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Annuities In Estate Planning

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Editor's Note: The following article is a preview of a presentation to be given at the 46th Annual Heckerling Institute On Estate Planning conference, which will be held January 9-13 in Orlando, Fla.

Commercial annuities have long been dismissed by some estate planners as being more beneficial to the insurance agent selling them than for the purchaser or beneficiary.

However, in these difficult economic times, when it takes sophistication to make good investment decisions and when many estate owners do not have access to that type of professional advice, an annuity can achieve certain goals, even in the largest estates. There are three common scenarios that can arise in an estate plan in which an annuity can prove useful:

1. Providing for a longtime household employee.

2. Making a gift or bequest to an individual privately, when there are concerns about his or her ability to handle funds. 

3. Managing the investment of a trust where the surviving spouse is not the parent of the remainder beneficiaries of the trust.

In these scenarios, an immediate annuity-an annuity contract where payments must begin within one year-may be appropriate. A deferred annuity, where funds accumulate until the contract is converted to an income stream, can be a useful tool in some estate planning situations, but not in situations that require payments to begin shortly after the annuity purchase.

Obviously, an annuity is not the sole solution to these situations; often, a trust could achieve the same goals with greater flexibility. However, trusts are expensive. Moreover, the selection of a trustee can be difficult and flexibility may not be a consideration. When this is the case, a commercial immediate annuity should be considered.  If annuity payments are needed for the recipient's lifetime, a life annuity is required. If the goal is merely to provide a set number of payments, a period certain annuity is called for. In either case, consideration should be given to whether the annuity payments ought to be fixed, increase each year or vary with the performance of investments. In the first two cases, a fixed immediate annuity will work. (Many, but not all, immediate annuities offer a cost of living adjustment,  in which payments increase each year by a specified percentage). In the third case, a variable immediate annuity is required in which annual payments may increase or decrease, depending upon how the variable investment accounts chosen for the annuity perform.

In any event, an immediate annuity will provide the certainty of an income for a period of years or for the lifetime of the "annuitant."

The first scenario is one that often arises in the estate plans of very wealthy individuals who employ longtime household help and want to provide for them at their deaths. Typically, the bequest is in the range of $50,000 to $250,000 and is intended to benefit employees who are accustomed to receiving a regular paycheck, with little or no experience dealing with large sums of money. Often, the estate owner is concerned about how well the recipient will manage a lump sum bequest, especially if it is intended to replace, if only in part, the salary he or she enjoyed while employed.

There is also the question of what size bequest will be "correct," since no one knows how old the employee will be at the estate owner's death or for how long the employee will need financial support. While these uncertainties would suggest a trust solution (since a trust could direct any amounts remaining at the death of the former employee to whatever remainder beneficiaries the estate owner wishes to benefit), it would be difficult to find someone willing to act as trustee for a trust of only $50,000 to $250,000. Even if a qualified trustee were found, the trustee fees would quickly deplete a trust of this size, even with modest distributions.

If, however, the estate owner were to direct that, at his or her death, an immediate annuity for life, of a specified annual amount, be purchased for the employee, the purchase price of that annuity-of either a fixed or annually increasing amount-will decrease over time as the employee grows older. (The cost of a life annuity decreases with the age of the annuitant at time of issue. While annuity rates may decrease as average life expectancies increase, the increase in age of an individual annuitant will almost certainly more than offset that trend). By contrast, a bequest to a trust to provide that employee with a specified lifetime income might well result in "overfunding" because, with each year the estate owner lives, the remaining life expectancy of the employee decreases.

With this strategy, the employee is guaranteed, at the estate owner's death, an income that he or she cannot outlive, no matter what. Moreover, neither a trust document nor trustees fees will be required.

The second scenario is also common with large estates. Here, the desire to ensure that the bequest is not squandered is paired with a desire to make the bequest private. If the annuity is purchased during the estate owner's lifetime, the transaction is not part of the written estate plan found in the will or revocable trust. But, if the annuity is owned at death by the estate owner, can be included in his or her estate and shown as an asset on the estate tax return. If the estate owner wishes to provide a legacy that will not commence until his or her death, a deferred annuity would be appropriate (as an immediate annuity must commence payments within one year of purchase). If the estate owner is willing to give the recipient access to the gift either in a lump sum or as a stream of income, the annuity payout options in a deferred annuity provide those choices. If there is concern that the recipient may squander the inheritance, a "restrictive beneficiary designation" can dictate that the accumulated value of the annuity must be taken by the beneficiary as an annuity, perhaps over his  or her lifetime.

A trust will provide the same benefits and more security, as long as the trustee is given the power to cease distributions out of concern about what the beneficiary is doing with the money.  However, the simplicity of an annuity is something that many clients respond to, even if it is not the perfect solution. Where the client has already established a trust for the benefit of a particular beneficiary, he or she may wish to purchase an annuity for that beneficiary as a supplement to the trust to ensure that he or she will always have income, even if the trustee makes no distributions from the trust.

In the third scenario, the client has established a trust for a beneficiary, but rather than purchasing an annuity outside of the trust, he or she directs that the trust itself purchase an annuity for the beneficiary. When a trust is created at the death of an individual for the benefit of his or her spouse and children, if the children are not also the surviving spouse's children, tension can develop over the trust's investments. The surviving spouse may be concerned about replacing the deceased spouse's income. Given the state of the economy and the low current interest rates, however, it may not be possible to replace the lost income from trust assets, so principal advancements will have to be made. The income-tax disadvantage applying to annuities owned by "non-natural persons" does not apply to immediate annuities and would be irrelevant, as immediate annuities do not accumulate "gain."

If the trust needs to produce as much income as possible, however, it may not benefit the children. That's because an investment strategy focused on income typically sacrifices asset growth. This may trigger a strained or even adversarial relationship between the surviving spouse and the stepchildren. The children, for example, may question the surviving spouse's standard of living and need for such income-something that was never done while the deceased spouse was alive.

It is possible to separate the two goals-growth for the children, or remainder beneficiaries, and income for the surviving spouse-with the use of an annuity. If the trustee were to sit down with the family to reach a mutual agreement that the trust principal would be divided into two parts, one part to be used to purchase an annuity to provide the spouse with the desired income, and the second part to be invested in growth investments for the benefit of the children, this may eliminate the tension between the family members. This idea may not always work, such as when the surviving spouse is very young or where his or her income needs are so great that the purchase price of an annuity sufficient to provide that income would consume too much of the trust corpus. If that is the case, an annuity could provide a portion of the spouse's needed income and the rest of the income needs could be met by other trust investments. This would relieve at least part of the pressure on trust investments to produce increased income.

In some estate planning situations, the use of an annuity is problematic, such as when the trust must qualify for the marital deduction from estate or gift taxes. One requirement of such a trust is that the spouse must receive all the income from the trust or a stated percentage of the trust fund in certain states where marital unitrusts are permitted. Paying the spouse the annuity payments will not satisfy that requirement. Moreover, in marital or non-marital trusts entitling the surviving spouse only to income, but not distributions of principal, the annuity would probably be considered an impermissible distribution of principal. If the family wants to proceed with this plan, the trust terms would have to be reformed, which is possible in most states either informally or through a court proceeding.

The regulation of annuities and those who sell them is full of uncertainties today, and is undergoing a transformation with the enactment of the Dodd-Frank financial reform act and other recent developments.

The purchaser of a fixed annuity receives at least a guaranteed minimum rate of return over the contract term. The insurance company assumes the risk of paying out this minimum return, even in a down market. As a result, fixed annuities are generally characterized as insurance products, regulated by state insurance commissioners, and exempt from the Securities Act of 1933 pursuant to Section 3(a)(8). The National Association of Insurance Commissioners (NAIC) has issued Suitability in Annuity Transactions Model Regulation 275 (SATMR), which sets forth suitability standards for annuity products. Many states have adopted SATMR. Moreover, state securities laws may apply to fixed annuities.

A variable annuity differs from a traditional fixed annuity because the risk of total loss shifts to the purchaser, who has no floor that acts as a "stop loss" on the rate of return if the underlying portfolio performs poorly. With no element of fixed return, the insurance company assumes no true investment risk. Over 50 years ago, the U.S. Supreme Court determined that variable annuities were securities and were subject to regulation under the federal securities laws. Because variable annuities are securities, those selling them are required to obtain securities licenses and adhere to FINRA requirements. In some states, a variable annuity is not considered a security.

In response to consumer demand to combine the benefits of increased stock market returns with protective floors against market downturns, the equity-indexed annuity was created. Initially, the SEC tried to treat equity-indexed annuities as securities, but after judicial repudiation the SEC withdrew its regulation. An amendment in the Dodd-Frank Act provides an expansive safe harbor that exempts from federal securities regulation not only equity-indexed annuities but also fixed annuities that meet its conditions, preserving state regulation of these products. Variable products cannot rely on this safe harbor exemption.

For now, an insurance agent seeking to comply with SATMR must gather certain information and must possess reasonable grounds to believe that an equity-indexed annuity transaction being recommended is "suitable" for the consumer. Broker-dealers may elect to subject equity-indexed annuity sales to the FINRA suitability rules. Sales made in compliance with FINRA rules are deemed to qualify as complying with the NAIC's SATMR rules. Dodd-Frank also contemplates the SEC applying a fiduciary standard to broker-dealers, as well as instituting federal oversight of life insurance, but the impact on insurance companies and those who sell their products remains uncertain.

Mary Ann Mancini, Esq., heads the worldwide private client practice of Bryan Cave LLP.

John L. Olsen, CLU, ChFC, AEP is co-author ofThe Annuity Advisor, Index Annuities:  A Suitable Approach and numerous articles on annuities.

Melvin A. Warshaw, JD, LLM, is general counsel at Financial Architects Partners and an author and speaker.


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January 6, 2012• Russ Alan Prince

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From his perch atThe Wall Street Journal , Robert Frank has become one of the nation's leading chroniclers of the 1%. He has been the newspaper's wealth reporter for eight years, writing about the lives, culture, economy, spending and investing of the wealthy. His blog, The Wealth Report, was recently named by Time magazine as one of the nation's most influential business blogs.

Following the success of his 2007 best-selling book,Richistan , Frank has published a new book on the American wealthy calledThe High-Beta Rich , which profiles millionaires and billionaires who lost their fortunes during the financial crisis. Yet the book also introduces the world to a new economic phenomenon: the increased volatility of today's large wealth.

While the top 1% used to be the most stable group on the income and wealth ladder, they are now the most unstable, prone to sudden booms and busts. Frank calls them the "high betas," the Wall Street term for stocks that have extreme highs and lows.

What caused this change in the world of wealth and how does it affect the rest of the economy?

We recently caught up with Frank to get the answer and to learn more about the high betas.

Prince:  What's the thesis of The High-Beta Rich?
Frank:High-Betatells the story of the increasingly manic nature of today's wealth. Conventional wisdom tells us that the rich just keep getting richer and we often hear in the media about how the wealthy are a protected species that is always getting bailed out. In fact, wealth today is more like a roller coaster than an escalator, and there are people constantly falling into and out of the 1%.

To tell the story, I interviewed more than 100 people with net worths or former net worths of more than $10 million. I tell several of their stories in colorful detail, rolling in stats and analysis from a new area of economic research that looks at the instabilities of modern wealth.

Prince: But hasn't that always been true? Haven't there always been people who get rich quick and lose it just as quickly?
Frank: To a degree, there has always been churn in the world of wealth. Austrian economist Joseph Schumpeter called it "creative destruction," where one sector of the economy replaces another because of business and product cycles. But the cycles of wealth are now far more rapid, extreme and frequent. The old saying used to be "shirtsleeves to shirtsleeves" in three generations. Now it can happen in three years.

Before the 1980s, the top 1% used to be the flat line on the income charts-rising and falling less than the rest of America

during economic cycles. Suddenly, in the early 1980s-1982 to be exact-the 1% started jumping off the charts, soaring far higher than the rest of the country during good times and crashing harder during recessions. They became like the binge drinkers of the economy.

Prince:  What caused this?
Frank: Economists don't know. The rise in inequality in America started the same year as high beta, so they are clearly linked. I try to find the answer by interviewing the high betas themselves. And what I found were three principal reasons. First, more fortunes are tied to the stock market. The Dow Jones rose from under 1,000 in 1981 to 11,000 and change today. That fueled the creation of the largest number of new millionaires and billionaires ever in America, with the rise of stock-based pay-and entrepreneurs who started and sold companies, either through IPOs or mergers. Those fortunes, however, are far less stable, since the stock market is up to 20 times more volatile than overall economic growth.

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January 6, 2012• Page 2 of 2

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The second reason is debt. The debt levels of the top 1% increased more than threefold since the 1980s, and many of the rich loaded that debt pile onto speculative bubbles or paper wealth. Leverage can be deadly, no matter how much you think is "manageable."

The third reason is spending. Some of the wealthy went overboard with homes, cars, yachts, planes, vacations, handbags, shoes and other luxury goods because they thought they could afford it. As it turned out, many looked rich but were actually living one crisis away from financial collapse. Some of the wealth of the past decade was a mirage.

Prince:  The best parts of this book are the personal stories. Tell us one or two.
Frank:
Well, I profile Tim and Edra Blixesth, who were on the Forbes list with an estimated net worth of $1.2 billion. They owned the Yellowstone Club, the private golf and ski resort. They had three private jets, two yachts and an estate in California with a household staff of 110 people. As they told me in 2007, "We'll never really have to worry about money again."

Flash forward to 2010. They divorced and Edra had to file for Chapter 7 bankruptcy liquidation. When I went to visit her at the house, all her staff was gone and the phones were cut off because she couldn't pay the bill. In the book, Edra talks about what it's like to lose everything, and suddenly cook, clean and drive herself and fly on a commercial plane. She has some amazing stories. But in the end, she feels that the wealth loss wasn't all negative-that in some ways, she found herself by losing her fortune.

I also profile a couple in Florida who was building the largest home in America-until they had a cash crunch. The house is now for sale for $75 million. But in the book, I explore their lives and detail the numbers that led them to their current troubles.

Prince:  Are you suggesting we should feel sorry for the high betas?
Frank: Not at all. My approach to covering wealth is never to judge or take a political view but to tell the true, up-close stories of today's rich. Readers can make up their own minds. We shouldn't shed a tear for people whose idea of a life trauma is giving up the Gulfstream and being forced to fly commercial. But high-beta wealth matters because more of our economy depends on this group. The 1% pays 40% of the country's income taxes and they're the biggest spenders. When they take a hit, taxes drop, spending drops and they employ fewer people. My fear is that our growing dependence on the rich will also make the rest of the economy more high beta.

Prince:  What do you think of the so-called "class wars" in America today?
Frank: Politics has turned the wealthy into silly stereotypes-either fat cat bankers who benefit at the expense of the rest of the country or job-creating heroes who will stop hiring or leave the country if they have to pay another dollar in taxes. Neither is accurate. The wealthy are a more diverse group than ever, and on the subject of taxes, they're as divided as the rest of the country. By sticking to this rich-get-richer narrative, the country may be missing the real danger, which is that we're more dependent than ever before on a group that is highly unstable.

Prince: So what's the solution?
Frank:
That was the hardest question to answer in the book. To solve the problem of high-beta wealth you have to roll back all the forces that have created inequality. You'd have to roll back all the recent advances in technology, you'd have to roll back globalization and you'd have to somehow wipe out most of the financial markets around the world. Not going to happen. So the practical solution is to better prepare for these wealth and income shocks. Governments need to create bigger, more robust rainy day funds that they can fill during good times and drain down during crises. As consumers and workers, we need to save more, spend less and borrow less to survive these cycles. And for those who aspire to be wealthly, they need to take money off the table as they're on the way up and use debt sparingly. You can't get around risk if you want to get rich today. But you can manage those risks and price it more intelligently.

Prince:  Do you aspire to become wealthy yourself?
Frank:
If there's one thing I've learned in my many years of interviewing rich people it's that wealth isn't all it's cracked up to be. It brings terrific freedoms and choices in life. The private jet is the one thing that the rich say they miss when they lose their wealth, and I can see the attraction because you're really buying time and freedom.
But wealth also brings its own problems and anxieties. And in a high-beta world, wealth no longer ensures stability and security in your life. What really matters in this world is doing something you love, having strong connections to family and friends, and making a contribution to your community or the world at large. I feel lucky to have all of those things. My family and two wonderful daughters make me feel like the richest guy in the world. Having said that, I still wouldn't mind having a G550.

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March 6, 2012• Russ Alan Prince

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Advising the very wealthy can prove quite rewarding personally and professionally. Being business partners with the very wealthy can translate into a substantial personal fortune-and it can be a lot of fun. Few professionals have the skills, disposition and mindset to work for and with the ultra-affluent. Pat Trammell, the founder of Omega Capital Enterprises in Birmingham, Ala., is one of those advisors.

Prince: What type of firm is Omega Capital Enterprises?
Trammell: Omega Capital Enterprises is our holding company. Presently, the firm encompasses two basic categories of businesses. The first is Omega Capital Advisors, a high-end wealth transfer and life insurance brokerage. The other is Omega Capital Equity Partners. This entity is more geared to our private equity-type initiatives.

We're not trying to be anyone we're not. The common theme of the companies is trying to identify and develop compelling ideas, provide innovative solutions and to have a focused plan of execution. What ties everything we do together is our relationships with the very wealthy that we've developed. Sometimes that might be in the form of capital, and in others it might be access. Quite often it's in the form of expertise. But at the end of the day, all roads lead to providing specialized services or ideas and connecting them to the very wealthy.
Omega Capital Advisors, for example, is a firm that provides proprietary and very specialized life insurance to the exceptionally wealthy. Insurance is often the solution to numerous issues or problems very successful people in the world face. In addition, because of our connection to these highly successful and motivated people, the firm provides its expertise to the institutional and employee benefit markets as well.

One of our primary strategies is cultivating and developing our relationships with the very wealthy through our event company. The Charitable Resource Group not only gives us the opportunity to put on events for our clients and important relationships, it's also the way we give back by putting on and assisting charities in their fund-raising efforts. We put on 23 events in some form or fashion in 2011. We recently hosted an event on Bourbon Street for the BCS Championship Game. Over 50 people with net worths in excess of $50 million attended the event, as did people from the world of sports and entertainment. These events are all about connectivity, access and, most of the time, just enjoying ourselves. Many of our ideas and best relationships have originated from these events.

Omega Capital Equity Partners is the entity where we are bringing together our ultra-affluent relationships to invest in very selected private equity-type opportunities. This is not a fund. To some degree these are club-type deals. They're our exclusive deals where we have invested our money and we're trying to build a business ourselves. Our first deals have been seeded with funds from some of our wealthy relationships.

In addition, we employ some innovative financing programs sponsored by the federal government that encourages foreign investment from other countries like China, Korea and certain South American countries. Because of the makeup of our deals, most have qualified for some form of tax incentive programs that are also sponsored by the federal government. As a result, we're seeing ourselves partnering with institutional investors as well as the very wealthy.

We firmly believe this part of our business is where Omega Capital Enterprises' real fortunes will be created and grown.

Prince: How did you end up building Omega Capital Enterprises?
Trammell: I wish I could tell you that I did some intense analytic assessment or it was part of some master plan. The reality is a lot simpler. I just listened to what many of my clients were telling me about their businesses and their interests. Over the years, I discovered I have an ability to see an idea, and then figure out how to bring together the right team of people to leverage the opportunity.

Prince: Could you walk through this concept in a little more detail?
Trammell: I started in the life insurance business almost 25 years ago. With Omega Capital Advisors, we're still very much in this business. In fact, in the last 60 days of 2011, we placed over $75 million of death benefits for three of our clients.

My goal in this business was to partner with the right people and build one of the best life insurance firms in the country. But that was the only focus of the firm. About 15 years ago, I heard Dan Sullivan talk about a concept called "unique abilities." He said that very few people are million-dollar marketers and also million-dollar technicians. And the key to creating a high level of success is to bring the two different parties together to leverage their respective talents.

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March 6, 2012• Page 2 of 4

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That's what we did. My strength or unique ability was definitely not in devising sophisticated tax-mitigation strategies. The place I had an unfair advantage was and is in connecting and building rapport with some of the wealthiest people and families in the country.

Even today, as our firm evolves, develops and expands, I do the exact same thing. Across the board in every one of our business ventures, we build the finest technical team possible and partner with them to bring innovative ideas and solutions to our clients and business partners. Our goal is to have everyone involved with us focusing only on their unique ability or in an area where they have an unfair advantage.

Over the years I had the good fortune to develop this group of ultra-affluent clients and relationships. All we did was decide to look for a few other arrows in the quiver to bring to them for consideration. Our new endeavors, the deals we're currently working on, follow the exact same model as we've implemented for the past 25 years. My role is nothing more than to provide the vision and then identify and connect the right relationships-whether that's the technical expertise needed or the people who can provide whatever particular financial backing that's required. I rarely bring any technical value to the deal.

Prince: Can you give us an example of one of your larger, more involved deals?
Trammell: We developed a very compelling story in our life insurance business. We will only approach our very wealthy relationships in a way that resonates with them. We'll only go to them with a very viable and meaningful proposition. As we look to add opportunities to our business it's very important to me to find the right ideas-ideas that are not only unique, but also very compelling.

Finding the first idea and opportunity took almost three years. For the last 18 months, we've developed a business model where we're partnering with megachurches to build senior living facilities on their campuses. I connected with this opportunity immediately. For one, I got the affinity aspect of the model. My dad died when I was 6 years old. My mother was a schoolteacher and it didn't matter what the cost-she was going to send me to the high school associated with our church. Second, I had seen the model about two years beforehand on a trip with our pastor to a 40,000-person church in Palm Beach, Fla.

We've invested a great deal of time and money to develop the business model. We've assembled a team on the operational side of the business that's unparalleled in the market. This culminated with our partnership with CRSA/LCS as our developer and operator-our technical partner.

Again, my role was to see the vision-possibly expand on it a little. Identify the expertise and people needed to execute the model. Then connect them together with the resources needed to fund the projects and model.

When we started the process, we anticipated approaching some of our high-net-worth relationships on the funding side. Based on a high level of trust, we have a few of them involved. As I mentioned, we employ some innovative capital sources. We've brought together various federal programs in a unique way. In fact, Greenberg Traurig, our legal advisor, recently applied for a patent on the concept.

We'll break ground on our first three senior living projects the second quarter of 2012. In addition, we have 50 to 60 churches somewhere in the pipeline. We believe the worldwide market for these senior living projects is over 10,000 churches.

Prince: Since all your deals are not this extensive, can you talk about a less elaborate project?
Trammell: Completely by accident, we've gotten into the film and entertainment business. We recently started Omega Capital Entertainment under Omega Capital Equity Partners. About two years ago, because of our relationship with a very famous celebrity coupled with the fact we could raise capital, we were approached about getting involved in a movie. That particular project did not work out, but we began looking into the industry and other potential projects.

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Category: Annuity

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