Estate planning is a comprehensive business. It should mean the coordination of most, if not all, aspects of a client's financial and retirement life. This could include tax management and reduction strategies, coordination of legal documents to help the client achieve the desired results, insurance management, asset protection, and effective money management based on the client's age.
The estate planner should have knowledge in each of these areas, as well as a large network of qualified professionals in each category to help clients craft a proper estate plan. Estate planning is not an event -- it entails an ongoing relationship with the client that must be managed and continually updated through regular reviews.
Too many times, I see clients in their 70s, 80s, or 90s with the same investment strategies as a 35-year-old. People in retirement, however, no longer need to take the risks they have in the past in order to receive a fair return on their retirement money.
We've run into retirees who have lost much of their retirement savings because of the market crashes of 1999 and 2007. Their advisors told them to hold on, that they the market would come back.
And it's true, it always does -- but when, and at what expense to the retiree? And will they be around to see it come back?
With today's annuities, retirees don't have to risk their hard-earned money in the stock market. Retirees can consider traditional fixed, fixed indexed, and immediate annuities for the portion of money on which they'll rely for their retirement lifestyle.
Indexed annuities first came into existence in 1995. Since then, there have been constant improvements, and today, these products serve as a viable option for many, if not most, retirees. Annuities just aren't what they used to be -- and for the better.
For many clients, annuities are a perfect financial and estate planning tool, and if you're going to work as an estate planner, you should fully understand their applications; this will help you understand why annuities fill the needs of many retirees.
First, let's look at taxes; if you can control or reduce the amount of taxes being paid out by your client, you can control or reduce the chance of them running out of money before they run out of time, or increase the legacy left to their loved ones.
Let's look at some scenarios.
Joe and Mary are 65 years old. They were advised to place their money into a taxable account and live off of the interest. We see this type of planning most often from brokers and banks. The income generated is 100 percent taxable, which can increase not only taxable income for income tax, but also, potentially, the amount of Social Security income the client has to add into their income tax (up to 85 percent).
What can you do as an advisor? Every case is different, but generally, you could find out the amount they need to receive. Let's assume $100,000; the banks may be offering 1 to 2 percent, of which 100 percent of the interest has to be added to their taxable income.
We may take a portion of that $100,000 and place it into a five-year single premium immediate annuity (SPIA). Let's work with a $2,000 income -- the high side of a bank. We could place approximately $9,610 into a SPIA to pay out $2,000 per year of income. With a 96.1 percent (exclusion ratio), this would create tax-free income of 3.9 percent, meaning that only $78 would be counted as taxable income.
Some would say to use tax-free bonds, but are they truly tax-free? The income generated is (or may be) tax-free for income tax purposes, but they can push up the gross taxable income and increase the amount of Social Security income that may have to be added to the client's income taxes (up to 85 percent). The income in the last paragraph does not generate much additional income tax unless, in this case, the $78 would bump up the client's income. Still, there is less tax being paid in this instance.
The balance of the $100,000 ($100,000 - $9,610 = $90,390) would be divided among several other accounts. One is a five-year deferred annuity, which could be moved via a 1035 exchange into a SPIA or turned into a five-year income stream in five years. With a guaranteed 4 percent return, we would need to place enough in this account to recreate the
$2,000-per-month income plus any necessary cost-of-living increases. You'll have to take into consideration that the exclusion ratio will be lower because of tax-deferred gains accumulated over the past five years, meaning that the taxable income will be greater, but still much better than 100 percent taxable.
The balance could be placed into a 10-year indexed annuity or two. You may include income riders where applicable for the income after the first five to 10-year periods, if appropriate for the client.
With income riders, you must make sure that they are the best option for the client. I find that many are sold inappropriately.
With competition being what it is, better products are being offered; paying for an income rider may limit the client's options down the road. There are a couple of income riders that don't have an annual cost, which may allow for the client to move to a new, more competitive product if it's best for them. In this case, paying for a rider may mean money down the drain.
In 2005, we took on a new client who retired in 2000. They had retired with $650,000 between the two of them at age 50.
They needed to take income, so their advisor placed 100 percent of their retirement money into mutual funds and took $48,000 annually (at an assumed 7 percent rate, which is very high now, and even a little high at that time) as a 72 percent distribution to avoid any early withdrawal penalties.
In 2005, they contacted us. They had $340,000 dollars left and had to keep taking the $48,000 per year income until they hit age 59 1/2 .
I ran the numbers. If they had just placed the money under their mattress and took the $48,000 per year income, they would have had about $365,000 left. Based on the same period of time, from September 2000 until they became my client in 2005, if they would had created income similar to Client #1, they would have had over $500,000 left without taking any market risk. When understood and used correctly, annuities can be very beneficial to the client.
Sam and Liz sold their home and now rent an apartment in an independent retirement community. Their only assets are monetary, plus a car and personal belongings. They planned to travel and didn't want the burden of a house.
Many people think that their will will keep them out of probate, but in fact, it will direct them right into it. Since they don't have a home, the assets can all be transferred to the heirs without probate, without any trusts, if that is the client's desire. First, any IRAs will have a beneficiary and move to the intended beneficiaries. Most times, we don't see TODs, PODs, or ITFs used on their brokerage or bank accounts; these beneficiary forms can be added and will direct that asset to a beneficiary, and around probate. This is especially beneficial because in order to get a discount, the client's beneficiary will need liquid money to pay for any inheritance taxes within 90 days.
Annuities are also a great option for avoiding probate. They can usually obtain a better rate of return than banks offer on accounts, but offer more flexibility with surrender-free withdrawals and the ability to turn the money into a guaranteed income stream if ever needed -- income that cannot be outlived. Bank accounts such as savings, checking, or CDs don't have this option. Plus, the annuity has flexibility with beneficiary designations that the TODs, PODs, or ITFs may not offer.
Many times, the following forms only allow for a maximum of two beneficiaries (BFs):
- Transfer on death
- Payable on death
- In trust for
The beneficiary forms for annuities have the ability to pay many BFs. Many companies also offer the ability to stretch the death benefit over one or two generations, substantially increasing the client's legacy.
If Sam and Liz were to do some long term care planning and used such trusts as irrevocable grantor's trusts, annuities could potentially control taxation inside the trusts, which is at 35 percent.
Harry and Sally were looking to retire within five years, at age 65. They didn't want to have to delay retirement if the markets were to drop in the next five years. They placed their retirement money into fixed indexed annuities. If the markets did well and their annuity interest rates reflected the market gains, they could retire without a problem. If there were no gains, then they may have to delay retirement, even though their principal and any interest were protected from market losses.
In this case, we can recommend an income rider. Let's use a 7 percent guaranteed annual increase. In the next five years, their retirement savings were guaranteed to increase 7 percent per year at a minimum -- more if there's a good year and the company allows the policyholder to lock in the higher of the two increases for the year.
When it's time for them to retire, they'll know exactly how much retirement income they'll have, with a guaranteed 7 percent gain in a worst-case scenario. Some companies have 8 and 10 percent simple interest adjustments, which means if you place $100,000 into one of these accounts, your increases would be $8,000 or $10,000 (respectively) annually, based on the initial premium times the 8 or 10 percent simple interest rate.
Over a short period of time, this can be better than a 7 percent annual rollup, based on the accumulation value.
In some cases, special planning for Medicaid allows for the use of SPIAs to increase the income to the community spouse from the share of the spouse in a nursing home.
Estate planning with annuities
People are looking for advice, and estate planning can be a perfect direction for your business to grow, if you want to put the time and effort into learning all aspects of someone's financial or estate planning needs.
Building relationships with such qualified professionals as attorneys and CPAs and working closely with them can help you become a sponge over a period of time. It may involve travel for the learning experiences, but it is well worth it if you want to position yourself as a trusted advisor.
You have to understand how annuities and riders work, and you should have many companies to represent, so you can offer your clients the best product for their situation instead of simply being an annuity salesman.
Your clients will thank you for it, and it can be a basis of a long-lasting relationship and referrals down the road.
Kevin Bock is the president of Integrity Estate Advisors, a full-service estate planning and advisory firm. He can be reached at 877-419-1040.