Annuities

TLC: Taxation, Longevity and Control


Annuities

Health care might be one of the most expensive risks in retirement. Today, and most likely to continue for the foreseeable future, government health care premiums are based on means testing based on income levels. It’s important to understand the components of the income calculations. And, it’s equally important to determine how to control that income.

 

In general, less taxable income translates to less health care premium. The goal for the retiree should not be to lower taxes, but increase net income. Net income can be positively affected by reducing taxes, lowering premiums and other costs, and increasing the gross income to the client. Let’s look at some techniques that can add control to the financial plan that might also increase the net after-tax income to your client.

 

Asset Location Vs. Allocation

Many people tell me that purchasing a single-premium immediate annuity (SPIA) in today’s low interest rate environment is one of the worst decisions they could recommend. However, I think a SPIA can be the most effective tool in raising after-tax income for our clients. With today’s interest rates, a nonqualified SPIA can provide a high exclusion ratio for every payment received. This excluded amount is a non-taxable event and does not go into the calculations against Social Security taxation and health care means testing. 

 

Housing Wealth

In the United States today,there is as much housing wealth as the industry has in assets under management. The use of housing wealth might be the most underutilized strategy for any retiree. We ran simulations using housing wealth as a noncorrelated investment strategy during retirement. Every year that the markets ended down, the home equity was used to generate the income needed instead of the investment portfolio. This provided some time for the investment portfolio to recover.

 

With a traditional systematic withdrawal strategy and no noncorrelated assets, the portfolio failed at age 95 in 26 percent of the simulations. The client would run out of income in more than one out of four situations. By using a withdrawal from the noncorrelated asset (home equity conversion mortgage), the failure rate dropped to just 2 percent. We decreased the risk of failure from one in four to one in 50. That’s a significant change in confidence for the American retiree.

 

Other Noncorrelated Assets

Noncorrelated assets don’t have to be just housing wealth. Fixed annuities with liquidity, cash and permanent life insurance are all noncorrelated assets. Life insurance and housing wealth provide access to these funds on a tax-free basis. Noncorrelated assets can be a great tool to control the tax on the retiree’s income and create flexibility of when to pay the tax based on the source of the income.

 

Winning Strategy

Instead of looking at rates of return, look at your client’s net after-tax income as a benchmark for performance. Look for solutions to increase gross income while managing taxes and expenses to increase the funds available for the retiree to spend. 

Retirement Webinar

Craving More?

Professor Jamie Hopkins joins us to explain how the tax reform bill impacts retirement income tax planning, focusing on tax efficiency.

Catch the Replay Here

 

About the Author

Mike McGlothlin is a team leader, retirement industry activist and disciple of Indiana Hoosier basketball. In addition to being EVP of retirement at Ash Brokerage, he is a sought-after writer and speaker. His web series, “Winning Strategies,” provides insight and motivation for financial advisors in many forms – blogs, books, videos, podcasts and more. You can get his latest book, “Winning Strategies: The New Rules of Retirement Planning,” on Amazon.

Retirement Taxes Health Care Home Equity Conversion Mortgage

Unintended Consequences and an Underutilized Solution


Annuities

Whenever there is a significant change in the tax code, there are always unintended consequences. The Tax Cut and Jobs Act (TCJA) is no exception. While many people thought the new tax law created simplification and reduced corporate taxes, it might also create a dramatic and negative affect on charities.

 

A few reasons why:

  • The TCJA increased the standard deduction to $12,000 for singles and $24,000 for couples
  • Tax brackets were lowered, making all deductions less valuable
  • The federal estate exemption was raised to $22 million for couples, making charitable bequests less urgent for wealthy households

 

The Tax Policy Center estimates that the share of middle-income households claiming the charitable deduction will fall by two-thirds, from 17 percent to just 5.5 percent. Even larger incomes will see a significant drop of nearly 25 percent.1

 

Obviously, those households that are charitably inclined will continue to support their favorite charities. However, many Americans are motivated to make donations based on financial advantages. I want to point out that there are great opportunities to continue making charitable contributions that can impact the tax control of a retiree’s income – one such technique is the use of Qualified Charitable Distributions (QCDs).

 

Help Clients Give

QCDs allow for required minimum distributions up to $100,000 to be directed to a charity directly from the plan participant’s IRA. The distribution does not count as income – that’s a really important distinction. A deduction, most likely, would be taken off adjusted gross income with some limits. A QCD simply does not count as income.

 

This strategy creates cascading benefits – some key ones include:

  • The client can make a charitable deduction even if their contribution is under the standard deduction
  • QCDs do not increase combined income for Social Security taxation calculations
  • QCDs do not increase the Modified Adjusted Income for Medicare premium thresholds
  • The lower income may allow a client to “bracket bump” and convert other qualified funds in a lower tax bracket

 

The use of QCDs hasn’t been popular recently, but I can’t pinpoint why. Many planners haven’t used this strategy because the client was able to take a deduction above and beyond the standard deduction. Now, tax laws have changed, making it more difficult to make a charitable contribution the “traditional” way.

 

Winning Strategy

The tax law change should make you think and act differently. Talk to clients who are taking RMDs about changing their contribution to Qualified Charitable Distributions.

Retirement Webinar

Craving More?

Professor Jamie Hopkins joins us to explain how the tax reform bill impacts retirement income tax planning, focusing on tax efficiency.

Catch the Replay Here

 

1Tax Policy Center, TaxVox, “21 Million Taxpayers Will Stop Taking the Charitable Deduction Under The TCJA,” January 2018: https://www.taxpolicycenter.org/taxvox/21-million-taxpayers-will-stop-taking-charitable-deduction-under-tcja

 

About the Author

Mike McGlothlin is a team leader, retirement industry activist and disciple of Indiana Hoosier basketball. In addition to being EVP of retirement at Ash Brokerage, he is a sought-after writer and speaker. His web series, “Winning Strategies,” provides insight and motivation for financial advisors in many forms – blogs, books, videos, podcasts and more. You can get his latest book, “Winning Strategies: The New Rules of Retirement Planning,” on Amazon.

Retirement Taxes Charitable Planning Qualified Charitable Distributions

Two Birds, One Stone: A Strategy to Retain Assets and Find New Clients


Annuities

The Tax Cut and Jobs Act made great strides in transferring wealth by increasing the federal estate tax exemption to $11.2 million per person. The problem is many Americans no longer feel the need to complete estate planning. That’s incorrect thinking.

 

One of the costliest taxes at death is the income tax on the transfer of nonqualified annuities. This will likely come as a surprise to many beneficiaries as most planners have not addressed the issue. You can address it by giving your clients and their beneficiaries more control.

 

One Rider, Several Advantages

One of the more innovative income riders has received a private letter ruling that provides great tax benefits. The income that is generated to the current owner/annuitant receives an exclusion ratio. All other income riders are taxed as last in, first out (LIFO).

 

This tax advantage allows the client to be more intentional about the source of retirement income. The use of an exclusion ratio might boost net after-tax income to the client while taking pressure off the assets under management to perform. For clients using taxable certificate of deposit interest as income, this maneuver can make a significant increase in gross and net income.

 

More importantly, the rider allows the beneficiary control over how they receive the transfer at the death of the owner/annuitant. The beneficiary can “harvest” the cost basis in the nonqualified contract through a lump-sum distribution or by continuing the monthly income. I like to think of this strategy as putting the tax man at the back of the line instead in the front of the line.

 

This strategy creates several advantages:

  • You’ve increased the overall income to the client with the income rider
  • The client enjoys more of the income since more of the income is received tax free in the form of a return of cost basis
  • The beneficiary has choice and control of when to get taxed on the remaining gain in the annuity

 

If you provide that level of value to your clients and their beneficiaries, you are in a great position to retain those funds through the next generation. That’s the best way to retain assets and attract new clients.

 

Winning Strategy

Think about getting your clients in a better position to harvest the cost basis on their nonqualified annuities during the transfer process. It can help the client now and the beneficiary later.

Retirement Webinar

Craving More?

Professor Jamie Hopkins joins us to explain how the tax reform bill impacts retirement income tax planning, focusing on tax efficiency.

Catch the Replay Here

 

About the Author

Mike McGlothlin is a team leader, retirement industry activist and disciple of Indiana Hoosier basketball. In addition to being EVP of retirement at Ash Brokerage, he is a sought-after writer and speaker. His web series, “Winning Strategies,” provides insight and motivation for financial advisors in many forms – blogs, books, videos, podcasts and more. You can get his latest book, “Winning Strategies: The New Rules of Retirement Planning,” on Amazon.

Retirement Taxes Wealth Transfer

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.”

Tax Efficient Wealth Transfer Estate Taxes Life Insurance Annuities

Take Advantage of Today’s Tax Laws


Annuities

Looks can be deceiving. Nowhere is that more true than in retirement planning. The client who drives a modest car, wears jeans and eats at Bob Evans ends up being the millionaire next door, while the flashy dresser with the fancy watch has a pile of debt and little to no nest egg to fall back on.  

 

Looks can also be deceiving when it comes to investments. All too often, clients get caught up in seeking the highest rate of return they can find in an investment. Unfortunately, many don’t always walk away with the best net return because of what’s hidden underneath: taxes and fees.  

 

Just like a fancy watch, those attractive, high interest rates do not tell the whole story. Within many typical, non-annuity-type investments, there are certain pieces of drag embedded in the total return. 

  • There are sales charges with the purchase or redemption of the asset
  • There may be annual fees for overall investment and planning 
  • Perhaps the most harmful are capital gains and ordinary income taxes – those can cost clients more than a third of return on an annual basis

 

So the initial high interest rate that enticed the client ends up being irrelevant after taxes and charges eat into it.    

 

Don’t Miss Out by Misunderstanding

Like I said, sometimes you will find the modest, jeans-wearing client ends up having the highest net worth. In the same vein, annuities are plain and simple but offer surprisingly essential benefits. One of the strongest reasons to position part of a portfolio with annuities is to take advantage of the tax-deferred growth. During the accumulation phase, the asset grows without the drag of either capital gain or ordinary income tax. 

 

Now, some will argue that the deferral creates a larger tax bill at distribution. But, that’s only true if you completely liquidate the annuity. If the goal is to live off the annuity with just interest and systematic withdrawals during retirement, you will have created a much larger nest egg during accumulation rather than paying taxes annually. After all, “It’s not what you earn – it’s what you keep,” and annuities are instrumental in helping the client do just that.

 

Build a Bridge

Additionally, the low interest rate and favorable tax treatment of annuities creates a unique planning opportunity to help maximize Social Security benefits. By bridging early income at age 62 with a non-qualified single premium immediate annuity (SPIA) rather than starting Social Security, as much as 96 percent of the client’s income is tax-free. This bridge allows the client to minimize tax drag on their income and wait to maximize their Social Security benefits at age 70.  

 

The difference in Social Security income at age 62 versus age 70 might be as high as a 50 percent. That increase might translate to more travel, more time with family, or a larger cushion for necessities like medication. More importantly, this strategy affords the client to have more of their money linked to income that keeps pace with inflation. And, inflation might be the cruelest tax of all. 

 

Today, the average younger baby boomer (aged 50-59) has only saved $130,1001, so it’s critical to create as much asset value as possible in the future. Tax laws are always changing – in fact, there have been 31 changes in U.S. tax rates in the 34 years between 1979 and 2013.2 So you have to take advantage of what's available now. It’s important to help your clients remove their “interest rate blinders” and see the many benefits of annuities – benefits they might miss on first glance. 

 

Winning Strategy

Many people do not realize the powerful tax advantages of annuities. Plan how you can help your clients seize the opportunity of the current tax laws governing annuities. The disparity between annuities and other investments may not last long.  

 

Learn More

1LIMRA, “Fact Book on Retirement Income 2016”: https://www.limra.com/bookstore/item_details.aspx?sku=23518-001

 

2Tax Policy Center, Statistics: http://www.taxpolicycenter.org/statistics/historical-average-federal-tax-rates-all-household

 

 

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.”

Retirement Taxes Tax Efficiency Financial Planning