Combine Annuities And Life Insurance For Your Clients' Estate Plans

This erosion doesnt end with just the current values. This same result persists in later years. Assuming a conservative 8% growth (net of expenses) and the top estate and income tax rates, the results are magnified. If Tim and Mary continue to allow the annuity to grow, without planning, for another 20 years, under the current tax law their heirs will see an erosion of more than 70% of the annuity value. These values are also found in Table 1.

However, the couple can proactively address this issue. Knowing that the income tax is due eventually on the annuity, Tim and Mary annuitize their contract. He then uses the after-tax portion of the annuity payments to purchase life insurance as wealth replacement planning to benefit his heirs.

Consider what would happen if the couple annuitized their contract. Under a single life annuitization option Tim might receive $46,500 in annuity payments; this is roughly the national average. Assuming Tim is in the top income tax brackets, the payout would net out to a little more than $30,000. If this amount purchased $750,000 of life insurance and Tim were to position the life insurance outside of his estate, he could redeploy the value of this annuity asset into the hands of the heirs through the life insurance death benefit, boosting the amount received by his heirs from $142,500 (without any planning) to the death benefit amount of $750,000. (See Figure 1.)

Of course, Tim and Mary could use a second-to-die policy to further leverage the death benefit available to their heirs.

Under this strategy the couple forced funds out of the annuity early. Although this reduces the amount of dollars growing in the annuity, they are able to successfully move the after-tax dollars out of his estate. This could be done through gifts to an irrevocable trust or directly to the couples children. The early access, coupled with leveraging the after-tax funds through life insurance provides Tims heirs with a much greater after-tax return.

This approach sometimes runs against the conventional wisdom of many clients. For years these clients have been “trained” to avoid income taxation. However, sooner or later these tax-deferred annuity assets will face annuity taxation. By doing some advanced planning and triggering the tax early, a client is able to turn a tax concern into a positive.

Under this approach, combining life insurance with an annuity payout offers clients an attractive means to address their overall planning. It addresses the tax problem faced by the annuity through additional planning. The life insurance can then be used to leverage the annuity payout for an overall larger benefit for the clients heirs.

Depending on how the numbers fall, this approach can also be utilized to help address a clients other estate planning costs, all through converting assets from taxable items into tax-advantaged assets owned outside of the estate.

Consider your client base and see who might benefit from this strategy.

Mark A. Teitelbaum, JD, LLM, CLU, ChFC, is second vice president, advanced marketing at Travelers Life and Annuity, Hartford, Conn. Mark can be reached via e-mail at MCLBTeitelbaum

Reproduced from National Underwriter Life & Health/Financial Services Edition, May 6, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.