Many Americans hold on to their long-term capital assets for two reasons. First, they simply do not want to pay capital gains taxes, and second, they don’t want to lose the tax benefit that the stepped-up basis at death provides to their beneficiaries. To avoid either or both of these contingencies, they simply let their money sit, even if holding the asset is not in their best interest.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) offers an opportunity for certain clients to move these assets, however, and pay no capital gains tax. With the right kind of rider, your clients can also retain the benefits of a stepped-up tax basis for their beneficiaries.

TIPRA: How it works, how to use it
Simply stated, TIPRA is a temporary tax break for those in the 10 to 15 percent tax bracket (in 2008, joint taxable income up to $65,100). Initially, it replaced the standard maximum long-term capital gains tax rate of 10 percent with a lower rate of 5 percent. In January 2008, the rate dropped again to 0 percent. That rate remains in effect through 2010, at which point a sunset provision kicks in — unless there is new legislation — and the tax reverts to the old level of 10 percent.

You can take a few simple steps to help your clients gain the benefits of TIPRA while it is still in effect. Begin with a comprehensive fact-finding session. Determine your clients’ objectives, insurance and liquidity needs, tax brackets, investments, and health and financial status. Based on the information you gather, offer all options that are suitable for their particular situation and goals. If clients choose to take advantage of the TIPRA tax provision, they should not transfer the funds as a lump sum. That could boost them into the next tax bracket, which would disqualify them for this special tax treatment. Instead, from 2008 through 2010, they can move the nonqualified money in increments into a suitable fixed index annuity with a premium bonus.

Let’s assume a client has a taxable income of $42,000 and a portfolio balance of $160,000. Based on an initial investment of $100,000, this portfolio has garnered $60,000 in capital gains. Over a three-year period, your client could sell that $60,000 in capital gains — $20,000 per year — and place it in a fixed indexed annuity with a premium bonus of 7 percent. At the same time, they could transfer the cost basis (the initial investment, adjusted for interest, dividends, etc.) into the same annuity in increments of $33,000 ($34,000 the last year). The timetable looks like this:

  • January 2008: Sell $20,000 in long-term capital gains at the 0 percent tax rate. Take that $20,000 and an additional $33,000 from the portfolio’s cost basis and put them into a fixed indexed annuity with a premium bonus. Assuming a 7 percent premium bonus, the annuity now has a value of $56,710.
  • January 2009: Repeat the process above, moving another $20,000 of capital gains and $33,000 of cost basis into the annuity with a 7 percent premium bonus. The annuity is now valued at $113,420, with 0 percent long-term capital gains tax on any of the transferred premium.
  • January 2010: Repeat again, moving the last of the assets into the annuity.

By the end of 2010, all of your client’s nonqualified money — including the $60,000 that might otherwise have been subject to capital gains tax — resides in the annuity. Assuming a 6 percent growth rate, the annuity is now worth more than $180,000, all free of long-term capital gains taxes, and offers additional safety for your client’s nest egg through principal protection and minimum interest guarantees. The money will grow, tax deferred, until it is withdrawn.

No loss for beneficiaries
Annuities do not have a stepped-up basis at death. However, with the right kind of rider attached to the annuity, you can work around this issue. Seek a non-underwritten life insurance death benefit rider that can offset 28 percent of all gains in the annuity. By doing this, your client can pass the annuity’s full value net of taxes, assuming the beneficiaries are in the 28 percent tax bracket. It’s not a stepped-up basis, but it delivers the same result.

With luck, TIPRA is here to stay. But if new legislation is not passed, help your clients take advantage of TIPRA while they can. It’s a great way to move nonqualified funds.

Bruce Beaty is regional director of sales at Legacy Marketing Group. He can be reached at bruce.beaty@legacynet.com.