How can line 20(b) help you sell more annuities?

By Ken Davis


So, how can we come to the rescue and help our clients reduce or eliminate taxation of Social Security income?

Is line 20(b) your ticket to new annuity sales? Line 20(b) shows the amount of Social Security income that is included in income.

From 1938 to 1983, Social Security income was not taxable at all. Then Congress decided to tax up to 50 percent of Social Security income. They liked that so much they upped the maximum to 85 percent.

Your clients may not know this. It surprises many people, and retirees can get very angry about the fact that their Social Security income is taxed. And as we all know, people take action on things they care about.

So, let’s all go find people passionate about saving taxes on Social Security income and help them accomplish that with combo annuities. And pre-retirees can set the stage nicely for this to happen in their retirement.

I ran a case study through a simple income tax calculator from H&R Block. I assumed my mythical client was a single 65-year-old female. She had $24,000 in Social Security income, $10,000 in taxable interest and $30,000 from pension distributions per year. The $10,000 of taxable interest came from $300,000 invested among bank CDs, taxable bond funds, and money market funds. She used a standard deduction.

I did an experiment. I reduced the interest income to zero in the calculator and the tax dropped by $4,210 on the $10,000 reduction in income. Multiply that by 10 years and they pay $42,100 in taxes on $100,000 in income.

How can that be? That means the $10,000 of earned interest on the client’s accounts was effectively taxed at a 42 percent rate. The maximum tax bracket is 35 percent for the wealthiest of taxpayers, yet this retiree earning a modest income is paying an effective rate higher than the wealthiest tax payers.

Are we really taxing the rich or beating up our seniors?

The answer is really simple. As a taxpayers’ income rises, more and more of their Social Security income becomes taxable until a full 85 percent of all Social Security income is included. More insidious is that the formula that causes this to happen adds in half of your Social Security income to the calculation. And, get this, municipal bond interest, which is touted as “tax free,” gets added into the equation as well.

And the drum roll please for the most subtle of all back door taxation: capital gains are included in the formula at 100 percent of the gain, not 15 percent. This is because the capital gain tax is 15 percent on the gain but the total gain flows through the tax return for all other calculations, including the taxation of Social Security income.

So, how can we come to the rescue and help our clients reduce or eliminate taxation of Social Security income? I would love to give you all the details here but that is way too long of a conversation, and we all know salespeople are all ADHD.

Let me just say this: study the old combo annuity or split annuity concept that has been around for years. Toss in some indexed annuities with lifetime income benefit riders. Focus on maintaining income for life rather than corpus and you can show your client a comfortable income flow and reduce the income that causes Social Security income to be taxable. The result is an increase in cash flow and a potentially large reduction in taxation of Social Security income.

This does not work for all clients. Calculations need to be made to see what impact this has, if any.

However, if they have a significant amount of $5,000 or more on line 20(b), they may be good candidates. And, if the formula does not work with a combo annuity, then toss in a Roth IRA conversion and mix it up. It could be this is an even more appetizing solution.