Turning Tax-Deferred Into Tax-Free

Turning Tax-Deferred Into Tax-Free

One of our most successful webinars this year featured two ideas for turning tax-deferred income into tax-free benefits. (If you missed it, you can watch the webinar replay here.) It’s easy to understand the excitement around the topic as there is a large, blue ocean of opportunity for financial advisors who focus on non-qualified annuity sales and the industry’s book of business. 


According to the 2016 LIMRA Fact Book, there are approximately $468 billion dollars of non-qualified, tax-deferred annuities in the United States. These contracts aren’t being used for annuitized, lifetime income. When you peel back the onion, you’ll see 31 percent of those contract holders are older than 75, and 68 percent are classified as affluent, high net worth, or mega-millionaires by LIMRA. That pairs the industry down to about $100 billion of annuities with a tax-deferred explosion ready to happen at death of the owner.


With long-term care as a huge risk in the longevity plan for retirement, it’s important to consider options for those annuities. Those idle assets are no longer need for their original purpose: income. Instead, they are being conserved and protected to be passed on to the next generation. 


A Better Way

Using a tax-free exchange under IRC Section 1035, the client may exchange the old annuity for a linked-benefit annuity. This transfer benefits the client in several ways:


  • The new product captures all the gain in the old policy. If the old annuity was connected to variable sub accounts, now might be a good time to “lock in” those gains using a fixed contract like a linked benefit annuity. 
  • Clients gain leverage on the policy’s value if used for long-term care expenses. For a 65-year-old, a $100,000 policy value may create a pool of long-term care benefits of $250,000 or more. This translates to transferring $1 and getting $2.50 when used for long-term care. You create tremendous leverage through this transfer. 
  • If the old policy had tax-deferred gains built in, those gains are transferred and continue to grow on a tax-deferred basis. If the contract is used for qualified long-term care expense, all the proceeds – the cost basis and the gain – are received tax-free. 


Look at your client’s balance sheet and the current purpose of certain assets. A lot of them aren’t being used for their original intent. Now is a great opportunity to repurpose those assets and create leverage and value in the planning process. 


Winning Strategy

Look to turn tax-deferred income into tax-free benefits. Repurposing assets that are no longer meeting client goals is a great way to add value to your relationship. By looking at old annuities, you may be able to reduce the tax burden of certain assets to the client and their beneficiaries.  


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


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.”