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.