Strategies & Trends
Tax
& Estate
Issues
How to Turn an Annuity Policy into
Monthly Income
by Richard W. Duff, J.D., CLU
F
inancially successful people tend to
bf intrigued by tbe investment possibilities i)t payout annuities. 1 he
idea ofan income "you can't outlive" is
particularly attractive at a time when
people are concerned about Social Security going bankrupt. According to surveys,
most policyholders intend to convert their
accumulation contracts to income later on.
In this article, the first in a series of
three on payout annuities, 1 will compare
tbcm with some alternative asset liquidation arrangements. You'll learn how annuity rates of return are improved when the
payee lives longer than anticipated. In the
second installment, I'll explain how to calculate IRS exclusion ratios and how these
are affected by deaths before and after an
annuitant's expected lifespan. Finally, in
the third article, ['11 describe some circumstance.s where payout annuities are especially useful in the financial plan.' Let's
imagine Harry Jensen, age 65, comes to
you for advice. He is a successful, optimistic investor who pays close attention to
the numbers. He has inherited $IOO,()O() in
cash and equities, and wants you to recommend an optimum cash flow program
for him and his family. You prepare the
following cash flow and financial analysis
for Harry Jensen.
Cash Income Versus Gradual
Liquidation o f Safe'Capital
For a Specific Period
If you invest $l()(),0()0 in so-called "safe"
Joumal ofFinancial Planning/November 2000
44The idea ofan income "you can't
outlive" is particularly attractive at a time
when people are concerned about Social
Security going bankrupt.
investments (CDs, Treasuries ami high
grade bonds), you'll probably earn at least
six percent annually—about $485 a
month. You will have full access to the
principal, and receive $5,820 annually over
your 20-year IRS life expectancy—a total
payout of $116,400.
If you want to maximize cash flow,
however, a capital liquidation program
offers some interesting possibilities. Let's
say, for instance, that you systematically
liquidate that $ 100,{)00 over a 20-) ear
period. Then, your income will come
from both principal and interest. Assuming six percent is consistently earned on
the unpaid balance, your monthly payment will be about $700. You'll receive
$8,400 each year over a 20-year period for
a total payout of $168,000.
Here are the disadvantages. If \'ou outlive the 20-year period, all payments will
cease and your capital will be gone. You"ll
probably have less aece.ss to principal in
the event of emergencies. The liquidation
plan is taxed as a "debt repayment program"—primarily an agreement to pay
interest—where most of your first year's
payment is taxable income. Gradually,
most of each payment becomes tax-free
principal, and in the last year virtually all
the payment i.s tax-free. And any plan that
gradually amortizes a sum of capital
requires some extra time ;IIR1 iniinaijement-—perhaps more trouble than it s
worth.
Cash Income Versus Gradual
Liquidation o f Equity'Capital
For a Specific Period
If you invest $100,000 in equities, such as
a mutual fund withdrawal plan, a higher
assumed liquidation rate of return may be
possible. For example, if a reasonable rate
is 12 percent annuall), you can anticipate
a $1,100 average monthly payment—
$1 3.100 each year over a 20-ycar period
for a total payout of $262,000. I lere's an
added benefit: Some of the taxable portion
may be taxed as a long-term capital gain
instead of ordinarj' income.
On the downside, you'll be taxed heavily in the early years. Here, too. you'll
only have limited access to your money
and will liquidate the original capital after
20 years. I here's also more risk, as is generally the case when the goal is stock
market-like returns.
Tax
& Estate
Issues
Gradual Liquidation of
Capital from a Fixed Payout
Annuity for a Specific Period
l^et's say you tnuisfcr $|{K),(XK) to an insurance company th:U agrees to pav a 2()-ye;ir
annuity of $7tK) a month—assuming a six
[x;rccnt ratt of return on the unpaid balance.
When you systematically lii|iii(iatc prlncipiil
and interest fioiii an annuiiv Loiunict in
accordance with the customary practice of
insnrariCL' companies, tax law gives a spcci;il
advantage. I he principal is amortized on a
le\el basis over the [layee's lite expectancy
(or a guaranteed period of time, if less),
Kor example, if $1(H),(K)O is invested in
a 2()-ye;ir payout annuity. $5,000
($IO(}.O(K) ^ 20) is ta.x-free principal each
year, ('ontrast this with a personal "debt
repayment" proyrani where most ofthe
income is taxable the first year and taxfree in the final year.
The result; Since taxable income is less
in the early years ofan annuity, you have
the use of some tax savings for the balance
of ilie pa}'out period. If a 2()-year fixed
annuity pays 6 percent on the unpaid balance {an attainable Dbjcctive in niid-20(KJ),
this is actually etjiial to about 6.5 to 7 percent jiaid in a debt repayment plan. Similarly, a 2()-year variable annuity that pays,
say, 12 percent on tlie unpaid balance is
etjuivalent to a mutual fund «itbdrawal
plan crediting from 1 i to 14 percent.
Payout annuities have another advantage. There are no management or monitoring issues. Your investment is managed
professionally, and the payments keep
coming as promised,
offers. For an extra premium fee, you can
add a lifetime feature to a fixed-period
payout policy.
For e.xample. let's say a $100,000 single
premium pays a male, age 6S, a $700
monthly income for 20 years. For an extra
premium of about $5,000, this insurance
company probably will guarantee payments for his lifetime, if longer, In other
uords, a $105,000 premium may promise
a Tninimiim of 240 monthly income checks
and a nia.\imum measured by tbe payee's
actual lifespan.
Table I shov\s liov\ this rate of return
improves if you live more than 20 years.
(It assumes, for convenience, that a
$100,000 investment will be sufficient to
pay out a $7(K)-a-month 20-year annuity
with a lifetime guarantee.)
Consec|Uently, if you live until age 100,
you'll receive A total payout of $294,000,
and this includes a 7.75 pereent rate of
return on the unpaid balance—a 1.7.i [icrcent increase from the 6 percent rate promised in a basic 20-year fixcd-jieriod anniiit)'.
Gradual Liquidation of
Capital from a Life-Only Fixed
Annuity, No Specific Period
Gradual Liquidation of
Capital from a Fixed Payout
Annuity for a Specific Period,
Life Income Guarantee
An insuranee company will increase \ our
monthly payment even more if you'll
assume a major risk—that is, the pavments eease if you meet an untimely
death. Let me explain: If a 20-year fixed
[>criod annuity, w ith a lifetime guarantee,
pays you $700 a month, a life-only annuity will probably pay $H0() a month. In
other words, for your assumption of the
mortality risk, the payment is increased
by $tOO monthly, nearly a 15 percent
guaranteed income bonus for as long as
you live.Tiible 2 shows how this rate ot
return improves with increased longevity.
iilly insured amiuities also have
a special option no other investment
Voila! If you'll assume this risk ol
dying t(K) .soon, compare these rates of
return with I'able 1, which promises a
Journal ofFinancial Planning/November 2000
THINK
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STOCKS
ARE
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Not always the most
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CD
Strategies & Trends
If You Live...
Tax & Estate
Equivalent Annual
Rate of Return
on Unpaid Balance
Total Payout
...11 years, 11 months
I $100,000
20 years (85)
0%
t $168,000
25 years (90)
6%
I $210,000
30 years (95)
$252,000
$294,000
35 years (100)
40 years (105)
If You Live...
$336,000
7.75%
8%
0%
I $100,000
20 years (85)
7.5%
.sL'If-managcd and commercial annuity
pr()j,Tams. It'.s even po.ssihlc to build hack
the client's original cash l)y reinvesting
some of this income in a separate inve.stment plan. Of course, everything,' depends
on the client's objectives, facts and circumstances.
In the second installment, Harry
Jensen asks you to prepare a report for his
ta.\ advisor. You'll explain how jwyoiit
annuities are taxed in the finaneial plan.
Some surprises await. Stay tuned.
Equivalent Annual
Rate of Return
on Unpaid Balance
Total Payout
...10 years, 5 months
6.75%
Issues
$192,000
25 years (90)
30 years (95)
35 years (100)
40 years (105)
guaranteed annuity period of 20 years.
The conclusion: Life-only annuities can
pay out some real money if you live
longer than the longevity tables predict.
Once more, be aw are that payments stop
if you die prematurely. Life-only annuity'
contracts are for optimistic, healthy people
who have prepared adequately for their
loved ones outside the annuity program.
Gradual Liquidation of
Capital from a Variable
Annuity
Endnote
7.5%
$240,000
8.375%
$288,000
$336,000
$384,000
9%
9.25%
9.5%
investments in the annuity account.
When you take a variable payment, the
first check is usually smaller than offered
by a fixed annuity. .•\s the investments
change in value, the payout rate can vary
dramatically.
For instance, let's say a fixed annuity
pays a 65-year-old male $XO(J monthly as
long as he lives. A variable annuity' might
begin uith a $625 monthly payment.
Then, assuming a gradual, steady, eight
percent earnings rate, the payments will
increase to about %^)50 monthly after U)
years and to $1,4UU or so after 20 years.
This is an abridged version of my special repc)rt, "1 low to Turn an Annuity
Piilicy into a Monthly Income," and is
printed witli permission. For moic
information on this subject, look for
my forthcoming CD ROM, "How to
Be a Professional Annuity Advisor,"
sponsored by MKS Investments,
Boston, Massachusetts 02116-3741.
Richard W. Duff.
J.D.,CLU.isa
financial advisor in
Denver, Colorado,
and is a principal
in First Financial
'Resources. He can
If reached by
phone at (303)
765-3599. by fax at
(303) 691-0474. ot by e-mail atRWDuffCLU@aol.com.
A variable payout annuity also can be for
(1) a fixed period. (2) a fixed period with a
lifetime guarantee or (.^) merely for a lifetime. It is called a variable payout annuity
because vour checks flitctuate with the
Joumal ofFinancial Planning/November 2000
Summary
I've shown how to improve cash flow by
systematically liquidating capital using
Stratesiies & Trends
Tax & Estate
Issues
How to Turn an Annuity Policy Into
Monthly Income, Part II
by Richard W. Duff, J.O., CLU
I
n my November 20(K) column, I
described a cash flow and financial
plan to optimize a $100,000 inheritance
for a client. I iarry Jensen. In particular. I
compared the gradual liquidation of cash
with systematic payments from an annuity policy. The conclusion: An annuity
wins every time because it is taxed on a
level basis usmg an exclusion ratio.
In this article, the second in a series,
you prepare an analysis for Harry's tax
advisor. In question and answer form, it
shows how income and transfer taxes
affect installments from an annuity contract.' We presume that Harry Jensen, age
65. acquires a single-premium payout
annuity in 2001.
How Income Taxes Affect a
Life-Only Fixed Annuity
Let's say a single-premium $100,000 lifeonly fixed annuity pays $800 a month
Starting at Harry's age 65 when his Internal Revenue Service (IRS) life expeetancy
is 20 years. Mis annual payout is $9,600,
and the 20-year expected return is
$192,000. Once determined, his $100,000
investment m the contract is divided hv
this expected return to obtain an cxcUision
ratio (lA hich may he expressed as a fraction or as a percentage). Then, this ratio is
applied to find how much of each annuity
payment is tax free; the halance. of course,
is ineludable in gross income.
The result: $100,000 ^ $192,000 tells
us that 52.08.^ percent ($5,000) of the
$9,600 in annual pa\'outs is tax free, and
47.917 percent ($4,600) is taxable.
Journal of Financial Planning/March 2001
4 4 A word of caution: Since Roberta may
not be aware of the estate taxes paid by
Harry's personal representative, Harry might
leave a note in the policy alerting her to the
deduction.??
What happens if Harry lives beyond
his life expectaney of 20 years and fully
recovers his investment in the eontract?
If Harr)\s annuit)' starting date had
been before January 1, 1987, he would
have continued receiving $9,600, of whieh
$5,000 is always tax-free even though his
policy had completely returned the
$100,000 investment.
However, since Harry's annuity staning date is after December 31, 1986,
$5,000 is excluded annually only until his
investment in the contract is recovered—
in this instance, when 240 monthly payments are received, i'hereaftcr, each payment is fully ineludable in I larry's gross
income.
What happens if Harry dies before
recovering his investment in the contract?
• If 1 larry's annuit)' starting date had
been before July 2, 1986, there would
have been no tax loss because he had
received all that was expected.
• However, since Harry's annuity starting date is after July 1, 19H6, there is a
special tneome tax deduction available
on his final income tax return. For
example. Harry dies after 12 years. He
bas recovered $60,0t)() ($5,000 x 12)
tax-free. The result: the deduction is
$40,000 ($100,000 - $60,000). It is
listed as a net operating loss us if attrib
utable to a trade or business.
How Income Taxes Affect a
Payout Annuity for a Specific
Period with a Lifetime
Guarantee
Assume Harry selects a monthly $700
payment for 20 years with a lifetime guarantee. His annual payout is $8,400, his 20year expected return is $168,000, and his
investment in the contract is $100,000.
Unlike a mere life-only annuity, however,
his exclusion ratio is niodified to reflect
the period eertain of 20 years. Here's how:
From Reg. Section 1.72-9, Table VII, the
value of the 20-)'ear guarantee is 18 pereent {$18,000) of the $100,000 single preniiiiTn, and tliis must be subtracted from
$100,000 to obtain an "adjusted" investment in the contract.
The result: After the adjustment,
Harry's investment in the contract is
$82,000. His exclusion ratio is $82,000 H$168,000; thus, 48.H1() percent ($4,100) of
eacb $K,400 annual payout is tax free, and
5 L19() percent ($4,300) is taxable.
STILL THINK
MI alegies & Trends^ IN SU RANCE
COMPANY
What happens if Harry lives beyond
age 85 and eontinues receiving payments,
after the period certain under his eontract
has expired?
Ixt's say Harry receives guaranteed
payments for 20 years, and he eontinues
taking $8,400 annually under the eontract
with its lifetime guarantee. When the 20th
year expires, he has received $168,000 (20
X $8,400), of whieh $82,000 ($4,100 x 20)
was tax free and $86,000 ($43,000 x 20)
was taxable under the exclusion ratio.
Since he hasn't received tax-free payments
totaling $100,000, a $4,100 ptirtion of each
additional annual payout is tax free up to
when all tax-free amounts equal $100,000.
What happens if Harry dies before
reco\ ering his in\'estment in the contract
(and hi.s son, Robert, is the beneficiary of
any remaining payments)?
Let's say Harry dies in 2010 after
receiving annual amounts of $8,400 for 10
years—a total of $84,000 ($41,000 tax free
and $4.!,000 taxable). Robert receives an
ailditional $84,0{)(l over the next ten years.
You'd think Roliert "steps into Harry's
shoes" and receives exactly $41,000 taxfree and $4.^,000 taxable during the ten
remaining years. Fortunately, it's better
than that. Here's what happens.
What Robert receives is 100 percent
tax free, until Harry's investment in the
contract has been completel\- recovered,
riu'n. all payments are fully taxed. Note:
If I larr)'s polic}' is a jK'riod certain annuity, without a lifetime feature, Robert does
exclude the same portion of each pa)'ment
as originally computed.
A bonus: The ($18,(XX)) value of Harry's
20-year refund guarantee is not subtracted
when detennining his unrecovered investment in the contract. Note: If Rol>ert
receives a cash refund, it works the same
way. He will not have any taxable income
unless his lump sum, when added to what
I larry received tax free, exceeds $100.0(X).
A potential extra bonus: If Harry (and
Kohert) don't receive tax-free amounts
ei.|ual to Harry's $100,000 investment in
the contract, the unrecovered amount is
eventually deductible on Robert's personal
tax return.
Are income taxes on annuity values
reduced if I larry's estate pa) s a federal
transfer tax? Yes! If Harry dies (1) owning
an accumulation annuity or (2) there are
payments remaining from an annuitized
contract, the policy's fair market value is
included in his estate tax ba.se. F.ventually,
his beneficiary can claim a deduction for
estate taxes paid on any profit in the policy.
F'^jr instance, assume death occurs in
2001 w hen Harry's accumulation policy
(premium cost basis of $500,000) is worth
$1 million. His taxable estate is $3 million,
and the estate taxes are $1,070,250. (Without the $500,000 of profit in the policy, his
taxable estate is $2.5 million and the estate
tax is $805,250, a reduction of $265,000 in
tax). Harry's beneficiary is Roberta, age
65, who has a 20-year IRS life expectancy.
If she takes a lump sum, she elaims
$265,000 as a deduction on her ineome tax
return. This shelters a portion of $500,000
in income and saves income taxes of
$106,000 in a 40 percent bracket. If she
annuitizes the policy, say over 20 vears,
slie'll deduct $15,250 eaeh year.
A word of caution: Since Roberta may
not be aware of the estate taxes paid by
Harry's personal representative, Harry
might leave a note m tbe policy alerting
her t(j the deduction.
Variable Immediate Annuity
Let's assume Harry acquires a $100,000
single-prcminm immediate life-only variable annuity. Payments start at $600 a
month ($7,200 the first year), and change
over time, depending on the investment
returns of bis underlying funds.
I larry's exclusion ratio is determined as
follows: Since his life expectanc)' is 20 years,
the expected retum is simply $5,0(X) (his
$100,(KJ0 investment divided by 20). The
balance of each year's payout is taxable.
Journal of Financial Planning/March 2001
STOCKS
ARE
BORING?
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SHARES TRUST
investing in banks and
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Average Annual
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5 Years
10 Years
20 Years
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,/|||
Strategies & Trends
Tax
Consequently, if Harry's first year
payout is $7,200, $5,000 is tax free and
$2,200 is taxable. F>en if his annual
payout drops below $5,000, he won't lose
any portion of his exclusion allowance. He
divides any loss by his remaining life
expectancy at the time, and adds the quotient to his originally determined exclud;ib!e amount.
$ 50.000 = 26.042% tax-free = $2,500
$192,000 - 7.^958% taxable = $7,100
Instead, assume Harry dies w hen his
$50,000 accumulation policy is worth
$100,000. If (1) Harry's contract is ownerdriven (and he owns the policy) or (2) his
eontract is annuitant driven {and he is the
annuitant), his policy matures and a lump
sum liccomes payable. I lis bcneficinrv
now has 60 days to choose a payout annuity income. Absent election, he or she is
taxed the 61st day on an)' profit in the
poliey.
When a Deferred Annuity is
Annuitized Later
Someda), ;i deferred annuity will either be
surrendered for cash or ;mnuitized. Let's
say Harry pays $.'i0,000 tor a single premium accumulation annuity polic}'. It is
worth $U)(),()00 at age fS5, v\ hen he annuitizes the contract for a monthlj' income.
Determine from the policy when the
6()-day period begins. Some contracts
commence everything at date of death.
Some start the period when the insurer is
notified of death.
Tell clients to contact you to schedule
a meeting immediately. If annuitizing is a
possibility, time is of tlie essenee.
If a transfer to another company's
immediate annuity is likely, it should be
completed w ithin the 60-day period.
For purposes of exclusion ratios,
$50,0(10 is his in\'estnient m the contract.
If his expected annual return is 19,600 for
20 years, the exclusion ratio is $50,000 -H
$192,000,
You don't have to go far
for CE credits.
Just turn the page...
Easy to find—
every issue of the Journal of Financial
Planning includes a continuing
education exam.
Easy to compiete—
exam questions are based on the
articles you've just read.
Turn to page 139
for this issue's continuing
education examination
and instructions for
processing.
Again, timing may be erucial to a successful tax-free exchange.
If Harry is mere ()V\ ner of any contract
issued after January \H, 19S5, at his death
the contract matures under the law and a
lump sum becomes payable. Harry's beneficiary has one \'ear to begin aniniit\' payments or five years to cash out the policy.
1 low ever, he or she still must elect to
annuitize within the applicable 60-day
period. If not, all profit in the policy is
taxed on the 61st diw.
Endnote
1. This is an abridged version of my special report, "How To Turn An Annuity Policy Into a Monthly Ineome,"
and is printed with permission.
Richard W. Duff,
J.D.XLU.isa
financial advisor in
Denver, Colorado,
in First Financial
''I'sources. He is
<nhorof
numerous books
ond reports on
estate planning and annuities. Duff can be reached by
phone at (303) 765-3599, by fax at (303) 691-0474, or
by e-mail at RWDuffCLU<§>aol.com.
JOURNAL
Joumal of Financial Planning/March 2001
Issues
ond is a principal
Easy to return—
mail or fax your completed CE exam
to the Journal ofFinonciol Planning.
•^F
& Estate
of Financial Plantiina
it^ & Trends
Tax
& Estate
Issues
How to Turn an Annuity into Monthly
Income, Part III
by Richard W. Duff, J.D., CLU
I
n the November 2(K)() i.ssue. I compared
payout kinniiitii.'s (iiiinicdiiitL's tliLit begin
;in income right away or deterreds,
\\ hicli arc iinmiitizcd hirer on) with some
;ikLTn;itive a.ssct li(]uiii;iti(in -.irningcnicnts.
In the March 2(K)1 issue, I explained how
income and tninsfer t;ixes affect installments from an anniiit}' polie\\ In this article, the tliird in a series, I'l! show why current trends will put pa}'out annuities in the
spotliglit for years to come.
Up until the 1970s, it seemed customary for a prudent person to plan ahead to
have an income stream he or she could
depend upon after retirement. Workers
received a steady, assured benefit from
Social Securit)' and employers added
delined-beiiefit (DB) pensions that guaranteed a lifetime income and tbe advantages afforded to tax-qualified plans.
insurers supplemented these income
streams with individual cash-value annuity and insurance policies, and promised a
month!)- lifetime income, usually guaranteed for ten years. This required about
$1,600 of cash value at age 65 for each $10
in monthly income. If there uas a profitsharing plan or some personal investments, these provided extra income or a
cash emergency fund.
1 )uring the last 2S years or so. everythini; has changed. Insurers pulled their
traditional annuity and retirement income
insurance policies. Now they mainly offer
single-premium deferred annuities that
build accumulation values alongside some
rather uninteresting annuity rates.
F.mployers gradually dropped their OB
plans—down from 122.1100 in 1977 to
64,000 in 1996 (last available data). Mean-
JounulofFinancialPlanning/August 2001
CC\ believe that people are once again
beginning to favor solid income streams at
retirement.??
while, defined contribution (DC) plans
increased from 281,000 to 630,000. And
now, some succest that Social Securit\'
gradually shift to an individual retirement
account—a DC program to give workers
"more control over their money." You can
even hiok at premiums paid into individual nonqualified annuities in 1999. Only
five percent of their contracts were immediates. the rest were deferreds. And, of ali
death benefits and cash values surrendered
in 1999, just five percent of the money
v^ ent into annuitized settlement i)|)tions;
the rest was paid in a lump sum.
A Shift in Financial
Consciousness
The trend is clear. Although we used to
place our savings into guaranteed pension
incomes, usually \\ ith a lifetime contingency, folks todav seem to find piles of
securities and cash more desirabie. This is
quite a shift in financial consciousness.
Yet, i believe that people are once again
beginning to favor solid income streams at
retirement. Here's some evidence:
' As baby boomers approach retirement
age, they'll become more interested in
distributions from accumulated assets.
As retirees seek maximum payouts,
planners will start thinking about the
income side of all investments. Financial advisors will manage money to
emphasize lit.|uidation as u'ell as accumulation. (You might re-read Cierald
Weiss' article, "Dynamic Rebalancing,"
in the Febniary 2001 issue of thi.s journal. He explains how to exhaust an
investment portfoUt) e.vactly at tbe end
of a client's life.) It's just simpler to
keep everything in eijuiiibrium \\ iicn
investments are piaced in conibinatioiis
of payout annuities.
Most retirees w ill be heaithy, and optimistic about life expectancies. Naturaiiy, they'll prefer incomes that can't
be outlived. .An annuity tasting into
someone's hundredth yearttt life
improves rates of return markedly,
Only commercial annuities offer the
promise ot a lifetime conti[igcnc\'; you
can't duplicate this financial strategy
with another approach to investing.
The conversion of principal int() aiinuit)-' income works wonders for an asset
presenation plan. Presently, alnmt onethird of the states shelter a |>olicyowner's annuity cash values from others
\\ho want the money. Add another onethird that safeguard annuity incomes for
annuitants and family memlwrs. Recent
cases even suggest that income streams
aren't worth much to someone else,
especially a creditor who must stand in
Slralegies & Trends
line as an annuitant's payment follows
him or her around in the world, ;Vlso,
most states protect what's left after an
annuitant-payee dies, especially if a
s}^>endthrift clause prohibits commutation or assignment of any remaining
payments.
• Taxable incomes from payout annuities iirc level biisej on tht: exclu.sion
ratio calculation. This gives them a
head start, financially, on other distribution strategies that are taxed as debt
repayment plans.
• In a mobile society, retirees want
checks that they can depend on. Annuity payments arc pralictahlc. too, and
can con\eniently be credited directly
to a bank account anywhere on earth.
• When a contract is annuitized, all gain
in the policy is taxed as ordinary
income. However, legislation will
pnihalily be introduced in niid-2001 to
tax this profit as capital gains instead of
ordinary income.
• Most investment progrnnis nre traditional, one-directional plans « here
assets are preserved and managed to
produce income for the owner. But
that\s not nearly as good as tu'o-directi))nal planning u here capital is divided
into separate shares—one that is systematically liquidated, the other accuuiLilated {»n a tax-deferred basis. (One
example: a split annuity where an
inimediate polic\ is combined with a
deferred accuinuhition contract.) Obviously, fixed-period payout annuities
iirc the cornerstone to the distribution
aspect of this strategy.
Educating Clients
It's one thing ro ui;irvcl at the opportunities for pa\()ut annuities. It's another to
educate our clients about the products
they \\ ill buy. 1 Iere's wh;it we need to do.
• In seminars and client meetings, prepare investors for income planning.
JoumalofFinancialPlannlng/August 2001
Tax
Show them, for example, how principal is liquidated over time. Finally,
explain that an age 65, a 2()-year annuity should cost only about fl\ e percent
more if it has a lifetime contingency.
Because insurers are Iikel\' to raise the
price of this guarantee, it pays to lock
in annuity rates now.
Until recently, pa\(»ut annuities have
not hecn marketed to persons w ith
shortened life e.\pectancies. Now, several carriers offer impaired-risk annuity
portfolios. Here's a suggestion; E.\plain
the concept ot a payout annuity. Then,
offer impaired-risk underwriting as an
added hencfit u hen the situation warrants.
Insurers need to pay more attention to
keeping contract values in-house.
Unfortunately, carriers seem more
interested in getting "new money" than
keeping "old money" from lea\ ing. I'm
told that about 50 percent of all individual annuity premiums come from
1O.?5 exchanges (I'd estimate that some
M) percent leaves through similar transfers.) And the fact that 95 percent of all
cash surrender and death heneflts are
lump sums is appalling. Insurers need
to he much more creative and proactive
when it comes to annuitizing cash
values and death proceeds.
Income distiihution planning is complicated and time-consuming. Insurers
should pay better compensation to
financial advisors who recommend
their payout products. Commissions
when dcatli benefits arc annuitized and
"trailers" on all annuitized policies
would be a good start. Bonuses also
should be earned on the tjuantity {>f
payout values "under management."
Surely, actuaries can come up with the
money from increased profits and
economies of scale.
Insurers also should offer more imaginative payout policies. Gi\e a bonus to
the payee if there is an actuarial gain.
In variable products, minimize inarkct
& Estate
Issues
swings with level payouts. (And make
a priispcctus easier to read.) Design
equity-indexed payouts in fixed products to pnnidf guarantees u Jth a
potential upside. Add (a) enhanced,
tax-free casli-rcfnnd ticiilli benefits in
life income contracts and (li) extra cash
in the policy if someone is a policyholder over many vears. Get creative:
investigate what consumers want, and
meet demand that w ill surface dtn ing
the years ahead.
• Most laws that safeguard annuities
from creditors are sadl\ out-of-date. As
insurers meet the demand for payout
annuities, lobby for legislation to clarify and incrc;i.se the protection. Use
Florida and Texas as an example, wnd
bring these laMS into the 21st century,
Payout annuities with life contingencies
are steady streams of income you can't outlive—fin;mcial strategies that clients want.
need and will demand shoitly. Ihey are
tine of the best financial opportunities your
investors never heard of. Their popularity
is about to surface, and it will pay for all of
us to become more aware of these wonderful financial products.
B
Richard W. Duff.
ID.. CLU, is a
financial advisor in
Denver, Colorado.
He can be reached
bv phone at (303)
6-3599. by fax at
iQ3) 691-0474.
ind by e-mail at
RWDuffCLU^
aol.com. His Web S/tes aie www.Professional
AnnuityAdvisor.com and wwvif.dickduff.com.