Retirement Income Blog

The Annual Report on the United States Government reports that Americans paid $25 Billion in estate planning tax. Every dime of those taxes could have been avoided.  How do you think the kids felt when they wrote out a check for $300,000 for estate planning tax and then learned from the estate planning attorney that mom and dad could have saved them every penny?

If you don’t like wasting money on taxes and don’t want your kids squandering money either, then this article will explain what you need to do.

You must realistically answer these questions: 

1. Will your estate be worth more than $2 million (2008 estate planning tax exempt amount, subject to change) when you die?   By the way, you cannot assume that the estate exemption will grow as some people believe.  Congress can change this number at any time and there are powerful people in Congress who want to reduce the exemption.  All you do know is that right now, you can shelter  $2 million of assets, while it lasts.
 
2. Do you have any assets that could be double-taxed at your death (double taxed by income tax and estate planning tax, which could consume 70% of the value) such as IRAs and annuities?
 
3. Do you think that if you need to take action, that your attorney would call you up on the phone and tell you? (He probably won’t as many attorneys wait until you call them).
 
4. Do you think you have plenty of time to take care of any estate planning tax problem–like the people who paid $25 billion last year?
 
5. Do you incorrectly think that to eliminate or reduce estate planning tax means giving up control of assets or making gifts or giving to charity?  (With good estate planning, you can keep total control of assets and still remove them from your taxable estate).
 
6. Do you have the false notion that a living trust will eliminate your estate planning tax? (You will pay estate tax on assets over $2 million living trust or not).
 
7. Do you think that you need to die in order to get your $2 million estate exemption? (You don’t, $1 million is available right now and many wealthy people use their estate exemptions when they can make the most of them– during their lifetimes).

If you answered “yes” to any of the above, you probably have an estate tax problem.

There are several ways to reduce or eliminate estate planning tax, including:

• gifting of assets to heirs now rather than leaving at death
• the use of estate planning strategies and tools (e.g. GRATS, QPRTS) to divide assets into their lifetime value and their discounted remainder value and this reduce the estate planning tax
• discounting the value of assets with minority or fractional discounts (and thus reduce the exposure to estate tax)
• proper estate division between spouses

Other posts in this blog will address these estate planning strategies individually.

Note:  this article uses the term “estate planning tax” to help the 6000 people who search Google each month for this term when they really mean “estate tax.”

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Index annuities are fixed annuities that have the interest you receive tied to a stock market index. An index annuity is ideal for investors who want to participate in market-related returns yet are uncomfortable
with market risk. But with about 40 known interest crediting methods, you may find that even if
two index annuities are linked to the same index, their returns might not be the same.  That’s because these index annuities have several moving parts as described below.

The Participation Rate in an index annuity is the amount of the increase (not including dividends)
in the underlying index that will be credited to your index annuity. For example,
suppose the index (the S&P 500) increased 9% and the participation rate is 70%. The index annuity will be
credited with 6.3% interest (9% x 70% = 6.3%).

Annuity companies can set different participation rates for newly issued index annuities as often as each
day. Therefore, the initial participation rate will depend on when the company issues your index annuity. Annuity companies usually guarantee the participation rate for a specific period (from one
year to the entire annuity term). Then when that period is over, a new participation rate is set for
the next period. Some annuity companies promise that the participation rate will never be
set lower than a specified minimum or higher than a specified maximum.

However, you should insist on a fixed participation rate for the entire annuity term.
Some annuity companies may provide 100% participation today, but if they change that
to 50% next year, you won;t be happy. Therefore, look for an index annuity with a fixed participation rate for the entire term.

Try to get an index annuity with an Annual Reset. This feature compares the index value at the end
of the contract year with the index value at the start of the contract year. And it is
especially important for retirees as the gains are better protected from subsequent declines in the index. Without the annual
reset feature, you cannot protect one year’s gain from the next year’s loss. There’s
nothing worse than when you make 30% one year then lose it the next. If you want to take that risk, you
may just as well be in a variable annuity or in a mutual fund.
However, in every case of an index annuity that offered an annual reset, we have seen it
combined with an averaging feature, which is not beneficial.

Averaging of the S&P 500 at the beginning of a term is supposed to protect you from
buying at a high point in the index cycle, which would reduce the amount of interest you might earn over the term.
Averaging at the end of the term protects against severe declines in the index and losing
index-linked interest as a result.
And while most annuity companies claim that this is a good feature, it’s not beneficiaial for the index asnnuity owner. It dilutes the return. However, it’s nearly impossible to find a product that
doesn’t use averaging.

Based on an analysis of periods over the past 30 years, an index annuity with a 55%
participation and no averaging will do about as well as a 100% participation, with
averaging. However, from the annuity owner’s view, the 100% sounds better.

The best index annuity performance will come from the riskiest arrangement: A point-to-point design
with no averaging. The point-to-point method calculates the interest return every
contract year and then, ultimately, combines these returns to arrive at the total return for
the contract term. This permits index annuity owners to take advantage of a market recovery after a
year of losses. The change in the index is a “price change only” measure and does not
reflect dividends.

The high-water point, or high-water mark, is a variation of the point-to-point term
method. Rather than using the ending point, the calculation is based on the highest
obtained value during the term of the contract based on annual contract anniversary index
values. For example, if the index doubled its original value on the first anniversary date
and then proceeded to decline for the remaining contract period, the high-water point
method would calculate an index return of 100%. The high-water mark is locked in no
matter how much the market may go down. This is a beneficial index annuity feature for the investor.

Any type of Annual Cap has a significant effect on returns. Most people don’t realize
that two or three years out of 10 produce the big gains in the stock market. If you remove
those big gain years by capping them, the performance dives. Averaging of the S&P 500
reduces those big gains. And since index annuities already protect the original principal,
there can be no argument that averaging provides any value in down markets. Try and avoid index annuities with any type of cap.

Index annuities are not designed to outperform the index long term. So you will
not earn anything near what the stock market delivers. Index annuities will deliver about 40%-65%
of stock market returns. So if the stock market has delivered a 12% return over time,
figure an index annuity (with the averaging feature) will deliver 6%.

Start with the retirement planning calculatorto see how index annuities may fit into your retirement income strategy and then use the fixed annuity calculator to determine what part a fixed annuity can play in your retirement portfolio.

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