A dying mom’s request

SPIA Case Studies

I recently consulted on an IRA SPIA case for a 40-year-old parent with 10-year-old child. The parent was terminally ill and needed a financial miracle. The parent was preparing a Chapter 7 bankruptcy filing due to substantial medical expenses not covered by her health insurance policy and the IRA was her last real remaining asset.

Recently divorced (nationally, divorce rates significantly escalate when one partner becomes chronically ill or injured), her thoughts turned to how to protect her young son from a fractured family environment that may not always have her son’s best financial interest at heart.

In her situation, a SPIA became a simple solution. As financial products go, a SPIA is not too difficult to understand: There are no moving parts and it doesn’t have to be managed. It’s guaranteed by an insurance company, has no cash surrender value and life-contingent payments are not valuable to third parties.

Given this scenario, it was the best way to protect her young son from a perceived predatory family environment and simultaneously provide her some current income.

A Joint (and 100 percent survivor) SPIA was suggested. In this case, the son became the Joint Annuitant and the contract would continue to pay him over his lifetime. Her obstacle was the RMD rules for IRA joint SPIAs published in 2002. Typically, a 100 percent survivor arrangement is not permitted for non-spousal individuals with 30-year age differences because the IRS feels this creates an inappropriate internal deferral in favor of the younger annuitant. 

In this case, the annuity payment has to be significantly reduced vs. a life-only payment to the parent to account for the young child’s lifetime expectations. Also, the IRS wants to keep IRA SPIA payments higher to collect tax revenue and not necessarily benefit SPIA beneficiaries.

However, in the final RMD rules published in 2004, and made effective in 2006, 100 percent survivor benefits may be permitted when the owner is under age 70 at the SPIA purchase date. 

Because the parent was only 40-years-old, she was able to provide a 100 percent survivor benefit to her 10-year-old son. In addition, if the child lives another 80 years, a $50,000 premium might provide the child a total benefit of $190,000. 

Not too bad for a simple gift, a last gift from a dying Mom to her son.

Another way to circumvent this 100 percent survivor RMD restriction is via a reversionary annuity. A relatively healthy parent (not in this case) just elects their SPIA income and provides a survivor income benefit via a reversionary annuity. 

Because the reversionary annuity is a separate contract from the IRA SPIA, the survivor benefit doesn’t count towards the 100 percent survivor RMD restriction. And, it has the side benefit because of SPIA-excluded income treatment of not being fully taxable unlike the IRA SPIA’s survivor benefit, which is 100 percent taxable.

The key to placing this case was in understanding the protection elements that mortality-pooled SPIAs produce and to know the SPIA RMD rules.

A lesson for success I live by: “You have to learn the rules of the game. And then you have to play better than anyone else” – Albert Einstein

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