Steven Jarvis (00:51)
Hello, everyone, and welcome to the next episode of the Retirement Tax Services Podcast Financial Professionals Edition. I’m your host, Steven Jarvis, CPA. And joining me once again on the show this week is Brian Smith. Brian, welcome back to the show.

Brian Smith (01:04)
Thank you, Steven. It’s my pleasure to be back.

Steven Jarvis (01:07)
Yeah, I love being able to have these conversations. Obviously the great work that you’re doing around annuity products and the way you approach it really fits in line with how I think about taxes and especially some of the, this is what we’re gonna talk about today, especially some of the things I focus on around, hey, let’s skip past all the noise and nonsense that you see online and actually just talk about how some of this stuff gets done. Because on the tax side, you can doom scroll on LinkedIn and your feed will get filled up with, well, you’ve got to hire your two-year-old kid and you should move to Puerto Rico and everyone should be a real estate professional. And it’s like, whoa, let’s just talk about how some of the basics work. And same thing on the annuity side, especially, and we talked about this when you were on before, this can be a little bit of a polarizing topic, even though it probably shouldn’t be. It’s really not as controversial as some people make it out to be. There are great products that are great fits for the right clients. And so really that’s what we want to talk about today is let’s just talk about how some of the basics work, because most people just wanna skip to all of this stuff that click bait and gets them views. So Brian, when you think about, like we strip away all of the extra fanfare and side circus stuff that goes on, like let’s just talk about some of the basics of how you present annuities to people and how these things work in day-to-day life.

Brian Smith (02:26)
I know exactly what you mean, Steven. It’s like Susie Orman 15 years ago, know, annuities were the devil. And then strangely, she got some kind of endorsement from some insurance company and then annuities were great. I have no idea where she is today because I don’t really pay attention to Susie Orman. Regardless, yeah, annuities are a tool. If you need to put a screw in a drywall, you don’t look for a hammer. You look for a screwdriver or you look for a power drill. Annuities are a tool. And if your clients don’t need that particular tool, great, but some of them probably do. So let’s talk about the ways that we can use annuities as tools. That’s how they were designed.

Steven Jarvis (02:55)
And I love the reference to Suzy Orman because there are a lot of people out there who are talking heads that talk about a whole bunch of different things. And if it’s a topic I actually care about, then I want to find somebody who does that all the time and knows how these things really work, which is why we love our partnership with you and the team at FIA. That’s why we’re so excited you’re sponsors of the summit, which is filling up. We’re super excited about that. If you’re not already attending the summit at the end of September in Phoenix, go out to retirementtaxservices.com. Hopefully by the time this airs, there will still be a few seats left, although it’s getting a little bit questionable at this point. But Brian, all that to say, as just kind of a case study, let’s start with an advisor who has a new client who comes to them who already has an annuity in place. What questions are we asking? What do we need to understand just to know how this impacts the client, whether we make any changes or not?

Brian Smith (03:40)
You bet, you bet, and it happens all the time, all the time. In fact, later on this week, I’m talking with an RTS client that had like five or six million of existing annuities. So I’ll kind of use them as an example. Most of the annuities that you’re gonna come across your desk, you can split them in probably one of four different categories. One is just a plain fixed annuity, simple, easy, like, If it was sold five or six years ago, it’s probably at 3.5 % guaranteed. Most people don’t sell them more than three to five years. So it’s just a fixed annuity. It’s like a CD. The only difference is it’s tax deferred. So fixed annuity. If it’s out of surrender and the client really likes that annuity, maybe you can find a better one. Interest rates are up significantly over five years ago, we have a saying here, we say it probably too much and I’ve probably said it in RTS, but in a low interest rate environment, you refinance your house. In a high interest rate environment, you refinance your annuities. So fixed annuity couldn’t get any simpler. It’s a guaranteed interest rate for a fixed period of time. So that’s one sleeve. Second sleeve is what we would call fixed indexed annuity. Market goes up, they participate in a portion, market goes down, they get a zero. Now those can come with or without income features. We’ll talk about income in a little bit. And then your third scenario, and this is really where I see most of the RTS listening audience when they send me statements, they’re oftentimes variable annuities. So this is an annuity wrapper with mutual funds as the underlying investment and there basically you have a full market exposure, upside and downside. And those can also come with or without income features. And those are the ones that are hardest to really sort of figure out what do we have? So most of the time when I get RTS clients sending me statements, that’s what we’re looking at. And what are we looking for?

(05:42)
Well, what are the fees on that investment? Is it qualified or non-qualified? And obviously we can apply this back to fixed annuities too. What are we trying to achieve? So we’ve really covered fixed annuities, indexed annuities, and then variable annuities. And there’s something sort of in between an indexed and a variable, which is called a RYLA, a registered indexed linked annuity. Sometimes people call them hybrid, where it’s a buffered product. It’s like a structured note. So you could get a 20 % buffer on the downside and maybe a 20 % cap on the upside. So that’s sort of between a fixed indexed annuity and a variable annuity. Now there are some other, you know, probably less common types of annuities like a SPIA, a single premium immediate annuity. That is basically where the client is just giving an asset to an insurance company and getting a return payment for a certain period of time, sometimes life. Those are very, very tough to do anything with because it’s an irrevocable settlement option. Give the money to the insurance company. It’s basically a bucket and they turn on the spigot. So there’s not much you can do but just to understand those. I mean, so fixed, indexed, variable, RYLA, and then others, we could throw QLock in there, but we don’t want to get too crazy at this point.

Steven Jarvis(07:01)
Well, and Brian, before I start asking some more specific tax questions, we’re going to tie this into a tax return in just a second. You mentioned RTS advisors reviewing policies with you. so for audience members who haven’t taken advantage of that yet, if you go to retirementtaxservices.com/FIA, Brian’s been very generous. Him and his team will do a policy review for listeners of the RTS podcast. And so you can go out and fill out your information. We’d love to get you a second set of eyes on these things that you’re looking at, because we talked about this last time we were on the podcast, but just like with tax returns, pictures are didn’t happen. Make sure you’re getting actual policies. It’s nothing against your clients, but don’t take their word for how their annuity product is set up or how it’s working. Just like with their tax return, if you haven’t seen the real document, you probably don’t have all the details. So Brian, we can come back a little bit to…how to review and think about annuities that are in place, when we might think, I mean, you mentioned, hey, how we think about what interest rates are doing and what we might do with annuities. But again, let’s talk for a second just about how an enforced annuity is gonna show up annually on a client’s tax return. I know there’s some distinctions here on whether it’s a qualified or non-qualified annuity and then how the money’s coming out. So kind of talk about the different scenarios here and how this is gonna show up on a tax return.

Brian Smith (08:12)
That’s a great question. Well, generally speaking, one of the things that the annuity carries that you don’t get from different types of investments is tax deferral. So unless the client is actually taking withdrawal, you’re actually not going to see it on the client’s statement. Now, the IRS is required on qualified money to send out evaluation for RMD purposes. But if the client is an RMD age, they’re gonna get a tax document that shows fair market value, but there’s not anything that needs to be done with that until they actually start taking withdrawals. But when they start taking withdrawals, that’s where things certainly change. So let’s talk about qualified money first. So IRA money and a client is taking withdrawals. That money has never been taxed and we all know that Uncle Sam is gonna get his share. On pre-tax money, when the client is taking withdrawal, that’s gonna be 100 % taxable at ordinary income rates.

Steven Jarvis (09:11)
Yeah, and if I can just interject real quick here, Brian, I love this distinction of are they taking money out of the annuity? Because that really is really important because unlike your taxable brokerage account where you’re gonna get a 1099, 1099B, a 1099Div, a 1099Composite, you’re gonna get one of these every single year essentially, with annuities, it’s really when the money starts coming out now, we’re gonna start getting 1099Rs is what we’re on the lookout for. And these are gonna come through on line five of a tax return as to your point, ordinary income. So that’s how this starts tying into a real tax return. So Brian, you keep going down that train of thought, I just wanted to pull out some of the tax forms involved there.

Brian Smith (09:46)
Perfect, well, you’re the guy to do it. For non-qualified, it’s similar in that it’s still ordinary income tax, but you’ve got a cost basis involved with non-qualified annuities. So it’s a little different on non-qualified annuities because on non-qualified annuities, we consider it LIFO, last in, first out, when a client starts taking withdrawals, and we’re just talking about ordinary withdrawals here, we’re not talking about an income rider or particularly annuitization, because that’s a different deal. When a client starts taking withdrawals on a non-qualified annuity, it’s gonna be, the first thing that’s gonna come out are gains, and that’s gonna be taxes ordinary income. After the client has taken all the gains out of the contract, then it would be a tax-free withdrawal, because they’ve gotten through all their gains and now they’re back to principal. At that point, it would be a tax-free distribution. And we can, do you wanna separate the difference between an income rider, Steven, or?

Steven Jarvis (10:48)
I do but real quick before before we go into that we we also need to keep in mind that age matters on this when we’re talking about qualified annuities. And so just I mean similar we were talking about IRAs or 401ks and these are things we have to be aware of so even if you’re an advisor listening to this that says well I don’t put my clients in annuities that’s probably in part because you don’t understand them super well because we want to make sure we’re giving a Well-rounded set of options to our clients. But even if you didn’t originate it, you still have to understand how this works if you’re gonna give good advice to clients. And we’ve seen this, I’ve had this come up talking to E&O providers of when advisors get themselves in trouble because they start making changes to things without really understanding the implications. And so if you’re having a client start taking money out of a qualified annuity, and you don’t, you aren’t considering the age, the other penalties or interests that might come into play here, we might be given some very incomplete advice.

Commercial (11:42)
THE SUMMIT: retirementtaxservices.com/summit

Brian Smith (12:15)
Absolutely. Well, in 25 years of wholesaling in the insurance industry, when I see people that are looking to fund an annuity at age 20, I go, hold on a minute, because you got to think about the back end, right? If it goes into an annuity, particularly for non-qualified money, now that money needs to stay in a non-qualified annuity until at least 59 and a half. If you take a distribution prior to 59 and a half, not considering whatever penalties the insurance company might place if it’s not out of surrender. Now you’ve got a 10 % penalty on the gains for a non-qualified annuity and 10 % of the withdrawal on a qualified plan. So, and when I say qualified plan, I mean an IRA, not a pension plan or something like that. Yeah, you need to understand that these annuities were designed for retirement. And if they need money prior to 59 and a half, things can get tricky. There are some ways around it. You can look at a 72T for an IRA or a 72Q for a non-qualified annuity, but these are complex topics that need exacting calculations that need to be followed every single year or the IRS can tack on another penalty for not following through with how they want that type of money being paid out.

Steven Jarvis (13:30)
Yeah, well, and Brian, again, I want to highlight some of your time on there because I clearly you’ve got the background expertise in there that you’re just casually talking about some of these things that I wanna make sure we highlight. You mentioned there that this is ultimately a retirement product and we’ve gotta remember that in tax planning in general, we’ve gotta make sure we understand the timeline that we’re looking at. And so I’ll have this come up sometimes when people will ask me, okay, well, what’s the break even point of converting to Roth as far as the amount of time it needs to have happened? That’s not the relevant question. We’ve gotta be looking at when are these funds going to be used. What timeline are we investing for and what’s alternative if a need comes up sooner? And so we have to, regardless of the tax planning we’re doing, the product we’re recommending, the investment that we’re trying to get people in, we’ve got to understand bigger picture goals and what those time horizons look like.

Brian Smith (14:13)
Absolutely, absolutely. And if you’re talking about annuities for distribution, that is a much different topic than annuities for accumulation. And annuities can do both. You can accumulate your money and then take distribution. But again, this all needs to fit in the overall client’s financial picture. And they need to understand implications of both deferral and accumulation.

Steven Jarvis (14:34)
Well, and Brian, I’m not an investment guy, so I’ll just remind everyone of that as I ask what might seem like an ignorant question. But to me, as we have more of these conversations around annuities and I see more of them, it does seem like one of the…the distinctions here that people need to keep in mind is that it sounds like a lot more of the decision making needs to happen upfront with annuity products than might need to happen if we’re just going into a taxable brokerage account or something else where we can continue to change, kind of change our mind throughout the process. And there’s obviously pros and cons to all of this, but the annuity design upfront is gonna have a bigger dictation on what it is we can do with it later.

Brian Smith (15:08)
For sure. In fact, I was just talking with Micah last week and he’s got a bent towards the, not the aggressive, just the very, very brutally honest, which I love about him, but he’s like, there is a cost for annuities. It’s time, right? So every annuity out, well, there are some exceptions, but most annuities out there have a surrender charge. So you need to take that in mind. Does that fit the client’s overall investment, needs and wants and are they okay with the time that we need to either defer or wait to take income? Those things all need to be factored in.

Steven Jarvis (15:42)
Yeah, great reminders there and always love Micah’s brutally honest approach .Brian, let’s go back to you. You had brought up income writers at one point and then I shifted us. Let’s go back to it. Let’s talk about how this works.

Brian Smith (15:51)
Okay, so there’s really only three ways you can get guaranteed income these days. One is social security, assuming that we can consider it guaranteed, I think we can. Two is pensions and very few people truly have a pension anymore. They exist, but they’re far more rare than they used to be. And third is by using an insurance product. So income riders typically, at least on the fixed side that I work, are gonna cost you somewhere between 75 basis points and 1.2% a year. And the insurance company is gonna take the money and then they’re gonna pay that money back to you for as long as you live. So ultimately, the better option there is for a client to get all of their money out and then get into the insurance company’s pocket. Then the faster they get there and the longer they stay there, the better the deal.

(16:38)
Here at FIA, we evaluate that using internal rate of return or IRR, and we’re happy to run those calculations for you if you’d like. But an income rider allows you, allows the client to maintain control of the asset. It’s not a newitization. So if they decide that this isn’t right for them, they can change their minds. With some carriers, you can stop and start the income, or you can just choose to stop the income and take your money back. Of course, you always be subject to the surrender charge if that’s the case. But in this case, there’s a way to abate longevity risk. In other words, get a client a paycheck for as long as they live. If they live to 137, great, the income’s still gonna come in without losing control of the asset like you do with annuitization. Annuitization still exists. You mostly see it in terms of immediate annuities or old annuities, typically 15 or 20 years old, you still see some old GMIBs, a guaranteed minimum income benefit. That’s more of an old school annuitization type product where you can still get a lot of income from them and then you can choose the iteration that you want, whether it’s a life only payment or a life with a 10 year period. There’s a myriad of choices, the kind of the negative thing that the industry has turned away from over time is the client can’t change their mind. Once you turn on an annuitization payment, it’s an irrevocable settlement. It’s actually considered the insurance company’s money. It’s in the insurance company’s general account. And that’s why you hear a lot of Medicaid friendly solving and people would look for an annuitization option because then it’s not technically their money.

(18:17)
Well, turns out the government figured out a way to get around that with look back rules and everything else, but just to differentiate an income rider payment where the client maintains control of the asset does get lifetime payments and annuitization where they get a lifetime payment, but it’s an irrevocable settlement option. They can’t reach in and grab more or less. It’s kind of done, if that makes sense.

Steven Jarvis (18:39)
Yeah, and Brian, I don’t want to gloss over the fact that you talked really transparently in there about the cost of these guarantees and riders. That’s one of the things I appreciate about all of our partners, is why we love partnering with you on this stuff, that there’s no smoke and mirrors here. There are costs to things, and there should be costs to things. If you’re going to take away risk, there’s going to be a cost to doing that. So really appreciate the context there and how that works. There also is a tax implication to annuitization versus a withdrawal because before you talked about, if you’re withdrawing money from an annuity, it’s life will last in first out, which means the gains are gonna come out first and be taxed as ordinary income before you get your basis back. But if annuitization is turned on, now we’re looking at a split with every payment.

Brian Smith (19:18)
Right, for non-qualified money, and this is really where the advantage comes of annuitization, the cost basis and the gain are gonna be calculated in so that, just like you said, there’s a split. So for a highly appreciated non-qualified annuity, where you don’t wanna have to pay taxes on all the gains upfront, sometimes annuitization is a good option because now you spread that taxable gain over the lifetime of the client. And sometimes from a tax planning perspective, that’s actually a benefit. There are a few companies out there that will treat annuitization. They’ll treat an income rider payment with the benefits of annuitization. Lincoln has a product called the iFOR, well, it’s not a product, it’s an income rider called the iFOR Life. It was available on the fixed site for a long time, then they took it off. And now it’s just on the variable side, but a little birdie at a conference told me that Lincoln might be bringing back the eye for life on the fixed side, which was brilliant because now we can get the tax benefits of annuitization where we spread that taxable gain over the client’s lifetime without having to take all the taxes upfront. So I hope they bring that back, but for particularly our…registered reps that are listening, the Eye for Life is available on the variable side. I’m not sure if it’s available on the fee only side, but that’s something I can look into. Yeah.

RTS (20:41)
Interesting. And Brian, made a note here. I want to make sure I didn’t skip over it, but you mentioned about how you guys evaluate cost benefit of some of these riders or provisions and annuities. And so again, for listeners, you can go out to retirementtaxservices.com/ FIA. That’s how you can request one of those reviews that Brian’s talking about so that you can get some insight from people who do this all the time. So Brian, again, as we talk about just, on the relative, I’ll use sarcastic air quotes here, but on the relatively simple side, which none of this is simple to your clients. This is all Greek to them. So the more you can articulate these things, the more you can help navigate the more value you’re adding as advisor. But what else comes to mind if we stick to that simple, basic side, whether it’s tax related or otherwise, as advisors are coming across clients who already have annuities in place or if they’re getting started with annuities for their clients.

Brian Smith (21:23)
Well, that’s a great question. I’ll give you an example. I’m not going to name any names, but there I was dealing with an RIA Western part of the country and they said, we don’t love annuities. We don’t hate annuities. We just don’t understand them. So would you, would you start at square one? And so we walked through the different types of annuities, just like we did fixed index variable RYLA. And then they actually sent me some statements. And so taking what the client’s objective is, mirroring it with the product that they were sold, not by this organization, but that they inherited, client brought in these annuity statements and said, I don’t even know what this is, can you help me? Okay, well, most of the policies that we looked at were variable. They carried between three and a half and 5 % of annual fees. And the ones that had the three to five in fees all had income features. And so we had to take a look at, all right, what are they paying for those features? What is the guaranteed income that those features are gonna generate? Does that still meet what the client wants in terms of objectives? And if not, what else is out there? And so by way of comparison, we looked at what’s available today with higher interest rates and we could provide them between 30 and 35 % higher guaranteed income, reduce their fees from three to five down to one and eliminate risk in terms of downside market risk. And they were thrilled. They didn’t even know that was possible. But it starts with understanding what you have. And then I think probably the most important thing is what does the client want? And if we can ascertain what we have and what the client wants, then we can decide hey, this is a great thing. I found one product, I won’t say the name of it, but it had done fantastically well. The fees were relatively low. And I said, that is a great variable. You should leave it. I wouldn’t move it. And they were like, great. So if we can either affirm that the product is doing what it was intended to do or ascertain that maybe it isn’t meeting the client’s needs, now number three, can take action, whether that’s tell them they’ve got the best thing out there or potentially make a change.

RTS (23:38)
Brian, I love the way you’re outlining that and the reminder there, this is a good thing for us to wrap up on. It really comes back to the client goals. Like at the end of the day, we have to understand what the client is trying to accomplish and then taking that next step of do we have the actual policy? Do we know what the existing situation is? And then making sure we have a plan of action. And I’m with you, sometimes the right course of action is to do nothing, but only after we’ve really evaluated this. And then the other thing I wanted to draw out from what you said there, Brian, is that again, I think similar to taxes, taxes and annuities both get brought up so often in this industry that I think there are some advisors who feel like they’ve missed their opportunity to raise their hand and say, I don’t understand this without feeling like they’ve somehow done a disservice.

(24:15)

But the only way you’re gonna do a disservice to your clients is if you keep not raising your hand to ask for help. So whether that’s on the tax side, you can engage more with RTS, or that’s on the annuity side and you go out to retirementtaxservices.com/ fia, you learn from Brian and his team, you get a policy review done. It’s not it’s not somehow too late to learn more about these topics and to serve your clients better. So that that’s really my biggest takeaway from the conversation today, Brian, we’ll definitely have you back on the podcast as we get closer to the summit. But really appreciate you coming on and sharing your expertise as always.

Brian Smith (24:45)
Well, my pleasure. And one of the questions I do get sometimes, Steven, is, hey, what do you charge? We don’t charge anything. If I can help you help your clients, that’s good. So there is no charge to look at existing client statements or just to talk about annuities in general or in specific. We’re just happy to help. So thanks for having us on, Steven.

Steven Jarvis (25:07)
Yeah, of course. appreciate the reminder though. That’s part of the, one of the benefits that we certainly appreciate about partnering with you guys, that you’re willing to so freely give information to our audience to get them pointing in the right direction. Again, Brian, thanks so much for being here. To everyone listening, until next time, good luck out there and remember to tip your server, not the IRS.