More On Tax Planningfrom The Advisor's Professional Library
- Taxation of Real Estate Real estate may be used to shelter income and may offer certain tax benefits. However, the type of real estate investment may result in different tax treatment. Learn how to use these investments to help your clients.
- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
Guaranteed lifetime income is increasingly important for retirees in a post-pension world. But the primary vehicle for guaranteed benefits–annuities–can be a hard sell for many investors. It seems that every other day an article panning annuities is published in the mainstream media; and regardless of whether these attacks are unwarranted or uninformed, they have a real effect on those who need the protection of lifetime income the most.
Enter Stand-Alone Living Benefits.
SALB offer a guaranteed stream of income without purchasing a traditional annuity. The product acts like an insurance policy on an investment account, with income benefits kicking in if the account is depleted during the insured’s lifetime. The product is sometimes referred to as a “hybrid annuity” product, although it is not an annuity in the traditional sense.
Here is how they work. The investor places assets in an investment account that is eligible for coverage by SALB. The SALB provide a 4% to 8% lifetime income guarantee, calculated over the Retirement Income Base–essentially the account value–in place when the SALB are purchased.
The lifetime income guarantee will then continue payments to the insured if the account is depleted to zero dollars and can no longer support the payments guaranteed under the contract. Benefits typically are not available until the insured reaches 65. Fees associated with SALB range from 75 to almost 200 basis points, in addition to advisory fees associated with the underlying account.
For example, if an investor purchases SALB on an account with a Retirement Income Base of $500,000 and a 5 percent guarantee, the SALB promises that payments of 5 percent of the $500,000 base, or $25,000, will be available annually for the insured’s lifetime, starting at 65. Then, if the account value drops to zero, the SALB will continue to make those $25,000 annual payments for the insured’s lifetime.
Guaranteed income can increase annually if the value of the account increases, giving clients access to market upswings while still protecting them from downturns. For example, 5% SALB on an account worth $500,000 would pay $25,000 per year, but if the account value jumps to $600,000, the guarantee will jump to $30,000 per year.
A spousal option may also be elected that will continue payments over the surviving spouse’s lifetime.
A lifetime payment option is available on some products. Under that option, the investor’s account is liquidated and the proceeds are applied to purchase a fixed immediate annuity from the company. Payments under the annuity cannot be less than those that would be available by multiplying the proceeds of the account by the return promised under the SALB.
Limitations on SALB
The product was developed as a way for fee-only and fee-based asset managers to offer clients guaranteed income benefits without selling an annuity. Accounts on which SALB are purchased are managed by an advisor, not the insurance company.
But SALB cannot be purchased on just any account. Carriers offering the product allow asset management exclusively through a partner organization. For example, Genworth’s LifeHarbor product is available exclusively through AssetMark Investment Services Inc. Likewise, Nationwide’s Portfolio Innovator SALB product is offered only through Envestnet and Phoenix’s Guaranteed Income Edge is offered through Investors Capital Advisory Services.
Also, trading in an account covered by SALB can be severely restricted. Fees associated with SALB depend on a number of factors, including the asset allocation used in the account and market volatility. Restrictions are placed on account management. If an account is managed in violation of those restrictions, the carrier may terminate SALB coverage for the account. The carrier may provide notice of an
Taxation of SALB
Although SALB may not be an annuity for nontax purposes, the IRS has indicated through a Private Letter Ruling that at least one brand of SALB products (Phoenix’s Income Edge) is an annuity for income tax purposes. As a result, carriers offering SALB products will typically treat payments made under a SALB as annuity payments for tax purposes. Accordingly, payments made after the investment account reaches zero will be treated as amounts received as an annuity.
Because payments are treated as being made from an annuity, each payment will be treated in part as a nontaxable return of investment and in part as gain taxed as ordinary income. But “investment in the contract” is not relative to investment accounts. Instead, investment in the contract consists only of amounts paid as fees on the SALB policy.
Unfortunately, this annuity treatment does not extend to the account underlying the SALB. Gains inside the account are still taxable to the investor.
SALB can be a great way to guarantee lifetime income for clients without purchasing a traditional annuity. However, the product is not widely available and current restrictions on asset management in accounts covered by SALB may make it difficult for many advisors to offer the product to their clients. Also, despite having lower fees than variable annuities with guaranteed living benefits, the taxation of the underlying account must be taken into account when determining whether the product is suitable for a particular client.
For additional coverage of this issue and similar ones, we invite you to sign up with AdvisorOne’s Summit Business Media partner, AdvisorFX, for a free trial.