Combining annuities for maximum value

By Jason Kestler

Kestler Financial Group, Inc.


Annuities may be one of the most valuable planning tools for the senior client. But all too often, advisers try to assist a client with a "one size fits all" solution.

Today's new high-performance products offer many attractive features. However, true client value may be measured by the options available to the client at the time of distribution. Here are seven situations where multiple contracts may be a better option for your client.

Large premiums — If you have a client who is considering a potentially large annuity purchase, consider multiple, smaller annuities. For example, rather than selling a $300,000 annuity, consider three $100,000 contracts. This strategy doesn't cost the client (or the agent) anything, but provides significantly more flexibility upon distribution. If the client decides to take some form of annuitization, doing so with a policy which has grown to $500,000 or $600,000 would be akin to trying to take a sip from a fire hydrant. Multiple contracts provide the opportunity to turn on some or all of the income as needed. You could also choose different payout options in order to accomplish specific financial goals.

Multiple beneficiaries — A multiple contract approach can provide significantly more flexibility when multiple beneficiaries are involved. You can more easily provide for disproportionate inheritances. In addition, you can eliminate the complications and delays involved with trying to get several beneficiaries to agree on settlement for a single large policy.

Feature diversification — If you are selling fixed indexed annuities, you know there are many design choices (annual point-to-point, monthly average, monthly point-to-point, etc.). Any of these designs could potentially out-perform the others under a given set of market circumstances. By using multiple contracts with different crediting methods, you essentially diversify your clients' portfolio and eliminate the idea of "putting all your eggs in one basket."

Company diversification — Similar to feature diversification, company diversification also spreads the risk among more than one insurance carrier. Even when dealing with highly-rated companies, this type of diversification may provide flexibility not available with one policy issued by a single carrier.

Tax leverage — The split annuity concept has been around for years. Split annuities work best with non-qualified funds and are an ideal alternative for clients using CDs to generate income. The income derived from a CD is subject to tax as ordinary income — typically reducing real cash flow by about 30 percent. The combination of a single premium immediate annuity (SPIA) with a single premium deferred annuity can provide some significant tax leverage.
If, for example, a SPIA is designed to provide the same monthly gross income, the net income to the client will be significantly larger because the exclusion ratio (the portion of each payment which is considered to be a tax-free return of principal) may be as high as 90 percent. The deferred annuity can grow undisturbed while the client receives what they want — a safe, consistent, dependable income stream.

Income ladders — The split annuity concept also works well when designing strategic income ladders. Whether qualified or non-qualified, a SPIA combined with several deferred contracts can be used to design a custom income strategy for your client. In today's low interest rate environment, annuitizing for a long period of time may not be in the clients' best interest. By choosing a relatively short SPIA term (five to 10 years), you not only provide for current income needs but can ladder contracts that require five or 10 years to provide maximum yield.

Annuity capital enhancement (ACE) — Often, clients purchase annuities as a way to defer taxes during their lifetime and pass proceeds directly to heirs without the costs and delays of probate. Whether the annuity is qualified or non-qualified, it may be subject to significant depletion at death. Assuming the beneficiary is someone other than a surviving spouse, the contract will be subject first to income taxation, to the extent of any gain in the contract for non-qualified policies and on the entire amount for qualified policies.

Next, it will be included in the decedent's estate for estate tax purposes. The combined tax hits can be significant. On the other hand, if the client is insurable, consider the following: Transfer the contract to a competitive single premium immediate annuity (SPIA) with a single life alone payout. Calculate the exclusion ratio (if any) and set aside enough of the monthly income to cover income taxes. Use the net income to purchase a guaranteed death benefit life insurance contract.

If the proper steps are taken, an ACE program could effectively double the proceeds to heirs and make it all tax-free. It will also immediately remove the annuity contract from estate taxation. We have effectively used ACE to increase inheritances or generate significant funds for charities.