Using Technology to Explain the Power of Partial Annuitization in Retirement (Part Two of Three)

July 14, 2014

This is the second installment of our three-part blog series focusing on a hypothetical couple, John and Theresa, planning to retire when they both reach age 62.

As you will remember in the first post, they met with their advisor. The goal was to shift assets from a taxable account to a tax-deferred annuity in order to limit the couple's exposure to income and net investment income taxes, as well as for tax-deferred growth potential.

Let's assume John and Theresa have reached retirement age 62, but there's a problem: The real estate development business suffered a tremendous downturn for several years following the financial crisis of 2008. The couple stopped making annual $50,000 contributions to their taxable brokerage account during the last five years and budgeted less funds for their defined contribution plan.

The table below summarizes their retirement income plans before the recession hit, as well as adjusted income plans based on new circumstances.

 

Assets Pre-2008 Retirement Income Plan New Retirement Income Plan
Defined Benefit Plan $120,000 combined distribution per year for life $120,000 combined distribution per year for life
Defined Contribution Plan / IRA Rollover $15,000 per year combined withdrawals for 35 years $9,000 per year combined withdrawals for 35 years
Taxable Account $55,000 per year estimated withdrawals for 35 years $30,000 per year estimated withdrawals for 35 years
Social Security $60,000 per year combined benefit for life $60,000 per year combined benefit for life
Nonqualified Annuity Only touched in the event of emergency. The annuity grew to $1,006,098 of value assuming a purchase payment of $500,000 12 years prior and 6% annual rate of return. Shortfall made up by partially annuitizing $603,659, which leads to $30,907 per year for both their lives (assuming Joint Life Only annuitization with both annuitants age 62). The remaining value of $402,439 is left in the deferred annuity to continue growing tax-deferred.
Total $250,000 per year in annual retirement income $249,907 per year in annual retirement income

 

Assuming they purchased the tax-deferred variable annuity 12 years earlier, John and Theresa were able to make up an approximate $31,000 shortfall through partial annuitization. By using the Pacific Life Tax Deferral Analyzer tool, the advisor shows the couple that the $31,000 “income gap” can be made up by a Joint Life Only annuitization of 60% of the annuity (which produces $30,907 in additional income per year for the lives of both spouses). In other words, of the total $1,006,098 that the tax-deferred annuity was worth when the couple reached age 62, $603,659 was partially annuitized and $402,439 was left in the deferred annuity. The couple likes knowing that the funds remaining in the non-annuitized portion of the annuity (i.e., the $402,439) can continue growing tax-deferred.

The couple also likes that spousal continuation may allow further deferral of the non-annuitized portion of the annuity contract if one of the spouses dies (assuming the contract is structured properly). Their advisor even showed them that in the hypothetical example, if either spouse is alive at 95, the non-annuitized portion of the annuity could grow to approximately $2.75 million with an assumed 6% annual rate of return.

The advisor showed the couple how to take advantage of partial annuitization for additional emergency income in retirement, and that any growth of the non-annuitized portion of the annuity is on a tax-deferred basis. The advisor also showed the couple they could access the non-annuitized portion of the annuity if they live too long, and possibly leave any remaining value to their children.

 

Read Part One

Read Part Three


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The purpose of the Pacific Life Tax Deferral Analyzer is to provide an estimate of the potential growth individuals may receive with a tax-deferred annuity versus a taxable investment. The methodology used is approximate, intended for educational purposes, and not meant as a predictive or forecasting tool.

The projections of information generated by the Pacific Life Tax Deferral Analyzer regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. The results and explanations generated by this calculator vary due to user input and assumptions. The Pacific Life Tax Deferral Analyzer output does not incorporate the impact of any specific federal or state tax other than an assumed tax rate and net investment income tax when elected.

These results do not take into consideration state taxes and any applicable premium taxes. Actual tax rates may vary for different taxpayers and assets from the results shown (for example, capital gains and qualified dividend income). Actual investment performance also will vary. Lower maximum tax rates on capital gains and dividends would make the investment return for the taxable investment more favorable, thereby reducing the difference in performance between the results shown. Investors should consider personal retirement objectives and income tax brackets, both current and anticipated, when making an investment decision. Hypothetical returns are not guaranteed and do not represent performance of any particular investment.

Pacific Life Tax Deferral Analyzer is not a comprehensive financial plan or strategy, and it should not be the sole means of determining such a plan or strategy. Results may vary over time based on changes to your input and the tool’s underlying assumptions.

Investors should carefully consider a variable annuity’s risks, charges, limitations, and expenses, as well as the risks, charges, expenses, and investment goals of the underlying investment options. This and other information about Pacific Life are provided in the product and underlying fund prospectuses. These prospectuses should be read carefully before investing.

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Annuities are long-term contracts designed for retirement. The value of variable investment options will fluctuate and, when redeemed, may be worth more or less than the original cost. Annuity withdrawals and other distributions of taxable amounts, including death benefit payouts, will be subject to ordinary income tax. For nonqualified contracts, an additional 3.8% federal tax may apply on net investment income. If withdrawals and other distributions are taken prior to age 59½, an additional 10% federal tax may apply. A withdrawal charge and a market value adjustment (MVA) also may apply. Withdrawals will reduce the contract value and the value of death benefits, and also may reduce the value of any optional benefits.

IRAs and qualified plans—such as 401(k)s and 403(b)s—are already tax-deferred. Therefore, a deferred annuity should be used only to fund an IRA or qualified plan to benefit from the annuity’s features other than tax deferral. These include lifetime income, and death benefit options, and the ability to transfer among investment options without sales or withdrawal charges.

Variable insurance products are distributed by Pacific Select Distributors, Inc. (member of FINRA & SIPC), a subsidiary of Pacific Life Insurance Company and an affiliate of Pacific Life & Annuity Company (Newport Beach, CA), and are available through licensed third-party broker/dealers. Variable and fixed products are available through licensed third-party broker/dealers.

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Variable insurance products are distributed by Pacific Select Distributors, LLC (member FINRA & SIPC), a subsidiary of Pacific Life Insurance Company (Newport Beach, CA) and an affiliate of Pacific Life & Annuity Company. Variable and fixed annuity products are available through licensed third parties.

No bank guarantee • Not a deposit • Not FDIC/NCUA insured • May lose value • Not insured by any federal government agency