Retirement Income Center’s YouTube channel has been rebranded to FiNANCIALLY InKLEIN’d™. FINANCIALLY InKLEIN’d™‘s motto is “Optimizing Your Retirement Income.”
Bob Klein created FINANCIALLY InKLEIN’d™ to help pre-retirees and retirees, alike, plan for and experience a less stressful and more financially rewarding retirement. The purpose of FINANCIALLY InKLEIN’d is to educate its audience about innovative strategies for creating and optimizing their after-tax retirement income.
Bob Klein’s article, 6 Proven Retirement Income Planning Strategies Beginning at Age 62 was published in The Street’s Retirement Daily. Beginning at age 62, it’s important to develop strategies for creating after-tax retirement income to optimize the longevity of your assets for the rest of your life.
Bob Klein was interviewed by Reverse Mortgage Daily to discuss how reverse mortgage professionals can partner and network with financial advisors in a recent article, Financial Planner Shares Advice to Reverse Mortgage Pros on Gaining Referrals.
Reverse Mortgage Daily featured a conversation between RMD editor Chris Clow and Bob Klein in its most recent edition of The RMD Podcast. In the conversation, Clow and Klein discuss the state of reverse mortgage product education to borrowers and professionals, the reticence many financial planners have about discussing reverse mortgages with clients, and advice to reverse mortgage originators about approaching financial planners to serve as referral partners.
Reverse Mortgage Daily published an article, Financial Planner Shares Journey of Reverse Mortgage Discovery, and How to Unlock More Participation. The article discusses Bob Klein’s discovery of reverse mortgages as a tool that can be presented to clients as a potential solution as part of their holistic retirement income plan.
Bob Klein was interviewed by Don Graves, RICP and President and Founder of HECM Advisors Group, about Bob’s recent Retirement Daily article, 5 Key Financial Metrics When Evaluating a HECM Reverse Mortgage.
Bob Klein’s article, 5 Key Financial Metrics When Evaluating a HECM Reverse Mortgage that was published on August 24th in Retirement Daily was featured in Reverse Mortgage Daily
Bob Klein’s article, 5 Key Financial Metrics When Evaluating a HECM Reverse Mortgage, was published in The Street’s Retirement Daily. There are five key financial metrics that should be analyzed individually and collectively when considering a HECM.
Retirement Income Center’s YouTube channel topped 100 subscribers today. The channel was launched in January to promote Retirement Income Center’s mission to deliver unparalleled holistic advice and service tailored to each client’s retirement income and other financial planning goals that provides a sense of relief and security, allowing all clients to feel they are being taken care of and empowered by someone with an intimate knowledge of their needs.
President Biden’s American Families Plan includes proposed increases in the top marginal income tax rate from 37% to 39.6% and the top long-term capital gains tax rate from 23.8% to 43.4% for households with income over $1 million. Both changes would negatively impact investment returns for affected individuals.
Stock market-based investment strategies, with their exposure to higher ordinary and long-term capital gains tax rates are being reevaluated by investors and financial advisers alike. One strategy that is attracting more attention that will be virtually unscathed by the proposed tax increase is longevity insurance, more commonly known as fixed income annuities.
Fixed income annuities provide sustainable lifetime or term certain income and, as such, are well suited for retirement income planning. There are three types of fixed income annuities: single-premium immediate annuities (SPIAs), deferred income annuities (DIAs), and fixed index annuities (FIAs) with income riders.
Each of the three types of fixed income annuities serve a different purpose within a retirement income plan. Two of the three options, SPIAs and DIAs, are tax-favored when purchased in a nonqualified, or nonretirement, account. This makes them an excellent choice for those in higher tax brackets who are seeking to maximize after-tax sustainable income.
SPIAs can be an appropriate retirement income planning solution if you are retiring soon or are retired and have an immediate need for sustainable income. Income distributions can be as frequent as monthly or as infrequent as annually (depending on the options available from the insurer), as long as the first benefit is paid within one year of the contract’s purchase date.
DIAs are a better fit than SPIAs in most retirement income planning scenarios due to their deferred income start date. Deferral of your income start date increases the amount of your periodic income payment since the insurance company will be making payments to you for a shorter period of time assuming a lifetime payout.
100% of income distributions from FIAs with income riders are taxed as ordinary income whether they are in a retirement or nonretirement account. While their flexible income start date and potential death benefit are attractive features, income tax savings is not a strong suit of FIAs with income riders.
DIAs and SPIAs enjoy a unique income tax advantage when they are purchased in a nonretirement account. Unlike FIAs with income riders that distribute ordinary income that reduces the accumulation value of the annuity contract, DIAs and SPIAs are annuitized.
The annuitization period is defined by the contract and is either a defined term, e.g., 10 years, or lifetime. Lifetime DIAs and SPIAs provide for an optional minimum payout period or lump sum payable to the annuitant’s beneficiaries to guarantee a minimum total payout.
The income tax advantage of DIAs and SPIAs is attributable to the allocation of each annuitized payment between income and a return of premium. The portion that is deemed to be a return of premium is your cost, or basis, and is nontaxable. Annuitization is analogous to amortization of a mortgage. When you make a mortgage payment, each payment is allocated between deductible interest and nondeductible principal.
In the case of a DIA or SPIA, the amount of each payment that is considered to be a nontaxable return of premium is calculated by applying an “exclusion ratio” to each monthly payment. The exclusion ratio is actuarially calculated by dividing the investment in an annuity contract by the total expected lifetime payments.
To illustrate the income tax advantage of nonretirement DIAs and SPIAs, suppose you are a woman, and you purchase a SPIA for $100,000 when you are 65 years old. Let us further assume that the insurance company determines that you have a 22-year life expectancy, and they will pay you $475 a month for the rest of your life. Your lifetime payments are expected to total $125,400 ($475 x 12 x 22).
Your exclusion ratio is calculated by dividing your premium, or investment, of $100,000 by your expected lifetime payments of $125,400. The result is that 79.75%, or $379, of each of your monthly payments of $475 will be nontaxable for the first 22 years. 20.25%, or $96, of each monthly payment will be taxable. Even though your annual payments will total $5,700, the insurance company will report taxable income of only $1,154 for the initial 22 years.
What happens if you survive your 22-year life expectancy? You will continue to receive monthly payments of $475 for the rest of your life, however, 100% of your monthly payments will be taxable as ordinary income. This makes sense since your nontaxable payments for the first 22 years will have totaled $100,000 which is equal to your original investment.
DIAs and SPIAs, like all fixed income annuities, provide sustainable lifetime income. When purchased in a nonretirement account, they distinguish themselves further as a retirement income planning solution since their after-tax income is predictable.
Income tax rates have minimal impact on the amount of after-tax income from DIAs and SPIAs due to their exclusion ratio. Furthermore, any increase in marginal income tax rates will not affect most annuitants’ after-tax periodic payments until cost basis has been recovered. As illustrated, this will not occur until the annuitant survives her life expectancy beginning on the annuity purchase date.
The ability to optimize after-tax income from nonretirement DIAs and SPIAs can also result in spillover income tax and other savings. This includes the potential reduction of taxable Social Security benefits, reduced exposure to the 3.8% net investment income tax, increased potential deductibility of medical expenses, and the opportunity to reduce marginal income tax rates and Medicare Part B premiums. Each of these things individually and collectively can result in additional increased after-tax retirement income for the duration of retirement.
Nonretirement fixed income annuities, with their sustainable lifetime income and tax-favored status, offer a timeless tax and retirement income planning opportunity.
Bob Klein’s article, How to Enjoy a Guilt-Free Retirement, was published in The Street’s Retirement Daily. Fixed income annuities could be the key to limiting your financial guilt in retirement.
Located at the end of President Biden’s American Families Plan released on April 28th is the administration’s wealth redistribution plan titled “Tax Reform That Rewards Work – Not Wealth.” The section begins with the statement that the goal is to reverse provisions of the Tax Cuts and Jobs Act of 2017 and reform the tax code “…so that the wealthy have to play by the same rules as everyone else.”
The American Families Plan would increase the top marginal income tax rate from 37% to 39.6%. In addition, the proposed top rate of 39.6% would replace the current long-term capital gains tax rate of 20% for households with income over $1 million. While income at this level is not the norm (539,000 income tax returns were filed in 2019 with 2018 adjusted gross income of more than $1 million, representing 0.4% of 141 million total returns filed), it is not unusual for business owners to cross the $1 million threshold when they sell a business.
Long-term capital gains tax rates for households with income over $1 million would almost double under President Biden’s plan, increasing 19.6% from 23.8% to 43.4% when you include the net investment income tax of 3.8%. Let us not forget about state income tax. Add on 13.3% if you live in California for a total marginal tax rate of 56.7% on all income, including long-term capital gains.
The proposed legislation would also eliminate the step-up in basis on unrealized gains exceeding $1 million at death. The step-up in basis allows individuals with appreciated assets to avoid income taxation on the appreciated value when they die. Unrealized gains exceeding $1 million at death would be taxed at a 43.4% rate unless the appreciated assets are donated to charity.
Lifetime charitable giving has historically benefited individuals with highly appreciated non retirement assets such as real estate, investment portfolios, and businesses. Many savvy business owners who are planning on selling their business and want to reduce or eliminate income tax liability attributable to the capital gain that they will realize from the sale can use a long-standing IRS-blessed strategy called a charitable remainder trust, or CRT. A properly designed and administered CRT managed by an experienced investment advisor who specializes in CRTS and is familiar with their four-tier payout scheme can be used as the cornerstone of a successful business owner’s retirement income plan.
A CRT is a tax-exempt trust. The initial and one of the most important benefits of a CRT is that the gain on the sale of assets owned by a CRT is exempt from taxation. This includes ownership of a business interest.
The proposed long-term capital gain tax rate increase of 19.6% has created a sense of urgency for business owners who are thinking about selling their businesses in the near future. The CRT strategy will increase in popularity with the proposed tax law changes. It will likely result in the acceleration of the sale of many businesses to avoid the increased tax liability attributable to long-term capital gains exceeding $1 million from the sale if the proposed changes are enacted.
It is important to keep in mind that the proposed tax legislation that’s part of the American Families Plan is in its early stages. The long-term capital gains tax rate increase of 19.6% and elimination of the step-up in basis at death are major departures from long-term fixtures of the income tax law, and, as such, are controversial and subject to modification.
Having said this, given the reality that one of the overriding goals of the current administration is redistribution of wealth as evidenced by the fact that the American Families Plan was released on the 98th day of the new administration, successful business owners have a lot at stake and need to act quickly before the proposed legislation or some form of it is enacted. Furthermore, business owners and others adversely affected by the proposed legislation need to keep in mind that any tax legislation that is enacted, whether it is in 2021 or 2022, could have an effective date as of the date of enactment or even a retroactive date.
When the CRT income beneficiary(ies) die, the remainder interest in the CRT is transferred to one or more charitable organizations specified in the CRT document. This creates a second income tax benefit to the business owner, i.e., a charitable contribution deduction, that can be used to offset otherwise taxable income.
The deduction, which is taken in the year that the business interest is transferred to the CRT, is the present value of the projected remainder interest of the CRT that will pass to one or more charities. The amount of the deduction can be hundreds of thousands of dollars or more depending upon the value of the business interest being transferred to the CRT and the age of the business owner and spouse if married. The allowable charitable deduction is limited to 30% of adjusted gross income, with excess amounts carried forward for five years.
The third income tax benefit enjoyed by a business owner who sells part or all of his/her business interest using a CRT is favorable taxation of CRT income. The net proceeds from the sale of a business interest owned by a CRT are reinvested by the CRT to provide a lifetime income stream to a designated beneficiary who is generally the business owner and his/her spouse if married.
The periodic income payment is calculated using either a fixed dollar amount if it is a charitable remainder annuity trust (CRAT) or a fixed percentage of the annually redetermined net fair market value of trust assets for a charitable remainder unitrust (CRUT). The taxation of CRT income, which is reported annually on Schedule K-1, is driven by the character of the income being distributed, taxed in the following order under a four-tier payout scheme: ordinary income, capital gains, tax free income, and principal.
Most of a CRT’s annual income will be taxed as long-term capital gains at a current top federal tax rate of 23.8% since the origin of a CRT from the sale of a business is untaxed long-term capital gains. CRT income classified as long-term capital gains will continue to enjoy favorable tax treatment if President Biden’s proposal is enacted provided that total taxable income in a given year is less than $1 million.
In summary, income tax savings attributable to establishing and funding a CRT in connection with the sale of business includes three components: elimination of the capital gain from the sale of the business, a sizable charitable contribution deduction, and favorable income tax treatment of CRT lifetime income distributions.
The latter benefit is threatened if the administration’s tax proposal is enacted and taxable income in a particular year exceeds $1 million. When this occurs, it generally happens in the year of sale. It could extend to future years if the business is sold on an installment sale basis depending upon the selling price and the amounts received in subsequent years.
The easiest way to illustrate the initial and ongoing income tax savings from a CRT is with an example. The example applies current income tax law and includes the following eight assumptions:
Cases #1 and #2 – Outright Sale of Business
The purpose of Case #1 is to calculate the income tax liability attributable to the long-term capital gain of $5 million from the sale of the business. Per the illustration, federal income tax would be $1.143 million, or 22.86% of the gain. California tax would be $623,000, or 12.46% of the gain, for total income tax liability of $1.766 million, or 35.32% of the gain.
Case #2 includes investment income of $81,000 and other ordinary income of $200,000, increasing taxable income from $4.975 million to $5.256 million. Total income tax liability increases from $1.766 million to $1.908 million, or 36.13% of total adjusted gross income.
Case #3 – Sale of 100% of Business by CRT
Case #3 assumes that 100% of the ownership of the business is transferred to a CRT prior to the June 30, 2021 assumed closing date. This would result in the following:
Enactment of the American Families Plan would result in additional federal income tax liability of 19.6% of $5 million, or $980,000, for an outright sale. Without a CRT, reinvestable net after-tax proceeds of $3.1 million would be reduced to $2.1 million, or 42.2%, of the long-term capital gain of $5 million.
Did I mention that there is another tax bill that Senator Bernie Sanders and the White House formally proposed on March 25th called the “For the 99.5% Act?” This proposal would reduce the federal gift and estate tax exemption of $11.7 million per individual to $3.5 million effective January 1, 2022. The “For the 99.5% Act” would also increase the estate tax rate from 40% to 45% on taxable estates exceeding $3.5 million, 50% on estates above $10 million, and 65% for estates over $1 billion.
A CRT is an excellent estate planning strategy for reducing estate tax. CRT assets avoid estate tax since the remainder of the CRT passes to charity at death, and, as such, it is excludable from one’s taxable estate. In the preceding example, the remainder value of the $5 million of assets transferred to the CRT would be excluded from the husband and wife’s estate.
A CRT is a powerful planning strategy that can be used as the cornerstone of a successful business owner’s retirement income plan. It offers the opportunity for sizable initial and ongoing income tax savings, increased sustainable lifetime tax-favored income, elimination of estate tax on CRT assets, and, last, but not least, a philanthropic/legacy component, i.e., the distribution of the remainder of the CRT to one or more chosen charities.
There are many situations where individuals who have used this strategy have accumulated a larger estate that has been distributed to their heirs than they would have without a CRT. This can occur when a CRT is combined with an irrevocable life insurance trust that purchases life insurance on the life of the business owner and his/her spouse if married using a portion of the income tax savings from implementing the CRT.
The CRT strategy, while it offers several significant benefits for business owners considering selling a business and for their families, is not for everyone. The implementation of a CRT generally should not be an all or nothing situation whereby 100% of the ownership of a business is transferred to a CRT.
It is important to strike a balance between CRT vs. individual ownership, weighing the pluses and minuses of each in a particular situation within the context of a holistic retirement income plan. Paying some income tax is not necessarily a bad thing – especially if you can do so at a federal tax rate of 23.8% vs. 43.4%.
Bob Klein’s article, Nonqualified Fixed Income Annuities: A Timeless Tax and Retirement Income Planning Opportunity, was published in The Street’s Retirement Daily. One retirement income planning strategy that will be virtually unscathed by President Biden’s proposed tax increase is longevity insurance, more commonly known as fixed-income annuities.
Every year since 2014 when I purchased a fixed index annuity (FIA) with an income rider in my SEP-IRA, I have added $20,000 to it. Furthermore, I plan on continuing to do this until I retire.
Why did I purchase a FIA with an income rider in my SEP-IRA in 2014 and add to it each year? For the same reasons that I am making the recommendation to do so today.
As I write this article, the Dow Jones Industrial Average (DJIA) is hovering at just below 31,000 after reaching an all-time high of 31,653.48 on February 22nd. The DJIA increased 13,440 points, or 74%, since its Covid low of 18,213.65 just 11 months ago on March 23, 2020.
While Covid-19 cases, hospitalizations, and deaths have all recently dropped and more people are getting vaccinated which has contributed to the sizable stock market increase, the party and associated euphoria will not last forever. With the exception of last year’s first quarter drop, the stock market has been on steroids since hitting a low of 6,469.95 on March 6, 2009 after declining 52% in 17 months beginning in October, 2007.
The DJIA has increased 480% in the last 12 years, or 40% per year on average, which is obviously not sustainable. Do the terms “bear market” or “reversion to the mean” ring a bell?
I have been extolling the virtues of making sustainable income the cornerstone of a retirement income plan since 2009 when I began specializing in retirement income planning. The 52% stock market decline in 17 months, combined with the elimination of secure lifetime income provided by private pension plans, created a perfect storm for implementing this strategy.
While my clients are happy with the 12-year increase in their portfolio values, I know from many years of experience that this state of exuberance is often short-lived. The reality is that their equity allocation is greater than what is targeted for their portfolio in several cases.
As a retirement income planner, I look for windows of opportunity for my clients to transfer slivers of their investment portfolio from the unpredictable fluctuation of the stock market to fixed income annuities that are designed to provide sustainable income that they can depend on throughout retirement.
There are three types of fixed income annuities that can be employed for this purpose: single premium immediate annuities (SPIAs), deferred income annuities (DIAs), and fixed index annuities (FIAs). Some FIAs have an income payout feature built into them while others require purchase of an income rider.
All payouts from fixed income annuities are calculated using mortality credits, or life expectancy, and current interest rates. If you invest in a SPIA or DIA today, your payout will be relatively low compared to three or more years ago because of declining interest rates. In the case of DIAs, this is true whether it is a new or an existing contract.
Income FIAs that were purchased between 2009 and 2018, including the one that I chose for my SEP-IRA in 2014, provide a unique opportunity for increased sustainable income payouts when new premium dollars are added compared to current SPIA, DIA and income FIA offerings. This is because the income payout for FIAs is calculated using a formula and the variables used to calculate the payout were more favorable and less likely to be tied to performance of the underlying contract accumulation value as is often done today.
The following four variables are responsible for higher income payouts in older income FIAs:
Besides the more favorable variables, there was greater availability of flexible vs. single premium contracts. Funds cannot be added after the first contract year to a single-premium FIA. Flexible premium FIAs, on the other hand, allow for subsequent investments after the initial contract year. Some flexible premium FIAs do, however, place caps on the amounts of annual additions. Finally, qualified, or retirement plan annuities, such as my SEP-IRA, are subject to annual contribution limits.
In addition to adding new premium dollars, anyone with an income FIA that was issued between 2009 and 2018 who has not begun taking income distributions should exercise their option to extend the initial growth phase interest crediting if this is available.
With the growing popularity of income FIAs beginning in 2009, a larger number of contracts offering the ability to extend interest crediting beyond 10 years are in play. If you have one of these contracts and have not started your lifetime income, it behooves you to exercise your interest crediting extension option.
This is a no-brainer since the crediting of additional interest, which can be for up to 10 years in some cases, will increase your income payout amount. The increase could be substantial if, for example, your contract provides for 8% compound interest crediting, you extend the growth period from 10 to 20 years, and you defer your lifetime income withdrawal start date.
This is a great time to purchase or add funds to fixed income annuities as part of an overall retirement income plan given the continued escalating stock market highs. Shifting a portion of one’s investment portfolio to sustainable lifetime income at opportune moments is a proven long-term strategy, especially if you are within 20 years of, or in, retirement.
Employing this strategy can enable you to accomplish two important goals shared by all individuals doing retirement income planning: portfolio risk reduction and decreased likelihood of running out of money in retirement.
Surveys as well as personal and client experience show that having predictable retirement income results in reduced short- and long-term stress levels, fewer cases of insomnia, and less health issues in general. This unequivocally trumps the often short-lived euphoria associated with increasing portfolio values in a bull market.
Bob Klein’s article, Reduce Capital Gains Tax on the Sale of Your Business, was published in The Street’s Retirement Daily. The article outlines how savvy business owners planning to sell their business can reduce or eliminate income tax liability from capital gains by using a long-standing IRS-blessed strategy called a charitable remainder trust, or CRT.
