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·         the 31% income tax bracket will be replaced by 33% and the 35% tax bracket has been replaced by 39.6%.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

Yesterday an agent asked me to compare three similar fixed indexed annuity products, each with an annual point-to-point interest crediting method, but with the following differences:

·         Surrender Charge durations of 7, 10, and 14 years

·         Bonus Rates of 0%, 5%, and 11%

·         Current Participation Rates of 8.90%, 7.80% and 7.80%

Often products with a premium bonus show higher values after 15 years, but if your client needs their money in 5 to 10 years, most of these products carry sizable surrender penalties. Since this particular insurance company pays an additional 1.10% interest rate on the non-bonus product, it is difficult to determine if the bonus products actually will deliver the highest values to the customer.

This spreadsheet compares the year-by-year surrender value of the above three products using hypothetical changes in the value of the index.  If you sell similar products, I encourage you to customize this spreadsheet to help your clients decide which product, or blend of products, best fits their needs.