Advisors Blog

Annuities are a great tool for accumulating cash – but are not always the ideal way to transfer assets to the next generation because of the taxes due at death. Here is an example of an actual case that GBS just completed which illustrates the power of thoughtful tax and insurance planning.

Background

• A 68-year-old client had a 28-year-old non-qualified, deferred annuity.
• He had purchased the annuity for $75,000 and later made a withdrawal of $30,000, thus reducing his cost basis to $45,000.
• The current value of the annuity is now $785,000.
• The client's wife is 56 years old, and they have both children and grandchildren.
• They do not need the income from the annuity for retirement purposes since they have plenty of other assets to draw from.
• Should he pass away, the after-tax value of the annuity would be approximately $260,000 since federal and state income tax would be due on the gain of $740,000.
• He lives in a very highly-taxed state therefore almost 50% of the value would be lost to state and federal income taxes. Even more could be lost to federal estate tax, depending on the size of the estate.
• The net value of the annuity for his wife’s benefit would be about $395,000.
• In addition, the client has a significant net worth and his wife’s estate would be subject to both federal and state taxes upon her death, further reducing the annuity value to approximately $260,000. A far cry from the $785,000 account value today.

A Better Way

Utilize the annuity to purchase a guaranteed death benefit survivorship life contract that leverages the annuity in a much more tax efficient manner. A legacy is created that may provide up to 10 times the after-tax benefit of the annuity

Process

• Initiate a section 1035 exchange of the $785,000 annuity into a 100% joint and survivorship immediate annuity. This will generate $40,000 per year of income while both or either of the annuitants are alive.
• With that income, purchase a guaranteed death benefit survivorship life policy with a premium of $30,000 per year (after taxes are paid). This will purchase a death benefit of $2,540,713 that is guaranteed to his wife’s age 110. Because the annuity payments and death benefit is guaranteed, there are no moving parts so the clients have 100% certainty that this benefit will be in place regardless of future economic uncertainty.

Conclusions

• Annuities are not ideal wealth transfer tools because of the taxes due on death.
• Life Insurance can leverage the amount payable to heirs with guaranteed results and lower taxes.
• SPIAs (Single Premium Immediate Annuities) can be used to leverage up the total benefits to heirs and can also be used to spread the taxes due over many years, utilizing a tax free 1035 exchange from the deferred annuity.

If you have clients who currently own a non-qualified deferred annuity that is not needed for retirement income, then this may be a very attractive option for them to consider. Call your GBS Brokerage Director for a case consultation today.