Ken Himmler.com

 An annuity is a contract between you (the purchaser or owner) and the issuer (an insurance company). In its simplest form, you pay money to the annuity issuer, the issuer invests the money for you, and then the issuer pays out the principal and earnings back to you or to a named beneficiary.

During your working years, you’ve probably set aside funds in retirement accounts such as IRAs, 401(k)s, or other workplace savings plans, as well as in taxable accounts. Your challenge during retirement is to convert those savings into an ongoing income stream that will provide adequate income throughout your retirement years.

Setting a withdrawal rate

The retirement lifestyle you can afford will depend not only on your assets and investment choices, but also on how quickly you draw down your retirement portfolio. The annual percentage that you take out of your portfolio, whether from returns or both returns and principal, is known as your withdrawal rate. Figuring out an appropriate initial withdrawal rate is a key issue in retirement planning and presents many challenges. Why? Take out too much too soon, and you might run out of money in your later years. Take out too little, and you might not enjoy your retirement years as much as you could. Your withdrawal rate is especially important in the early years of your retirement, as it will have a lasting impact on how long your savings last.

One widely used rule of thumb on withdrawal rates for tax-deferred retirement accounts states that withdrawing slightly more than 4% annually from a balanced portfolio of large-cap equities and bonds would provide inflation-adjusted income for at least 30 years. However, some experts contend that a higher withdrawal rate (closer to 5%) may be possible in the early, active retirement years if later withdrawals grow more slowly than inflation. Others contend that portfolios can last longer by adding asset classes and freezing the withdrawal amount during years of poor performance. By doing so, they argue, "safe" initial withdrawal rates above 5% might be possible. (Sources: William P. Bengen, "Determining Withdrawal Rates Using Historical Data," Journal of Financial Planning, October 1994; Jonathan Guyton, "Decision Rules and Portfolio Management for Retirees: Is the ‘Safe’ Initial Withdrawal Rate Too Safe?," Journal of Financial Planning, October 2004.)

Don’t forget that these hypotheses were based on historical data about various types of investments, and past results don’t guarantee future performance. There is no standard rule of thumb that works for everyone–your particular withdrawal rate needs to take into account many factors, including, but not limited to, your asset allocation and projected rate of return, annual income targets (accounting for inflation as desired), and investment horizon.

Which assets should you draw from first?

You may have assets in accounts that are taxable (e.g., CDs, mutual funds), tax deferred (e.g., traditional IRAs), and tax free (e.g., Roth IRAs). Given a choice, which type of account should you withdraw from first? The answer is–it depends.

For retirees who don’t care about leaving an estate to beneficiaries, the answer is simple in theory: withdraw money from taxable accounts first, then tax-deferred accounts, and lastly, tax-free accounts. By using your tax-favored accounts last, and avoiding taxes as long as possible, you’ll keep more of your retirement dollars working for you.

For retirees who intend to leave assets to beneficiaries, the analysis is more complicated. You need to coordinate your retirement planning with your estate plan. For example, if you have appreciated or rapidly appreciating assets, it may be more advantageous for you to withdraw from tax-deferred and tax-free accounts first. This is because these accounts will not receive a step-up in basis at your death, as many of your other assets will.

However, this may not always be the best strategy. For example, if you intend to leave your entire estate to your spouse, it may make sense to withdraw from taxable accounts first. This is because spouses are given preferential tax treatment with regard to retirement plans. A surviving spouse can roll over retirement plan funds to his or her own IRA or retirement plan, or, in some cases, may continue the deceased spouse’s plan as his or her own. The funds in the plan continue to grow tax deferred, and distributions need not begin until the spouse’s own required beginning date.

The bottom line is that this decision is also a complicated one. A financial professional can help you determine the best course based on your individual circumstances.

Certain distributions are required

In practice, your choice of which assets to draw first may, to some extent, be directed by tax rules. You can’t keep your money in tax-deferred retirement accounts forever. The law requires you to start taking distributions–called "required minimum distributions" or RMDs–from traditional IRAs by April 1 of the year following the year you turn age 70½, whether you need the money or not. For employer plans, RMDs must begin by April 1 of the year following the year you turn 70½ or, if later, the year you retire. Roth IRAs aren’t subject to the lifetime RMD rules. (Note: The Worker, Retiree and Employer Recovery Act of 2008 waives required minimum distributions for the 2009 calendar year.)

If you have more than one IRA, a required distribution is calculated separately for each IRA. These amounts are then added together to determine your RMD for the year. You can withdraw your RMD from any one or more of your IRAs. (Your traditional IRA trustee or custodian must tell you how much you’re required to take out each year, or offer to calculate it for you.) For employer retirement plans, your plan will calculate the RMD, and distribute it to you. (If you participate in more than one employer plan, your RMD will be determined separately for each plan.)

It’s important to take RMDs into account when contemplating how you’ll withdraw money from your savings. Why? If you withdraw less than your RMD, you will pay a penalty tax equal to 50% of the amount you failed to withdraw. The good news: you can always withdraw more than your RMD amount.

Annuity distributions

If you’ve used an annuity for part of your retirement savings, at some point you’ll need to consider your options for converting the annuity into income. You can choose to simply withdraw earnings (or earnings and principal) from the annuity. There are several ways of doing this. You can withdraw all of the money in the annuity (both the principal and earnings) in one lump sum. You can also withdraw the money over a period of time through regular or irregular withdrawals. By choosing to make withdrawals from your annuity, you continue to have control over money you have invested in the annuity. However, if you systematically withdraw the principal and the earnings from the annuity, there is no guarantee that the funds in the annuity will last for your entire lifetime, unless you have separately purchased a rider that provides guaranteed minimum income payments for life (without annuitization).

In general, your withdrawals will be subject to income tax–on an "income-first" basis–to the extent your cash surrender value exceeds your investment in the contract. The taxable portion of your withdrawal may also be subject to a 10% early distribution penalty if you haven’t reached age 59½, unless an exception applies.

A second distribution option is called the guaranteed* income (or annuitization) option. If you select this option, your annuity will be "annuitized," which means that the current value of your annuity is converted into a stream of payments. This allows you to receive a guaranteed* income stream from the annuity. The annuity issuer promises to pay you an amount of money on a periodic basis (e.g., monthly, quarterly, yearly).

If you elect to annuitize, the periodic payments you receive are called annuity payouts. You can elect to receive either a fixed amount for each payment period or a variable amount for each period. You can receive the income stream for your entire lifetime (no matter how long you live), or you can receive the income stream for a specific time period (ten years, for example). You can also elect to receive annuity payouts over your lifetime and the lifetime of another person (called a "joint and survivor annuity"). The amount you receive for each payment period will depend on the cash value of the annuity, how earnings are credited to your account (whether fixed or variable), and the age at which you begin receiving annuity payments. The length of the distribution period will also affect how much you receive. For example, if you are 65 years old and elect to receive annuity payments over your entire lifetime, the amount of each payment you’ll receive will be less than if you had elected to receive annuity payouts over five years.

Each annuity payment is part nontaxable return of your investment in the contract and part payment of taxable accumulated earnings (until the investment in the contract is exhausted).

This new law was just signed by President Bush on December 23, 2008 and it includes the suspension of Required Minimum Distributions (RMDs) for 2009. It states that individuals are are not required to take any distribution from their IRA or any other retirement plan for 2009.  This legislation contains numerous pension related provisions; however, a taxpayer who attained age 70 1/2 during 2008 has to receive their initial distribution by April 1, 2009 despite this law change, as that distribution is for 2008.  Taxpayers in this situation may have already received their initial distribution in 2008, and thus no further action is required.

The RMD is calculated based on life expectancy tables that are applied to the fair market value of the retirement account(s) as of the end of the prior calendar year.  Under the Internal Revenue Code, upon reaching the age of 70-1/2, individuals must begin receiving RMDs from their IRAs, 401(k) plans, and other retirement plans.  The initial RMD must be received no later than April 1 of the year following the year the age of 70-1/2.  Thereafter, annual distributions are required.

It should be noted that taxpayers who are required to get RMDs during 2008 have had to receive distributions based on the much higher fair market value of their retirement plan asset portfolios that existed on December 31, 2007, compared with the current values.  The 10% penalty for premature distributions taken from an IRA or other retirement plan prior to age 59-1/2 has not been changed for 2009.

Although this new law has been signed, many people will still choose to  take distributions from IRAs and other retirement plans during 2009 to cover living expenses and provide necessary cash flow in these difficult times .

I am writing this from my office away from my office, downtown Sarasota, Fl. Many times I have to get out of the office to get my mind straight and think. As I was thinking about this recession we are in I asked myself what has really caused this. I think there has been many reasons from a Rip Van Winkle fed chairman (not that I think Greenspan was any better) to a greedy real estate market and to put the cherry on the cake the unregulated oil commodity market. That brings me to my next question. How did we get back in this oil crisis? I do know that it has affected everyone we know from those who travel and now have to pay for luggage, to those who depend on transportation and finally those who are retired and are dependent on retirement income from the stock and bond markets. I am not going to complain about the situation because all that does is boil the blood. I am however going to tell you about part of the problem with our oil crises. Oil prices respond to Read more…

Each time one taxpayer transfers wealth to another, the transfer is potentially subject to federal transfer tax, in the form of gift or estate tax. The federal transfer tax system is designed to impose a tax on each and every generation (e.g., father to son, son to grandson, etc.).

The transfer tax system accounts for the fact that a transfer might “skip” a generation by passing from parent to grandchild, for example. This is accomplished by imposing an additional tax whenever transfers of wealth are made to persons who are more than one generation below the taxpayer (e.g., father to grandson). This additional tax is called the generation-skipping transfer tax (GSTT). GSTT is imposed at the highest estate tax rate in effect at the time of the transfer (45% in 2008).

Additionally, most of the individual states impose their own transfer taxes. Together, these taxes can take an enormous bite whenever wealth is being handed down, and eventually eat away a family’s fortune. This can be troublesome to individuals with substantial wealth who would prefer to have their legacies benefit their own family members. It’s from these circumstances that the dynasty trust evolved.

A dynasty trust is created to provide for future generations while minimizing overall transfer tax. With a dynasty trust, a taxpayer transfers assets to the trust. This transfer, from the taxpayer (the grantor) to the trust, is potentially subject to transfer tax (although the taxpayer may use his or her exemption amounts to shield the transfer from tax). The trust then provides for future generations for as long as it exists. Although the trust assets effectively move from generation to generation, there are no corresponding transfer tax consequences.

For more information on dynasty trusts and other trusts such as family foundation, you can go to http://kenhimmler.com.

Read more…

As I sat at my desk today and watched the crazy tumble of the Dow Jones it really reinforced the difference between accumulation and distribution. Everyday I meet with retirees or people about to retire and see the stress and the worry on their faces. Their worries are more founded lately because of this massive recession that we are in. In many of their cases I can understand why they are worried. Their entire future is dependent on the outcome of the stock market and they go up and down like a slinky. If you are twenty years old then you should by all means be invested in the stock market and probably 100% in. If you are in your sixties or in your seventies and you are dependent on at least 3% to 4% coming to you in a distribution and you are more than 40% in the stock market then you should be worried. Is this because I think the stock market wont come back – no, it is because I don’t think it will come back and grow for at least another two to three years. If you think I am crazy look at the business cycle. Just now the main street businesses are starting to go out of business. I know main stream financial media says that we are coming out of this recession but all the economic factors point the other way. Just yesterday Warren Buffett stated that this recession will last even longer than he originally anticipated. Lets look at the oil crisis. The oil supply has not kept up with the demand and therefore the sellers of oil have the market ability to increase prices and the world must pay it. If you think that this isn’t true just look at what is happening in Dubai. They expect to get over 1.7 trillion in profits over the next two years. They have at least 70% of the worlds tall cranes in one city – for building high rises. To add insult to injury now they are building another mall with another inside ski slope. This sudden increase in demand cannot be met in a short term. It will take a period of time for alternative fuel sources, alternative energy (solar), alternative transportation (hybrid and hydrogen cars) to not only be designed but produced. Once this happens then the oil produces don’t have as much power as they do now. What this means for people trying to plan their retirement income is that they may have a hard time living in today with inflation above 4%.  The real question is how can a person possibly feel comfortable with their retirement income when they don’t have a good asset allocation plan in place that includes a way to get an income from a fixed – no risk investment over the next two to four years. Let me know what are your thoughts and guesstimates of what will happen in the next few years in regards to the economy?

What is it?

For the most part, annuities will impose various administrative charges and fees. At first, the expense may seem minimal. However, over time, the cumulative effect of the charges and fees can be substantial. These expenses typically arise when dealing with variable annuities. However, fixed annuity contracts may also assess fees in the form of surrender charges.

For more information on fees on variable and fixed annuities such as a guaranteed annuity or equity indexed annuity, you can go to http://kenhimmler.com

Fixed annuities

Fixed annuities usually do not impose express charges and fees (except for surrender charges). Because there are fewer fees involved with fixed annuities, it may seem that it is the cheaper alternative to the variable annuity. However, this may not always be the case, because a fixed annuity will usually contain implicit charges that are reflected in the interest rates in the underlying contract. These implicit charges arise when the insurance company sets the interest rate that it promises to pay at a lower rate than the rate it expects to earn on its investments (sometimes, the difference is called the spread). This spread allows the insurance company to make sure that it will recover its administrative costs.

Variable annuities

Annual maintenance charge

The annual maintenance charges for variable annuities may typically range from $0 to $100. These charges are usually deducted from the various investment accounts in which the annuity holder has placed his or her funds.

Example(s): Mr. Smith purchases a variable annuity from ABC Insurance Company. Mr. Smith has placed 20 percent of his funds in a money market fund and 80 percent of his funds in a growth fund. ABC has an annual maintenance charge of $50. Mr. Smith’s money market fund will be charged 20 percent or $10. Mr. Smith’s growth fund will be charged 80 percent, or $40.

Tip: Some contracts will waive this charge when the annuity’s value exceeds a certain amount (e.g., $25,000).

Investment management fees

Investment management fees pay for an investment management group that advises the insurance company on which investments to buy and sell. Investment management fees for variable annuities may range from .25 percent to .75 percent. While a variable annuity account can be charged a flat percentage rate, some variable annuity contracts will call for each type of fund to incur a different percentage cost.

Example(s): Mr. Smith purchases a variable annuity from ABC Insurance Company. Mr. Smith’s funds are within a money market fund and a growth fund. ABC charges an investment management fee of .35 percent for the money market fund and .60 percent for the growth fund.

Mortality and expense risk charge (M & E charge)

The mortality and expense risk charge (M & E charge) is imposed by insurance companies to protect against risk associated with the annuity contract (e.g., an annuitized contract paying out income longer than mortality tables projected the life expectancy of the annuitant). Generally, the M & E charge ranges between 1 percent and 1.5 percent of the value of the variable annuity account. The M & E charge is deducted proportionately from the variable accounts, similar to the annual maintenance charge (discussed previously).

Transfer fee

Some variable annuities will charge a fee for the transfer of funds between investment accounts. These charges can range anywhere between $0 and $15 per transfer. Some annuity contracts will allow a certain number of transfers per year without charge, assessing a charge for any transfers over the permitted number.

Surrender charge

Most annuity contracts will assess a charge for partial and full surrenders from the contract during a certain time period after the annuity is purchased (usually 5 to 10 years). This charge is often referred to as the surrender charge and can have a wide range that decreases over time. Depending on the annuity contract, the surrender charge percentage will be applied either to the full amount surrendered or the portion of the withdrawal that exceeds the earnings of the contract. Some annuity contracts allow some withdrawals without a surrender charge (e.g., 10 percent of the contract value or the contract earnings). The surrender charge is intended to prevent annuity owners from moving funds in and out of the annuity and allows the insurance company to recoup its losses if the contract does not remain in force for a lengthy time period.

Tip: Some annuity contracts will provide that there will be no surrender charge if the annuity holder dies or becomes disabled.

Tip: Keep in mind that if you surrender your annuity when you are under the age of 59�, you may also be subject to the 10 percent penalty tax that applies to premature withdrawals.

Miscellaneous fees

Variable annuities might also levy charges for administrative expenses, such as record maintenance, accounting, and reporting. In addition, a variable annuity may charge extra for certain guarantees to be written into the annuity contract. Finally, several states levy a state premium tax on annuity premiums. The tax is generally a percentage of the gross premium paid and it is generally deducted prior to the computation of sales charges. Some insurance companies choose to add the cost of the tax into the price of the premium, rather than levy a direct tax.

Recently C.D. Ulrich CPA won a hard fought battle with the IRS. For years Ulrich really believed that the IRS was unfair to taxpayers (I really want to laugh right now but I am trying to be professional as I think the IRS has never been fair) when it came to the taxation of the stock they received from the demutualization of the insurance companies.

In the 90s many mutual insurance companies decided that they would go public and they went through the effort to sell their stock to the public. When they demutualized ( a mutual company is a company that is mutually owned by their policy holders) they not only sold stock to the public but the policy owners all got stock for owning policies.

You may have been one of the lucky (or so you thought) few that received notice that you were going to get a stock distribution from owning that policy until you also received a bill for taxes on the entire amount of stock distributed. As an example if you owned a policy with John Hancock and you received $100,000 in stock you would have been taxed on the entire $100,000.

Mr. Ulrich thought this was a rip off (like all the other financial planners out there) but he had the guts and staying power to fight the mighty IRS and he won.  His opinion was that if you are a mutual owner of a company you have paid for your policy which would constitute a cost basis for the stock. You are only getting an exchange for the premiums you paid. This means that if you take the first example of getting the $100,000 you would only pay tax if the $100,000 increased to $105,000. Then you would only pay tax on the increase of the $5,000.

Currently if you have ever received a distribution check from a company that has demutualized then you might be entitled to a refund. We are reviewing this for clients and people that contact us. The best way you can find out if you might be eligible for a refund is to send us an email to taxrefund@kenhimmler.com   Please let us know the company you received stock from, when and the amount. If we feel you might be eligible then we will contact you for more information. Please include your name and your mailing address and phone number in the email you send us.