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Financial Planning > Trusts and Estates > Estate Planning

Slott, Pfau: When and How to Use Annuities, Life Insurance in Client Plans

By Ginger Szala

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What You Need to Know

  • Ed Slott and Wade Pfau provide their view of life insurance and annuities as part of a portfolio.
  • Life insurance is the most flexible and tax-efficient asset to leave to a trust, Slott says.
  • Advisors should look at the client's lifestyle when choosing an annuity.

What is better for retirement and estate planning: life insurance or annuities?

In a recent webinar by The American College of Financial Services, moderator Steve Parrish, adjunct professor of advanced planning, asked this question of Ed Slott, CPA and head of Ed Slott & Co., and Wade Pfau, professor of retirement income at the college. Here is an excerpt of their answers:

STEVE PARRISH: Ed, as we go into 2022, has the recent increase in premiums for life insurance and the tougher underwriting standards affected your opinion or is [life insurance] still a great RMD alternative?

ED SLOTT: Obviously, price is something to be evaluated, but remember for planners, you have to look at the long-term, big picture — not what it costs now, but what you can provide to a family. When I say long term, not just for retirement, but beyond the estate plan: The plan for the beneficiaries — those are your new clients.

Obviously, there are costs in anything upfront, but even with the higher premiums in general, I’ve always been a life insurance fan because I look at the long term. …

Now with the Secure Act, all Congress did was shoot themselves in the foot by eliminating the stretch IRA. They downgraded IRAs for wealth transfer and estate planning vehicles and upgraded things like life insurance. … All they did is incentivize us to do the better planning we should have been doing all along.

But somebody said an IRA trust probably won’t work anymore after the Secure Act. That’s true, because most of them will be subject to this 10-year rule. And the existing trusts have to be looked at because under the 10-year rule, there are no more [required minimum distributions] after death. It’s just one big RMD.

Well, if that all gets dropped into the trust at the end of the 10 years, you could have the exact opposite of what the client intended: post-death control and low taxes for their beneficiaries. Now you have $5 million being paid out at the end of the 10 years.

Life insurance is a great alternative to that. [It’s a] better option, similar to the Roth conversion, to take down that growing IRA, pay some of the tax now at low rates and use it, if the client wants that post-death control, to purchase life insurance and leave [that] to the trust.

Life insurance is the most flexible and tax-efficient asset to leave to a trust. You don’t have those tricky RMD rules. You don’t have all these tricky and very complex IRA trust rules.

And best of all, you don’t have any income tax on life insurance, unlike IRAs. [And it] can be set up to be outside, or excluded from the estate. IRAs, even Roth IRAs, are always included in the estate.

PARRISH: Wade, the annuity debate seems lately to have really been over annuities as an accumulation vehicle. What are your thoughts?

WADE PFAU: A competitively priced annuity can play a role in a lot of different strategies. Now that we have this retirement income style awareness, I always think in terms of that and what role an annuity can play with the different retirement styles.

There’s not going to be a lot of play for annuities in the top half of that [RISA] matrix with the total returns or the time segmentation, but that’s where if there is a role, it would be more as an accumulation tool instead of for lifetime income.

So if you’re [looking for] total returns, you might think about a low-cost investment, [such as a] variable annuity. For less tax-efficient asset classes, you might look at a registered index linked annuity, which is a structured annuity that cuts off some of the downside risk. And therefore, it can give you more of the upside potential than something like a fixed indexed annuity.

Now, if you’re in the time segmentation quadrant, you might look at a few different accumulation-based annuities to also think about that front-end piece of funding, those retirement expenses that could be a [multi-year guaranteed annuity] or other type of a deferred fixed annuity … no risk of capital loss and competitive with other bond asset classes.

And then if you get down into the bottom half with the income protection risk wrap; that’s where you’re really looking at the lifetime income as a driving motivator. And in the income protection world, that can be the [qualified longevity annuity contract], the deferred income annuity, or the single premium immediate annuity, or the fixed index annuity with the living benefit.

And then if you’re in the world of risk wrap, that’s where a RILA with a lifetime income benefit or a variable annuity with a lifetime income benefit, both of which give you more of that upside exposure to the market.

The contract value takes risk [so] you can have a risk of loss there. But at the same time, that income provision with the opportunity for step-ups, you benefit when the markets do well, but your income is protected.

And so you have that guardrail. If the markets don’t do as well, again, you end up outliving the contract value of those assets. Then you have that protected lifetime income.

Pictured: Wade Pfau

Ginger Szala

@gingerszalaink

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