THE IRA GENERAL S PLAN SM ADDRESSING THE CONCERNS OF THE AFFLUENT SENIOR CITIZEN

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1 THE IRA GENERAL S PLAN SM ADDRESSING THE CONCERNS OF THE AFFLUENT SENIOR CITIZEN BY JOEL KOENIG, CLU AND ALISON L. SEGALL, CLU, CHFC MEMBERS THE KOENIG GROUP, LLC LOOKING BACK IN HISTORY TO PROJECT THE FUTURE People are living longer and many, even the most affluent, are concerned about maintaining their comfortable lifestyle along with independence from being dependent on their spouses and/or their children. In the 1940 s there were 5,800 Centenarians living in the United States. In the year 2000, that number had grown to over 58,000. In the year 2035, the number of people living beyond age 100 will grow to over 158,000! When we combine the increasing longevity of our aging population with the next problem facing them: the higher rates of inflation for our affluent older clients, there will be a growing need for larger income, particularly from their IRA s. IRA S AND QUALIFIED PLANS ARE THE BEST ASSETS FOR WEALTH ACCUMULATION BUT ARE THE WORST ASSETS FOR ESTATE DISTRIBUTION Under today s wealth transfer laws, there is a $2.0 million exemption from estate taxes at the death of the decedent. In 2009, that exemption will increase to $3.5 million. An affluent client can gift assets up to $12,000 per person each year without limitation, plus up to $1.0 million more during their lifetime. If they use the $1.0 million lifetime exemption up, the amount available as an exemption at death is reduced as well. Let us suppose our client (age 75) has assets that include one or two residences, a stock, bond and investment portfolio that is in excess of $1-2 million and an IRA that exceeds $1.0 million. Like most people, our client was advised by her CPA and financial advisor to take required minimum distributions (RMD s) from the IRA. The attached Chart 1 assumes the client takes the annual required minimum distributions (RMD) and that the IRA grows at 8%. 1

2 Chart 1: Minimum Distribution Calculation 2

3 THE HIGH COST OF DYING WITH AN IRA If our client has a taxable estate at his or her death and has a $1.0 million or larger IRA in their estate, the IRA may be subject to double taxation: Estate Tax as high as 45% and Income in Respect of a Decedent (IRD - Income Taxes) as high as 35%. The total taxes when adding the state inheritance and state income taxes in high taxed states such as NY, NJ, PA, Conn, DC, MD, VA, IL, CA and many others can be as high as 75% of the entire IRA, when distributed at the client s death. AN ALTERNATIVE STRATEGY OUR IRA GENERAL S PLAN SM Let us assume that our 75-year-old client lives to age 90 (15 years) and the IRA has earned 8% per year. At the client s death, the 1.0 million initial IRA of today would be includible in the client s taxable estate at a value of $1,226,431. The net after-tax value to the client s heirs (children) would be approximately $404,722. If the IRA assets were to be distributed to the client s grandchildren, there would be an additional Generation Skipping Transfer Tax further reducing the net amount going to the client s heirs. For the client with a medium sized estate (under $10 million) the IRA General s Plan SM strategy is an excellent way of addressing the following three concerns: 1. Living too long the longevity risk 2. The risk of inflation post-retirement 3. The high cost of dying with a large taxable IRA Larger estate owners (with assets over $10 million) owning large IRA s should consider using our alternative LIRA II Plan SM. The original General s plan was developed about 10 years ago. The General s tax attorney had referred us to his client (a retired and widowed three star general) to help design a plan to reduce his taxable estate of $4.0 million and to increase his distributions to his heirs. We implemented our first hedged program for this 83-year-old general and named it The General s Plan SM. He wanted to be able to protect his income against living too long, to increase his income and he wished to reduce his current income taxes and ultimately his estate taxes. The plan we put into place combined a tax-favored, guaranteed lifetime income using a single premium immediate annuity (SPIA) with a wealth replacement vehicle (life insurance) owned by a trust (outside his taxable estate) for the benefit of his heirs. By implementing the plan, he successfully accomplished four goals: 1. He reduced the current taxation on his fixed income securities, while at the same time greatly increasing his after-tax yield as compared to all of his fixed income securities. 3

4 2. He protected his income stream at a much higher level while guaranteeing the income regardless of how long he lives. 3. He protected the value of the annuity principal if he died early through the wealth replacement trust with life insurance. 4. He reduced his estate tax liability by over $500,000, thereby, increasing the net amount going to his heirs. Today, 10 years later, some even greater planning opportunities exist through the repositioning of the client s large IRA assets into our IRA General s Plan SM. Under this arrangement, we can successfully address the client s concerns while also leveraging the IRA assets to: 1. Significantly increase the guaranteed income payments over the client s lifetime with the same net amounts going to their heirs or 2. Increase the guaranteed income payments over the client s lifetime and significantly increase the net amounts to children and /or grandchildren. CHART 2 PROJECTS THE NEW GUARANTEED INCOME FROM A SPIA OVER THE CLIENT S LIFETIME $1,000,000 SPIA Example Based on Female Age 75 Year Monthly Income Annual Income % Yield Net to Heirs through age , , % 0 4

5 IN CHART 3, WE COMPARE THE ANNUITY S GUARANTEED LIFE INCOME WITH A SYSTEMATIC WITHDRAWAL OF THE SAME AMOUNT FROM THE IRA GROWING AT 8% AND 10%. 8% Growh Taking Disbursements Equal to Guaranteed SPIA Income 10% Growh Taking Disbursements Equal to Guaranteed SPIA Income Guaranteed SPIA Annual IRA End of Yr IRA End of Yr Income Yr Age Value Income 8% Yr Age Value Income 8% ,000,000 1,080, ,000,000 1,100, , (147,723) 1,006, (147,723) 1,047, , (147,723) 927, (147,723) 989, , (147,723) 842, (147,723) 926, , (147,723) 750, (147,723) 856, , (147,723) 650, (147,723) 779, , (147,723) 543, (147,723) 694, , (147,723) 427, (147,723) 601, , (147,723) 302, (147,723) 499, , (147,723) 166, (147,723) 387, , (147,723) 20, (147,723) 263, , (20,441) (0) (147,723) 127, , (0) (0) (127,201) (0) 147, (0) (0) (0) (0) 147, (0) (0) (0) (0) 147, (0) (0) (0) (0) 5

6 CHART 4- COMPARES THE NET TO HEIRS AT THE CLIENT S DEATH (AGE 90) OF BOTH ALTERNATIVES Net to Heirs Comparison of Alternatives Net to Heirs Net to Heirs Net to Heirs Yr Age SPIA Growth ,000, , , ,000, , , ,000, , , ,000, , , ,000, , , ,000, , , ,000, , , ,000, , , ,000,000 99, , ,000,000 54, , ,000,000 3,745 86, ,000,000 (0) 41, ,000,000 (0) (0) ,000,000 (0) (0) ,000,000 (0) (0) ,000,000 (0) (0) Potential Qualified Plan Taxation at Death Income Tax 22% Net Value to Heirs 33% Federal Estate Tax 45% 6

7 IN SUMMARY The IRA General s Plan SM addresses the three concerns facing our affluent senior citizens when applied to their large IRA s. 1. Living too Long 2. Higher rates of Inflation for the aging population 3. The high cost of IRA wealth transfer due to the double taxation By annuitizing the IRA using a high yielding single premium immediate annuity (SPIA) the client s IRA income will be increased dramatically over the RMD s and it will provide the guarantee of never outliving the client s IRA. When the IRA is self-annuitized under the same assumptions, even if it s earning a high rate of return of 8-10% per year, it still places the longevity risk squarely on the client. At the client s death, the SPIA, like a company pension plan, provides no remainder to be included in the taxable estate. By creating the wealth replacement trust using assets from other existing trusts (such as Credit Shelter Trusts or funded Irrevocable trusts) or by using some of the significantly higher annuity cash flow, the client s heirs can receive a higher after-tax distribution than from the IRA through the life insurance death benefits. The principal risk of this strategy is the early death of the client, prior to life expectancy. By designing the wealth replacement death benefit to decrease as the client s annual annuity payments are paid over a longer period, the IRA General s Plan will address the longevity risk, the mortality risk, the inflation risk and the risk of high taxes on the IRA (as high as 75% combined estate and income taxes) at the client s death. 7

8 ABOUT THE AUTHORS Joel Koenig is the Managing Member of The Koenig Group, LLC, a registered investment advisor and consulting organization located in Chevy Chase, Maryland. Alison L. Segall, CLU, ChFC is also a Member of the firm. Our firm specializes in executive benefits and wealth preservation planning for business owners, senior executives, entrepreneurs and high income and high net worth individuals. We have also created strategic alliance relationships with CPA and Law Firms. Joel Koenig s Bio Joel graduated from the University of Michigan and attended NYU Graduate School of Business. He has had considerable experience as a consultant and broker implementing executive benefit plans funded with corporate-owned life insurance (COLI) for senior executives of large public corporations. He was an original partner of M Financial Corporation and an officer and director of The Management Compensation Group, Inc. (MCG), The Todd Organization, Inc. and National Philanthropic Affiliates. Joel currently serves on the editorial board of Trusts & Estates Magazine (Insurance). He has written numerous articles for the magazine including his article on Wealth Preservation for the Affluent Client with large Qualified Plan and IRA Balances published in May, The article dealt with rolling back a large IRA account balance into a new diminimus qualified profit sharing plan and purchasing a large life insurance policy inside the qualified plan. The plan was known as the LIRA Plan SM. In Revenue Ruling and then in Revenue Procedure , the IRS issued new rules regarding the valuation of such life insurance policies that were being transferred out of the profit sharing plan. In July 2001, he wrote another article for Trusts & Estates entitled: The World without Death Taxes. Joel at the NYC Estate Planning Council and The Arizona Institute of the American Society of Financial Services Professionals highlighted the same subject in It was also his topic as a main platform speaker at the 2004 annual meeting of AALU (the Association for Advanced Life Underwriting.) In October of 2002, he participated at the NYU Annual Tax Institute and lectured on The Fiduciary Liability Prevention Plan, a topic he reviewed in the July 2002 issue of Trusts & Estates Magazine in his article entitled: Diffuse this Time Bomb. He spoke on the same subject at the January 2003 Annual Meeting of the International Forum. Joel has served on the Advisory Board of Directors for The International Forum. He also has lectured extensively at Estate Planning Councils, The Association for Advanced Life Underwriting (AALU), The International Forum, American Society of CLU Seminars and numerous industry meetings. He has been a contributing author for the American College's Advanced Pension Planning course and The AALU Handbook on Split Dollar. Currently, he also serves on the Charitable planning sub-committee of AALU, having a sub-specialty in Charitable Tax Planning. He has also been published in The CLU Journal, Keeping Current, Life Association News. 8

9 Alison Segall s Bio Alison Segall, CLU, ChFC, has over 19 years of experience in estate and business planning for affluent people. She has worked as an advanced planning specialist for Wolf & Cohen Financial Group, Thomas Financial Group (both M Financial Group firms) and CIGNA which later became Lincoln Financial. In 2003, Alison became a partner of The Koenig Group LLC. Since joining The Koenig Group, Alison has been involved in working closely with CPA firms and Law firms and their clients in New York, Washington, DC and Florida providing strategies for very wealthy older clients to help them increase their legacies to their children, grandchildren and to their family charities and also providing strategies for high net worth/high income professionals and entrepreneurs to help them plan for a variety of needs including asset protection, inadequate retirement income and healthcare needs both pre and post retirement, and ultimately wealth transfer. Alison is a specialist in the technical uses of life insurance in wealth and estate planning, as well as, business planning and executive benefits. She has created and conducted numerous workshops including continuing education seminars for insurance and other financial professionals, attorneys and CPAs on the uses of life insurance in estate and business planning. Alison has a degree from the College of William & Mary in Williamsburg, Virginia. She received her Chartered Life Underwriter and Chartered Financial Consultant designations from the American College in Bryn Mawr, PA. She is an active member of the Washington, DC Estate Planning Council and is currently serving a two year term on the board of the National Capital Chapter of the Society of Financial Services Professionals. Joel and Alison are reached at (301) or joel@koeniggroup.com or alison@koeniggroup.com 9