We would like to first apologize for such a strong title, but unfortunately, we’ve seen at least a dozen situations in the past year in which changes made to existing variable annuities during the estate-planning process have negatively impacted clients’ retirement plans. 

With more than $1.7 trillion1 in variable annuity contracts in the United States, annuities are an often-misunderstood investment when it comes to estate planning.  Essentially, annuities are an investment product tied to an insurance company, which offers guaranteed monthly payments over the lifetime of an individual and often a death benefit.  There are many nuances that make them unlike other types of investments.  A contract with little or no actual account value can still provide rich guarantees to the investor.  Each contract is different and has distinct provisions and features based on the carrier and year of issuance.  Additionally, over the past 10 years, there have been many living and death benefit provisions that are unique to variable annuities.

 

Real Life

Approximately 22 percent of millionaires own a variable annuity,2 but we have many high-net-worth individuals walk into our office who’ve been advised by their estate-planning attorney to set up their contract in a way that doesn’t maximize the benefits available to them and may actually hurt their situation or impede their estate planning goals.  Here’s an example of a real couple who revisited their estate plan because they were moving to a new state.  As their financial advisor, we provided the new estate-planning attorney with information on the current holdings and assets at the client’s request. 

This specific situation outlines an error that occurred in an individual retirement account, which is where beneficiary errors seem to be especially common.  The attorney returned the document drafts, which included a recommendation that the trust be named as the beneficiary on the variable annuities instead of the spouse. The attorney didn’t realize that these specific contracts had joint income benefits.  Changing the beneficiary as the attorney had advised would have eliminated the surviving spouse’s ability to continue receiving the lifetime guaranteed income.  

Fortunately, we had the opportunity to explain to both the attorney and our client why this change would have a potentially detrimental impact.  The collaboration between our offices benefited our mutual client, and although, sadly, the wife passed away not long after the estate planning was complete, our joint efforts provided her husband with confidence.  If we hadn’t been actively engaged in the process, the husband would have been prohibited from continuing the lifetime income guarantee in the contract.

Although the attorney had all of the information from our office, he didn’t know what questions to ask about their variable annuities.  He considered the amount of the assets, if they were qualified or non-qualified, who owned which account, beneficiary arrangements and the rate of survivorship, but never questioned the features or benefits of any of the programs.  He didn’t know to look at the impact the beneficiary changes would have in the variable annuities. 

 

Settling an Estate

Due to the federal estate-tax exclusion of over $5 million today, there’s now less of a need to leave assets directly to children on the death of the first parent.  There’s portability available for over $10 million of exemption today.  For the vast majority of people, there may no longer be a need to fund a bypass trust on the first death to try to maximize the two estates.  Leaving money directly to the spouse and having the additional flexibility is a much more appealing option today.  When the spouse is the primary beneficiary on the contract, he can consider a number of options, which include continuing the lifetime income payments (if there’s a joint income rider), commuting guaranteed payments to a lump sum, annuitizing the contract or Roth conversion.  On a joint contract, an important consideration is if the death benefit pays out on the first or second death.  The spouse is certainly not forced to take a distribution, and if he wants it to go directly to the children, disclaimer planning is available. 

An annuitization payment is based on the life expectancy and often includes a “period certain,” which protects the children in the case of the annuitant’s premature death.  This is especially effective if there’s a significant difference between the death benefit and the current income guarantee on the contract, which is often the case for investors who’ve experienced adverse market scenarios while taking income.  Consider a hypothetical couple who own a variable annuity with a guaranteed minimum income benefit and standard death benefit riders.  The husband passes away and the wife, who’s named as the primary beneficiary on the contract, is able to annuitize the contract for life with 10-year “period certain.”  This provides a higher monthly payment for her, and if she dies prematurely, the children would still receive the payments, which are guaranteed for 10 years. 

 

Liability

Due to the complexity of variable annuities, there are many considerations at play and the devil is truly in the details.  There’s potential liability if the estate-planning attorney doesn’t understand what the client owns.  To mitigate this risk, proper communication must exist between the attorney and financial advisor during the estate-planning process. 

Your client specifically hired you because you’re a specialist in estate planning.  Often, the client’s financial advisor may also be an excellent generalist, but not an expert in complex products such as variable annuities.  If the broker of record and/or the financial advisor isn’t actively engaged with your client, or the financial advisor isn’t an expert in variable annuities, you may want to hire an hourly planner or third-party consultant to do an independent analysis of the contracts and provide a detailed report for a fee. We believe that financial planning and estate planning aren’t conducted in a vacuum, and when possible, we engage the other professionals our client selects.  You may be surprised how many financial advisors will welcome the opportunity to work together as a team to help protect your client, their heirs and their legacy. 

 

Endnotes

1.     Insured Retirement Institute, June 6, 2013.

2.     Spectrem’s Millionaire Corner, December 2012, www.millionairecorner.com.