Insured Annuity Concept-Does it still work?

You believe that you have a client who may be a perfect candidate for an Insured Annuity but wonder if the concept will still work for her under the new tax rules for insurance and prescribed annuities.

You wonder if it is possible to create a compelling solution for your client. Consider the following example:

The facts:

Insured Annuity

Taxable Investment @ 3.0%

Pre-tax yield required to match the Insured Annuity: 4.71%

In looking at the Insured Annuity concept the client would have to earn 4.71% before tax on the GIA in order to provide the same after tax cash flow as the Insured Annuity. Is 4.71% a compelling rate of return? Consider the following:

The client’s life expectancy is 16 years. Assuming a 3% discount rate the present value of cash flow from the Insured Annuity to life expectancy is $194,154. Current 3 year GIA rates are in the 2% range. If the client maintained their investment and estate planning strategy they would have to hope that GIA rates increase at renewal to 5.46% for the remaining 13 years to life expectancy for the GIA to provide the same present value of cash flow as the Insured Annuity. This means that rates will need to increase by almost 2 ½ times in 3 years to match the benefits available under the Insured Annuity. As you can see not only can the Insured Annuity provide more immediate cash flow but it also reduces the risk of not obtaining higher GIA rates in the future.

Old Age Security (OAS) benefits begin at age 65. Where taxable income exceeds $73,756 taxpayers will start losing a portion of the benefit. This reduction in benefit is referred to as the OAS clawback. 100% of the interest earned from a GIA is reported as taxable income for purposes of the OAS clawback. With a prescribed annuity only the taxable portion of the annuity is reported as taxable income. If we assume the client has retirement income of $70,000, the taxable portion of the annuity increases this amount to $73,406. This is below the threshold for the clawback. With the GIA the client’s taxable income is $85,000 or $11,244 over the threshold. This will result in an annual OAS clawback of $1,687. If we factor this savings into the Insured Annuity solution it effectively increases the pre-tax yield to 5.22%.

Where the client has named a beneficiary, at death the insurance proceeds will not form part of the deceased’s estate. At death the GIA will form part of the deceased’s estate and will be subject to probate fees where applicable. The Insured Annuity could save the estate thousands of dollars in probate fees.

Conclusion:

Yield is an important factor in measuring the benefit of the Insured Annuity but it is not the only factor to consider. When considering where GIA rates need to go in the future to match cash flows under the Insured Annuity, the potential impact of the OAS clawback and the potential for probate fees, pre-tax yield is not the only factor to consider when measuring the effectiveness of the concept.

Date: April 2017