June 2008 Archives
Listen in to Mark Triplett, RVP of Annuity Distribution
A new sales concept to help clients develop their own "personal pension." With so many companies dropping defined benefit plans, learn how to help your clients create secure retirement income -- guaranteed. (16:18)
Cure the mid-life crisis: Stop funding qualified plans
By Jeff Janes
Time to be honest here—mid-life comes around 40, maybe 45 at the latest. By the time you reach 50, you’re way past prime-time. Sure, I’d love to live to 100, but I don’t think that’s going to happen. Average life expectancy is 87 (by the way, we’re all pretty average). Considering that most financial professionals have saturated the baby boomer market, isn’t it about time we start looking at the next retirement catastrophe—those approaching their mid-life crisis?
As I hit middle age, I fondly remember when retirement seemed personally unattainable. Now, with each birthday, I wonder, “Am I adequately prepared for retirement?” Then, the government likes to spoil your birthday party, too. Have you ever read page two of your annual Social Security statement, right below “Your Estimated Benefits”? How’s this for a birthday spanking, as the bold-print disclaimer reads:
Your estimated benefits are based on current law. Congress has made changes to the law in the past and can do so at any time. The law governing benefit amounts may change because by 2041, the payroll taxes collected will be enough to pay only about 78 percent of scheduled benefits.
Today, not many people younger than age 40 are even counting on Social Security as a retirement income supplement. Many of your clients also face this frightening fact: With a perfect storm brewing, why would we even consider recommending stopping qualified plan funding? Well, through some recent product innovations, you can honestly recommend stopping qualified plan funding and provide your clients with a comfortable retirement, all while creating a stronger overall financial plan. It’s quite simple, really.
Why stop funding qualified plans?
According to the 2008 Retirement Confidence Survey, 47 percent of workers say they have tried to calculate how much money they will need for a comfortable retirement. In addition, the percentage of workers confident about having enough money to enjoy a comfortable retirement sits at a lowly 18 percent. With so few Americans adequately prepared, and most worried; again, why would we even suggest stopping qualified plan funding? It comes down to flawed assumptions and inefficient vehicles.
First, for a qualified plan to work efficiently, the theory goes that you defer taxes during your peak working years and then consume the money and pay taxes in retirement—where hopefully you will be in a lower tax bracket. That’s a great theory, but with the massive explosion of baby boomers now moving through the system and starting to rely on and use government programs, where will the money come from to fund those benefits and taxes?
I don’t know a single person who’s age 45 or younger who really believes their tax rates will be lower when they retire. Throughout the past century, the U.S. marginal tax rate ranged from below 10 percent to more than 90 percent. Today, the marginal tax rate hovers at around 35 percent. And, almost every economic expert agrees that tax rates will most likely be higher—perhaps significantly—one or two decades from now.
Second, the U.S. Department of Labor shows that a worker between the ages of 18 and 38 changes jobs an average of 10 times. With frequent job switching going on, most individuals younger than age 45 probably left behind a few 401(k) plans along the way—orphaned and not rolled over to the new employer. Client portability should have a strong appeal, as well as consolidation and control over all the retirement assets.
Finally, qualified money—by law—must be consumed at some point in retirement, but definitely no later than age 70.5. So, you can only defer those taxes for so long, then the government steps in and says, “You owe us blank. Now start consuming so we can collect our taxes,” regardless of what the tax rate actually is when you turn 70.5.
A new retirement revolution
For this strategy to work, you need to reach the right market with the right situation and the right mindset. It’s not going to work for everyone, but if you can focus your efforts on those younger than age 50, it makes the most sense.
First, roll over all the orphaned 401(k) plans and other qualified accounts into one individual retirement account (IRA)—but not just any IRA, an IRA annuity with a guaranteed lifetime withdrawal benefit (GLWB). In addition, your client can convert that 401(k) to a Roth IRA and, from a tax perspective, it may make more sense, as all future distributions will be tax-free—however, converting today creates an immediate tax liability. For this article, let’s assume the client doesn’t convert to a Roth, as they don’t want to come up with the funds to pay the taxes today.
By moving to an IRA annuity, your clients don’t obtain any additional tax benefit—but you do have other valuable benefits not found in most other IRAs; namely the guaranteed lifetime withdrawal benefit. But should you go with an indexed or variable annuity? Specifically, we’re looking for a lifetime withdrawal benefit with the absolute highest guaranteed growth possible and the biggest up-front bonus and, today, those are only found in indexed annuities. Here’s an example:
Justin Case, age 45
- Ex-employer No. 1: 401(k) balance = $41,000
- Ex-employer No. 2: 401(k) balance = $36,000
- Ex-employer No. 3: 401(k) balance = $23,000
Roll over the entire $100,000 into a 10 percent up-front bonus contract with an 8 percent guaranteed growth factor. By age 65, that annuity with the lifetime withdrawal rider has a benefit value—not contract value—of $753,332. Then, at age 65, the client can start a guaranteed annual lifetime income of about $41,433, regardless of how long they live—without ever annuitizing the contract. How’s that for a guaranteed retirement income and not putting an additional penny into a qualified plan after age 45? But, if we maintained the qualified nature of this money and didn’t convert it to a Roth, all of the money consumed from the annuity will be taxed as ordinary income. Let’s now consider lessening the impact of taxes and offsetting the risk of premature death.
Not a one product solution
The second step involves making a change with the qualified plan funding. Let’s assume the client was putting $1,000 a month into the qualified plan. Well, that $1,000 was pre-tax money, so after-tax we’re looking at approximately $650. Suppose the client uses those dollars to purchase an indexed universal life insurance policy. Why life insurance? Because the client receives tax treatment similar to a Roth, but without the funding, distribution or income-limit restrictions.
With cash-valued life insurance your clients receive tax-deferred growth coupled with tax-free income. I can’t tell you how often I hear from younger people that they wish they could put more money into a Roth. Try this quick little question on your prospects and watch in amazement by the results, “If you could contribute more than the maximum amount to a Roth, how much would you contribute on an annual basis?” Chances are clients will say they’d put in more than the maximum. Then hit them with your follow-up question, “If I could show you a product that has similar tax advantages as a Roth without the funding restrictions (or income limitations), how interested would you be in purchasing that product?”
Again, clients will likely show interest; then hit them with the logical alternative—life insurance—yes, life insurance. Don’t be ashamed to offer the right product for the right need. If we stopped funding the qualified plan, most people could stuff $8,000 or more annually into the policy. Why IUL? Because some carriers offer 15-percent caps without market risk and, over the long-term, an IUL can outpace every variable universal life (VUL) product in the market today.
Justin Case, age 45, preferred non-smoker
- IUL monthly premium: $650 to age 65
- Cumulative premium to age 65: $163,800
- Initial death benefit: $376,471
- Age 66 projected cash value: $346,242
- Age 66 projected annual income: $49,472
When you combine the guaranteed lifetime annual withdrawal from the annuity ($41,453), with the projected income from the IUL ($49,472), you’ve just created an annual income for your client of more than $90,000. About 46 percent of this money will be taxed at ordinary income and 54 percent paid to the client without the impact of income taxes when structured properly. Again, clients generate all this retirement income without contributing one penny to qualified plans after making the switch. However, if the client’s employer provides matching funds, you could keep contributing a small amount of money to the 401(k) to take advantage of the matching funds. But, even if you didn’t, what average client wouldn’t like an annual retirement income of $90,000?
The power of the GLWB creates the income base so the client can rest easy at age 65, knowing that regardless of market performance, terrorist attempts, natural disasters, etc., they have a specific and guaranteed lifetime income. The beauty of the life insurance contract is it works much like a super-powered Roth. The client can contribute as much as they’d like to the policy—receive tax-free income at retirement and offset the risk of premature death. If you have clients reaching the mid-life crisis, offer them a new approach to retirement income. This new powerful combination provides a guaranteed income regardless of future performance from the annuity, with an additional tax-free income from the life policy. It’s really quite simple.
IUL Illustration Secrets Revealed
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Learn the 8 Costly Annuity Marketing Mistakes and How to Avoid Them
If you sell indexed annuities, don't go it alone, learn the biggest mistakes producers make and how to avoid them. (49:34)
Biggest blunders, mistakes and myths about IUL
In this episode of On the Air with AMZ you will learn about the biggest blunders, mistakes and myths about IUL. (28:35)
The best income planning tool
By Jason Konopik
Income planning has been the talk of the town in the insurance industry for the last decade. This is due to the more than 75 million baby boomers transitioning over the next 15 years from income accumulators to income harvesters. Combine that with the 60 million people already looking to harvest wealth and you have nearly $3.5 trillion in total wealth - and it is easy to generate a lot of excitement about this wealth distribution opportunity. However, the income solutions currently being promoted to clients don’t offer a lot of excitement.
The life insurance industry offers more tools and suitable solutions for these clients than any other industry. So why haven’t more insurance producers been focusing on this opportunity? It all comes down to education and, unfortunately, we have only been educated on some of the tools available.
Indexed universal life (IUL) is one of the most stable accumulation and income generation tools available. Traditionally, the words “life insurance” conjure visions of mutual insurance companies peddling participating whole life with very limited upside potential, or other companies pushing variable universal life (VUL) with no downside protection. Indexed life, however, provides significantly greater upside potential than traditional fixed life insurance does. Additionally, indexed life exposes the client to far less risk than a VUL product. Finally, IUL still offers all the tax benefits and flexibility of cash-value life insurance, but on a much more efficient model.
Major risks and simple solutions
The four major risks facing clients who wish to develop a “harvesting” plan include growth, safety, flexibility and taxes.
No. 1: Growth
Even though senior clients interested in generating income may have a shorter accumulation period, they still desire an attractive return. The key to reaching this goal involves setting the right expectations for the definition of attractive. When setting expectations, several factors need to be taken into account, but the biggest factor is the incremental return over inflation, even as a client takes distributions.
No. 2: Safety
This is perhaps the most significant risk facing an income-oriented client. Safety can be defined many different ways, but generally, clients want a vehicle that offers returns regardless of the economic environment. As Will Rogers once said, “It’s not the return on your money - it’s the return of your money.”
No. 3: Flexibility
I see many bumper stickers that read “‘Blank’ Happens”—you can fill in the blank. Whether it is Murphy’s Law or just impossible to predict all needs while developing a strategy, a plan is only as good as its ability to adapt. The absence of flexibility forces a client to live his or her life by a rigid plan. As advisors, our job involves developing a plan that evolves with your clients’ lives so they can live freely without worry.
No. 4: Taxes
Throughout the past 100 years the U.S. marginal tax rate ranged from below 10 percent to more than 90 percent. Today, the marginal tax rate hovers around 35 percent. Almost every economic expert agrees that tax rates will most likely be higher - perhaps significantly - one decade from now. Think about millions of boomers reaching retirement age and qualifying for government benefits and programs. Where is all the money going to come from to support those programs? The answer? Taxes. However, years ago many financial professionals advised clients that their average tax rates will go down in the future, specifically during retirement. Now that assumption gets turned upside down as experts start to assume that tax rates will most likely be higher - even if clients are in a lower tax bracket. This ultimately leads to client uncertainly. It is relatively impossible to take an instrument for which taxes are paid on accumulation - or harvesting or both - and be able to project the impact taxes will have on the ultimate return.
Harvesting with the right tools
These four risk factors all determine whether a harvesting plan ends up meeting a client’s expectation or falls dramatically short. The simplest answer involves finding a tool that offers the best answer for each risk. That leads to a fairly simple scoring sheet, which enables us to show clients their options along with the positives and negatives of each choice.
The tools traditionally used in income planning (highlighted below) offer both benefits and drawbacks.
Tax-qualified account
As the primary tool for growing wealth to be consumed in the future, a tax-qualified account certainly meets the first objective of potential growth. However, even with diversification, this tool can never meet the best definition of safety without significantly reducing its growth potential. Plus, due to the tax-favored nature of qualified plans, flexibility is significantly reduced. Then, the limitations on contributions and withdrawals make adaptation difficult for clients - not to mention that every cent coming out of the qualified plan will be subject to taxes at the current tax rate. When it comes to qualified plans, the only one that makes sense when you take into consideration higher future tax rates is probably the Roth IRA. But, the low contribution rates make them less attractive to those looking to harvest in the immediate future.
Nonqualified account
The growth and safety risks of this tool mirror qualified accounts. The biggest differences involve flexibility and taxes. As one of the most flexible tools for income, distributions can be increased or decreased as needed - as long as the returns warrant the change. But, many experts agree that you should limit the income you take out of your accounts to no more than 4 percent annually. The most significant drawback under a nonqualified plan involves being taxed on the gains each year; you receive no tax-deferred growth as you would under a qualified account, and definitely no tax-free income. Of all the options discussed to this point, the nonqualified account is the least tax-efficient tool.
Single-premium immediate annuity (SPIA)
Perhaps the only tool available designed exclusively for generating income, a SPIA clearly addresses safety in providing clients the assurance of an income down to the penny. Unfortunately, in today’s economic environment, the inherent growth in this tool is unlikely to beat inflation. For example, while a client might receive $2,000 a month for life, the amount of goods they can purchase down the road decreases as inflation erodes purchasing power. In addition, this tool is relatively inflexible (although some designs have somewhat increased flexibility). For example, if your client needed emergency funds, you just can’t get them out of a SPIA; those funds would need to come from other sources. Additionally, if death occurs early in the payout stream - depending on how the payment duration was structured - there may be limited, if any, benefits paid. Finally, from a taxation perspective, there is limited tax benefit to this tool as taxes are paid in proportion to the benefits being paid out.
Annuitizing a deferred annuity
Deferred annuities have been used as a retirement accumulation tool for decades. Deferred annuities accumulate wealth on a tax-deferred basis until those funds are needed, at which time the policy is annuitized. While this concept looks great on paper, the statistics on how few of these funds actually have been annuitized in retirement can be mind boggling. The suspected reason for this has to do with the same shortcomings of purchasing a SPIA: The limited flexibility and growth potential, coupled with the taxation of all contract earnings while the annuitization benefit that generates income leads to a less than attractive means of providing income. In addition, I strongly suspect that annuitization interest rates on deferred annuities are typically lower than equivalent rates on newly purchased single-premium immediate annuities.
Withdrawing funds from a deferred annuity
Recently designed to overcome the inflexible nature of annuitization, a deferred annuity can offer lifetime withdrawal features to provide sustained income. While these riders look attractive, they often generate more questions than answers, such as:
- How will the lifetime withdrawal income be taxed?
- How will the actual product perform? Will the account value ever come close to the benefit value?
- What limitations exist in taking income?
- How much do these riders cost and is it really worth it in the end?
- What happens if I need emergency funds, and how will that impact future lifetime income?
At the end of the day, these riders can help clients sleep better at night, but in reality, accomplish nothing more than providing a simple guarantee on a future income benefit. Another way of putting it is that you can guarantee a future SPIA-like income with today’s dollars.
Indexed universal life
IUL is the only product that addresses all four harvesting concerns. First, it offers very good growth potential with no downside exposure. The high cap rates (as high as 15 percent), the lower internal expenses of newer IULs, and the valuable loan provisions enable these products to offer a realistic chance at significantly beating inflation and keeping pace with the overall market. Second, the minimum guarantees associated with any IUL product provide the safety needed for income-oriented clients. Third, the flexibility of IUL allows clients to stop and start income at any time and provides significant additional benefits through the death benefit. Finally, and probably most importantly, the tax-free nature of cash-value life insurance provides a safe haven from paying future taxes on any income taken when the policy is structured properly.
If you’ve ever heard the old adage, “There are only two certainties in life: death and taxes,” I believe the expression should be updated to, “There are two certainties protected with life insurance: death and taxes.” First, only cash-value life insurance addresses the biggest impact on harvesting future income - taxes. Not only do all values accumulate tax-deferred but, when structured properly, only life insurance provides a tax-favored income stream. Second, every single person on this planet is going to die, the only uncertainty is when that death is going to occur. At least with cash-value life insurance, you can protect against premature death with a tax-free death benefit, which most likely will be greater than the amount of premium you placed in the contract - no other product can make that claim. If the death occurs later in life, you just enjoyed a tax-free income throughout retirement - again, only available through life insurance. In my humble opinion, the IUL is the best income planning tool today.
Popular Index Interest Crediting Methods
How can you get help if they’re lying down on the job.
When it comes to Indexed Universal Life products, not everyone is an expert. In fact many marketing organizations do not have enough experience or stay up-to-speed with the new carriers entering this revolutionary market. At AMZ Financial, we focus solely on products you sell, we show you how some companies may twist facts to make their products look pretty. And since we’re 100% independent, we tell you when a product fits and when it doesn’t. Isn't it about time you heard the truth? Speak to the indexed product experts at AMZ Financial today.
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Listen in to Mark Triplett, RVP of Annuity Distribution from AMZ
Sales strategies are just ripe for the picking in today's economic environment. It's time to pick some low-hanging fruit and generate some easy annuity sales. (14:15)