Use Annuities As A Tax Shield: CPA

October 23, 2013 by Linda Koco                 

Time was, before the era of the feature festival in annuities, agents and advisors used to present annuity options based on the client’s tax needs.

According to Jeffrey Levine, certified public accountant, this may be the time to return to that strategy. Anytime there is an increase in taxes, “we’ve got to look at re-evaluating our tax strategy,” he told a workshop at the recent annual meeting of National Association of Insurance and Financial Advisors (NAIFA) in San Diego.

A lot of people do not realize it, but many Americans could see higher taxes in 2013, said the individual retirement account technical consultant with Ed Slott and Co. That is due to changes in the tax code that are going into effect this year.

Annuities as a tax play

Tax increases might be the incentive that advisors need to go back to using annuities “strictly as a tax play,” instead of just for the benefits and riders, which Levine said has become more of the norm in recent years.

In 2013, he explained, there will be four income calculations that wealthier clients will need to make. Depending on the outcome of those calculations, a client could be facing higher taxes than expected.

In brief, the four calculations Levine mentioned are:

1)      Taxable income.  Clients could be subject to the 39.6 percent top income tax rates after doing the calculation for taxable income, he said. That top income tax rate kicks in if the client’s taxable income is more than $400,000 for single filers, or more than $450,000 for marrieds filing jointly.

The taxable income is the amount that remains after taking out itemized deductions and personal exemptions, both above and below the line, the CPA said. A client could have gross income of $600,000 but after calculating deductions and exemptions, the taxable income could be much lower.

2)      Adjusted gross income. In 2013, Levine said, personal exemptions and itemized deductions will begin to phase out. The phase-out will be based on adjusted gross income (AGI), not taxable income, he pointed out, noting that this calculation does allow for deductions of things like IRAs and student loans but not for itemized deductions. In addition, the threshold for phase-out begins at $250,000 for single filers or $300,000 for marrieds filing jointly, so it’s different than for the taxable income calculation. The calculation for this needs to be done separately, he said.

3) and 4) Health care surtaxes. The threshold for two health-related surtax calculations is the same as for the AGI calculation ($250,000 for single filers or $300,000 for marrieds filing jointly). “But you have to calculate income in two different ways to get there,” the CPA said.

A 3.8 percent surtax (related to Medicare)applies to people who have a modified adjusted gross income (MAGI) above the threshold; for most clients, the MAGI will be the same as the AGI, he said.  A 0.9 percent surtax, also related to Medicare, has the same income threshold as the AGI calculation but “you need to calculate this based on earned income,” Levine said, pointing to use of W-2 income tax amount and self-employment income—not AGI or MAGI.

Most clients are clueless

Most clients have no idea about the thresholds and other taxes that are coming in this year, Levine said.

“They don’t realize that adding just one dollar of income might equate not just to putting them into a higher tax bracket; it might also cost them their deductions and exemptions, and it might throw them into a 3.8 percent health care surtax.”

The great thing for advisors is that they have many tools at their disposal to help clients, Levine said. The tools include wealth conversion and annuities.

Advisors who work with annuities can use the products to smooth out a client’s income, he said. For instance, advisors can use the products to “shield” from taxes not only the income that would otherwise be subject every year to taxes on interest, dividends or capital gains, but also from taxes related to the 3.8 percent surtax.

Non-qualified annuity distributions are subject to the surtax, he added, but that doesn’t happen until the client takes the money out. And that usually doesn’t happen until retirement, when the client’s income might be lower, he said.

Hence the incentive to consider using annuities for tax planning, Levine said.

Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda can be reached at linda.koco@innfeedback.com.

If you were born poor...it's not your mistake.

Whether you follow Don Trump or not, you would have had to be really out of it to miss his Twitter remarks this week: "If you were born poor, it's not your mistake. If you die poor it's really your mistake."

Trump's other remark today also bears some consideration: "I try to learn from the past, but I plan for the future by focusing exclusively on the present. that's where the fun is."

Whether you agree with Trump is not as important as the provocative "stick it in your eye" issue of what the young does with the future these days -- which is probably some more important than whether the current political environment plans to take care of them in the end.

Based on what this government is going to do for the elderly, the young should pay attention. How you prepare for retirement will make a big difference in the way you celebrate it.

The phrase Generation Y first appeared in an August 1993 Ad Age editorial to describe teenagers of the day, which they defined as different from Generation X, and then aged 12 or younger as well as the teenagers of the upcoming ten years.^[6] Since then, the company has sometimes used 1982 as the starting birth year for this generation

It appears that the recession has walloped the youngest, least experienced workers the hardest. They have the highest unemployment rate AND the highest rate of educational attainment (and school loan debt), which leaves them much worse off as they start out than their parents were in the Boomer Generation. Even if their parents were in Generation X, they were still better off than today’s 20-something Millennials.

Having said all of that, the 80/20 rule still applies. Twenty percent will survive well, 80% won't. That rule is pretty well established over time, or such has been said consistently.

Given that at least some of the millennials are into the 30 year old group, some of them, believe it or not, are already thinking about retirement, if not much.

Here's an idea. Let's start thinking about a financial plan other than up the risky ladders at the wall street casino -- something with some meat in it -- and little or no risk -- something that can be gained with little money invested. Something that will get our young started into the future early and not after the piggy bank is broken and all the money is gone, spent in "happy for the night" and frivolous and pointless experiences.

Let's say Jayson, a millennial at 29, has no retirement plan yet and no company to leverage his contributions or buy him a life insurance plan to cover his debts when he exits.

Let's also say Jayson has a pretty good job and a little loose change. What can he do with it? If he's paying back college debt, he'll still be able to do this with a little focus on the future.

He can buy an indexed life insurance plan from a reputable company now at $100 per month (or less) and turn that contribution into $200k at retirement, having contributed only $44k himself. The rest is interest and indexing magic with no risk from the ups and downs of the market.

Make sense to the millenials? Not many, you might say. But, some will take the bait and end up in retirement with a sizeable buffer against the incoming tide of retirement.

If not, it will probably be their  mistake and if my hunch is correct, less other people will stand by them as we do now with our elderly as these millennials age into retirement, home equity spent on continuous lines of credit until there is nothing left to finance.