Managing money for high net worth clients is challenging in volatile markets. The economy is still the great unknown. Financial professionals need to develop solutions based on what we currently know and can manage.
One solution, particularly for those in the higher tax brackets, is to provide them with tax-free guaranteed lifetime income in retirement. This can be accomplished by combining an annuity that offers a guaranteed lifetime income benefit with a Roth IRA.
For clients nearing age 59 1/2 or older, this strategy would entail funding a traditional IRA with an annuity offering guaranteed lifetime income that can be taken or stored, and electing to initially store that income. This can be accomplished through a rollover from a qualified plan or by transferring existing traditional IRA assets to an annuity. Then, the traditional IRA would be converted to a Roth IRA and federal income taxes owed on the conversion would be offset with the annuity’s stored income.
Why does this concept make sense? Clients who are looking for greater control over their finances, particularly in these challenging financial markets, need a plan that factors in two components of a retirement strategy: the known and the unknown. For the strategy to be successful, clients need to leverage the first to get control of the second. In the table are key knowns and unknowns of a typical retirement strategy.
Clients know they need income they can’t outlive. What they don’t know is how long they’ll need that income (or how long they’ll live) and how long their current investments will last (or how the market will perform). If you can guarantee clients a set income amount for life, you’ve provided a powerful and soothing method of control.
Clients are also well aware of their current federal income tax rate. They don’t know, however, what their tax rate will be in retirement. Factors that would influence this include income level and changes in income tax rates that are impossible to predict.
Since federal income tax rates are historically low now for higher income tax brackets, one could surmise they’re more likely to increase than decrease in the future. Having your clients pay all their retirement taxes now at a rate they know, rather than accumulate earnings and pay at a rate that could be higher, would provide another measure of control. Here is how this strategy would work.
Roth IRA tax advantages
Let’s start with the Roth IRA, which can be beneficial for high net worth clients whose tax bracket will remain high or be higher in retirement. After age 59 1/2 , clients who have held a Roth for at least 5 years could take federal income tax-free withdrawals, which include earnings. Additionally, there are no required minimum distributions with a Roth IRA for owners; beneficiaries, however, would have RMDs.
Unfortunately, Roth IRA income limits are currently too low for high net worth individuals to qualify. That’s probably why these clients and their advisors are often not familiar with them. Fortunately, in 2010 these income limits will be removed for Roth IRA conversions.
Providing income for life
Living benefits are offered with variable annuities for a fee and either protect principal or provide guaranteed income for life with a set percentage of growth–sometimes as high as 7%. Most investors who buy variable annuities elect a living benefit. And no doubt those investors who currently have these benefits have a sense of security, despite today’s economy.
A winning combination
A variable annuity with a living benefit, combined with a Roth IRA, can ensure that clients will never run out of income and will know how much income they’ll get. And they won’t need to pay federal income taxes when they are ready to access it. Keep in mind that rolling over retirement plan money or converting a Traditional IRA to a Roth means that federal income taxes on qualified assets are due upon the conversion. This is a barrier for many individuals.
Offsetting the taxes
Clients can roll over qualified money to the variable annuity, establish a guaranteed stream of lifetime income with the initial investment amount and store the income. Then in 2010, they can convert to a Roth IRA and, with the stored income, offset much of the federal income taxes owed. Because of a special federal tax law for 2010 conversions, they could pay 50% of the federal taxes owed on the converted amount in 2011 and 50% in 2012, giving those clients more years to store the tax money.
A measure of control
Markets will go up and down. Income tax rates will vary over the years. Taking control of these two areas of your clients’ retirement strategy can put them in a more predicable and advantageous situation. Take a look at a VA with a guaranteed living benefit to give your clients retirement income they can’t outlive.
If they think their income tax rate in retirement will remain high or will be higher, consider a Roth IRA by means of a conversion. If they’ll need a way to pay the federal income taxes on the Roth conversion, look for a VA living benefit that allows clients to store income for later use.
These economic times are requiring us to be savvier about how we approach financial planning. Your clients will welcome your strategic thinking by giving them more control and peace of mind regarding their retirement.
Jeffrey Grant is executive vice president and director of sales for Sun Life Financial Distributors, Inc., Boston, Mass. He can be reached at [email protected]