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Have you ever tried to cut a steak with a plastic knife?

Have you ever tried to cut a steak with a plastic knife?

January 10, 2022
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If so, you understand that while the plastic knife may get the job done, a steak knife would be a more efficient tool.

When it comes to building and preserving your wealth, financial vehicles need to be structured in such a way that they will carry you to your desired destination. Reviewing your plans regularly and considering adjustments when appropriate are important ways to help ensure that you are on track to reach your goals.

While each situation is unique and there is no "one size fits all" when it comes to product recommendations, case studies can often help us to understand various financial solutions that may available. In this article, we examine a hypothetical example where a combination of his existing annuity and a new life insurance plan was determined to be appropriate for one individual’s legacy planning needs.

When developing retirement strategies, many people struggle to understand annuities, wonder if they truly need one and are often confused as to how different financial instruments can work together to solve the "retirement puzzle."

To help shed some light on this situation, let’s look at a scenario where a man who was a few years from retirement was able to create more wealth for his heirs......

Chuck’s Story

“Chuck Billy,” now a 60 year old widower, purchased a non-qualified deferred fixed annuity 20 years ago at the suggestion of his financial advisor. Chuck was making a nice income, maxing out his 401(k) contributions, had significant savings in the bank and was looking for an additional retirement savings so that he and his Wife Tiffany could diversify their tax exposure when they begin to take income.

During a recent annual review, Chuck’s current advisor asked him to explain the intended purpose of the annuity assets today that have now grown to $100,000 as well as the desired “end game.”  Chuck shared that at this stage his needs have changed and his plan is to pass the funds in his annuity to his adult children upon his death.*

Now that Tiffany has passed on and he is five years from retirement Chuck determines that the assets in his 401(k), the life insurance proceeds from Tiffany's death and his projected Social Security benefits would be sufficient and that and he no longer anticipates the need to utilize the annuity to supplement his income.

As Chuck’s primary concern now is leaving his son and daughter an inheritance, the growth that has accrued tax deferred in the annuity will be taxed as ordinary income and potentially subject to estate tax, leaving each beneficiary with less than he would like to provide upon his passing.  

Based on Chuck’s current goals and after consultation with his advisor, he considers either executing a tax free 1035 Exchange of his annuity to a single premium immediate annuity (SPIA)*** or annuitizing his deferred annuity. The portion of each annuity payment that is considered "gain" would be taxed each year upon withdrawal and as Chuck is healthy, the net income generated could be used secure a greater death benefit by funding a life insurance policy.

So, what option did Chuck choose? 

After running calculations, it was determined that annuitizing his deferred annuity was more advantageous than exchanging it for an immediate annuity.

In this case, the insurance policy discussed was a limited pay (10 Year) whole life product to match the 10 Years of annuity payments received from a 10 year period certain annuitization on his existing plan. providing Chuck the opportunity to pass a greater amount to his children in a more tax efficient manner.  In this particular scenario, the life insurance death benefit would be $160,000.

In choosing to reposition his deferred annuity, Chuck is able to maximize the amount passed on to his heirs. Not only will his life insurance policy help him realize his goal of yielding a higher death benefit, the life insurance proceeds may be tax-free.  Moral of the story……….work with your trusted advisor to review your accounts and ensure that your current plans are properly positioned to help you reach your goals.  While this strategy is certainly not appropriate for everyone and the numbers will vary, it simply provides an example of how the process can work if/when suitable.

Ancient Rome & Retirement Income

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*While annuities can provide lifetime income protection when properly structured, in many cases, they might not be the most efficient wealth transfer vehicle.

**All Life Insurance applications will require evidence of insurability and will need underwriting; the rate classes and individual product offerings may differ from this example and various insurance companies may offer different benefit levels. There is no guarantee of eligibility or of a specific tax consequence. 

A SPIA is a contract between you and an insurance company and is designed for income purposes only. Unlike a deferred annuity, an immediate annuity skips the accumulation phase and begins paying out income either immediately or within a year after you have purchased it with a single, lump-sum payment. SPIAs are also called immediate payment annuities, income and immediate annuities.  

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