By Barry Goldwater
AnnuityNews.com
Feb. 2, 2011 -- Wealthy people save money in pension
plans not because they will use the money for retirement purposes as we imagine
it, but because of the associated tax deduction. These wealthy IRAs accumulate
significant funds and can become a significant tax problem.
Here is a startling fact according to some estate attorneys and CPAs: An IRA can
lose as much as 80 percent of its value passing from the present generation to
the next generation because of a triple layer of taxes that await its
distribution. The analogy is the salmon shark that waits for the salmon to
return upstream. They patrol the mouth of a body of water where the salmon will
flood and then they just pick them off, fishing without bait if you will. It is
the same way when the governments, federal and state slap income taxes and then
estate taxes on our clients’ IRAs that they wish to pass to a non spouse person.
The government has been waiting to get paid a long time and when it is their
time, they are as vicious about getting their money as a wild animal is about
hunting for food. You can stretch your IRA, put in a trust, delay the tax but
unless you donate the whole thing to charity, you will pay the tax.
The solution to triple layer taxes on an IRA is tied to estate and income planning
with the proper use of an indexed annuity. The IRA tax relief strategy works
like this; A contribution is made via a rollover to an indexed annuity from an
existing IRA. Indexed annuities offer three compelling features which create the
opportunity for this extraordinary solution to the IRA tax problem. First, money
received in the first year gets a 10 percent bonus.
So $100,000 becomes $110,000 the next day. Then there is a feature called a
guaranteed income rider that guarantees growth at a
certain percentage rate for a certain period of time but only for income
purposes. In this case and with this product, the growth factor is 8 percent and
the time frame for this rider is 20 years, meaning you can trigger the income
anytime from the annuity over a 20 year period. The third feature is the
high payout rate for income –5 percent if you are
getting income in your 60s and 6 percent if income starts in your 70s.
The central thought behind this idea is to trigger the income from the IRA,
setting the stage for the client to potentially pay the least of the three big
taxes: income taxes on annual distributions and if the client lives a long life,
the other two taxes disappear from this IRA. Because of the income riders’
amazing ability to grow a numeric value in the annuity for income purposes, we
can determine what the guaranteed income value will be in every corresponding
year and income lasts for life whether there is any money left in your cash
account or not.
Example:
A 59-year-old male rolls over $385,000 to an indexed annuity IRA. With the 10
percent first-year bonus and the 8 percent growth factor compounded annually, we
know that in year 10, when the client is 69, we can get a guaranteed income of
$45,715, which is calculated as a 5 percent payout on a base number of $914,304.
This income lasts the rest of the client’s life. Wealthy clients carry life
insurance to cover estate taxes and this client’s life insurance premium is
$34,500 while his long-term-care insurance premium costs $10,000. In year 10 of
the annuity, the client can trigger an income stream of $45,715, which is
sufficient to cover the costs for the life and long-term-care premiums. The
annual tax on the IRA distribution is less then half the premium costs, so the
check the client writes for the distribution is rolled up into his annual tax
bill. He has created $4.7 million of tax-free life insurance
for his heirs and a $300 daily tax free long-term-care benefit and all for the
cost of less then half the premium that he was used to paying.
The best part of this story is that this client never understood how he was
intending on using his IRA money. This strategy gave the IRA an important and
defined purpose, to pay premiums and avoid draconian taxes and that registered
positive in the mind of my client. The income from the annuity is never seen,
goes directly to the insurance companies holding the life and long-term-care
policies, the tax on the distribution is rolled into the annual tax bite and
because money for premiums stops coming out of the client’s checkbook, it
eliminates the mental bite of paying premiums which everyone hates to do.
This strategy inverts the tax. Instead of an IRA being a triple taxed asset, it
now becomes the funding vehicle for the creation of tax free benefits for long
term care needs and for tax free life insurance for heirs. We have created a tax
free legacy using taxable IRA dollars, a much smarter use of money.
To summarize; Wealthy people who do not use their IRA will lose most of their
IRA to taxes when trying to pass it to the next generation. By rolling over an
IRA to an indexed annuity IRA, the client can now plan an income stream with
less tax obligation, to fund tax free benefits for present day use and for
legacy purposes. This kind of planning is not only smart but clients get it
because it is easy to understand. Lastly, my clients feel great because finally,
one of their advisors had a tangible plan that makes sense, was easy to
implement, took the pain away from them addressing their long-term- care and
legacy needs and implemented a plan dealing with the taxation issues surrounding
their IRA. One of the most interesting questions I ask my clients is "What are
you going to do with your IRA assets?" Greater than 95 percent have no clue. Now
they have a clear answer.
Barry Goldwater is an insurance specialist practicing in Newton, Mass.
He works with CPAs and financial planners designing appropriate risk management
strategies and ideas for their clients. He can be reached at 617-527-9736 and
Barry@frg-creative.com.
Product illustrated in this article is American Equity Retirement Gold,
not sold in New YorkState. Indexed annuities have severe bonus restrictions in
New YorkState and indexed annuity products vary from company to company. Some
indexed annuities have bonuses, some do not. 8% guaranteed income rider is a
contractually paid rider in the contract and not based on stock market returns.
The rider is has a premium cost paid from the cash values of the annuity.
Guarantees in the rider are not based on stock market assumptions and the rider
is contractually guaranteed by the financial strength of the insurance company
issuing the contract.
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