Income Tax Planning

The 2013 Tax Law Schizophrenic Definition of Income – Part 2 of 2

Per last week’s blog, as a result of President Obama’s signing on January 2nd of the American Taxpayer Relief Act of 2012 following changes legislated by the 2010 Health Care Reform Act effective beginning in 2013, there are now five different definitions of income affecting seven different tax areas. Exhibit 1, which was also included in last week’s post, summarizes 2013 individual federal income-based tax law changes, comparing each one with the law in effect in 2012.

Please see last week’s post for a discussion of the first three definitions of income. This week’s post examines the last two.

Adjusted Gross Income Exceeding $250,000 or $300,000

Once your adjusted gross income (AGI) exceeds $250,000 if single or $300,000 if married filing jointly, your income tax liability will increase as a result of two affected tax areas: (1) Itemized deductions limitation and (2) Personal exemption phaseout. Although neither of these provisions was effective in 2012, both have been part of prior years’ tax law.

Itemized Deductions Limitation

The limitation on itemized deductions, known as Pease after the congressman who helped create it, was originally part of the Economic Growth and Tax Relief Reconciliation Act of 2001, was phased out beginning in 2006, and was repealed in 2010.

Back in 2013, the itemized deductions limitation reduces most otherwise allowable itemized deductions by 3% of the amount by which AGI exceeds the specified threshold of $250,000 or $300,000, depending upon whether you’re filing as a single or married filing joint taxpayer. Itemized deductions can’t be reduced by more than 80%. In addition, the reduction doesn’t apply to deductions for medical expenses, investment interest, casualty and theft losses, and gambling losses.

Personal Exemption Phaseout

The personal exemption phaseout is another reincarnation of prior tax legislation. Since 1990, the personal exemption has been phased out at higher income levels. The 2001 tax act phased out the phaseout beginning in 2006 with repeal in 2010.

Back in 2013, 2% of the personal exemption amount, projected to be $3,900, is eliminated for each $2,500 of AGI in excess of $250,000 for single filers and $300,000 for those using married filing joint tax filing status.

Taxable Income Exceeding $400,000 or $450,000

Welcome to 2013 tax law income definition #5 affecting two more income tax areas. If your taxable income exceeds $400,000 if single or $450,000 if married filing jointly, your income tax liability will be further increased by two different tax provisions: (1) Income tax bracket and (2) Long-term capital gains and qualified dividends.

Income Tax Bracket

The top tax bracket of 35%, which was in effect from 2003 through 2012, jumps by 4.6% to 39.6% beginning in 2013 for those individuals whose taxable income exceeds the single and married filing joint thresholds of $400,000 or $450,000, respectively. The last time that the 39.6% rate was part of the tax law and was also the top tax rate was in 2000.

Long-Term Capital Gains and Qualified Dividends

Beginning in 1982, tax rate reductions reduced the tax rate on long-term capital gains, i.e., capital gain income from assets held longer than one year, from 28% to a maximum of 20%. The rate was further reduced from 20% to 15% beginning in 2003 and also began applying to qualified dividends.

The 20% maximum rate on long-term capital gains and qualified dividends has returned in 2013 for those individuals whose taxable income exceeds the $400,000 or $450,000 threshold depending upon filing status.


With the exception of the Medicare Earned Income Tax and Medicare Investment Income Tax discussed in last week’s post, the other five affected tax areas resulting in higher federal income taxes in 2013 are reincarnations of prior tax law. Everyone with employment or self-employment income of any amount with limited exception will pay more tax in 2013 than they did in 2012, all else being equal. In addition, income tax liability will increase for anyone with certain types of income exceeding specified thresholds starting at $200,000 or $250,000 depending upon filing status. The cumulative effect of the various changes and associated increase in federal income tax liability will be significant for many people.

Annuities Deferred Income Annuities Fixed Index Annuities

Invest in DIA to Fund LTCI Premiums When Retired – Part 4 of 4

The first three posts in this series discussed five differences between fixed index annuities (“FIA’s”) with income riders and deferred income annuities (“DIA’s”) that will influence which retirement income planning strategy is preferable for funding long-term care insurance (“LTCI”) premiums in a given situation. If you haven’t done so already, I would recommend that you read each of these posts.

This week’s post presents a sample case to illustrate the use of a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement.


As with all financial illustrations, assumptions are key. A change in any single assumption will affect the results. The following is a list of assumptions used in the sample case:

  1. 55-year old, single individual
  2. Planned retirement start age of 68
  3. Life expectancy to age 90
  4. Current annual LTCI premium of $4,000 payable for life
  5. Need to plan for infrequent, although potentially double-digit percentage increases in LTCI premium at unknown points in time
  6. Given assumptions #4 and #5, plan for annual pre-tax income withdrawals of approximately $6,000 beginning at retirement age
  7. Solve for single lump sum investment at age 55 that will provide needed income
  8. Investment will come from a nonqualified, i.e., nonretirement, investment account
  9. One investment option is a fixed index annuity (“FIA”) with an income rider with lifetime income withdrawals beginning at age 68.
  10. Second investment option is a deferred income annuity (“DIA”) with no death benefit and lifetime income payout beginning at age 68.
  11. FIA premium bonus of 10%
  12. FIA annual return of 3%
  13. FIA income rider charge of 0.95% of income rider value otherwise known as the guaranteed minimum withdrawal benefit (“GMWB”)
  14. No withdrawals are taken from the FIA other than the income withdrawals.
  15. All investments are purchased from highly-rated life insurance companies known for providing innovative and competitive retirement income planning solutions.

Investment Amount

The first thing that needs to be solved for is the amount of investment that must be made at the individual’s age 55 in order to produce lifetime annual income of approximately $6,000 beginning at age 68. The goal is to minimize the amount of funds needed for the investment while choosing a strategy from a highly-rated insurance company that’s known for providing innovative and competitive retirement income planning solutions.

It turns out that an investment of $50,000 to $65,000 is needed to produce lifetime annual income of approximately $6,000 beginning at age 68. Given the fact that my goal as a retirement income planner is to use the smallest amount of investment for a fixed income annuity to produce a targeted income stream in order to preserve the remainder of a client’s investment portfolio for my client’s other financial goals, the amount of the investment needed is $50,000.


There are three items we will examine to compare the results between investing $50,000 in a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement. They are as follows:

  • Annual gross income
  • Annual taxable income
  • Value/death benefit

Annual Gross Income

Per the Exhibit, the annual payout, or gross income, from the FIA is $5,764, or $236 less than the annual gross income of $6,000 from the DIA. This equates to a total of $5,428 for the 23 years of payouts from age 68 through age 90.

Annual Taxable Income

If the investment was made in a retirement account like a traditional IRA and assuming there have been no nondeductible contributions made to the IRA, 100% of the income would be taxable. This would be the case for both the FIA or DIA.

As stated in assumption #8, the investment will come from a nonqualified, i.e., nonretirement, investment account. Per Part 2 of this series, this makes a difference when it comes to taxation of the withdrawals. Per the Exhibit, 100% of the annual FIA income of $5,764 is fully taxable vs. $3,066 of the DIA income. This is because the DIA, unlike the FIA, is being annuitized and approximately 50% of each income payment is nontaxable as a return of principal. Over the course of 23 years of payouts, this results in $62,054 of additional taxable income for the FIA vs. the DIA.

The amount of income tax liability resulting from the additional taxable income from the FIA will be dependent upon several factors that will vary each year, including (a) types, and amounts, of other income, (b) amount of Social Security income, (c) potential losses, (d) adjusted gross income, (e) itemized deductions, (f) marginal tax bracket, and (g) applicable state income tax law.

Value/Death Benefit

While the present value of the future income stream of a DIA represents an asset, you generally won’t receive an annual statement from the life insurance company showing you the value of your investment. In addition, while some DIA’s will pay a death benefit in the event that the annuitant dies prior to receiving income, per assumption #10, this isn’t the case in this situation. Consequently, the DIA column of the “Value/Death Benefit” section of the Exhibit is $0 for each year of the analysis.

On the other hand, there’s a projected value for the FIA from age 55 through age 79. This value is also the amount that would be paid to the FIA’s beneficiaries in the event of death. There’s a projected increase in value each year during the accumulation stage between age 55 and 67 equal to the net difference between the assumed annual return of 3% and the income rider charge of 0.95% of the income rider value.

Per the Exhibit, the projected value/death benefit increases from $56,278 at age 55 to $68,510 at age 67. Although the assumed premium bonus of 10% is on the high side these days, this is reasonable given the fact that FIA values never decrease as a result of negative performance of underlying indexes, the assumed rate of return of 3% is reasonable in today’s low index cap rate environment, and the assumed income rider charge of 0.95% of the income rider value is on the upper end of what’s prevalent in the industry. The projected value/death benefit decreases each year from age 68 to age 79 until it reaches $0 beginning at age 80 as a result of the annual income withdrawals of $5,764.


As discussed in Parts 1 – 3 of this series, there are five important differences between FIA’s with income riders and DIA’s that will influence which retirement income planning strategy is preferable for funding LTCI premiums during retirement in a given situation. Two of the differences, income start date flexibility and income increase provision, haven’t been addressed in this post.

In addition to the five differences, the amount of the investment required to produce a targeted lifetime annual income amount to pay LTCI premiums, including potential increases, will differ depending upon the particular FIA or DIA strategy used. In the illustrated case, which isn’t uncommon today, an investment of $50,000 resulted in an almost identical lifetime income payout whether a FIA with an income rider or a DIA is used.

As illustrated, the taxable income associated with a DIA in a nonqualified environment is much less compared to a FIA. As previously discussed, the amount of tax savings resulting from the reduced taxable income will depend upon an analysis of several factors and will vary each year. Ignoring the potential income tax savings resulting from the tax-favored DIA payouts, the FIA with income rider would be the preferred investment choice for many individuals in this case given the presence, duration, and projected amount of, the investment value/death benefit.

The FIA edge is reinforced by the fact that, unlike most traditional DIA’s, the income start date and associated annual lifetime income payout amount for FIA’s is flexible. This would be an important consideration in the event that the year of retirement changes. Furthermore, this is quite possible given the fact that the individual is 13 years away from her projected retirement year.

As emphasized throughout this series, the purchase of LTCI needs to be a lifetime commitment. Planning for the potential purchase of a LTCI policy should be included as part of the retirement income planning process to determine the sources of income that will be used to pay for LTCI throughout retirement. Whether it’s a FIA with an income rider, a DIA, or some other planning strategy that’s used for this purpose will depend on the particular situation.