Structured Settlements 4Real® Blog: Structured Settlements | Settlement Planning News and Commentary

Amortizing TIPS Would Compete With Structured Annuities

by John Darer CLU ChFC CSSC RSP 

A senior investment strategist at BNY Mellon Asset Management  proposing the creation of a new investment vehicle to address what he perceives to be the shortcomings of life annuities. His letter to Secretary of Treasury, Tim Geithner,  " A Good TIp For Better TIPS" was published in Barrons on November 27, 2010.

The idea? 30-year Amortizing Treasury Inflation-Protected Securities, or "A-TIPS".

1. Similar to existing TIPS in that they are issued by the Treasury
2. Provide an inflation-adjusted rate of return. But rather than just paying interest until maturity, the A-TIPS would make regular payments of both income and a portion of the principal, adjusted for inflation. On a 30-year A-TIP, Ralph Goldsticker suggests that payments might be twice the size of those of a regular TIP.
3. The A-TIPS, if structured properly, like annuities, would let retirees know exactly how much they will have each year, in inflation-adjusted terms, over the 30-year life of the security.
4. After 30 years, the investment wouldn't provide more income because its value would be fully exhausted. Goldsticker suggests that retirees (and by implication accident victims) could purchase longevity insurance, a deferred payout annuity that starts paying in at the end of the bond term, to mitigate the risk of outliving  savings.
5. Unlike annuities, payments would be guaranteed by the government
6. True inflation adjustments, unlike the "UNCOLA" currently offered by many insurers
7. Secondary market spread would be less severe than annuities and the market would be highly liquid.

TIPS are already being used in recovery managenent solutions for plaintiffs. It's not hard to see how the proposed new vehicle could have application and, in my opinion could be a game changer for the primary and secondary structured annuity market.

I strongly suggest that all stakeholders in the structured settlement industry read the Barron's article and gain an understanding of the implications.

 

CPAs Recommending Clients Buy Structured Settlement Payment Rights

by John Darer® CLU ChFC CSSC RSP CLTC

I was at a social gathering recently when one of the guests approached me and related that his CPA is suggesting that he purchase structured settlements for his retirement plan.

I've reported here that the purchase of structured settlement payment rights is no longer simply the province of hedge funds and big European banks. According to our sources and research, personal injury lawyers have bought them, grandma and grandpa have bought them and some sophisticated financial strategies involving Roth IRA conversions are afoot.

Some in the structured settlement industry are fearful that the widespread knowledge of these strategies could affect Congress's\  view of the tax exclusion for injury victims that is essential to making structured settlements work. Yet these strategies are already out there, entering the mainstream by being offered in many cases by credentialed financial advisors to clients seeking stable income alternatives to low interest rates on CD and Treasuries. One of our sources tells us they are enjoying record activity at this time. The structured settlement watchdog believes that in a fair system, to the extent possible, these cash flows should be channeled to other injury victims.

 

They're Exploiting Roth IRA Conversions With Factored Structured Settlements

by John Darer

A sophisticated financial cocktail is now being served by financial advisors that purports to dramatically save taxes for Americans with substantial wealth in their IRA who are facing the higher tax rates in the future we know are coming. The technique takes advantage of a loophole created by the Tax Increase Prevention and Reconciliation Act of 2005 ("TIPRA 2005") in which the the Modified Adjusted Gross Income ("MAGI") limits and filing status restrictions were abolished for Roth IRA conversions starting this year 2010. The cocktail blends this with an exploitation of fair market valuations in the context of assets with less liquidity, like, Limited Liability Companies AND, purportedly , cash flows acquired by structured settlement factoring transactions and could serve to  ramp up individual investor interest in structured settlement factoring transactions and the acquisition of such cash flows in the secondary market.

Let's "belly up to the bar" and learn a little more about this potentially potent cocktail...

What is a Roth IRA?

A Roth IRA is a special type of retirement plan introduced by the Tax Payer Relief Act of 1997  (P.L. 105-34) whose "qualified distributions" are generally not taxed, provided certain conditions are met (most notable is a 5 year in Roth hold time). The Roth IRA's primary difference from most other tax advantaged retirement plans is that, rather than granting a tax break up-front when money is placed into the plan, the tax break is granted on the money withdrawn from the plan during retirement.

Roth conversions

If someone wants to convert from a Traditional IRA to a Roth IRA they must pay taxes on the fair market value in the year of conversion. The question is how do you value your IRA assets at the time of the conversion?  The income tax bill for a Roth conversion is based on the "fair market value" of the property that is moving from the traditional IRA to the Roth. The IRS definition of fair market value is "the price at which the asset would chnage hands between a willing buyer and willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts".  (see Treasury Regulation § 25.2512-1-6   Valuation of property; in general.)

 Prior to August 2005, regular commercial annuity contracts were valued based on either their cash surrender value or current market value (if the sales charge surrender schedule had expired) This method of valuation gave annuity insurers an opportunity to artificially lower the value of their annuity contracts by assessing enormous surrender penalties to exploit the greatly reduced surrender value which would be taxed instead of the current value of the contract. The IRS eventually closed the loophole. Annuity contracts inside traditional IRAs are still valued according to their  ash surrender value, but there are now limitations on how much less that amount can be than its fair market value.

The IRS issued final regulations on the valuation of annuity contracts in Roth conversions in July 2008. These regulations outline three methods that can be used to value annuity contracts for conversion purposes. They are listed as follows:

1. Cost of Comparable Contract – This type of valuation can be used for contracts where the owner purchased the contract at an earlier date and will receive a payout on the contract at some point in the future. Then the contract is valued at the fair market value of a comparable current contract with the same future payout schedule, assuming that the annuity carrier offers a contract that matches those parameters.
   
   If the conversion is made within a short period of time of the initial purchase, then the actual value of the current contract is used instead.
   
   
2. Estimate of Reserves – If no comparable contract is available for the conversion in question. an interpolation is made of the contract’s terminal reserves, and the fair market value of the contract is then based upon this amount.
   
   
3. Accumulation Method – Is used only for annuity contracts that have not annuitized. This method simply takes into the account the accumulated value of the contract, including any one-time sales charges or fees that were assessed over the prior year. Future distributions of any kind are disregarded under this method.

The "In Force Structured Settlement / Structured Settlement Factoring Gambit"

Some financial advisors are promoting a purported tremendous wealth preservation opportunity using a  cocktail of in force structured settlements and Roth conversions and suggest that tremendous tax savings are to be had by employing the following steps:

1. Use the money in the traditional IRA to buy cash flows in the structured settlement secondary market. These are all acquired via a series of transactions that require Court approval.

2. The IRA holder then must have the acquired assets valued for purposes of the transfer to a Roth IRA. The standard is a  fair market value , not a present value calculation, such as would be required in the event of premature death of payee for estate tax purposes.

3. Pay the taxes on the "fair market value", a substantial reduction from the cost of purchasing the assets.

4. Hold on for 5 years

How do we calculate the fair market value of a series of factored structured settlement cash flows?  Are they valued like annuities or not? Some say in such cases that the IRA holder must get an appraisal which involves a survey of the open factoring market for structured settlement payment rights and getting a series of quotes. We all know from years of experience that the fair market will represent a substantial discount off the cost of the benefits. Think about the discount to cost that occurs when a "wet ink" factoring deal gets concluded. ostensibly we could be talking 30% less!

And to boot you can spread the tax over 2 years!   IRC 408A(D)(3)(A)(iii) states:    

"unless the taxpayer elects not to have this clause apply, any amount required to be included in gross income for any taxable year beginning in 2010 by reason of this paragraph (rollovers from eligible retirement plan other than Roth IRA) shall be so included ratably over the 2-taxable-year period beginning with the first taxable year beginning in 2011".

Questions

So in theory, can you spend $1,000,000 on structured settlement payments with your bloated IRA and magically turn it into a $700,000 value for tax purposes, toss it in a Roth and still keep the cash flows which are worth more than the FMV in terms of present value, wait 5 years and then "kick more ass" in retirement? Or is this another loop hole that will be closed?

Further comments

Please note that if you avail yourself of any tax provisions that use Adjusted Gross Income ("AGI") as a baseline, income recognition as the result of the  Roth IRA conversion process could affect any tax provisions that use AGI  --e.g. including medical expenses (7.5% of  AGI floor), miscellaneous deductions (2%  of AGI floor), tax ability of Social Security (based on AGI), passive loss limitations (which based on AGI), and many others.

More on Roth IRAs  

See IRC 408A

Footnote to the structured settlement industry primary market

We're not in Kansas anymore folks!

 

Annuitize Part of Annuity, Continue to Defer Part of Annuity HR 5297 Passed by Senate

by John Darer CLU ChFC CSSC RSP

If  you hold an annuity outside of a retirement plan it may get easier to annuitize only a portion of your annuity contract while allowing the remaining amount to grow tax-deferred

The small-business lending bill HR 5297 which just passed in the United States Senate.,included a provision enabling just this very thing.

The Retirement Income Journal reports that HR 5297, which passed the Senate by a vote of 61-38, resembles an earlier version passed by the House of Representatives, and reflects an idea that has been around for a while. "This is something that has been proposed before," said Whit Cornman, an ACLI spokesman, citing work by Sens. John Kerry, D-MA, Max Baucus, D-MT, and Rep. Earl Pomeroy, D-ND.   

Please note that differences between the House and Senate versions of the bill still need to  be resolved and there is little time to complete this before the upcoming November elections. According to Congress’ Joint Committee on Taxation, the annuities provision would generate revenue of $956 million over ten years, from 2011 to 2020.

The ability to do a partial annuitization represents a  welcome income planning option 

Have questions about stable income planning? Want to see an immediate or deferred income annuity quote, please contact John Darer at 888-325-8640 or via email to [email protected]

Immediate Annuities: "The Ultimate in Predictable Income", Says Investment News

by John Darer CLU ChFC MSSC RSP CLTC

A diverse collection of safe income producing strategies, including immediate annuities, is important for a comfortable retirement according to Five Ways To Boost Retirement Income, an article by Jeff Benjamin in Investment News (a publication which claims to be "the leading news source for financial advisers"), published September 19, 2010.

"...the best way to ensure enough flexibility to move in and out of riskier assets and strategies is to establish a steady and predictable income stream that will enable clients to ride out a stretch of lean years". Investment News September 19, 2010

The 5 strategies addressed in the article are:

• Immediate annuities, which Investment News dubs "the ultimate in predictable income"
• Individual bonds. The article states "Bonds are obviously a critical part of an income portfolio, but in a rising-interest-rate environment — which is likely over the next several years — individual bonds have a distinct advantage over pooled-mutual- fund strategies. As opposed to bond funds, which are never as nimble as a separately managed and customized bond portfolio, the idea here is to shift the emphasis from risk tolerance to income objectives".
• Reverse Mortgages  The article states  "While reverse mortgages are still a long way from being the first choice for most retirement income strategies, they do represent an opportunity that is worth considering. One reason reverse mortgages will continue to gain popularity among retired people is that unlike home equity loans or second mortgages, the loans are not structured based on income or an ability to make payments"
• • Investment News issues this caveat "On the surface, the idea of enabling older homeowners to convert part of their real estate equity into tax-free income while staying in the home seems like a no-brainer. The trouble is, since reverse mortgages started gaining popularity in the late 1990s, many senior citizens have been victimized by shoddy sales practices. A cited quote says "It's still The Wild west out there".  But "as the 70 million members of the baby boom generation hit the qualifying age for a reverse mortgage (62), there is good reason to believe the forces of supply and demand will lead to significant improvements in the way these loans are sold, structured and maintained".
• Convertible Bonds  Investment-grade convertible bonds can introduce some capital appreciation to a portfolio heavy on income-producing intermediate-term bonds.
• Master Limited Partnerships- article discusses how  teh packaging of master limited partnerships into mutual funds, exchange-traded notes and exchange-traded funds is introducing a viable way to hold these higher-yielding investments in qualified retirement accounts with a less complicated tax structure.

Although the article does not specifically discuss structured settlement annuities, plaintiffs often face the same issues as retirees as their disabilities, or the loss of a primary bread winner may, in effect, make them "retirees" Furthermore, a structured settlement is a "souped up" form of immediate annuity that can also be a deferred annuity and can have more than one payment stream to address multiple needs as to timing and amount.

Investment News' immediate annuity strategy is the "longevity insurance approach",   to write life only annuities that cease payment upon death to maximize yield. They refer to this as " the no-load version, skip the death benefit, just lock in the income"

This is all well and good if you have life insurance to offset loss of principal if you care about the possibility that you could die before the cost of the annuity has been paid out. For healthy and insurable retirees it may be is a superior strategy because this risk can be mitigated with life insurance. It IS possible to find 20 year level premium term insurance through issues ages as old as 70. For more information call me at 888-325-8640 or email me at [email protected]

I do have a technical criticism of the article where it gives the following example of an immediate annuity:

"A current-market-rate example for a 70-year-old married couple is a 6.7% annual yield for life, which includes all fees.

Depending on the size of the initial premium, the annual income from a 6.7% yield might seem low, representing a non-inflation-adjusted annual income stream of $6,700 on a $100,000 one-time premium".

Investment News uses the yield on the principal investment without disclosing that a portion what it states as the "yield", includes a return of principal component. If you invest $100,000 in a 10 year Treasury bond that yields 2.7% annually, and hold it to maturity, you get the 2.7%  and you still have the $100,000 at maturity, whether you live or not.