journal of personal finance volume 14, issue 1 2015

Transcription

Volume 14 Issue 1 2015
www.journalofpersonalfinance.com
Journal of
Personal Finance
Techniques, Strategies and Research for Consumers, Educators and Professional Financial Consultants
IARFC
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Volume 14, Issue 1
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Journal of Personal Finance
Volume 14, Issue 1
2015
The Official Journal of the International Association of
Registered Financial Consultants
©2015, IARFC. All rights of reproduction in any form reserved.
4
CONTENTS
Editor’s Notes.........................................................................................................................................................................................8
Which Assets to Leave to Heirs and Related Issues................................................................................................................9
Tom L. Potts, Ph.D., CFP®, Professor of Financial Planning, Baylor University
William Reichenstein, Ph.D., CFA, Powers Professor of Investment Management, Baylor University
Many retirees have funds in several savings vehicles including taxable accounts, tax-deferred accounts (TDAs) like a traditional IRA,
and tax-exempt accounts (TEAs) like a Roth IRA. In this study, we address several questions. For simplicity, we assume the retiree is
a widow, but the same considerations apply to a widower and a retired couple. Assume the widow has funds in a tax-deferred account
and a tax-exempt account. The first question is: Should she spend the money in the TDA and leave the TEA to her beneficiary child,
or vice versa? The second question is: If this widow has multiple children who will inherit the remaining funds and these children
have different tax rates, how can she tax-efficiently split the TDAs and TEAs to maximize the after-tax value of these accounts for her
children? Third: When should the widow convert funds from the TDA to a TEA? Finally, whether the beneficiary(ies) inherit TDAs
or TEAs or some combination of each, the widow should make sure she has taken the steps to ensure that they will be able to stretch
distributions from the inherited IRAs over their remaining lifetime(s). Based on the work of Slott (2012), we explain what steps the
widow should take now to make sure the IRAs can be stretched. In the next section, we explain how funds in TDAs are best viewed as
partnerships with the government. This framework will prove useful when answering these questions.
Mitigating the Impact of Personal Income Taxes on Retirement Savings Distributions......................................17
James S. Welch, Jr., Senior Application Developer for Dynaxys, LLC.
When retirement savings include a large tax-deferred account distribution, strategies for sequencing withdrawals from these
accounts differ in the amount of money available for annual spending during retirement. The common practice for the scheduling of
withdrawals from retirement savings accounts is to first deplete the after-tax account, then the tax-deferred and finally the Roth IRA.
This paper quantitatively evaluates optimal plans that maximize spending by sequencing annual withdrawals to minimize the impact
of taxes, in order to achieve a targeted final total asset value. I show that the optimal retirement savings withdrawal strategy improves
on common practice by increasing the money available for retirement spending by 3% to 30%. Most of the optimal withdrawal
plans evaluated in this paper make withdrawals from the tax-deferred account across the entire span of retirement in parallel with
withdrawals from first the after-tax account and then the Roth IRA later in retirement.
Volume 14, Issue 1
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Exploring the Antecedents of Financial Behavior for Asians and Non-Hispanic Whites: The Role of
Financial Capability and Locus of Control .............................................................................................................................28
John E. Grable, Ph.D., CFP®, Athletic Association Endowed Professor of Family and Consumer Sciences, University of Georgia
So-Hyun Joo, Ph.D., Professor, Division of Consumer Studies, Ewha Womans University, South Korea
Jooyung Park, Ph.D., Professor in Consumers’ Life Information, College of Human Ecology, Chungnam National University,
South Korea
Using data collected over a three-year time span (2008 through 2011), this paper examines the association between racial background
and financial behavior. This study specifically evaluated differences between Asians and non-Hispanic Whites living in the United
States (N = 341). Findings from this research suggest that any racial differences in financial behavior appear to exist only in a two
variable correlational sense. Both financial capability and locus of control act as mediators between race and financial behavior. In
general, those with high financial capability tend to exhibit better financial behavior. Additionally, individuals who exhibit an internal
locus of control perspective also report better financial behavior. Age was also found to be positively associated with better financial
behavior. When these factors were controlled for in a multivariate analysis, no meaningful racial differences were noted in this study.
The Greatest Wealth is Health: Relationships between Health and Financial Behaviors ...................................38
Barbara O’Neill, Ph.D., CFP®, CRPC, AFC, CHC, CFEd, CFCS, Extension Specialist in Financial Resource Management,
Distinguished Professor, Rutgers Cooperative Extension
Financial advisors are encouraged to consider their clients’ health and personal finances holistically. Strengths and challenges in
one area of a client’s life often affect the other. Like culture, health status is another “lens” with which to assess clients’ values,
goals, plans, personality traits, and lifestyle. This article was written to increase advisors’ understanding of relationships between
health and financial practices. When advisors understand a client’s personality traits and projected state of future health, they can
provide more comprehensive, targeted advice instead of giving the same advice to clients in different situations. The article begins
with a review of recent literature and describes two personality factors found to be associated with positive health and financial
behaviors: conscientiousness and time preference. Next, it previews a new online tool to self-assess the frequency of performance of
recommended health and financial practices. It concludes with a summary and implications for financial planning practice.
Life and Death Tax Planning for Deferred Annuities ...............................................................................................48
Michael E. Kitces, MSFS, MTAX, CFP®, CLU, ChFC, RHU, REBC, CASL, Pinnacle Advisory Group, Columbia, MD
The concept of the annuity – a stream of income that will be paid for life – has been around for almost two millennia, and in the
US for nearly 200 years now. Annuities became far more popular in the past century or so, though, due to both rising longevity that
creates longer retirement periods which need to be funded, and significant tax preferences established in the Internal Revenue Code to
incentivize the use of annuities as a vehicle for retirement accumulation (and subsequent decumulation). This article explores the tax
implications of deferred annuities in detail.
6
CALL FOR PAPERS
JOURNAL OF PERSONAL FINANCE
(www.JournalofPersonalFinance.com)
OVERVIEW
The Journal of Personal Finance is seeking high quality submissions that add to the
growing literature in personal finance. The editors are looking for original research
that uncovers new insights—research that will have an impact on advice provided
to individuals. The Journal of Personal Finance is committed to providing high
quality article reviews in a single-reviewer format within 60 days of submission.
Potential topics include:
• Household portfolio choice
• Retirement planning and income distribution
• Individual financial decision-making
• Household risk management
• Life cycle consumption and asset allocation
• Investment research relevant to individual portfolios
• Household credit use
• Professional financial advice and its regulation
• Behavioral factors related to financial decisions
• Financial education and literacy
Please check the “Submission Guidelines” on the Journal’s website (www.
JournalofPersonalFinance.com) for more details about submitting manuscripts for
consideration.
CONTACT
Wade Pfau and Joseph Tomlinson, Co-Editors
Email: jpfeditor@gmail.com
www.JournalofPersonalFinance.com
Volume 14, Issue 1
7
JOURNAL OF PERSONAL FINANCE
VOLUME 14, ISSUE 1
2015
Co-Editors
Wade Pfau, The American College
Joseph Tomlinson, Tomlinson Financial Planning, LLC
Editorial Board
Benjamin F. Cummings, Ph.D., Saint Joseph’s University
Dale L. Domian, Ph.D., CFA, CFP™, York University
Michael S. Finke, Ph.D., CFP™, RFC® Texas Tech
Joseph W. Goetz, Ph.D., University of Georgia
Michael A. Guillemette, Ph.D., University of Missouri
Clinton Gudmunson, Ph.D., Iowa State University
Sherman Hanna, Ph.D., The Ohio State University
George W. Haynes, Ph.D., Montana State University
Douglas A. Hershey, Ph.D., Oklahoma State University
Karen Eilers Lahey, Ph.D., The University of Akron
Douglas Lamdin, Ph.D., University of Maryland Baltimore County
Jean M. Lown, Ph.D., Utah State University
Angela C. Lyons, Ph.D., University of Illinois
Carolyn McClanahan, MD, CFP™, Life Planning Partners
Yoko Mimura, Ph.D., California State University, Northridge
Robert W. Moreschi, Ph.D., RFC®, Virginia Military Institute
Ed Morrow, CLU, ChFC, RFC®, IARFC
David Nanigian, Ph.D., The American College
Barbara M. O’Neill, Ph.D., CFP™, CRPC, CHC, CFCS, AFCPE, Rutgers
Rosilyn Overton, Ph.D., CFP™, RFC®, New Jersey City University
Alan Sumutka, CPA, Rider University
Jing Jian Xioa, Ph.D., University of Rhode Island
Rui Yao, Ph.D., CFP™, University of Missouri
Tansel Yilmazer, Ph.D., CFP™, The Ohio State University
Yoonkyung Yuh, Ewha Womans University Seoul, Korea
Mailing Address:
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Disclaimer: The Journal of Personal Finance
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authoritative information. The editorial staff of the
Journal is not engaged in providing investment,
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8
EDITORS’ NOTES
T
his issue begins with an article by Tom Potts and
William Reichenstein on which assets to leave to heirs
as a function of the tax status of the assets—taxable,
tax-deferred, or tax free (Roth IRAs for example). This article
extends earlier work by Reichenstein on which types of
investments to hold in accounts with differing tax treatment. The
authors describe tax-deferred accounts as akin to a partnership
with the government, with the taxing authority owning a share of
the account equal to the marginal tax rate. This concept can be
extremely useful in promoting correct thinking about strategies
for tax-deferred accounts and avoiding erroneous thinking, which
is all too common.
The second article by James Welch also deals with tax
management, and how to optimize the sequence of withdrawals
from taxable, tax-deferred, and tax-free accounts. The common
practice is to first withdraw funds from taxable accounts
before tapping tax-deferred or tax free accounts. But the author
demonstrates that this practice may fall short of optimal, and
optimization techniques can be utilized that increase the money
available for retirement spending by 3% to 30%.
We next turn to a behavioral theme where co-authors John
Grable, So-Hyun Joo, and Jooyoug Park compare the financial
behavior for Asians and Non-Hispanic Whites. They utilize data
collected over the three-year time span 2008 through 2011 in
making the comparison. They find that financial capability and
locus of control (the degree to which a person feels that they
personally control what happens in their life) exert the strongest
influence on financial behavior, and when these variables are
controlled for, there are no significant racial differences in
behavior.
The next article by Barbara O’Neill encourages advisors to
take a more holistic approach to planning by developing an
understanding of how health status may relate to financial
behavior. The study reviews recent literature and describes how
two personality factors, conscientiousness and time preference,
have been found to be associated with both positive health and
positive financial behavior. The article also previews a new online
tool to assess health and financial practices.
In the final article, Michael Kites delves into the details of
annuity taxation—a subject area where important details are
not well understood by many financial advisors. Non-qualified
annuities are subject to a unique set of tax laws including
“older” grandfathered rules that apply in certain situations and
must be navigated to make good annuity decisions on behalf
of clients. These considerations apply to both liquidations
from contracts during life and consequences after death. Many
potential problems can only be fixed while the original annuity
owner is alive. Many aspects of annuity taxation rely on nonbinding private letter rulings and the way things are handled
may be different for different insurance companies selling and
administering the annuities. So it’s important to understand
particular insurer’s policies ahead of time. In a larger context, it’s
important to balance tax consequences with other non-tax aspects
of annuity contracts and to develop a full understanding of the
potential impact on the client and potential heirs.
As co-editors, we welcome the submission of research papers that
uncover new insights in personal finance and show the potential
to have an impact on the financial advice provided to individuals.
—Wade Pfau
—Joe Tomlinson
Volume 14, Issue 1
9
Which Assets to Leave to Heirs and Related Issues
Tom L. Potts, Ph.D., CFP®, Professor of Finance, Baylor University
William Reichenstein, Ph.D., CFA, Powers Professor of Investment Management,
Baylor University and principal, Retiree Income, Inc.
Many retirees have funds in several savings vehicles including taxable accounts, taxdeferred accounts (TDAs) like a traditional IRA, and tax-exempt accounts (TEAs) like
a Roth IRA. In this study, we address several questions. For simplicity, we assume the
retiree is a widow, but the same considerations apply to a widower and a retired couple.
Assume the widow has funds in a tax-deferred account and a tax-exempt account. The
first question is: Should she spend the money in the TDA and leave the TEA to her
beneficiary child, or vice versa? The second question is: If this widow has multiple
children who will inherit the remaining funds and these children have different tax rates,
how can she tax-efficiently split the TDAs and TEAs to maximize the after-tax value of
these accounts for her children? Third: When should the widow convert funds from the
TDA to a TEA? Finally, whether the beneficiary(ies) inherit TDAs or TEAs or some
combination of each, the widow should make sure she has taken the steps to ensure that
they will be able to stretch distributions from the inherited IRAs over their remaining
lifetime(s). Based on the work of Slott (2012), we explain what steps the widow should
take now to make sure the IRAs can be stretched. In the next section, we explain how
funds in TDAs are best viewed as partnerships with the government. This framework will
prove useful when answering these questions.
10
Tax-Deferred Account Viewed as Partnership
In this section, we explain why a TDA is best viewed as a
partnership with the government. The government effectively
“owns” t of this partnership, where t is the marginal tax rate when
the funds are withdrawn in retirement. We begin by examining
the after-tax future value of $1 market value in, respectively, a
TDA and a TEA. To hold everything else constant, the underlying
investment is the same in both the TDA and TEA as is the investment horizon of n years. The underlying asset can be stocks,
bonds, or cash and the investment horizon can be any length of
time. For now, assume the marginal tax rate in the year of withdrawal will be tn.
The TEA begins with $1 of after-tax funds. It grows at the r
percent pretax rate of return for n years. At withdrawal, its market
value is (1 + r)n dollars. Assuming the funds are withdrawn after
age 59½ and the account has been in existence for at least five
years, the withdrawal is tax-free. So, the after-tax value is also (1
+ r)n dollars.
The TDA begins with $1 of pretax funds. It grows at the r percent
pretax rate of return for n years. At withdrawal, its market value
is (1 + r)n dollars. Assuming the marginal tax rate in the year of
withdrawal is tn, the after-tax value is (1 + r)n (1 – tn) dollars.
Regardless of the underlying investment or length of investment
horizon, the TDA buys (1 – tn) as many goods and services as
the same market-value investment in the TEA. Conceptually,
the dollar in the TDA today can be separated into (1 – tn) of the
investor’s after-tax funds plus tn, which is the government’s share
of the current principal. The purchasing power of a dollar in the
TDA is the same as the purchasing power of (1 – tn) dollar in a
TEA. Thus, a TDA is like a partnership, where the government
effectively owns tn of the partnership.
A related point is that, properly viewed, the after-tax value of the
TDA grows effectively tax-free, just like funds in a TEA. For a
given tax rate at withdrawal, tn, the after-tax value of the TDA
grows at the pretax rate of return; that is, it grows effectively tax
free. To repeat, a dollar of pretax funds in a TDA can be separated into (1- tn) dollar of the investor’s funds, while the government
effectively owns the remaining tn of the TDA. From above, the
after-tax value n years hence of the dollar in the TDA is (1 + r)n
(1 – tn). The after-tax value of the TDA grows from (1 – tn) to (1
+ r)n (1 – tn), that is, it grows at the pretax rate of return.
Industry and academic researchers uniformly agree with this risk
and return sharing analogy (e.g., Dammon, Spatt, and Zhang
(2004), Horan (2005, 2007a, 2007b), Horvitz and Wilcox (2003),
Reichenstein (2001, 2006a, 2006b, 2007a, 2007b, 2008a, 2008b,
2008c), Reichenstein, Horan, and Jennings (2012), Reichenstein
and Jennings (2003), and Wilcox, Horvitz, and DiBartolomeo
(2006)). In the following sections, we use this framework to
address the questions addressed in this study.
Question 1: Should a Parent Leave the TDA or
TEA to a Child?
To avoid the constant use of his or her, we assume the retired
parent is a widow and the child beneficiary is her son. But the
conclusions are the same for a widow, widower, or married
couple. For simplicity, assume the market values of the TDA
and TEA are $100 each. Initially, we assume the widow will die
shortly after the withdrawal and her son will withdraw and pay
taxes on inherited funds this year. In a later section, we explain
the benefits of allowing the beneficiary to stretch the IRAs over
his lifetime. Initially, we assume the remaining funds earn a
pretax return of 0%, but this is later relaxed. Withdrawals occur at
the beginning of the year.
In Example 1.1, we assume the widow would pay a federal-plus-state marginal tax rate of 40% on TDA withdrawals, while
her son would pay 15% on TDA withdrawals. She will spend $60
this year, which requires after-tax funds. In Strategy 1.1A, the
widow withdraws $60 from the TEA to meet her spending needs,
and her son inherits the rest. He inherits $40 of after-tax funds in
the TEA plus $100 of pretax funds in the TDA. After paying taxes this year, his inheritance is worth $125 after taxes, [$40 TEA +
$100(1- 0.15) TDA]. In Strategy 1.1B, she withdraws $100 from
the TDA to meet her spending needs. Her son inherits the TEA,
which is worth $100 after taxes. Clearly, Strategy 1.1A is better.
Someone is going to pay taxes on the TDA withdrawal. This account should be withdrawn by the son because of his lower marginal tax rate. In fact, the son’s $25 advantage in Strategy 1.1A
compared to Strategy 1.1B is due to the taxation of the $100 TDA
at 15% instead of 40%. Finally, the analogy holds whether or not
required minimum distributions apply. If RMDs are required, the
widow should compare the marginal tax rate she would pay on
additional TDA withdrawals beyond RMDs to the marginal tax
rate her beneficiary would pay on those same TDA withdrawals.
Next, let’s reverse the tax rates. Now, the widow would pay a
marginal tax rate of 15% on TDA withdrawals, while her son
would pay 40% on TDA withdrawals. She will spend $85 this
year. In Strategy 1.2A, the widow withdraws $100 from the
TDA to meet her spending needs, and her son inherits the $100 in
the TEA, which is worth $100 after taxes. In Strategy 1.2B, she
withdraws $85 from the TEA and her son inherits the rest. After
paying taxes this year, his inheritance is worth $75, [$15 TEA +
$100(1- 0.40) TDA]. Strategy 1.2A is better. In fact, the son’s
$25 relative advantage in Strategy 1.2A is due to the taxation of
the $100 TDA at 15% instead of 40%.
The better strategy in each case may appear obvious. But
respected authorities often recommend that parents leave the
TEA to their child(ren). For example, in the Wall Street Journal,
Coombes (2014) writes, “A general rule is that Roth IRAs are
good accounts to leave to loved ones.” In that article, one planner
says, “The Roth IRA is pretty much the Cadillac of accounts for
[children] to inherit.” The son would be better off inheriting
$100 in a Roth TEA than $100 in a TDA, but this ignores the
Volume 14, Issue 1
spending needs of the parent(s). To return to the partnership
principle, the government owns t of the TDA, where t is the
marginal tax rate of the withdrawal. The objective is to minimize
the embedded tax liability, which requires the lower tax rate party
to withdraw funds from the TDA. Since the parent may or may
not have the lower tax rate, there is no general rule as to which
account to leave to the child.
The same conclusion applies if we assume the underlying investment earns a pretax return of r. In Example 1.1, the son’s ending
after-tax value at the end of the year is $125(1+r) in Strategy
1.1A and $100(1+r) in Strategy 1.1B. The equivalent comparison applies in Example 1.2 and in the other examples related to
Questions 1 through 3.
Question 2: If multiple children with different tax
rates will inherit the funds, how should the widow
allocate the remaining accounts?
For this question, assume the widow has two children, one with
a marginal tax rate of 40% and the other with a marginal tax rate
of 15%. Further assume that the widow wants to leave an equal
after-tax amount to each child. How should she allocate the
remaining funds?
In Example 2, we assume the children will inherit $100 from a
TDA and $100 from a Roth TEA. She wants to leave an equal
after-tax amount to each child. Her daughter has the 40% tax rate
and her son has a 15% tax rate. In Strategy 2A, the widow leaves
the entire $100 in the TDA and $7.50 of the TEA to the son. The
after-tax value of the son’s inheritance would be $92.50, [$100(1
– 0.15) + 7.50]. The daughter would inherit the remaining $92.50
in the TEA, which is also worth $92.50 after taxes. In Strategy
2B, the widow leaves half of each account to each child. In this
case, the son’s will still inherit $92.50 after taxes, [$50(1 – 0.15)
+ $50], but the daughter will inherit only $80 after taxes, [$50(1 –
0.40) + $50]. The combined after-tax inheritance is $12.50 more
in Strategy 2A than in Strategy 2B. This $12.50 advantage is the
tax savings from having the entire $100 (instead of $50) of the
TDA taxed at the son’s 15% rate instead of the daughter’s 40%
tax rate.
Perhaps the widow wants to leave more after-tax funds to the
son, because he is less well off financially. In this case, she might
leave the TDA plus $20 of the TEA to her son and the remainder
to her daughter. He would inherit $105 after taxes, while the
daughter would inherit $80 after taxes. This strategy would leave
the daughter with the same after-tax inheritance as she would
attain in Strategy 2B, but in this case the son gets the extra $12.50
in tax savings.1
11
To return to the partnership principle, the government effectively
owns t of the TDA. To leave the funds tax efficiently to children,
parents should leave the TDA to child(ren) with lower tax rates.
This requires unequal distributions in terms of market values of
accounts. For example, in Strategy 2A, the lower-tax rate son
inherits $107.50 across accounts. But this strategy enhances the
children’s combined after-tax inheritance – and they buy goods
and services with after-tax funds.
Question 3: When does it make sense for a parent
to convert funds from a TDA to a TEA?
Let us return to the setting where there is a widow and her beneficiary son. As before, we assume the market values of the TDA
and TEA are $100 each. We also assume for now that the widow
will die shortly after the withdrawal and her son will withdraw
and pay taxes on inherited funds this year.
In Example 3.1, the widow has a marginal tax rate of
40%, while the son has a marginal tax rate of 15%. She will
spend $60 this year. In Strategy 3.1A, she withdraws $60 from
the TEA to meet her spending needs and leaves the rest for her
son; that is, she does not convert the TDA to a Roth TEA. After
paying taxes this year, the son’s inheritance is worth $125 after
taxes, [$40 TEA + $100(1- 0.15) TDA]. In Strategy 3.1B, she
withdraws $60 from the TEA, but she also converts the TDA to a
Roth TEA. She owes $40 in taxes on the converted TEA. At the
end of the year, the son inherits the remaining $40 of after-tax
funds from the original TEA plus $60 of funds converted to a
TEA for a total of $100 after taxes. Clearly, Strategy 3.1A is
better. The son’s inherits $25 more after taxes in Strategy 3.1A,
and this is due to the taxation of the TDA at 15% instead of 40%.
Since she has the higher tax rate, she should not convert the TDA
to a Roth TEA. To use the partnership principle, the government
owns t of the TDA, where t is the marginal tax rate at withdrawal.
The objective is to minimize the embedded tax liability. In this
example, the widow should not convert the TDA, so the son will
pay taxes on the TDA withdrawal.
In the same Wall Street Journal article, Coombes writes, “Some
say if you don’t need the money for living expenses, it may make
sense to convert all or part of a traditional retirement account to a
Roth simply to benefit your heirs.” Let’s examine when it makes
sense for a person who does not need the fund for living expenses
to convert a TDA to a TEA. In this example, we assume there are
no inheritance taxes and taxes on TDA conversions are paid with
funds from this TDA.
1Communicating
the rationale for unequal pretax distributions of the estate
among heirs can be difficult and complicated. Different tax rates of heirs is one
of several reasons that may call for unequal pretax distributions. Other reasons
for unequal distributions may include special needs of one or more heirs and differences in types of assets to be inherited, where one child may inherit real estate
or a family business and the other child may inherit financial assets. Equal is not
always equitable. Regardless of the reason involved in unequal distributions, it
is best to discuss the estate distribution and property division while the parent is
alive. This allows the parent to explain the rationale for the estate distribution.
In the example in this study, it should be easy to explain that the objective is to
minimize taxes and thus maximize the after-tax value going to the heirs. This
requires unequal pretax distributions, but it should be easy to explain that each
pretax dollar is smaller than each after-tax dollar. 12
As we will show, the conversion of the TDA to a TEA would
make sense if the widow has a lower tax rate than the beneficiary son. For example, if the widow would pay 15% on TDA
withdrawals or conversions and the son would pay 40% then the
widow should both withdraw and convert funds from the TDA.
Suppose she will spend $51 this year. In Strategy 3.2A, she
withdraws $60 from the TDA and converts the remaining $40 to
a Roth TEA. The $60 withdrawal from the TDA would provide
her after-tax spending needs of $51. Her son would inherit $134
after taxes, $100 from the original TEA plus the $34 of after-tax
funds from the converted TDA after the widow paid $6 in taxes
on the $40 conversion amount. In Strategy 3.2B, she withdraws
$60 from the TDA to meet her spending needs, but she does not
also convert the remaining $40 to a TEA. In this case, her son
would inherit $124 after taxes, [$100 + $40(1 – 0.40)]. The son’s
$10 advantage in Strategy 3.2A represents the tax savings by having the remaining $40 in the TDA taxed at the widow’s 15% tax
rate instead of her son’s 40% tax rate. Someone will pay taxes on
the TDA withdrawal. The party with the lower tax rate – in this
example the widow – should pay these taxes.
That same article concludes that the conversion decision depends,
at least in part, on the length of the investment horizon. Coombes
writes, “Withdrawing a lot of money in the years soon after a
conversion extends the length of time it takes to reach the breakeven point – or the point at which the hefty upfront tax bill you
pay when you convert is outdone by the benefit of your money
growing tax-free in the Roth.” She quotes a financial professional who said, “If you aren’t able to leave that [converted] money
alone for at least 10 years after you convert it to a Roth, most of
the time it’s just not going to work.” We will demonstrate that
when taxes on TDA conversions are paid from these funds the
length of the investment horizon has nothing to do with the conversion decision. Rather, the conversion decision depends only
on the relative sizes of marginal tax rate in the conversion year (if
the TDA is converted) versus the marginal tax rate if not converted and withdrawn later in retirement. (Later, we will show
that the size of these two marginal tax rates is the key factor even
if taxes on TDA withdrawals are paid with funds in a taxable
account.)
Let’s compare the after-tax value of this TDA if converted this
year and taxes paid at this year’s tax rate, t0, from the converted
funds to its after-tax value if not converted and withdrawn after n
years at which time taxes are paid at tn. To hold everything else
constant, the underlying investment must be the same. Without
loss of generality, assume the pretax return is r. The investment
horizon, n, can be any length of time. If converted this year, the
$100 in the TDA becomes $100(1 – t0) in the TEA. Its after-tax
value when withdrawn n years hence is $100(1 – t0)(1+r)n. If
retained in the TDA and then withdrawn n years hence, the
pretax value at withdrawal is $100(1+r)n and its after-tax value is
$100(1+r)n(1 – tn). Comparing the after-tax values clearly shows
that the strategy to convert the TDA depends upon the comparison of the tax rate if converted this year, t0, to the tax rate if not
converted but withdrawn in n years, tn. Therefore, a taxpayer –
whether retired or working – should convert funds from a TDA to
a TEA this year if he has a lower marginal tax rate this year than
he expects to have if not converted and withdrawn in retirement.
The length of the investment horizon does not matter. Furthermore, the underlying asset –whether stocks, bonds, or cash –does
not matter. The key consideration is the marginal tax rates in the
conversion year if funds are converted and withdrawal year in
retirement if funds are not converted. Thus, a 20-year-old with a
traditional IRA who has a low tax rate – perhaps 0% if a student –
should consider converting this traditional IRA to a Roth IRA. He
or she can maintain the same investment decision and still plan to
withdraw funds for spending in retirement. It is simply a matter
of comparing the tax rate in the conversion year to the expected
tax rate in retirement.
We now show that if taxes on TDA conversions are paid from
funds in a taxable account then the length of the investment
horizon can matter. Suppose George has $100 in a TDA and $25
in a taxable account and the marginal tax rates this year and in the
withdrawal year in retirement are 25% each. If he converts all
TDA funds this year and pays taxes from the taxable account then
he has $100 of after-tax funds growing tax free. In contrast, if he
retains the funds in the TDA then, using the partnership principle,
he effectively has $75 of his funds growing tax free, but the $25
in the taxable account grows at an after-tax rate of return. Thus,
potentially there is an advantage to converting the TDA this year
even if he would be in a lower tax bracket in retirement. To see
how long it would take for the Roth conversion to make sense
if he would be in 25% tax bracket in all years before retirement
but have his tax rate fall to 15% in retirement, let’s compare the
after-tax value of two strategies. In the first, he converts the TDA
this year, pays taxes out of the taxable account, and the underlying investment is a bond earning 4% per year. His after-tax ending wealth is $100(1.04)n, that is, the $100 in the TEA grows tax
free at 4%. If not converted but withdrawn n years hence when
the tax rate is 15%, the after-tax value of the TDA plus taxable
account is $100(1.04)n (1 – 0.15) + $25(1.03)n, where 3% is the
after-tax return on the bond held in the taxable account since the
tax rate was 25% for all years before the withdrawal year. In this
example, it would take 53 years before the Roth conversion this
year would make sense despite the lower tax rate in retirement.2
In short, for reasonable investment horizons, the key factor remains the relative sizes of the two marginal tax rates.
The same logic applies to parent(s) deciding whether to convert
funds from a TDA to a Roth TEA when the funds are intended for
the children. Suppose a widow could withdraw additional funds
beyond her spending needs each year that would be taxed at 25%
rate. Eventually, her son who is living in an income-tax-free state
would inherit these funds, which at the margin would be taxed
at the 33% federal rate. Obama’s 2015 budget calls for forcing
inherited IRAs to be distributed within five years (with some exceptions). Therefore, if this feature is enacted, this son may be in
a 15% tax bracket in most years, but since he would be forced to
withdraw $1 million in inherited TDAs within five years after his
mother’s death then he would be in the 33% federal tax bracket
2The
breakeven period would be even longer if the underlying asset was stock that
was taxed at the 15% preferential tax rate.
Volume 14, Issue 1
13
during these five years. In this case, the widow should convert
funds beyond her spending needs each year as long as they would
be taxed at a lower marginal tax rate than her son would pay. In
this example, the widow may be able to convert say $25,000 each
year for decades without having the converted funds cause her
income to rise above the top of the 25% tax bracket. In this case,
the son’s marginal tax rate when he withdraws the funds after his
mother’s death may not exceed 25%.3
In the next section, we show how a parent can set up an IRA –
whether traditional IRA or Roth IRA – so that the beneficiary can
stretch withdrawals over his or her life expectancy.
Stretching the IRA
In the prior three sections, we generally assumed the funds would
be withdrawn and taxes paid this year by the beneficiary. In this
section, we relax this assumption and show the importance of
allowing the beneficiary to stretch withdrawals of the inherited
TDA or TEA over the beneficiary’s life expectancy. We rely on
the work of Ed Slott (2012) to explain the steps a person must
take to ensure that a beneficiary (as long as the beneficiary is a
person and not, say, the parent’s estate) can stretch distributions
over his or her life expectancy.
For simplicity, but without loss of generality, assume the widow
has $1 million in her traditional IRA and she wants to leave it
to her son. She should name her son the primary beneficiary
on the IRA. This makes him a designated beneficiary. As such,
he can inherit the IRA and withdraw the funds over his life
expectancy. For example, if his mother (the widow) died in
2014 after taking that year’s RMD then in 2015 he would have
to take his first RMD. To determine the size of his 2015 RMD
let’s assume he turned 40 that year. The life expectancy from
the Single Life Expectancy Table (for inherited IRAs) is 43.6.
Thus in 2015, the son’s RMD would be the December 31, 2014
closing balance divided by 43.6. His RMD for 2016 would be
the December 31, 2015 closing balance divided by 42.6, one less
than the prior year’s life expectancy. His RMD for 2017 would
be the December 31, 2016 closing balance divided by 41.6, and
so on. In 2058, he would have to withdraw the remaining funds.
In short, by naming a designated beneficiary, the IRA could be
withdrawn over a 44 year period. The RMDs are precisely that –
required minimum distributions. If the son wanted to withdraw
a larger amount in any year then he could. Assuming the TDA’s
December 31, 2014 closing balance was $1 million, the son’s
RMD would be $22,936, [$1,000,000/43.6]. A series of such
withdrawals would not likely cause his marginal tax rate to rise
substantially.
3 Coombes (2014b) discusses the implications if inherited IRAs must be withdrawn within five years after inheritance, that is, if there is no stretch IRA. Ed
Slott is quoted as saying, “If there’s no stretch IRA, it doesn’t pay for an older
person to pay to convert a Roth. Why should someone 60, 70 years old, who’s
mainly doing it for their beneficiaries, pay a tax when the deferral rate after they
die is limited to five years?” Our example answers his question. In our opinion,
Mr. Slott’s advice is best when it comes to stretching an IRA and related themes,
but his opinion on investment horizon is demonstrably wrong. The investment
horizon is not a critical factor in the conversion decision. Rather, the conversion
decision should be based on the comparison between the marginal tax rate in the
conversion year and the marginal tax rate if not converted but withdrawn later.
In contrast, suppose the widow named her estate as the beneficiary and the son ultimately was named the beneficiary of the TDA.
Since the estate was the first-named beneficiary in the TDA,
the son would be a beneficiary, but not a designated beneficiary. Since the estate has no life expectancy, the son would have
to withdraw the funds in the first five years, that is, from 2015
through 2019. If he withdraws $200,000 from the TDA in 2015,
this additional income would likely cause his marginal tax rate
to jump substantially and it may also trigger a higher tax via the
Alternative Minimum Tax . Worse yet, if he fails to withdraw
anything from 2015 through 2018 then his RMD for 2019 would
be the entire TDA balance. Even worse, if he failed to withdraw
all funds then he would face 50% penalty tax on the remaining
balance since the remaining balance would be the amount by
which his distribution failed to match his RMD for that year. In
this case, his marginal tax rate would likely jump dramatically. The net result is that the government would get a lot larger
chunk of the TDA withdrawals. Using the partnership principle,
the government would effectively own a lot larger portion of the
TDA, while the son would effectively own a lot smaller portion
of this TDA.
Let’s return to the widow and her son. But now assume the widow also named a contingent beneficiary, the son’s daughter. In
2015, the son would be 40 and his daughter would be 17. If the
son does not need part or all of the $1 million IRA then he could
disclaim part or all of it, in which case the daughter would inherit
the disclaimed IRA. According to the Single Life Expectancy Table, her life expectancy is 66 years. So, she could enjoy 66 years
of tax-deferred growth.
In summary, if the widow does not name a primary beneficiary
(or records of her beneficiary choices are not found or the named
beneficiary predeceases the widow) then her son would have
to withdraw all funds within five years. By naming her son as
primary beneficiary, her son could enjoy up to 44 years of tax-deferred growth. If the widow named her son the primary beneficiary and her granddaughter contingent beneficiary then, if the
son disclaims the IRA, her granddaughter could enjoy up to 66
years of tax-deferred growth. Finally, suppose the widow had $1
million in a Roth IRA at her death instead of an IRA. In this case,
the son or granddaughter would enjoy up to 5, 44, or 66 years of
tax-free growth depending upon beneficiary designation in the
Roth IRA. The ability to grow funds tax-deferred or tax-free for
long periods is, indeed, a valuable option.
There are numerous exceptions to RMD rules affecting tax-deferred accounts including traditional IRAs and other TDAs and
tax-exempt accounts like the Roth IRA and Roth 401(k). For
an excellent discussion of these rules, we recommend Ed Slott
(2012). He is the master of IRAs.
14
Conclusion
Many retirees have funds in several savings vehicles including
tax-deferred accounts (TDA) like a traditional IRA and tax-exempt
accounts (TEA) like a Roth IRA. This article addressed several
key questions: 1) how funds in TDAs and TEAs should be allocated between a parent and beneficiary child when they are subject
to different marginal tax rates, 2) how the parent should bequeath
funds in TDAs and TEAs between beneficiaries who are subject
to different tax rates, and 3) whether a parent should convert funds
from TDA to Roth IRA if these funds are not needed to support the
parent’s retirement spending. A key concept is that a TDA is best
viewed as a partnership. The government effectively “owns” t of
this partnership, where t is the marginal tax rate when the funds are
withdrawn. In each case, the objective is to minimize t, to government’s share of the TDA partnership. If required minimum distributions exist then t refers to the marginal tax rate on withdrawals
from TDAs or conversions from TDAs beyond the RMD.
Someone will pay taxes on withdrawals or conversions from the
TDA. These withdrawals or conversions should be saved for
the taxpayer with the lower tax rate. For example, if a widow is
subject to a lower marginal tax rate than her beneficiary son then
she should withdraw funds from the TDA and save the TEA for
her son, and vice versa. Similarly, a parent could bequeath the
TDA to the beneficiary with the lower marginal tax rate, while
bequeathing the TEA to the beneficiary with the higher tax rate.
Finally, the parent should compare his or her marginal tax rate
to the beneficiary’s and convert funds from TDA to Roth IRA as
long as the parent’s marginal tax rate is below the beneficiary’s
tax rate when he withdraws these inherited funds.
One implication for financial and tax professionals is that they
can add value to client accounts by helping them maximize the
after-tax value of the combined TDA and TEA accounts. Stated
differently, these professionals can add value to client accounts
by helping the client minimize the portion of his or her TDAs
taken by the government in the form of taxes. Even if financial
markets are strongly efficient, professional can still add value to
client account by helping them arrange their financial affairs to
take advantage of the tax code. A second implication is that clients may need assistance with communication strategies for heirs
about asset distributions that seem “unfair” on the surface until
tax implications are considered.
Example 1.1: Comparing After-Tax Values of Withdrawals
Strategy
1.1A
Person
Widow
Son
TEA
$60
$40
TDA
$0
$100(1-.15)
Total
$60
$125
1.1B
Widow
Son
$0
$100
$100(1-.40)
$0
$60
$100
Market values of tax-exempt account (TEA) and tax-deferred account (TDA) are $100 each. Marginal tax rates are 40% for widow
and 15% for son.
Example 1.2: Comparing After-Tax Values of Withdrawals
Strategy
1.2A
Person
Widow
Son
TEA
$0
$100
TDA
$100(1-.15)
$0
Total
$85
$100
1.2B
Widow
Son
$85
$15
$0
$100(1-.40)
$85
$75
and 40% for son.
Volume 14, Issue 1
15
Example 2: After-Tax Values of Inheritances
Strategy
2A
Person
Son
Daughter
TEA
$7.50
$92.50
TDA
$100(1-.15)
$0
Total
$92.50
$92.50
2B
Son
Daughter
$50
$50
$50(1-.15)
$50(1-.40)
$92.50
$80
Market values of tax-exempt account (TEA) and tax-deferred account (TDA) are $100 each. Marginal tax rates are 15% for son and
40% for daughter.
Example 3.1: After-Tax Values
Strategy
3.1A
Person
Widow
Son
TEA
$60
$40
TDA
$0
$100(1-.15)
Total
$60
$125
3.1B
Widow
Son
$60
$40
$100(1-.40)
$0
$60
$100*
and 15% for son.
*In Strategy 3.1B, the son gets $40 after taxes from TEA withdrawal and he inherits $60 of after-tax funds from his mother’s (a.k.a.,
the widow’s) TDA conversion for a total of $100 after taxes.
Example 3.2: After-Tax Values
Strategy
3.2A
Person
Widow
Son
TEA
$0
$100
TDA
$100(1-.15)
$0
Total
$51
$134*
Widow
$0
$60(1-.15)
$51
Son
$100
$40(1-.40)
$124
and 40% for son.
*The son gets $100 after taxes from TEA withdrawal and $34 inheritance from his mother; his mother (a.k.a., the widow) withdraws
$100 from the TDA, which provides $85 after-taxes. She spends $51 and her son inherits $34.
16
References
Coombes, Andrea. 2014. “The Most Valuable Assets to Leave to Your Heirs,
Wall Street Journal, June 3, p. R5.
Coombes, Andrea. 2014b. “Beware Leaving a Roth for Heirs,” Wall Street
Journal, September 7, http://online.wsj.com/articles/should-i-leave-aroth-to-my-heirs-1410120116.
Dammon, Robert M., Chester S. Spatt, and Harold H. Zhang. 2004. “Optimal
Asset Location and Allocation with Taxable and TaxDeferred Investing.”
Journal of Finance, vol. 59, no. 3 (June): 999–1037.
Horan, Stephen M., 2005, Tax-Advantaged Savings Accounts and Tax-Efficient Wealth Accumulation, Research Foundation of CFA Institute, 2005.
Horan, Stephen M. 2007a. “An Alternative Approach to After-Tax Valuation,” Financial Services Review, vol. 16, no. 3: (Fall) 167-182.
Horan, Stephen M., 2007b, “Applying After-Tax Asset Allocation,” Journal
of Wealth Management, 10(2) (Fall): 84–93.
Reichenstein, William. 2007a. “Implications of Principal, Risk, and Returns
Sharing Across Savings Vehicles.” Financial Services Review, vol. 16,
no. 1 (Spring): 1–17.
Reichenstein, William. 2007b. “Calculating After-tax Asset Allocation is Key
to Determining Risk, Returns, and Asset Location,” Journal of Financial
Planning, July: 66-77.
Reichenstein, William. 2008a. In the Presence of Taxes: Applications of
After-tax Asset Valuations. FPA Press.
Reichenstein, William. 2008b. “One Concept and Some of its Applications,”
Journal of Wealth Management, Winter, vol. 11, no. 3: 82-91.
Reichenstein, William. 2008c. “How to Calculate an After-tax Asset Allocation,” Journal of Financial Planning, vol. 21, no. 8, August: 62-69.
Horvitz, Jeffrey E. and Jarrod W. Wilcox. 2003. “Know When to Hold ‘Em
and When to Fold ‘Em: The Value of Effective Taxable Investment Management.” Journal of Wealth Management, vol. 6, no. 2 (Fall): 35–59.
Reichenstein, William, Stephen M. Horan , and William W. Jennings. 2012.
“Two Key Concepts for Wealth Management and Beyond,” Financial
Analysts Journal, vol. 68, no. 1, January/February: 14-22.
Reichenstein, William. 2001. “Asset Allocation and Asset Location Decisions
Revisited.” Journal of Wealth Management, vol. 4, no. 1 (Summer):
16–26.
Reichenstein, William and William W. Jennings. 2003. Integrating Investments and the Tax Code. John Wiley & Sons, Inc. New York, NY.
Reichenstein, William. 2006a. “After-tax Asset Allocation.” Financial Analysts Journal, vol. 62, no. 4 (July/August): 16–26.
Reichenstein, William. 2006b. “Withdrawal Strategies to Make Your Nest
Egg Last Longer.” AAII Journal, vol. 28, no. 10, (November): 5-11.
Slott, Ed. 2012. The Retirement Savings Time Bomb … and How to Defuse It,
Penguin Books, NY, NY.
Wilcox, Jarrod, Jeffrey E. Horvitz, and Dan diBartolomeo. 2006. Investment Management for Private Taxable Investors. Charlottesville, VA:
Research Foundation of CFA Institute.
Volume 14, Issue 1
17
Mitigating the Impact of Personal Income Taxes on
Retirement Savings Distributions
James S. Welch, Jr.
James S. Welch, Jr. has been implementing Mathematical Programming Systems since 1964. His
particular interests are in matrix description languages, high performance optimizers and pre
solving models prior to optimization in order to speed the solution process. Mr. Welch is currently a
Senior Application Developer for Dynaxys, LLC.
Abstract
When retirement savings include a large tax-deferred account distribution strategies for
sequencing withdrawals from these accounts differ in the amount of money available for
annual spending during retirement. The common practice for the scheduling of withdrawals from retirement savings accounts is to first deplete the after-tax account, then
the tax-deferred and finally the Roth IRA. This paper quantitatively evaluates optimal
plans that maximize spending by sequencing annual withdrawals to minimize the impact
of taxes in order to achieve a targeted final total asset value. We show that the optimal
retirement savings withdrawal strategy improves on common practice by increasing the
money available for retirement spending by 3% to 30%. Most of the optimal withdrawal
plans evaluated in this paper make withdrawals from the tax-deferred account across the
entire span of retirement in parallel with withdrawals from first the after-tax account and
then the Roth IRA later in retirement.
Keywords: retirement planning, withdrawal strategy, Roth IRA, tax-deferred savings,
linear programming, optimal distribution plan, retirement spending.
18
Mitigating the Impact of Personal Income Taxes on
Retirement Savings Distributions
Many retirees have multiple types of retirement savings accounts
with different distribution characteristics1. These retirees seek a
strategy for the annual withdrawal of funds from their savings in
a way that will maximize spending2, not exhaust savings prematurely, and not leave a large surplus.
The answer to a problem depends on how we phrase the question.
In retirement planning the question is usually along the lines of
“Given my living expenses when will my savings run out?” The
answer comes in the form of which year the savings are exhausted. This idea is extended to the Monte Carlo method which
computes the probability of plan failure due to asset volatility.
Professor William F. Sharpe [2013] succinctly defines the problem in his blog:
It seems to me that first principles dictate that any rule for spending out of a retirement account should at the very least adhere to
the following principle:
The amount you spend should depend on
1. How much money you have, and
2. How long you are likely to need it
In other words, given my assets, my estimated life expectancy
and my desire to spend all my savings, leaving some predefined
final total account balance (FTAB) what is the maximum
amount of money that I will have to spend each year, after taxes?
This paper addresses retirement planning from the perspective of
maximizing spending.
Figure 1 presents an overview of the retirement financial model.
The process is the storing and distribution of funds over the term
of retirement (time dynamic) [Hirshfeld 1969]. The boxes inventory money which increases in value each year (circular arrows)
according to a rate of return (ROR). The top three boxes are
liquid savings accounts from which any amount of money can be
withdrawn for spending, taxes or to fund the estate (FTAB).
• Money flows from the Roth IRA to spending or the
estate.
• Money flows from the tax-deferred account (IRA)3 to
the Roth IRA or the after-tax account, as well as spending,
taxes or the estate.
• Money flows from the after-tax account to spending or
the estate.
• Illiquid assets can only be sold as a complete entity and
the sale proceeds, after taxes are deducted, are transferred to
the after-tax account to be distributed later.
• Social Security benefits and pensions are other sources
of funds that are not part of savings but contribute to spending, taxes, or the estate.
From the perspective of how they are taxed, these accounts are
four entirely different entities.
We omit Social Security benefits and Illiquid Assets from this
study because we want to concentrate on the impact of personal
income taxes generated by tax-deferred account distributions on
spending.
Distribution strategies for sequencing withdrawals from retirement savings accounts differ in the amount of money they
produce for spending during retirement because of income taxes
on tax-deferred account distributions.
There are two issues in devising a strategy for making annual
withdrawals:
1. The order in which accounts are selected for withdrawal
affects the amount of money available for spending.
2. The amount to be withdrawn each year affects the
FTAB.
1Appendix
Figure 1: Overview of Retirement Planning
A is a glossary providing the narrow definition of terms used in
this paper.
2 Spending is the money available for annual personal consumption. We find
that real spending is a more useful retirement plan metric than either “age at
which the money runs out” or “plan’s nominal ending balance”.
3 We use the term IRA to represent all tax-deferred accounts.
(See Appendix A)
Volume 14, Issue 1
19
Issue 1 – Order of Withdrawal
Discussion
The order of annual withdrawal affects spending because spending is reduced by personal income taxes paid on tax-deferred
account withdrawals. Under the Federal progressive income
tax a large IRA distribution is taxed at a higher rate than several
small distributions made in different years. There are no taxes on
distributions from the other accounts.
Regarding optimization, this paper describes how linear programming is used to maximize spending throughout retirement while
leaving a specified balance in retirement savings; i.e. no plan
failure and no large surplus. The result is an efficient retirement
savings withdrawal plan that provides a steady stream of inflation
adjusted money over the term of retirement.
The common practice is to withdraw savings from retirement
accounts in this order:
Linear Programming (LP) is an operations research tool that
has been a successful computer application since the 1950’s [Orchard-Hays 1984]. An LP model is solved by commercial computer software that accepts a model consisting of a set of activities that can be done within constraints on those activities. From
the large universe of model solutions the LP optimizer computes
one that has some maximum economic value. The objective of
an LP model is to optimize an economic value that, in this paper,
is the retirement planning value of spending. LP mathematically
guarantees that there is no better solution than the one computed
[Danzig 1963]. The optimizer reports the economic value of the
model and the activities that contribute to the solution.
1. The after-tax account until it is depleted,
2. The IRA until it is depleted, and
3. The Roth IRA account to the end of the plan.
Issue 2 – Amount of Withdrawal
The size of annual distributions determines the plan’s final deficit
or surplus. Too large of an annual distribution will cause savings
to be exhausted before the end of the plan; a great concern to
many retirees. A surplus is not of such great concern but an excessive surplus means that the retiree may have practiced unnecessary self-denial while seeking insurance from the deficit threat.
The common practice is to estimate retirement spending through
analysis of pre-retirement spending and retirement budget planning. Using this estimate a retirement calculator may be used
to determine the plan’s deficit or surplus. A variation of this approach is to utilize a Monte Carlo method calculator to estimate
the probability of plan failure, i.e. running out of money before
the plan end.
A Unified Approach
We compare results from two computer programs that have a
unified approach to these two issues:
This paper demonstrates scenarios in which linear programming
is used to compute withdrawal plans that increase spending in the
range of 3% to 30% as compared to common practice.
A common criticism of simulators and optimizers is that they do
not reflect the market volatility of asset values and returns. We
argue that active, capital preservation portfolio management can
dampen the adverse effects of market volatility so that, when
combined with a long planning horizon of 25 years or more the
fixed return assumption is valid for planning purposes. Given
this assumption, we compare the efficiency of two methods of retirement income planning while ignoring the question of longevity (defined as the chance of exhausting savings before the end of
the planning horizon), as is commonly measured with the Monte
Carlo method. We assume market volatility and associated risks
would impact both methods similarly.
1. A simulator that implements the common practice for
Issue 1 (fixed order of withdrawal) and computes maximum
savings withdrawal amounts and thus maximum spending
(Issue 2).
In this paper we seek to establish the credibility of the two
computer programs, measure the differences between the two approaches for various scenarios, and discuss the dynamics of their
resultant withdrawal plans.
2. A linear programming optimizer that maximizes
spending by computing both the optimal account withdrawal
order and the withdrawal amount.
Literature Review
Both programs report a schedule of annual withdrawals; the withdrawal plan.
The fundamental difference between these two programs is
that the order of account withdrawal is defined in the simulator
whereas the optimizer computes the optimal account withdrawal
sequence.
The common practice is based on published, quantitative studies.
Raabe and Toolson [2002] showed that the common practice of
withdrawing from retirement savings is more efficient than any
other permutation of sequential account distribution strategies.
Their approach recognized the interaction between the IRA and
the after-tax account.
Saftner and Fink [2004] compared the results of retirement
savings that are exclusively in one of the three accounts. Their
results showed that saving in a Roth IRA and an IRA will result
in the same plan value (spending plus the FTAB). They showed
20
that the after-tax account is less efficient than the other two
accounts because of the reduced compounding that results from
after-tax account income being taxed as it is incurred. Horan
[2006] studied the question of whether to withdraw from the
IRA or the Roth IRA first. He compared two “naïve” models, 1)
Withdraw from the IRA first and the Roth IRA second; 2) vice
versa, to his “informed” method. He concluded that withdrawing
from both accounts in parallel is the most efficient strategy. He
distributed from the IRA until it reached the top of the current tax
bracket and then satisfied any remaining spending requirements
from the Roth IRA.
We know of two published papers describing LP models that
compute optimal retirement savings withdrawal plans.
Ragsdale, Seila and Little [1993] demonstrated that their LP
optimal withdrawal plan is superior to two heuristic withdrawal
methods. Withdrawals are made from two tax-deferred accounts
with differing rates of return. Their model fixed the withdrawal
rate and maximized generated plan surplus. They computed personal income taxes on withdrawals, met the Required Minimum
Distribution (RMD), minimized the Excess Distribution Penalty
(no longer a feature in the tax code), and minimized estate taxes.
They modeled two IRAs with different RORs and concluded that
distributing the lower performing account first is optimal.
Coopersmith and Sumutka [2011] compared the results of their
Tax Efficient (TE) linear programming model to their common
rule. Their model computed personal income taxes on tax-deferred withdrawals plus Social Security benefits, satisfied the
RMD and minimized estate taxes. TE showed improvement over
common practice for situations where
The Experiment
Our experiment is to compare the common practice retirement
plans to optimized plans. There are three elements of the experiment; the modeling software, the situation being modeled, and
the scenarios for obtaining the computational results.
The Software
We used two computer programs:
1. The Common Practice Simulator (CPS) is an Excel
spreadsheet that we use to simulate the common practice
for scheduling account withdrawals and compute maximum
withdrawals.
2. The Optimal Retirement Planner (ORP) is the linear
programming system that we used to compute the optimal
plans for this study.4
CPS is based on a generally recognized heuristic but with its
direction reversed, i.e. set the FTAB to zero and maximize withdrawals. ORP maximizes spending for a zero FTAB in a manner
that directly compares to CPS.
The two programs use the same parameter set and compute to
the same objective: maximum spending. The computed plan is
measured by spending at age 66 in today’s dollars. Spending
for subsequent years is this amount adjusted for inflation; i.e.
the anuitization of spending. Both programs model the Federal
progressive income tax and the RMD using 2014 IRS tables.
•
he after-tax account ROR is greater than the taxT
deferred ROR.
Given a set of parameters both programs’ objective is to compute
the maximum spending level that will leave a zero balance in the
FTAB.
•
I nitial after-tax account savings are greater than
10 percent of total retirement savings.
The Situation
•
I temized deductions are greater than the standard
deduction.
The situation being modeled is a single, 66 year old retiree with
$1,000,000 in retirement savings and a planning horizon of 29
years (to age 95). The FTAB is zero, i.e. there will be no estate.
We extend this prior work by:
•
Holding the FTAB constant and maximizing spending,
•
Modeling all three accounts and their interaction,
•
Relaxing TE’s restrictions,
•
Implementing IRA to Roth IRA conversions.
•
ssigning a single ROR to all accounts to concentrate
A
on the effects of taxes on the retirement plan.
All three retirement savings accounts assume the same ROR.
The purpose of this study is to demonstrate the impact of personal
income taxes on the optimal withdrawal plan without the need to
address the confounding impact of different RORs for the three
accounts. [Coppersmith and Sumutka 2011].
Annual inflation is assumed to be 2.5%.
4
The CPS spreadsheet is available on request. ORP may be found at
www.i-orp.com.
Volume 14, Issue 1
21
Computational Results
The experiment was to run the two programs with the parameter
set described above, for different scenarios, and compare their
results.
Rates of Return
In the ROR scenarios one million dollars of retirement savings are distributed across all three accounts. The IRA contains
$400,000, the Roth IRA $350,000 and the after-tax account
$250,000. These proportions were chosen by computing accumulation phase savings for a 30 year old who allocates 1/3 of her
annual retirement savings to each of the three accounts. The accumulated asset totals were evaluated at age 66. The initial Roth
IRA account balance is lower than the IRA because of income
taxes deducted from the Roth IRA contributions. The initial
after-tax account balance is even lower due to income taxes deducted from contributions and because the 15% capital gains tax
paid on annual investment returns reduces compounding [Saftner
and Fink, 2004].
The scenarios compare CPS and ORP spending for a range of
RORs. Recall that for the purpose of comparison, RORs are considered average rates and the volatility of the RORs would impact
both methods similarly.
ROR selection is one of the important discretionary choices that
the retiree has to make. A low ROR indicates a willingness to
sacrifice return to achieve low portfolio volatility. A high ROR
indicates a desire to achieve greater return by tolerating a higher
level of volatility. Since these models are deterministic, not probabilistic, their results are more realistic for low RORs.
ROR scenario summary. Table 1 compares spending in today’s
dollars, for plans computed by CPS and ORP, using a range of
RORs.
Spending - $000
ROR
%
0.5
1
2
3
4
5
6
7
8
9
10
15
Efficiency
CPS
ORP
%
22
24
28
33
38
43
49
54
60
66
72
104
25
27
31
35
40
45
51
56
62
68
75
107
13.6
12.5
10.7
6.1
5.3
4.7
4.1
3.7
3.3
3.0
4.2
3.0
Table 1: Comparison of CPS to ORP
Column ROR % contains the rate of return parameter that was
varied for the results in Table 1.
The Spending columns show each program’s maximum spending. A year’s withdrawals can come from of any combination of
accounts, their sum minus taxes will equal spending for that year.
The Efficiency column quantifies the advantage of the ORP withdrawal plan over CPS. We define efficiency to be the spending
difference as a percentage of CPS spending at age 66:
Efficiency = (ORP spending – CPS spending)/CPS spending
The Efficiency column indicates that as the RORs grow the
advantage of optimization over common practice diminishes. As
discussed earlier, small RORs indicate less volatile assets and the
constant ROR assumption is more credible. Thus ORP spending improvement is more relevant to conservatively invested
accounts. ORP’s improved spending partially compensates for
reduced returns on lower risk savings.
The 5% ROR plan. This section explores how ORP and CPS
determined the spending levels for the 5% ROR scenario.
Withdrawal plan. Withdrawal scheduling is selecting one or more
accounts and determining the amount to withdraw each year.
CPS account selection is defined as part of the algorithm. ORP
computes the account and the amount for each year’s withdrawal.
Figure 2 shows the distribution plans reported by CPS and ORP
for 5% ROR.
22
Figure 2. Annual Distributions by Account, 5% ROR Scenario Figure 3. Savings Account Balances, 5% ROR Scenario
Panel A of Figure 2 shows CPS withdrawals for each year of the
5% ROR scenario. The after-tax account distributes until age 70,
when the RMD forces the first IRA distribution. The IRA makes
distributions until it is depleted at age 82 when the Roth IRA
takes over. IRA withdrawals overlap withdrawals from the other
accounts only at the boundaries. The IRA withdrawals are elevated above the other two lines because of extra money withdrawn
to pay taxes.
Panel B is the ORP withdrawal plan. The after-tax account and
the IRA make parallel distributions until age 70 when the RMD
begins. Then IRA distributions are just large enough to push
taxable income to the top of the 0-no tax bracket (See Figure
4). The RMD increases the IRA distributions and reduces the
after-tax distributions. After the after-tax account is depleted the
IRA and Roth IRA make parallel distributions. IRA distributions
are maintained at a level sufficient to hold taxable income at the
top of the 10% tax bracket while the Roth IRA satisfies remaining
spending requirements
Savings account balances. Figure 3 shows the account balances
over time under the distribution plans shown in Figure 2.
In Panel A the annual asset balances are falling in tandem as expected for the common practice. In both panels the IRA and Roth
IRA continue to accumulate as the after-tax account declines.
In Panel B after ORP depletes the after-tax account the IRA and
the Roth IRA decline in parallel.
Income taxes. Figure 4 shows how real (de-inflated) IRA distributions are allocated across the Federal income tax brackets.5
Each vertical bar represents income subject to taxes. Each bar is
segmented into parts according to the tax bracket that the income
falls into. For example, in Panel A, the age 72 bar shows income
divided into the No Tax, 10% and 15% brackets. The No Tax
bracket includes the standard deduction, one personal exemption,
and the allowance for being over 65.
Panel A shows the CPS income tax brackets. When there are no
IRA distributions there is no income to be taxed. During IRA
distributions, CPS taxable income climbs into the 15% tax bracket. Panel B shows ORP income tax brackets. After the after-tax
account is depleted IRA distributions fill up the 10% bracket (See
Figure 2). This process is being driven by the annualitization of
spending and the zero FTAB requirement.
5
Both models were run with 2.5% inflation then the tax reports were “de-inflated”.
Figure 4. Real Income Tax Brackets, 5% ROR
Volume 14, Issue 1
23
CPS is paying all of its taxes early in the plan while ORP spreads
taxes across the plan at an overall lower level.
Table 2 shows the total taxes paid in both nominal (Inflated) dollars and real (de-inflated) dollars for the 5% ROR scenario.
System
ORP
CPS
Difference
Taxes - $000
Nominal
33
64
31
Real
21
50
29
It is well to remember at this point that each optimal solution is
the best available for the given circumstances.
Account Size
Table 2: Total Taxes Paid, 5% ROR
The differences between the program’s taxes are not consistent
with ORP’s $2,000 spending advantage reported in Table 1. Compared to each other the differences are dramatic. But $29,000
spread over a retirement of 29 years leaves $1,000 of spending
unaccounted for. We conjecture that the timing of tax payments
is as important as the magnitude of tax differences. CPS pays
more taxes early in the plan which reduces IRA compounding
and thus reduces spending.
Account allocation. An interesting question is “How much do
these results depend on the initial allocation of funds in the savings accounts?”
Table 3 summarizes the difference between CPS and ORP for a
selection of starting account allocations using a 5% ROR. The
first column shows the percentage of the one million in savings
allocated to each account. The first row is the 5% ROR scenario
from Table 1.
Allocation
The five scenarios with no Roth IRA balance show efficiencies
that are significantly larger than the rest of the results. ORP takes
full advantage of the strategy of distributing the IRA and after-tax
accounts in parallel to the end of the plan as in the 40/00/60 scenario or depleting the after-tax account near the end of the plan
as in the 60/00/40 scenario. When there is a Roth IRA balance
present then ORP distributes the IRA in parallel with the other
two accounts but depleting the after-tax account before beginning
Roth IRA distributions, similar to the common practice.
Spending - $000
Efficiency
IRA/ROTH/AT
CPS
ORP
%
40/35/25
00/50/50
30/50/20
43
45
45
45
45
46
4.7
0.0
2.2
50/50/00
44
45
2.3
50/30/20
30/00/70
40/00/60
50/00/50
60/00/40
70/00/30
80/10/10
90/10/00
90/00/10
100/0/00
44
33
33
34
36
38
43
42
42
42
45
43
43
43
43
43
43
42
42
42
2.3
30.3
30.3
26.5
19.4
13.2
0.0
0.0
0.0
0.0
Table 3: A Sampling of Initial Account Balances, 5% ROR
Table 4 summarizes spending and efficiency for retirement
accounts of different sizes using the 5% ROR scenario. The first
column shows the dollar amount of the total portfolio, distributed
across the three accounts in the same proportions as the ROR
scenarios.
Beginning
Spending - $000
Balance
1 Million
2 Million
3 Million
4 Million
5 Million
CPS
ORP
43
83
123
163
201
45
89
131
172
214
Efficiency
%
4.7
7.2
6.5
5.5
6.5
Table 4: Different Initial Account Balances, 5% ROR
ORP’s efficiency is not sensitive to the amount of retirement savings.
IRA to Roth IRA Conversions
Discussion
From Table 1
Low IRA initial balance provides low levels of
taxes to work with.
Parallel IRA and Roth IRA distributions at top of
15% bracket until IRA is depleted at age 86.
Large IRA , Roth IRA, and after-tax balances
No Roth IRA. From age 70 (RMD start) ORP
distributes from after-tax and IRA in parallel.
High IRA balances with low after-tax balances
means that small parallel distributions have little
effect.
24
All of the results reported thus far were produced with no IRA
to Roth IRA conversions (conversions). The experiments were
repeated with conversions allowed.
For every pair of scenarios the total amount of nominal spending
increased by less than $1,000. The withdrawal plans differed but
the end results were the same.
For example, the results of both of the two 5% ROR, IRA only,
scenarios (bottom row of Table 3) show a spending level of
$60,000 and a total plan value of $2,629,000. Any improvement
due to Roth conversions was lost in rounding error. Hardly
worth the extra paper work!
An exception was that the zero Roth IRA scenarios in Table
3 showed a $1,000 spending increase when conversions were
allowed.
Figure 5 compares real IRA withdrawals, distributed across the
Federal tax brackets, for the two 5% ROR scenarios, one with no
Roth conversions, the other with conversions allowed.
Early in the no conversion scenario IRA distributions are at the
top of the 0-no tax bracket. The after-tax account supplements
the IRA to meet spending requirements.
In the conversions panel IRA withdrawals for conversions are at
the top of the 10% bracket while the after-tax account contributes to spending. Late in the plan IRA distributions drop back
to the top of the 0-no tax bracket as the Roth IRA supplements
spending.
Less total nominal tax was paid ($21,000 over the entire plan)
when conversions were permitted then when not ($33,000) even
though annual spending was the same. Similar to the Figure 4
discussion we conclude that this is because the reduction in the
IRA balance early in retirement meant lower IRA compounding
of returns throughout retirement. The compounding loss was
offset by the reduction in taxes paid.
Roth conversions may be preferred when factors other than
economics are taken into account; e.g. the anticipation of an
increase in Federal income tax rates or the desire to leave a
substantial estate in a tax free account. Also, the retiree must
assess the effect of income on Medicare premiums, given that
Roth conversions affect annual incomes in each of the income
dependent Medicare premium categories.
Model Validation
Before accepting these results we need some assurance that they
are valid. We validate our programs by comparing CPS and
ORP results for degenerate scenarios and comparing ORP results
to other, independent models of similar purpose.
Degenerate Scenarios
Our degenerate scenario tests are based on a model with the full
$1,000,000 in only one account and with nothing in the other
two accounts. Since there is only one active account there is no
interaction between accounts and the spending values computed
by CPS and ORP should be the same.
Table 5 compares CPS and ORP spending for the degenerate
scenarios.
Active Account
After-tax
Roth IRA
IRA
Spending - $000
CPS
ORP
42
42
46
46
42
42
Table 5: Degenerate Scenario Comparisons, 5% ROR
Figure 5: Nominal Tax Brackets for IRA to Roth IRA Conversion Scenarios, 5% ROR
Volume 14, Issue 1
25
Considering how different CPS and ORP are from each other
(Excel vs FORTRAN) the computed values for the degenerate
scenarios are acceptable.
For the IRA-only scenarios both systems compute personal
income tax on withdrawals. The results indicate that the two
programs’ income tax calculations are consistent.
Compare ORP to Other Models
The second test is to compare ORP’s results to that of other
retirement calculators. This is generally not practical because
conventional retirement calculators do not include progressive
income taxes in their computations. We are aware of four published papers with computational results that can be meaningfully
compared to ORP.
Table 6 compares ORP results to the results of the four other
models. These models are all of the specify-spending-and-compute-the-FTAB variety. We compare ORP to these models by
having ORP assume their computed FTAB along with the term
of their plan, and compute the optimal spending levels to see if
ORP’s ending results compare to the models’ beginning values.
Model
CTM
TE
Reichenstein [2006]
Reichenstein [2013]
Term
FTAB
Years
30
25
30
33
$000
1,608
824
0
0
Conclusion
We have demonstrated that:
•
Linear programming is a credible retirement planning tool.
•
Common practice, as represented by CPS, is an efficient but
suboptimal withdrawal strategy.
•
Minimizing taxes is only part of the optimal schedule. When
higher taxes are paid early in the plan then spending is reduced by reduced account compounding.
•
Optimization improves on common practice, as represented
by CPS, by 3% to 30%.
•
If there is no IRA then there are no income taxes and optimization follows common practice.
•
Optimization shows a significant advantage over the common practice for scenarios with similar IRA and after-tax
account balances but with no Roth IRA.
Spending - $000
Model
ORP
80
60
103
37
78
62
105
34
Table 6: Compare ORP’s Spending to Those of Other Models
CTM is the Comprehensive Tax Model by Sumutka, et al [2012].
CTM assumes a spending rate and computes the maximum
FTAB.
TE is the “Tax-Efficient Retirement Withdrawal Planning model
by Coppersmith and Sumutka [2011]. TE assumes a spending
rate and maximizes the FTAB.
Reichenstein assumes a zero FTAB and computes the age at
which all savings are depleted.
Of course, we could argue that that our comparison validates
these models.
•
Partial IRA to Roth IRA conversion
decisions may be based on considerations other
than plan economics.
Future work may study when to begin Social
Security benefits in the context of optimal
spending. Another interesting topic is to
compare linear, inflation adjusted spending to
a scheme that reflects retirees’ actual spending
patterns.
26
References
Appendix A: Glossary
Coopersmith, Lewis W. and Alan R. Sumutka. (2011). Tax-Efficient Retirement Withdrawal Planning Using a Linear Programming Model. Journal
of Financial Planning, September.
After-tax Retirement Savings Account: Contributions to the
after-tax account can be from any source that has been taxed.
Taxes are paid annually on asset sales’ profits, dividends and
interest. Withdrawals are not taxed. When the IRA withdrawal
exceeds spending, say, due to the RMD, the surplus is transferred
to the After-tax account. Taxes, at the capital gains rate, are assumed to be paid annually, thereby reducing the account’s ROR.
This reduced after-tax ROR is the main reason that both common
practice and ORP distributes the after-tax account first.
Dantzig, George B. (1963). Linear Programming and Extensions. Princeton,
NJ: Princeton University Press.
Horan, Stephen M. (2006). Optimal Withdrawal Strategies for Retirees with
Multiple Savings Accounts. Journal of Financial Planning, November.
Hirshfeld, David S. (1969). Linear Programming Advanced Model Formulation. Management Science Systems Inc.
Orchard-Hays, William. (1984). History of Mathematical Programming
Systems. Annals of the History of Computing, July.
Raabe, William, and Richard B. Toolson. (2002). Liquidating Retirement
Assets in a Tax-efficient Manner. AAII Journal, May.
Ragsdale, Cliff T., Andrew F. Seila, and Philip L. Little. (1994). An Optimization Model for Scheduling Withdrawals from Tax-Deferred Retirement
Accounts. Financial Services Review, 93-108. Retrieved from www.
twenty-first.com/pdf/Ragsdale-An_Opt_Model.pdf
Reichenstein, William. (2006). Tax-Efficient Sequencing of Accounts to Tap
in Retirement. TIAA-CREF Institute Trends and Issues, October.
Reichenstein, William. (2013). How Social Security and a Tax-Efficient
Withdrawal Strategy Extend the Longevity of the Financial Portfolio.
Morningstar. Retrieved from www.socialsecuritysolutions.com/case_coordination.pdf
Saftner, Don and Philip R. Fink. (2004). Review Tax Strategies to Ensure
That Retirement Years are Golden. Practical Tax Strategies, May.
Sumutka, Alan R., Andrew M Sumutka, and Lewis W. Coppersmith. (2012).
Tax-Efficient Retirement Withdrawal Planning Using a Comprehensive
Tax Model. Journal of Financial Planning; April, Vol. 25, Issue 4.
After-tax accounts typically include common stock, which often
pay dividends that are subject to income tax. We assume that
the after-tax account is invested only growth in stocks or mutual
funds which pay insignificant dividends relative to the rest of the
plan. Also, since the after-tax account is drawn down first there
are no dividends later in the plan.
The literature frequently uses the term taxable account for what
we call the after-tax account. In our view all accounts are taxable
because they are taxed either as money enters the accounts or as
it is distributed.
Efficiency: the percentage improvement of one model’s results
over another.
Estate: The plan’s FTAB. This is a non-negative number specified as part of a scenario’s assumptions.
Final Total Account Balance (FTAB): The sum of all three
savings account at the end of the plan. FTAB is also known as
the plan’s estate. The FTAB is a settable parameter. It is set to
zero for the scenarios in this paper. Positive values are required
for comparing ORP to other systems.
Heuristics: business rules used to recommend a decision. The
heuristic of interest here is the common practice for sequencing
of accounts for retirement savings withdrawal.
Illiquid Asset: An asset that can only be sold as a single entity.
A home, business or partnership are examples of illiquid assets.
The proceeds of the sale less capital gains taxes on any profits are
transferred to the after-tax account in the year of the asset sale.
Optimization: finds the “best available” value of some objective
function given a defined domain. For retirement savings distribution the domain is the retiree’s financial situation and choices to
be made. The objective function (economic value) is the amount
of money available for spending. Optimization is the balancing
of asset compounding against minimizing taxes.
Volume 14, Issue 1
Rate of Return (ROR): The profit on an investment expressed
as a percentage of investment’s value.
Required Minimum Distribution (RMD): The RMD is an
amount that the IRS requires be withdrawn from the IRA annually beginning at the age of 70½. It is computed as the IRA account
balance on December 31 of the previous year divided by a life
expectancy value taken from an IRS published table [IRS 2014].
The RMD is recomputed annually with a different life expectancy
divisor. RMD withdrawals cannot be converted to the Roth IRA.
Roth conversion: the partial distribution of funds from the IRA
to the Roth IRA after personal income taxes have been paid.
Roth IRA Retirement Saving Account: Income taxes are paid
on the employment income contributions to a Roth IRA but there
are no taxes on withdrawals. In addition to employment contributions withdrawals from an IRA may be converted to a Roth
IRA after personal income taxes have been paid on the withdrawals. After age 59 ½ withdrawals can be made from the Roth
IRA in any amount without penalty.
27
Appendix B: ORP Calculations
Modeling progressive income taxes in an LP model is straightforward.
ORP maximizes spending. Taxes reduce spending. LP increases spending by reducing taxes. Income subject to income taxes
includes all IRA distributions without regard to their use, i.e.
spending, Roth Conversions, or transfers to the after-tax account.
The optimal solution will assign income to the zero tax bracket
first because it does not affect spending. Taxable income (income
beyond the exemptions and deductions) goes into the 10% bracket, the bracket with the next smallest effect on spending. And
so on up through the brackets. All brackets, except the 39.6%
bracket, have an upper limit on how much money can be assigned
to them. We use the 2014 tax tables in all income tax calculations.
ORP and CPS use the same account arithmetic:
Simulator: imitates a heuristic’s behavior over time.
1. Account balances are reported as of the end of the age year
after the year’s distribution and compounding.
Spending: the amount of money, after taxes, available for retiree
consumption expressed in today’s dollars. Spending is money
that leaves the model. ORP balances tax minimization against
maximization of asset returns to maximize spending.
2. The account balance as of the beginning of the year is the
account balance at the end of the previous year.
Tax-deferred Retirement Savings Accounts (IRA): There are
no income taxes on employment earnings contributed to the IRA
but all withdrawals are taxed as personal income. This type of
account includes IRA, 401k, 403b and a variety of others, all of
which are generically equivalent for purposes of this study. The
term IRA is used to denote the collection of these accounts since
most are converted into an IRA before or at retirement. After
age 59 ½ withdrawals can be made from the IRA in any amount
without penalty.
Withdrawal Plan: The amount of money withdrawn from each
account each year. The plan includes money used for taxes, Roth
conversions, spending, and the FTAB.
3. Withdrawals are made at the end of the year after the account
has been credited with its annual returns.
4. Contributions and Roth conversions are made at the end of
the year.
5. A year’s investment return is at the end of the year. The
year’s ending balance is computed as:
(1+ROR) * beginning balance – distribution.
This is the previous year’s ending balance increased by the
account’s ROR prior to making distributions.
6. Taxes are paid for with account withdrawals and not Social
Security payments.
28
Exploring the Antecedents of Financial Behavior for
Asians and Non-Hispanic Whites:
The Role of Financial Capability and Locus of Control
John E. Grable, Ph.D., CFP®,
Athletic Association Endowed Professor of Family and Consumer Sciences, University of Georgia
So-Hyun Joo, Ph.D.,
Professor, Division of Consumer Studies, Ewha Womans University1, South Korea
Jooyung Park, Ph.D.,
Professor in Consumers’ Life Information, College of Human Ecology,
Chungnam National University, South Korea
Abstract
Using data collected over a three-year time span (2008 through 2011), this paper
examines the association between racial background and financial behavior. This study
specifically evaluated differences between Asians and non-Hispanic Whites living in the
United States (N = 341). Findings from this research suggest that any racial differences
in financial behavior appear to exist only in a two variable correlational sense. Both
financial capability and locus of control act as mediators between race and financial
behavior. In general, those with high financial capability tend to exhibit better financial
behavior. Additionally, individuals who exhibit an internal locus of control perspective
also report better financial behavior. Age was also found to be positively associated
with better financial behavior. When these factors were controlled for in a multivariate
analysis, no meaningful racial differences were noted in this study.
Key Words: Financial Capability, Locus of Control, Financial Planning, Financial
Behavior, Racial Differences
1
Contact: Professor, Ewha Womans University, Seoul, Korea. Email: sohyunjoo@ewha.ac.kr
Volume 14, Issue 1
29
Introduction
What are the antecedents of financial behavior? This is a question that has shaped the careers of many economists, as well as
researchers interested in personal and household finance topics.
Pursuit of an answer to this question has created a vast body of
literature showing that, in many ways, the strongest predictor of
financial behavior is a person’s financial capability. For many,
this association has led to an acknowledgment that financial
knowledge—an indicator of capability—and financial education
are key factors that allow “individuals and families to accumulate assets and achieve their financial goals.”1 This quote, from
Charles Evans, the CEO and President of the Federal Reserve
Bank of Chicago, hints at the notion that financial behavior can
be influenced through interventions that improve financial capabilities. Financial capability, as used in this study, refers to ‘possessing the knowledge on financial matters to confidently take
effective action that best fulfils an individual’s personal, family
and global community goals’ (National Financial Educators
Council, n.d.). Although there are a few studies that show otherwise, nearly all reports indicate support for concluding financial
capability and financial behavior are positively linked. Individuals who exhibit the best financial behavior almost always possess
high levels of financial capability (Fonseca, Mullen, Zamarro, &
Zissimopoulos, 2012; Perry & Morris, 2005).
One may conclude that after more than 50 years of study, the
answer to what shapes financial behavior—beyond financial
capability—would be adequately addressed in the literature. In
many respects, this is true. Factors such as income, age, education, race, and certain personality factors are thought to influence
the manner in which people evaluate behavioral choices within
the financial marketplace. What is most interesting, however,
is the growing realization that there may be other issues at play
when people conceptualize financial behavioral choices.
Consider reports of racial differences in financial behaviors. The
literature is replete with reports that non-Hispanic Whites tend
to exhibit better financial behavior than others. It is no surprise
then that policy makers, educators, and concerned citizens have
increasingly allocated resources, both monetary and human, to
facilitate and disseminate broad based financial education, especially to populations typically underserved by financial institutions. Take, for example, the growth of financial literacy centers,
clinics, and inner-city asset building programs. The goal of such
initiatives is simple; namely, to provide access to free or low cost
financial education and information to underrepresented individuals and families as a mechanism to increase financial capability.
Nevertheless, if asked, many financial counselors and educators
are quick to acknowledge that sometimes the neediest are the
least likely to seek financial education. It is more common for
individuals with already high levels of financial capability to
be the ones who attend educational meetings. Sometimes these
“help-seekers” are looking for behavioral confirmations (Grable & Joo, 1999). That is, they think their behavior is properly
1 Quote available at the Financial Literacy and Economic Summit, 2012,
website: http://www.practicalmoneyskills.com/summit2012/
directed, but they want a free or low cost second opinion that
supports their current saving and spending activities. Others attend as a social activity—a place to meet people, receive refreshments, and gather handouts. When viewed globally, help-seekers
make up, at most, 40% to 45% of the population (Grable & Joo,
1999; 2001).
Rarely do individuals and families pro-actively seek financial
counseling, planning, or education on a voluntary basis. It is
unusual for the most financially needy to seek help from professional advisers or educators (Grable & Joo, 2001). This might
stem from cultural or societal barriers that make help-seeking
behavior uncommon. The lack of educational-seeking behavior might also be attributable to low levels of knowledge (Lee,
1997). Another possible explanation may be that some individuals feel that their financial fate is beyond their control, and as
such, they do not feel compelled to improve either their level of
financial capability or behavior. In other words, some individuals may believe in fate, luck, and fortune to such an extent that
they see no need to improve their financial capability as a way
to enhance their financial situation. Those with an external locus
of control perspective (e.g., believing in luck and fate) might
believe that their financial future is already predetermined, and
as such, conclude that their ultimate behaviors are unchangeable.
While much of the previous literature has described racial differences in financial behaviors, little research has been devoted
to explaining such differences. As discussed later in this paper,
it is reasonable to hypothesize that variances in behavior may
be associated directly with psychosocial variables and financial
capability. It is also possible that indirect effects also explain
some differences in behavior. As such, this paper was developed with the following intentions. Tests were first conducted
to confirm that financial capability, locus of control, and racial
background are associated with financial behavior among Asians
and non-Hispanic Whites. In this study, financial capability is
most closely aligned with the concept of self-assessed financial
knowledge, whereas locus of control refers to the extent to which
someone believes they can control life events and outcomes.
Second, evaluations were made to examine the possibility that
financial capability and locus of control mediate the association
between race and financial behavior. This research advances the
literature in two important ways. At a basic level, results add further support to the notion that financial capability and financial
behavior are positively associated. At a deeper level, findings
indicate that both financial capability and locus of control likely
play an important role in explaining the relationship between
race and financial behavior.
Review of Literature
The Race-Financial Behavior Association
A notable variable commonly found to be associated with
financial behavior is racial background. The general evidence
indicates that there are distinct differences between non-Hispanic
30
Whites and others in terms of financial behavior (Lyons, Rachlis,
& Scherpf, 2007; Lusardi & Mitchel, 2007; Lusardi, Mitchell, &
Curto, 2010). Non-Hispanic Whites tend to exhibit better financial behavior (e.g., management of debt, secured and unsecured
loans, and daily money tasks) (FINRA, 2013) compared to other
racial groups. Much of the research showing racial differences
has tended to focus on African-American populations compared
to non-Hispanic White populations. There have been fewer
studies that compare non-Hispanic White and Asian populations.
One such study was conducted by Grable, Park, and Joo (2009).
They replicated an earlier study by Perry and Morris (2005) in
an effort to address this deficiency in the literature. They found
that, similar to other racial comparisons, Asians and non-Hispanic Whites differ in terms of both financial behavior and financial
knowledge. Several explanations have been proposed to explain
why racial differences should have an impact on financial behavior. The most common framework used to describe dissimilarities relates behavioral outcomes to minority groups in the United
States having fewer assets, lower incomes, and less access to
financial services (Coleman, 2003; Kim, Chatterjee, & Cho,
2012). This is known as the resource deficit hypothesis. The hypothesis leads to the conclusion that, to some extent, the cultural
orientation of minority groups is one that limits the transference
of financial capabilities and skills from one generation to another
(Gutter, Fox, & Montalto, 1999).
Although the resource deficit explanation is widely articulated,
some (e.g., Phares, 1976) have noted that this thinking can lead
to research that is stereotypical. For example, while the resource
deficit hypothesis may be true for some racial groups, it may not
be fully applicable to Asians living either in the United States
or away from their country of origin. It is equally plausible that
there are cultural preferences that account for differences in
financial behavior. Alternatively, it is possible that race is only
significant in a two variable correlational sense. If this is true,
then other factors may work to mediate the effect of race on
financial behavior. This possibility is explained in more detail
below. Initially, however, this research proposes the following
hypothesis:
H1: Non-Hispanic Whites and Asians will exhibit
divergent financial behavior.
The Financial Capability-Behavior Association
Perry and Morris (2005) were among the first to document, within a multidimensional model, the role played by a person’s financial capabilities in shaping financial behavior. They found that
the propensity to save, control spending, and budget, among a
diverse population of Americans, was positively associated with
financial capability. Their research supported a similar finding
reported by Hilgert, Hogarth, and Beverly (2003). More recently,
Robb (2011) found that financial capability is an important factor
that influences college students’ credit card practices.
Experiential learning has been shown to be the most effective
method for achieving some degree of financial capability for the
average person (Hogarth & Hilgert, 2002). This is one reason
formal financial education has been touted as a key element in
improving financial outcomes. It is important to note, however,
that some have questioned the effectiveness of formal education.
Mandell and Klein (2009) found that high school students who
had taken a personal financial literacy course did not demonstrate
better financial behavior than those who did not take a course.
They used their insights to question the long-term effectiveness of
high school financial literacy programs. Although the largest part
of the literature suggests a positive association between capabilities and behavior, there is, as Mandell and Klein noted, active
debate regarding the true validity of the relationship. This paper
adds to the debate by testing the following hypothesis, which is
similar to one proposed by Perry and Morris (2005):
H2: Financial capability will be positively associated with better financial behavior.
There is evidence to indicate that financial capability may
also serve as a mediating factor when people evaluate and
engage in financial behavior (Chan, Burtis, & Bereiter, 1997;
Lopez-Cabrales, Perez-Luno, & Cabrera, 2009). Rather than
assume that financial behavior is directly associated with racial
differences, the existing literature hints at the possibility that
financial behavior may really be associated with different levels
of financial capability among different racial groups. As such,
the following hypothesis was proposed:
H3: Financial capability will mediate
differences in financial behavior between nonHispanic Whites and Asians.
The Locus of Control-Financial Behavior Association
As discussed in the introduction to this paper, locus of control
(LOC) has been shown to be associated with financial behavior. Rotter (1966) defined LOC as a psychosocial construct that
captures beliefs about the causes of punishments and rewards
experienced by an individual. LOC is typically measured on a
continuum, with two extremes. On one end is an internal LOC
perspective. Those with internal LOC associate life outcomes
with their own skills, abilities, and actions. That is, they assume
that outcomes are predictably based on personal efforts, skills,
and motivations. External LOC falls on the other end of the continuum. An external LOC perspective is represented by a belief
that luck, fate, chance, and the influence of powerful outside influences dictate life outcomes. Those with an external LOC often
view the role of skill and motivation in determining behavioral
outcomes as less important (Zimmerman, 1995). There is evidence to suggest that LOC is associated with financial behavior.
Davies and Lea (1995) noted in their study that external LOC
was related to the accumulation of debt, whereas Perry and Mor-
Volume 14, Issue 1
ris (2005) found a negative association between external LOC
and a person’s ability to save, budget, and control spending. It is
also possible that LOC acts not only as a direct factor influencing financial behavior, but also as a mediating characteristic.
In order to fully appreciate the potential role of LOC in shaping
behavioral outcomes, both directly and indirectly, it is useful to
understand the theoretical underpinnings of the LOC construct.
According to Phares (1976), the concept of LOC emerged from
tests of Social Learning Theory (SLT). SLT was developed as a
means to explain how individuals make choice decisions. The
theory is premised on six core assumptions: (a) the unit of study
is the interaction of a person in his/her meaningful environment;
(b) biological determinants of behavior are less important than
learned determinants; (c) over time, a person’s personality and
behavior stabilize; (d) behavior is determined by both specific
and general determinants; (e) behavior is goal-oriented and
motivated; and (f) both expectancies and reinforcement play key
roles in shaping behavior.
The general consensus among personality researchers is that LOC
is most effective in explaining behavior that is somewhat ambiguous in terms of situational cues. This is certainly the case with most
forms of financial decision making. That is, rarely are consumers
provided with direct instructions for use in solving complex financial questions or when making financial decisions. Phares (1976)
reported that researchers and clinicians should expect those with
an internal LOC perspective who feel that they have some control
over behavioral outcomes to engage in more information and help
seeking compared to those with an external LOC. As more information is obtained and integrated into decision-making processes
(e.g., past experiences, expectation generalizations, and behavioral
reinforcements), it is more likely that those with an internal LOC
will be better able to distinguish between optimal and sub-optimal
choice alternatives. In other words, an internal LOC perspective
should be associated with positive financial behavior. As such, the
following hypothesis was tested:
H4: Internal LOC will be positively associated with
better financial behavior.
Additionally, it is important to assess whether LOC might
also play an indirect role in shaping behavioral choices. Those
holding an external LOC orientation, for example, often use this
perspective as a mechanism to “protect themselves from anticipated failure or other personal inadequacies” (Phares, 1976, p.
144). This may be a learned response. Some racial groups, for
instance, have traditionally had less access to power, economic
mobility, and human capital resources than others. Some have
argued that this historical background tends to create a world
view that is defined by an external LOC perspective. What is
most interesting, however, is that holding an external LOC view
is not always associated with lower social and/or socioeconomic
status. In what has since become a seminal piece, Hsieh, Shybut,
and Lotsof (1969) compared LOC profiles of non-Hispanic
White American children attending school in Illinois, Asian
31
children born in the United States (i.e., Asian-American) going
to school in Chicago, and Asian children enrolled in a Hong
Kong school. They found that the non-Hispanic White children
were the most internal, whereas the Hong Kong children were
the most external. The Asian-American children fell in between.
They attributed these differences primarily to learned cultural
differences. Non-Hispanic White Americans tend to hold a social
perspective that highly values independent thought and action,
whereas Asians have a tendency to be situation-oriented basing
decisions on kinship. Further, a status-quo bias appears to be
present in most Asian cultures, as does a strong belief in chance,
fate, and luck (Grable et al., 2009).
Using SLT as a guide, it is possible then that biological determinants, such as race, may only appear to be directly associated
with financial behavior. The direct relationship between race and
financial behavior may be mediated by LOC, with those holding
an external LOC exhibiting worse financial behavior. This possibility was tested with the following hypothesis:
H5: LOC will mediate differences in financial
behavior between non-Hispanic Whites and
Asians.
Methods
Data for this study were obtained over a multi-year period by
combining information from three distinctive financial attitude
and behavior surveys. The research team was the same for each
of the surveys, which were approved by the principal investigator’s IRB university office. The purpose of each survey was
different, and as such, the respondents to each investigation were
unique. One survey, for example, was focused on assessing marital and financial attitudes among individuals. Another survey
was developed to evaluate resource acquisition behavior among
low income households. The third survey was developed to
evaluate financial decision making among consumers. The only
similarities among the surveys were the questions from which
data were obtained for use in this study.
The data represent information obtained from consumers living
throughout the United States between 2008 and 2011. Given
the research questions underlying this research, the sample
was weighted to over-represent non-Hispanic Asian and other
non-Hispanic White respondents. It is important to note that
while the sample was appropriate for this exploratory study, it
was not necessarily representative of the U.S. population. Data
were collected using both paper-and-pencil and online survey
methods, with both questionnaire types containing the same
questions. In total, 1,000 surveys were distributed. In total,
341 non-Hispanic White and non-Hispanic Asian individuals
responded to the three surveys. Among those who completed
the questionnaires, 69% were female, with a mean and standard
deviation age of 38.71 and 13.85 years, respectively. Twenty-nine percent of respondents were non-Hispanic Asian, with
the remainder being classified as non-Hispanic White. Although
32
limited, respondents were grouped together without regard
to their familial country of origin. Among the non-Hispanic
Whites, for instance, it is possible that a wide number of cultural
backgrounds were represented. Similarly, Asians were categorized as being non-Hispanic and as a group rather than through
national differentiation. Given the diverse nature of the surveys,
it was not possible to match other respondent demographic data.
Non-Asians and those who were not non-Hispanic Whites were
excluded from the study.
The variables of interest in this study were financial capability,
financial behavior, and LOC. The measures used to assess these
constructs were adopted from Perry and Morris (2005). Financial
capability in this study was measured with subjective evaluations on a five-item financial capability measurement. Responses
were combined into a summated capability scale. The items
were introduced as follows: “How much do you know about the
following?” Choice options included: (a) Interest rates, finance
charges, and credit terms, (b) Credit ratings and credit files, (c)
Managing finances, (d) Investing money, and (e) What is on
your credit report. A five-point Likert-type scale was used, with
“nothing” coded 1 and “a lot” coded 5. A range from 5 to 25 was
possible, with higher scores representing more financial capability. In this study, the mean score was 17.74 (SD = 4.46).The
scale’s Cronbach’s alpha was .78.
Financial behavior was measured with five items that were combined into a summated scale. The question was asked as follows:
“How do you grade yourself in the following areas?” (a) Controlling my spending, (b) Paying my bills on time, (c) Planning
for my financial future, (d) Providing for myself and my family,
and (e) Saving money. A five-point Likert-type scale was used,
with “poor” scored as 1 and “excellent” scored as 5. A range
from 5 to 25 was possible, with higher scores indicative of better
behavior. The average score was 18.54 (SD = 3.78). The scale’s
reliability, as measured with Cronbach’s alpha, was .87.
LOC, as defined by Perry and Morris (2005), was assessed using
seven items measured on a five-point Likert-type scale, with 1=
almost never and 5 = almost always. The question was asked as
follows: “How often do you feel?” (a) There is really no way I
can solve some of my problems, (b) I am being pushed around in
life, (c) There is little I can do to change the important things in
my life, (d) I can do anything I set my mind to, (e) What happens
to me in the future depends on me, (f) Helpless in dealing with
the problems in life, and (g) I have little control over the things
that happen to me. Answers to questions (d) and (e) were reverse
coded. Scores were summed into a LOC scale, with higher
scores representing an external LOC perspective. The average
score was 13.07 (SD = 4.49). Using a possible range of 5 to 35,
the sample was almost evenly split between internal and external
LOC. The scale’s Cronbach’s alpha was .85.
Other variables included in the analyses were coded as follows:
respondent sex was coded 1 = male, 0 = female; age was coded
in years as reported by respondents; racial background was coded 1 = Non-Hispanic White, 0 = non-Hispanic Asian (i.e., Asian
in this study).
Data Analysis Methods
Given the specific research questions of interest in this study, the
following data analysis tools were used to evaluate the study’s
hypotheses: (a) Spearman’s Rho correlations, (b) t-tests, (c) an
ordinary least squares (OLS) regression, and (d) Sobel mediation
tests. Results from the tests are reported below.
Results
Table 1 shows correlation estimates among the key variables
of interest in this study. As expected, financial capability and
financial behavior were found to be statistically significantly
associated. Having an external LOC perspective was negatively
associated with both financial capability and financial behavior.
It was determined that men were more likely to hold an external
LOC perspective. Age was found to be positively associated with
financial capability and financial behavior, but negatively associated with external LOC. As expected, non-Hispanic Whites held
an internal LOC perspective compared to Asians, and they were
more knowledgeable and demonstrated better financial behavior.
Volume 14, Issue 1
FC
FB
LOC
Sex
Age
Non-Hispanic White
Asian
1.00
0.38**
-0.24**
0.02
0.18**
0.26**
-0.26**
1.00
-0.30**
1.00
-0.02
0.16**
0.23**
-0.03
0.19** -0.46**
-0.19** 0.45**
1.00
-0.01
-0.35**
0.35**
1.00
-0.07
0.07
1.00
n.a.
Asian
Non-Hispanic White
Age
Sex
Locus of Control (LOC)
Financial Behavior (FB)
Financial Capability (FC)
33
1.00
Note: *p< .05 **p< .01
Table 1: Correlation Coefficients among Key Variables (N = 333)
The correlation results reported in Table 1 were useful in describing basic associations between and among variables. As
expected, these bivariate results matched, in general, the working assumptions in the literature. Table 2 extends the analysis by
comparing non-Hispanic Whites and Asians in terms of financial
capability, financial behavior, and LOC. Results indicate that
non-Hispanic Whites exhibited better financial behavior than
Asians. Non-Hispanic Whites also had a higher level of financial
capability than Asians, but they scored lower in external LOC.
Variables
Non-Hispanic Whites
(N=239)
Financial Behavior Score
Financial Capability Score
LOC
19.00 (3.74)
18.49 (4.38)
11.77 (3.88)
Asians
t
(N=100)
17.45 (3.66)
15.93 (4.15)
16. 31 (4.27)
3. 50**
4. 97***
-9.41***
*p< .05 **p< .01 ***p< .001
Table 2: Descriptive Statistics of Financial behavior,
Financial Capability, and LOC for Non-Hispanic Whites and Asians
A regression model was developed to examine the relationships
among financial capability, LOC, race, and financial behavior.
The primary purpose behind the use of the regression was to
confirm, in a basic multivariate model, that these variables were
directly associated with financial behavior. Age and gender were
controlled in the model. Although non-Hispanic Whites were
found to report better financial behavior in the bivariate analyses,
the relationship between these two variables was not statistically
significant when controlling for the other variables in the model
(Table 3). Based on the regression results, only partial support
was noted for Hypothesis 1. Financial capability was found to be
positively associated with financial behavior, holding all other
factors constant. Given this result, Hypothesis 2 was accepted.
34
Variable
Parameter
Standard
t Value
Standardized Estimate
Gender
Age
Financial Capability
LOC
Non-Hispanic White
Constant
Estimate
0.153
0.043**
0.244***
-0.190***
0.107
14.877***
Error
0.433
0.014
0.045
0.048
0.499
1.251
0.353
3.098
5.436
-3.992
0.215
11.894
0.433
0.014
0.045
0.048
0.499
Table 3: OLS Regression Results Showing Independent
Variable Effects on Financial Behavior
Note: F5, 324 = 17.63*** R2 = .214
*p< .05 **p< .01 ***p< .001
Information regarding Hypothesis 4 is also shown in Table 3.
Internal LOC was found to be associated with better financial behavior. As hypothesized in this study, those with an internal LOC
(i.e., low scale scores represent an internal LOC) were found to
report better financial behavior. Demonstrating an external LOC
perspective was shown to be related to worse financial behavior.
As such, the hypothesis was accepted.
Preacher and Hayes’s (2004) criteria for estimating mediation, using B
Preacher and Hayes’s (2004) criteria for estimating mediation,
using Baron and Kenny’s (1986) Sobel test procedures, were
Sobel test procedures, were used in this study as described below:
used in this study as described below:
(1)(1)
Y = 𝑖1 +𝑐𝑋
𝑀 = 𝑖2 +𝑏𝑋
(2)
(2)
𝑌 = 𝑖3 +𝑐′𝑋+𝑏𝑀 (3)(3)
Hypotheses 3 and 5 proposed that financial capability and LOC
mediate the association between race and financial behavior. A
where:
where:
mediation model (Figure 1) was developed to test these hypotheses. As shown in Figure 1, X represents race, M is financial
Y = outcome variable
capability or LOC, and Y is the outcome variable financial
Y = outcome variable
behavior. The linkage between X and Y is the direct effect of
X = independent variable
race on financial behavior. The effect of X on Y, through M, is
X = independent variable
, (3) M must
and (4)
mustfor
significantly
Y controlling
for X (i.e., b≠
M = mediating variable
the predict
indirectY,effect.
InMorder
mediation predict
to occur,
four criterion
must exist concurrently: (1) X must predict M, (2) X must predict
M = mediating variable
dition to these
mediation
rules,
the (4)
predicted
coefficient
for Xpredict
must be
i = intercept coefficient
Y, (3)four
M must
predict
Y, and
M must
significantly
Y smaller in
controlling for X (i.e., b 0). In addition to these four mediation
i Results
= intercept
coefficient
n (model) 4 than in condition (model) 2 and Y must not be a cause of M. For the
from the mediation tests are shown in Tables 4
rules, the predicted coefficient for X must be smaller in condition
and 5. Each mediation criterion has been matched to a model in
(model)
4 than
conditionusing
(model)
2 and Yleast
mustsquares
not be regression
a cause
of this test,
each path
wasinmeasured
an ordinary
the table. As shown in Table 4, the direct and total effect of race
of M. For the purposes of this test, each path was measured using
on financial behavior when controlling for LOC was not signifan ordinary least squares regression procedure.
e.
icant. A post-hoc analysis, as indicated by Hayes and Preacher
(2009), was used to estimate the effect size of the indirect effect.
c
X
Y
A bootstrap (n = 3,000) estimation procedure (see Hayes, 2012)
was employed to calculate confidence intervals for the indirect
effect. Based on a 95% confidence interval and the Sobel test
M
results (sab = 1.023, p < .001), confirmation was obtained for the
mediation effect of LOC on financial behavior for race. Addib
a
tionally, a relatively high effect size was noted (.958). Based
on these results, Hypothesis 5 was accepted. That is, LOC was
X
Y
c’
found to mediate the effect of race on financial behavior.
: Hypothesized
Mediation
EffectMediation
of FinancialEffect
Capability
and LOC on Financial
Figure 1:
Hypothesized
of Financial
Capability and LOC on Financial Behavior
r
reacher and Hayes’s (2004) criteria for estimating mediation, using Baron and Kenny’s
obel test procedures, were used in this study as described below:
𝑋𝑋
+𝑏𝑏� (2)
(1)
Volume 14, Issue 1
Model 1
Model 2
Model 3
35
Independent Variables
Dependent Variables
Coefficients
Race (Non-Hispanic Whites)
Financial Behavior
LOC
Financial Behavior
1.653***
-4.558***
.621
LOC
-.226***
Note: *p< .05 **p< .01 ***p< .001
Table 4: Mediation Test of Financial Behavior as a
Function of Race and LOC
A similar mediation test was developed to test Hypothesis 3.
As shown in Table 2, the financial capability of non-Hispanic
Whites and Asians was different. It was proposed that differences in financial capability may mediate the effect of race on
financial behavior. This proposition was tested using the same
procedure described above (Preacher and Hayes, 2004). Table
5 shows the mediated effect of financial capability on race and
financial behavior. As presented in the table, the direct effect of
race on financial behavior was insignificant when controlling for
financial capability. A Sobel test (sab =.781, p < .001) and bootstrapping procedure, similar to the method used with the LOC
mediation test, confirmed the significant indirect effect.
Model 1
Model 2
Model 3
Independent Variables
Dependent Variables
Coefficients
Race (Non-Hispanic White)
Financial Behavior
Financial Behavior
1.588***
2.574***
.808
.303***
Table 5: Mediation Test of Financial Behavior as a
Function of Financial capability and Race
Discussion
Note: *p< .05 **p< .01 ***p< .001
Hypothesis
H1: Non-Hispanic Whites and Asians will exhibit divergent financial behavior.
Results
Partially Accepted
H2: Financial capability will be positively associated with better financial behavior. Accepted
H3: Financial capability will mediate the association between race (Non-Hispanic Accepted
Table 6 summarizes the results from this study.
Each of the hypotheses was supported, with the
White and Asian) and financial behavior.
exception that Hypothesis 1, which stated that
H4: Internal LOC will be positively associated with better financial behavior.
Accepted
non-Hispanic Whites and Asians would exhibit
H5: LOC will mediate the association between race (Non-Hispanic White
Accepted
divergent financial behavior. Hypothesis 1 was
and Asian) and financial behavior.
only partially supported. Behavioral differences
were noted in the bivariate analysis; however,
the difference was diminished when LOC and
Table 6: Summary Results from the Hypothesis Tests
financial capability were controlled for in the
multivariate analysis. When taken together, these findings are
noteworthy. Results confirm several associations commonly
The key findings from this study, however, are related to the
reported in the literature; namely, individuals with higher levels
relationship between race and financial behavior. In a simple
of financial capability, regardless of age, gender, or racial backtwo variable bivariate sense, non-Hispanic Whites appear to
ground, exhibit better financial behavior. Additionally, LOC apmanage their financial behavior better than Asians. However, all
pears to be associated with both financial capability and financial
racial differences disappear when LOC and financial capability
behavior. Individuals who hold an internal LOC view reported
are accounted for in a more robust model. The mediation tests
being more capable in relation to their financial situation. They
illustrate something even more important. What really appears
also engaged in better financial behavior than those with an exto matter, when shaping financial behavior, is LOC and finanternal LOC. Although not tested directly, older respondents were
cial capability for Asians and non-Hispanic Whites. Individuals
found to exhibit better financial behavior as well.
36
holding an internal LOC perspective are predicted to report
better financial behaviors than others, regardless of their racial
background. In addition, those who are financially capable are
also predicted to exhibit better financial behavior. Results from
this study support a core assumption within SLT; namely, learned
perspectives appear to be more important than some biological
determinants when people are faced with ambiguous choice
dilemmas.
Results from this study suggest that some behavioral differences
between Asians and non-Hispanic Whites are likely a result of
variations in LOC, rather than being strictly a racial differentiation. Because holding an external LOC is associated with
worse financial behavior, it is no surprise that Asians exhibited
more problematic behavior. This leads to an important question;
namely, can LOC be altered. Regarding the malleability of LOC,
the answer to this question, unfortunately, is complicated. As
described within SLT, the ability of some individuals to change
perceptions, viewpoints, and belief systems tends to diminish
with age. If one acknowledges this, but focuses instead on factors that affect controllability perceptions, the evidence clearly
suggests that LOC can be altered (see Phares, 1976). In other
words, it is possible with effort and guidance, for a person to
move along the continuum of control from external to internal.
If it is assumed that both financial capability and LOC can be
changed (albeit less dramatically as a person ages), then the
question becomes how to bring about change in the most resource effective manner possible. Consider a recent, and widely
quoted, review paper by Willis (2008-2009). She concluded that
financial education does not increase capabilities, but rather confidence. Willis argued that enhanced levels of confidence likely
work against the interests of consumers by tricking those who
are confident into making problematic consumer finance choices.
Willis based many of her conclusions on primary research
published by Mandell and Klein (2007) who noted that among
young people who participated in Jump$tart programs, financial capabilities were not strongly related to financial practices.
Further, and maybe more importantly, Mandell and Klein found
that playing a stock market game was highly associated with
financial capability scores and financial outcomes. They hypothesized that the stock market game might be more effective, as
compared to traditional education interventions, because participants find games to provide intrinsic motivation to learn about
personal finance topics. Might there be another explanation as
well? It is important to note that neither Willis nor Mandell and
Klein were able to control for important psychosocial characteristics when evaluating the effectiveness of financial literacy
programming due to limitations in the Jump$tart dataset. We
believe that had the study accounted for LOC, as suggested in
this study, the modest associations between financial education
and behavior might have been different. Specifically, as shown
in this study, LOC appears to have both a direct and mediating
effect on financial behavior. The stock market game may be
perceived by young people as a game with learned patterns and
outcomes. These patterns are reinforced with immediate feedback. Although most educators would likely argue that the game
is random and something that encourages risky choices, players
may adopt a gambler’s fallacy mentality when playing. That is,
the game may provide an illusion of controllability and stability that helps engender an internal LOC perspective, especially
when the game’s outcomes are positive. Further, the game may
tap into a preference among some with an external LOC for
learning scenarios that have inherent aspects of luck, fate, and
chance. If a sizable portion of the population shares an external
LOC perspective, it is no surprise that education received via a
randomized (non-skill based) game would appeal to players and
provide a long-lasting knowledge and behavioral impact.
How might results from this study impact financial education?
To begin with, the results indicate that financial capability
is positively associated with financial behavioral outcomes.
Also, having an external LOC outlook appears to be negatively
related to positive financial behavior. Additionally, the evidence
suggests that both of these variables mediate the association between race and financial behavior. If true, then it behooves financial counselors, planners, and educators to incorporate games,
assignments, and simulations that might appeal to those with
an external LOC into educational programming. Rather than
assuming that a well-designed educational program focused on
information, handouts, calculators, and traditional tools preferred
by those with an internal LOC is appropriate for all audiences, a
better alternative may involve assessing the control preferences
of each audience or educational needs of a given population.
Additionally, results from this study provide an additional reason
to reconsider the role of LOC in personal and household finance
research. Researchers and educators who have an interest in
helping improve the financial outcomes of consumers should
consider designing and testing creative ways to alter consumer
perceptions of financial behavior. If the typical consumer today
feels that behavioral outcomes associated with financial decisions are somewhat random and beyond their control, then it is
unlikely that the consumer will either seek additional information or attempt to improve their behavior. On the other hand,
if consumers can be shown ways to develop reasonable goal
orientations and methods to reinforce the association between
personal decision-making effort in such a way that outcomes are
measureable and meaningful, then SLT predicts that behavioral
change is possible.
While the results from this study provide an explanatory insight
into racial differences in financial behavior, it is important to
interpret results within the context of methodological and sample
limitations. This paper used a limited dataset. It was not possible, for example, to know whether respondents in the sample
were native born, immigrants, or students. Further studies should
attempt to segment survey respondents by residency status and
regional background. Other important determinants of behavioral intentions and actions were not available in the dataset. While
the mediation test results will not be impacted by the inclusion
of other variables, a more encompassing regression analysis certainly would be. Future research, therefore, should be conducted
to confirm that basic direct associations between and among
Volume 14, Issue 1
37
racial background, LOC, and financial capability and financial
behavior, controlling for other demographic and socioeconomic
characteristics, hold true. Additionally, additional research is
needed to help clarify whether variables, such as education and
income, also mediate the relationship between racial background
and financial behavior. Based on this and future studies, it may
be possible to move discussions regarding financial behavior
away from purely descriptive studies to ones that focus on explaining financial behavior.
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38
The Greatest Wealth is Health:
Relationships between Health and Financial Behaviors
Barbara O’Neill, Ph.D., CFP®, CRPC, AFC, CHC, CFEd, CFCS, Extension Specialist in Financial
Resource Management, Distinguished Professor, Rutgers Cooperative Extension
Abstract
Financial advisors are encouraged to consider their clients’ health and personal finances
holistically. Strengths and challenges in one area of a client’s life often affect the other.
Like culture, health status is another “lens” with which to assess clients’ values, goals,
plans, personality traits, and lifestyle. This article was written to increase advisors’
understanding of relationships between health and financial practices. When advisors
understand a client’s personality traits and projected state of future health, they can
provide more comprehensive, targeted advice instead of giving the same advice to
clients in different situations. The article begins with a review of recent literature and
describes two personality factors found to be associated with positive health and financial
behaviors: conscientiousness and time preference. Next, it previews a new online tool to
self-assess the frequency of performance of recommended health and financial practices.
It concludes with a summary and implications for financial planning practice.
Volume 14, Issue 1
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Introduction
More than 2,000 years ago, the ancient Roman poet Virgil was
quoted as saying “The greatest wealth is health.” As any financial advisor can attest, accumulated wealth is of little value
if someone is unhealthy and unable to enjoy it. In a special
edition about health care, Money magazine encouraged readers
to maintain their “health capital,” noting “Poor health carries a
huge opportunity cost. After all, you can’t save if you can’t earn,
and you can’t earn without your health” (Schurenberg, 2007, p.
18). Unfortunately, about 69% of the U.S. population is either
overweight or obese (Obesity and Overweight, 2014) and some
people sacrifice their health in the pursuit of wealth. They fail
to take positive actions on a daily basis such as eating nutritious
meals and engaging in physical activity and their health and personal finances suffer accordingly. Poor financial practices, such
as overspending, have been found to be associated with physical symptoms of stress (Drentea & Lavrakas, 2000; O’Neill,
Sorhaindo, Xiao, & Garman, 2005) and, conversely, poor health
practices such as overeating and smoking engender associated
financial costs to both individuals and society. The cost of preventable direct health care costs resulting from bad health habits
is immense and estimated at $133 billion for smoking (Smoking
and Tobacco Use, 2014) and $147 billion for obesity (Causes
and Consequences, 2014). Other “issues” such as direct costs
associated with alcohol abuse just increase the total further. Poor
health also affects individuals and families by draining funds that
could otherwise be used for wealth accumulation and financial
goal attainment.
Give a multitude of associations between health and personal
finances (Hollerich, 2000; O’Neill, 2004; O’Neill, 2005; O’Neill
& Ensle, 2013; O’Neill & Ensle, 2014; Sharpe, 2008), financial
advisors are encouraged to consider their clients’ health and
personal finances holistically (O’Neill, 2005). Strengths and
challenges in one area of a client’s life often affect the other.
Like culture, health status is another “lens” with which to assess
clients’ values, goals, plans, personality traits, and lifestyle.
Typically, health and personal finances are considered separately
by professionals with their own literature and agendas (Vitt, Siegenthaler, Siegenthaler, & Kent, 2002). This article was written
to increase financial advisors’ understanding of relationships
between health and financial practices. It begins with a review
of recent literature and then describes two personality factors
found to be associated with performance of positive behaviors:
conscientiousness and time preference. Next, the article previews a new online tool for users to self-assess their frequency
of performance of recommended health and financial practices.
It concludes with a summary and implications for financial advisors about motivating clients to adopt positive behaviors.
Review of Literature
The relationship between health status and economic resources
is significant, dynamic, and complex (Sharpe, 2008, p. 50). This
literature review of studies of health and wealth associations
published during the past decade extends a previous summary
of earlier research compiled by O’Neill (2005) and discusses
findings that are instructive for financial advisors. Not all of the
study results are what one would expect. For example, a study
by the Center for Retirement Research found that the “cost”
of better health is the need for greater wealth, which initially
sounds counter-intuitive to those expecting unhealthy people
to pay more for health care. Although current health care costs
of healthy people are often lower than those of their unhealthy
counterparts, not to mention having a better quality of life for
a longer period of time, the healthier cohort will actually face
higher total lifetime health care costs (versus unhealthy persons
who often die at younger ages) due to an increased like expectancy resulting in more years of out-of-pocket expenses and an
increased likelihood of succumbing to a chronic disease (e.g.,
diabetes) or needing expensive long-term care at an advanced
age (Sun, Webb, and Zhivan 2010). Another somewhat counterintuitive finding is the impact of recessions on physical health. When the economy gets sick, people
get healthier (Colvin, 2009). Rather than experiencing negative
health impacts, it has been documented that healthy living habits
actually improve during tough economic times as the cost of
leisure time decreases. In other words, health maintenance activities like walking, riding a bicycle, sleeping, and preparing food
at home are time-intensive. When people work and/or commute
fewer hours, they have more time for rest, physical activity, and
preparing nutritious meals, which improves their health (Hernandez-Murillo and Martinek 2010). When more people work less,
workplace related deaths and commuting auto accidents also
decrease. Ruhm (2005) found that a 1% rise in unemployment
reduces the total death rate by 0.5 %. Conversely, in a study
by the National Business Group on Health (Employees Blame,
2008), employees blamed stress from work, finances, and work/
life balance for lack of a healthy lifestyle. Nearly half (47%)
of more than 1,500 workers surveyed said that work demands
prevented them from leading a healthier life.
During the past decade, studies have investigated relationships
between personal health and financial behaviors and associated
personal characteristics. A recent example is a study that found
that the decision to contribute to a 401(k) retirement savings plan
was associated with whether individuals acted to correct poor
physical health indicators (e.g., abnormal blood-test results) that
were revealed during an employer-sponsored health examination
(Paper Links, 2014; Retirement Planning, 2014; Richtel, 2014).
Employees were given an initial health screening and were told
of the results, which were also sent to the worker’s physicians.
The workers were also given information on risky health behaviors and anticipated future health risks. The researchers then
followed the workers for two years to see how they attempted to
improve their health, and if those changes were tied to financial
planning. The 401(k) plan contributors showed improvements
in health behaviors about 27% more often than non-contributors despite having few health differences prior to program
implementation (Gubler & Pierce, 2014). Similarities in time
discounting preferences and a trait called conscientiousness were
40
believed to be related to retirement contribution patterns and
health improvement behaviors. It should be noted, however, that
the relationship between retirement savings and health practices
was correlational, not causal.
Moffitt et al. (2011) studied childhood self-control and found
that it could predict research subjects’ future physical health,
wealth, substance dependence, and criminal offending outcomes.
The researchers’ findings were derived by following a cohort of
1,000 children from birth to age 32. They also studied another
cohort of 500 sibling pairs and found that the sibling with lower
self-control had poorer outcomes, despite shared family background. A recommendation was made for interventions that address self-control to reduce societal costs, save taxpayers money,
and promote prosperity. This study harkens back to the classic
“marshmallow experiment studies” of delayed gratification in
the late 1960s and early 1970s conducted by psychologist Walter
Mischel and colleagues where young children were offered a
choice between a small immediate reward or two small rewards
if they waited 15 minutes. In follow-up studies with the children,
those who waited longer for two rewards had better school performance and overall life outcomes, emphasizing the benefits of
delayed gratification (Mischel, Shoda, & Rodriguez, 1989).
Another way that health and finances have increasingly been
connected is through workplace programs that integrate both aspects of employees’ lives. These programs may include smoking
cessation, weight management, personal finance and health/nutrition classes, and online resources. Human Resources departments of large companies typically contract with specialized
companies that provide holistic “workplace wellness” programs
for their employees. Examples of these companies are Two Medicine Health and Financial Fitness and Simplicity Health Plans,
both of which provide customized workplace wellness programs
for employers that incorporate health and financial education.
Simplicity Health Plans has also developed a proprietary Health
Index Calculator to forecast for individual employees the financial impact of their poor health habits and the potential savings
of improved health habits. Seeing an actual dollar figure resulting from unhealthy personal habits (versus impersonal average
national figures) has been found to be a powerful motivator to
change behavior (L. Holland, personal communication, July
16, 2014). Sutherland, Christianson, and Leatherman (2008)
summarized findings from studies of the use of financial incentives to encourage healthy behaviors, wellness activities, and use
of preventive services. They concluded that financial incentives,
even relatively small ones, can positively influence individuals’
health-related behaviors. For example, smokers who are paid to
quit succeed far more often than those who get no cash reward
(Tomsho, 2009; Volpp et al., 2009). Innovative approaches that
have also been successful in changing health behaviors include
lotteries for prizes if workers achieve health goals and “deposit
contracts” where participants can lose their own money if they
are unsuccessful (Money May Lure People, 2008; Volpp et al.,
2008).
Studies have also explored the effect of health status on earnings.
For example, Kosteas (2012) investigated the economic effects
of engaging in regular physical activity and found a positive
relationship between regular exercise and labor market earnings.
Engaging in regular exercise (defined as working out at least
three hours a week) was found to yield a 6 to 10% wage increase. Study results indicated that moderate exercise resulted in
a positive earnings effect and more frequent exercise generated
an even larger impact. One possible reason is that fit employees
are highly disciplined and more productive, which can lead to
career advancement and higher earnings.
On the flip side, studies have found that people who are not in
good physical health tend to earn less money than their healthier
peers. Conley and Glauber (2007) found that women who were
obese earned, on average, 18% less than those who weren’t
and also had 25% less household income and a 16% reduction
in their probability of marriage. This study supported previous
research that found that U.S. women pay an “obesity wage penalty” while men had no economic or marital status effects with
the exception of a small wage penalty for obese African-American males. The authors noted that the income difference due to
obesity in a White woman’s wages “is equivalent to the difference due to almost two years of education” (p. 272). In addition,
negative effects of obesity on earnings persist throughout the life
cycle, thereby “widening the gender gap in economic well-being” (p. 273).
Studying this issue from the opposite direction, Kim and Leigh
(2010) estimated the effects of wages on obesity and body mass
and found that wages were a predictive factor. The findings of
this study were consistent with the hypothesis that low wages
increase obesity prevalence and body mass. Munster, Ruger,
Ochsmann, Letzel and Tische (2009) explored associations
between over-indebtedness and obesity with data from a sample
of 949 over-indebted German subjects and found a higher risk
of obesity for over-indebted individuals compared to the general
population. After adjusting for a variety of demographic variables and health factors, they concluded that over-indebtedness
was associated with an increased prevalence of overweight
and obesity that was not explained by traditional definitions
of socioeconomic status such as education and income. In a
similar vein, Grafova (2007) examined the relationship between
non-collateralized debt or NCD (e.g., credit cards, student loans,
medical and legal bills, and family loans) and health behaviors
using data from the Panel Study of Income Dynamics. Study
results revealed that households whose members tend to lead
less healthy lifestyles were more likely to hold NCD, leading to
a conclusion that factors such as time preference and self-control
may underlie the observed correlation.
Negative income effects are included in estimates of costs to
individuals of being overweight and obese in the U.S. Dor, Ferguson, Langwith, and Tan (2010) estimated overall annual costs
of being obese as $4,879 for an obese woman and $2,646 for an
obese man, Their analysis included non-medical indirect costs
such as sick days, lost productivity, lower wages, life insurance
Volume 14, Issue 1
41
premiums (i.e., not being able to qualify for preferred rates),
and even the need for extra gasoline. The difference between
genders was mostly the result of lost wages for obese women.
Obese women lost more income through lost wages than from
medical costs. Like Conley and Glauber (2007), Dor et al. found
that wages don’t differ for obese men. Their estimated costs for
obesity were far more than the cost of merely being overweight
which were pegged at $524 for women and $432 for men.
Another interesting area of inquiry has been studies of the
relationship between health status and portfolio asset allocations.
Here, results have been mixed. Some studies suggest that health
status is an important influence on investor decision-making. For
example, Berkowitz and Qiu (2006) concluded that the effect
of changes in health status on household financial portfolios is
indirect. A health shock significantly reduces household total
financial wealth, in turn leading households to restructure the
composition of their financial assets. Rosen and Wu (2004)
found that health is a significant predictor of both the probability of owning different types of financial assets and the share
of financial wealth held in each asset category. Households in
poor health are less likely to hold risky financial assets and poor
health is associated with a larger share of financial wealth in safe
assets. Lin and Sharpe (2007), however, found a lack of relationship between mental and physical health and portfolio change.
In their study, lagged changes in wealth were significantly and
negatively associated with the proportion of stocks and bonds
subsequently held while lagged changes in health were not,
implying that investor reaction to wealth changes was relatively
more important.
Personality Factors
In conclusions to some of the studies cited above, researchers
made reference to personal qualities potentially underlying positive health and financial behaviors. These personality traits affect
patterns of thinking and behaving and are relatively stable over
time and across various life situations. In this section, two specific personality factors found to be associated with performance of
recommended health and financial practices (e.g., losing weight
and saving money) are discussed: conscientiousness and time
preference. Findings from studies linking these personality factors with personal finance behaviors are also described.
Conscientiousness can be defined as a personality trait characterized by being very careful about doing what you are supposed to
do and concerned with doing something correctly. Conscientious
people are characterized by being organized, self-disciplined, reliable, and hard-working and conscientiousness can be assessed
in research studies using self-report measures, peer reports, and
third-party observation. It is considered one of the “big five”
personality traits along with openness to experience, extraversion, agreeableness, and neuroticism (Duckworth & Weir, 2011).
Conscientiousness was cited as a possible reason for the Gubler
& Pierce (2014) finding of a relationship between retirement
savings plan participation and improved health practices following the receipt of results from an employer wellness screening.
If someone is conscientious in one area of life, they may also be
in another because they have a tendency to take action to secure
their future.
Duckworth and Weir (2011) examined how conscientiousness
prospectively predicted responses to the financial crisis of
2008-2009 using Health and Retirement Study (HRS) data. They
found that more conscientious people spent less on impulse than
others and less frequently bought things that they did not need.
They also earned more money than others and saved more of
their income. The researchers concluded that behavioral tendencies predicted the proportion of earnings spent vs. saved.
Letkiewicz and Fox (2014) examined the relationship between
financial literacy, conscientiousness, and asset accumulation
among young adults. Their findings indicated that both conscientiousness and financial literacy are consistent predictors of asset
accumulation. Conscientiousness was measured with two questions on a personality inventory from the National Longitudinal
Survey of Youth (NLSY97). A one- standard-deviation increase
in conscientiousness was correlated with a 40% increase in net
worth, 53% increase in illiquid asset holdings, and 33% increase
in liquid asset holdings. The authors recommended that financial
education be interpreted more broadly to include interventions to
increase conscientiousness and self-control.
Time preference (a.k.a., time discounting and intertemporal
choice) refers to the inclination of an individual towards current
consumption (expenditures) over future consumption or vice
versa. In other words, how likely is someone to delay current
spending in anticipation of greater returns in the future? A
person who wants to spend their money now and not save it is
said to have a high time preference (i.e., a preference for the
present than the future) or a high propensity to discount future
consumption while a person who values saving in addition to
spending has a low time preference. The higher the rate of time
preference, the larger the factor by which individuals discount
future risks to their health or finances associated with current
consumption (e.g., overeating or overspending). A multitude of
daily health and financial decisions involve trade-offs between
immediate consumption and delayed benefits.
Gubler and Pierce (2014) attributed their findings about the
correlation between retirement contribution patterns and health
improvements to time preferences, noting “time discounting
stems from an underlying psychological trait, which is difficult
to change, yet predicts employee behaviors on multiple dimensions” (p. 8). Finke and Huston (2003) explored saving for
retirement as a function of time preference using a sample of
6,812 college students. Their results showed strong correlations
among decision-making domains that involve time discounting.
In addition, a factor of intertemporal preventive health behaviors
was a stronger predictor of the importance of saving for retirement than all other explanatory variables including age, race,
parental income, gender, GPA, and college major. On the health
side, Komlos, Smith, and Bogin (2004) suggested that linkages exist between obesity and time preference and encouraged
more research in this area. Fuchs (1980) explored relationships
42
between time preference, health behaviors, and health status and
concluded that family background, especially religion, appears
to be an important determinant of time preference, which was
measured by a series of six questions asking a sample of adults
age 25-64 to choose between a sum of money now and a larger
sum at a specific point in the future.
Personal Health and Finance Quiz
Each year, when people are asked to state their New Year’s resolutions, issues related to improving health (e.g., losing weight)
and personal finances (e.g., saving money) rise to the top of the
list. To help Americans reach their personal health and financial
planning goals, Rutgers Cooperative Extension developed a
new online self-assessment tool called the Personal Health and
Finance Quiz. The quiz is available online at no charge at
http://njaes.rutgers.edu/money/health-finance-quiz/ and is believed to be among the first online surveys available for public
use (versus proprietary tools that are used by workplace wellness
program providers) to simultaneously query users about their
daily health and personal finance practices. Some examples of
these behaviors include eating breakfast, getting at least 7 hours
of sleep per night, avoiding sugar-sweetened beverages, following a budget, owing less than 20% of monthly take-home pay on
consumer debt payments, and maintaining an adequate emergency fund.
The Personal Health and Finance Quiz is part of Small Steps to
Health and Wealth™ (SSHW), a national Cooperative Extension program developed to motivate Americans to take action
to simultaneously improve their health and personal finances.
SSHW was built around a framework of 25 research-based
behavior change strategies. People who complete the quiz indicate one of four frequencies for their performance of ten health
behaviors and ten financial behaviors. The responses are Never,
Sometimes, Usually, and Always. Upon completion of the quiz,
they receive a score for each section of the quiz (i.e., a Health
Score and a Finance Score), a Total Score, and links to additional
online resources for improved health and financial management.
A high quiz score means that respondents are doing many of the
activities that health and financial experts recommend to improve health and build wealth, which increases their likelihood
of success.
The Personal Health and Finance Quiz has two additional purposes beyond providing feedback to individual users. The second
is to collect research data about the daily health and financial
practices of Americans to inform future Cooperative Extension educational programs and the third is to use quiz scores to
evaluate the impact of SSHW learning activities. The quiz can be
taken as a pre-test before people attend a Cooperative Exten-
sion-sponsored SSHW program and as a post-test several months
later to determine if they changed their health and financial practices after learning new information. Initial research analyses
about respondents’ health and financial practices and relationships between them are planned for FALL 2015.
About a dozen experts in health and nutrition, personal finance,
and evaluation methods provided helpful feedback during development of the Personal Health and Finance Quiz. They helped
construct the quiz format and content including specific daily
activities that are a “step in the right direction,” even if they are
not at the highest level of action recommended by health and
personal finance experts. For example, investing $3,650 annually
is probably not a sufficient sum for a 55 year old to achieve financial security in later life, as it might be for a 22 year old with
three more decades of compound interest. However, investing
the equivalent of at least $10 per day is much better than doing
nothing, which, unfortunately, is the case for many Americans.
According to the 2014 Retirement Confidence Survey or RCS
(Helman, Adams, Copeland, & VanDerhei, 2014), 36% of American workers have less than $1,000 saved for retirement and
60% reported that the total value of their household’s savings
and investments, excluding the value of their home and a defined
benefit pension, was less than $25,000. Only 11% of 1,501 RCS
respondents had saved $250,000 or more.
Quiz data will be used to test relationships between health and
financial practices. Relatively few studies of this type have been
conducted aside from proprietary workplace wellness research.
Questions that will be explored include the relationship between
scores for health and finances (i.e., is it a positive relationship?),
scores for individual health and financial behaviors, the relationship between the answer to Question #20 (about personal planning behaviors) and health and financial behavior quiz scores,
and demographic differences in health, financial scores and total
quiz scores.
Health and personal finance behavior changes start with daily
action steps. Financial advisors are encouraged to share the
Personal Health and Finance Quiz with their clients as a self-assessment tool and to increase awareness of recommended health
and personal finance practices and potential opportunities for
self-improvement in both domains of life. The quiz is based on
frequently cited recommended activities. The quiz is shown in
Table 1, below:
Volume 14, Issue 1
43
Table 1
Personal Health and Finance Quiz
Want to improve your health and personal finances? It starts with daily health and financial management practices. Take this
quiz to assess your current daily activities. Choose the response that best describes how frequently you perform health and
financial management practices:
1 = Never
2 = Sometimes
3 = Usually
4 = Always
When you’re done, add up your scores from the 20 questions below. There is a separate score for daily health practices and
daily financial practices and a summary at the end of each section. The two separate scores also combine to produce a total
quiz score.
Daily Health Behaviors:
_____ I eat breakfast before starting my day (e.g., work, school, or other daily activities).
_____ I avoid drinking sugar-sweetened beverages (e.g., regular soda and sweetened coffee or tea)
_____ I eat 3 ½ to 4 ½ cups of fruits AND vegetables daily.
_____ I get at least 7 hours of sleep per night.
_____ I eat at least 1-2 high fiber foods each day (e.g., whole wheat bread and pasta, oat bran, beans)
_____ I eat and drink fat-free and/or low-fat dairy products.
_____ I avoid high-calorie salad dressings, gravies, spreads, and/or sauces.
_____ I eat foods that are low in fat and/or saturated fat.
_____ I get at least 30 minutes of aerobic and/or muscle-strengthening physical activity at least 5 days per week.
_____ I drink at least eight 8-ounce glasses of water and other fluids per day, excluding alcoholic beverages.
Health Score: __________
Score Interpretation
10-16 points
-Your health choices could be better, but don’t despair. It’s never too late to take action to improve your
health.
17-24 points
-You are doing a fair job of managing your health practices and have taken some steps in the right direction.
25-32 points
-You are doing a good job and are above average in managing your health.
33-40 points
-You are in excellent shape managing your health. Keep up the good work!
Note: Items that you scored with a 1 or 2 are actions that you should consider taking in the future to improve your health.
44
Daily Financial Behaviors:
_____ I follow a hand-written or computer-generated spending plan (budget) to guide my spending and savings.
_____ I maintain an emergency fund equal to at least three months of basic, essential household expenses.
_____ I save the equivalent of at least $1 daily ($365 annually) in loose change in a savings account and/or or jar.
_____ I invest the equivalent of at least $10 daily ($3,650 annually) in investment accounts and/or retirement plans.
_____ I avoid payday loans, car title loans, pawn shop loans, cash advances, tax refund loans, and other high-cost debt.
_____ I owe less than 20% of my monthly net income on monthly consumer debt payments (e.g., credit cards, car loans, student loans, and/or personal loans excluding a mortgage). Example: $3,000 net income x .20 = $600.
_____ I eat at least two meals a day prepared at home instead of eating out (excluding traveling).
_____ I use advertisements, coupons, promo codes, sales, web sites, and/or discounts to save money on purchases.
_____ I live below my means (i.e., spend less than I earn).
_____ I make written “to do” lists or specific plans to organize my financial goals, spending, and/or daily activities.
Financial Score: __________
Score Interpretation
10-16 points
- Your financial choices could be better, but don’t despair. It’s never too late to take action to improve your
finances.
17-24 points
-You are doing a fair job of managing your personal finances and have taken some steps in the right direction.
25-32 points
-You are doing a good job and are above average in managing your finances.
33-40 points
-You are in excellent shape managing your finances. Keep up the good work!
Note: Items that you scored with a 1 or 2 are actions that you should consider taking in the future to improve your personal
finances.
Total (Health + Financial) Score: __________
Summary and Implications
Health and wealth are closely knit together in financial
planning. Poor health habits almost always wind up costing people money and health care will be many people’s largest expense
in retirement (Rozen, 2014). This article described a variety of
studies that indicate relationships between health and personal
finances. These health and wealth associations include “weight
bias” resulting in lower incomes for women, better health habits
during recessions, high medical expenses for the treatment
of chronic diseases, and higher lifetime health care costs for
healthy individuals with higher than average life expectancies.
Also discussed were two personality traits, conscientiousness
and time preference, which have been linked to the performance
of recommended health and financial practices. A number of
studies have investigated the role of psychological factors as an
influence on health and financial behaviors. The Personal Health
and Finance Quiz was also introduced as a simple online tool to
simultaneously assess respondents’ health and financial wellness
behaviors and collect data for future studies of health and wealth
relationships.
Volume 14, Issue 1
Following are implications of health and wealth relationships for
financial practitioners:
♦ Include a discussion of health care spending during annual
reviews with clients. If this is a routine part of the review
process, questions about health status (“Have you recently
been hospitalized or had any outpatient surgery?”) won’t
seem so out of place. Without being judgmental with clients
who are smokers, obese, or have other unhealthy habits,
share statistics about the cost of unhealthy habits (e.g., a
$7 pack a day of cigarettes) and how healthier lifestyles
correlate with lower medical expenses (Rozen, 2014). For
example, smokers purchasing life insurance will generally pay higher premiums than non-smokers as will those
purchasing health insurance on a government-facilitated
exchange under the Affordable Care Act in some states. As
is the case with other areas of financial planning, advisors
differ on their approach to addressing clients’ health. Rozen
described one advisor who recommended avoiding any
mention of clients’ personal habits and, instead, using “the
vocabulary of financial planning” (e.g., current budget, projected expenses, and retirement income). Another advisor
tells clients “What’s the point of planning if you are going to
have an early death?” and has seen clients lose weight and
stop drinking, perhaps in response to his frankness.
♦ Consider including several questions about basic health issues (e.g., Do you drink? Do you smoke? How often do you
exercise? Do any diseases or medical conditions run in your
family?) on client prospect questionnaires. The answers
provide advisors with useful information that can fuel deep
conversations (Rozen, 2014). Responses to the Personal
Health and Finance Quiz or a “lifestyle” based life expectancy calculator with questions about personal habits, such
as https://www.livingto100.com/, http://www.msrs.state.
mn.us/info/Age_Cal.htmls, and http://gosset.wharton.upenn.
edu/mortality/perl/CalcForm.html may also be instructive
as are results from a client’s workplace wellness program
health risk assessment tool, if available. The latter is used
by employers to assess the likelihood of workers having
certain health conditions in the future based on their lifestyle
data and health statistics. As noted in the literature review,
discipline in other areas of a client’s life (e.g., regular exercise) may translate to discipline with respect to personal
finances. Pullen & Wehner (2007) note that, just like money
and property, health is an asset that should be managed
wisely. In the absence of adequate health capital, the power
of financial capital is greatly diminished. When health is
viewed as an asset by financial advisors and discussed with
clients from this perspective, it may open discussion of
practices that support or undermine it. In addition, when advisors understand a client’s projected state of future health,
they can provide more comprehensive, targeted advice instead of giving the same advice (e.g., make retirement asset
withdrawals according to the 4% rule) to clients in different
situations.
45
♦ Realize that changing ingrained personality traits (e.g.,
increasing conscientiousness) is never easy but people can
change their habits for more consistent positive behavior
(e.g., saving money and exercising regularly). Two ways
that clients can become more conscientious are automating
desired behaviors (e.g., retirement savings plan deposits)
to eliminate the need for constant self-control and decision-making and using “precommitment devices” such as
telling a friend/family member (for accountability) that they
will start exercising or will no longer buy lottery tickets or
order dessert at a restaurant (Hess, 2013). Better still, have
clients create a personal behavior change contract that lists
their desired health and financial goals and required actions
(see http://njaes.rutgers.edu/sshw/workbook/25_Set_a_
Date_and_Get_Started---Just_Do_It.pdf) Helping clients
become more conscientious can produce benefits on many
fronts including physical health, mortality, occupational
attainment, job performance, and marital stability (Roberts,
n.d).
♦ Assess your client’s time preferences. Be aware of their
propensity to value future gains (or not) and incorporate this
in your planning. Like conscientiousness, time preference
is a key determinant of personal behavior. Clients with future-oriented time preferences (i.e., those who value future
outcomes relative to immediate ones) should be more likely
than others to adopt preventive health and financial measures. Fuchs (1980) assessed health-related time preference
with a series of six questions that offered a choice between
two cash prizes (e.g., $1,500 now or $4,000 in 5 years and
$2,500 now or $4,000 in 3 years). Changing clients’ innate
time preferences isn’t easy but they can be shown the benefits of modest decreases in current consumption to free up
funds for capital asset accumulation. Online tools like The
1% More Savings Calculator on the New York Times website
(http://www.nytimes.com/interactive/2010/03/24/your-money/one-pct-more-calculator.html?_r=0) can be useful. With
increased awareness of potential future benefits, clients may
become amenable to decreasing current consumption and be
less likely to discount future investment growth.
46
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48
Life And Death Tax Planning For Deferred Annuities
Michael E. Kitces, MSFS, MTAX, CFP®, CLU, ChFC, RHU, REBC, CASL,
Pinnacle Advisory Group, Columbia, MD
The concept of the annuity – a stream of income that will be paid for life – has been
around for almost two millennia, and in the US for nearly 200 years now. Annuities became far more popular in the past century or so, though, due to both rising longevity that
creates longer retirement periods which need to be funded, and significant tax preferences
established in the Internal Revenue Code to incentivize the use of annuities as a vehicle
for retirement accumulation (and subsequent decumulation). This article explores the tax
implications of deferred annuities in detail.
Volume 14, Issue 1
49
The concept of the annuity – a stream of income that will be
paid for life – has been around for almost two millennia, and
in the US for nearly 200 years now. Annuities became far more
popular in the past century or so, though, due to both rising
longevity that creates longer retirement periods which need to be
funded, and significant tax preferences established in the Internal
Revenue Code to incentivize the use of annuities as a vehicle for
retirement accumulation (and subsequent decumulation).
A unique complication of annuities after death is that, unlike
IRAs, it is difficult to stretch post-death annuity distributions
through a trust. While the Treasury Regulations allow
retirement accounts to “see through” the trust to the underlying
beneficiaries, and stretch on their behalf, no such rules have
been established for annuities. As a result, planning for annuities
may have to trade off between the opportunity to stretch, and the
desire to control assets with a trust.
The primary tax preference for deferred annuities still in the
accumulation stage is that annual growth on the contract is
tax deferred, and does not have to be reported as income until
actually withdrawn from the contract. Notably, though, this taxdeferral treatment is only available for annuities that are actually
owned by a “natural person” – a living, breathing human being –
or in limited circumstances, where a trust owns an annuity “as an
agent for a natural person”.
Because many annuity rules are based on private letter rulings,
the interpretation of the tax rules may vary from one insurance
company to the next. As a result, to plan effectively it’s crucial
to understand the rules of the particular annuity contract and
annuity company before a death occurs.
When distributions are ultimately taken from an annuity, any
gains are taxable as ordinary income, and the tax code requires
that any withdrawals from an annuity be treated as “gains first”
to the extent of any gain, before any principal is paid out. In
addition, gains distributed to an annuity owner prior to age 59
½ may be subject to a 10% “early withdrawal penalty” unless
the distribution is after death or disability of the annuity owner,
as part of a series of substantially equal periodic payments, or
because the contract is an immediate annuity.
To make effective decisions regarding annuities, including with
respect to their taxation, it’s important to understand the key
details of the annuity contract itself, including both the type of
annuity, and the parties to the contract. The key distinctions in
both categories are explained below.
If an annuity is fully surrendered, and the net proceeds received
are less than the original cost basis, the loss is deductible and
is treated as an ordinary loss (not a capital loss). Unfortunately,
though, the loss is claimed as a “miscellaneous itemized
deduction subject to the 2%-of-AGI floor” which both limits the
benefit of deductibility, and potentially eliminates it entirely for
those subject to the Alternative Minimum Tax (AMT).
Because the tax preferences for annuities are intended primarily
for retirement accumulation, at the death of an annuity owner,
contracts are required to make payments to the beneficiaries,
similar to other types of retirement accounts. Notably, though,
in the case of an annuity, post-death distributions must begin
upon the death of any owner, which can create significant
complications in the case of joint ownership of annuity contracts
(especially between non-spouses).
A surviving spouse who is the beneficiary of an annuity has
the option to continue the contract in his/her own name.
Other natural person beneficiaries have the choice to take
distributions out over their life expectancy – though only some
annuity companies allow this to be done by taking systematic
withdrawals each year, while other companies require that the
beneficiary actually annuitize the contract (and give up their
liquidity) to stretch payments out over life. For those who are not
able to do spousal continuation or take stretch payments over life
expectancy, the annuity must be liquidated under the 5-year rule
(by the 5th anniversary of the owner’s death).
Understanding Key Annuity Details
Types of Annuities
The term “annuity” is actually used to describe a wide range
of possible types of annuity contracts, and so when evaluating
annuities it’s crucial to narrow the scope and understand which
particular type is being analyzed. The three primary ways that
annuities can be broken down are:
Immediate vs Deferred. An immediate annuity is a contract
where a lump sum is paid to receive a set stream of payments,
either “for life”, for a certain period of time, or a combination
thereof, where the regular payments begin within 1 year of
purchase. By contrast, a deferred annuity is a contract that
has not yet been converted to a stream of payments. The act
of converting a deferred annuity into an immediate annuity
is generally called “annuitizing” the contract; to ensure that
a deferred annuity is an annuity, all contracts will have some
[mandatory] annuity starting date at which the contract must be
annuitized (if it was not purchased as an immediate annuity in
the first place).
Notably, the label “deferred” annuity is actually a reference
not to its tax treatment, but the fact that its annuity starting
date at which annuitization must occur is deferred until
some point in the future (and in the meantime, the annuity is
accumulating growth/return of some sort). Separately, deferred
annuities also enjoy tax-deferral treatment, as discussed later,
and this treatment is so appealing for some investors that they
deliberately seek out contracts that have distant late-age required
annuity starting dates, specifically to allow them to maintain
the deferred annuity in tax-preferenced deferred status as an
accumulation vehicle for a longer period of time.
50
Fixed vs Variable. Another important distinction for annuities
is between fixed versus variable contracts. Although typically
viewed as whether the contract provides a fixed (e.g., bond-like)
versus variable (e.g., stock-like) rate of return, technically the
fixed/variable distinction is a measure of the value of the annuity
units associated with and underlying the contract.
For instance, in a fixed annuity contract, a contribution of
$100,000 will typically buy 100,000 annuity units, valued at
$1.00 each. Thus, the total value of the contract is 100,000 x
$1.00 = $100,000. As the contract generates interest, the returns
are used to purchase more annuity units; for instance, $20,000
of interest would buy another 20,000 annuity units (which at a
$1.00/unit value are worth $20,000). Throughout, the value of
the annuity units remains fixed at $1.00, and the only question
is how many annuity units are owned. The fact that the annuity
units are fixed at $1.00, and cannot decline in value (or fluctuate
at all), is the primary reason why fixed annuities are regulated as
insurance products, and not investment securities.
By contrast, in the case of a variable annuity, the value of the
units themselves change (up or down) over time. An investor
might own 15,000 units of a stock fund valued at $4.00 each, and
20,000 units of a bond fund at $2.00 each, for a total value of
15,000 x $4.00 + 20,000 x $2.00 = $100,000. Similar to the Net
Asset Value (NAV) of mutual funds, the value of each annuity
unit is ‘arbitrary’ and has no inherent meaning unto itself; it is
simply computed based on the value of the underlying assets
to determine the total value of the investment position. As with
mutual funds, though, returns over time are then generated by
the returns in the underlying fund that increases (or decreases)
the value of the annuity unit; for instance, if the stock fund was
up by 10% to $4.40, the new value of the stock position would
be 15,000 x $4.40 = $66,000, and if the bond fund was down by
5%, its new value would be 20,000 x $1.90 = $38,000.
Although this distinction – between fixed annuity units where the
number of units accumulate, versus variable annuities where the
value of the units grow over time – may seem purely academic
(and has no direct impact on taxation), it is important both for
regulatory purposes (as noted earlier, the fact that the annuity
units are variable is what makes variable annuities regulated as
securities), and also in the event the contract is ever annuitized
(where annuitized payments are actually calculated based on
units and, in the case of variable annuitization, the changing
value of the units can lead to changing ongoing annuitized
payments).
Non-Qualified vs Qualified. The distinction between nonqualified versus qualified annuities is a reference to the tax
status of how they are held. Simply put, “qualified” annuities
are contracts that are held inside of tax-qualified retirement
plans (e.g., employer retirement plans like 401(k)s, 403(b)s, and
profit-sharing plans, or traditional or Roth IRAs), while “nonqualified” annuities are those that were purchased with after-tax
dollars (e.g., from a bank or brokerage account).
In the context of the tax code, qualified annuities are subject to
the tax laws of the retirement account in which they are held; the
fact that it happens to be an annuity inside is generally irrelevant
(though special rules do apply to the valuation of annuities in
retirement accounts for the purposes of Roth conversions and
calculating Required Minimum Distributions). By contrast, nonqualified annuities are taxed under the standalone rules of IRC
Section 72.
We will focus specifically on the tax treatment of non-qualified,
deferred annuities (regardless of whether they are fixed or
variable, as that does not directly impact the tax treatment).
Parties To The Contract
In addition to understanding the types of annuities, it’s also
vitally important to understand the parties to the contract before
making any type of (tax-related or other) annuity decision.
Ultimately, there are four key parties involved in any annuity
contract, of which the advisor should always be aware when
making a potential decision:
Owner. The owner of the contract – also known as the “holder”
throughout much of the tax law – is the party that holds legal
title to the annuity, and has the rights to make any/all decisions
regarding the contract, from whether to change to investment
allocation (to the extent allowed), whether to keep or surrender
or exchange or take withdrawals from the contract, whether to
annuitize or not, and who the beneficiary will be. Except in a
few rare circumstances with trusts (discussed later), the owner is
also generally the one on those income tax return any gains will
be reported (when taxable events occur), and in whose estate the
value will be reported for estate tax purposes.
Annuitant. As discussed earlier, there are two primary types
of annuities: immediate annuities that have been converted to
a stream of income for life (or a period of time); and deferred
annuities, which haven’t been annuitized (yet?). In this context,
the annuitant has one real purpose: in the event the contract
is annuitized, and the payments are to continue “for life”, the
annuitant will be the measuring life for those life contingent
payments. Notably, beyond this point, though, the annuitant has
no legal rights or ownership interest in the contract, now or in
the future; the annuitant does not own and control the contract,
and is not necessarily the beneficiary (unless separately declared
as such). For better or worse, the purpose of that annuitant is
simply to be the measuring life if/when the contract is ever
annuitized (and in limited cases, to also be the measuring life
for certain lifetime income or withdrawal riders under a deferred
annuity).
Insurance Company. The insurance company is the entity
on the other side of the annuity contract. In the case of a fixed
annuity, the funds are actually held in the insurance company’s
general account and subject to their credit risk; with a variable
annuity, the funds are generally held in the underlying
subaccounts and not subject to the credit risk of the insurer,
Volume 14, Issue 1
though any overarching guarantees (e.g., death benefits, or living
benefit riders) are still subject to the credit risk of the insurer.
From the tax perspective, because many tax rules typically
applied to annuities are based on non-binding Private Letter
Rulings, knowing the insurance company and its policies and
procedures can be important, as not all insurance companies will
report on or ‘cooperate’ with certain tax-related strategies in the
same way.
Beneficiary. The beneficiary of an annuity does not have any
formal legal rights to the contract until the owner passes away
and the contract properly passes to the beneficiary by operation
of the contract (unless established earlier as an irrevocable
beneficiary, which is rare). Nonetheless, it is critical to know
who the beneficiary is, as the options available for an annuity’s
post-death distribution requirements can and will vary depending
on the type of beneficiary (spouse, non-spouse individual
designated beneficiary, or non-designated beneficiary) as
discussed later.
Tax Treatment of Deferred Annuities During Life
Annual Tax Deferral
As noted earlier, deferred annuities are not actually labeled as
“deferred” because they are tax-deferred; instead, the label is
a reference to the fact that the annuity starting date at which
the contract must be annuitized has been deferred to some
point in the future. Historically, this annuity starting date was
often aligned to a common retirement age (e.g., age 65), at
which time periodic payments for life would begin, similar to
other pensions. In turn, to encourage this kind of saving-fora-personal-pension behavior, Congress enacted preferential
tax treatment for annuities under IRC Section 72 by providing
tax-deferred growth during the deferral/accumulation phase.
Notably, in today’s environment using annuities for tax-deferred
accumulation has become so popular that they are rarely
annuitized, and instead are often selected for deliberately-late
annuity starting dates that will allow the annuity to remain in
deferral/accumulation status until a very advanced age.
However, an important caveat to this general rule is that tax
deferred growth on a deferred annuity is only allowed in
situations where the contract is owned by a natural person (i.e.,
a living breathing human being).1 If the annuity is not owned by
a natural person (e.g., a trust or a business entity), any increases
in the value of the annuity each year (i.e., gains) are taxable
annually as ordinary income. The “exception to the exception”,
though, is that an annuity may still maintain annual tax-deferral
of gains, even if it is owned by a non-natural person, if the
ownership arrangement is serving “as an agent for a natural
person.”
Unfortunately, the tax code and associated regulations do not
fully define what constitutes an “agent for a natural person” in
the first place. However, a long list of Private Letter Rulings
51
over the years have consistently shown that, at least in the case
of trusts, the “agent for a natural person” rule applies as long
as all the beneficiaries of the trust are natural persons.2 In fact,
one Private Letter Ruling appears to have allowed favorable tax
treatment for the annuity merely because the income beneficiary
was a natural person (though it happens to be the case that
the remaindermen were natural persons, too).3 These rulings
imply that typical bypass (i.e., credit shelter) trusts, along with
revocable living trusts, should easily qualify for favorable
treatment, as the beneficiaries are typically all living, breathing
human beings.
In the case of other non-natural entities – e.g., business entities
– the situation is rather straightforward in the opposite direction:
business entities are respected for business purposes, and
therefore clearly are not functioning as an agent for a natural
person. In the one Private Letter Ruling to consider the issue
directly – where an annuity was going to be owned by a (family)
limited partnership to implement certain estate planning transfers
– the IRS indicated that the nature of the limited partnership as
a business entity alone would disqualify the annuity from tax
deferral treatment, at which point the PLR was withdrawn (as
that would have defeated the remainder of the estate planning
strategy).4 Of course, it’s also worth noting that obtaining
favorable tax treatment for a partnership-owned deferred annuity
would run counter to most typical family limited partnership
(FLP) strategies in today’s environment; for the FLP to be
respected for discounting purposes, it must clearly be a bona
fide business entity separate from the taxpayer, which entirely
undermines the case that it is an agent for a natural person
for annuity tax deferral purposes (or conversely, successfully
showing the partnership is just an agent for a natural person
for annuity tax deferral would undermine the credibility of its
partnership-related discounts for transfer tax purposes!).
In any event, these rules apply only to non-qualified annuities.
As noted earlier, in the case of qualified annuities, the tax
deferral treatment is dictated by the rules of the retirement
account that holds the annuity (the IRA, or 401(k), or 403(b),
etc.).
Distributions from Annuities
Under IRC Section 72, the taxation of withdrawals or payments
from annuities are broken into two categories: 1) amounts
received as an annuity; and 2) amounts not received as an
annuity.
The first category is a reference to amounts that are received as
payments from an annuity that has reached its annuity starting
date – i.e., an immediate annuity, or a deferred contract that has
subsequently been annuitized. Amounts received as an annuity
are subject to special so-called “exclusion ratio” rules that allow
a portion of each payment to be treated as principal, with the
remainder as growth taxed as (ordinary income) gains.5
52
The second category – for amounts “not received as an
annuity” – addresses the tax treatment of withdrawals from
(non-qualified) deferred annuities. In the case of “amounts not
received as an annuity” from a deferred annuity contract, the
general rule is that gains are taxable first (always as ordinary
income) to the extent that there is any gain in the annuity, and
only then is any of the principal recovered.6
Example 1. John owns a deferred annuity with a cash value of
$105,000, to which he had originally contributed $100,000.
For any distributions that John takes from the contract, the first
$5,000 (the amount of embedded gain) will be treated as taxable
gains. Any additional withdrawals beyond that first $5,000 will
be treated as a return of principal.
Notably, the rules in determining gain for the purposes of gainsfirst partial withdrawals from deferred annuities stipulate that
the gain should be determined without regard to surrender
charges7; in other words, a contingent surrender charge that
hasn’t actually been deducted from the actual cash value is not
considered in determining the gain, although in the case of a full
surrender of the annuity where surrender charges were actually
paid, only the net amount actually received is considered in
determining gain.8
Example 2a. Larry owns a deferred annuity with a cash value
of $105,000, to which he had contributed $100,000, and the
contract still has an $8,000 contingent surrender charge. Thus,
the net surrender value (if he walked away now) would be only
$97,000, less than his original contribution. If Larry surrenders
the entire contract, he will have put in $100,000, and only
receive back $97,000, so he will have a $3,000 loss.
Example 2b. Continuing the prior example, if Larry takes a
partial withdrawal of $12,000, gain is determined without regard
to surrender charges, which means Larry will report taxable
income of $5,000 (the embedded gain) and receive a $7,000
return of principal. His cash value will be down to $93,000,
his net surrender value will be down to $85,000 (assuming the
$8,000 surrender charge still looms), and his cost basis will be
down to $93,000 (after adjusting for the return of principal that
was paid out). If Larry subsequently takes a full surrender of his
contract, he will have an $8,000 loss (proceeds of $87,000 with a
cost basis of $95,000).
Notably, in example 2b, Larry would have ultimately had a
$5,000 gain and an $8,000 loss, for $3,000 of net loss, which
is the same as the $3,000 loss in example 2a as well. However,
due to the tax laws pertaining to gains and losses from annuities,
with example 2b and the partial surrenders, the gain was
recognized now (at the time of surrender), while the loss is only
recognized in the future when the contract is fully surrendered;
although gains are recognized with a partial surrender, losses are
not. When losses are claimed, they are generally an ordinary loss
claimed as a miscellaneous itemized deduction subject to the
2%-of-AGI floor (see sidebar).
Deducting Losses On Annuities
Losses are not common on most types of fixed annuities, as the
guaranteed nature of the annuity principal typically prevents
losses (except in the case of an early surrender triggering
significant surrender charges). However, in the case of variable
annuities, losses can and do occur with market declines.
An annuity loss can only be claimed upon the total surrender
of an annuity; a partial surrender, or just bearing an intra-year
decline in value, is not deductible.
In the event that a deductible loss does result at the time of
surrender, the loss is ordinary income (just as the gain would
be) under Revenue Ruling 61-201; accordingly, annuity losses
are not capital losses, and cannot be netted against capital
gains.
However, while the IRS has affirmed annuity losses as being
ordinary losses, there is still some debate about where/
how to claim the loss. Some have suggested that the loss
should be claimed as an “other ordinary loss” on the first
page of Form 1040 (i.e., as an “above the line” deduction)
and the associated Form 4797 for “[Other] Ordinary Gains
and Losses [on the Sale of Business Property]”. However,
annuities generally are not “business property” and the tax
code prescribes that any itemized deductions that don’t have
specifically tax code sections to the contrary should all be
claimed as a miscellaneous itemized deduction under IRC
Section 67(b); accordingly the IRS itself guides in its own
Publication 575 that the proper way to claim an annuity loss
is as a miscellaneous itemized deduction subject to the 2%-ofAGI floor.
Unfortunately, this is not very favorable treatment, due both
to the fact that it requires the taxpayer to itemize deductions
in the first place, it limits the deduction to the excess above
the 2%-of-AGI threshold, and most significantly the fact that
such miscellaneous itemized deductions (thereby including
annuity losses) are an adjustment for AMT purposes under
IRC Section 67(b)(1)(i). As a result, any taxpayer subject to
the AMT will receive no tax benefit for annuity losses, and a
significant annuity loss could actually push the taxpayer into
the AMT in the first place. Despite the unpopularity of this
unfavorable treatment, though, there have been no significant
proposals in Congress in recent years to alter the tax treatment
for annuity losses, though it is always possible this will be
changed in the future.
Volume 14, Issue 1
Anti-Abuse Aggregation Rule
To work around the general gains-first rule for annuity
distributions, some annuity owners will purchase multiple
annuity contracts for planned liquidations. The idea of the
strategy is that with separate contracts, the annuity owner can
work through distributions from one contract – income and
principal – before moving on to (income/gains from) the next
contract.
Example 3a. James is a 55-year-old who plans to put $1,000,000
into an annuity to use for retirement spending when he turns 60.
If 5 years from now the contract is up to $1,250,000, then the
first $250,000 that James withdraws will be taxable, before he
can spend any of his principal. To avoid this consequence, James
instead purchases 10 contracts for $100,000 each, invested in the
same manner. Now, with similar total gains, James will have 10
contracts worth $125,000 each, which means he can withdraw
$250,000 (by surrendering just two of the 10 contracts) and face
gains of only $50,000 (as there would be $200,000 of principal
between those two contracts).
To partially block this strategy, the tax code prescribes an “antiabuse aggregation rule” – that all annuities issued during a single
calendar year by the same insurance company are treated as one
annuity for the purposes of determining gains and the taxable
amount of the distribution.9
Example 3b. Given the anti-abuse aggregation rule, if James tries
to split his $1,000,000 into 10 contracts, for tax purposes they
are still treated as a single contract (with a $1,000,000 cost basis
and a $1,250,000 appreciated value), such that the first $250,000
of withdrawals will be taxable, even if it’s the full surrender of
two contracts that otherwise just had $25,000 of gains each.
Because the anti-abuse aggregation rule only applies if the
annuities are purchased in the same calendar year, and from
the same insurance company, the splitting strategy can still
be accomplished if the funds are either split over time across
multiple calendar years, or amongst multiple insurance
companies. Thus, in the above example 3b, James would either
have to buy annuities from 10 different insurance companies,
or spread his purchases across multiple tax years, to avoid gains
aggregation for tax purposes.
Loans from and Gifts of Annuities
To prevent “abuse” of the annuity taxation rules, any loans
taken from (or collateral pledges of) an annuity are treated as a
distribution of that amount from the annuity (with the standard
gains-first tax treatment).10 This rule – which differs from
the non-taxable loan treatment for life insurance policies –
prevents annuity owners from trying to use the cash value while
avoiding gains on an annuity by taking loans again the contract;
by rendering the taxation of the loan exactly the same as the
taxation of simply taking a withdrawal directly, the owner may
as well just take a distribution and pay taxes accordingly (and
53
this loans-same-as-distributions tax treatment is why annuity
contracts typically do not offer loan provisions in the first place).
Similar, the rules also prevent individuals from trying to shift the
tax burden of annuities by transferring ownership. If an annuity
is “transferred without adequate consideration” (i.e., partially
or fully gifted), the tax law stipulates that any gains will be
recognized at the time of the transfer.11
Example 4a. Harold owns an annuity worth $150,000 with an
original cost basis of $100,000, and tries to gift it to his son
Daniel to avoid the $50,000 gain himself and shift it to be taxed
at Daniel’s more favorable tax rates.
However, the actual result will be that the $50,000 gain is
recognized immediately by Harold as the transferor, and his
son Daniel will simply receive a $150,000 contract with a new
$150,000 cost basis. This is the equivalent of Harold having
simply surrendered the contract for $150,000, and gifted the
$150,000 proceeds to his son, who then reinvests the $150,000
into a new contract.
On the other hand, Harold might still wish to gift an annuity
to Daniel, despite the tax consequences, if there were special
contractual annuity provisions that were worth keeping (and
assuming those guarantees are transferrable under the annuity
contract in the first place); the tax rules do not legally prevent the
gift of an annuity, but simply remove any income tax benefits of
doing so.
Notably, this ‘anti-gifting’ rule also prevents individuals
from gifting an annuity to a charity to avoid the income tax
consequences. Once again, such a gift would be treated the
equivalent of liquidating the contract, and gifting the proceeds.
Example 4b. Continuing the prior example, assume instead that
Harold wishes to donate his $150,000 annuity with a $100,000
cost basis to charity to avoid the $50,000 gain. Due to the
annuity tax rules, instead such a gift would trigger recognition
of the tax gain ($50,000), and would then be followed by a
charitable deduction for the full fair market value ($150,000).
Obviously the $150,000 charitable deduction may more than
offset the $50,000 gain, but from the tax perspective this is
no better than having Harold simply liquidate the $150,000
contract, recognize the $50,000 gain, and gift the $150,000 of
cash proceeds.
Grandfathering “Old” Tax Rules
The annuity tax laws went through a series of significant changes
in the 1980s, especially as a part of the Tax Equity and Fiscal
Responsibility Act of 1982 (TEFRA 1982) and the Tax Reform
Act of 1986 (TRA 1986). In the case of many new provisions
adopted at the time, the new rules applied only to new annuity
contracts (or new contributions to existing contracts) that
occurred after the rules were implemented; contracts purchased
prior to those dates retained their “old” rules.
54
Gifting “Old” Annuities
For instance, one grandfathering rule under TRA 1986 pertains
to the gift of annuities; under prior law, the rule had been that if
an annuity was gifted, the gains embedded at the time of transfer
were attributable to original owner, but were not recognized
until the time that the donee actually surrendered the contract
(rather than at the time of transfer). The rule still applies to any
annuities that were issued before April 23rd, 1987 (even if gifted
long afterwards).12
Example 4c. Continuing the earlier example, if Harold’s
$150,000 annuity with a $100,000 cost basis had been purchased
prior to 1987, then if the annuity is gifted now (in 2014), Harold
will ultimately be required to recognize the $50,000 gain, but
the gain will not be reported until the donee he gifts to actually
surrenders the contract. If there are additional gains during the
intervening time period – for instance, Harold gifts it to his son,
and the contract appreciates to $160,000 before it is surrendered
– the original gains are taxable to the donor, but the post-gift
gains are taxable to the donee (i.e., Harold still reports the
$50,000 gain, but his son reports the subsequent $10,000 postgift gain).
“Old” Annuities Purchased By Non-Natural Persons
Another grandfathering rule under TRA 1986 pertains to the
requirement that annuities be owned by natural persons (or as an
agent for a natural person) to receive tax-deferral treatment.
Under the prior rules, this natural person requirement did
not exist, and accordingly when it was created, a special
“grandfathering” rule was established that allows any annuities
that were owned by non-natural persons prior to March 1,
1986, to continue to receive preferential (i.e., tax-deferral)
treatment; however, any annuities purchases since this date (or
contributions to existing annuities after this date) have been
subject to the new natural-person-owner requirement.13
Principal-First Withdrawals From “Old” Annuity Contracts
One additional important grandfathering rule dates all the way
back to TEFRA 1982, and pertains to the “gains-first” treatment
that typically applies to deferred annuities.
Under the pre-TEFRA rules, the tax treatment was the opposite
of what it is today – original principal contributions were
assumed to be withdrawn first, and gains were received last
(similar to how Roth IRA distributions are treated today). When
TEFRA was enacted, the rules shifted to their current gainsfirst treatment, but contributions made to any contracts prior to
August 13, 1982 retain their pre-TEFRA treatment.14
In the case of contracts that have both pre- and post-TEFRA
contributions, withdrawals are assumed to come first from preTEFRA contributions (principal first), then pre- and post-TEFRA
gains, and then finally post-TEFRA contributions; notably,
this treatment persists even if the contract was subsequently
exchanged for another under IRC Section 1035, which means
even a more recent contract could still have pre-TEFRA
principal available for tax-free withdrawal if it was funded via
exchanges that date back prior to TEFRA.15
Early Withdrawal Penalties
Because deferred annuities (like IRAs) are provided tax-deferral
benefits to encourage their use for retirement savings, they also
(again like IRAs) are potentially subject to “early withdrawal
penalties” if gains are withdrawn before age 59 ½ (though
certain exceptions apply, beyond just waiting until age 59 ½, as
discussed below).16
The early withdrawal penalty is a 10% surtax on any portion of
the annuity withdrawal that is included in income, and applies
in addition to any other income taxes owed on the withdrawal.17
Notably, though, the early withdrawal for annuities is only
applicable to the amount that is otherwise taxable and reported in
income; return of principal distributions that are not taxable are
not subject to early withdrawal penalties, either (though annuity
contract surrender charges may still apply).
Example 5a. Jeremy has an annuity with a $105,000 cash value
and a $100,000 cost basis. If Jeremy surrenders the contract
and is subject to early withdrawal penalties (prior to age 59 ½
with no other exceptions), he will owe a 10% penalty on just the
$5,000 of gain – a $500 penalty – and not the entire $105,000
contract value.
Example 5b. Continuing the prior example, if Jeremy chooses
to withdraw only $10,000 from the $105,000 contract, his
early withdrawal penalty will still be $500. The reason is that,
as discussed earlier, partial withdrawals from annuities are
deemed to come from gains first; as a result, Jeremy’s $10,000
withdrawal includes the first/only $5,000 of gain, and the
remaining $5,000 is principal. Since there is $5,000 of gain and
Jeremy is assumed to be subject to the early withdrawal penalty,
the 10% penalty will apply to that $5,000 gain.
Example 5c. Assume instead that Jeremy’s annuity is only worth
$95,000 (with the same $100,000 cost basis). If Jeremy takes
a partial withdrawal from the annuity, there will be no early
withdrawal penalty – regardless of whether has reached age 59
½ or not – as there cannot be an early withdrawal penalty on the
gains included in income if there are no gains associated with the
withdrawal in the first place!
Exceptions to Early Withdrawal Penalties
In addition to the ‘standard’ rule that the early withdrawal
penalty does not apply to distributions from an annuity on/
after the date the owner reaches age 59 ½, a number of other
exceptions to avoid the early withdrawal penalty are also
Volume 14, Issue 1
available. While these rules are very similar to the exceptions
applicable to IRAs, they are not identical, and in fact are listed
in a completely different subsection of the tax code (IRC Section
72(t) for IRAs, and IRC Section 72(q) for annuities).
The additional exceptions to the early withdrawal penalty from
non-qualified deferred annuities (beyond being past age 59 ½)
are for distributions made:
- On/after the date of the annuity owner’s death18 (i.e.,
distributions to beneficiaries after death are never subject to
early withdrawal penalties)
55
withdrawal penalty exception in the case of annuities does not
apply for payments after age 55 and separation from service, nor
for payments for medical expenses, health insurance premiums
for the unemployed, distributions for college expenses, or
the first-time homebuyer exception. In all of those cases,
distributions from a non-qualified annuity will still be subject to
the early withdrawal penalty (to the extent of gain, and assuming
no other exception applies).
Tax Treatment of Deferred Annuities After Death
- To a disabled owner19
Estate Tax Treatment
- As a part of a series of Substantially Equal Periodic Payments20
(the IRS has indicated that taxpayers can use the same rules in
calculating SEPPs for annuities as are used to calculate them for
IRAs21)
The treatment of a deferred annuity for estate tax purposes is
relatively straightforward: the deferred annuity is an asset in
the decedent’s estate, and is reported based on its value on the
date of death (or the alternate valuation date 6 months later, if
appropriate24). Notably, though, the “value” of an annuity for
estate tax purposes is not merely its cash value on the date of
death, but its value including adjustments to do death itself. In
other words, if there is any form of “enhanced death benefit”
that increases its value when the annuity owner passes away, this
amount should be reported for estate tax purposes as well.
- From an immediate annuity contract22 if it is purchased with a
single premium and payments begin within 1 year of purchase
This last rule – avoiding the early withdrawal penalty via
annuitization – is important to recognize as well, as it only
applies in certain very specific circumstances.
Example 6a. Betsy is 50 years old, and purchases an immediate
annuity for a 5-year period certain payout. As long as the
payments start within 1 year, the payments from the annuity will
be exempt from the early withdrawal penalty, even though Betsy
is under age 59 ½ (and all the payments will be received prior to
age 59 ½!).
Example 6b. Continuing the prior example, if Betsy chooses
to purchase her immediate annuity via a 1035 exchange from
an existing deferred annuity purchased four years ago, the
exception does not apply. The IRS has ruled that in the event of
a 1035 exchange, the “purchase date” for the purposes of this
rule is the purchase date of the original annuity, not the new one.
As a result, the annuity is still deemed to have been a contract
from four years ago, where payments did not begin within 1
year of purchase; more generally, a recent 1035 exchange cannot
be used to circumvent the annuitize-within-1-year-of-purchase
requirement23.
Example 6c. Continuing the prior example further, if Betsy
chooses to purchase her immediate annuity via a 1035 exchange
but chooses lifetime payments instead of a 5-year period certain,
she will still be exempt from the early withdrawal penalty. In
this case, it is not because of the immediate annuity exception
– as the purchase date of the original annuity was still more
than 1 year ago – but simply because lifetime annuitization
will (generally) meet the substantially equal periodic payment
requirements anyway, as payments are being made over the life
expectancy of the annuity owner!
Notably, many early withdrawal penalty exceptions that apply
to IRAs are not on this list of exceptions for annuities; the early
Example 7. Seven years ago, Trevor invested $200,000 into
a variable annuity with an enhanced death benefit that was
guaranteed to grow at 6%/year. Due to losses in the financial
crisis and ongoing fee drag, the growth in Trevor’s annuity has
not kept pace with its guaranteed death benefit; 7 years later
when he passes away, the cash value is up to only $270,000, but
the 6%-compounded death benefit is now just over $300,000.
Accordingly, the proper amount to report on the estate tax return
is the $300,000 value that the beneficiaries will actually receive
as a death benefit under the terms of the contract, not merely the
$270,000 cash value on the date of death.
An important caveat for situations like the one above is that if
the accountant preparing Trevor’s estate tax return contacts the
annuity company and merely requests the “value” of the annuity
on a particular date (when Trevor died), the value may stated as
$270,000. To ensure the proper reporting of the annuity’s value
on an estate tax return, it is crucial to specifically ask for and
confirm the date of death value on that date that includes any
adjustments due to death itself!
For estate planning purposes, it’s also important to note that
while the annuity is reported in the decedent’s estate for estate
tax purposes, annuities generally are not a probate asset (and
therefore do not need to be held in a revocable living trust or by
other means to avoid probate). As with life insurance, annuities
pass by operation of the contract and are payable at death of
the owner directly to the stated beneficiary of the annuity,
and outside of the probate process (unless the estate itself is
named the beneficiary, or becomes the beneficiary by default
in the absence of having any other stated beneficiary under the
contract).
56
Income Tax Treatment After Death
The core income tax treatment of withdrawals from annuities
after death is the same as it is during life: distributions are
taxable as (ordinary income) gains first to the extent of any gains
above cost basis, and then principal is returned, with any pre1982 principal coming out first for grandfathered contracts.
The cost basis in the hands of the beneficiary is the same as it
was in the hands of the original owner; unlike many other assets,
annuities do not receive a step-up in basis at death, though
another special “grandfathered” rule does provide step-up in
basis for any annuities purchased prior to October 21, 1979 and
still held as the original pre-1979 contract25 (given that such
deferred annuities would now be in accumulation status for 35+
years, they are relatively uncommon, especially since even a
1035 exchange invalidates this grandfathered step-up-in-basis
rule26; nonetheless, some grandfathered annuities eligible for
step-up in basis do exist).
Because the embedded gains in an annuity at the death of the
owner carry over to the beneficiary (since there is normally no
step-up in basis), those embedded gains are treated as Income
in Respect of a Decedent (IRD), which in turn means the
beneficiary will be eligible for an income tax deduction for any
additional estate taxes that were paid due to the embedded gains
in the annuity27.
Example 8a. Harriet passes away leaving a $15M+ estate to
her daughter Sally that will face a top marginal estate tax rate
of 40%. Harriet’s estate includes a $600,000 annuity with a
$400,000 cost basis. Given that the last $200,000 of gains
effectively increased Harriet’s estate tax liability by 40% x
$200,000 = $80,000, Sally will receive an $80,000 income
tax deduction for the additional estate taxes triggered by the
embedded gain.
Thus, if Sally subsequently liquidated the annuity, she would
report $200,000 of income, and an $80,000 IRD deduction
Post-Death Transfers & 1035
Exchanges
beneficiary inherited an annuity from a
The caveat to these new rules allowing
company of questionable credit quality
post-death 1035 exchanges is that because
and wanted to move the funds to a new
the guidance came in the form of a PLR,
Because annuities are IRD assets after
company (but without triggering income
the rules are not binding across all annuity
death, a transfer or change of annuity
taxation).
companies, and there is no obligation for
ownership will trigger immediate
recognition of gains under IRC Section
691(a)(2), similar to the consequences
of transferring an annuity during the
life of the original owner. The actual
transfer of ownership due to death itself
(from the original decedent owner, to the
named beneficiary) is the only change
that can be made to the ownership of an
annuity that allows a shift in the income
Fortunately, the IRS recently indicated that
they will relent a bit in such situations. In
PLR 201330016, the IRS declared that
a beneficiary of an annuity could still do
a 1035 tax-deferred exchange from one
annuity contract to another after the death
of the original owner (just as the original
owner could have done while he/she was
alive).
tax consequences of embedded gains
The IRS indicated that to receive
(again, from original decent owner, to the
preferable (i.e., tax-deferred) treatment
beneficiary).
for the exchange, the new annuity needs
Historically, the rules for transfers of
annuities after death (without income tax
ramifications) were interpreted so strictly,
that beneficiaries were not only stuck
facing the income tax consequences of
the inherited annuity, but couldn’t even
change to a new/different annuity contract.
This often created friction, such as when
a young beneficiary who inherited a fixed
annuity wanted to change to a variable
to contractually obligate the beneficiary
to take withdrawals from the contract at
least as rapidly as would have occurred
under the original contract (in accordance
with the annuity post-death distribution
rules), and that the annuity needs to
be exclusively for the benefit of that
beneficiary (i.e., any further change in
contract or any ownership would still
trigger tax consequences).
annuity companies to honor the request.
Instead, it’s up to the surrendering and
receiving annuity companies about
whether they will acquiesce to cooperate
with a post-death 1035 exchange (if not,
the beneficiary may need to obtain their
own PLR to force the issue with the
annuity company).
As a result, in practice not all beneficiaries
who inherit a deferred annuity will be
able to 1035 exchange the contract.
Nonetheless, for those who are concerned
about the issue and wish to make a postdeath exchange to another contract,
the beneficiary should at least contact
the annuity company and inquire about
the feasibility of either an external
1035 exchange to an annuity at another
company, or at least an internal 1035
exchange to another annuity from the same
company (e.g., if the sole goal is just to
switch from a fixed to a variable annuity).
contract for more growth, or where a
Volume 14, Issue 1
(which is claimed as a miscellaneous itemized deduction not
subject to the 2%-of-AGI floor28). If Sally only takes partial
withdrawals from the annuity after death, the $80,000 deduction
is generally claimed on a pro-rata basis (e.g., if she withdraws
$50,000, or 1/4th of the gains, she will be eligible to claim
$20,000 or 1/4th of the IRD deduction29).
The benefit of the IRD deduction, which applies as well to other
pre-tax ordinary income assets that do not receive a step-up in
basis at death (e.g., pre-tax IRAs), is that it mitigates what would
otherwise be double-taxation (paying income taxes on money
that was already going to be paid out for estate taxes). Notably,
this also means it is not necessary to liquidate an annuity (or
other pre-tax assets) before death, to try to avoid the potential for
double taxation.
Example 8b. Continuing the example above, if Harriet was
concerned about paying income taxes and estate taxes on the
same $200,000 gain, she might liquidate the annuity before
death. Assuming a 33% tax rate, she would pay $66,667 of
income taxes, reducing the net value of the annuity to $533,333.
With a top 40% estate tax rate, the estate tax liability on the
$533,333 would be $213,333, and Sally would inherit $320,000.
By contrast, if Harriet simply kept the annuity through death,
her total estate tax liability on the $600,000 annuity would be
$240,000, but as noted above Harriet would only owe income
taxes on $120,000 of the gain (the total $200,000 of gain reduced
by the $80,000 IRD deduction), and at a 33% tax rate for Sally
the income tax liability would be $40,000. Thus, if Harriet kept
the annuity, Sally would inherit $600,000 - $240,000 (estate
taxes) - $40,000 (income taxes) = $320,000.
The end result: whether Harriet liquidates the annuity before
death or Sally does so after death, Sally inherits the same net
$320,000 at the end of the day (and in fact the whole purpose of
the IRD deduction is to ensure that these two scenarios come out
the same!).
It’s important to note that the IRD deduction is only available
for Federal estate taxes triggered by the annuity gain; there is
generally no IRD deduction for state estate taxes attributable to
pre-tax assets in the estate at death (unless the state explicitly
allows it).
On the other hand, because the IRD deduction is an income
tax deduction for estate taxes paid on a pre-tax asset, it’s also
notable that the IRD deduction is entirely a moot point if the
decedent was not subject to Federal estate taxes in the first place!
Required Minimum Distributions From Annuities
After Death
While the income tax treatment of deferred annuities after death
is substantively the same as it is during life, where withdrawals
are treated as gains-first (to the extent of any gain, albeit with
an adjustment for IRD for wealthy decedents) and are taxed
57
as the withdrawals occur, the death of any annuity owner does
trigger special rules regarding the timing of those withdrawals:
specifically, beneficiaries of inherited annuities are subject to
post-death required minimum distribution rules30, similar to
those applicable to IRAs and employer retirement plans31.
These post-death distribution requirements apply to annuity
beneficiaries after the death of any original owner, regardless of
the fact that annuities are not subject to RMDs while the origial
annuity owner was alive. And these rules apply at the death of
any owner32, which means in the case of a jointly owned annuity,
it is actually the first death that triggers the post-death required
distribution rules, even though there is a surviving joint owner!
When the death of any owner does occur, the actual post-death
distribution requirement will vary depending on the type of the
beneficiary. Again, in a manner similar to IRAs, the annuities
have different requirements for distributions to beneficiaries
depending on whether the beneficiary is a spouse, any other nonspouse individual, or a non-living entity (e.g., the decedent’s
estate, or certain types of trusts).
Spousal Continuation
In the event that the surviving spouse of the original annuity
owner is the beneficiary of the contract (regardless of whether
he/she is a joint owner and a beneficiary, or “just” a beneficiary),
the spouse may elect to continue the annuity in his/her own
name, as though he/she was the original owner.33
In practice, this is similar to the “spousal rollover” rules that
apply to retirement accounts, which also allows the beneficiary
to continue the original account in the individual’s own name.
Typically, spousal continuation for annuities is accomplished by
actually re-registering the annuity in the name of the spouse as
the new owner. From that point forward, the contract continues
as though he/she owned the contract in the first place for tax
purposes (though notwithstanding spousal continuation for tax
purposes, the continuity of any annuity contract death benefit or
living benefit retirement income guarantees depends on the terms
of the annuity itself and may not remain in place beyond the
death of the original owner).
An important caveat for the spousal continuation rules to apply
is that the surviving spouse must be directly named as the
beneficiary of the annuity. A trust for the benefit of the surviving
spouse is generally not eligible for spousal continuation. Thus,
an annuity left to a bypass trust or QTIP trust for the benefit of
a surviving spouse will not be eligible for spousal continuation
treatment, and naming even the spouse’s own revocable
living trust will generally not apply (though in at least one
circumstance, the IRS has allowed in a PLR an annuity that was
‘accidentally’ left to a revocable living trust to ultimately be
continued in the name of the surviving spouse, as she had full
dominion and control over the trust assets anyway34).
In addition, it’s notable that for a surviving spouse to continue
58
Joint Annuity Ownership
Between Non-Spouses
While the spousal continuation rules allow a non-qualified
deferred annuity to be continued in the name of a surviving
spouse, the continuation rule is available only for a surviving
spouse beneficiary. And because annuities must begin a payout
at the death of any (i.e., the first) owner, this means that even
in the case of a jointly owned annuity, the surviving (nonspouse) owner cannot continue to keep the annuity after the
death of the first owner!
Thus, for instance, an annuity owned by a husband and wife
can be continued by the wife after the death of the husband
(assuming she is named as the beneficiary), but an annuity
owned jointly by two siblings cannot be continued in the name
of the second sibling after the death of the first; instead, one of
the post-death distribution rules (stretch over life expectancy
or the 5-year rule) must apply after the death of the first
owner.
Accordingly, advisors should be highly cautious about any
situations involving joint ownership of an annuity between
non-spouses. In situations where each individual contributes
the contract after the death of the first spouse, he/she must
actually be named as the beneficiary. Accordingly, if an annuity
is owned jointly between a husband and wife, with a child
named as the beneficiary, at the death of the husband (first death
of any owner) the annuity will pay out to the named beneficiary
(child) and the wife will not be able to continue the contract,
even though she is a surviving joint owner! In fact, not only will
the wife be disinherited as the contract is paid to the beneficiary,
but the wife may even be required to file a gift tax return for the
implied gift of her share of half the annuity to the child (while
the other half is classified as a bequest from the estate of the
husband)!
Fortunately, in some joint ownership situations, annuities will
“override” a beneficiary designation and stipulate in the contract
itself that a surviving joint owner is automatically deemed to be
the primary beneficiary, avoiding this scenario where a surviving
owner can be both disinherited, lose the ability to continue the
contract (in the case of a spouse; for non-spouse joint owners,
see sidebar), and be compelled to file a gift tax return for the
half-share that is gifted. However, such deemed beneficiary
provisions are not present in all annuity contracts; as a result,
if there is truly a desire for a surviving spouse to continue a
contract, mere joint ownership is not necessarily sufficient,
and the annuity beneficiary designation form should explicitly
state that the beneficiary is “surviving joint owner” or simply
“surviving spouse.”
half of the value of the contract, joint ownership creates a
risk – or in fact, a certainty – that if the annuity is held long
enough until someone passes away, the surviving owner will
find themselves compelled to withdraw their own money (and
the decedent’s share) as a series of post-death distributions!
Conversely, in situations where one individual makes the
entire contribution but names a second owner – for instance,
where a parent funds the annuity but names the child as joint
owner to facilitate access to the contract – an untimely death
of the joint owner (the child) could force the remaining owner
(the parent) to liquidate their own contract with their own
assets, and pay the associated tax consequences!
As a result of these rules, most situations with joint ownership
of an annuity between non-spouses will be better served
by either simply having a power of attorney for the annuity
owner (if the issue is control/access of the annuity), or having
joint owners each contribute their own money to their own
individual annuity with the other person named as beneficiary,
rather than actually following through with joint ownership
and its complications.
Stretch Annuities For Non-Spouse Beneficiaries
As noted earlier, deferred annuities must begin to pay out to
beneficiaries upon the death of any owner. And in situations
where the beneficiary is someone besides the spouse, the annuity
must pay out; in other words, it cannot be continued in deferred
status by the beneficiary, even if that non-spouse beneficiary is a
joint owner.
Instead, after the death of the (first) owner, the deferred annuity
must begin payments over the life expectancy of the beneficiary,
with the first payment occurring within 1 year of the owner’s
death.35 (Note: Unlike IRAs, where the first distribution to the
beneficiary must begin by December 31st of the year after death,
with deferred annuities the first payment must occur precisely
within 1 year – i.e., within 365 days of the date of death.)
Notably, while the rules allow for non-spouse beneficiaries to
take distributions from an inherited deferred annuity over life
expectancy, there has been some uncertainty about how those
distributions must be taken. Historically, the interpretation was
that payments “over life expectancy” meant annuitizing the
contract on behalf of the beneficiary over his/her life expectancy.
For many young beneficiaries this was unappealing, as the
payments were sometimes “trivially” small over a long life
expectancy; more generally, many beneficiaries chose not to
annuitize simply because they wanted to maintain liquidity
and have continued access to the annuity (above and beyond
small ongoing monthly or annual payments for life) should the
Volume 14, Issue 1
need arise. In this situation, beneficiaries were forced to choose
between receiving payments over life expectancy (but stuck
without liquidity), or keeping liquidity and losing the ability to
do a lifetime stretch at all.
However, in 2001 this changed with the issuance of an IRS
Private Letter Ruling that permitted a beneficiary to take nonannuitized systematic withdrawals from an inherited deferred
annuity, effectively using the same process that applies to
determining Required Minimum Distributions from inherited
retirement accounts.36 And in a surprising follow-up PLR two
years later, the IRS granted permission for the taxpayer to claim
those systematic withdrawals over life expectancy using the
“exclusion ratio” tax treatment, and not the normal “gains-first”
treatment that applies to withdrawals from deferred annuities,
even though the beneficiary had not annuitized the contract!37
In today’s environment, executing this strategy is often referred
to as a “stretch annuity”, similar again to the use of a “stretch
IRA”.
The caveat to this “stretch” treatment for an inherited annuity
is that, because its “authorization” is from a PLR, there is no
requirement for all annuity companies to allow the approach, and
as with other PLR-based rules some companies have adopted
the rule and others have not. As a result, if obtaining stretch
annuity treatment is important/desirable for the annuity owner, it
should be verified in advance whether the annuity company will
allow it. In addition, it’s important to bear in mind that inherited
annuities are only as flexible as the terms of the contract allow,
and annuities can be more restrictive than the stretch rules may
permit; in other words, even if the annuity company would
otherwise allow the stretch, if the specific annuity contract has
a requirement to pay out more quickly or be annuitized, the
contract itself is still binding on the beneficiary. Nonetheless,
in practice a large and increasing number of annuity companies
at least permit stretch annuities for beneficiaries, especially for
newer contracts that are typically designed to be more flexible
and accommodate the strategy.
In the case of multiple beneficiaries, the post-death distribution
rules for annuities have generally been interpreted as allowing
each beneficiary to annuitize their share of the contract in their
own name and use their own life expectancy. However, at this
point there has been no explicit requirement that such splitting
treatment be permitted in the event that multiples beneficiaries
want to take non-qualified systematic withdrawals over their
respective life expectancies without annuitizing. Although
arguably such an approach appears to fall within the intention of
the rules and the general framework of the PLR allowing postdeath systematic withdrawals, and thus “should” be permitted,
the lack of any clear and binding rules means some annuity
companies will cooperate with beneficiaries who wish to do so,
while others will not and may require either the 5-year rule or
for multiple beneficiaries to each annuitize to stretch over their
individual life expectancy.
59
Notably, in order to elect to stretch payments over the life
expectancy of any beneficiary at all, the named beneficiary
must be a “designated beneficiary” – i.e., a living, breathing
human being who has a life expectancy to stretch over in the
first place.38 In the event that the beneficiary is not a designated
beneficiary – e.g., the estate, or a trust – then stretch treatment
is not available. (See breakout below for further discussion of
trusts as annuity beneficiaries.)
The 5-Year Rule
In the absence of electing Spousal Continuation or taking an
inherited annuity stretch over the life expectancy of a nonspouse beneficiary, the default payment option for deferred
annuities after the death of the owner is the “5-year rule” – that
the contract must be liquidated by the 5th anniversary of the
owner’s deth.39
The 5-year rule may apply because a spousal beneficiary
chooses not to do a spousal continuation, or because a nonspouse individual beneficiary fails to begin life expectancy
payments within 1 year of the owner’s death, or simply because
the beneficiary of the contract is not eligible for any of these
options in the first place (e.g., the beneficiary is an estate or a
trust). Technically, the 5-year rule is always the default, and
beneficiaries must proactively elect spousal continuation or
begin life expectancy payments to a designated beneficiary in a
timely manner to avoid having the 5-year rule apply.
Notably, while the 5-year rule requires the annuity to be
liquidated by the 5th anniversary of the owner’s death, it does not
specify the timing of the payments within that 5-year window.
The beneficiary could liquidate immediately after death, wait
to withdraw everything at the end of the 5-year deadline, or
spread out the payments in any manner desired between those
two points, for instance to spread out the tax consequences of the
withdrawals. However, given that withdrawals after death still
follow the standard “gains-first” tax treatment, spreading out the
tax consequences can actually necessitate leaving most of the
money in the contract until the end of the 5-year time horizon.
Example 9a. Polly inherits a deferred annuity from her mother,
who died on March 30th of 2014; at the time of her mother’s
death, the contract was worth $240,000, and had original
contributions (i.e., cost basis) of $150,000. If Polly does not
elect to take payments over her life expectancy, the contract must
be fully liquidated by March 30th of 2019 under the 5-year rule
(which actually allows for 6 tax years, including the remainder
of the 2014 tax year, 2015, 2016, 2017, 2018, and the permitted
withdrawals in the first few months of 2019).
If Polly takes out 1/6th of the contract ($40,000) per year for 5
years, though, she will receive $40,000 of gains-first taxable
income in 2014, another $40,000 in 2015, the last $10,000 of
gains in 2016 along with $30,000 of principal, and then only
principal payments in the remaining 3 years.
60
Trusts As Beneficiaries Of (Non-Qualified) Deferred Annuities
When a non-qualified deferred annuity
Arguably, there is a case to be made for
the maximum rate that can be used in the
is payable directly to an individual
cross-applying the retirement account “see
calculation, can be cross-applied to non-
beneficiary, the potential to stretch over
through” trust regulations to annuities
qualified annuities as well.
the life expectancy of that designated
as well. The requirements for post-death
Nonetheless, until there are Treasury
beneficiary is explicitly permitted in the
distributions, including the definition of a
Regulations or a ruling directly authorizing
tax code under IRC Section 72(s)(2).
designated beneficiary, and the potential
the cross-application of the retirement
However, the result is far less clear in the
to stretch post-death distributions over
account see-through trust rules to apply
scenario where an annuity is payable not
the life expectancy of that beneficiary,
for annuities, most annuity companies
directly to an individual beneficiary, but to
are virtually identical between IRC
have refused to acquiesce and allow
a trust for his/her benefit instead.
Section 401(a)(9) and IRC Section 72(s)
such a stretch to occur with one of their
In the case of retirement accounts,
(for retirement accounts and annuities,
own annuities, fearing the consequences
Treasury Regulation 1.401(a)(9)-4, Q&A-
respectively). Accordingly, it seems
as the annuity company for failing to
5 explicitly allows an IRA or employer
logical that where the underlying rules
properly administer the annuity post-death
retirement plan to “see through” a trust to
are the same, the Treasury Regulations
distribution rules in compliance with the
its underlying beneficiaries, and as long as
interpreting the application of those rules
tax code. As a result, until the IRS and
the relatively straightforward requirements
should be the same as well. And there is
Treasury take action – or an unfortunate
are met, the trust itself can stretch post-
precedent for this; for instance, the rules
taxpayer who finds themselves in this
death required minimum distributions
allowing substantially equal periodic
circumstance decides to submit a Private
from the retirement account out over the
payment (SEPPs) to avoid an early
Letter Ruling to specifically ask the IRS
life expectancy of the oldest underlying
withdrawal penalty are technically separate
to grant this treatment – the challenge
trust beneficiary. However, these Treasury
for retirement accounts and annuities (IRC
remains that annuity owners who want
Regulations allowing see-through
Section 72(t)(2)(A)(iv) and 72(q)(2)(D),
to bequeath an annuity to a trust for the
treatment for trusts and heir beneficiaries
respectively), but IRS Notice 2004-15
benefit of an individual beneficiary, rather
were written specifically for IRC Section
has explicitly declared that the rules and
than to the beneficiary directly, must
401(a)(9) – which pertains to retirement
regulations for SEPPs from retirement
accept less favorable stretch treatment as
accounts – and not for non-qualified
accounts, including the permitted
a trade-off for the greater control of assets
annuities.
methodologies to calculate SEPPs and
otherwise permitted with the trust.
Example 9b. Continuing the prior example, if Polly actually
wishes to spread out the tax consequences, she would actually
need to withdraw $15,000/year in 2014, 2015, 2016, 2017,
and 2018 (a cumulative $75,000 of gains), and in the final year
withdraw $165,000 (including the last $15,000 of gains and
all of the $150,000 of principal), producing a highly uneven
series of cash flows to create an even distribution of the tax
consequences! (Note: If the contract was assumed to have some
growth rate, withdrawals may be slightly higher in the earlier
years to even out both the $90,000 of embedded gain, plus future
growth, but the fundamental principal of uneven cash flows to
create an even spread of tax consequences remains the same.)
Conclusion
In the end, non-qualified deferred annuities are subject to a
unique set of tax laws and preferences – including a number
of “older” grandfathered rules that can still apply in certain
situations – which must be navigated to make good annuity
decisions on behalf of clients, both in how to handle spending
and liquidations from contracts during life, and also how to
navigate the tax consequences after death. Understanding the
rules is especially important for prospective planning situations,
including how the annuity contract will be owned and structured,
and who the beneficiaries will be, because many potential
problems that can arise are only able to be fixed while the
original annuity owner is alive, and not after death.
Unfortunately, though, even with prospective planning, many
aspects of annuity taxation – especially for beneficiaries – are
reliant on non-binding private letter rulings, which means
Volume 14, Issue 1
61
the choices and their associated tax consequences may truly
vary from one insurance company to the next. As a result, if
a particular planning strategy – such as a systematic stretch
withdrawal after death – is important to the client, it’s crucial to
understand how a particular annuity company will handle the
situation ahead of time, so changes can be made if necessary.
And of course, beyond the tax planning opportunities that
annuities present, it’s vital to understand the actual mechanics of
the annuity contract as well, and all of its fine print, as the simple
reality is that in the end an annuity is a contract, which means
annuity owners and their beneficiaries will – for better or worse
– be bound to the terms and conditions of the contract. While
in some cases this may be appealing – where the annuity owner
purchases an annuity specifically for the guarantees that the
contract provides – it’s still important to remember that planning
with annuities must balance the tax consequences, the terms
of the annuity itself, and the details of what the contract (and
insurance company) will or will not allow.
Endnotes
1
IRC Section 72(u)
PLRs 9120024, 9204014, 9316018, 9322011, 9639057, 199905015,
199933033, and 200449017.
3 PLR 9752035
4 PLR 199944020
5 IRC Section 72(b)
6 IRC Section 72(e)(2)(B)
7 IRC Section 72(e)(3)(A)
8 IRC Section 72(e)(5)(E)
9 IRC Section 72(e)(11)
10 IRC Section 72(e)(4)(A)
11 IRC Section 72(e)(4)(C)
12 Tax Reform Act of 1986, Section 1826(b)(3)(C)
13 Tax Reform Act of 1986, Section 1135(b)
14 Tax Equity & Fiscal Responsibility Act of 1982, Section 265
15 Revenue Ruling 1985-159
16 IRC Section 72(q)(2)
17 IRC Section 72(q)(1)
18 IRC Section 72(q)(2)(B)
19 IRC Section 72(q)(2)(C)
20 IRC Section 72(q)(2)(D)
22 IRC Section 72(q)(2)(I)
24 IRC Section 2032
26 PLR 9245035, TAM 9346002
27 IRC Section 691(c)
28 IRC Section 67(b)(7)
29 IRC Section 691(c)(1)(A), Treas. Reg. 1.691(c)-1
30 IRC Section 72(s)
31 IRC Section 401(a)(9)
32 IRC Section 72(s)(1)
34 PLR 200323012
35 IRC Section 72(s)(2)(C)
36 PLR 200151038
37 PLR 200313016
39 IRC Section 72(s)(1)(B)
2
IARFC
AGENDA
subject to change
April 29, 2015
April 30, 2015
Business Owner Consulting Workshop (BOCW)
Moderator: Steve Bailey
National Financial Plan Competition Finals
Moderator: Ed Morrow
Speaker: Ed Morrow
7:30 am – 8:00 am
Registration
7:30am – 8:00 am
Registration
8:00 am – 8:15 am
Welcome and Opening Remarks
8:00 am – 8:05 am
Welcome and Opening Remarks
8:15 am – 8:20 am
Introduction Team 1
8:05 am – 10:15 am
Risk Measurement
2:45 pm – 2:55 pm
Break
2:55 pm – 3:30 pm
Preparation of Strategic
Business Plan, Five Case Studies
Moderator: Faculty Instructor
8:20 am – 8:55 am
Team 1 Presentation, Q&A
8:55 am – 9:00 am
Scoring
9:00 am – 9:15 am
Sponsor Presentation
9:15 am – 9:20 am
Introduction Team 2
9:20 am – 9:55 am
9:55 am – 10:00 am
Scoring
10:00 am – 10:15 am
Break
10:15 am – 10:30 am
3:30 pm – 4:00 pm
Post-Workshop Action Checklist
10:30 am – 10:35 am
4:30 pm – 5:30 pm
Speedway Tour
6:30 pm – 8:30 pm
Welcome Dinner
10:35 am – 11:10 am
11:10 am – 11:15 am
Scoring
11:15 am – 11:30 am
11:30 am – 12:00 pm
Path to Accreditation
10:15 am – 10:25 am
Break
10:25 am – 12:00 pm
Business Planning Process
Business Valuation, Alternate Funding
12:00 pm – 1:00 pm
Buffet Lunch
1:00 pm – 2:45 pm
Business Loan Cancellation
Excel Calculations
Introduction Team 3
Speaker: Amy Primeau
12:00 pm – 1:00 pm
Buffet Lunch
1:00 pm – 2:00 pm
Presentation
Speaker(s): Steve Bailey and Stephanie Bailey
Sponsors
2:00 pm – 3:00 pm
3:00 pm
Awards Presentation
Close
IARFC National
Financial Plan Competition
April 29-30, 2015 — Charlotte, NC
focusing on the future
Step 1
Step 3
Check your events
Schedule of Events
Total Payment: _____________________________
Please check appropriate box:
Business Owner Consulting Workshop
(BOCW)
4/29/15
Credit Card
Check made payable to IARFC
___________________________________________ _____________
Exp. date
Credit Card # (Discover, MasterCard, Visa, AmEx)
4:30 pm–8:30 pm
________________________________________________________
Signature
4/30/15
Payment Information:
8:00 am–4:00 pm
Charlotte Motor Speedway Tour &
Welcome Dinner
4/29/15
Put total event price on the
Total Payment line, fill out form
below and return to the IARFC.
REGISTRATION INFORMATION
8:00 am–3:00 pm
Please print or type information below.
Step 2
Take advantage of Special Packages
.
Price*
Business Owner Consulting Workshop
Speedway Tour/Dinner
$395
$65
$95
Special Packages
BOCW, Speedway Tour/Dinner
$400
BOCW, Speedway Tour/Dinner &
Competition
Speedway Tour/Dinner & Competition
$475
$145
Mr.
Ms.
Mrs.
_________________________________________________________________
First Name
Last Name
_________________________________________________________________
Firm or B/D
_________________________________________________________________
Street Address
_________________________________________________________________
City
State
Zip Code
________________________________________________________________
Phone
_________________________________________________________________
E-mail
Registration Deadline and Cancellation Policy: Attendees may register or cancel up to 15 days prior to the event date. Cancellations will receive a full refund,
less a $20 processing fee. See Hotel cancellation policy, which is separate from IARFC. Travel and Lodging: are not included in the price. The IARFC has
negotiated discounted room rates starting at $124 per night at Hampton Inn & Suites, Concord, NC, charlotteconcordmillssuites.hamptoninn.com group
code IAR. Food: Buffet lunch will be provided at the BOCW and the Competition, Welcome Dinner style is sit down. Ground transportation: A shuttle bus
will be available, to and from the Speedway Club at no extra charge for scheduled events. Note: Program Subject to Change.
PLEASE RETURN THIS COMPLETED FORM TO IARFC
IARFC
International Association of Registered Financial Consultants
Financial Planning Building
P.O. Box 42506
Fax: 513.424.5752
Questions: 800.532.9060
www.IARFC.org
info@iarfc.org
International Association of Registered
Financial Consultants - IARFC
P.O. Box 42506
Middletown, Ohio 45042
www.journalofpersonalfinance.com
2015 National Financial Plan Competition Sponsorship
Individual Sponsors
Diamond
Steve Bailey
Pete D’Arruda
Harvey Charbonneau
Ed Morrow
Ram Tak
Jon Rogers
Angie Trandai
Denis Walsh
Platinum
Les Anderson
Jay Bailey
Michelle Blair
David Howard
Rik Saylor
Gold
Silver
Jan Belyeu
Douglas Brown
Isabel Cooper
Ahmed Edris
Frank Eberhart
Victor Ferreira
David Lamorte
Fraj Lazreg
Patrick Lyman
Joseph Lolli
Burnett Marus
Robert Meints
Nancy Onderko
Chris Roberts
Daniel Roberts
Nicholas Royer
Thomas Stark
Anonymous Donation
Patrick Astre
George Atkinson
Andrew Bearre
Christopher Beneke
Jeffrey Bettermann
Jimmy Booth
Bill Brice
George Brown
Mark Cade
Dee Carter
William Casteen
Richard Chrzanowski
Judy Clark
Scott Colbertson
James Davidson
Elisabeth Dawson
Edward Deutschlander
Vicki Diggles
Vincent DiPietro
George Flack
James Flanagan
Penni Foust
Gary Fulk
Jessica Harris
learn more:
www.IARFC.org/FinancialPlanCompetition
Robert Hearn
Bryan Hegarty
Marc Hernandez
Chris Hill
Drew Horter
Gerard Iacangelo
Rene Isuk
Norman Johnson
Darren Josephson
David King
Larry Lambert
Vernon Larson
Denis Leyder
Zachary F. Longley
Charles McKinney
Timothy Morgan
Susan Morrow
John Mulcahy
Chris Nelson
Ron Nisbet
Yukiko Ogino-Christman
Frederick Ostermeyer
Gary Padussis
Garry Parrish
Bryan Philpott
Barbara Pietrangelo
Allen Rumble
John Repass
Owen Seidenberger
Troy Sharpe
Mark Sheahan
Bob Shlesinger
Dora Siegferth
Aghee “Bill” Smith
Lea Smith Johnson
Melvin Spain
Neil Spicer
Stuart Spivak
Ken Stone
Jessica Sullivan
Gnilane Ndiaye Sylla
Charles Reed Terry
Darrell Timberlake
Jeff Vogan
Michael Wall
Mary Jo Walker
Brian Walsh
Brenda Whitman
Kirk Barr Young
Salvatore Zimbardi
Corporate Sponsors
Join in the Sponsorship and have your name listed here and on IARFC.org.
Thank you for Supporting the Future of Financial Planning.

journal of personal finance volume 14, issue 1 2015

Transcription

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