High Income Tax Strategies with Low-Cost Variable Annuities

“Optimizing High Income Tax Strategies: Leveraging Low-Cost Variable Annuities”

Jeremy Reif | June 3, 2016 |

In the technologically advanced age that we live in, why does every major insurance company have their advisor base-peddling their costly products? There are other options that cost significantly less, have better investment options, more investment options, no surrender penalties, and no trade costs. Then why is it almost never brought up in conversation by financial advisors? These large insurance companies don’t want the consumer to know the direction our industry is heading — fee-based.

There are several fee-based annuities available. They have been gaining traction by people who research accounts, custodians, and products prior to purchasing. With all of the rich content on the internet now, researchers can easily find blogs or articles just like this to help understand how the insurance industry works.

Let’s get back to the basics. What is the purpose of a present day annuity?

1. As pensions are trending as a thing of the past, annuities were designed to provide income over the annuitant’s lifetime. The annuity became a personal pension replacement option for the self-employed or those without a pension. Annuitizing the money (to turn a lump sum into income), provides the annuitant with payments over their lifetime.
2. Tax Benefits. Annuities were originally designed to provide tax benefits by deferring tax payments on non-qualified monies. As the money annuitizes (as described above), the annuitant’s payments would be part principal and part growth. This helps minimize taxes on the growth of the money over the annuitant’s lifetime, as well as by spreading taxes out over many years, potentially at a lower tax bracket.
3. Deferring Tax. Annuities were typically for high-income earners and for people who have a significant amount of non-qualified money, or money that is taxable every year (checking, savings, CDs, brokerage accounts, etc.). Many look to defer paying current taxes. The Department of Labor (DOL) is cracking down on advisors moving money that is already in retirement accounts, which are already tax-deferred investments into annuities.

Over the last few decades, big insurance companies have added many bells and whistles to annuities as the industry evolved. As the insurance companies develop new products with features, the fees for those products increased. In order to market to retirees, the insurance companies needed a new product to attract them.

Since the DOL rules have gone into effect, those planning for retirement will be able to find lower-cost solutions and take more control of their money. With all of the new options available, it’s even more important to research each option to see if it aligns with your goals. The DOL is trying to make sure financial advisors put their client’s interest ahead of their own.

Many know the general rules to investing and how to play it safe:

• Don’t spend more than 4% of the principal.
• Invest your age in fixed income.

To simplify how some variable annuities, and their underlying benefits, work is very similar to the general rules to investing. The difference is that annuities are a pre-built product backed by the insurance company. The insurance company pre-determines the distribution percentage given to the annuitant, which is usually based on age and the benefits selected. Different companies offer variations on products for ways to grow and distribute, and the timeframe for all of the above. Variable annuities with benefits are typically higher-cost solutions compared to the general rule-of-thumb investing.

Statistics tell the story. The majority of investors and the advisors that sell these products tend to underperform the markets. The advisor gets a high commission and no incentive to meet and/or service clients, as they got paid up front and are moving on to their next sale. For high-cost solutions, little help and below average returns, the results can be less than desirable.

Fee-based annuities offer a way to get back to the basics and gain some control on investing. These annuities are a low-cost solution, stripped down from the bells and whistles, used for: income planning, tax management, and increased investment options. Consider adding the ability to have these fee-based annuities professionally managed and now results could go from being less than desirable to a winning solution.

8/3/2023 Update

“Annuities in the Age of Retirement: Reflecting on Technological Advancements and the Stalling Industry Transformation”

As the baby boom generation

steadily entered retirement, annuity companies found themselves reaping the rewards of this demographic shift. In a previous article, we explored how technology was poised to revolutionize the insurance industry, hinting at potential changes ahead. Now, seven years later, it’s evident that the envisioned transformation has somewhat stalled.

Despite the technological advancements and the convenience the internet offers for independent research on the pros and cons of annuities, the insurance industry has faced considerable pushback in fully embracing commoditization and moving towards fee-only products. While chat rooms and online debates allow for a wealth of information exchange, the majority of the public still gravitates towards commissionable products rather than fee-based alternatives.  There are more commission-based insurance advisors than fee-based insurance advisors.

This is largely in part because insurance salesmen do not necessarily need to be fiduciaries nor are they required to have the licensing to sell fee products.  During the same period of time,  the rules and regulations from State Insurance Commission, FINRA and SEC have made great strides over the same period of time to push insurance companies in this direction for fee-based products, advisors taking on a bigger role and for some even becoming closer to being a fiduciary.  For many, this still remains as available, but not their primary focus.

Take a closer look at the current state of the annuity market and the factors contributing to its slower transformation.  Commission-based products remain dominant because of the potential for large one-time commissions.  The pushback on the regulations is one of the challenges the industry faces in transitioning towards a fee-only model.  Despite the initial expectations of a more rapid shift, we already know where the industry is headed.  Those that have already implemented these changes will be ahead of the game and called the pioneers of the industry.

High Income Tax Strategies with Low-Cost Variable Annuities

https://www.finra.org/#/

https://www.sec.gov/