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Life Health > Annuities

Top Story: Converting qualified money to annuities and other opportunities

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Chicago – Producers can look forward to greater sales in the year ahead, thanks in part to current demographic trends and a loosening of federal regulations governing annuities and individual retirement accounts, according to experts.

“Boomers are turning age 60 every 10 seconds,” said Michael Berry during a workshop here.

“These folks are only 10 years away from having to take their required minimum distributions, so the opportunity to help them with their income planning needs is now,” said the manager of advanced annuity sales at ING Americas – U.S. Financial Services, Windsor, Conn. Annuities should factor into that planning, he indicated.

As boomers continue to exit the workforce, such opportunities for advisors will only expand. An Investment Company Institute report on the role of individual retirement accounts and cited by Berry estimates IRA assets at $4.8 trillion and the defined contribution planning market, including 401(k), 403(b) and 457 plans, at $4.5 trillion.

Most of these assets ultimately get cashed out, either because of federally mandated required minimum distributions or because of financial circumstances. Forty-seven percent of all IRA withdrawals, the report notes, are a result of the age 70 1/2 RMD requirement. Meeting living expenses accounts for another 20% of forced withdrawals.

Too often, income distribution planning gets postponed until the last minute–with potentially adverse consequences for the client, Berry told the workshop, which was part of the annual Advanced Sales Forum of LIMRA International, Windsor, Conn.

“A lot of advisors wait until age 70 to discuss income planning with clients,” said Berry. “But clients really need to start their RMD planning at least five years prior, at age 65. That will allow not only for continued wealth accumulation but also better position retiring couples to extend their RMD distributions over 2 or even 3 decades.”

Such long periods of retirement are no longer a stretch. Berry said that among married couples age 65, there is a 50% chance that one or the other spouse will reach age 92. The probability declines to 25% and 15%, respectively, for death at ages 97 and 100.

Longevity risk–the possibility of outliving retirement savings–increases not only with age, but also with excessive withdrawals from retirement savings. Many advisors, Berry said, assume an annual withdrawal rate of 4% or 5% to be “safe,” meaning the client will have some savings remaining at death. Yet, a hypothetical client at year-end 1972 holding $500,000 in investments, divided evenly between large company stock and 50% intermediate term bonds, runs out of money within 24 years, assuming a 5% withdrawal rate. As the withdrawal rate increases to 6% and 8%, funds are completely depleted within approximately 15 years and 10 years, respectively.

“Given a portfolio that’s invested 80% in equities and 20% in bonds, a 5% withdrawal rate will yield a 31% chance that the client runs out of money before he or she dies,” said Berry. “Does the typical senior want to take a one-in-three chance of running out of income? I think not.”

He added that clients can best address longevity risk stemming from RMD distributions by converting the IRA to an annuity offering a guaranteed 5% income stream for life, along with a rider that allows for RMD distributions exceeding the 5% rate.

Thus, an insurance carrier would pay out the higher of the RMD or the contractual 5% for life, without causing any benefit reduction. Using a hypothetical example, Berry observed that an 83-year-old who takes an RMD of $84,500 against an account balance of $1,377,343 surpasses the maximum annual withdrawal amount of $72,676–an excess distribution of 16.27%–yet suffers no reduction in the MAW for the next contract year.

Clients who don’t need RMDs to cover living expenses, said Berry, can use the annuity payouts to fund a life insurance policy and, thereby, cover estate taxes on assets intended for beneficiaries or replace assets going to charity. By placing the policy inside an irrevocable life insurance trust or ILIT, the death benefit comes out not only income tax-free, but also estate tax-free.

In one scenario that Berry showed, RMDs from a $1 million IRA annuity are used to fund ILIT policy premiums; proceeds distributed at the IRA owner’s death are paid to trust beneficiaries. In an alternative scenario, the IRA death benefit is paid to a designated charity.

Roth IRA Conversions

Turning to the impact of recent tax law changes, another speaker, Patricia Korn, used a similar scenario to show how an annuity rider can be used to effect an IRA-to-Roth IRA conversion where the account holder doesn’t have the cash to pay income tax on the conversion.

Here, a guaranteed minimum withdrawal benefit rider is attached to a $1 million IRA/annuity that provides a level income to fund an ILIT, said Korn, who is an attorney and advanced marketing consultant at Pacific Life, Newport Beach, Calif. The ILIT death benefit is then used by the trust beneficiary to cover the tax. In a second scenario, the IRA income funds a life policy held outside of the trust, and the IRA’s designated beneficiary uses the policy’s death benefit to pay the tax.

“Now, the spousal beneficiary has a Roth IRA and she doesn’t have to take RMDs,” said Korn. “And she can pass the assets on to kids as an inherited Roth IRA.”

Korn added that questions remain as to whether a non-spousal IRA beneficiary can convert an inherited IRA to an inherited Roth IRA. But she noted that a non-spouse beneficiary of a qualified plan, such as a 401(k), 403(b) or 457 plan, can roll qualified plan assets into an inherited IRA and begin taking distributions.

A new revenue procedure (2008-24) under the Internal Revenue Code governs partial 1035 exchanges between annuities and also offers producers new planning opportunities, continued Korn. This procedure supersedes a previous IRC notice (2003-51), reducing to 12 months from 24 months the time during which a distribution cannot be taken from an annuity contract to fund a partial exchange.

But language specifying exceptions to the 12-month requirement yields “weird results,” Korn pointed out. For instance, the requirement is waived should any of several conditions “occur between” (as opposed to “exist”) the dates of exchange and distribution or contract surrender. These conditions are: the annuity holder dies, becomes disabled or reaches age 59 1/2 .

“If we interpret the [revenue procedure] literally, then if you do a partial exchange at age 59 1/2 , that means the event occurred before the exchange and you cannot take a distribution,” said Korn. “But if you do an exchange at age 59 and not quite a half and then turn 59 1/2 right after the exchange, you can take a distribution. This exception is bizarre, but the IRS says no further guidance should be expected.”

“That said,” she added, “there are planning opportunities to pursue so long as you bear in mind the quirks of the [revenue procedure].”


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