Monday, February 22, 2010

Estate Planning & Annuities: Should Parents Take Smaller Monthly Payments So Survivors Can Receive Some Sort Of Inheritance?

On February 20, 2010, the Wall Street Journal's online edition has an article entitled "A Tough Choice: Your Or Your Kids." The article discusses the dilemma some families face when buying an annuity: Should a parent take smaller monthly payments so that their surviving spouse or children can get some sort of inheritance?

Each person or family's situation is different but the article has several interesting points that can be considered.

1. Have your financial planner work with your estate planning attorney when deciding on how to structure annuities, whether to have a fixed or variable annuity, whether to pair the annuity with an insurance policy and/or whether to purchase riders to guarantee payments for your heirs.

Often times without the input of an estate planning attorney, most people opt for the smaller payment without considering other and possibly better strategies to help the heirs come out ahead, including pairing an annuity with an insurance policy.

2. Pairing an annuity with an insurance policy. The WSJ article gave the example of a certified financial planner who advised an 80-year-old client to use the $266,000 value of a variable life-insurance policy to buy an immediate annuity, providing her with $2,500 a month for the rest of her life. The mother is using $1,500 a month from that $2,500 payment to buy a guaranteed life-insurance policy worth $300,000. Now her son stands to inherit more than the annuity's cost.

The WSJ article gave another example of pairing an annuity with an insurance policy to hedge against inflation. Let's say you and your spouse have $1 million saved at age 65 from which you hope to pull 4% a year. You could spend $185,000 to buy a second-to-die permanent life-insurance policy with a $1 million guarantee that would eventually go to your children. And with about $800,000, you could get an immediate inflation-indexed annuity that would pay $40,750 the first year and continue paying through both spouses' lifetimes.

3. There are two main types of annuities, each usually starting with a lump-sum payment. With variable annuities, you invest in stocks or bonds with an insurance guarantee. There usually are surrender payments if you withdraw the money in the first few years. With immediate fixed annuities, your lump sum buys regular payments from an insurer for the rest of your life. They are being hailed by everybody from financial planners to President Barack Obama as a way for Americans to stretch their retirement nest eggs.

4. Riders to guarantee payments for your heirs or to adjust monthly payments for inflation. Annuities come with complex features and fees that are often not found in investments like mutual funds. It takes careful analysis to figure out if an annuity makes sense for you and, if so, which features to purchase.

When one spouse has health problems and the other could live a long time, variable annuities with guaranteed-minimum payments can pay off, despite annual fees that can top 3.5% of the invested amount. The WSJ gave an example of a 69-year-old retired teacher whose husband died last year from post-polio syndrome. The couple was drawing 6% a year from a variable annuity in which they had invested $300,000. The investment had lost half its value during the financial crisis, but the retired teacher inherited the original amount invested because of a guarantee they had purchased. The money should still be there for her two daughters as well.

5. Immediate fixed annuities are simpler to understand and cheaper: You get a regular payment for life. But when you die, the downside is that your family loses that payment unless you pay extra for a rider returning at least some of the money you invested. The rub is that such a rider will typically lower the monthly payment you receive by anywhere from 2% to 15% or even more.

6. The WSJ article suggested an approach for buying an annuity that involves determining one's basic expenses—utilities, food, taxes, insurance and so on. Purchase a plain-vanilla annuity to cover those costs. Then you can invest the rest of your savings to spend on vacations, cars or grandchildren. Anything left over can be your family's inheritance. As the article pointed out, however, if you are early in retirement, who knows how much the basics will cost in 20 or 30 years? And what if your savings barely cover an annuity that will pay for those basics?

7. As annuities gain in popularity, make sure you consult with an experienced estate and trust lawyer as well as with your financial planner before you purchase the annuity so it is consistent with your estate plan and wishes for providing for your heirs.

Posted by Henry J. Moravec, III. Henry (Hank) Moravec is a partner at Moravecs, A Professional Law Corporation in San Marino, California, a suburb of Los Angeles. He is a very experienced estate planning attorney. Should you have any questions regarding your own situation, you can e-mail Hank Moravec at hm@moravecslaw.com or call him at (626) 793-3210. The firm website is http://www.moravecslaw.com/