Use Obamacare tax increases to sell life insurance and annuities before year end, Pt. 2Article added by Ken Davis, Retired CPA, CLU, ChFC on August 10, 2012
Ken Davis

Ken Davis, Retired CPA, CLU, ChFC

Scottsdale, AZ

Joined: November 23, 2009

In the first article in this two-part series, we discussed the tax pitfalls of:
  • Triggering OMIT (Obamacare Medicare investment tax of 3.8 percent)

  • Being pushed into the new 36 percent and 39.6 percent income tax brackets

  • Avoiding the higher Medicare premiums of as much as $3,434 per year per person

  • The 10 percent AGI limitation on itemized medical expenses (it jumps from 7.5 percent to 10 percent because the Bush tax cuts are set to expire at the end of 2012)

  • The impact higher AGI has on the alternative minimum tax being triggered

  • Including up to 85 percent of Social Security income into taxable income
In part two, we will discuss how we can use life insurance and annuity products to help mitigate these onerous taxes and premiums.

Solutions for people not needing to live off income from investments

Reallocating assets into life insurance policies has three potential benefits:
  • Possible mitigation of the tax issues listed above

  • Cash accounts available if needed

  • Legacy planning for kids and charities
As we all know, life insurance can be designed to maximize wealth transfer to the kids or charity. Or it can be designed to build cash values in combination with leaving very significant wealth to the kids or charities of the donor’s choice.

The tax deferral attributes of cash value life insurance may reduce the amount of MAGI reported on the tax return thereby mitigating part or all of the rogue’s gallery of taxes listed above. And of course, if managed well, the client can access cash values on a tax deferred or tax-free basis during life. And in most cases, the kids or charity get the life insurance proceeds income-tax-free and possibly estate tax free.

Solutions for people needing income to live on from their investment assets

When the client needs income immediately, they may want to use a combination of annuities. This is also true if they are not interested in leaving a legacy to someone or a charity. Or if they do want to leave a legacy to someone but cannot qualify for life insurance, this could work too.

In a previous article, “How can line 20(b) help you sell more annuities?” I discussed modernizing an old concept known as either combination annuities or split annuities. This strategy focuses on providing current income while reducing taxes overall. In that article, we were talking about helping people in retirement reduce or eliminate taxation of Social Security income. The demographic focus was mostly middle income families.

For purposes of this article, we would use the same technique to potentially reduce Medicare premiums or the new Obamacare Medicare investment tax (OMIT) of 3.8 percent. It may also drop the client into a lower income tax bracket as well.
The strategy suggested is discussed more completely in my article referenced above. It suggests the combination of immediate annuities with deferred annuities to provide current income and tax deferral. A portion of the premiums are put into an immediate annuity to provide income for five years. The remainder is put into several deferred layers of fixed or indexed annuities. When the five-year immediate annuity runs out, another one of the deferred annuities is annuitized until it runs out and we repeat the process.

Finally, after all the other deferred annuities are annuitized, the indexed annuity, with a lifetime income rider, starts its guaranteed withdrawal process. The base income on that contract will have grown substantially over the years and the client’s now advanced age will allow for even better guaranteed lifetime distributions under the withdrawal formulas.

This structure maximizes the amortization of tax basis while deferring taxes into the future, thereby helping to mitigate the taxes we are trying to reduce or avoid. It also has the important advantage of allowing the interest rates to rise every five years if we find ourselves in an inflationary trend. And the layering of annuities can be designed to provide increased income along the way by adjusting the amount of premiums allocated to each layer of annuities. Doing so reduces the upfront income but allows more money to be invested in the other deferred annuities to provide income later on to combat inflation.

The layering uses shorter-term deferred annuities which keeps early withdrawal penalties low. This may be more appropriate for retirees than longer penalty periods. At the end of each five year period, new contracts with better rates could be put in place with no penalties incurred on the original deferred annuities; with the exception of the indexed annuity with a lifetime income benefit rider.

Working with CPAs to make the sale and obtain referrals

The strategies suggested in this article to mitigate the increase in taxes are the perfect way to build relationships with CPAs. Insist the client include their CPA in the planning process. Tell them that there may be thousands of dollars in potential tax savings and that the only accurate way to know how it will affect them is to run a tax projection with and without your planning advice.

You need not be afraid of the CPA, because these concepts are effective and legitimate. Bringing the CPA to the table does a whole bunch of good things. First, you will increase the client’s trust because they see you are not afraid of the CPA's scrutiny. Secondly, the CPA will see the same thing.
You are more likely to be accepted as a trusted team member instead of being put on the defensive. It is better for you to explain the transaction to the CPA than to have the client consult with the CPA without your input. Having the CPA involved may keep you out of regulatory trouble too, because of the independent representation of a fee-only advisor in the mix. And remember, you are not allowed to give tax advice nor does your E and O insurance cover you for that.

And best of all, you may find the CPA wants to use these concepts with other clients. It is their job to save clients taxes. These strategies do that. At the same time they generate billable time for the CPA for doing the necessary tax projection work. In most cases, the tax savings should more than pay for their time. Everyone wins and the transaction is clean.

Think about it. We all want to build relationships with CPAs, and struggle to gain access. This is a great way to meet a bunch of CPAs on favorable terms. Your client is essentially giving you a warm referral to their CPA and even introducing you in person.

Although the author believes the content of this article to be accurate to the best of his abilities he makes no warranty nor offers any legal or tax advice herewith. It is the responsibility of the reader to engage their own tax advisor for their personal or client use of any of the information included in this article.

IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.
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