Transitioning Live On Assets To Leave On Assets Producers can provide a valuable service to their clients

By Dan Munroe and David Bruckman

Every successful producer knows that simplicity is paramount when explaining concepts to clients. Even in the complex world of financial planning, one might divide assets into those that clients use to “live on” and those that clients plan to “leave on.”

Producers who understand how to maximize the value of “live on” assets can create “leave on” assets, thus providing a valuable service to their clients and economic rewards to themselves.

To that end, producers might do well to recommend a single premium immediate annuity (SPIA) and a life insurance policy. While no technique is perfect, the combination of the SPIA and life insurance may provide a superior option to relying on required minimum distributions (RMDs) from an IRA.

A Hypothetical Client

The client profile of this sales concept has a moderate net worth and is concerned about outliving her money. Like many of her peers, she is in good health, active, and hopes to live a long and productive life.

The client’s assets may be subject to estate taxes. In addition to an unencumbered home, most of her money is in a rollover IRA. The client is 75 years old, has an IRA valued at $500,000, and is in a combined federal and state 37% tax bracket. Assume further that she has two grown children, both of whom are her sole beneficiaries.

The client’s primary concern is to maintain her lifestyle. While other nonqualified assets support her lifestyle, she wants distributions from her IRA to generate at least $35,000 (after tax) until she is 100 years of age.

She also wishes to ensure that, upon her death, a $500,000 estate will be left for her heirs. And she desires to have a guaranteed annual income of at least $18,000 for discretionary spending.

Producers may approach the client with three options:

Option 1 Withdraw RMDs Only

If the client chooses to only take her RMDs each year until death, she will be disappointed with the results. Assuming a rate of return of 5%, her RMDs will never reach a net (after-tax) amount of $35,000.

Assuming death occurs at age 95, her heirs would inherit the IRA, but its balance would only total $309,941. This amount is subject to income tax and possible estate tax.

This approach is advantageous in that the client knows the entire IRA can be used immediately. However, she doesn?t know the amount her heirs will receive. Indeed, the only certainty is that her heirs will not receive the full $500,000.

Option 2 Level Distributions Approach

Under this approach, the client recognizes that the RMDs do not supply the needed immediate cash flow. She therefore opts to take a higher distribution each year from the IRA.

Assuming the same 5% annual growth, the IRA could yield $32,526 (pre-tax) each year for 30 years until the client is 105. The client would receive more money each year during the first 11 years than if she took the RMDs.

However, the amount is still considerably less than the $35,000 after-tax (or $55,500 pre-tax) amount she desires. If she wants to take annual distributions of the $35,000, she greatly increases the chance of outliving the IRA money.

Under both this approach and scenario 1, annual payments are not guaranteed. The client assumes that each year the IRA will grow at 5%. Even one or two years of subpar investment returns could dramatically reduce the funds available to the client.

Like scenario 1, the client’s heirs will receive any IRA balance subject to income tax and potentially estate tax.

Option 3 Single Premium Annuity and Life Insurance

Under this scenario, the client would apply the entire $500,000 in the IRA to purchase a qualified single premium immediate annuity. The SPIA makes fixed, guaranteed payments to the client each month or year while she is alive; payments cease at death.

A SPIA makes payments based on the actuarial life expectancy of the participant. Because insurance carriers generally assume that a participant will not live past expected mortality, the annual after-tax cash flow from the SPIA is $35,510, after-tax. It is noteworthy that this amount exceeds the initial net level distribution provided in scenario 2. And it?s more than she requires.

The client can also leave her daughters a guaranteed inheritance. Of the $35,510 annual payment, $18,478 from each year?s annual payment can be applied to the purchase of a life insurance policy.

Note that because a SPIA has no value at the client’s death, without life insurance the heirs would not receive any IRA money. However, by applying $18,478 of the excess money to life insurance premiums, the client is assured the heirs will receive a certain amount upon death, especially if the life insurance has a secondary guaranteed death benefit.

In our example, assume your client purchases a single life universal life policy with a secondary guarantee. The $18,378 annual premium will purchase $500,000 of death benefit under the policy assumptions above.

If this premium is paid to age 100, the policy is guaranteed to pay $500,000 in death benefit. With proper planning, the client could arrange to have an irrevocable life insurance trust (ILIT) own the policy.

By naming her two children as beneficiaries of the trust, and properly sending annual “Crummy letters,” she may avoid paying gift taxes. If the trust is properly created and administered, the death benefit will be outside of the client’s estate.

The advantages of this option are clear. First, the client obtains the amount of guaranteed lifetime income she desires. Second, she creates an estate for her heirs, income and potentially estate tax free.

The sole disadvantage is that the participant forfeits the ability to access qualified plan money beyond what the SPIA distributes, net any life insurance premium payments. However, the client has direct access to the annuity payouts.

Also, in our example, the annual gift tax exclusion covers the amount to be gifted to the ILIT each year.

Careful attention is required to determine the income and estate tax consequences of the strategy discussed above. The decision on what course of action to undertake should factor in both the tax results and non-tax needs of the client. By using the annuity and life insurance strategy, producers may find highly effective ways to put “live on” assets to work for their clients.

Daniel J. Munroe, JD, CLU, is the director of advanced marketing for MONY Partners, a division of MONY Life Insurance Company. David B. Bruckman, JD, MS Tax, is director of advanced Planning for Professional Financial Services, LP, Bedford Hills N.Y. They can be reached at dmunroe@mony and attysavetax@aol.com, respectively.


Reproduced from National Underwriter Edition, October 28, 2004. Copyright 2004 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.