Legacy & The Finance of Retirement

A Less Taxing Approach to accumulate, and safeguard, your client’s wealth

by Laurence P. Greenberg

Mr. Greenberg is President of Jefferson National, innovators of the industry’s first flat- fee Investment Only Variable Annuity (IOVA) with the industry’s largest selection of underlying funds. To learn more, please visit http://www.jeffnat.com or call 1-866-WHY-FLAT (866-949-3528).

Peaking at 78.8 million in 1999, the Baby Boomers’ outsize presence has radically changed the financial services industry. But a shift is taking place as more Boomers reach retirement age.

Today money is in motion. The most successful advisors are retooling their business to serve multiple generations. And legacy planning is becoming increasingly important.

Generations Shift—Wealth Changes Hands

The first Boomer turned 65 in 2011. And roughly 10,000 Boomers will turn 65 every day until 2029 according to the Pew Research Center. Many financial advisors have found success by catering to Boomers’ financial needs as they prepare for and enter retirement. When Jefferson National recently surveyed RIAs and fee-based advisors, 75 percent said that Boomers will continue to be their primary target for new clients over the next five years.

But at the same time that Boomers are exiting the workforce, the Gen X population is in their prime earning years, projected to peak in 2018 and to outnumber Boomers by 2028 according the U.S. Census Bureau. Likewise, the number of Millennials is on pace to surpass Boomers this year—and will remain the largest cohort for the next three decades.

For RIAs and fee-based advisors, this presents a massive opportunity. In recent years, an estimated $12 trillion has been changing hands, as Boomers inherit wealth from their parents. And an even greater transfer of wealth will take place over the next 30 to 40 years. More than $30 trillion—almost twice the GDP of the United States—will pass from Boomers to their Gen X and Millennial heirs according to Accenture.

Retaining Heirs—and Protecting Wealth

To capitalize on this generational shift, more than half (57 percent) of advisors have a strategy in place to retain the heirs of their clients, according to Jefferson National’s latest survey. And the vast majority (78 percent) of these advisors says their primary strategy is building relationships with the heirs of their current clients. More than half (57 percent) are confident or very confident in their approach

This survey also showed that nearly two-thirds (63 percent) of advisors say that legacy planning is important or extremely important to their clients. While your expertise in holistic planning and investment management is essential to maximize and protect their assets, you can further help your clients by developing effective legacy plans by partnering with an experienced estate planning lawyer and tax expert. Without a plan for the transfer of wealth, clients’ heirs may be subjected to a number of factors that can erode the value of the legacy that you and your clients worked hard to create.

Trusts are widely used for legacy planning, especially with high net worth and ultra-high net worth clients. Whether making charitable contributions or providing for family members, trusts can offer many advantages, helping to reduce estate and gift taxes, avoid probate, and protect assets from creditors and lawsuits. According to Jefferson National’s latest survey, nearly three-fourths (72 percent) of advisors use trusts as a vehicle for wealth transfer. And a plurality of advisors (47 percent) said that trusts are their primary vehicle for this purpose—substantially outpacing all other options.

A Less-Taxing Approach to Legacy Planning

Drew J. Bottaro, Esq., CFP®, Vice President & Senior Financial Counselor at Weston Financial (Weston), and an expert who has taught estate taxation at the graduate level, cites two main reasons for recommending trusts. “One is for controlling assets that one person owns or used to own, where someone else is the beneficiary. That’s the classic purpose, the governance point of view. The second, which tends to drive the decision more often lately, is tax planning—typically estate tax planning or income tax planning.”

An overwhelming majority of advisors (97 percent) consider tax consequences when looking at vehicles to use for wealth transfer, and 84 percent said it is important or extremely important to use a vehicle for wealth transfer that helps manage long term tax consequences. One strategy that is becoming increasingly popular is funding a trust through an investment-only variable annuity (IOVA).

A new category of annuity, IOVAs are designed to maximize tax deferral with low fees, or even flat-fees, no commissions, and no surrender charges and an expanded lineup of underlying funds. The idea behind using an IOVA to fund a trust is simple—it can maximize tax-deferred growth during the accumulation phase and is easily transferrable to a named set of beneficiaries. At the same time, by funding trusts with an IOVA, trustees can control the timing of income distribution from the trust—and control when taxes are paid on that income.

Today money is in motion. The most successful advisors are retooling their business to serve multiple generations. And legacy planning is becoming increasingly important.

This is important because tax rates on trust income are high—even at very low thresholds. In 2015, the maximum tax rate of 39.6 percent plus the 3.8 percent net investment income tax come into effect at just $12,150 of trust income, compared to $413,200 of income for an individual taxpayer. By funding a trust with an IOVA, no income will be recognized until the beneficiary begins making withdrawals, so it will continue to accumulate tax-deferred.

Eight out of ten advisors agree an IOVA would better serve a client’s trust than a traditional variable annuity. “Typical annuities are not the right fit for most investment management models, as they’re not advisor-friendly in many ways,” Bottaro notes. “The layers of asset-based fees. The limited selection of funds. The back-end ‘deferred sales’ charge [redemption fee]. And that’s where a low-cost Investment-Only Variable Annuity with a broad choice of underlying funds provides the competitive advantage.”

With low costs that help maximize tax-deferred growth, and the right choice of funds to enhance diversification and manage volatility, IOVAs can help clients build and maintain more wealth within the trust. “We can execute the investment strategy almost exactly as we do on the taxable side,” Bottaro adds. “We can use it for managing investments with unlimited tax deferral wrapped around it.”

Funding Trusts with IOVAs to Reduce Taxes—and Increase Accumulation

When using an IOVA to tax-optimize trusts, there are important guidelines. The trust must act as an “agent of a natural person” for any type of annuity to be used. Further, there are distinct types of trusts that keep the annuity’s tax-deferral intact, and each of these can offer specific advantages to minimize, delay or eliminate trust income, helping reduce the tax burden to increase accumulation. The most common types include:

  • Revocable trust
    Valuable for grantors in a high tax bracket, to avoid investment income during working years, and leverage tax deferral until taking a distribution. Typically adopted for three reasons: 1) assets in the trust will avoid probate at death; 2) Trustee can manage trust assets if grantor is unable or unwilling; 3) Trust terms dictate transfer of assets after grantor’s death, acting as a “will substitute.”
  • Net income with makeup charitable remainder unitrusts (NIMCRUTs)
    Reduce taxation of highly appreciated assets and take tax deduction for charitable contribution the year NIMCRUT is established. Retain ongoing stream of income, while control the timing of income distribution until it is needed in retirement.
  • Credit shelter trusts/Bypass trusts
    Part of a plan to reduce estate taxes, set up by one spouse for the benefit of the surviving spouse and any children. If surviving spouse has sufficient resources for current needs, putting assets into an IOVA keeps current trust income to a minimum—and saves more future assets for children. Consider holding one annuity for each child within the trust, making it easier to distribute when the trust terminates.
  • Special needs trusts
    Keep trust assets separate from the assets of the special needs child to help preserve Supplemental Security Income and Medicaid benefits. Premature distributions from the IOVA will likely be exempt from 10% IRS penalty for early withdrawal since the annuitant is likely to be disabled.

Start Planning for Your Business—and Your Next Generation of Clients

With an effective legacy plan, you can help clients accumulate wealth most efficiently—and then safeguard that wealth for their heirs and control the distribution. Trusts are widely used for this purpose. And funding trusts with a low-cost Investment-Only VA can offer measurable benefits in many scenarios. The longer tax obligations are deferred, the longer the assets can build upon themselves and compound. IOVAs help you control how much is paid in taxes—and when those taxes are paid— to reduce the tax burden and retain more wealth for clients and their beneficiaries.

Don’t wait for clients to bring up their concerns about wealth transfer. With many studies showing that up to 90% of children fire their parents’ financial advisor after they receive an inheritance, it’s important to take action. Our research shows that the most successful advisors focus on multi-generational legacy planning. Redefine your approach with family-centric solutions. Implement strategies to retain clients’ heirs—and to attract the next generation of investor. By evolving your practice in this way, you can plan for your business—and bring on your next generation of clients.