Do you have a client who is considering a potentially large annuity purchase? If so, you may want to consider the benefits of breaking up the big contract into smaller, bite-sized ones instead. Here’s why.
Instead of selling a $300,000 annuity, consider three $100,000 contracts. This strategy doesn’t cost the client (or the agent) anything but provides significantly more flexibility.
2. Targeted payout options
Should the client decide to take some form of annuitization, doing so with a policy that has doubled in size would be akin to trying to take a sip from a fire hydrant. Multiple contracts provide the opportunity to stagger payout options to accomplish specific financial goals.
3. Multiple beneficiaries
A multiple contract approach can provide significantly more flexibility when multiple beneficiaries are involved. You can more easily provide for disproportionate inheritances and eliminate the complications and delays involved with trying to get several beneficiaries to agree on or submit a claim for a single large policy.
4. Feature diversification
If you are selling equity indexed annuities, you know there are many design choices (annual point-to-point, monthly average, monthly point-to-point, etc.). Any of these designs could potentially outperform the others under a given set of market conditions. By using multiple contracts with different crediting methods, you essentially diversify your clients’ portfolio and eliminate the idea of “putting all your eggs in one basket.”
5. Reduced company risk
Multiple contracts with different companies also reduce the risk of failure by a single carrier.
6. Tax leverage
The Split Annuity concept has been around for years. Split annuities work best with non-qualified funds and are an ideal alternative for clients using CDs to generate income. The income derived from a CD is subject to tax as ordinary income – typically reducing real cash flow by about 30%.
The combination of a single premium immediate annuity (SPIA) with a single premium deferred annuity can provide significant tax leverage. If, for example, a SPIA is designed to provide the same monthly gross income, the net income to the client will be significantly larger because the exclusion ratio (the portion of each payment considered to be a tax-free return of principal) may be as high as 90%. The deferred annuity can grow undisturbed while the client receives a safe, consistent, dependable income stream.
7. Income ladders
The split annuity concept also works well when designing “strategic” income ladders.Whether qualified or non-qualified, a SPIA, combined with several deferred contracts, can be used to design a custom income strategy. In today’s low interest rate environment, annuitizing for a long period of time may not be in the clients’ best interest. By choosing a relatively short SPIA term (5 years for example), you not only provide for current income needs but can “ladder” contracts that require 5 or 10 years to provide maximum yield.
8. Annuity Capital Enhancement (ACE)
Clients often purchase annuities to defer taxes during their lifetime and pass proceeds directly to heirs without the costs and delays of probate. Whether the annuity is qualified or non-qualified, it may be subject to significant depletion at death. Assuming the beneficiary is someone other than a surviving spouse, the contract will be subject first to income taxation (to the extent of any gain in the contract for non-qualified policies and on the entire amount for qualified policies). Next, it will also be included in the decedent’s estate for estate tax purposes. The combined tax hits can be significant.
On the other hand, if the client is insurable, consider transferring the contract into a competitive single premium immediate annuity (SPIA) with a single life alone payout. Calculate the exclusion ratio (if any) and set aside enough of the monthly income to cover income taxes. Use the net income to purchase a guaranteed death benefit life insurance contract. If the proper steps are taken, an ACE program could effectively double the proceeds to heirs and make it all tax-free. It will also immediately remove the annuity contract from estate taxation! We have effectively used ACE to increase inheritances or generate significant funds for charities.
Annuities clearly are one of the most valuable planning tools for the senior client. But, as you can see, providing clients with a big, “one size fits all” contract solution may not always be the best way to go. Is smaller better? It can be, depending on the circumstances.
That’s why, at Highland Capital Brokerage, we specialize not only in accumulation and preservation for your clients but also in effective distribution strategies.