Divorce Planning Using Annuities with Guaranteed Income Riders
I was talking to someone the other day about their impending divorce, and it dawned on me that there is a terrific and simple use of annuities with Guaranteed Income Benefit (GIB) riders in divorce planning.
Stereotypical Divorce Fact Pattern-I don’t mean to be sexist, but the typical divorce is still one where the husband is the main breadwinner and where the wife may not work, or if she does, it may be part-time or full-time, but makes less money than the husband. Most of the time the couple has one or more children of varying ages.
Not every divorce fact pattern is a candidate to use annuities GIB riders, and so I’ll lay out the fact pattern where I think they will work best:
-Married 10 or more years
-Husband makes decent money
-Some amount of liquid assets (including IRA or 401(k) plan assets)
-Wife does not work or works part-time
Why the above fact pattern? Because with marriages of longer than ten years where one spouse didn’t work or worked and made little money, most states will allow the judge to award long-term alimony payments to the non-working or part-time working spouse (in addition 50% of the assets).
The Settlement-most divorces settle. As part of a settlement using my above fact pattern, the husband is most likely going to have to pay alimony for a lengthy period of time (it will depend on how employable the other spouse is and how much she could earn) and will give up 50% of the marital assets.
The goal in the divorce is typically to allow the non-breadwinning spouse to keep the lifestyle she has become accustomed to. The more affluent the client, the more this will cost and the more likely the husband will have to pay a good amount of money for support.
FEAR-the fear of the non- or low-income spouse is that, once the support runs out (be it in 5, 7, 10+ years), how is she going to make a living and what about the 30+ years of retirement she will have to financially sustain herself?
She typically has not been paying into Social Security and, therefore, her benefits will be reduced. She may have been awarded only 50% of the husband’s 401(k) plan or IRA and other assets, but is that going to be enough?
Using annuities with GIB riders to facilitate a settlement-for this to work, the soon-to-be divorced couple needs $100k, $200k, or more in liquid assets. That most likely will be in a 401(k) or IRA if they are ages 45-50+.
When the settlement is discussed, the breadwinning spouse will suggest that spousal support (1-10+ years) be at a lower or much lower rate than what would normally be calculated/awarded.
Why would the non-bread winning spouse agree to lower spousal support?
In exchange for lower spousal support, the offer would include up-front funding of an annuity with a GIB rider that would kick in and make guaranteed income payments for life to the non-bread winning spouse. The income rider could pay for 30+ years if the spouse lives long enough (meaning the income will outlast by decades the spousal support payments).
Let’s look at an example-assume both spouses are 55-years old. The husband has $250,000 in a 401(k) plan at work. Through a QDRO (Qualified Domestic Relations Order) he transfers ALL of those assets to the soon-to-be ex-spouse. Inside the new IRA of the spouse, she purchases an annuity (FIA) with a GIB rider and lets the benefit based used to calculate the income roll up for 10 years. If she kicked the income in after 10-years, the GIB every year for life would be $25,451.
How does the $25,451 annual payment every year for life affect the rest of the settlement?
With the $25,451 annual payment that the ex-spouse will receive for up to 30+ years (if she lives until age 95), the paying spouse could negotiate a much better settlement of other assets (much more than 50% of the remaining assets).
Or, short- or even long-term alimony can become part of the negotiation. For example, if the alimony would normally be calculated at, let’s say, $45,000 a year for 10 years, the soon-to-be ex-spouse might agree to $30,000 so long as the $25,451 payment from the annuity starting at age 65 was guaranteed.
But couldn’t the spouse do this on her own without negotiating down what the settlement would have been?
No. With a typical settlement, the spouses would split the 401(k) balance. In my example, that would knock her GIB payment in half.
If the spouse takes 50% of the assets and rolls them to her own IRA, she’ll most likely invest in a “properly balanced mix of stocks and mutual funds” which will be 100% at risk to market downturns and will NOT be able to provide her a GIB for life in the amount of $25,451.
And by the way, if I illustrated a stacked income FIA (one with a 4% guaranteed roll up + whatever the index returns), the guaranteed income would be $33,398. (I used the OnPointe FIA illustrator’s Monte Carlo forward testing application to derive this number). To learn about this product, click on the following link: http://www.best-fia-imos-wont-offer.com/stackable-income.
Potential benefits of using an FIA with a GIB rider is:
1) unequal division of assets slanted towards the breadwinning spouse
2) reduced or even significantly reduced alimony payments
3) the breadwinning spouse shifted a tax-hostile asset (the worst asset to hold onto in a divorce is the 401(k) asset) to the ex-spouse.
Summary-using GIB rider FIAs in a divorce settlement can provide financial certainty for life for the non-working or part-time working spouse while improving the financial terms of the final settlement for the bread winning spouse. It can be a win-win for both sides if used right and properly postured.