Annuity Stretch IRA (Post 02.24.2022)

“The news of my death has been greatly exaggerated” – Mark Twain

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The Stretch IRA continues to survive. The “investment industry” has written much about the death of the Stretch IRA who; would have you believe, the Stretch IRA is dead.  My recent attempts to publish in the investment industry have been met with several rejections.  Not surprising because, the “investment industry” is not part of the IRS stretch IRA exempted class in which, the “insurance” industry continues to enjoy membership.

Following, the recent Federal Register/Vol 87. No 37/Thursday, February 24, 2022/Proposed required minimum distribution (RMD) rules water shed moment, the annuity (periodic payment) IRA and also defined benefit “pension” plan RMD foundation established by the 01.01.2006 Pension Protection Act and IRS code section code 1.401(a)(9)-6 was re-affirmed.

Last month I posted (Stretch IRA – A Triumphant Return 03.11.2022), a LinkedIn blog regarding the IRS Federal Register 02.24.2022 publication and details regarding annuity (periodic payment) Stretch RA contracts. Because periodic payment IRA annuities and defined benefit pension plans have their own separate and distinct RMD rules governed by IRS code 1.401(a)(9)-6 they are not entirely set free of RMD requirements. The IRS only permits RMDs for these arrangements under certain limitations.

This means individual IRA owners can still purchase periodic payment IRA annuity contracts and establish Stretch IRAs for anyone they wish. A periodic payment annuity contract is distinguished by guaranteed (by the insurance company) payments, paid on scheduled future dates all known in advance. There are no moving parts and once the insurance company issues this annuity, neither you nor the insurance company may change any of its terms and conditions.  This kind of annuity (as opposed to other kinds of annuities) like a defined benefit retirement pension plan becomes a very permanent retirement financing mechanism.

Now it’s time for a real case example. Let’s look at how a following IRS permitted Stretch IRA case might play out

A Father, age 75, purchases an IRA annuity (periodic payment) for a lifetime payment but no matter, for a minimum of 20 years. He names his adult Son age 48 as the person (“Survivor”) who, if he survives the Father, will receive the Fathers annuity income for his lifetime over what remains of the initial 20 years paid at the father’s rate.  Then, following what remains of the initial 20 years, at 63% of the Father’s annual rate until the Son’s death. (The IRS says the Son (non-spouse) is eligible for this maximum survival % because at his age, he will most likely survive the father and live several more decades).  However, if neither the Father nor the Son survive 20 years a third person (perhaps the Son’s own son/Father’s Grandson) is name the IRA ”Beneficiary” to receive any of what remains of the initial 20 years of payments should the Father and the Father’s Son both not survive to the end of that time. There is also an IRS RMD permitted feature for this case starting after the first year, a guaranteed annual 2.00% compounded cost of survival adjustment aka a cost of living adjustment (COLA).  

The annuity premium purchase cost is $100,000 and father’s initial annual income is about $3,210 (rounded), typically paid monthly, at prevailing annuity market conditions subject to change, growing at a 2.00% compounded annual rate until both Father and Son become deceased. If they both die during the initial 20 – year period then, the IRA beneficiary receives what remains of the 20 year payments all growing at the 2.00% annual rate. 

Statistically an “expected” result: After 10 years, Father dies, age 85. Survivor Son, now age 58, assumes Fathers annual payment rate now at $3,913, still growing at 2% per year for the next 10 years (because 20 years was the minimum payment time) then, upon the conclusion of this time, after reaching an annual income of $4,770 at Son’s age 68, the Son’s 63% Survivor percentage kicks in and his annual income is reduced to $3,005 but continues to grow from that new level at 2% compounded interest rate per year until he dies. For the Son, this could be another 30 years or longer to say, his age 88. Of course, the longer Son lives the more he collects and the larger his annual income becomes.

If all the above occurs, you can see the traditional power of the Stretch IRA. After 10 years when Father dies, he received about $35,000 in total annual income with the rest of the IRA value shifted by the terms of the IRA annuity contract to the ultimate benefit of his Son who collects the vast majority of the Father’s IRA value over the Son’s lifetime.

Consequently, an IRA Owner who needs all the IRA income they can muster for their own purposes is not a good candidate for a Stretch IRA. A Stretch IRA is much less about the IRA Owner’s income need and all about the IRA Owner’s Survivor/Beneficiary benefit. It’s a de-facto life insurance arrangement but done through the IRA and not via a traditional life insurance policy.   The IRA Owner pays for this Survivor benefit by taking a lower annual income.  This is why the IRS sets limits. The Owner is currently taxed less at his tax rate with his Son eventually being responsible for most of the IRA taxation over the many future income payment years, at the Son’s tax rate.

The IRS has always felt an “insurance” mechanism (but not an “investment”) via such annuities or defined benefit pension plans should be permitted keeping individuals and their families from becoming completely dispossess as a consequence avoidance device helping them maintain some standard of living that, if things should go financially or otherwise wrong over the decades of retirement , will help prevent individuals from falling back on social service safety nets and ultimately, to the great expense of the government. That’s why periodic payment annuities and defined benefit pension plans also have greater State financial and martial property protections vs contributory retirement plans or other IRA savings/investment plans (discussion outside the scope of this article).

Typical IRA Savings/Investment Account (non-insurance)

In a typical savings/investment account IRA for this same case, Father’s (age 75) initial year IRS RMD is about $4,000 (new 2022 IRS Uniform Lifetime Table – ULT) assuming the $100,000 is the 12/31 balance. The difference between this annual income and the initial IRA annuity income ($3,210) is $790. This becomes a small part of the total annuity income value ultimately shifted to son.

Savings/Investment Account Assumption (non-insurance)

First, making the great assumption the savings/investment account IRA even survives the Father and that’s a big assumption given what’s going on with the national economy and households in general. When the Father dies; the Son unless qualifying under limited and special circumstances at the time of his Father’s death and in order to “stretch” his inherited savings/investment account IRA over the longest period must “minimally” distribute at least annual, over the Son’s life expectancy (utilizing the IRS Single Life Table – SLT) over the next nine years followed by a lump sum distribution after the tenth year. But, typically with the “average” person what happen is: the Son doesn’t bother with the 10 – year rule and just takes the lump sum IRA value paying the income tax. The Father has to decide, balanced by his own need for retirement income, for this specific IRA and while he is still alive, in what manner he wants his Son to inherit.

However, that’s where the comparison stops because one is an insurance arrangement the other is an investment/savings arrangement. You need an investment arrangement to grow assets but an insurance arrangement to keep from becoming broke. And just as in any other insurance arrangement you are not meant to greatly profit by it.  Annuity/Pension income insurance exists to protect you from any financial loss that might incur early on but also later in retirement when other resources, for one reason or another, couldn’t stay the course. Some people think they can just self insure with investments alone. But this, in reality, is really just a wager, basically making a bet.  A bet that not only you will be able to realize favorable investment results (whatever that means to you) year after year but you can personally keep your life together over all the decades of retirement.   

Probably the most challenge aspects over a 25 or even a 30 year retirement won’t be the investment part but will be the “keeping your life together” part. After all, if people are really being honest with themselves, they will have to admit things may happen not in their control like; divorce, significant illness health declines, injuries, job loss, death of spouses, kid problems, business losses, litigation, frauds, etc (it’s endless) all of which will ultimately affect your “non-permanent” assets but they shouldn’t affect your permanent retirement income. 

Financial loses of assets at later ages, are basically unrecoverable because, no time remains too recover them. And that’s simply what periodic payment annuities and also defined benefit pension plans are designed to do; protect your future income sources because; unlike saving/investment accounts they are permanent arrangements for future income combined with strong payment guarantees. That’s why the IRS still likes them. Moving forward, it’s the only way. Take it or leave it.

(Note: Thanks to Jeff Affronti at FSD Financial for helping with annuity market surveys)

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