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Life Health > Annuities > Fixed Annuities

Special Report: Managing taxes, managing risks

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Why are insurance companies ideal custodions for IRA distributions?
Since 2001 we’ve all heard lots of talk but have seen very little action regarding the new IRA distribution rules that created the Stretch or Multi-Generational IRA. In 2002 the new rules created a powerful financial planning opportunity that can turn a modest IRA into a lifetime of income for IRA owners, spouses, children and grandchildren. With just a 5 percent rate of return, a $200,000 IRA can generate as much as $1 millon of income over three generations, depending on life expectancies of the beneficiaries. >>

What happened is simple. The IRS reduced the Required Minimum Distribution that IRA owners must begin taking from their qualified accounts beginning at age 70 1/2 . The reduction was substantial and cut the RMD almost in half. If owners of IRAs are forced to take less income during their lifetimes there will likely be more money left in their accounts to be passed on to their beneficiaries. It gets even better. The children and grandchildren who are likely to inherit these IRAs are no longer forced to pay the tax in one to five years. Under the new rules these non-spousal beneficiaries can spread the distributions over their individual life expectancies. Instead of rapid distribution causing rapid taxation these beneficiaries can enjoy a lifetime of income and continue to earn interest on money that otherwise would have been paid to the IRS. If it’s so simple, why aren’t all IRA owners taking advantage of the “stretch”?

Here’s the problem. Different custodians of qualified accounts have different agendas, causing the owners of these accounts to get mixed signals. Naturally all custodians of IRAs and 401(k)s want the owners to keep their money invested with them and continue to enjoy the fees, loads and expenses associated with managing these accounts. According to the ICI’s 2007 Investment Company Fact Book, there is over $16 trillion of qualified money in America. Managing this money is big business and every potential custodian wants their share of the pie.

The question is … who is the ideal custodian for your IRA? Let’s examine the facts. Since ERISA in 1974 most IRA owners have been making contributions to their qualified retirement accounts and many of these accounts have become sizeable. IRAs and other qualified accounts have two unique lives. One is accumulation and the other is forced distribution at age 70 1/2 .

Let’s look at the accumulation period first. During accumulation IRA owners could continue to make contributions to their retirement account until age 70 1/2 . We all know the market goes up and down, but for the most part these accounts continued to grow. Contributions helped compensate for market fluctuations. The number one reason these accounts continued to grow is the benefit of dollar cost averaging. If account owners continued to contribute when the market was down they bought securities at reduced prices and consequently benefited when the market went back up. Dollar cost averaging, for many investors, saved the day and qualified accounts continued to grow.

Now the owners are retired or nearing retirement and are planning for the distribution phase. When these account owners turn 70 1/2 , three important things change.

  1. Owners can no longer contribute to their qualified accounts. This means they can no longer compensate for market losses.
  2. Because they can no longer make contributions all of the advantages of dollar cost averaging are lost. When the market goes down their retirement accounts go down.
  3. They are forced into mandatory distribution (RMD) and must begin taking income from their qualified accounts. (exception — Roth IRAs)

During distribution, market losses equate to income losses, for those taking only the required minimum distributions. If the market drops their RMD drops as well. Market losses, fees and loads are IRA owners and beneficiaries biggest challenges. According to the ICI’s 2007 Investment Company Fact Book, 80 percent of retirement funds are invested in securities and mutual funds. It might be a good time to choose a new custodian for the distribution of your IRA.

So who is the ideal custodian for the “stretch” distribution of IRAs and 401(k)s? For over 200 years insurance companies have been paying lifetime distributions to fixed annuity owners and beneficiaries without risk. Fixed annuities offer unique advantages for those who are retired or nearing retirement, and planning for the distribution phase of their qualified retirement accounts. Fixed annuities are not subject to market fluctuations and guarantee the principal. Most fixed annuities also offer a minimum guaranteed rate of return. The interest rate in many cases will be greater than the required distribution allowing the account to continue to grow even when distributions are being taken. This means more money left in the account for the heirs. Insurance companies, through fixed annuities, can make lifetime distributions to IRA owners and their beneficiaries without the usual fees or loads associated with brokerage accounts.

Payouts administered through fixed annuities include all state lotteries, school teachers, court awarded recipients, churches, nonprofit entities and the list goes on. The reasons that fixed annuities are used so widely for distribution is that they offer guaranteed principal, guaranteed rate of return and no fees or loads. IRA owners and their heirs can enjoy these same guarantees and save thousands in administration costs, fees and loads. That means more income for IRA owners and their beneficiaries.

The new tax rules give IRA owners and their beneficiaries the gift of a lifetime of income. Rapid distribution causing rapid taxation can be avoided by knowing how to unwrap this wonderful gift. Choosing the ideal custodian during the distribution of your IRA can make the difference between a guaranteed lifetime income and disaster. Fixed annuities administered by insurance companies may be the solution and the best place to “stretch” your IRA.

David F. Royer is president of DLCA Enterprises, LLC and is a nationally recognized speaker and trainer in Qualified plan distribution.

Investors with self-directed retirement plans see opportunities in foreclosures
A new trend is emerging from the nation-wide real estate slump: An increasing number of investors with self-directed retirement plans are seizing the opportunity to buy bank-owned properties at depressed prices, using money from their IRAs.

Bank repossessions, or REOs, account for 30 percent of total foreclosure activity in the second quarter, according to RealtyTrac. Along with foreclosure activity increasing around the nation, there has been a spike in investors buying all types of foreclosed real estate with IRA funds.

The western states are among the hot spots for investors taking advantage of the chaotic housing market and downward trend in prices by purchasing property with their self-directed IRAs.

The IRS allows all types of real estate to be purchased by an IRA, including single- and multi-family homes, timeshares, rental property, office buildings and tax liens. Because the property is held within a retirement account, investors must follow IRS rules about this type of asset or run the risk of having their entire IRA disqualified. For example, an investor cannot live in the property once the IRA has made the purchase and all expenses for the property must be paid for with funds from the IRA. More information on IRS rules concerning IRAs can be found on the IRS Web site at

IRA owns property if mortgage foreclosed
Holding deeds of trust/mortgages has also become a popular alternative, which has led to another trend: A larger percent of investors who purchased deeds of trust/mortgages with IRA money are ending up with not just the note but the property, due to foreclosures. From April to July of this year, Fiserv Investment Support Services, which acts as the trustee for self-directed retirement plans, recorded 37 instances in which the deeds of trust/mortgages held as assets in client accounts were defaulted on. Clients then foreclosed upon the property and now own the actual property within their IRA. Last year during the same time frame, only one or two clients foreclosed on deeds of trust/mortgages.

Investors interested in holding deeds of trust/mortgages in their IRA should be aware of this possibility and find a trustee that can also hold real property, in case a foreclosure ensues. An experienced trustee can make the process seamless from holding a mortgage in the IRA to owning the actual property.

Lenders tightening up on loans for real property in IRAs

The record number of foreclosures is also causing lenders to tighten their requirements for investors interested in getting a loan to buy real property with their IRA. Today it’s typical for lenders to require a 35 percent down payment, which must come from the IRA. Per IRS regulations, the lender must lend money to the IRA entity, not the investor.

If the IRA defaults on the loan, the only recourse the lender has is to take ownership of the property. Despite the crack down by lenders, IRA owners are still finding it possible to obtain these loans through some national lenders, as well as private money lenders and local banks. Sometimes the property seller is also willing to act as a lender.

For individuals who find real estate to be an appropriate investment for their portfolio, the key is having a self-directed IRA with a trustee that allows real property to be held as an asset within the account. Investors should choose a trustee that has experience administering real estate in retirement plans, is familiar with IRS laws and can answer questions about this type of investment. The right custodian will be able to help every step of the way to make the real estate transaction an easy process.

Sean Gultig is the vice president of IRA Services with Trust Industrial Bank, also known as Fiserv Investment Support Services.

Identifying the key Risk-Management challenges for life insurers
Considering today’s volatile financial environment, it may come as a shock to hear that most U.S. life insurance companies have made little or no progress in implementing Enterprise Risk Management programs. Interestingly, while many companies adequately address basic capital management needs (i.e. ratio-based ratings, regulatory management, reinsurance buying, etc.), these efforts have largely happened in silos. In other words, life insurers have generally avoided integrated modeling of both sides of their balance sheets and typically model their lines of business separately. Consequently, they have not had a complete and comprehensive view of their various risks.

How do we encourage the right risk management behavior? Should we wait until companies are under pressure to upgrade their financial management system capabilities to meet the changing regulatory reporting requirements — similar to what is currently happening in Europe with Solvency II?

As a first step, we must understand that the key risk management challenges facing life insurers involve macro-economic exposures (including interest rate/macro-economic exposures and equity market risk management), policyholder behavior, longevity and the accuracy of risk management.

Macro-economic exposures include the risks that future interest rates can’t cover such as policy guarantees, corporate default risks, and various implications of the sub-prime mortgage crisis. Macro-economic exposures must also take into account a new period of higher inflation with implications for pricing, bond values and equity returns. Additionally, the current equity markets are extremely volatile; some life insurance companies are receiving credit downgrades and access to cash may be drying up.

While smaller life insurers may be better able to conduct business without utilizing an ERM program, it can provide a competitive advantage for companies of any size. For example, being able to understand, measure and manage risks through an ERM program allows companies to offer customers product guarantees that are priced properly — i.e. not too high that the policyholder isn’t overcharged but not so low that the company can’t meet its obligations.

Part of properly understanding, measuring and managing these risks involves developing the right investment strategy, as well as holding the right amount of reserves and capital. This includes the dynamic hedging strategies that constantly review and change asset holdings in response to the unfolding financial market situation.

But there are also indirect economy-based risks like policyholder behavior that are often driven by changes in the economy and financial markets. For example, holders of variable annuities tend to surrender their policies when the guarantee is worth more than the underlying assets, so it’s imperative that companies clearly understand, measure and manage that risk.

New and Better Tools

Because most people want to live as long as possible, longevity is a risk that is becoming more and more complicated. Indeed, while advances in medical science and biotechnology are leading to increased longevity, for insurers actual longevity is more complex because of the lifestyle choices that policyholders make.

The important thing to realize is that all of these risks need to be thoroughly understood and modeled so the customer gets the best value and the provider meets all of its obligations.

Fortunately, a new generation of ERM tools has been created that enable companies to manage these risks. These tools allow insurers to design and offer the guarantees customers want (at the right price), while ensuring that providers can pay claims when they become due. What makes these ERM tools especially effective is that they include:

  • Liability models that incorporate policyholder behavior and multiple cohorts to allow for accurate modeling of partial surrenders, etc.
  • An economic scenario generator that accurately models the economy
  • An integrated whole company model that takes into account diversification effects and second order risk factors in other parts of its business

In general, ERM tools can provide life insurers with greater accuracy in strategic financial decision-making, and improved ratings agency and regulatory compliance. They also can play a key role in optimizing investments and hedging strategies, modeling risks surrounding policyholder behavior, and more precisely calculating overall risk-adjusted value. Bottom-line: effective and thorough ERM can create more value and security of policyholders and therefore a real competitive advantage for providers.

John Knott is a Vice President in the Cologne, Germany office of DFA Capital Management – a leading provider of comprehensive Enterprise Risk Management technology – and is responsible for business development in Europe. He is a Fellow of the Institute of Actuaries and an Associate member of the D.A.V.


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