Annuity Illustrations
Annuity Marketing, Sales Ideas, Suitability, and Issues by Michael J. Prestwich

The conventional wisdom when doing a Roth IRA conversion in 2010 is to advise your clients to take Congress’ generous offer and wait to pay half the tax in the 2011 tax year and the other half in the 2012. However, it will be better for many of your clients to attribute the income to the 2010 tax year because of the tax increases that start in 2011:

·         the 10% tax bracket sunsets. This means that those filing Joint tax returns will pay 15% instead of 10% on the first $17,200 of income ($8,600 Single), an $840 tax increase.

·         the marriage penalty will return. Taxpayers who file a Joint return will pay 25% on $29,050 of their income instead of 15%. This is a $2,905 increase for Joint tax payers with Adjusted Gross Incomes of $174,800 or more.

·         the 31% income tax bracket will be replaced by 33% and the 35% tax bracket has been replaced by 39.6%.

·         If HR 3200 becomes law, add a 1% surcharge to the 31% tax bracket, a 2% surcharge to the 39.6% tax bracket, and a 4.4% surcharge on income that exceeds $1,000,000 – that’s 44%.

So what does this mean in dollar and cents terms?  Here are the tax calculations for a $1,000,000 Roth IRA conversion for a retired married couple, filing a joint return, who have an Adjusted Gross Income of $250,000 and itemized deductions of $50,000:

2010 Taxes Without Roth IRA Conversion: $41,811

2010 Taxes With $1,000,000 Roth IRA Conversion:  $386,848

Roth IRA Conversion Cost: $345,037

2011 Taxes Without Roth IRA Conversion: $43,484

2011 Taxes With $500,000 Roth IRA Conversion:  $241,716

2012 Taxes Without Roth IRA Conversion: $43,173

2012 Taxes With $500,000 Roth IRA Conversion:  $240,280

Roth IRA Conversion Cost: $395,339

In this situation, your client would save over $50,000 in Federal Income Taxes by attributing the $1,000,000 income from the Roth IRA Conversion to 2010 instead of $500,000 in 2011 and 2012. Clients who have lower incomes and/or smaller rollovers may find that splitting the income between 2011 and 2012 is ideal, but in this situation, this is clearly not the case.

Take home message: Before making a Roth IRA Conversion recommendation, first calculate the income tax ramifications for your client.

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In 2010 thousands of retirees will get conned by misinformed or unscrupulous salespeople who will talk them into an unsuitable Roth IRA conversion. If you want to become one of those people who, like Bernie Madoff, make themselves rich at the expense of their unsuspecting clients, here is a step-by-step guide:

1)    Use a Roth IRA Conversion calculator similar to the one offered by CalcXML.  This calculator is perfect, because it leaves no trace; your name does not appear, nor does the name of your client. Throw away the second page to avoid embarrassing questions about your input.

2)    Use a lower tax bracket in the pre-retirement, “accumulation” years than the post-retirement, “distribution” years.  This printout uses 25% and 33%.

3)    Since this client does not have $250,000 of ready cash to pay the taxes for the conversion, use “Option 2,” where the taxes are painlessly paid from the existing IRA funds.

4)    Sell a product that has a 25% premium bonus and explain that the bonus will cover the income taxes.

Informed financial professionals can instantly see problems with the above scenario:

1)    Ethical financial professionals never use calculators that omit their contact information, the client’s name, assumptions used, pertinent disclosures, and includes a sentence about seeking the advice of an income tax professional.

2)    A Roth IRA Conversion calculator that uses “Tax Bracket” fields can be manipulated to deceive the client as I did in the sample printout. As a minimum it should have an input for “Adjusted Gross Income” and use the income tax rates that President Obama proposed for 2010 and beyond.  Nobody who has $500,000 added to their income in a single year is in a 25% tax bracket!

3)    The software should take all income tax ramifications into account.  The sample printout does not take into account the fact that the client is age 56, and would incur an additional $25,000 tax penalty (10% early withdrawal penalty).

4)    Taking into account both of above mentioned potential tax issues, the income tax impact for this client is about $250,000 higher than what was disclosed!

5)    Products with premium bonuses may help offset current income taxes, however, a premium bonus is never “free.”  There is always a cost somewhere, often in the form of lower interest rates.

I recommend the following safeguards to protect consumers from tax penalties and financial institutions and their representatives from potential lawsuits:

1)    Insurance companies, marketing organizations, and broker / dealers should train their representatives about a how a Roth IRA conversion will affect a client’s current and future income tax situation, and how to determine whether it is suitable for their client.

2)    Insurance agents and registered representatives should insist that a licensed income tax professional review the tax calculations and assumptions of Roth IRA conversions over $100,000.  This may save the client tens of thousands of dollars in taxes, and a tax professional’s endorsement may shield against a future lawsuit.

3)    File a complaint with the appropriate supervising authority against any insurance agent or securities representative who uses the above unethical approach to Roth IRA conversions. 

4)    Financial institutions should review all calculations and reports, including the tax professional’s review, before implementing a Roth IRA conversion.

If you sell annuities you probably know on December 17, 2008, the SEC enacted Rule 151A that redefines the definition of the term “annuity contract” under the Securities Act of 1933. The primary target of this ruling is fixed indexed annuities, but many in the insurance industry believe that this rule may soon extend to all fixed annuities because of the SEC believes the rule extends to annuities “if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract.”

ImagiSOFT, Inc. is sponsoring a promotion to help the National Association of Fixed Annuities (NAFA) fight this SEC rule. The heart of the SEC’s arguments center around suitable sales.  Through September 1, ImagiSOFT is offering a FREE two-year license to DataNet, a powerful software system to help you make higher quality annuity sales by following state suitability laws. Click this I Love Suitability link for details. This page gives an overview of state suitability law and how DataNet addresses these issues.  This page also explains how to get a lifetime free license to DataNet when you donate $250 or more to the NAFA Opposition Fund.

Lack of suitable annuity sales is the key argument that the SEC has used to defend their position why they should regulate fixed annuity sales instead of the states.  This argument has deep flaws. State suitability laws state that each agent should have a “system” to ensure that suitability laws are being followed, and that records must be kept (depending upon the state) from 3 to 10 years.  If you sell fixed annuities, make sure that you are not part of the problem — use a compliant “system” to follow state suitability laws, even if it is a thick, paper file.

Lastly, write a letter / email to your State Insurance Commissioner.  Tell them that you are following state suitability law, that you have a “system” to comply with the law, and that you believe that the state suitability law adequately protects consumers in your state.  Also write your State Representative and give him or her the same message, with the admonition to support the “Indexed Annuities and Insurance Products Act of 2009” recently introduced by Congressmen Greg Meeks (D-NY) and Tom Price (R-GA).  For more information see http://www.nafa151a.com/.

Please let your colleagues and associates know about ImagiSOFT’s free two year license to DataNet by sending them a link to this site.  The two-year free license offer ends September 1, 2009 so do this now.  The future of everyone who sells fixed annuities depends upon winning this fight!

Mark, age 39, reported on CNBC’s “On the Money” program that he invested $175,000 into Equity Indexed Annuities over the past five years and the value today is over $225,000. He has friends telling him to surrender the annuity for the $200,000 “put it into the market.” Mark asks the panel if this is a good idea. Off camera Mark must have told the panel that the surrender period ends in May, which explains why two of the panelists suggest that he wait a few more months to review this product.

See http://www.youtube.com/watch?v=iOyXfcB9r6s

Here are some highlights:

“It’s a ludicrous penalty (obviously understands that annuities have a 10% tax penalty prior to age 59 1/2) – you shouldn’t get out now. This is an Equity Indexed Annuity. That means that your principal is protected – you are going to get $225,000 out of this annuity.”

(By getting out) “You are looking at product picking . . . this product here, this timing here . . . you really need to sit down and work out a plan to decide what you are trying to accomplish over time . . . what is this money for?”

“You started with $175,000 and now have $225,000 now? I wish I had a product that had grown from $175,000 to $225,000 in the past five years, that’s not bad.

“Don’t try to time it [the market] we saw what happened today . . . if you put all your money in one day, you could lock in your losses.”

“This is a 5.15 – I figured it out – a 5.15% rate of return for the past five years. You should patting yourself on the back – actually thanking that person that sold you the equity indexed annuity – stick with it!”

It is refreshing to see a few positive statements made by the press and about fixed indexed annuities.

The take home message for agents: sell the product that is best for the client as Mark’s agent obviously did. Five years ago, when Mark was age 34, he must have been looking for a safe place to put $175,000, for the long term, that had tax deferral, and the potential to earn an interest rate higher than most other safe-money accounts.

The other day in Costco I found the small book, Jeffrey Gitomer’s Little Teal Book of Trust: How to Earn It, Grow It, and Keep It to Become a Trusted Advisor in Sales, Business, and Life. Over the years, I have found that lack of trust, or credibility, is the number one reason people fail in the financial services industry. What is worse, your prospect won’t tell the salesperson that lack of trust is the reason they didn’t buy, but they offer an excuse such as, “I want to shop around,” “the rate is too low,” or a million other things. Here is an outline of Jeffrey’s book:

·         Tell the truth. This is the number one element of trust AND relationships.

·         Do what you say you will do. This is a test for being trustworthy and reliable.

·         Communicate in a timely manner. This shows you are responsible, on top of it, and that you care.

·         Bring value beyond your product or service. What you do to help others be more successful is a true reflection of your character.

·         Be on time. Being on time shows you respect the other person’s time.

·         Be friendly. Smiling people are the gateway to open communication.

·         Be sincere. This can only come from belief in what you do, loving what you do, and caring for others.

·         Show and say genuine thanks. Be grateful for the opportunity to be of service.

·         Be consistent. I believe this element of trust is the most difficult to master because it combines all the other elements.

·         Give trust. You become trustworthy by giving trust.

This may be the best $20 you will ever spend.  Buy it, and live by its principles.

I spoke yesterday with an agent who had just made a substantial annuity sale. I asked him which product he sold. I then asked him how he disclosed the fact that this Fixed Indexed Annuity product is designed primarily for income, the index growth only applies to the annuitization value, not the accumulation value, and that the cash surrender value of this product after 10 years would probably be less than the original premium.  He was shocked, and couldn’t believe his ears. He said that this particular product is one of the most heavily promoted and highest sold in the industry. Among other things, I told him to read the fine print in the six page disclosure.

I believe that there is a relationship between the number of complaints a company has, and the quality of the agent training, disclosures, and illustrations a company produces. Do you agree?  Jack Marrion’s Index Annuity website just released a list of companies that sell Indexed Annuities and listed them in order of the least number of complaints to the highest: 2007 Index Annuity Complaints

The company with the highest number of complains receives 20 times the number as the company with the lowest. Comment if you believe there is a correlation between the number of complaints and the quality of training, products, disclosures, calculators, illustrations, and other agent’s services that a company provides. Do the companies listed provide a calculator that discloses the guaranteed minimum surrender value, for example?  I know, for example, that the company listed at the top, Great American Financial Resources, provides an Indexed Annuity Illustration system that discloses everything – formulas, surrender values, guaranteed minimum surrender values, cost of income riders, hypothetical values both current and guaranteed.

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There are important lessons to be learned by those who sell financial products from yesterday’s FINRA News Release announcing that Morgan Stanley is ordered to pay over $7 Million in fines and restitution to clients. Here are the main points:

a)    Representatives made recommendations based on unrealistically high projections

b)    Morgan Stanley did not properly supervise their field force

People lost their jobs, the firm got bad press, and must pay a hefty fine. Why? Representatives promised more than they could reasonably deliver.

Each day I talk to agents who market fixed indexed annuities on the phone. Some want to illustrate their products at 6%, or even 8% interest.  They don’t understand that these rates are virtually impossible to achieve when the caps for indexed annuity products range from 6.50% to 9.40%. See the Index Annuity Product Comparison spreadsheet that I developed to help educate these agents.

The above FINRA News Release is a reminder that customers only complain when they feel like they have been hurt financially or when their expectations have not been realized.  If you sell Fixed Indexed Annuities I offer the following suggestions:

a)    Always show the guaranteed values, and put your emphasis there

b)    Always explain the tax benefits that annuities may offer

c)    Sell at least two annuities – one with a six year or shorter surrender charge so that your customer will have adequate liquidity if their situation changes in the future or if they have an emergency

d)    When discussing the potential values, explain that the primary purpose of Indexed Annuities is to prevent loss, not to create large gains

e)    When illustrating a hypothetical interest rate for Indexed Annuities, use a maximum of 5%, but half the cap rate is good rule of thumb.

Some agents disagree strongly with the above opinion. Examine the Index Annuity Product Comparison spreadsheet closely and you will see that I am right.

Remember annuities provide strong, after-tax values. Here is an illustration that compares a $100,000 Jumbo CD earning 3.73% interest with two index annuities, one illustrated as earning a 1.00% return and the other illustrated at a 3.00% return.

The main point: Be conservative with your promises and projections. This will keep you out of trouble, and if your products exceed your client’s expectations, you will have happy clients.

Noreen J. Parrett, Esq. wrote an excellent article in the Fall 2008 Federation of Regulatory Counsel Journal that uses facts from the settlement on June 16, 2008 between the Wisconsin Office of the Commissioner of insurance and Pennsylvania Life Insurance Company. I highly recommend that you read her entire article, but here is a brief outline:

a)    Penn Life was fined $925,000 for not properly supervising its agents

b)    The article cites many examples of obviously unsuitable sales made by Penn Life’s agents

c)    Penn Life was ordered to provide its agents with written standards, processes, and procedures as to what constitutes a suitable sale

d)    Agents are required to provide a written a disclosure to clients to assist in the consumer’s understanding of the product

e)    Agents are required to perform a client liquidity analysis

f)     Penn Life must hire a compliance department to review most annuity sales, and to call all applicants over the age of 70

g)    Penn Life must approve all lead cards, marketing material, and sales scripts / presentations

h)   Penn Life must provide uniform mandatory annuity product training, including a written test

Her main point: Even though most annuity carriers have implemented much of the above, regulations will continue to get more stringent until abuses stop completely.

For more information see an earlier article by Connie O’Connell and Noreen Parrett. 

In Sunday’s “60 Minutes” interview President Obama shot down the House’s proposed 90% tax bracket on bonuses from employees of companies who receive bail out money by saying,

“As a general proposition, you don’t want to be passing laws that are just targeting a handful of individuals. You want to pass laws that have some broad applicability … you certainly don’t want to use the tax code to punish people.”

Notice that he did not condemn the concept of a 90% tax bracket. Obama has proposed a tax increase that increases the current 35% top tax bracket to 39.6%. If President Obama follows Franklin Delano Roosevelt’s lead, these tax increases may be only the beginning of a new wave of income tax increases. In 1932, and again in 1936, when faced by budget deficits caused by the Great Depression, FDR increased the top tax bracket from 25% to 79% (Source: IRS Website).

When helping clients plan their future income, annuity producers should discuss the possible income tax effect of this income, and whether annuities can help reduce these taxes.  Annuities can help your clients in the following ways:

1)    Taxes on interest can be deferred to a time when the client is in a lower tax bracket

2)    SPIA (Single Premium Immediate Annuities) that are funded with non-qualified money can produce income that includes a tax-free return of principal

3)    Although all the income from Lifetime Income Riders is 100% taxable, even from non-qualified money, those who desire a guaranteed lifetime income can lock in a high, fixed interest rate for the rest of their life

If history repeats itself, and Congress raises taxes back to the 90% tax bracket for unearned income (meaning, non-wage income), annuities have the potential of causing your clients to pay massive future taxes. Explain to your clients the problem that they may have if they defer the taxes until they die, when all the accrued interest becomes payable in a lump sum. If they want to leave their heirs a tax-free lump sum at death they perhaps should purchase a life insurance product instead of an annuity.

The point is that “taxes” is a hot topic right now, and is the perfect door-opener to tell your story to your clients, prospective clients, and their income tax advisors.

• Married, Joint Return
  1. Tier 1: $32,000
  2. Tier 2: $44,000
• Single
  1. Tier 1: $25,000
  2. Tier 2: $34,000

If your client has defined benefit pension or other fixed income above Tier 2, they cannot avoid paying taxes on Social Security. If they have no non-qualified money, they usually cannot avoid paying taxes on Social Security without reducing their income. However, here is an example of a married couple who filed a joint tax return and used annuities to reduce their Social Security and ordinary income taxes (2007 tax rates):

Helping someone save over $7,000 on their taxes may look “too good to be true” but it is actually well within the ability of most annuity producers:

1. $500,000 safe assets generates $15,000 in taxable interest
   1. Use $65,000 to buy a 5-Year Single Premium Immediate Annuity to generate $14,000 income per year
   2. Put $385,000 in several deferred annuities to provide future income
   3. Leave $50,000 in a money market fund for emergencies
2. The $40,000 this couple is taking from their 401(k) is higher than the Required Minimum Distribution (RMD) — reduce it to $25,000

Smart agents will work with the client’s accountant to work the above numbers and to create the ideal product mix. The key is to get the taxable income as close to the Tier 1 income as possible. This has at least four advantages:

1. The accountant’s OK adds credibility to your sale
2. The accountant will earn extra fee income
3. If product suitability is ever an issue, you have the accountant as a friendly witness
4. The accountant has other clients that need your help — excellent referrals

In summary, this idea created a $65,000 SPIA sale, $385,000 in SPDA sales, and opened the door for an IRA rollover from the client’s 401(k).