Tax Planning In Retirement with Guaranteed Lifetime Income Annuities


Troy Sharpe: Today, I want to incorporate tax strategies into the guaranteed lifetime income planning, continuing along with this annuity series that we’ve been doing, to show you how it can have positive ripple effects throughout the rest of your income in retirement. What I find in my experience is it helps people feel more comfortable and sleep better at night and bring more security and peace of mind to their retirement.

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, host of The Retirement Income Show, a certified financial planner professional, and also a certified tax specialist. This has been a great series educating you about annuities and how they can play a role in your retirement if you’re someone who’s looking for safe growth or guaranteed income, which is a paycheck that’s deposited into your account every single month no matter how long you live, and how those tools can work with your stocks or your bonds, how they can work inside a retirement plan. Today, we’re going to focus on the tax side of things.

We have a couple of examples. Married filing jointly with what we call non-qualified assets that generate capital gains and dividends, or if you’re like a lot of our clients, you don’t have many non-qualified assets, most of your money is inside an IRA. We want to look at the impact of RMDs. Then, we’re also going to look at this for a single filer because I know I get a lot of questions and comments asking me, “Troy, don’t do it just for married people. Do it for us, single people, as well.” We’re going to show you both of those examples today.

There’s a lot of misconceptions out there about annuities. One, there are many different types of annuities. People tend to lump them all together into one single word, where you have immediate annuities, you have variable annuities, you have fixed annuities, you have indexed annuities, you have multi-year guaranteed rate annuities. They all have different features, benefits. Here, I’m talking about the deferred income annuity, which the most competitive ones, the ones that give you the most guaranteed lifetime income, are fixed indexed annuities that have what we call an income rider attached to them.

You make your deposit. This is your walk-away value. This is your death benefit. The insurance company doesn’t keep your money. When we add the income rider, we get a guaranteed growth component usually. A typical market rate right now is around 7% guaranteed growth. What it does is it ensures that at some point down the road when you want to start taking income from your retirement savings, this is a long-term planning tool, that you get to take a lifetime income off whichever side is higher. If the cash value performs better than the income side, your lifetime income will be based on the performance of your cash value.

These are designed to average somewhere between 4% to 6%, though, the best growth ones out there. I wouldn’t anticipate this side outperforming the guaranteed income side. It compounds at 7%, so that ensures at some point in the future, you have a much higher balance to withdraw a lifetime income from. You’ll take that income. It’s a math calculation, as we talked about in the other videos, fully guaranteed. You know what it is before you ever make a deposit. That’s a lifetime income that if you live to be 85 or 185, you’ll always receive that income in your bank account.

If you’re like most of our clients, most of your money is probably inside that tax-infested retirement account, the IRA, the 401(k). We get a great benefit by deferring those taxes throughout our working years, but once we get to retirement and we roll that money over to our IRA, you have to take it out, and you have to pay income taxes on every single dollar that you’ve ever put in, as well as all the interest that you’ve ever earned. That creates a tax problem over time because, at age 72, you’re forced to start taking that money out. It’s called required minimum distributions, and it’s an increasing annual percentage.

When you have to take larger amounts out, combined with your social security, if you have a pension, if you have rental income, dividends, interest, et cetera, it stacks on top of all your other income. A lot of times, we find people in their 70s or 80s and they have massive amounts of income that they don’t necessarily need because there was no tax planning leading up to that point.

Just want to give you a quick example here. I’m assuming this is about a 65-year-old couple, social security combined of about $60,000 a year. They’ve decided, “You know what? It makes sense for us to take a portion of our retirement savings, set it aside into something that’s 100% protected from loss, that’s going to give me guaranteed growth, guaranteed lifetime income.” That calculation is about $30,000 a year. Now, in the planning process, to show you the impact, we’ve assumed that this has now been converted to a Roth. You can’t just convert the annuity to a Roth. It has to be inside a retirement account, and then you convert the retirement account.

Now, just briefly, I want to address a misconception out there. Many years ago, even in some circles today, people say you shouldn’t put your annuity inside a qualified retirement account. The reason they say that is because both of those tools, the IRA and the annuity, they both grow tax-deferred. If you’re of the singular mindset that the only reason to buy an annuity is before the tax deferral, then yes, it would not make sense to put that inside of a retirement account.

The truth is today, the reason people buy annuities and add them as a part of their overall retirement plan is because fixed indexed annuities in particular can provide 100% principle protection, they can provide reasonable opportunity for growth in that 4% to 6% average return range, and they have additional benefits that we’ve talked about in this series such as lifetime income for you and your spouse.

That income can double if you need home healthcare or long-term care. There’s many, many benefits with these tools. The fact that they’re tax-deferred per the internal revenue code today is really only an ancillary benefit if you’re very wealthy and you’re looking to put some money somewhere that’s safe and growing and you’re trying to defer taxes. 99% of you, you’re going to look or consider an annuity for your retirement because of the income benefits because of safe growth.

When we have our IRA that owns that annuity, you own the annuity but the annuity is inside the retirement account. We have the option of converting it to a Roth, a tax-free Roth, which then means the lifetime income that we’ll receive is 100% tax-free for as long as you and your spouse are alive. We have social security, guaranteed lifetime income stream. $60,000 per year. Your Roth guaranteed lifetime annuity at $30,000 per year. This is $90,000 of paychecks that as long as you’re living, that income will be 100% income tax-free. Multiple streams of income. We’re big fans of multiple streams of income.

Now over here, we have dividends and capital gains. This is if you do have money outside of that retirement account in what we call a non-qualified account. I’m assuming here, let’s call it, it’s a million-dollar account. Maybe it’s 700, maybe it’s 1.2. It doesn’t matter. I’m focused on the income that that account generates. Let’s assume it’s generating $40,000 per year of either capital gains from rebalancing or dividends from qualified dividend stocks. Now, I want you to guess with this level of income, $90,000 guaranteed lifetime income plus $40,000 of dividends or capital gains, I want you to guess what the income tax liability due is for this level of income.

If you guessed $220, you’re absolutely right. In this scenario, we can have 90,000 here, plus 40-, so $130,000 of income and only paid $220 in taxes. Here’s the tax calculation. We have $40,000 of qualified dividends, social security of 60,000. The Roth fixed indexed annuity guaranteed lifetime income, that’s a Roth, as we’ve talked about before, it was previously converted to a Roth, and that’s always 100% tax-free.

We have just a gross income of 68,100. Provisional income, which we’ve done videos on social security, this is a social security term. Provisional income, $28,000 of your social security is subject to income tax, but because of the tax brackets and our progressive tax system, you don’t have to pay tax on that entire amount.
Now here, most people aren’t aware of this either. There’s a 0% long-term capital gains bracket. Most people just think there’s a 15% bracket for long-term capital gains. There’s actually 0%, a 15%, and 18.8, and a 23.8 when you look at Medicare excise taxes or surcharges based on your overall income level. Long story short here, the total tax is $220 with $130,000 of income.

What this really does, what I find is this is a small portion of this overall portfolio. I would never recommend someone take most of their money and put it into some type of guaranteed lifetime income product. Typically, that’s not going to make sense. These are tools. They’re tools that are meant to complement a broader retirement investment strategy. Now, when we incorporate a tax plan into this, we start to see–How many of you would feel comfortable if you knew, come heck or high water, you had $90,000 of income coming in? If the market crashes, doesn’t bother you; if the market’s going great, excellent. Your investment accounts will be doing really, really well. You don’t have fears of running out of money. You also don’t have fears about the government increasing taxes later in retirement.

What this does is it really brings, for me, a ton of security, peace of mind knowing that, “Hey, no matter what happens, I always have these paychecks being deposited into my account, and I’m not paying any income tax on it.” The dividends, as I said, we could change this number, but I wanted to go up to about the maximum amount under current law and still have a negligible tax liability.

Now, many of you may not have that much money in a non-IRA or a non-qualified investment account, so I want to show you the impact of taking additional withdrawals from your retirement account. We can take a little bit less income before we start to pay taxes, but ultimately, we’re still in a position where we have a lot of income and paying a very small amount of tax relatively speaking.

Same situation we just looked at. Social security. Married, filing jointly of 60,000 per year. We still have the Roth guaranteed lifetime income of 30,000 per year, so that’s 90,000 coming in. Now, if we take 25,000 out of our IRA, either for a requirement on distribution later in life or maybe it’s a one-time withdrawal or maybe that’s just what you need, you add all that income together to maintain your standard of living.

Either way, we notice down here that the total tax for this is 1,445. The reason why with long-term capital gains or dividends that we’re paying only $220 in tax with $40,000 of income there is because of that special curve out in the tax code that for dividends and capital gains, you can be in the 0% bracket. For IRA withdrawals, that curve out doesn’t exist. It simply adds onto the rest of your income.

Still that 60 plus the fixed indexed annuity, lifetime income, 30, in a Roth, it’s 90 and 25, that’s $115,000 of income, and we’re paying $1,445, a little more than 1% of the total income received in federal income taxes. When we start to introduce this tax planning, it really makes a big, big difference. This is why a proper retirement plan isn’t just put 60/40 in stocks and bonds, take out 4% and pray for the best, we need to incorporate these different elements, tax planning, income planning, social security planning, Medicare, health care, legacy, estate. These are all components that need to be optimized in order to have a fully functional retirement plan that puts your best interests first.

Now, for those of you who are not married, same situation. We have social security now a little bit less because this is one spouse versus two of $30,000 per year, guaranteed lifetime income inside a Roth of $30,000 per year, so this gets us to 60. Then we have dividends or capital gains can max out at about $29,000. These are long-term capital gains. About $89,000 of total income, take a guess on what the tax will be, $5. Pretty cool.

When we start to incorporate the tax strategies with an income plan, we start to see how we can really create this synergy of different planning strategies, techniques, looking at the broader picture to put you onto a much more optimal situation, not just with income, but, of course, with taxes.

Now, I’m giving straightforward examples here just to show you the power of planning, but ultimately, the income need needs to be identified, your risk tolerance, your current tax bracket, your estimated future tax brackets. We have to extrapolate all these out. We have to have conversations, the pros, the cons. There is a lot that goes into this. I just want to convey that if we do this properly, for many of you, there’s a tremendous amount of benefit that can be had, and if you don’t do it properly, there’s a tremendous amount of money that you’re leaving potentially on the table.

Now, if you’re single without the non-qualified investment account, you just have a retirement account, invest in stocks and bonds, to go along with the guaranteed lifetime income that we’ve converted to a Roth and the $30,000 of social security, if we take out $25,000 from the IRA, we’re starting to get a little bit higher in the tax bracket, but still $30,000 in social security, $30,000 from the guaranteed lifetime income, $25,000 here, that’s $85,000 of total income received and due to the planning, we’re only paying about $2,400 in total tax. Let’s call it about 3%.

Now, I’ve done a lot of videos on this in the past if you look at our Roth conversion videos or tax planning videos. If you look at those, you’ll see this is a very, very important concept. What it is is you can have much less income as a single taxpayer than a married filing jointly taxpayer before you start to go into the higher brackets. If you are single, there’s nothing you can do about this except plan, like I’ve showed you today, and, of course, there are other techniques and strategies available.

When you are a married filing jointly taxpayer, when one spouse predeceases the other, especially if this happens unexpectedly or early on in retirement without any planning on the tax side of things, all of a sudden you have all these assets. The required distributions are forced to come out. You have the social security, maybe some other income, and what was supposed to be in the married filing jointly brackets, you actually are penalized. It’s punitive. You drop down to the single brackets. From that point, you’re paying usually a lot more tax than you otherwise would have.

The big takeaway from this is that tax planning not only helps you during your lifetime, but if one spouse happens to predecease the other unexpectedly, it has tremendously more benefits, and it’s much more powerful to be looking at this stuff now, as opposed to later, because later, there’s really not much that can be done.
In this annuity series, we’ve covered so much. You really should be a lot more educated about annuities at this point. We talked about the safe growth annuities.

We talked about the guaranteed lifetime income features, the pros, the cons. We’ve looked at the hood into the insurance industry to give you insight that you probably otherwise would not have gained. Now, we’ve talked about strategies in the past couple of videos, and we’ve also now introduced tax planning, incorporating that into not only those possible income strategies but your overall retirement plan as well.

I hope this has been very, very powerful for you. I hope you are a more informed and educated investor at this point. If you have any questions, feel free to go ahead and reach out to us. We’ll be glad to help you.

Tax Planning In Retirement with Guaranteed Lifetime Income Annuities
Tax Planning In Retirement with Guaranteed Lifetime Income Annuities

Having a Tax Plan in Retirement with Guaranteed Lifetime Income Annuities can help save you tons of money throughout retirement. Planning out your income sources can keep you in lower tax brackets.