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Retirement Planning > Social Security

A retiree’s best friend

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With company pensions nearly extinct, retirees have even more reason to make sure they are reaping the full benefits of the Social Security system. Often confusing to retirees and soon-to-be retirees, most clients do not realize that powerful strategies exist to maximize their Social Security payments. Armed with these optimization strategies, financial advisors can empower their clients as they navigate the retirement income jungle.

Quite simply, a retiree’s Social Security payment is higher if he or she delays the payment starting date. Take, for instance, someone who elects to begin their payments at age 62, which is the minimum required age. Beginning at 62, the maximum monthly benefit for 2012 is $1,855. Delay the start of Social Security payments until age 70, and the same person will now receive $3,266 per month.

While delaying benefits will eventually provide a boost in annual income, the challenge then becomes filling the income gap until age 70. Fortunately, an annuity can solve this problem. A “term certain” income annuity, either a SPIA (single premium immediate annuity) or DIA (deferred income annuity), will provide the client with guaranteed income during the gap, or later if desired.

Tax treatment

In addition to the guaranteed income and high payout rate, the tax treatment is often a vastly underrated advantage of annuities. The tax exclusion ratio found in annuities renders only 5 percent to 25 percent of the payments subject to tax, while the remaining 75 percent to 95 percent is the return of principal. Consider if a client tried to fill this gap with growth or yield from stocks, bonds and mutual funds. First, to generate enough income to live on would require an inordinate sum, since it takes a $350,000 investment at 10 percent growth to create $35,000 of annual income. Regardless, this “non-guaranteed” income would also be subject to tax.

If invested in a stock mutual fund, all of a client’s $35,000 annual return on investment is subject to tax. At 15 percent, that tax would be $5,250. Compare that to receiving an annual payout of $35,000 from a SPIA or DIA. In this scenario, the total tax would be reduced from $5,250 to $1,050, assuming an 80 percent exclusion ratio. This tax savings is due to what I call FIBO® (First In/Blend Out). Each annuity payment is a blend of income and principal, unlike other types of investments where income is taxed up front. 

With the savings created from lower taxes and delaying Social Security, retirees now have options regarding how they can structure the rest of their investment portfolio in developing their retirement plan. Two possible options for some of the remaining portfolio could be to invest in a deferred income annuity with a 15-year delay and a COLA-adjusted payout or a variable annuity (VA) with a guaranteed lifetime withdrawal benefit (GLWB).

With our new plan, the Social Security payments would kick in at age 70 and, since the payments are larger, many retirees may find they have more than enough income to cover basic expenses in their 70s. By investing in the DIA or VA with GLWB, they could help protect their financial future from inflation or hedge the risk of high medical costs associated with living into their late 80s or 90s. Also, any growth within these annuities is tax-deferred, which can help reduce the tax burden on their Social Security benefits.

Consider that with just $50,000, a 70-year-old male could purchase a deferred income annuity so that starting at age 85 he would receive $13,100 every year for the rest of his life. To counter the objection of loss of deposit in the event of early death, we include an installment refund payout option so if he died before he began receiving income, his beneficiaries would receive a death benefit for the full amount of the $50,000. Even if he died in the first few years of receiving income, he would receive a death benefit for the remaining balance of the $50,000 investment. By age 90 he will have received a sum of $65,000 of annuity payments and if he lives to age 100 he will have received nearly $197,000.

The combo option

Another option is a combination deferred annuity with a long-term care component. As discussed in a Kiplinger article, “a $100,000 annuity could pay up to $300,000 in long-term-care benefits. These policies are attractive to people who already own a deferred annuity and want to exchange it tax-free for a combo annuity policy. And it may be easier to qualify for one of these combo policies than for a traditional long-term care policy.”

The main point is to leverage the power of lower taxes and increased retirement income provided from delayed Social Security strategies while protecting clients’ future needs. Most retirees’ don’t fully understand how expensive it can be if they live into their 90s or beyond. They may have done a fantastic job with managing their investments, but the annual cost of a nursing home, long-term care or assisted living can literally wipe out their savings and cause a huge burden on their family. This is the reality they need to plan for and insurance companies are ideally positioned to offer the right security.

The next time you’re in meetings with clients, remind them that annuities may be a retirees’ best friend. By using specialized annuities, they have the power to squeeze Social Security for all it’s worth and save more of their hard-earned dollars from Uncle Sam. Most importantly, they protect themselves, and their families, from the unknown future and can live their retirement dreams to the fullest.

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