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Alan Haft
Alan Haft
 

PB&J and Retirement Income

A match made in heaven.

April 19, 2010
by Alan Haft

You may find this a bit nutty, but to begin a brief discussion about a unique income strategy, I will first remind you of what I truly believe to be one of mankind’s greatest creations: yes, what else other than the one-and-only legendary Peanut Butter and Jelly (PB&J) sandwich.

Who was the person, as bold as Albert Einstein, as clever as Leonardo Da Vinci to invent the PB&J? For the moment, I’ll put this important question aside. But one thing the legendary PB&J should forever remind us of is that quite often, “the sum is far greater than its parts.”

Alone, Peanut Butter and Jelly represent two separate jars of somewhat uninviting food products. But joined together, they represent eternal soul-mates, a true marriage made in heaven.

Similarly, there are two “investments” many people most likely have not considered to plan for or receive retirement income. But just like PB&J, together these individual parts could possibly create the greatest Income Sandwich an income-starved-belly has ever tasted.

Before I tell you about the Income Sandwich, let’s take a brief look at some of the more common places many consider to generate income from their investments:

  • CDs: Given today’s low interest rates, yes a client will protect their principal but they’ll starve while doing so. If a client puts $100,000 into a five-year CD, they’ll earn maybe around 2.5 percent or $2,500 a year (shorter term CDs generally earn significantly less). If that doesn’t seem attractive enough, it obviously gets worse. If a client is in the 28 percent tax bracket, after tax, they’ll only be able to spend somewhere around $1,800 a year. Furthermore, interest from a CD could also cause additional taxation on Social Security income as well.
  • Bonds: What about them? Sure, when investing in a quality bond a client should get their investment back at maturity but to get any reasonable rate of return, they’ll usually have to take considerable risk by investing in low quality debt. In addition, a bond might be “called,” and if one sells prior to maturity, they may get back less than the amount put in.
  • Stock Market: Then, of course, there’s the stock market for dividends, preferred stocks, real estate investment trusts and more. While these income-producing vehicles might very well be completely fine for some, unless one has the stomach for volatility and uncertainty, to get reasonable and guaranteed income, these days, one needs to think “outside the box.” Be imaginative. And that’s where my Income Sandwich comes into play.

Secret Ingredient in Income Sandwiches

The Peanut Butter side of this Income Sandwich is something called an immediate annuity. Offered by insurance companies, an immediate annuity is essentially an irrevocable-insurance vehicle that provides a client with a guaranteed “pension” for the rest of their life with access only to the income and not the lump sum contributed.

Example: “Henry” who is 73-years old. Current mortality tables state he should easily live another 10 years or so, and Henry is hungry for more income, especially the guaranteed and reliable kind. After he explored all options, he fell in love with the Income Sandwich and decided it was what a portion of his cash wanted to eat.

So he put $100,000 into an immediate annuity and in exchange for this one-time contribution, he gets a lifetime income of just under $10,000 per year. As for taxes, the income is partly tax-free due to the “exclusion ratio” (IRS Publication 939).

While a locked in, lifetime 10 percent return on his money might sound quite attractive, if Henry somehow ends up on a cloud tomorrow, the income stops and the $100,000 contribution goes bye-bye, providing a great deal for the insurance company and not so good for Henry’s wife “Francine.”

To solve that problem, let’s switch to the other side of Henry’s Income Sandwich. For the Jelly, every year he takes $4,000 from the $10,000 annuity income and contributes it into a life insurance policy with a death benefit equal to the amount he contributed into the annuity in the first place. The insurance policy returns to Francine (or his contingent beneficiaries) the amount he placed into the annuity through a tax-free death benefit, leaving Henry with actual income of roughly $6,000 per year.

Where else could Henry get a partially tax-free, lifetime six percent return for income that will never change regardless of market conditions with a guarantee that the amount originally contributed returns to his beneficiaries tax-free upon his demise?

As for inflation, remember: The Income Sandwich represents only a portion of his portfolio. Certainly there are a number of ways to hedge against this.

Along with supplementing income from his other accounts, the insurance policy can be designed myriad of different ways, one of which is to potentially build up cash value, providing a tax-free addition to the annuity income when and if needed. The insurance policy's death benefit can also be designed to return less than the amount initially contributed into the annuity, thereby leaving Henry with more spendable income. And lastly, in the extreme, there is always a possibility he might sell the insurance policy into the secondary life settlement market, providing Henry with a lump sum of cash.

I’ve seen and worked with many “Henrys,” especially during this ultra-low interest rate environment. Some have invested thousands to create their sandwich, while others have done it with much, much more. Needless to say, if one eats the sandwich, they absolutely must have ample savings outside this strategy for other important considerations not mentioned here. Keep in mind age, health, the experience of the planner designing the sandwich and other factors will ultimately determine a client’s exact bottom line and whether or not this actually makes any sense at all.

Conclusion

In general, the earlier one plans for this or the older one is and the better the health, the tastier the sandwich. As long as one can qualify for any level of insurance (some simply cannot), the outcome of a properly designed sandwich for individual retirement accounts (IRAs) or monies outside of them could work out quite well for a client and their beneficiaries.

Bonds? CDs? Stock Market?

Creamy? Crunchy? Super-Chunky?

Everyone has their own tastes but one thing is for sure: in this current interest rate environment filled with risk, uncertainty and of paramount importance, the fear many share about outliving their money, the Income Sandwich could be one well worth sinking one's teeth into.

Additional Resource: The AICPA’s PFP Section provides information, tools, advocacy and guidance to CPAs who specialize in providing tax, retirement, estate, risk management and investment advice to individuals and their closely held entities. All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter apply to become a PFS Credential holder.

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Alan Haft is an investment advisor representative with an insurance license, author of three books including the national bestseller, You Can Never Be Too Rich, and makes frequent appearances in national print, television and radio media such as The Wall Street Journal, Money Magazine, CNBC, BusinessWeek and many others. The amounts represented in this article should all be considered hypothetical and for example only.

* For full disclosure, Haft is a part of a firm that utilizes all industries which typically includes us receiving percentage based fees for brokerage servicesas well ascommissions when implementing insurance based plans. Haft does not work for any particular financial company or industry nor should this column be construed as an endorsement or condemnation for any particular product. Readers should note that all views and vendor recommendations as expressed in this article are solely the author’s and do not necessarily reflect the views of the AICPA CPA Insider™ or the AICPA.