Why Estate Plans Need Annuities

In our current interest rate environment, annuities combined with life insurance have the power to be the hero of your client’s estate plan.

With an estimated $84 trillion transferring from one generation to the next over the next two decades, the use of insurance and annuities can play a critical role in both the lifetime income needs of a retiree and the transfer of wealth.

To start, let’s consider the true purpose of estate planning.

In my opinion, estate planning is more than reducing taxes to the beneficiaries. It’s an important part of the planning process that can’t be ignored. But I think the following is a more appropriate definition of estate planning:

Estate planning is making sure you enjoy the assets for as long as you want and then have the assets go to the proper person at the proper time at the proper value with the least amount of delay. And, if there are tax advantages to doing so, that is an additional benefit.

Why Annuities are Powerful NOW

For years, I’ve attended educational events, seminars, and webinars that claimed annuities were great to have in your portfolio but terrible to have in your estate on your date of death.

For years, I didn’t disagree with that assessment.

However, I recorded a video about how the current environment favors the use of annuities in estate planning. You can find it on my LinkedIn profile.

Tax-deferred growth is always a great tool to assist in the accumulation of wealth.

Conventional wisdom dictates that you should liquidate the annuity prior to death so that your beneficiaries do not incur all the tax consequences on the deferred growth. That would be especially true if the current annuitant or owner is in a lower tax bracket than the beneficiaries. This is often the case as many times the beneficiaries are children and are in their peak earning years. All of this is done with the wealth transfer in mind to help lower the taxation of the assets going to the next generation.

But, looking back at our definition, the first part of estate planning involves allowing someone to use assets for as long as they need them. And that creates a lot of problems for many Americans. With longevity ever increasing, we must be more efficient than ever on creating income.

For example, a low-interest-rate environment from 2009-2022 forced many retirees to commit more dollars to their income needs. And they used more of their assets to produce income by having a withdrawal percentage higher than their return. Overall, this might have lowered the gifting rate for many Americans.

Add to that the uncertainty of the Tax Cut and Jobs Act (TCJA) repeal and decision-making becomes tenuous. Regardless of the outcome of the extension or a sunset of the TCJA, the main tax issue for many beneficiaries remains income taxation.

How Assets are Transferred

Nearly half of the assets being transferred are qualified funds.

Since the mid-1970s, many workers have taken advantage of defined contribution plans like 401(k)s, IRAs and 403(b) plans. Unlike a pension, which typically has zero estate value at the death of both spouses, these defined contribution balances are included in the estate of the decedent. The estate tax exemption may cover the estate tax; however, the transfer of those will be income taxable at the beneficiaries’ highest marginal rate. This affects the final value of the asset that will be transferred to the next generation. Trying to complete the transfer for full value and the control of timing is critical.

We have a unique economic opening as interest rates have improved significantly since the financial crisis and the pandemic-era monetary policy.

When interest rates are at their current level, there are two benefits to insurance products.

First, annuity payout rates have increased dramatically over the past 24-30 months.

Second, higher interest rates favor lower life insurance premiums for the same amount of coverage just a few years ago.

Annuities + Life Insurance = Arbitrage

Because of this break, the arbitrage on annuities and life insurance has not been as wide for several decades. Therefore, we need to take advantage of the current situation and create wealth transfer that will last for decades.

We are seeing incredible increases in income from annuities that are as recent as just four to five years old. This is largely due to the change in pricing that the higher interest rate environment provides. These higher payouts actually use more of the client’s assets faster, so the contract reaches zero sooner than in years past. That might not seem like a great deal, but the estate value goes to zero at that point. Essentially, the contract becomes an annuitized contract. Even if it were to remain a deferred contract with an income rider, the beneficiary can be a charitable entity to manage the income tax and create a legacy beyond the family.

Some of the annuity audits that we see come across our firm have increased income by 30% to as much as 67%.

With the additional income from the annuity, cash flow can be directed to purchase a life insurance policy equal to the amount of the qualified fund or asset. The policy can have specific beneficiaries or be placed inside of a trust for more control of the distribution of the proceeds. Of course, the advantage of life insurance is that it is received by the beneficiary income tax free.

Therefore, the amount of the asset transfers for the full value (or value the owner chooses to transfer to the next generation) on a timely basis with no taxation. If inside a trust, the owner has complete control of the distribution and timing of the asset through the trust document. You may think that the Secure Act limits some flexibility on qualified funds but remember that the qualified funds have been replaced by life insurance, a nonqualified asset with no gain in the trust.

End Result

Annuity Arbitrage allows your clients to pass a significant amount of assets without the cost of taxes. Because we don’t have to worry about income taxes to the beneficiary, we can focus our attention on the true meaning of estate planning: making sure the client controls the asset as long as they want and pass the value they want when they want and how they want.

I am confident that if you ask your clients if they want to control how their qualified accounts are distributed and do so with control and eliminate or reduce taxation, many will sit down with you and listen to the strategy.

Our Resources

Ash Brokerage has many resources to help you develop these cases. Please check out our recorded webinars, short videos, and blogs explaining the concept and providing conversation starters.