One of the definitions for control is “to hold in check.” Another is, “to exercise restraint or direction over.” I think both are applicable when it comes to the goals of many retirement investors. No one wants to completely avoid their obligation to support our shared services, i.e., pay their share of taxes. However, everyone I talk to wants to reduce their portion or make sure the tax is used appropriately.
Let me give you an example of control. As I drive to my in-laws with my wife, many times during the three-hour drive, our definition of comfortable is different. She tends to set the passenger side of the car much cooler than I like it. In our car, each vent allows the air flow to be reduced or completely shut off. The car’s fan continues to push air through, but, when blocked, the air gets pushed out of another vent – on the driver’s side. When the temperature gets too warm, the air flow can be opened again on the passenger side. The air flow has changed direction while being held in check on one side of the car. The vent (or, I suppose, my wife) has exercised control.
In retirement, tax control vehicles such as annuities allow investors to decide when and how they pay tax. The flexibility of annuities provides a mechanism to turn income on and off, and choose how to distribute the tax consequences associated with the income. Annuities can also provide a tool to distribute assets to the next generation or second generation, which can provide additional tax control.
Having tax control in your retirement vehicles creates an important lever for income planning. Just like the vents in the car, investors can exercise control over their income and tax consequences. You can elect to turn on income when you need it and decide how much you need. Additionally, the manner that you accept the cash flow dictates how you pay tax. Distributions may be taxed as gain first or with an exclusion ratio. You may want to tax your distributions as gain first if you are in a lower tax bracket when you begin income. Otherwise, you may want to spread the tax consequences over the rest of your life. What’s important is that an annuity gives you choice and control.
The stretch IRA (individual retirement arrangement) provision is now being challenged in Congress. IRA holders may only be able to stretch $450,000 to the next generation. Non-qualified annuities allow for multiple distribution options that include skipping generations. The beneficiary designations of annuities provide greater flexibility and control versus institutional IRAs. While those designations add no value in the accumulation phase, the tax control at death and during the income phase can add several basis points to the overall return of the annuity. There is additional value to tax control vehicles beyond the simple interest rate.
Between “holding in check” and “exercising restraint and direction over,” controlling taxes remains an important part of the retirement income discussion. Make sure you have the appropriate control over income and taxes as you plan your clients’ strategy. Tax laws change often – in fact, there have been 31 changes in U.S. tax rates in the 34 years between 1979 and 2013.* So it’s important to create flexibility and control in the financial plan.
Have tax control embedded in your financial plans. Choosing when and how you pay tax is an important discussion point for clients looking to retire. Tax deferral is important during the accumulation phase, but can add basis points to your income and distribution strategy at death.
The marketplace is demanding financial professionals to work in our clients' best interest, which will not only need to address retirement income, but also the risk of longevity.
*Tax Policy Center, Statistics: http://www.taxpolicycenter.org/statistics/historical-average-federal-tax-rates-all-household
Mike McGlothlin is a tireless advocate for the retirement planning industry. As executive vice president of retirement at Ash Brokerage, he heads a team providing income planning solutions focused on longevity and efficiency. He’s also a thought leader who provides guidance and assistance for advisors and broker-dealers navigating marketplace and regulatory changes. You can find a collection of his blog posts in his book, “Above the Clouds … Winning Strategies from 30,000 Feet.”