The final part of an eight-part series
When it comes to annuities and qualified money, some may take the position that annuities are good choices for wealth accumulation.
Historically, however, fixed annuities just can't compete with mutual funds over any period of time. Neither can
equity index annuities, regardless of the charts and tables that insist they can. And when it comes to variable annuities, even with all the bells and whistles, there are always built-in additional charges. Basic math shows that annuities should have lower returns when compared with equivalent mutual funds.
In some cases, however, annuities may be particularly suitable for certain clients. Annuities can be the vehicle of choice when it's time to distribute funds from qualified accounts. By nature, annuities are distribution vehicles
and, as such, are designed to address all aspects and issues surrounding distributed funds.
In addition to guarantees, annuities also offer various distribution options that can make them an almost-perfect fit for any qualified fund distribution goal. Because you can use them as standalone products or combine them with other annuities, you may be able to build a distribution plan that provides flexibility other vehicles can't come close to matching.
The 'three-stage strategy'
One of the more commonly used distribution strategies is sometimes
referred to as a "three-stage strategy."
It has also been called "three legs," "three tiers," and "three buckets."
Whatever the name, however, they all employ the same strategy.
In the first stage, an immediate annuity is used to provide income. The amount of income to be generated
annually in this stage is pre-determined and often based on the required minimum distribution (RMD). Al-though the most common time frame for the first stage is five years, both three and seven years have also been used.
The second stage is based on two assumptions:
1. You can take inflation into consideration, which means you always build in an inflation factor.
2. The proposed timeframe must provide enough time for the third stage to grow back to the original total deposit.
The third stage must accomplish two things. First, it must grow over the period during which the payouts will be made from the first two stages. This must be done to a point where it is capable of making payments for the remainder of the policyholder's life. Always ensure that a client doesn't outlive their money. To do this, you must establish what life expectancy calculation you plan to use, the choices being the regular life expectancy table or the IRS required minimum distribution tables. This does make a difference.
For example, based on normal mortality tables, a 70-year-old man has a remaining life expectancy of 11.7 years; however, that same man at 81 has a remaining life expectancy of 6.5 years. As such, we need to plan for 18.2 years. With that in mind, we would base the three-stage strategy on 19 years. If, on the other hand, we want to build the program around the IRS required minimum distribution life expectancy tables, we would use 27.4 years.
Stage One: Put $40,490 into a five-year SPIA that pays $735 dollars per month, or $8,820 per year. This figure is based on the client meeting the RMD in the fifth year.
Stage Two: Put $52,627 into a five-year fixed annuity with a five-year annual guaranteed rate of 4.75 percent. At the end of the fifth year, you will have $66,371 in the second stage, which your client then annuitizes for another five years.
Stage Three: The remaining $106,884 is put into two equal 10-year annuities that give you the best prospect to average 6.47 percent per year. If this can be achieved, then the $106,884 will have grown back to the original $200,000 and you can start the three-stage program over again.
Another way to put qualified funds to good use is to transfer those funds into a qualified SPIA and use the after-tax dollars to fund a life insurance policy for estate planning or charitable gifting. Using the SPIA can be beneficial for your clients in many ways. For one, it will guarantee that the RMD is met. After-tax premium will also provide any heirs with a larger tax-free lump sum than an IRA would have provided. In those cases where the estate is subject to estate taxes, the qualified SPIA adds an additional benefit as the remaining amount vanishes from the estate and is replaced by dollars with no income tax or estate tax. Of course, this wealth transfer strategy only works if the client is insurable and the life insurance is first put in place.
These are just a few ideas of how you can use annuities to enhance the value of qualified accounts. Annuities, are distribution vehicles, and as such, they are and have always been extremely good tools for retirement or income planning. Those who take the time to incorporate annuities into distribution plans provide their clients and prospects levels of certainty that few, if any, products on the market can match.
Jonathan Neal is the senior partner at CCG-Capital Consulting Group, an Atlanta-based sales and marketing consulting company. He can be reached at jneal@ccgcap.com.
