For those of you who’ve been in the business quite some time, the date Aug. 13, 1982, is hardwired into your memory. For those of you who haven’t, it was the day the taxation of nonqualified (NQ) deferred annuities changed from FIFO (first in, first out) to LIFO (last in, first out).
The planning point of a pre-'82 NQ annuity was that you could recover your basis first before any taxable event occurred. For post-'82 annuities, it’s interest out first, until you get to basis, then it’s return of basis.
Believe it or not, this strategy still exists with NQ monies, with a few caveats. In a world where income planning and taxation is paramount, this strategy may be huge for an income planning case.
Here is how this concept works. Say a client, age 55 with a spouse also age 55, has $100,000 of NQ money to invest. They plan on retiring at age 65, so they have 10 years until income is needed from this deposit. They would place this in a fixed, deferred annuity with an indexed minimum guaranteed withdrawal benefit. The annuity isn’t designed for accumulation, only income. Therefore, in the 10th year, should they decide to walk away, the value would still only be $100,000.
But therein is the positive of this concept. In year 11, the guaranteed income for life is $7,988 over two lives. This is about the equivalent of a 6 percent compounded rollup with a 4.5 percent payout rate. Here’s the home run: Since it’s a deferred annuity with a guaranteed minimum withdrawal benefit, the withdrawals are FIFO since there’s no additional cash value in the contract. Therefore, the first 10 years of income are return-of-premium and tax-free.
Once the principal is recovered, it’s all taxable. But think of the planning possibilities here! If you could have your first 5-10 years of retirement income-tax-free, think of the possibility of converting some of your qualified monies to Roth IRA, as well as the possibility of delaying Social Security to age 70 to maximize benefits.
Throw in the fact you can now move up to 25 percent of your IRA money to a Qualified Longevity Annuity Contract and avoid required minimum distributions to age 85, and now you have some pretty creative income planning scenarios to work with – not just putting monies into an annuity with an income rider and turning it on at 65!
The Bottom Line: A lot changed in 1982, and a lot has changed since then. Talk to your clients about strategies to maximize their income and minimize their taxes in retirement.
© 2018 Ash Brokerage LLC.