Outlasting the storm by Phil Wasserman

Outlasting the Storm: A Survival Guide to Retirement Income Planning

About the Author Phillip Wasserman is recognized as one of the leading experts on annuities, life insurance, and wealth transfer strategies. He has a B.A. degree in Economics from Kalamazoo College and a law degree from Stetson University College of Law. Phil lives in Sarasota, Florida with his wife Diane and has three great children. His hobbies include music and tournament poker. He is an avid Tampa Bay Buccaneers football fan. He is also a dog nut, and is the happy owner of Luca, a descendant of the real University of Georgia bulldog UGA, Alstott, an Olde English Bulldog, and Buc, a German Shepherd.

Table of Contents General Retirement Thoughts / 9 Ten Retirement Planning Tips / 17 Annuity Basics / 21 Is an Annuity Right for Me? / 33 Annuity Strategies / 49 The Rainbow Strategy / 63

Table of Contents How the New Hybrid Index Annuities Work / 77 Life Insurance / 97 Income Maximization / 111 Some General Tax-Saving Ideas / 125 Rule of 72 / 141 151A / 145

Introduction There are over one million people licensed to sell annuities nationwide. Unfortunately, most of these well-intentioned people are ill-prepared and poorly trained to sell a product that can be a powerful retirement income planning tool. I once did a training seminar for about one hundred agents in Atlanta, Georgia. I asked how many of the agents represented a well-known company and about ninety percent raised their hands. I then offered $100 to the first agent who could explain how that company’s most popular product worked – one with a two-tier strategy (explained later in the book) – to the rest of the group. Not a single agent came forward. So when several class action suits were filed against that company, I wasn’t surprised.

Introduction I remember another time an agent I know contacted one of my clients, who then called me concerned. The agent had told the client how he would do things differently â&#x20AC;&#x201C; and worried the client â&#x20AC;&#x201C; yet this agent had never even sold as many annuities in his life as the client owned. Yes, even in our field, beyond the well-intentioned, there are morons. The purpose of this book is to help you, the consumer, understand annuities and life insurance so that you will be educated and make the right choices if you choose to use these powerful tools. This book is written to be easily comprehensible. Critics may say that itâ&#x20AC;&#x2122;s too simple. I say that if you understand it, then you will know more than most of the people selling you the product.

Chapter 1 General Thoughts on Retirement

Chapter 1: General Thoughts on Retirement

Retirement is a Gift of Time • “Aging is humanity’s greatest, most important, and most enduring discovery. The discovery and exploitation of human longevity is what has led to the globe-dominating species we have become.” - Dr. William Thomas, M.D.

• We have the most awesome resource in our retirees to help solve society’s most difficult problems. – Retirees can give of their time, skills, wisdom, and shared experiences. – This legacy will make for better individuals and communities. – To do this, retirees must have a safe, sustainable retirement income. 11

Chapter 1: General Thoughts on Retirement

Threats to Your Retirement Nest Egg • Inflation • Health • Age • Fees • Taxes • Risk/Volatility

Chapter 1: General Thoughts on Retirement

Wise Sayings Doing the same thing over and over again, and expecting different results. â&#x20AC;&#x201C; Einstein's Definition of Insanity

The first rule is not to lose money. The second rule is not to forget the first rule.

â&#x20AC;&#x201C; Warren Buffet

Chapter 1: General Thoughts on Retirement

Four Solutions for Your Retirement Income Planning • Beat Inflation • Lower Fees • Minimize Taxes

• Reduce Risk/Volatility

Chapter 1: General Thoughts on Retirement

What is needed? Self-informed awareness combined with comprehensive independent financial planning to: • Keep your retirement money safe • Help you make money on your money

• Provide you with easy access to your money • Help with estate planning, wealth creation, and wealth transfer • Minimize your tax consequences

Chapter 1: General Thoughts on Retirement

Chapter 2 Ten Retirement Planning Tips

Chapter 2: Ten Retirement Planning Tips

Ten Retirement Planning Tips 1. Have your money in savings, not investments. 2. Save on fees. 3. Save on taxes. 4. Be realistic about life expectancy.

5. Use annuities for guaranteed income. 6. Don’t listen to what neighbors, friends, or relatives say about money. 7. You don’t need 2-3 homes. Ever hear of a hotel? 8. Question your doctor and get a second opinion. 9. Enjoy your money. After all, you can’t take it with you. 10. Don’t believe everything you read. Everyone has an agenda. 19

Chapter 2: Ten Retirement Planning Tips

Chapter 3 Annuity Basics

Chapter 3: Annuity Basics

Why an Annuity? Some Offer Guaranteed Lifetime Income! Some Offer No Risk Growth!

Some Offer No Fees!

Chapter 3: Annuity Basics

Four Types of Annuities Fixed Immediate (also known as SPIAA) Index (also known as Equity Index, or EIA) Variable

Chapter 3: Annuity Basics

What is an Annuity? • A contract between you and an insurance company • Four types: Variable, Fixed, Immediate, and Index • Purchased through: – A one-time, lump-sum payment, or – A series of on-going payments over time

• Can provide regular, periodic payments for income • Amount invested depends on: – Short and long-term financial goals – Composition of current portfolio – Tax situation

Chapter 3: Annuity Basics

What is an Annuity? • Investment grows tax-deferred • No limits on the amount you can invest • Avoids probate • Creditor proof

Chapter 3: Annuity Basics

Annuity Terms Annuity – A guaranteed investment contract with an insurance company Owner – The owner of annuity contract (can be a trust or the annuitant or a third party)

Beneficiary – To whom the money goes upon the annuitant’s death (can be the owner) Annuitant – Person on whom the annuity is based (does not have to be owner). All annuities have annuitants (some annuities allow joint annuitants)

Chapter 3: Annuity Basics

Common Myths about Annuities • “Annuities are not good for IRA’s or other qualified plans” – Not true! Fixed, immediate, and index annuities may be very good in IRA’s. • “All annuities have fees” – Not true! Fixed and immediate annuities have no fees. Many index annuities have no fees. • “When you die, the annuity is gone”

– Not true! Your heirs will inherit your fixed, variable, or index annuities. Immediate annuities stop at time of death unless you choose a set period certain. 28

Chapter 3: Annuity Basics

Common Myths about Annuities • “Annuities are not meant for seniors” – Not true! Annuities are specifically designed for seniors and retirees. • “You should not die owning an annuity”

– Not true! We often hear this ridiculous statement from life insurance salespeople. Since annuities grow on a tax-deferred basis, your heirs will pay ordinary income tax on the profit, which is compounded because of the tax deferral.

Chapter 3: Annuity Basics

Annuities vs. Other Investments Question

Tax-Deferred Fixed Annuity

Municipal Bond

Certificate of Deposit

Corporate Bond

Is your principal free from market risk?

Yes

Are you interest and principal guaranteed?

Yes

Is your deferred interest free from current taxation?

Yes

Do you interest earnings accumulate without affecting taxation of your Social Security benefits?

Yes

Can you make cash withdrawals without a surrender charge?

Yes

Can you automatically avoid probate expenses and delays?

Yes

Does the purchase avoid incurring a sales charge?

Yes

Is there a provision to provide a guaranteed lifetime income with additional tax advantages?

Yes

Chapter 3: Annuity Basics

Conclusion • An Annuity can protect you against: – – – –

Outliving your savings Risking your principal Inflation Taxes

• Bonus – Many annuities offer up-front bonuses that add even more to your savings • Annuities can offer: – Benefits to ensure optimum quality of life – Greater benefits than other investment options – Secure savings for the rest of your life

Chapter 3: Annuity Basics

Chapter 4 Is an Annuity Right for Me?

Chapter 4: Is an Annuity Right for Me?

Annuities are a wise investment if you are: • Seeking – Guaranteed, steady income for the rest of your life – Principle protection – Inflation protection

• Older, conservative investors – Various investment options to match investment and risk tolerance levels

• Concerned about outliving your money – Protection against outliving your assets – Benefits to your heirs

• Seeing investment returns being diminished by volatility and fees – Ability to save money on a tax efficient basis

Chapter 4: Is an Annuity Right for Me?

What to ask if purchasing an annuity 1. What type of annuity is it?

2. What is the length? 3. What are the surrender penalties? 4. Are there any riders?

5. What are the specific fees? 6. If it is a variable, who is responsible for managing it? 7. If it is a fixed annuity, is the interest rate adjustable?

8. What is the company rated?

Chapter 4: Is an Annuity Right for Me?

State Guaranteed Funds Most states have guarantee funds to help pay the claims of an insurance company unable to meets its obligations. Most states also restrict agents and companies from advertising the fundâ&#x20AC;&#x2122;s availability. These funds operate similar to an FDIC-like protection for annuities, life insurance, long-term care, and health insurance. The purpose of these funds is to protect the consumer and instill trust in the products. I am highly critical of states that do not allow agents to discuss this protection. Fixed annuities, including SPIAAâ&#x20AC;&#x2122;s and Index, are among the safest products available. Certain states (like Florida) are changing their laws to allow agents to discuss the existence of guaranteed funds with consumers who inquire.

Chapter 4: Is an Annuity Right for Me?

Unprecedented Challenges Retirees are facing unprecedented challenges in maintaining their standard of living in retirement. A study by Ernst and Young shows that almost 3 in 5 retirees can expect to outlive their financial assets. This number climbs to almost 90% when excluding retirees who have employer-defined benefit plans (pension plans). This number is growing daily as more and more employers move their employee retirement benefit plans to employerdefined contribution plans (such as IRA’s, 401(k)’s, etc) and trend away from pension plans.1

1. Ernst & Young LLP. “Retirement Vulnerability of New Retirees: The Likelihood of Outliving their Assets.” July 2008. 38

Chapter 4: Is an Annuity Right for Me?

Traditional Models No Longer Work It appears that if retirees do not develop other sources of guaranteed income, then their choices for creating an enduring retirement plan will only include either 1) working longer or 2) reducing their standard of living. The Ernst and Young study calculates that retirees would need to reduce their standard of living by 33% to 49% to ensure that they will not outlive their financial assets. As retirees continue to depend on traditional models of retirement income planning to maintain their lifestyles, they are discovering that in many cases these models simply do not work.

Chapter 4: Is an Annuity Right for Me?

The Wharton Report Professors David F. Babbel and Craig B. Merrill of The Wharton Financial Institutions Center are leading academics in the area of retirement income planning. In their paper, “Investing your Lump Sum at Retirement,” they state that: “…forces are combining to make planning for outliving your resources more important than it has been in the past. Old rules of thumb for spending your assets in retirement, called decumulation, need to be reconsidered.” When taking into account all the challenges that retirees face today in planning for a long and happy retirement – longevity risk, health care costs, inflation and taxes – just to name a few, the need for guaranteed income streams becomes apparent.

Chapter 4: Is an Annuity Right for Me?

The Wharton Report Babbel and Merrill conclude in their paper: “When individuals consider the list of positive attributes associated with life annuities, i.e., guaranteed payments you cannot outlive, low cost, access to invested capital, and reasonably priced features such as inflation adjustment and legacy benefits, the argument for this income solution in retirement is compelling. By covering at least basic expenses with lifetime income annuities, retirees are able to focus on discretionary funds as a source for enjoyment. Locking in basic expenses also means that the retiree’s discretionary funds can remain invested in equities for a longer period of time, bringing the benefits of historically higher returns that can stretch the useful life of those funds even further. Income annuities may also be a vehicle that enables retirees to delay taking Social Security benefits until they are fully vested, bringing substantially higher payments at that point. The key in all of this is to begin by covering all of the basic living expenses with lifetime income annuities. Then, to provide for additional desirable consumption levels, you will want to annuitize a goodly portion of the remainder of your assets, while making provisions for extra emergency expenses and, if desired, a bequest. These last two items can be accomplished through combinations of insurance and savings. When this is undertaken, you can enjoy your retirement without the burden of financial worries and focus on more productive uses of your time and attention!”2 2. Babbel, David F., and Craig B. Merril. “Investing Your Lump Sum at Retirement.” Wharton Financial Institutions Center, August 2007.

Chapter 4: Is an Annuity Right for Me?

Use Annuities to Cover the Basics In other words, if you cover your basic expenses with money received from guaranteed streams of income, them you would have the freedom to use the rest of your money as you wish. You would no longer have to worry about outliving your money in retirement. You would be able to enjoy your discretionary funds at the time in your retirement when you still can. You would also avoid fluctuations in the stock market or in any other place where your money is invested because you would be able to move those investments when it is most advantageous for you to do so, rather than based on necessity. This would allow you to maximize the use of your resources and do what you want with the rest of your money.

Chapter 4: Is an Annuity Right for Me?

The MassMutual Study MassMutual Financial Group released a study provomg that incorporating a fixed income annuity into a retirement income account not only provided more income security, but also produced greater long-term wealth for the investor than equities and bonds alone. “Incorporating a fixed income annuity in a retirement income account yielded greater longterm wealth for an investor—along with more income security—than a portfolio of equity and bond investments alone, even in an "up" market.”

They also discovered that fixed income annuities create greater cash flow for retirees while significantly lessening their risk of outliving their savings. "By including fixed income annuities in a retirement income account, retirees may achieve greater growth potential while also addressing their desire to avoid running out of money in retirement and to leave a legacy for their spouses or children."

Chapter 4: Is an Annuity Right for Me?

The MassMutual Study The study set up 4 accounts that were then tested using actual data from a 27 year period (January1, 1980 to December 31, 2006). The study then did head to-head comparisons of the 4 different allocations. The results were as follows: • •

•

Account A, which had no fixed income annuity component and was made up of U.S. equities1 (50 percent) and U.S. bonds2 (50 percent), had a liquid value (the current market value invested in equities and bonds) of $489,346, nearly five times the original $100,000 deposit, at the end of the 27-year study period. Account B, which was made up of the same 50/50 allocation as Account A except that, at the start, 33.3 percent of the account (all from the bond portion of the investment portfolio) was used to purchase a lifeonly fixed income annuity, had a liquid value of $667,688, almost seven times the original deposit, at the end of the 27-year study period. Account C, made up of U.S. equities (50 percent), U.S. bonds (30 percent), as well as an initial purchase of a life-only fixed income annuity (20 percent) with additional fixed income annuity purchases in the second through seventh years, had a liquid value of $735,292, more than seven times the original deposit, at the end of the 27-year study period. Account D has the same initial asset allocation as Account C; however, the payout method for all fixed income annuity purchases is life with 20 years certain (thereby providing protection for the beneficiaries in the event of an early death of the investor), and generated more than five times the original deposit in liquid value ($546,200) at the end of the 27-year study period.3

3. MassMutual Finance Group. “Study of Retirement Income Account Allocations Among Equities, Bonds and Fixed Income Annuities.” November 2007.

Chapter 4: Is an Annuity Right for Me?

The MassMutual Study In summary, not only do income annuities provide the luxury of time and create a stress-free retirement, but in all instances in the study, portfolios including income annuities also experienced a much better net result.

Chapter 4: Is an Annuity Right for Me?

The Babbel Report In an additional study, David F. Babbel, professor of Insurance and Risk Management at the Wharton School of Business, compared the performance of income annuities to the S & P 500 index, Vanguards S&P 500 fund and the Money Market Index among others, using data starting in 1995 through 2008. He considered policies issued on the first day of each year starting on 1/1/95 and calculated the account values as of the end of the surrender charge period or October 31, 2008, whichever came first. In all cases except one, the income annuities outperformed all of the other indices.

Chapter 4: Is an Annuity Right for Me?

The Babbel Report While being interviewed by Annuity Digest, Professor Babbel stated: “Our studies show that the products of at least some of the companies in this field are viable – indeed, rather attractive products. Our findings regarding actual products show that since their inception in 1995, they have performed quite well – in fact, some have performed better than many alternative investment classes (corporate and government bonds, equity funds, money markets) in any combination.”

He also stated that: “…what surprised me was that the returns on FIAs outperformed the alternatives over the lifetime of their existence (since 1995) for every year that they have been issued. This relates to 9-year FIAs and 14-year FIAs, held through maturity. This superior performance prevailed EVEN BEFORE there was any adjustment for risk, which adjustments typically reduce the risk-adjusted returns of the alternatives to FIAs, thereby boosting even more the FIA relative returns.”4

4. "An Interview with Wharton Professor David Babbel – Parts One and Two." Interview by Tom Cochrane. Annuity Digest, July 2009.

Chapter 4: Is an Annuity Right for Me?

So How Do I Know If An Annuity Is Right For Me? So how do you know if an income annuity is right for you? Are you retired or nearing retirement? Do you currently have a retirement income plan in place? Do you have guaranteed income streams or are you working with defined contribution plans (401(k), IRA, etcâ&#x20AC;Ś)? If you do not currently have guaranteed income streams to cover your basic expenses throughout your retirement, you need to look at the possibility of getting an income annuity or a series of income annuities to provide for you in retirement or you will continue to run the risk of outliving your financial assets.

In these uncertain times, when events outside of our control can change our world, financially intelligent people want guaranteed income streams so that they can respond to whatever life throws at them. 48

Chapter 5 Annuity Strategies

Chapter 5: Annuity Strategies

Tax-Deferred Fixed Annuity • Similar to a certificate of deposit • Income tax is deferred until you access your cash • You earn: – Interest on your principal – Interest on your interest (compounding) – Interest on the money would have used to pay taxes

• Guarantees: – Return of your principal – Return on your principal

Chapter 5: Annuity Strategies

Tax-Deferred Fixed Annuity • Defers tax liability until cash is withdrawn • Lifetime income • Guaranteed principal • Guaranteed interest • Avoids high costs and delays of probate Warning

Some fixed annuities have adjustable interest rates. Make sure you know if your rate is fixed or adjustable.

Chapter 5: Annuity Strategies

Immediate Annuity (also known as a SPIAA) • Product that most people think of when they think of an annuity, purchased by a premium payment to an insurance company • Designed to enhance cash flow • Monthly payments can begin immediately • Payments can last for a fixed term or for your lifetime • Payment amounts depend upon: – Life Expectancy, Age, and Health – Amount Invested – Interest Rates

Chapter 5: Annuity Strategies

Is an Immediate Annuity Right for You? An immediate annuity may be appropriate if you are: • A retiree needing increased monthly cash-flow • A person who has no heirs or is not concerned about leaving an estate

• Someone who has set aside other funds to leave to their heirs • Someone who needs to shelter assets and qualify for Medicaid • A retiree wanting to avoid the hassles of investing on one’s own

Chapter 5: Annuity Strategies

Positives of a SPIAA 1. Actuarially based, so the older you are and if in poor health the more the annuity will pay out. 2. Tax advantages outside of an IRA on qualified money because payments are partially treated as return of capital (annuity exclusion ratio rule). 3. Can guarantee an income for life

Chapter 5: Annuity Strategies

Negatives of a SPIAA 1. Payments are set and may not increase for inflation (with some exception) 2. When the annuitant dies, the payments stop (except for period certains) and the money belongs to the insurance company

3. SPIAA aren’t liquid – once done they are permanent and the money paid can’t be accrued

Chapter 5: Annuity Strategies

Period Certain SPIAA One of the biggest drawbacks for people considering purchasing a lifetime SPIAA is that once the purchase is made the money belongs to the insurance company. Payments will be made to the annuitant for life. But what if the annuitant dies suddenly? Then all of that money is gone. The answer is a period certain, which would guarantee the payments to the heir for a certain period of time even if the annuitant dies immediately.

Chapter 5: Annuity Strategies

Example John is a 70-year old male. He purchases a SPIAA for 100,000 from a wellknown insurance company. His lifetime payments are 10,000 a year forever. But if he dies soon after, that money is lost to the insurance company. So John purchases an option known as a period certain, which can be any period he chooses (5-10-20 years). If he dies before that period, payments will be made to his heirs for the remainder of the period certain. However, when a period certain is chosen, payments are reduced depending on the length of the period certain. The longer the length, the higher the reduction. Example: John chooses a 10-year period certain. His payments are reduced from the previous example to 9,500 a year. He dies at the four year anniversary. Payments will continue to his heirs for another 6 years.

Chapter 5: Annuity Strategies

Variable Annuities What is a variable annuity? It is an investment product that places the risk is on the consumer, unlike other annuities that place the risk only on the company. A variable annuity is a group of mutual funds surrounded by an annuity. The annuity provides the tax deferral. Many in the past criticized VAâ&#x20AC;&#x2122;s for outrageously high fees and few benefits for the consumer. This was true but times have changed. Currently, VAâ&#x20AC;&#x2122;s have strong benefits in return for fees that are high, but serve to help offset market risk.

Chapter 5: Annuity Strategies

Aspects of Variable Annuities Fees – Most VA’s have fees of 2-4% when the mutual fund and ride fees are factored in. Riders – Today, some VA’s offer riders that may protect the initial principal and/or provide lifetime income even if the market falls.

Who are VA’s good for? People who only want to be in the market but need to limit their risk. Positives of Variable Annuities • Can choose from options of mutual funds • Riders can protect initial investment for death benefit and/or income

Chapter 5: Annuity Strategies

Negatives of Variable Annuities â&#x20AC;˘ Fees are high for the insurance of market risk â&#x20AC;˘ The death benefit is taxed as ordinary income, not tax-free like regular life insurance (this is important because many agents emphasize the death benefit)

â&#x20AC;˘ Access to money may be limited in a down market due to market losses.

Chapter 5: Annuity Strategies

Chapter 6 The Rainbow Strategy (Global Lookback)

Chapter 6: The Rainbow Strategy

Chapter 6: The Rainbow Strategy In these times of high volatility, people are looking for ways to diversify their portfolio in order to protect their nest egg and try to capture as much of the upside as possible. But what exactly is diversification? Is it choice? A Jelly Bean Store can have thousands of different choices of colors and flavors but everything you buy is still a jelly bean.

True diversification is a mixture of uncorrelated, or lesser correlated, items. When looking for diversification for where you put your nest egg, you want to be spread out across the different economies around the globe.

Chapter 6: The Rainbow Strategy Where do you think we are going to see the economy improving in the next ten years? China? Europe? Japan? America? How would you like to be in a position where you would not have to guess which economy will grow the fastest to be able to take advantage of that growth? That is what the new "rainbow crediting methodâ&#x20AC;? does. Many of the experts familiar with this strategy say it is like being able to bet on the race after the horses have run. Here is how it works. The strategy uses four indices from around the world: the Hang Seng in China, the Dow Jones Eurostoxx 50 in Europe, the Nikkei 225 Index in Japan, and the S & P 500 in America. This strategy is not only diversified using economies from around the world, but it is also weighted so that most of the money is going to the indices that are producing the best results. 66

Chapter 6: The Rainbow Strategy At the end of the year, the rainbow strategy allocates 40% of the money in the strategy to the index that has grown the most, 30% of the money to the index which came in second, 20% of the money to the index which came in third, and 10% to the the trailing index. This means that the 70% of your money is allocated to the top two highest growth indexes. It then adds up all of these results and multiplies the total by 60%. A 1.5% free is subtracted. If the result is positive, your account is credited with the earnings. If the result is negative or zero, your account remains unchanged from the prior year. So in up years, your account is growing at a substantial rate and in down years your principal and past earnings are protected.

Chapter 6: The Rainbow Strategy Here is an example of how this would actually work: Index A grows 60% X 40% of money is allocated = 24%

Index B grows 30% X 30% of money is allocated = 9% Index C grows 20% of money is allocated = 4% Index D shrinks 10% X 10% of money is allocated = -1%

Total

36%

36% X 60% = 21.6% - 1.5% spread = 20.1% interest credited

And you did not have to worry about which of the four Global Markets was going to grow the most. This strategy did all of the work for you!

Chapter 6: The Rainbow Strategy In summary, the Rainbow strategy offers the most innovative response to the volatile times that we are currently living in. If you are looking for a way to protect your retirement nest egg and still have a very good chance to earn some impressive returns, then this new and innovative strategy has definitely earned the right to be highly considered. Finding these kind of returns with the safety that these products are famous for is the perfect answer to the uncertainty of the era in which we live.

Chapter 6: The Rainbow Strategy

Rainbow Connection (Getting the largest pot of gold)1 The rainbow crediting method launched towards the end of 2007. Unfortunately the launch coincided with the tail of the previous bull market and annuity-buyers selecting the rainbow method in 2007 and much of 2008 received the same zero returns as other indexed methods. However, as the stock market rebounded in 2009 the rainbow began to show its performance colors and this article looks at the relative performance of the different rainbow methods first reviewed two years ago.

1. Jack Marion. â&#x20AC;&#x153;Rainbow Connection (Getting the largest pot of gold).â&#x20AC;? May 2010. 70

Chapter 6: The Rainbow Strategy

Rainbow Connection (Getting the largest pot of gold) The rainbow method is an option basket whose best-performing indices are weighted more heavily than those that perform less well. It is always a "lookback" because the money is allocated based on the ranking of the performance after the period is over. Rainbows are always index blends, but not all index blends are rainbows. The difference is blended methods state at the beginning what the percentage make-up is of the indices in the blend, but the rainbow method combination is based on the returns calculated with the largest portion going to the best performers. The Rainbow marketing appeal has been expressed by saying that the annuitybuyer gets to bet on the race after it has been run and that most of the bet will be put down on the horses that â&#x20AC;&#x153;win or place.â&#x20AC;?

Chapter 6: The Rainbow Strategy

Rainbow Connection (Getting the largest pot of gold) In my earlier look I said that if the choice was between the S&P 500 method with a cap and a rainbow method with a higher cap that I would pick the rainbow method every time – and I still feel that way. However, I noted that capping the rainbow return somewhat defeats the main attraction of using the method – it’d be like picking the winning horses after the race but being limited to a $2 bet. The other point raised was that of correlation, or how closely one index tracks another. For example, the S&P 500 and Dow Jones Industrial Average have over 99% correlation over the last 50 years. If your goal is diversity in returns it doesn’t make sense to put together indices that move the same way. My feeling is if you are using the rainbow method you should attempt indices that have the lowest correlation because one might hit a home run. Sure, one index could be a stinker, but the lowest performer is given the least weight thus the impact is minimized. 72

Chapter 6: The Rainbow Strategy

Global Lookback: The Basket • S&P 500 • Dow Jones EURO STOXX 50

• Nikkei 225 Index • Hang Seng Index

Chapter 6: The Rainbow Strategy

Global Lookback: The Basket Nikkei 225 Index An Index of the Most Actively Traded Issues on the Tokyo Stock Exchange i.e. Toyota, Canon, Sony Hang Seng Index An Index that contains the 40 Leading Stocks on the Hong King Stock Exchange i.e. HSBC, Cosso, Espirit, Holdings

Chapter 6: The Rainbow Strategy

Global Lookback: The Basket Dow Jones EURO STOXX 50 An Index that includes blue-chip sector leaders in Western Europe

i.e. Bayer, Nokia, Volkswagen S&P 500 A US Index that includes 500 Leading Companies from a Range of Industries i.e. General Electric, Wal-Mart, Microsoft

Chapter 6: The Rainbow Strategy

Chapter 7 How the New Hybrid Index Annuities Work

Chapter 7: How the New Hybrid Index Annuities Work

What is an Index Annuity? • A type of fixed annuity that offers the potential to capture some of the gains in the stock market without the risk of loss. • Returns are determined by the performance of an index such as the S&P 500. – Also known as Equity Index Annuities (EIA) – Other indices can be selected, e.g. DJIA, NASDAQ, Russell 2000

• Investors’ returns are usually calculated as a percentage of the index performance.

Chapter 7: How the New Hybrid Index Annuities Work

What is an Index Annuity? An index annuity was designed to be a fixed annuity, one in which the principal was safe, with an interest rate determined by tracking a stock market index. Originally, the idea was to receive some of the market gain with no risk to the principal. Companies often compared it to going to a casino with $10,000 and getting to keep the $10,000 no matter how you played. Even if you lost, you would get to keep your $10,000. But if you managed to win, you would get to keep a chunk of your winnings but have to give up some of the gain.

Chapter 7: How the New Hybrid Index Annuities Work

How they Work The insurance company invests the annuity premium in bonds. The principal remains secure because it is not attached to the market. The interest rate that the bonds throw off is used for the following: 1 - Any interest guarantee

2 - Commission to the agent 3 - The purchase of options to provide market upside 4 - The insurance company profit A rarely noticed observation: It is obvious that when a higher commission is paid to the agent or a bigger upfront bonus given to the client, there is less money remaining to purchase options. The more money left from the interest to purchase options, the higher the potential gain for the client. 81

Chapter 7: How the New Hybrid Index Annuities Work

Index Annuity Features • Surrender periods are usually 7 – 15 years. – Bonuses as high as 10% of the initial investment are often offered for longer surrender periods

• Investors give up some of the upside in return for a no-loss guarantee. – Most have a maximum interest rate (cap) and a floor

• Provide traditional annuity benefits. – Tax-deferred growth – Permit early withdrawal without penalty under certain adverse medical conditions

Chapter 7: How the New Hybrid Index Annuities Work

Surrender Periods The higher and longer surrenders are usually determined by either one of two things: (1) the upfront bonus to the client or (2) high commissions to the agent. Annuities with large upfront bonuses require a longer holding period so that the company can recoup its money. A higher bonus for the client creates higher surrender fees and a longer surrender period.

Chapter 7: How the New Hybrid Index Annuities Work

Performance of Equity Index Annuity Factors that can influence performance: • Participation Rate (Percentage of Profit) – The percentage of the annual gain in the index that is credited to the account value – May or may not be guaranteed (so it can change)

• Annual Asset Fee – A flat percentage deduction from the index growth – Sometimes called “yield spread” or “margin cost” – Most index annuities have no asset fee (but some do)

• Cap – The maximum percent of the gain in the index to be credited to the account – Some Equity Index Annuities have no cap 84

Chapter 7: How the New Hybrid Index Annuities Work

Crediting Methods - Caps and Spreads It is important to get an annuity that resets annually. Statistics show that an annuity that locks in the annual profit, called ratcheting, will outperform an annuity that takes two years or more to lock in the profit. This is the case even if the benefits appear higher in an annuity that locks in the profits over a 2 year period or longer. A cap is the top end percentage an annuity crediting method can earn (think of it as a ceiling). A spread is a fee.

Chapter 7: How the New Hybrid Index Annuities Work

Different Crediting Methods Why are most annuities dependant on the S&P 500? This is simply because the S&P 500 is less volatile and the options cost less. From our experience the two most successful crediting methods are: 1 - The S&P 500 point-to-point with a cap that is usually 7 or 8%. This crediting method resets annually and thus compounds. However, it will miss a big year because of the cap. EVEN WHAT APPEARS TO BE A SMALL CAP, 7 OR 8%, CAN BE VERY EFFECTIVE DUE TO COMPOUNDING. 2 - In a big year, the most profitable crediting method appears to be the S&P monthly point-to-point. This strategy has a monthly cap. In a year when the market goes steadily up, it has provided amazing gains to be locked in at yearâ&#x20AC;&#x2122;s end. The negative side of this strategy is that in a volatile market, a bad month or two can wipe out all of the gains THE TWO ABOVE USUALLY HAVE NO FEES OR SPREADS.

Today there are NASDAQ, Dow, and even global crediting strategies. Most have caps.86

Chapter 7: How the New Hybrid Index Annuities Work

The New Hybrid Annuities The new hybrid annuities with guaranteed income riders create guaranteed income streams that you can turn on as you need, while your lump sum continues to earn interest based on a crediting strategy of your choice, without the fear of loss. These annuities have become increasingly popular as people look for ways to generate guaranteed streams of income without losing control of their lump sum. Your initial principle increases with guaranteed annual interest and payouts also increase with age. This gives retirees the guaranteed income streams that they need to ensure themselves of always having the money they need to continue enjoying their retirement.

Chapter 7: How the New Hybrid Index Annuities Work

The New Hybrid Annuities The fact that these income streams can be turned on and off gives people control of their retirement income and, therefore, their lives. The owners of these annuities have guaranteed income waiting to be used when they need it. This income is available to them when unforeseen circumstances create a need for it.

What follows is an example of the income available from one of these new hybrid annuities for a 70 year old person who places $100,000 in the annuity.

Chapter 7: How the New Hybrid Index Annuities Work

The New Hybrid Annuities (example) End of Year

Attained Age

Accumulation Period Withdrawal Payment Base

Issue 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85

$110,000 $115,500 $121,275 $127,339 $133,706 $140,391 $147,411 $154,781 $162,520 $170,646 $179,178 $188,137 $197,544 $207,421 $217,792 $228,682

Guaranteed Withdrawal Percentage n/a 6.10% 6.20% 6.30% 6.40% 6.50% 6.60% 6.70% 6.80% 6.90% 7.00% 7.10% 7.20% 7.30% 7.40% 7.50%

Guaranteed Annual Withdrawal Payment n/a $7,045.50 $7,519.05 $8,022.34 $8,557.16 $9,125.41 $9,729.09 $10,370.33 $11,051.37 $11,774.58 $12,542.49 $13,357.75 $14,223.18 $15,141.76 $16,116.64 $17,151.16

Chapter 7: How the New Hybrid Index Annuities Work

Income Riders and How They Work When an annuity is annuitized the money is given to the insurance company, which then returns it back to the client based on a contractual obligation. The client can receive their money as an income stream for life or over a predetermined number of years, or a combination of both. Regardless of which payout option is selected, the client has no control of their money. In recent years, annuities have added an income rider to their menu of options. This rider allows the owner of the annuity to receive guaranteed lifetime income from an annuity without annuitizing it and therefore retain full control of their money.

Chapter 7: How the New Hybrid Index Annuities Work

Income Riders and How They Work These riders are offering the best of both worlds: guaranteed income and availability of the lump sum of money if an unexpected need arises. The riders have various forms but some common features. They all have a payout factor based on the age of the annuitant. Many have guaranteed growth rates that apply to a special â&#x20AC;&#x153;Income Account Value.â&#x20AC;? All of the riders guarantee an income stream that can go up but will never go down as long as the owner does not take additional withdrawals from the annuity. Most of the riders allow the owner to turn the income on and off as they choose.

Chapter 7: How the New Hybrid Index Annuities Work

Income Riders and How They Work Income Account Value – The Income account value is only a number that is used to calculate income at the time the client wishes to activate the rider. The income account value is NOT the same as the account value. The account value is the client’s money and grows based on the crediting method that is selected every year during the annual review. Many clients confuse their Account Value (their actual money) with their Income Account Value (a value which is used to calculate a guaranteed income stream). Most income riders have a guaranteed growth factor that creates a separate income bucket (Income Account Value), which then grows at a guaranteed rate. You must carefully read the fine print on these riders to determine what will keep you from receiving these guaranteed growth rates. Many riders do not give the guaranteed growth rate if a withdrawal is made in the year. This means that if the annuity is in a qualified account, and the client is over 70 ½ years of age, the required minimum distribution, which must be taken by law, will nullify the guaranteed growth. This is particularly true in the larger growth rates.

Chapter 7: How the New Hybrid Index Annuities Work

Income Riders and How They Work Payout Factor – All Income Riders have a payout factor. This factor is a percentage that is based on the age of the annuitant when they first wish to receive a guaranteed income. These factors are almost always the same: 5% at age 60, 6% at age 70, 7% at age 80 and above. However, in different insurance products, the factor changes every 10 years, every 5 years, or every year. Product A – Payout factor = 5% at age 60, 6% at age 70, 7% at age 80 and above. Product B – Payout factor = 5% at age 60, 5.5% at age 65, 6% at age 70, 6.5% at age 75, 7% at age 80, 7.5% at age 85 and above. Product C – Payout factor = 5% at age 60, 5.1% at age 61, 5.2% at age 63, 5.3% at age 64, ….up to 8% at age 90. All income riders have a fee associated with them. These fees are usually within a 35 to 50 basis point range. Some of the fees are taken only from gain (e.g. no gain = no fee) and others are taken regardless of the performance of the annuity. 93

Chapter 7: How the New Hybrid Index Annuities Work

Income Riders and How They Work So which riders is the best for you? It depends on your real situation and when you want to start taking income. If you are going to let your account build for a period of time (5 to 6 years) before you plan on taking income and you will not need to make any withdrawals, then an annuity with a high guaranteed growth factor might be the right one for you. On the other hand, if you are looking to start your income in 1 or 2 years, then the annuity with the highest payout factor and lowest fees might be the most appropriate.

Chapter 7: How the New Hybrid Index Annuities Work

Criticisms of Equity Index Annuities As EIA’s have grown into a huge business, a lot of criticism has been leveled against them. Most of these claims are just from advisors pushing other products and are dead wrong, but some are accurate. The following are the most common criticisms of EIA’s: 1) 2) 3) 4)

The products are too complex The salespeople aren’t trained well-enough The products don’t give you all the market upside The fees are too high

Numbers 1 and 2 are valid comments. Number 3 is accurate but misses the point that EIA’s are savings plans, not investments. It also misses the point that over the last few years, because of market volatility and low interest rates, the best of these annuities have outperformed most others savings and investment vehicles. Number 4 is ridiculous, as most of these annuities have little or no fees. 95

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Quotes on Index Annuities “If you do not want to take any risks but still want to play the stock market, an Index annuity may be right for you.” “I really like Index Annuities in markets that are going down.” - Suze Orman, The Road to Wealth “A Bear-Proof Way to Ride the Market: Equity-index annuities remove downside risk.” - Lewis Braham, Business Week, April 30, 2001 “Equity Index Annuity: Safe Place to Grow your Money.” - Robert Valentine, Certified Senior Advisor Senior Journal.com, July 16, 2005 “Although the future path of the market has yet to be walked, index annuities have proven they offer safety in bad times and extraordinary potential in good.” - Jack Marrion, President, The Advantage Group Reprinted from the Wall Street Journal. 96

Chapter 8 Life Insurance

*This chapter was co-authored by Alan Haft, Best-Selling Author and National Columnist

Chapter 8: Life Insurance

General Thoughts on Life Insurance Life insurance allows you to guarantee tax-free money or replace income to those you love. Life insurance can be used with annuities to generate more income and wealth (income maximization), to offset huge IRA taxes, and to offset eventual estate taxes.

Policies can be financed with no out-of-pocket costs. Term insurance can be bought with return of premium riders. Indexed Universal life can be used for investment purposes. Whole life can pay for itself with minimum deposit or vanishing premium. Accelerated benefits are available for nursing home, terminal illness, or critical illness. And now, companies will refund your premiums if the estate tax is replaced or limits are raised. 99

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General Thoughts on Life Insurance Life insurance is the best way to transfer wealth tax-free. The major advantage of life insurance is that, if titled properly, the death benefit is tax-free. Today life insurance can even be written to people in their 80â&#x20AC;&#x2122;s and to people with various kinds of health conditions. An expert can advise you properly. There are all kinds of ways to pay for large amounts of life insurance needed for estate taxes, including company-approved financing, in which the policy is the collateral and no money out of pocket is required.

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Purpose of Life Insurance â&#x20AC;˘

Create Wealth for Heirs

Instant Wealth: Recently, we had a person approach us with some cash on hand, wanting to make an investment in the stock market that would provide the best possible returns for his granddaughter. He had little need for the money, had plenty of money outside this investment, and was quite clear that this money was being put to use for one reason and one reason only: to leave behind to his granddaughter. In his case, we told him to stay away from the stock market and instead invest the money into a life insurance policy. Why?..... The investment into the life insurance policy instantly more than doubled his money and guaranteed it to his granddaughter upon his demise. The risk of the market and the time it would take to potentially grow the money to equal the life insuranceâ&#x20AC;&#x2122;s guaranteed death benefit were completely eliminated, thereby making the investment into the life policy well worth the effort and the monies left to her are tax free. 101

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Purpose of Life Insurance •

Replace Income

If a pension and or social security doesn’t carry over to a spouse or special needs child upon death, life insurance is the best source to replace needed income. •

Cover Estate Tax

In most cases, taxes are due at death, creating a burden for those who are left behind. Estates, IRA’s, annuities and a long list of other investments and accounts can be taxed. Needless to say, someone has to write a check to pay the tax, and the “liquidity” of an estate is sometimes limited, especially when one passes away with generally illiquid large real estate holdings and relatively low cash amounts. In many cases, a quality life insurance policy can be a beneficial “gift” to leave behind so that taxes are paid from the tax-free death benefit the life insurance provides. 102

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Purpose of Life Insurance â&#x20AC;˘

Tax-Free Income

Depending on how the life insurance policy was designed, there could be significant cash buildup within the policy. With cash in the account, as mentioned above, it is highly possible that you could withdraw cash from a life policy tax-free. Being able to generate income from the cash value within a low-cost, high-quality life insurance policy could make this one of the strongest benefits of adding some life into your life. â&#x20AC;˘

Free Up Principal

We meet many people in retirement who are saving as much as they possibly can for their family. For a fraction of the estate value, they may want to consider investing a small portion of their investments into a life insurance policy that guarantees the value of the estate at death. Doing so often provides the insured peace of mind knowing that even if they wind up spending all of their money down to the last penny, they will still leave the value of the estate 103 behind thanks to the life insurance policy.

Chapter 8: Life Insurance

Types of Life Insurance â&#x20AC;˘

Whole Life

Once the most popular, then out of vogue, whole life policies are now making a comeback. Whole life offer permanent coverage, whole life also has the highest cost for life insurance, but builds cash value. Policies can use dividends and paid up additions to increase the death benefit, cash value, or EVEN PAY FOR PREMIUMS! The main disadvantage of whole life is the cost for coverage amount. The main advantage â&#x20AC;&#x201C; if done properly, is a concept called Minimum Deposit or Vanishing Premium, which allows you pay only a few years premium (may be as little as two years) and then the policy pays for itself. Used properly, this is a powerful concept that most agents do not understand.

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Types of Life Insurance â&#x20AC;˘

Term

Set premium for a term of years. Some term policies allow conversion regardless of health to permanent coverage. Some term policies have return of premium riders where your premiums are refunded. â&#x20AC;˘

Universal Life

A combination of term and whole life. Designed to be permanent insurance but at a lower cost as it minimizes cash build up. â&#x20AC;˘

Universal Indexed Life

Life insurance indexed to the stock market, usually S/P 500. Designed as an alternative investment vehicle and gaining in popularity. For people who want the opportunity for growth in their cash value or death benefit without market risk. 105

Chapter 8: Life Insurance

Types of Life Insurance â&#x20AC;˘ Universal Life (Cont.) An investment into a life insurance policy will allow its cash value to grow tax-deferred. Universal Life insurance policies typically increase cash value based on current interest rates, whereas Variable Universal Life insurance policies will potentially grow cash value based on the performance of various stock market investments. For those who need life insurance and have contributed the maximum amounts to their 401ks or IRAs, investing in a life insurance vehicle is worth considering. Just like the IRA, an investment into a life insurance policy provides tax-deferred accumulation. â&#x20AC;˘ Survivorship or Second-to-Die (2 lives) Popular for estate planning. The death benefit is paid upon the death of the second person, usually the spouse. Premiums are cheaper than on an individual life. 106

Chapter 8: Life Insurance

Reasons for Purchasing Life Insurance As far as we’re concerned, an investment into a life insurance policy is often a more prudent choice than an investment into its somewhat close cousin, an annuity. Here are a few reasons why: • They both offer tax-deferred growth. • The cash value in a life insurance policy is almost always far more “liquid” (accessible) than annuities that often have limited penalty-free access to the cash value during the term of the contract. • Earnings in a life insurance policy could potentially be withdrawn tax-free whereas earnings in an annuity are taxable as ordinary income, the highest of all possible taxes.

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Reasons for Purchasing Life Insurance â&#x20AC;˘ The potential for earnings within a life insurance policy is typically comparable to earnings potential within an annuity (if not better). â&#x20AC;˘ When a life insurance policy is passed to your heirs, not only is the amount passed tax-free, but the amount is almost always far greater than the cash value due to the death benefit.

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Accelerated Benefits Today it is common for life policies to allow for accelerated benefits to pay for: â&#x20AC;˘ Terminal illness â&#x20AC;˘ Long term nursing care and home

â&#x20AC;˘ Critical illness (such as cancer, stroke, or heart attack) These powerful benefits are usually included at no cost, although not all policies have them.

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Chapter 9: Income Maximization

The Scenario Retirees have been hit hard by market fluctuations and the decline in interest rates. Retirees are finding that their retirement nest egg is unable to provide the income that they were counting on.

Many investors were under the impression that they would be receiving much higher returns on their investments than are currently available.

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Why is the Well Running Dry? • CD Rates – Down • Bond Rates – Down • Stock Market – Extremely Volatile

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The Bottom Line People dependent on interest income from fixed income investments are in a tough situation. People dependent on the stock market risk losing their savings. Are you eating into your savings?

Are you worried about your income?

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Income Maximization May Be Right for You If you are age 60 or older and â&#x20AC;˘ Concerned about having enough or more income â&#x20AC;˘ Concerned about leaving money to your heirs

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Hereâ&#x20AC;&#x2122;s How it Works Three simple steps: 1.

Liquidate or sell existing unproductive assets.

Use the proceeds to purchase a single premium immediate annuity (SPIA)

Make annual exclusion gifts of the excess annuity income to an irrevocable life insurance trust (ILIT)

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Advantages of Income Maximization • Income is safe • Eliminates market risk – Secure, guaranteed income from the annuity – Maximizes net after-tax income

• Usually provides more income • Potentially increases investment rate of return • Can have tax advantages

• Life insurance assures that a legacy is preserved – Heirs still receive the value of the asset – Increases legacy to heirs 118

Chapter 9: Income Maximization

Some Caveats 1.

You must be underwritten for life insurance

Likely loss of liquidity

Income is fixed

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How to Figure Whether Income Maximization is Right for You 1.

Determine how much income will be produced from an immediate annuity purchased with the assets you have available

Determine the cost (premium) of life insurance to replace those assets

The net give you your new gross income

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An Example John has assets of $750,000 subject to market risk and not producing enough income He purchases an immediate annuity with these assets giving him a guaranteed life time income of

$87,500/yr

John then uses some of the income to purchase a life insurance policy to replace the $750,000 upon his death

Cost $32,500/yr

John then has a guaranteed income of

$55,000/yr

And $750,000 tax free to his heirs upon death 121

Chapter 9: Income Maximization

Features • Gross income from the annuity is guaranteed • Life insurance premium is guaranteed • No market risk • Potential income & estate tax savings (if policy ownership is correctly structured)

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FAQ’s 1.

Why do I need life insurance?

• Because an immediate annuity stops upon the death of the party or parties to whom it pays income – like a pension – the assets are then gone. The life insurance replaces those assets.

This sounds too good to be true. How can it be done?

• One company provides lifetime income, like a pension. The second company provides life insurance to replace the assets. 3.

Are there tax savings?

• There can be both ordinary income tax and estate tax savings with income maximization. Immediate annuities work by the exclusion ratio tax rule and life insurance is income tax free and can be estate tax free if set up properly. 123

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Results of Income Maximization Peace of Mind Tax Savings Legacy Creation

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Chapter 10 Some General Tax-Saving Ideas

*This chapter was co-authored by Alan Haft, Best-Selling Author and National Columnist

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Chapter 10: Some General Tax-Saving Ideas

Reducing Capital Gains and Income Tax: Two Trusts That Can Help How would you like to lower your capital gains and estate taxes at the same time? Yes, it can be done through a charitable remainder trust (CRT) or a private annuity trust (PAT). Setting up either of these trusts will allow you to reduce your estate taxes. But hardly anyone knows that, depending upon which you choose, you will also be able to defer paying capital gains taxes on highly appreciated assets â&#x20AC;&#x201D; such as real estate and stocks â&#x20AC;&#x201D; or avoid paying them altogether.

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CRT With a CRT, you make an irrevocable gift of assets (such as appreciated securities, real estate, or cash) to a trust. For the remainder of your life, you (or a party you designate) receive the investment income from the assets held within the trust. Upon your death, the principal value of the assets is transferred to your designated beneficiary, which must be a recognized nonprofit organization. People typically shy away from a CRT because while the donors receive income for life, the “donated” asset gets left behind to charity, which disinherits heirs. To solve this problem, many who do set up a CRT “sweep” some of the income off the income stream and use it to pay for a life insurance policy that replaces the amount of the donated asset tax-free upon their death.

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CRT There are a number of benefits to setting up a CRT, but the three major pertain to reduced taxation: 1) You won’t pay any capital gains tax on the appreciated assets in the trust, making CRTs ideal for assets with a low cost basis but high appreciated value, such as real estate. 2) Contributions to a CRT are considered charitable contributions, so they qualify for an income tax deduction (and any deduction not taken in the year of contribution can be carried forward for the next five years).

3) The value of the assets held in a CRT trust is considered “outside of your estate” by the Internal Revenue Service (IRS), meaning it’s excluded from the calculation of your estate taxes. This could reduce your estate tax rate by as much as 46 cents of every dollar, given current estate tax rates. 129

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CRT To summarize the workings of a CRT, when including life insurance as part of the plan, the donor: 1) Avoids capital gains tax when donating the asset and selling it 2) Gets income for life from the CRT, which has its own tax breaks given the donation of the asset itself

3) Removes the asset from the estate, which would lower the estate tax, if there is any 4) Replaces the donated asset tax-free to heirs through the life insurance policy. Itâ&#x20AC;&#x2122;s really not a bad deal, and it is something that certainly should at least be considered by those who are planning to sell highly appreciated assets and have lots of taxes awaiting them. 130

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PAT A PAT is another type of trust thatâ&#x20AC;&#x2122;s similar to a CRT. With a PAT, you transfer the desired assets into the trust, the assets are then sold, and the proceeds are used to purchase an annuity. As with a CRT, the assets held in a PAT are excluded when calculating your estate taxes. But part of each payment you receive from the PAT will contain a portion of the capital gains that were due on sale. So while a CRT eliminates the capital gains tax, the PAT spreads them out over the rest of your life. This latter point may make the PAT less desirable than the CRT. Yet some people consider the PAT a better option because over time, the investor and the investorâ&#x20AC;&#x2122;s family receive all proceeds from the sale of the asset. Thus, if you create a PAT, upon your death the asset will be removed from your estate and your heirs will receive whatever portion of the asset remains, free of estate taxes, gift taxes, generation-skipping taxes, and transfer taxes. However, your heirs will have to pay any remaining capital gains tax due. 131

Chapter 10: Some General Tax-Saving Ideas

Income How much income can you receive from a CRT or PAT? That depends. With a CRT, for example, your income will be based on the amount of income your assets generate while they are inside the CRT, as well as the “payout percentage,” or the size of the payments you choose to receive. The IRS requires CRTs to distribute a minimum of 5 % of the net fair market value of its assets annually. If you don’t need income from the CRT in one year, you can defer it through a “makeup provision,” but the CRT's net distributions must eventually equal 5%. This means that you don’t have to start taking income right away. In some cases, if you defer taking the income, then you can potentially take more income out later than if you would have taken the distributions in the first place. One caveat here: The higher the payout percentage, the lower your charitable income tax deduction will be, so you’ll want to talk to an advisor about striking the right balance between the two.

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Chapter 10: Some General Tax-Saving Ideas I would strongly urge anyone considering a CRT or PAT to speak with a qualified estate planning attorney. Although the concepts as presented here are somewhat simple, the complexity of the taxation, along with one’s estate and income requirements, all need to be well factored into the decision-making process. This is not run of the mill type planning, and it definitely takes an experienced individual to assist you. That said, don’t be shy. A CRT or a PAT can be an excellent choice in helping you reduce taxes, create lifetime income and of most importance to some — leaving a legacy behind.

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Too Much Tax Have you ever had the paranormal experience of holding a mutual fund that went down in value, only to discover that you somehow wound up owing taxes on it? As strange as it sounds, it could happen. How and why it happens is beyond the scope of this preview, but the bottom line is sad but true --- when investing in a managed mutual fund, you have virtually no control over the taxes you pay while holding the fund. If someone is interested in reducing tax, one of the first things they should ask themselves is whether or not they are investing in managed mutual funds outside of an IRA. Investing in managed funds outside an IRA could result in taxable consequences that are beyond your control. As a result, paying taxes each year on a fund only reduces your return and thatâ&#x20AC;&#x2122;s certainly not an efficient way to invest.

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Too Much Tax How much tax does your fund cause? Your tax return should give you a good idea as to how much tax you’re paying on your funds. Another way of checking out the taxable consequences of holding a fund(s) is to investigate something called “turnover” and Morningstar.com is a good place to research this. “Turnover” simply means “the amount of times a year the fund manager replaces the portfolio with a different set of stocks.” If the fund manager changes the portfolio once a year, that’s a 100% turnover. If the fund manager changes the portfolio two times a year, then that’s a 200% turnover. If the manager changes half the portfolio , then that’s a 50% turnover, etc., etc. Each time the fund manager “turns over” a portfolio, it usually leads to one thing: paying tax, and in some cases, too much tax.

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Too Much Tax Certainly, there are some funds out there that are more tax efficient than others, but as far as I’m concerned, the simplest way to reduce taxes on managed mutual funds is to invest in the indexes instead. Remember: an index is a “passive” investment. There is no one trading stocks within the index and given there are typically few trades (if any) done within the index, there is often zero “turnover” that would cause taxable events from taking place. Investing in the indexes often puts you in control of when you pay the tax, not a fund manager out there making those decisions for you.

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The “Step Up In Basis” Rule In general, when you sell an asset that has risen in value, you pay taxes on the gain. For assets like stocks, the “capital gain” is generally calculated as the difference between the purchase and sale price. For example, if you buy shares in a company for $100 and sell them for $300, you have $200 in capital gain. The original purchase price, $100, is called your “basis” in the shares.

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The “Step Up In Basis” Rule But there is a special rule for inherited property. Here’s how it works:

If you inherit a stock from your late aunt and later sell it, then you are taxed on the difference between what you sold it for and what the stock was worth when Auntie died. Let’s say Auntie bought the stock a long time ago for $1,000 and its value climbed to $50,000 during her lifetime. When you inherit the stock, your “basis” is the stock’s fair-market value upon Auntie’s death, or $50,000, rather than the $1,000 she paid for it. That step-up in basis means that when you sell the stock now, you’ll only pay taxes on any gain above $50,000 that occurred while you held the stock. Since Auntie held the stock until she passed away, she never “realized” the $49,000 in gain, and therefore never paid taxes on it either. So the step-up in basis rule means that $49,000 goes permanently untaxed. 138

Chapter 10: Some General Tax-Saving Ideas

The “Step Up In Basis” Rule We’ve used company stock as an example here but the step-up in basis occurs with other appreciated assets, such as real estate or closely held businesses, which are passed from one generation to the next. The result is that hundreds of billions of dollars in income go entirely untaxed every year.1

Under current Tax Law, when someone passes away their Capital Gain Property, real estate, stocks and other, basis is the value on date of Decedent’s death. Under the Proposed Tax Law, the beneficiary of this property would have the Carryover Basis, or have the same cost as the decedent.

1 Hanlon, Seth . "Tax Expenditure of the Week: Step-Up in Basis." Center for American Progress. N.p., 16 Feb. 2011. Web. 9 Apr. 2012. <http://www.americanprogress.org/issues/2011/02/te021611.html>. 139

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The â&#x20AC;&#x153;Step Up In Basisâ&#x20AC;? Rule One 1998 study has shown that if capital gains were taxed resulting from the above Carryover rule, that 84% of all capital gains would result from sale of property that was acquired from a decedent. This is a hot topic in politics now, even though politicians avoid speaking about it. We expect that you will hear more about this topic in the near future. Please make sure your Estate Plan has taken into account possible changes/scenarios in the STEP-UP in basis rules.

Chapter 11 Rule of 72

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Compound Interest and the Rule of 72 • Albert Einstein is credited with discovering the compound interest Rule of 72. • Albert Einstein (1879-1955) called compound interest the 8th Wonder of the World – it can work for you, or against you: – When you invest, it works for you. – When you borrow, it works against you! • Making interest on interest, the power of compounding interest, is truly magical. – At 15% interest for 25 years, $10,000 would grow to $330,000. 142

Chapter 11: Rule of 72

The Rule of 72 • Find the average annual return on your investments from your financial statements. This is your growth rate. • Divide 72 by your growth rate. This is the number of years it will take for your investment to double, assuming your rate of return remains constant. Keep in mind that rates of return for most investments are not guaranteed. • Example: If you put 2,000,000 in a tax-deferred retirement account, it will grow to $4,000,000 in 9 years, assuming a constant growth rate of 8%.

However, it will take 14 years for the $2,000,000 to double in a taxable account at that same 8% annual rate of return (assuming a 33% tax rate). 143

Chapter 11: Rule of 72

The Power of Tax Deferral $100,000 Initial Investment $600,000

$574,350

$500,000

$441,532

$400,000

$355,654 $320,714

$300,000 $200,000

$258,914 $232,998 $179,084 $123,488 $133,822 $124,352

$152,642

$156,940

$100,000 $0 5 Years 10 Years Taxable Account Tax-Deferred Acount

20 Years 30 Years Tax-Deferred Account After Tax

Assumes 28% Tax Bracket. Hypothetical Annual Return of 6%. 144

Chapter 12 151 A

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Chapter 12: 151A

146

Chapter 12: 151A

151A: The Fight for Jurisdiction Variable annuities are regulated as securities. Fixed, indexed, and immediate annuities are insurance products and regulated by each state under that stateâ&#x20AC;&#x2122;s insurance commissioner (fifty states equals fifty separate regulations).

In 2008, while the United States economy was melting down, Securities and Exchange commissioner Christopher Cox was on a crusade to make index annuities, a properly regulated insurance product, a security. This was while Bernie Madoff, Lehman Brothers, Bears Sterns and more were happening.

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Chapter 12: 151A

151A: The Fight for Jurisdiction The SEC passed a rule, 151A, making EIA insurance products a security, and thus subject to their regulation. Feeling that the SEC couldnâ&#x20AC;&#x2122;t even regulate what it was supposed to, let alone an insurance product, this author joined the ensuing court fight along with a coalition (several insurance companies and two insurance marketing groups) as the sole single agent in the United States to fight the SEC.

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Chapter 12: 151A

Why did the SEC Do This? Simple: Money EIAâ&#x20AC;&#x2122;s were introduced in 1995. They remained a small part of the overall insurance and annuity business, gathering little attention until they became big business in the latter part of the first decade of this century. ` As EIAâ&#x20AC;&#x2122;s became more successful, money followed from stocks and bonds, depriving securities professionals of the income generated from tens of billions in sales. Many people, including this author, felt that rule 151A was money motivated and brought about to have the securities industry profit from the sale of insurance products. If 151A had passed then thousands of jobs would have been lost and the superior regulation of the states would have been gone. 149

Chapter 12: 151A

Victory This author submitted a brief along with the coalition and others. The US Court of Appeals asked the SEC to respond to the points in the brief. Upon this happening, the annuity industry began a political campaign to have Congress and the Senate make EIA’s an insurance product. This author helped a huge group of good people pass the law that made EIA’s an insurance product. Shortly after the law was passed making EIA’s an insurance product, the Court ruled against the SEC. We had won, jobs were saved, and consumers were protected, but at a high cost – millions of dollars were spent.

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Chapter 12: 151A

Conclusion On a personal note, during the worst economic meltdown since the Great Depression, former SEC commissioner Cox was worried about a safe, fixed, and properly regulated insurance product. Millions of Americans were hurt by this manâ&#x20AC;&#x2122;s failures. It is in the opinion of this author thatâ&#x20AC;Ś

Former SEC Commissioner Cox was, is and remains a moron!

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Unforgettable Quotes “The most powerful force in the universe is compound interest.” - Albert Einstein “A big part of financial freedom is having your heart and minds free from worry about the what-ifs of life.” - Suze Orman “You should invest in a business that even a fool can run, because someday a fool will.” -Warren Buffet “The list of qualities an investor should have include patience, self-discipline, common sense, a tolerance for pain, open-mindedness, detachment, persistence,…, and the ability to ignore general panic.” -Peter Lynch “For some reason people take their cues from price action rather than from values. Price is what you pay. Value is what you get.” - Warren Buffet 153

Unforgettable Quotes “Insanity: doing the same thing over and over again and expecting different results.”

- Albert Einstein “The indispensable first step to getting the things you want out of life is this: decide what you want. You can do what you think you can do and you cannot do what you think you cannot.”

- Ben Stein “Winning at money is 80 percent behavior and 20 percent head knowledge. Most of us know what to do but we just don’t do it.” -Dave Ramsey “First time a Victim; second time a Volunteer.” - Suze Orman

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