What is Longevity Insurance?

Longevity insurance, also known as a longevity annuity or a deferred income annuity, is a risk-shifting tool to insure against the risk of outliving your retirement assets.  The risk of outliving retirement assets has become a very real possibility given increasing life expectancies and the decline of employer-provided defined benefit retirement plans.  With longevity insurance, you invest a lump-sum of money now with the objective of waiting for many years (e.g. until age 85) before receiving a stream of payments for the rest of your life.  If you die before the starting date, your heirs receive nothing.  Requesting a payback guarantee so your heirs receive back your investment if you die early will significantly reduce the annuity payment, defeating some of the benefit of the longevity policy.  The objective is to provide an enhanced income stream in your old age when much of your retirement assets may have been depleted.  So in a sense, longevity insurance is like any other insurance policy that pays when some event occurs, such as a car wreck, a fire in your home, etc.  But with longevity insurance, the event is living to a certain age.

The fact that not everyone lives to old age enables the insurance company to pay a fairly high amount in relation to the premium.  The longer you wait to receive the annuity the higher the payout.  However, you must remember that the stated benefit is in future dollars, meaning that the real purchasing power of the annuity will have been reduced by inflation.  For example, assuming a 3% inflation rate, today’s dollar will only buy 55 cents worth of goods and services in 20 years.  Some policies provide an inflation adjustment for an additional premium payment.

Who should consider a longevity annuity?  A person in their 50’s or 60’s who is in good health.  A person having family members who lived to an old age.  Those who have sufficient retirement assets and Social Security or other pension benefits and can afford to make the lump-sum premium payment and wait until the annuity begins.  On the other hand, longevity insurance doesn’t make financial sense for those persons with sufficient money that the risk of outliving their retirement funds is remote.

Generally no more than 10% to 25% of retirement assets would be placed in longevity insurance.  The money paid in is generally not accessible to you during the time period before payout.  The payout amount depends upon your age and upon interest rates at the time of purchase.  The younger you are when purchasing the policy, the higher the future payout.  The higher interest rates are at the time of purchase, the greater the future payout.

Only financially sound and historically stable insurance companies should be considered for this type of policy.  If the insurance company were to fail before you receive your benefits, you would receive nothing or only some amount from the state insurance guaranty fund.  For this reason, it makes sense to use more than one insurance company in order to reduce the risk of loss if an insurance company goes bankrupt.  Longevity insurance policies are relatively new to the financial landscape, and it is anticipated that the policies will improve once more competition arrives.

In the past, purchasing a longevity annuity in an IRA or 401(k) plan has been problematic because of the start of the required minimum distribution (RMD) rules at age 70 ½.  If the RMD isn’t distributed on time, a 50% penalty applies.  Since the longevity annuity doesn’t typically start paying until well after the age of 70 ½, this financial product didn’t fit well within these plans.  However, the government just issued new regulations permitting IRA owners and 401(k) plan participants to invest in qualifying longevity annuity contracts (QLAC) inside their retirement accounts without having to worry about the RMD rules.  In essence, the value of the QLAC is removed from the year-end account value used each year in calculating RMDs.  However, the regulations limit the amount that may be invested in a QLAC to 25% of the account balance or $125,000 whichever is less.  The QLAC must be a fixed annuity but may be adjusted for inflation.  The $125,000 ceiling will be adjusted for inflation in $10,000 increments.  The 25% limit for IRAs is applied by aggregating the account values of all traditional IRAs as of December 31^st of the year before the year the premium is paid.  The QLAC must begin payout no later than age 85.  Each spouse can have his or her own QLAC without impacting the limitations on the other spouse’s IRA or 401(k).  Because Roth IRAs are not subject to the RMD rules during the account owner’s lifetime, there appears to be no limitation on the amount or percentage of a Roth IRA that can be used to purchase a longevity annuity.

IRS Again Revises its Offshore Voluntary Disclosure Program

The Federal government is continuing to use its power to catch taxpayers who did not report their foreign financial accounts and/or pay income tax on the income derived in those accounts.  The U.S. taxes worldwide income of its citizens and residents and requires the disclosure of certain foreign financial accounts and assets.  The rules for determining who must report and what must be reported are exceedingly complex.  Many taxpayers have been blissfully ignorant of the rules.  The government is using the threat of large penalties to encourage taxpayers to catch up on accounts that haven’t been reported in the past.  In the past these threats have not distinguished between taxpayers who ignorantly omitted their foreign disclosures and taxpayers who have willfully concealed their accounts.  Responding to some criticism of their approach, the IRS has revised some of the rules pertaining to the offshore voluntary compliance program.  See their statement dated June 18, 2014.  There appear to be four programs currently in place as described on the IRS website.  Various financial penalties apply.

1.     The Offshore Voluntary Disclosure Program (OVDP) is a voluntary disclosure program specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to a willful failure to report foreign financial assets and pay all tax due in respect of those assets.  OVDP is designed to provide to taxpayers with such exposure (1) protection from criminal liability and (2) terms for resolving their civil tax and penalty obligations.  A special rule under this program requires taxpayers to comply with an August 3, 2014 deadline.  This is the date that FBAR non-filers  who have foreign bank accounts with a foreign financial institution that has been publicly identified as being under investigation, or is cooperating with a government investigation.  See the list here.  If such individuals voluntarily come forward by the deadline, their penalty is reduced to 27.5% of the account balance instead of the 50% penalty that will be imposed if they voluntarily come forward after this date.

2.     “Streamlined” filing compliance procedures are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part.  The streamlined procedures are designed to provide to taxpayers in such situations (1) a streamlined procedure for filing amended or delinquent returns and (2) terms for resolving their tax and penalty obligations.  These procedures will be available for an indefinite period until otherwise announced.  The IRS definition of “streamlined” does not mean that a lot of work isn’t necessary to comply with the requirements.

3.     Delinquent FBAR Submission Procedures.  Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:  (1) have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114, previously Form TD F 90-22.1), (2) are not under a civil examination or a criminal investigation by the IRS, and (3) have not already been contacted by the IRS about the delinquent FBARs should file the delinquent FBARs according to the FBAR instructions and include a statement explaining why the FBARs are filed late.

4.     Delinquent International Information Return Submission Procedures.  This program pertains to foreign reporting for forms other than the FBAR.  Taxpayers who do not need to use the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:  (1) have not filed one or more required international information returns, (2) have reasonable cause for not timely filing the information returns, (3) are not under a civil examination or a criminal investigation by the IRS, and (4) have not already been contacted by the IRS about the delinquent information returns should file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file.  As part of the reasonable cause statement, taxpayers must also certify that any entity for which the information returns are being filed was not engaged in tax evasion.

The IRS states that simply filing amended tax returns to correct past problems won’t protect taxpayers from penalties and possible criminal prosecution.  The IRS wants taxpayers to come in under one of the above programs and pay the financial penalty associated with the program.  This type of threat is not normally associated with amended tax returns filed to correct mistakes, and it shows the attitude of the government towards taxpayers who have not timely reported foreign financial accounts.

U.S. Supreme Court Rules that Inherited IRAs are not Protected from the Claims of Creditors

On June 12, 2014, the U.S. Supreme Court unanimously held in Clark v. Rameker that the protection afforded individual retirement accounts under the Bankruptcy Code is lost once such accounts are inherited.  The reason given is that the account loses its traditional character as “retirement funds.”  While it seems clear that an IRA inherited by a non-spouse is now no longer protected, it is unclear whether the protection is also lost if a spouse inherits the IRA.

The Court concluded that an inherited IRA did not constitute “retirement funds” in the hands of the beneficiary by citing the following limitations imposed on inherited IRAs.  Such limitations do not exist for IRAs that are owned and not inherited.

1.     The beneficiary cannot contribute money into the inherited IRA.

2.     The beneficiary must begin minimum required distributions from the inherited IRA and cannot wait until the beneficiary’s own retirement.

3.     The beneficiary may withdraw the entire inherited IRA balance without an early withdrawal penalty if under age 59 ½.

A spouse beneficiary has the ability to roll over the inherited IRA to his or her own personal IRA, whereas non-spouse beneficiaries are unable to do so.  This fact brings up a few important questions: Will this rollover allow the inherited funds to be protected under the Bankruptcy Act?  Or, will the protection not be permitted because the spouse did not set aside such money him or herself?  We may not know the answer to these questions without future litigation.

IRA owners should now consider naming a discretionary trust as beneficiary.  Giving the trustee discretion on how and when to make distributions to beneficiaries may enhance creditor protection.  The trust must be properly drafted to qualify as a designated beneficiary to avoid unfavorable income tax results upon the IRA owner’s death.

This case deals with Federal bankruptcy law.  State law may nevertheless provide some protection to an inherited IRA.  Individuals with large IRA balances who are concerned about asset protection should consult with their attorney.

2013 Foreign Bank Account Report (FBAR) Must be Electronically Filed by June 30, 2014, Using New FinCEN Form 114 (Form TD F 90-22.1 is Obsolete)

U.S. persons having interests in or signature authority over a foreign financial account must file an annual report with the U.S. government if the maximum value of all foreign accounts exceeds US$10,000 on any day during the calendar year.  A foreign exchange rate is used for conversion purposes.  Conversion rates as of December 31^st should be used and they are published here.

New for 2013 is that the old paper-filed Form TD F 90-22.1 has been replaced by new FinCEN Form 114 which must be electronically filed.  FinCEN stands for Financial Crimes and Enforcement Network.  The foreign bank and financial accounts report, or FBAR, must be filed by June 30, 2014 through the BSA E-Filing System here.  BSA stands for Bank Secrecy Act.  You may file your FBAR by using the services of a third-party upon granting the proper permission.  An attorney, CPA, or enrolled agent may act as an account holder’s representative.

No extension of time is permitted.  Significant penalties exist for late or non-filing.  Such penalties can range from $500 to the greater of $100,000 or 50% of the account balance.  In addition, criminal penalties can range from a fine of up to $500,000 plus 10 years in jail in some situations.  Clearly the US government is serious about forcing FBAR compliance.  You should consult legal counsel if you have serious concerns about any delinquency.

Owners of entities that are required to file an FBAR must also file an FBAR at the owner level if they have more than a 50% direct or indirect ownership interest.  So-called “disregarded entities” for income tax purposes are not disregarded for this purpose and must file the report.  Records of accounts required to be reported on the FBAR should be kept for five years from the due date of the report.

Be sure to also check the appropriate boxes at the bottom of Schedule B, Form 1040, and to include any account earnings in your U.S. income tax return.

For more information, consult the IRS’ online FBAR Reference Guide here.

Tax-Exempt Organization Tax Return Filing Deadline Approaching

Tax-Exempt Organizations using a calendar year are required to file 990-series returns by May 15. However, not all organizations are required to file the same form.  The 990-series includes Forms 990, 990-EZ, 990-N and 990-PF, and are not technically income tax returns but are rather informational returns.  However, private foundations are subject to excise taxes on investment income and all exempt organizations are subject to tax on unrelated business taxable income.  In addition to financial information, organizations must describe their organization’s mission and charitable activities. These forms must be filed annually, and organizations that fail to file for three consecutive years will have their federal tax-exempt status automatically revoked.

Depending on the size and type of your organization different forms are required.  Small tax-exempt organizations with average annual receipts of $50,000 or less may file Form 990-N, also known as an e-postcard.  The 990-N filing is only available online, and asks for some basic information regarding your organization.  Organizations that file Form 990-N are not required to file Form 990 or 990-Z.  However, the 990-N is not allowed an extension, and as such must be filed by May 15 if your organization operates on a calendar year.

Form 990-EZ is a shorter and simpler version of Form 990 that can be used by smaller organizations that have average annual receipts of less than $200,000 and less than $500,000 of assets.  Form 990 is required for all exempt organizations with average annual receipts of $200,000 or more and assets of $500,000 or more.  Private Foundations must file Form 990-PF regardless of the amount of receipts or assets.

The due date for filing Forms 990-EZ, Form 990 and Form 990-PF may be automatically extended 3 months by filing Form 8868.  However, a filing extension does not extend the payment due date if any taxes are owing.  If an additional filing extension is required, page two of Form 8868 may be submitted, but reasonable cause must be given as the second extension request is not automatic.

How Many Income Tax Systems Do We Have?

Now that the 2013 tax filing season is over, it is time to consider just what income taxes you had to pay.  Our income tax system is more complex than what many people believe.  One major reason for the complexity is that a brand new income tax system, created by the Affordable Care Act (Obamacare), came into being in 2013.  So, you might wonder, how many income tax systems do we have?  The answer:  we have four parallel income tax systems.  See below. We pay all four taxes when they apply.  The first three starting from the left are federal taxes and are combined on your federal income tax return.

Each of the tax systems have their own definitions of income, deductions, credits, and tax rates.  They apply when taxpayers have certain types of income or deductions in sufficient amounts.  Taxpayers with similar overall income levels can pay very different amounts of income taxes depending upon the make-up of their income and deductions.

For example, some tax-exempt interest not taxable under the regular tax system or under the net investment income tax (NIIT) system might be taxable by the alternative minimum tax (AMT) system and by your state income tax system.  Another example is that not all itemized deductions allowed for regular tax purposes are deductible under the AMT or NIIT systems, and if your income is too high in Utah, none of your itemized deductions are permitted.

Tax planning is difficult to get right if you don't consider all four of these income tax systems.  Tax planning requires the use of sophisticated software and the analysis must consider at least the current and the subsequent tax year.  Now that your 2013 tax return has been filed, consider how these four parallel tax systems impacted your tax expense, and how you might better arrange your financial affairs to reduce their impact on your 2014 income tax.

Tax Court Limits IRA Rollovers, IRS Grants Transition Relief

The IRS recently issued an announcement that will impact taxpayers’ use of IRA rollovers.  An IRA rollover is technically a receipt of funds from one IRA followed by a contribution to another IRA within the 60-day period beginning the day after the date of receipt.  If the rollover is accomplished within the 60-day period, the receipt of the IRA funds is not taxable.  If the contribution to the second IRA occurs after 60 days, the receipt of the IRA funds is considered a taxable distribution (with a 10% early withdrawal penalty if the owner is younger than 59 ½) and the contribution to the second IRA will generally not be permitted and will be counted as an excess contribution subject to penalties.  A similar result occurs if more than one rollover is made within 12 months.  The 12-month period is measured beginning on the date of receipt. 

The 12 month provision discussed in IRC §408(d)(3) has been interpreted by IRS Publication 590 and Prop. Reg. 1.408-4(b)(4)(ii), which state that the once-every-12 months IRA rollover provision be applied on an IRA-by-IRA basis.  On January 28, 2014, the Tax Court ruled in Bobrow v. Commissioner, T.C. Memo. 2014-21, that the once-every-12 months IRA rollover provision applies at the taxpayer level and not at the IRA level.  This decision greatly disrupts the commonly accepted interpretation of the tax law.  On March 20, 2014, the IRS issued Announcement 2014-15 stating that it will follow the Tax Court’s decision and revise Publication 590 and the regulation.  The announcement grants transition relief applying the former interpretation to IRA rollovers made through December 31, 2014, to give IRA owners and custodians time to change to the new procedure.

A direct transfer by one IRA custodian to another IRA custodian is termed a direct “trustee to trustee” transfer and is not considered a rollover for this purpose.  Therefore, the practical implication of this new ruling is that taxpayers should move IRA funds by arranging for the direct transfer from one institution to another institution, rather than receiving the funds and then depositing the funds within the 60-day period.