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Written by: Natalia D. Keene, Advanced Sales Consultant at Lincoln Financial
Now is a great time to review assets in client retirement portfolios, determine their plan for income … and analyze any tax implications.
Nonqualified deferred annuities are a great retirement portfolio asset. There are pros and cons regarding the benefits they provide and limitations they have. The earnings within the annuity avoid income taxation until a distribution is made. In addition, the client can turn on a stream of lifetime income at a future date. But your client will have to pay taxes on the earnings, at ordinary income rates, when they receive income or take a withdrawal. Withdrawals made prior to age 59½ could result in a 10% early withdrawal penalty.
It is important to weigh these pros and cons with other investment vehicles to see which provides the most benefit to the client. For example, an investment portfolio would be taxed annually on any growth but would have pre-59½ access to the asset. And it allows for long-term capital gains versus only ordinary income taxation. When we are filing our 1040 and looking at a potential tax bill, we may rethink where we position our assets and what products make the most sense given the client's situation.
Annuities can also offer a unique tax advantage if your clients are taking income. When annuities first became popular in the 1920s and 30s, the immediate stream of income was taxed using an exclusion ratio — that means part of the income payment included gains from the contract (taxed at ordinary income rates), and part was a return of the cost basis (not taxed). The IRS wanted to encourage retirement savings, so they offered tax-smart growth and income.
However, in the 1970s and 80s, clients wanted to hold onto their annuities longer due to high interest rates and the magic of compounding interest. Since they weren't being used for lifetime income, Congress implemented new legislation. Deferred contract distributions were to be taxed on a LIFO (last in, first out) tax basis. This meant that gains came out first. As a result, annuitized and deferred contracts continue to receive different tax treatment today.
Lincoln's unique rider can help bridge between the two tax provisions of annuitized and deferred annuities. Annuities are meant to be spent! Unfortunately, clients may put off drawing that income because they don't like the resulting tax associated with it (i.e. LIFO), or they don't want to give up access to their money or their beneficiary protection.
Enter a solution: Lincoln's i4LIFE® Advantage, an optional benefit available only with Lincoln variable annuities for 0.40% per year above standard contract expenses. Our unique rider allows the contract owner to receive the preferential exclusion ratio tax treatment of an annuitized contract on income taken, but still allows the client access to the account value (unlike traditional annuitized contracts). Clients can choose to take more money from the account, and those additional withdrawals would also have that tax preferential exclusion ratio.
When they die, they are then passing benefits of an annuitized contract to their beneficiary (their children, or even their trust).
We've been making a big difference for tax-sensitive investors for more than 25 years. Lincoln is the only carrier that offers the ability to take income with the tax exclusion ratio and access the account. A group of Lincoln actuaries got together and brainstormed ways to enhance life insurance and annuity features, particularly as it relates to increasing tax efficiency.
They found people weren't annuitizing their contracts because they didn't want to give up their entire account value to the insurance company. i4LIFE® was created to help the annuity owner with tax efficiency and allow them access to their investment. And we got the IRS's blessing for this via several Private Letter Rulings.
Here are some practical applications you can bring to your clients:
- Access tax-efficient lifetime income stream without giving up access or control of the asset
- Pass the benefits on to their beneficiaries
- Allow a beneficiary to add the rider to the annuity they inherited, even if the original owner did not
- 1035-exchange contracts to Lincoln to access i4LIFE for tax-efficient income
- Tax-efficient gifting of nonqualified deferred contracts without triggering the taxation of the gain
- Provide solutions when planning with nongrantor irrevocable trusts, such as special needs trusts or spendthrift trusts
- Provide a unique method of multigenerational planning, by allowing generation one (i.e., grandparents) to provide income to themselves, and a legacy of income to their children
Here's how you can take action today to better prepare and support your annuity clients:
- Review ALL beneficiaries on all annuity contracts. Make sure clients understand how their annuity will distribute and what the implications will be.
- Review all deferred nonqualified annuities owned for a number of years (say 10 or more) and determine what the purpose of the annuity is now. This will help direct what changes may need to be made structurally to right purpose it. Consider situations such as:
- Have a special needs family member
- Have an existing annuity they no longer need
- Wish to leave a lasting legacy to their children and grandchildren
- Need to access retirement assets prior to age 59½
- Inherit a nonqualified annuity as a death benefit
- Review your client's estate plan and determine whether they intend to use trusts to pass their annuity. There can be complexities with annuities and trust ownership and/or trust as beneficiary, and i4LIFE can be a sound solution for those situations.
Get the full story on i4LIFE! Our client-approved brochure details how it offers investors tax-efficient lifetime income and legacy planning: Income Powered by Innovation
With these steps, you can ensure that some trickier client needs are met. You can better ensure that assets are retained, and relationships through numerous generations are maintained. This benefits not only the planning outcome for the client, but the success of your own business in increasing and maintaining assets under management. Our team would love to support you as you reach out to your clients. You can contact your Lincoln representative at 877-533-0265.
To read other blog content like this, visit Lincoln's informed financial professional blog.
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About the Author:
Natalia D. Keene is a Lincoln Financial Advanced Sales Consultant. Prior to this position, Natalia was Advanced Sales Counsel with Securian Financial, teaming up with financial professionals, wholesalers and channel partners on estate, business and tax planning cases, and other advanced planning concepts. She traveled frequently to present on a wide variety of complex topics at financial firms, client events and national conferences across the U.S. Natalia also worked for Northwestern Mutual, helping clients and financial professionals as an Estate and Business Planning specialist, financial professional and business exit planning consultant. Prior to joining the financial services industry, she practiced law focusing on estate and trust planning and administration, business consulting and tax preparation.
Lincoln products are not a deposit nor FDIC-insured, may go down in value, and are not insured by any federal government agency or guaranteed by any bank or savings association. All guarantees and benefits of the insurance policy are subject to the claims-paying ability of the issuing insurance company. They are not backed by the broker-dealer and/or insurance agency selling the policy, or any affiliates of those entities other than the issuing company affiliates, and none makes any representation or guarantees regarding the claims-paying ability of the issuer.
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