ANAHEIM, Calif. – Older clients with liquid assets and a desire to reduce estate taxes may want to consider buying a guaranteed income annuity partnered up with a life insurance policy.
That was the suggestion from John W. Homer, president of Oxford Financial Group. He outlined several strategies for doing that during a focus session at the annual meeting of Million Dollar Round Table (MDRT).
All the strategies — which he terms Cinderella Slipper Strategies — use single premium immediate annuities (SPIAs) with a life-only payout option. In his talk, he referred to these products as guaranteed income annuities. The annuity is sold “simultaneously” with a life insurance policy.
The guaranteed income annuity seems to be a “forgotten tool” for most advisors, Homer remarked. Still, he said he has found ways to work with the products, in combination with life insurance, that result in a plan that meets the needs of certain older clients.
The client situations where he says the strategies fit like a “slipper” is when the client is 70 to 90 and has liquid assets or can convert to liquid assets and needs a means of generating good cash flow. In addition, the client generally wants to remove assets from the taxable estate.
The guaranteed income plan
He called one of his strategies that used this approach the “guaranteed income plan.” He described this strategy this way:
Assume the client has liquid assets in different instruments. Although she will never spend or access all of that money, she wants as much cash flow from it as she can safely receive. So far, she has been receiving $30,000 in cash flow from $1 million of those liquid assets each year. However, after taxes, she has been getting only $20,000 a year in spendable cash flow.
The strategy would entail repositioning that $1 million, which has been earning 3 percent.
“If we reposition $1 million of her assets into a guaranteed income annuity, and the payout is made monthly, she will receive about $10,500 every month,” Homer said, indicating that he calls the annuity payouts cash flow.
“That is $126,000 per year, or 12.6 percent of the $1 million she transferred to the annuity,” he said.
However this opens up a problem, he indicated. This is the fact that when the woman dies, the cash flow will stop and the remainder of the $1 million will stay with the annuity company, with the heirs receiving none of it.
His guaranteed income plan addresses that issue by having the woman purchase a $1 million life insurance policy using the cash flow from the annuity. In the example Homer gave, the monthly premium would be $6,200, or a total annual premium of about $74,000. “As a percent of the $1 million death benefit, this is 7.4 percent,” he said.
The result is that the woman would receive 12.6 percent cash flow from the annuity and pay 7.4 percent into a life insurance policy in order to protect that annuity investment, he continued.
“For as long as she lives, she has a positive cash flow, the difference of which is 5.2 percent. But the cash flow from the annuity has an exclusion ratio of 86 percent. This means that 86 percent of the monthly cash flow is tax free for several years. Only 14 percent is taxable.”
Homer calculated that, if the woman is in a 35 percent tax bracket, she would have to pay about $6,200 of income tax on the taxable portion. That would make her after-tax cash flow about $46,000 per year, “more than double the $20,000 of the after-tax cash flow she was getting from her CD,” he said.
Furthermore, if her estate is subject to estate taxes, the strategy would remove $1 million of liquid assets from the estate, thereby reducing her estate tax bill.
Questions and cautions
Homer presented several other examples, drawn from his experiences with clients with estate issues, possible health issues, age-related issues and those in certain charitable or other advanced sales situations. He also pointed out that the strategies may not work in certain instances (such as if the client can’t qualify for the life insurance).
When dealing with older clients, he cautioned at one point, it is very important to keep the explanations very simple.
“I go slow and always begin by drawing the boxes and arrows so that the concept is understood before we try to get into the numbers. Once the concept is grasped, the numbers will fit into the diagram nicely.”
Many times, the proposal will go to other parties for review and approval, he added. These other individuals could be an accountant, an attorney or family members. In those instances, he said he presents the numbers in a “before” and “after” scenario on a single page, including estate tax implications, if they are present.
“This is the only strategy I have discovered in which people buy very large policies and have greater cash flow after the purchase than before,” Homer said.
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