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IRA Transfer Station

Workers clicking through the turnstiles of retirement are turning over vast amounts of wealth out of plans such as individual retirement accounts (IRAs), but where should they go next?

Ahead are conductors yelling to board one of several trains. They are all compelling, but which one offers the best route to retirement? Time’s ticking, and people are boarding; they have to decide now. And here’s the kicker: This is often a decision they can’t undo.

Everything they saved for has led to this moment of decision. Welcome to IRA Rollover Station.

It’s a busy place. Lots of dollars flow through these halls. In fact, the market is expected to grow to half a trillion dollars annually by 2018.

Where is it all going? The answer is a good one for insurance, and perhaps more important, exciting for the industry’s future.

Here’s why:
The IRA market is enormous. About $425 billion is expected to be rolled over from IRAs this year. If that is true, it will have risen by $25 billion over the previous year – the increase by itself would be about half the size of fixed index annuity (FIA) annual sales.


They fuel annuities. A mere nine years ago, 49 percent of money going into fixed index annuities came from IRAs; the majority, 51 percent, came from unqualified money. Last year, 62 percent came from IRAs and 38 percent from unqualified funds. Variable annuities (VAs) had a similar kind of growth, but started sooner with earlier consumer acceptance. But those trend lines are reversing, just as FIAs are surging.

Let’s take a look at what’s happening with IRA rollovers and how some expert practitioners in the field are helping clients work through this transition.

All About Income
Consumers did not jam agents’ waiting rooms in 2008, chanting, “We want annuities!” But they did demand safety. In those days, even a key money market fund “broke the buck,” meaning it failed its central reason for existence – to be worth eternally at least the dollar an investor put in the fund.

With interest rates sinking to zero, a plain annuity was not the most attractive option. Fixed index annuities, with their low-downside-and-potential-upside message, attracted consumers. But when FIAs started offering guaranteed living benefits (GLBs) of different varieties, that sealed the deal for IRA holders, according to Todd Giesing, senior business analyst at the LIMRA Secure Retirement Institute.

“If we go back seven years, GLBs weren’t as prevalent as they are today in the index annuity space,” Giesing said. “And, now, consumers are taking rollover dollars from their IRAs, their 401(k)s, and bringing them in for the ‘income later’ story, to have that guaranteed lifetime income.”

How can the increase in IRAs rolling into FIAs be so tied to the riders? Partly by looking at the variable annuity experience. VAs started earlier than FIAs and then found enthusiastic consumer acceptance with GLBs. VAs took off with the soaring stock market.


The crash in late 2008 also dragged VA sales, but they didn’t drop as drastically as the market did. Insurers also eased off selling VAs post-crash because the guarantees were difficult to sustain.
They also started dialing back on riders, even though the riders were a key reason consumers bought VAs. For example, in the first quarter of 2008, 90 percent of consumers elected a rider when one was available. By the next quarter, companies were backpedaling furiously. That summer, some carriers went as far as offering to buy back the guarantees from policy holders.

Since 2010, the percentage of VA money from IRAs has been dropping, precipitously so in 2012. It is now at 59 percent.

First, a Warning
Jeffrey Levine, CPA, is an Ed Slott and Company IRA technical consultant who has a warning about a little-known tax court interpretation going into effect this year.
The tax code allows taxpayers to complete only one IRA rollover once in a 12-month period.

“Prior to a court case earlier in 2014, the rule was understood to be an account-specific rule,” Levine said. “So if you had IRA 1 and took a 60-day rollover out of that account, and you put it into IRA 2, if you later took a distribution from IRA 3 within the same calendar year, it was understood that that distribution from the third and separate account could still be rolled over. The court said, ‘Nope.’”

Apparently, even the IRS got that wrong, because the example Levine cited was one from the agency’s guidance on the rule.  “If you do a 60-day rollover from IRA 1 to IRA 2, you can’t do any other 60-day rollovers for the next 365 days – it doesn’t matter whether it comes from IRA 1, or IRA 3 or IRA 2,500,” Levine said. So, all the client’s IRAs are considered together.

“I think that’s going to be a change that perhaps destroys many clients’ retirement savings, because you have situations where clients have four or five different CDs or fixed annuities for the different interest rates,” Levine explained. “They have three different fixed annuities because they did various rollovers and locked in different rates. Now, every year as those CDs, annuities or whatever accounts come due, the client has always done a rollover to the other account that pays the highest interest.”

That was not a problem until this year, because the one-rollover-per-year limit applied only on an IRA-by-IRA basis. Beginning in 2015, the limit will apply by aggregating all of an individual’s IRAs, effectively treating them as if they were one IRA for purposes of applying the limit, according to the IRS. Clients, starting this year, could unwittingly violate the rule by doing more than one rollover, just as they have always done. And once they do it, there is little that can fix it. Even time won’t heal that wound.

“Not only is that amount taxable for the year, but the second rollover that wasn’t allowed to go into the IRA becomes what’s called an ‘excess contribution’ and is subject to a 6 percent penalty for every single year it remains in that account,” Levine said, adding that it could be a lot of years. “There was a major tax court case that said if you don’t file for a 5329, which is the form that gets filed to report excess IRA contributions, then you have no statute of limitations. So the IRS may pick up on this 20, 30, maybe 40 years later. They can come back and say, ‘You owe us back tax and back interest for the last 40 years.’  That’s 6 percent a year, plus penalties, plus interest. So it’s something that clients really, really have to be mindful of.”

Clients have ways around it. For example, trustee-to-trustee transfers are not limited. But if they don’t know about the rule, they won’t know about their options.

RMD Planning
The better-known complication with IRAs is the required minimum distribution (RMD). For people with large accounts, they come with a commensurately sized RMD impact on taxable income.

Levine said people have a few options, such as simply not retiring at 70.5. If the plan is with the same company, people can delay the RMD until they retire. If that’s not the case, they can use a qualified charitable distribution, which will not affect taxable income. One trade-off, though, is that a client cannot also take the charitable deduction.


Then, of course, there’s the Roth IRA. Roth IRAs have no required minimum distributions during the account owner’s life. Once the Roth IRA owner dies, nonspouse beneficiaries are required to take minimum distributions from those accounts, but they can generally stretch those distributions so they’re a little bit smaller.

The question with converting to a Roth is essentially always  “Am I better off paying taxes at today’s rates of income or tomorrow’s rates of income?” That answer largely depends on whether people think they will be in a similar or higher tax bracket or whether tax rates will be significantly higher when they take money from the IRA. Rates are near historic lows now, so that can often be the nudge that pushes people to pay tax now and convert their IRA to a Roth.

“In fact, you’re eliminating at least one unknown,” Levine said of choosing to pay today’s tax and opting for the Roth. “Clients have a million different unknowns in their retirement planning. What’s the market going to do? What’s inflation going to do?  What are interest rates going to be like? What are taxes going to be like?”  

But the longer clients wait, the more complicated the picture gets. “If you do a Roth conversion in retirement, that could also have other facts that aren’t applicable beforehand,” Levine said. “For instance, if you do a conversion later in life, you might trigger more Social Security taxation in that year. You might actually make your Medicare Part B premiums two years in the future higher than they otherwise would have to be. To do those conversions before you take Social Security or before you’re on Medicare, that obviously takes away that issue.”

Looking at the Whole Client
Looking at the issues early is a central message that Carlos Dias tries to convey to his clients.

Dias has two practices near Orlando, Fla., that serve two distinct clientele: the Portuguese community and professional athletes.

Because he is securities-licensed, he can look at the client’s overall financial picture. He also gleans their motivation at that moment.

“A lot has to do with their goals,” Dias said.  “Are they short-term? Is it immediate income? Is it a little bit more long-term?  And if it’s long-term, a lot of times we may use the fixed index annuities, because they give the greatest potential for gain without going into something that you’re purchasing at a higher interest rate. But you have to lock it in for the same amount of time that you could be potentially receiving some higher gains.”


Again, RMDs are a key issue. They can be particularly problematic for wealthier families with larger IRAs.

RMDs can become staggering. “The RMD on someone who’s got a million in an IRA is almost $37,000,” Dias said. “In that case, other income coming in, such as a little bit of a dividend income or
Social Security, they’re already at that cusp of being taxed higher on their Social Security.  So a good portion of their Social Security would be taxed.”

Dias said he tells his clients that the time to think about the RMD trap is long before 70.5, when people are required to take the minimum distribution.

“Right now, we have relatively lower tax brackets,” Dias said. “So removing money or doing Roth conversions – it’s best to do that before you take Social Security. So everything is kind of at your leisure versus if you’re going to wait until later on in life, and then you’re forced to take almost $37,000 in income. Then you’re kind of stuck because your Social Security is stuck.”
He recommends having that talk with clients in their 50s, even it’s a little uncomfortable for them.

“In their 50s, it’s tough for them to talk about this because they just have the mentality of trying to accumulate as much as possible,” Dias said. “But no one’s ever given them a number to say, if you’re looking for XYZ dollar amount in retirement, then you’re going to need to have at least this amount of money saved up.’”

But people typically wait until their mid-60s, when they are about to retire, or when they’ve been laid off. “They say, ‘Well, now I have to go to my IRA or employer plan or whatever’ to get the money to make up for their income or the shortfall.”  

Some near-retirees delay because they’re just plain scared, and that only makes things worse. “They don’t want to ask because they don’t want to get the bad news,” Dias said. “I had one lady recently whose husband had just passed. She didn’t know that her husband had stopped paying the mortgage for a couple of months. She just had a little bit of life insurance money that came from him.  Besides that, she had this IRA, and now she had to plan for what kind of money she’s going to need because she just had a back operation.”

The situation was familiar to Dias. The client was 65 and, desperate to know what her options were. Her biggest questions were the ones he always hears: “how short am I of what I need? How can I guarantee that income?”

The answers at that point were limited. “If she had maybe monitored it years prior,” explained Dias, “she would have had some kind of guideline and I would have said ‘You’ll have to contribute this much to get there.’”

Putting It All Together
Mark Lumia, a financial planner in The Villages, Fla., calls himself a retirement cash flow specialist. He looks at the big picture and puts together complex solutions to get clients the income they want.

Sometimes the answers might seem surprising to clients. For example, for one woman he used a strategy that had her paying back her Social Security at age 63.

“If someone has enough money where they don’t need Social Security, and I’m telling them to trade IRA dollars for Social Security dollars because they have something out there called a tax torpedo, that’s how we reverse it,” Lumia said.

The tax torpedo is why conventional wisdom can lead to trouble. Typically, retirees might take a Social Security benefit in order to preserve an IRA. After all, they can outlive the IRA, but not Social Security. But then they might still have to withdraw from their IRA, which is 100 percent taxable, perhaps even pushing them to a higher rate of taxation on Social Security.

So, in this case, Lumia counseled the client to use her IRA to reimburse Social Security and delay taking it – to pretty dramatic effect. Social Security can be paid back in the first year only. And Lumia told his client that her Social Security could almost double, with delayed credits and the cost of living adjustments (COLAs).

“So you’re basically purchasing an annuity from the government that has a guaranteed cost-of-living increase,” Lumia said. “There’s no other product out there like it.  So she’s going to have a higher income there, but she’s still going to be required to take the RMDs. And when she has both of those things at 70, she’s going to have excess money.”  

Then he turned to two variable annuities she had: one was in an IRA and the other not. She had the nonqualified one surrender-charge free. The tax-penalty-free amount that she could take out every year was $39,842. She retained $9,842 to replace the income she lost from stopping Social Security.

While she was still 62, he suggested that she was probably relatively insurable and that she put excess money into a $500,000 whole life policy. The policy would be overfunded with the $30,000 payment, but not enough to make it a modified endowment contract.

She can pay for seven years and then she will have $210,000 growing tax-free in the policy from then on. She can borrow or withdraw from it, or just leave it for the death benefit.
It fit together in a bigger strategy for her situation. When she hits 70.5, she will have to pull RMDs but she will also have the whole life policy’s cash value. But also, the strategy considers the contingencies.

“Let’s say the husband dies. When that happens, she’s going to lose one of the two Social Securities, and she’s going to lose half, or all, of his pension,” Lumia said. “She’s also going to be taxed as a single taxpayer, not married and filing jointly. She’s going to lose half of her standard deduction and half of her exemption. That means she can have the same taxable income and pay $1,900 more in tax.”

Her husband was receiving Social Security, which was larger than hers, so she takes that over, rather than taking her own. She can start taking the RMD from the VA in the IRA when she is 70.
It made sense to draw down at least one of the VAs because of the fees, which totaled 4.85 percent. But Lumia certainly could make an argument for rolling the other one into a fixed index annuity.
He figured out the fee impact on the money over 10 years if a $600,000 VA were purchased in 2004, and compared it with an FIA’s performance. Once the fees were deducted and the return figured each year, you would end up with $606,609. Looking at an FIA with a 4 percentage point cap and a floor of zero, you would end up with $809,000.

“Even with a 4 percent cap,” Lumia said, “you averaged 3.04 percent rate of return versus 0.01 percent. So that’s why someone would take qualified money that’s in a variable account and put it into a fixed index.”

The moral of Lumia’s story is similar to Dias’: Plan early. In Lumia’s illustration, it was almost too late, because the client could pay back Social Security only in the first year.

The lesson for agents and advisors is that millions upon millions of people are rushing along through the stations of life to retirement age but not really looking up, afraid of where they are heading. But these examples and countless others show that when clients turn to professionals earlier, the planning opportunities are far wider for them – and for advisors.

“That’s what I mean by ‘retirement cash flow specialist,’” Lumia said. “I can help them increase their income and reduce their taxes, but also increase their lifestyle – just by using the rules that are out there.”

Steven A. Morelli is editor-in-chief for InsuranceNewsNet. He has more than 25 years of experience as a reporter and editor for newspapers, magazines and insurance periodicals. Steve may be reached at [email protected] Follow him on Twitter @INNSteveM. [email protected].

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