued that these criticisms are misplaced, particularly the focus on arbitrators’ age.

In their terms of service, most brokers require investors to agree to mandatory arbitration to settle potential disputes, rather than going to court. Since FINRA has a near-monopoly on arbitration, the organization’s panels are many investors’ only recourse.

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What Is an Asset? Definition, Types, and Examples

Written by admin. Posted in A, Financial Terms Dictionary

What Is an Asset? Definition, Types, and Examples

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What Is an Asset?

An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.

Assets are reported on a company’s balance sheet. They’re classified as current, fixed, financial, and intangible. They are bought or created to increase a firm’s value or benefit the firm’s operations.

An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses, or improve sales, regardless of whether it’s manufacturing equipment or a patent. 

Key Takeaways

  • An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.
  • Assets are reported on a company’s balance sheet.
  • They are bought or created to increase a firm’s value or benefit the firm’s operations.
  • An asset is something that may generate cash flow, reduce expenses or improve sales, regardless of whether it’s manufacturing equipment or a patent.
  • Assets can be classified as current, fixed, financial, or intangible.

Understanding Assets

An asset represents an economic resource owned or controlled by, for example, a company. An economic resource is something that may be scarce and has the ability to produce economic benefit by generating cash inflows or decreasing cash outflows.

An asset can also represent access that other individuals or firms do not have. Furthermore, a right or other type of access can be legally enforceable, which means economic resources can be used at a company’s discretion. Their use can be precluded or limited by an owner.

For something to be considered an asset, a company must possess a right to it as of the date of the company’s financial statements.

Assets can be broadly categorized into current (or short-term) assets, fixed assets, financial investments, and intangible assets.

Types of Assets

Current Assets

In accounting, some assets are referred to as current. Current assets are short-term economic resources that are expected to be converted into cash or consumed within one year. Current assets include cash and cash equivalents, accounts receivable, inventory, and various prepaid expenses.

While cash is easy to value, accountants periodically reassess the recoverability of inventory and accounts receivable. If there is evidence that a receivable might be uncollectible, it’ll be classified as impaired. Or if inventory becomes obsolete, companies may write off these assets.

Some assets are recorded on companies’ balance sheets using the concept of historical cost. Historical cost represents the original cost of the asset when purchased by a company. Historical cost can also include costs (such as delivery and set up) incurred to incorporate an asset into the company’s operations.

Fixed Assets

Fixed assets are resources with an expected life of greater than a year, such as plants, equipment, and buildings. An accounting adjustment called depreciation is made for fixed assets as they age. It allocates the cost of the asset over time. Depreciation may or may not reflect the fixed asset’s loss of earning power.

Generally accepted accounting principles (GAAP) allow depreciation under several methods. The straight-line method assumes that a fixed asset loses its value in proportion to its useful life, while the accelerated method assumes that the asset loses its value faster in its first years of use.

Financial Assets

Financial assets represent investments in the assets and securities of other institutions. Financial assets include stocks, sovereign and corporate bonds, preferred equity, and other, hybrid securities. Financial assets are valued according to the underlying security and market supply and demand.

Intangible Assets

Intangible assets are economic resources that have no physical presence. They include patents, trademarks, copyrights, and goodwill. Accounting for intangible assets differs depending on the type of asset. They can be either amortized or tested for impairment each year.

While an asset is something with economic value that’s owned or controlled by a person or company, a liability is something that is owed by a person or company. A liability could be a loan, taxes payable, or accounts payable.

What Is Considered an Asset?

When looking at an asset definition, you’ll typically find that it is something that provides a current, future, or potential economic benefit for an individual or company. An asset is, therefore, something that is owned by you or something that is owed to you. A $10 bill, a desktop computer, a chair, and a car are all assets. If you loaned money to someone, that loan is also an asset because you are owed that amount. For the person who owes it, the loan is a liability.

What Are Examples of Assets?

Personal assets can include a home, land, financial securities, jewelry, artwork, gold and silver, or your checking account. Business assets can include such things as motor vehicles, buildings, machinery, equipment, cash, and accounts receivable.

What Are Non-Physical Assets?

Non-physical or intangible assets provide an economic benefit even though you cannot physically touch them. They are an important class of assets that include things like intellectual property (e.g., patents or trademarks), contractual obligations, royalties, and goodwill. Brand equity and reputation are also examples of non-physical or intangible assets that can be quite valuable.

Is Labor an Asset?

No. Labor is the work carried out by human beings, for which they are paid in wages or a salary. Labor is distinct from assets, which are considered to be capital.

How Are Current Assets Different From Fixed (Noncurrent) Assets?

In accounting, assets are categorized by their time horizon of use. Current assets are expected to be sold or used within one year. Fixed assets, also known as noncurrent assets, are expected to be in use for longer than one year. Fixed assets are not easily liquidated. As a result, unlike current assets, fixed assets undergo depreciation.

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