Annuities

How to Reduce or Eliminate Taxes on Wealth Transfer


Annuities

When estate planners talk about annuities and IRAs, they say those vehicles are the worst to be holding when you pass away. I generally agree with the statement. Moreover, planners focus on the estate tax and reducing the impact of it. The deferred gains in a tax-deferred product – qualified or non-qualified – has the tendency to force the gain to be taxed at the recipient’s highest marginal tax bracket.

 

Because those assets become taxed at the highest marginal bracket, it’s important to have plans for the tax deferral or qualified accounts in a client’s estate. Many planners should look to life insurance as a way to create the necessary capital to pay for the tax. Life insurance also provides the liquidity needed in order to pay the tax without invading the IRA.   

 

Other planners look to leverage the power of the stretch IRA to minimize taxes and reduce the burden of the overall tax on the beneficiaries. Unfortunately, it appears that Congress is making plans to limit the amount that can be stretched to $250,000. For the mass affluent and middle-America clientele, the loss of the stretch provision might be devastating to wealth transfer. 

 

One Product, Two Tax Strategies

So, how can life insurance work in conjunction with IRAs and tax-deferred vehicles like non-qualified annuities? 

 

  • Life insurance can be used to pay for the income tax on the transfer of wealth. Income tax brackets remain extremely high – as high as 39.6 percent on a federal rate. That doesn’t even take into consideration the state tax revenue. That can push it well over 40 percent of the gain being taxed. As I travel around the country, I don’t hear enough people talking about the income tax effect on wealth transfer. Clients and planners hide behind the exemption of the federal or state estate taxes. Unfortunately, those do not apply to income taxes. Creating liquidity to meet the demands of the income tax due the April after the death of the IRA is a smart option. Life insurance pays for the cost of the tax on discounted dollars, and it generates the cash position when people need it most. 

 

  • Qualified assets above those that can be stretched can be transferred to life insurance. This allows the client to turn the transfer of wealth from tax-deferred to tax-free. This can be meaningful to beneficiaries and easier to transfer outside of the estate with proper use of trusts.  

 

Look at your tax-deferred vehicles and identify clients who will pass along not only a big inheritance, but also a big tax bill. Talk to them about using life insurance to reduce overall costs or completely eliminate the federal income tax on the transfers of wealth. 

 

Winning Strategy

Life insurance can be meaningful for those with larger IRAs or accounts with tax-deferred gains. These vehicles are the worst to have in your estate on the date of death. There are strategies to eliminate or reduce the income tax.  

 

About the Author

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.”

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Alternatives for the Uninsured and Underinsured


Annuities

Ownership of life insurance remains at all-time lows. With a few exceptions, it has continued to decline over the last couple of generations. This has left a lot of Americans without life insurance by choice. However, a subset of those people are truly uninsured. They may have never qualified or, like many Americans, they waited until a health concern bubbled up, which made the coverage unaffordable. 

 

Too often, I see planners tell their clients they will have to “self-insure” their future. That translates to becoming more aggressive in their allocation to grow their funds faster. And, keeping more assets in brokerage accounts and wrap accounts instead of shifting their risk. In reality, there are other ways to shift this risk. 

 

Coverage with Leverage

As I’ve mentioned before, long-term care is more of a cash flow issue than an asset issue. I hear many planners looking to protect assets instead of creating additional cash flow to pay for the care. Annuities can provide a guaranteed income and many riders accelerate the payment for those confined to a facility or needing home health care. In some cases, the income doubles during the time of need. 

 

Asset-based long-term care products have become a popular solution because clients can maintain control over their account and balance sheet. These products shift the account value to a leveraged situation. You have to ask yourself … 

 

Who wouldn’t want to receive two to three times the value?

 

To make this solution even more attractive, tax advantages exist due to the Pension Protection Act. Now, some underwriting exists, but this solution offers the best use of a deductible – your account value – followed by the leverage provided by an insurance company. 

 

Many life insurance companies offer enhanced riders that provide part of the death benefit if you qualify for two of the six activities of daily living (ADL). In many cases, these companies underwrite toward the mortality risk and not so much of the morbidity risk. Again, underwriting exists, but it can help the underinsured capture more risk mitigation. 

 

We have to look at alternatives for our underinsured and uninsurable clients. Simply keeping assets under management presents a conflict of interest by not looking at other risk mitigation tools in the planning process. Take time to serve your clients and evaluate how life insurance and annuities can fit into the income distribution planning strategy. 

 

Winning Strategy

Look at your clients who can’t afford traditional insurance coverage or can’t qualify for the coverage they want. Alternatives exist where the risk of long-term care can be shifted, in part, to an insurer instead of remaining with the assets under management. 

 

About the Author

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.”

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Creating True Liquidity


Annuities

As I travel and speak with different groups and advisors, I’m pleasantly surprised by their willingness to learn how annuities and life insurance can create true and free liquidity. Too often, clients and their advisors view mutual funds, stocks and bonds as the only source of liquidity in the markets. 

 

I agree those instruments provide liquidity due to the markets on which they are listed. However, market risks and sequencing risks may hinder liquidity when you need to convert the vehicle to cash quickly. And, that is the most worthwhile definition of liquidity – the ability to convert something to cash quickly. 

 

If properly used, life insurance and annuities can help create liquidity as part of an overall asset allocation strategy in just about any portfolio. Let me give you a couple of examples. 

 

  • Annuities and life insurance may work as a non-correlated asset class in the income phase of a retirement strategy. In our studies, we ran 50 simulations using the past 20 years of market sequences. For every year with negative market returns, we took the required income from a non-correlated asset. Over 20 years, the use of a non-correlated asset fell from 26 percent to 2 percent. Non-correlated assets may be found in the form of cash, cash value life insurance, and fixed annuities. The net difference in values was neutral (both had at least one failure) to as much as $621,000 in portfolio value. This can create overall liquidity when you don’t want to liquidate securities during bear markets.

 

  • Our research also shows that most retirees can maximize their income and create the most liquidity with 15-25 percent producing guaranteed income. Guaranteed income comes from three sources: Social Security, defined benefit plans, and insurance companies in the form of annuities. With guaranteed income securely positioned, the assets under management are not required to create the retirement income. And, those incomes are more stable due to the fact that the withdrawal percentage is below 4 percent in many instances. This positioning creates a “pool” of assets that are not needed for income purposes. It can be used for charitable purposes, to address health care and long-term care, or maintain a healthy reserve pool for the emergencies. 

 

  • Longevity creates many concerns for retirees. One of the most costly is long-term care. It is an unknown risk and increasing cost in any retirement plan. Today, it is not a capital issue, but rather a cash flow issue. For a client who has a 95 percent probability of success in their retirement plan, their chances of not running out of money with just one, three-year long-term care event reduces their probability of success to 2 percent. Had the client purchased long-term care insurance – either hybrid on a life policy or annuity, or a rider on a life policy – the probability of success is buoyed at 85 percent.  

 

I’m happy to show you these numbers and studies in action, so you can see the impact for yourself. But, the bottom line is this: While the specific product may not create immediate liquidity, the proper use of annuities and life insurance can provide free, unrestricted liquidity for many portfolios. The use of annuities and life insurance may create many tax advantages by investing in a different asset allocation focused on long-term capital gains. (Please consult a tax advisor for specific benefits.) Take the time to learn how a small portion of the product allocation makes exponential gains in the performance of the income plan. 

 

Winning Strategy

Many times, clients want to do a lot with little money. They end up choosing which priority to address. Look at annuities and life insurance as an alternative. They create liquidity within the portfolio if used properly. 

 

About the Author

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.”

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3 Ways to Use Life Insurance in Retirement Plans


Annuities

September is Life Insurance Awareness Month. Why should this matter to you? Because the percentage of households that own life insurance continues to fall. We have recently changed the face of “financial planning” to only engage with clients through asset management services. Worse yet, our industry refers to that engagement as “wealth management.”

 

The idea of wealth management should dictate holistic planning, which includes basis risk management, income stability during retirement, legacy goals, tax planning, and health care planning – both medical and long-term care. However, our industry falls short of holistic planning. The first step is to look how our asset managers and retirement advisors can benefit from a healthy and robust annuity partnership. Below are just a few quick ideas to bridge the gap for our clients.

 

  • We find that many of our clients don’t need to live off their required minimum distributions (RMDs) in retirement. Currently, some clients elect to defer their RMDs using a qualified longevity annuity contract (QLAC). Instead, we need to evaluate whether our clients would rather transfer more wealth via life insurance. By using the RMDs to purchase life insurance, they can pass more qualified funds to the next generation, and the transition happens tax-free instead of at the highest tax bracket. 

 

  • Our research shows that the use of a non-correlated asset benefits the distribution strategy of most retirees. With any systematic withdrawal strategy, taking the income from a non-correlated asset improves the success ratio of the income over 20 years. Using multiple iterations, we found that a typical withdrawal strategy fails 23 percent of the time. When we introduce a non-correlated asset and take withdrawals from it after every down market year, the client only had failure in 2 percent of the time. Portfolio values ranged from neutral to as high as $600,000 more in assets under management after 20 years. Non-correlated assets can be cash, fixed annuities, and fixed indexed annuities; however, life insurance and Home Equity Conversion Mortgages (HECMs) provide tax-free access to capital with little or no cost and with flexibility to choose when to initiate the income replacement. 

 

  • The other way to leverage annuities in the planning process is to maximize the long-term care pool of assets and income. There are several ways to accomplish this goal. First, existing annuities may be annuitized for a 10-year period certain (assuming older than age 59 ½) and used to purchase life insurance with new long-term care riders. Second, several carriers have annuity-based long-term care policies. This allows you to take tax deferral that was purchased for emergency purposes and make those gains tax-free for qualified long-term care expenses. 

 

There are many ways annuity producers, financial planners, wealth managers – whatever retirement income planners want to call themselves – can utilize life insurance to better their clients’ plans. These are just a few. We will explore some other ideas during the month of September for Life Insurance Awareness Month. 

 

Winning Strategy

For retirement income planners, life insurance should be an integral part of the holistic planning process. Without risk management, income and retirement cash flow can be in jeopardy due to unplanned circumstances. 

 

About the Author

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.”

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The Immeasurable Return on Family Values


Annuities

While we’ve had our eyes on the U.S. Department of Labor’s Fiduciary Rule and Conflicts of Interest Rule, Congress has recommended some new tax laws that might adversely affect the American consumer even more so. 

 

A proposed bill would limit the amount of retirement funds that might be stretched to the next generation or the following generation. The proposal limits the amount a retirement investor can stretch to only $250,000. 

 

This is where you should look at different angles and new ways to attack the problem. Many annuities allow for joint, non-spousal annuitants. The advantage of this set-up is that both annuitants get income for both their lives. This allows annuities to be a vehicle that creates a “stretch-like” provision above the $250,000 of assets under management. 

 

More than Money

How would your clients and beneficiaries react to being able to do the following?

  • Grandparent receives an income on an asset for the rest of their life – guaranteed – with a cost of living increase each year
  • When the grandparent passes away, the grandchild receives the same income – guaranteed for their life – with a cost of living increase each year
  • On the grandchild’s 16th birthday, the planning firm sends a check plus a note from the grandparent about how special the “Sweet 16” is and to enjoy their teen years
  • On the grandchild’s 21st birthday, the planning firm sends a larger check plus a note from the grandparent about how important family values are as an adult – the grandparent writes about the fears they had when they were 21 and how they succeeded
  • When the grandchild weds, the newlyweds get a letter from the grandparent about the secrets to a 50-year marriage, and reaffirms the family values that helped them weather the storms
  • When the couple has their first child, a letter arrives talking about how challenging parenting will be, but the rewards of raising a child far outweigh the early mornings, teething, potty-training, and other heartaches in raising a child. The letter reassures them everyone has been there and, if they stick to the family values, their child will be successful, healthy and wealthy. 
  • And so on…and so on…

 

In these cases, the return on money becomes irrelevant. You are not helping your clients pass along just tax savings or a better return; you are perpetuating value that is important – their family values. 

 

Winning Strategy

Talk to your clients who have grandchildren. Show them how they could create a stretch provision that is not dictated by tax law. Instead, it is driven by their family values – I think they will find the idea more valuable than any return you could provide. And, it will likely give the family even more than you can ever provide through asset allocation. 

 

About the Author

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.”

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