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How’s it hanging fellow finance enthusiasts? Are you guys looking for a sophisticated financial planning technique that can help transfer wealth out of your estate tax-free and create income for life too? Yep, so am I . Look no further than annuity arbitrage! This strategy is remarkably simple to implement and may provide significant benefits for you and your beneficiaries .
Well, how does annuity arbitrage work? It involves purchasing an annuity and using the income from that to purchase a life insurance policy . The key is to select the optimal combination of annuity and life insurance contracts to maximize the advantages .
A Winning Combination: Single Premium Immediate Annuity (SPIA) and Term Life Insurance
If you aim to execute annuity arbitrage effectively, you need the right products . The ideal combination is a single premium immediate annuity (SPIA) and a term life insurance .When you combine this two product; you had a decent mix.
‘’Term life insurance’’ is the least expensive form of life insurance . It offers a death benefit without accumulating cash value or additional costs . The premiums remain fixed over the life of the contract, making it a perfect match for the fixed income stream provided by an SPIA .
On the other hand; a single premium immediate annuity is a pure form of annuity that starts paying a lifetime income immediately after a lump sum payment . There is no deferred growth or accumulation period and it doesn’t involve any additional costs .
Why is it Called Arbitrage?
Arbitrage!? What an exquisite word! The term “arbitrage” is commonly used on Wall Street to describe taking advantage of pricing mismatches by buying and selling the same asset on different exchanges . In the context of annuity arbitrage so it refers to a different kind of mismatch .
Every other insurance companies underwrite life insurance and annuities based on different mortality assumptions . This results in a discrepancy between the value of a large annuity and the cost of a life insurance policy with an equivalent death benefit . For instance; a $500,000 SPIA for a healthy 70-year-old male might generate approximately $2,850 per month for life . However, that income would be more than enough to purchase around $4 million of 10-year term life insurance .
For example, the insurance company receives $500,000 for the annuity but ends up paying over $34,000 annually until the annuitant dies . Simultaneously, it collects $34,000 in term life insurance premiums over 10 years . If the annuitant passes away within the 10-year term, the insurance company stops paying the annuity but pays a nearly $4 million death benefit to the heirs .
That is a mismatch that creates an opportunity for annuity arbitrage, allowing annuitants to receive lifetime income while providing a tax-free windfall to their survivors through the insurance policy’s death benefit .
Using Annuity Arbitrage for Retirement Planning and Estate Management
Annuity arbitrage offers valuable benefits for retirement planning and estate management . It provides lifetime income for their spouses, and when one spouse passes away, the survivor receives a tax-free windfall from the insurance policy’s death benefit . This can be achieved through the purchase of an SPIA with a joint and survivor rider .
For those individuals with large, taxable estates, annuity arbitrage becomes an effective tool for transferring wealth tax-free . By using an Irrevocable Life Insurance Trust (ILIT) to own and be the beneficiary of the life insurance policy, annuity income can finance premium payments made from the ILIT . Any excess annuity income can be kept or gifted to the trust . When the annuitant dies, the death benefit is paid to the trust and distributed to the beneficiaries, free from taxes .
Considerations and Planning
Before implementing annuity arbitrage, it’s crucial to carefully evaluate your current portfolio composition, as funds used to purchase the annuity must come from somewhere . You need to understand how this strategy will impact your income and liquidity .
Ideally, the funds used for the annuity should come from low-yielding assets whose income won’t be missed, as the annuity’s cash flow will be consumed by insurance premiums . Additionally, consider making a 1035 exchange from an existing deferred annuity in the accumulation stage to a new SPIA . This avoids taxes on the sale of other assets and maintains the portfolio’s overall cash flow .
You should also take liquidity into account as well as funds used for the annuity will be tied up for the long term . Make sure to preserve assets intended for high-priority consumption goals unless you can confidently replace them without compromising your objectives .
Your tax situation and overall income should be considered when structuring this strategy . Those in higher income and estate tax brackets tend to benefit the most, but annuity arbitrage can still create a legacy for heirs, even if the estate is not subject to taxation .
The final factor in how annuity payments may affect your total income, especially if you receive Social Security benefits . A portion of annuity payments is taxable and potentially impacting the taxation of Social Security income . However; lower interest rates result in higher exclusion ratios, meaning a larger proportion of annuity payments may be tax-free .
So as a conclusion annuity arbitrage is a powerful financial planning technique that can optimize your resources and provide lifetime income while facilitating tax-efficient wealth transfer . Evaluate your unique circumstances, consult with a financial advisor and consider adding annuity arbitrage to your financial toolkit . It’s a strategy worth exploring for those seeking to enhance their retirement income and create a lasting legacy .
It may get your attention:
Life Insurance vs Annuity: Understanding the Key Differences
