Divorce planning using FIAs with GIB ridersArticle added by Roccy DeFrancesco on March 1, 2011
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I was talking to someone the other day about their impending divorce, and it dawned on me that there is a terrific and simple use for fixed indexed annuities (FIAs) with guaranteed income benefit (GIB) riders in divorce planning.
Stereotypical divorce fact pattern
I don’t mean to be sexist, but the typical divorce is still one where the husband is the main breadwinner and where the wife may not work, works part-time, or makes less money than the husband. Most of the time, the couple has one or more children of varying ages.
Not every divorce fact pattern is a candidate for FIAs with GIB riders, and so I’ll lay out the fact pattern where I think they will work best:
Why the above fact pattern? Because with marriages of longer than 10 years where one spouse didn’t work or worked and made little money, most states will allow the judge to award long-term alimony payments to the non-working or part-time working spouse.
- Married 10 or more years
- Husband makes decent money
- Some amount of liquid assets (including IRA or 401(k) plan assets)
- Wife does not work or works only part time
Most divorces are settled by the parties. As part of a settlement using my above fact pattern, the husband is going to have to pay alimony for potentially a lengthy period of time (it will depend on how employable the other spouse is and how much she could earn).
The goal in the divorce is typically to allow the non-breadwinning spouse to keep the lifestyle to which she has become accustomed. The more affluent the client, the more this will cost and the more likely that the husband will have to pay a good amount of money for support.
The fear of the non- or low-income spouse is, once the support runs out (be it in five, seven, or 10+ years), how is she going to make a living, and what about the 30+ years of retirement she will have to sustain herself through financially? She typically has not been paying into Social Security and, therefore, her benefits will be reduced. She may have been awarded 50 percent of the husband’s 401(k) plan or IRA and other assets, but is that going to be enough?
Using FIAs with GIB riders to facilitate a settlement
For this to work, the soon-to-be divorced couple needs $100k, $200k, or whatever in liquid assets. That most likely will be in a 401(k) or IRA if they are ages 45-50+.
When the settlement is coming together, the attorney representing the breadwinning spouse will suggest that the requested alimony (one to 10+ years) be at a lower or much lower rate than what normally would be calculated by the court as a reasonable support payment.
Then the attorney would offer a GIB for life for the supported spouse starting at age 65 at some dollar figure as a tradeoff for lower support now and a more favorable property settlement. The GIB for life payment could last for up to 30+ years to a time when no court of law would require the paying spouse to provide financial support.
Let’s look at an example. Assume both spouses are 50 years old. The husband has $200,000 in a 401(k) plan at work. Through a qualified domestic relations order (QDRO), he transfers those assets to the soon-to-be ex-spouse. Inside the new IRA of the spouse, she purchases an FIA with a GIB rider. With the best product in the market, she would receive a payment of $34,893 every year for life.
How does the $34,893 annual payment every year for life affect the rest of the settlement? With the $34,893 annual payment that the ex-spouse will receive for up to 30+ years (if she lives until age 95), the paying spouse can negotiate a much better settlement of other assets (much more than 50 percent of the remaining assets).
The short- or even long-term alimony can also be significantly altered. For example, if the alimony would normally be calculated at, let’s say, $40,000 a year for 10 years, the soon-to-be ex-spouse would probably agree to $25,000, so long as the $34,893 payment starting at age 65 was guaranteed.
But couldn’t the spouse do this on her own without negotiating down what the settlement would have been?
No. With a typical settlement, the spouses would split the 401(k) balance. In my example, that would knock her GIB payment in half.
If the spouse takes 50 percent of the assets and rolls them to her own IRA, she’ll invest in a “properly balanced mix of stocks and mutual funds,” which will be 100 percent at risk to market downturns and will not be able to provide her a GIB for life in the amount of $34,893.
The ultimate benefits of using an FIA with a GIB rider are:
- unequal division of assets slanted towards the breadwinning spouse
- reduced or even significantly reduced normal alimony payments
- the breadwinning spouse shifted a tax hostile asset (his tax-deferred 401(k) plan) to an ex-spouse.
Using GIB rider FIAs in a divorce settlement can provide financial certainty for life for the non-working or part-time working spouse while improving the financial terms of the final settlement for the breadwinning spouse. It can be a win-win for both sides if used correctly and properly postured.
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