Consider the wealth transfer benefits of annuities
by Brandon Buckingham, JD, LLMMr. Buckingham is Vice President, National Director, Advanced Planning Group Prudential Annuities. Visit prudential.com
Wealth transfer advice is in high demand. Baby Boomers are receiving inheritances from their aging parents and, in turn, want to set up strategies to transfer their own wealth to the next generation. It’s estimated that $30 trillion of generational transfers will take place over the next three decades. 1
Proper wealth transfer planning will be critical for these Boomers.
Although estate planning in the past largely focused on avoiding or reducing estate taxes, with a current federal estate tax exemption of $5.49 million per person and the possibility that the estate and gift tax could be repealed, that’s no longer the case.2 For most, the focus will probably be on how to grow, protect and control their legacy. Accordingly, it may be time to consider the legacy planning benefits and features offered by some annuity providers.
Growing and Protecting Your Legacy
Many variable annuities today provide owners the ability to participate in the market, build a customized and well-diversified portfolio with a full range of high-quality investment strategies to help meet their needs and goals. Annuities may also provide various protective features. A common annuity guarantee provides a death benefit equal to the greater of (a) the contract value at death or (b) the original contribution, less any prior withdrawals.
Additionally, some annuities offer an enhanced roll up death benefit that will grow at a guaranteed rate, sometimes up to 200% of the original investment, regardless of investment performance. This gives owners the upside potential of the markets for their beneficiaries, the confidence to stay invested during volatile times and a level of protection against loss for their heirs. Another benefit of an annuity is that it grows tax deferred, possibly over multiple generations, providing the owner and beneficiaries control over the timing of taxes as well as tax-free portfolio rebalancing.
Annuities also pass outside of probate, avoiding associated expenses and delay. Finally, annuities often provide owners flexible wealth transfer options and the ability to control how and when their legacy is distributed.
Flexible Wealth Transfer Options
Beneficiaries can choose to take their inheritance in a lump sum, to annuitize their inheritance, providing guaranteed lifetime income, or elect to stretch the distributions over a period of time not to exceed their lifetime.
The IRS rules stipulate that beneficiaries are required to take an amount, at least annually, based on their life expectancy, beginning by the first anniversary of the death of the account owner. For IRAs, the distributions must begin by December 31st of the year following the year of the owner’s death (the “RMD rules”). The minimum amount is calculated each year by dividing the account balance by a life expectancy factor based on the beneficiary’s age. This distribution election permits beneficiaries to stretch their tax liability over their life expectancies, allowing the undistributed amount to continue to be invested and grow in a tax deferred manner.
If the surviving spouse is the beneficiary, he or she can elect to be treated as the new owner of the contract and not merely a beneficiary. This spousal assumption (or “spousal continuation”) is not a taxable event and the spouse can elect to distribute money from the contract at any time, or not annuitize until the contracts maximum maturity date.
Controlling Your Legacy
Seventy-eight percent of Baby Boomers feel the next generation is not financially responsible to handle an inheritance3. Restricted beneficiary forms provide the contract owner the ability to control their legacy “from the grave” by placing restrictions on how and when beneficiaries will receive their inheritance. The owner can generally select one of several predetermined payout options.
For example, the owner could force one or all beneficiaries to withdraw only the minimum amount required by the IRS. In other words, the beneficiary would be forced to take a “stretch” payout. Some restricted beneficiary forms are more flexible than others. Some annuity providers permit the owner to force the beneficiary to take a fixed percentage amount each year so long as the RMD rules are satisfied.
Other beneficiary forms will allow the beneficiary to receive a percentage of the death benefit up front with the remainder paid out over his or her lifetime. The owner can also elect to lift the restrictions once the beneficiary attains a certain age or can elect a combination allowing a portion of the death benefit to be paid up front, then just RMDs for the remainder amount, but then unlimited account access at an age predetermined by the owner. These restricted payout options are appealing for those who fear their beneficiaries will mismanage, lose or otherwise squander their inheritance.
Annuities with enhanced death benefits may be appropriate for those that have investments, retirement accounts or existing annuities which they no longer need for retirement income purposes but would rather grow those assets to pass on to the next generation.
1. Investors who are concerned about increased volatility and market losses
We are more than 8 years into a bull market. For some, it might be a good time to “lock in” market gains and continue to grow them on a guaranteed basis for the next generation.
2. Investors who would like to control their legacy
For those that do not feel their heirs are financially responsible, a restricted beneficiary payout election provides contract owners the ability to control their legacy “from the grave” by placing restrictions on how and when the beneficiaries will receive their inheritance.
3. Investors where life insurance may not be available or suitable
Annuities will never replace the wealth transfer benefits of life insurance. But they could be an attractive alternative for those where life insurance may not be available or suitable, whether due to insurability issues, the desire to participate in the markets or the need for greater access to their underlying investments.
4. Investors looking for tax deferral
Annuities with death benefits gives owners the ability to grow and compound their legacy on a guaranteed and tax deferred basis. Some may not want to pay taxes on income they are not spending and on assets they plan to pass to their children and grandchildren at a later time.
5. Irrevocable trusts
Certain funded irrevocable trusts where the goal in part is not to generate current income but rather to grow trust assets to pass to the next generation. The income generated in these trusts is taxed much differently than income received by individuals. Irrevocable trusts are subject to very compressed income tax brackets. A trust hits the top federal income tax rate of 39.6% on income as low as $12,500 (in 2017, indexed for inflation). If structured properly, the annuity will maintain its tax deferred status and provide trustees the ability to avoid recognizing current income that could be subject to such high tax rates.
6. Roth IRAs
Many wealthy clients funded Roth IRAs purely for estate planning purposes. Roth IRAs grow tax free over the owner’s life but also over the life expectancy of the beneficiaries. That’s two generations of tax free growth potential. Furthermore, many clients funded Roth IRAs because they are not subject to the RMD rules during the owner’s lifetime. Therefore, they are not forced to spend down assets they want to pass to the next generation. This may present an opportunity to guarantee and control tax free assets that clients already have earmarked for legacy purposes.
For those that are looking for ways to grow, protect and control their legacy, it may be time to learn about some of the features and benefits offered by today’s annuities. ◊
1. Source: Accenture. The “Greater” Wealth Transfer – Capitalizing on the Intergenerational Shift in Wealth, Morgan Stanley, 2016
2. Source: www.IRS.gov 2007.
3. State Street Global Advisors, 1/4/2016; US Trust Survey of High Net Worth of $3 Million or more, June 2015;