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Investment Opportunity With Income Certainty

This tool allows fee-only RIAs to provide the income-guarantee benefits of variable annuities without the downside of surrender charges, high fees, and ordinary income tax treatment of investment gains.

Helen Modly, CFP, ChFC, 03/20/2014

Consider this common dilemma: a client who bailed out of the markets at the bottom of the last recession and has been in cash ever since. The client knows that cash returns will not support a sustainable withdrawal strategy and fears outliving his or her money.

RIAs don't typically promote variable annuities as a solution due to high expenses, long surrender periods, and the loss of control over investable assets--although there are some very reasonable no-commission/no-surrender-charge products available to us now. The greatest downside to deferred annuities in my mind is the loss of long-term capital gains tax treatment on the appreciation of investment assets and the loss of basis step-up at death. Both issues are avoided with this strategy.

Enter a new idea, the Stand Alone Living Benefit (SALB), which adds an income guarantee to a portfolio account (qualified or non-qualified) that we continue to manage for our client at our regular custodian. Essentially, the client purchases a Contingent Deferred Annuity (CDA) wrapper issued by an insurance company for an existing investment account.

Although CDAs are not a panacea, are not appropriate for everyone, and certainly not free, they are an innovative tool that could be just right for some clients.

The Investment Account
The investment account is just like any other investment account you manage, although there are constraints on the funds you can use and the asset allocation you select. The strategy I reviewed is offered by Aria Retirement Solutions, works with the most popular custodians, and has a strong lineup of eligible funds and ETFs to build your portfolios. They even have a broad offering of Dimensional Funds making this even more attractive for many RIAs. The most aggressive allocation that they permit is 80% equities/20% fixed income.

The investment account is not transferred to an insurance company or registered as an annuity, so it continues to have the same tax characteristics as it did before the CDA was purchased. If it is an individual account, then interest, dividends, and capital gains will be treated the same as any other taxable account for tax purposes. If it is an IRA, then investment income will continue to be deferred until distribution.

The ownership of the account does not change, your role as the investment advisor does not change. The only operational change is that the custodian must provide a daily electronic account feed to the insurer who provides the CDA wrapper (in the strategy I reviewed, Transamerica).

A CDA Certificate
What the client actually purchases is a CDA Certificate that guarantees income for life in the form of guaranteed withdrawals from the associated investment account. The amount of the guaranteed income is based upon the age of the annuitant when the payments begin, the calculated value the payments are based on, and the current yield on the 10-year Treasury bond. The certificate reads much like any traditional annuity guaranteed income rider, except that the underlying asset pool (Covered Assets) is not part of the actual CDA contract.

Helen Modly, CFP, ChFC, is executive vice president and director of investment services for Focus Wealth Management, a fee-only registered investment advisor in Middleburg, Va. Modly has more than 20 years of experience providing wealth-management services. She is a member of NAPFA and FPA. She can be reached at info@focus-wealth.com. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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