Options are the future of retirement planning

By Warren S. Hersch

July 13, 2016 at 02:00 AM

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With the dust not yet settled on the U.S. Department of Labor's fiduciary rule, finalized last April, agents and advisors are questioning whether and how their practices can remain viable in the retirement plan arena.

Put that question to members of the Million Dollar Round Table — an association of top-producing life insurance and financial service professionals that held its annual meeting in Vancouver, B.C., June 12-15 — and you're likely to hear a resounding "yes!"

Optimism about the future of retirement planning was an overriding theme in one-on-one interviews with LifeHealthPro and National Underwriter Life & Health held at the annual meeting with a select group of MDRT members, including those from United States, the United Kingdom Canada, New Zealand and South Africa. The wide-ranging discussions explored trends buffeting retirement advisors globally such as the tightening compliance requirements, paired with an evolution in savings and investments vehicles that (with some exceptions) are helping pre-retirees and those in retirement achieve their objectives while availing advisors of more flexible planning vehicles.

Catering to the worksite

For Cornerstone Financial, the sweet spot is small businesses, in particular employer-sponsored 401(k) plans. Now accounting for 35 to 40 percent of its practice revenue, the worksite market is expected to garner half of firm revenue in the coming years. (The company also generates income from life insurance sales and managing non-qualified plan investments for individuals.)

Why the heavy focus on qualified plans?

"One attraction is repeatability: It's easy to do plan implementation on a large scale," say Adam Rex, vice president of risk management at the U.S.-based firm. "You can do a retirement educational meeting for a 100-person company within an hour. To do this individually would take a lot longer."

To be sure, Cornerstone's principals — Rex runs the firm with his brother and Dad — generate additional business helping senior-level executives prepare for retirement with supplemental, nonqualified plans. Among them: life insurance-funded deferred compensation plans, executive bonuses and supplemental executive retirement plans.

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New Zealand's KiwiSaver

Employer-sponsored retirement plans also are a growing source of revenue for AdviceFirst, a practice with 10 offices in New Zealand. KiwiSaver, a popular retirement savings vehicle, is like the 401(k) a defined contribution plan that receives dollars from both the plan participant and the employer.

Unlike the 401(k), contributions are limited to 3, 4 or 8 percent of an employee's pay. The KiwiSaver also is taxed like a Roth IRA: Contributions are made on an after-tax basis, then accumulate and are distributed at retirement tax-free (though as a lump sum, not an annuity).

Plan participants ("members") also receive an annual, government-paid tax credit. As with a traditional IRA in the United States, younger participants can use the plan to help pay for a first home without incurring a tax penalty.

At retirement, individuals can draw on not only these voluntary accounts, but also the New Zealand Superannuation (NZ Super): a government pension paid to "kiwis" (a nickname for New Zealanders) over age 65.

Kick-started in July 2007, the KiwiSaver represents a growing revenue stream for advisors to participants looking to maximize investment yields through active management of the accounts during the accumulation phase. At retirement, many are also turning to advisors for help in rolling over the accounts to other investment vehicles offering superior returns and/or a guaranteed retirement income stream.

"More and more people are talking to advisors about what to do with these retirements funds, particularly those with 6-figure accounts, says Peter Chote a director at AdviceFirst. "In years past, there was less planning around these accounts because the amounts saved were comparatively insignificant."

Savings plans in Canada

The same can't be said of Canada's registered retirement savings plans, called RRSPs, which are tax-advantaged savings and investment accounts that have been on the books since 1957. Established to supplement employer-sponsored registered pension plans, the vehicles enjoy the same tax treatment as a conventional IRA or 401(k): Pre-tax contributions grow tax-deferred, then are taxed at distribution.

Encompassing several account types — the accounts can be set up as an individual, spousal or group/employer-sponsored plan — RRSPs can be invested in both equities and fixed income assets. At retirement, many Canadians opt to roll these accounts over to a segregated fund registered retirement income fund, called an RRIF, held by a life insurance company.

The equivalent of variable annuities in the United States, segregated funds are guaranteed by the life insurer (the guarantee varying between 75 and 100 percent of the original investment) if held for a required length of time (typically 10 years).

Aurora Tancock, a financial planner and principal of Aurora Tancock Financial Services in St. Catharines, Ontario, derives between 50 to 75 percent of her business from product sales and advising on these accounts, plus mutual fund RRIFs. Tancock's practice has matured in tandem with her boomer-age clients, and so her focus has increasingly shifted from nest egg accumulation to retirement income planning.

"Over time, I foresee these products playing a larger role in my practice," says Tancock. "There's also growing demand among retirees for tax-free savings accounts."

Launched in 2009, tax-free savings accounts function like the American Roth IRA: contributions to the accounts (limited, as in the U.S., to $5,000 annually for those under age 50) are made with after-tax dollars, and earnings are not taxed at distribution. But the tax-free savings account enjoys a few advantages over its U.S. counterpart: Tax-free withdrawals of earnings come with no strings attached (e.g., no need to wait to age 59 ½); contributions to the accounts are not income-dependent; and these contributions can be carried forward (if you don't deposit $5,000 into the account this year, you can stash away $10,000 next year).

(Retirees looking to generate a comfortable income stream in their golden years, added Tancock, can also draw on two other sources of income. One is the Canadian Pension Plan, an arrangement to which both an employer and employee contribute equally and that (depending on the employee's contribution) pays from $3,500 to $53,600 annually. Also available to retirees is Old Age Security, a guaranteed income supplement available beginning at age 65.)

Retirement in the United Kingdom

Roth IRA-like vehicles also are much in demand in the United Kingdom, where the Financial Conduct Authority kick-started individual savings accounts, called ISAs, in 2013 as part of its Retail Distribution Review: A set of rules instituted to bring more transparency and fairness to the delivery of investment advice.

Under the country's old pension scheme, individuals could take part of their savings at retirement as a lump sum, the balance paid as a fixed interest rate annuity — a disadvantage in a low interest rate environment. Post-Retail Distribution Review, ISA holders can stop, start or modify the tax-free annuity income as needed.

"You now have the flexibility to change the payout to suit your circumstances — that's a big plus," says Alessandro Forte, an advisor and CEO of London-based Forte Financial Group UK. "Funds not taken as income can remain invested. And any 'uncrystallized' benefit — monies not taken as income should the account holder die — can be passed on to beneficiaries free of income and capital gains tax."

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A role for life insurance?

Permanent insurance can also generate an annuity-like income stream for retirees. The product has long been favored in the United States because of its tax-preferred tax treatment: Cash values grow tax-deferred and are distributed tax-free up to the cost basis. Earnings can also come out tax-free if taken in the form of a loan.

Permanent life insurance is especially valued among affluent clients who have maxed out contributions to other tax-advantaged products and are looking to grow additional assets on a tax-favored basis.

Life insurance sales account for about 10 percent of Cornerstone Financial's business, whose clients aren't buying the policies solely to achieve retirement and tax planning objectives. Cornerstone's Rex says linked-benefit products — insurance contracts that come with a long-term care rider — also appeal to a growing segment of his customer base.

An outgrowth of the Pension Protection Act of 2006, the combo products (generally a whole or universal life chassis) typically are purchased with a single premium or a series of up to 10 annual payments. The products offer a monthly income tax-free benefit (usually for a fixed period) to cover qualified long-term care expenses, such as home care, adult day care, assisted living and/or skilled nursing care.

In addition to supplementing existing retirement savings, the benefit can serve as a hedge against long-term care expenses that might otherwise drain assets intended for heirs. The hybrid solutions, notes Rex, are displacing stand-alone long-term care products that, while offering more generous benefits, are also more expensive.

"We've backed away from traditional long-term care insurance because of client concerns about cost," he says. "Linked-benefit life insurance probably now accounts for about 80 percent of long-term care-related product sales," says Rex. "Linked benefit annuity-LTC offerings contribute the other 20 percent."

Given the multiple advantages of hybrid life products — all-in-one solutions that provide a death benefit and cash value with which to cover retirement or long-term care expenses on a tax-advantaged basis — one might imagine the vehicles are enjoying widespread adoption internationally. Alas, that's the not case, and for reasons not connected with long-term care or other benefit rider.

Life insurance elsewhere

Advisors note growing scrutiny by governments worldwide of individuals (notably the affluent) and businesses that are using permanent life insurance for tax-sheltering and investment purposes. Case in point: Canada, where a new Income Tax Act provision respecting the tax-exempt status of cash value life insurance takes effect beginning Jan. 1, 2017.

The legislation will cut the maximum premiums and/or deposits permitted in tax-exempt policies. And it will lower permissible maximum cash value accumulations inside these contracts.

Upshot: Less tax-deferred growth (both for participating/dividend-paying and non-participating policies), making permanent life insurance less attractive for cash accumulation purposes. Among those negatively impacted by the new law, notes Tancock, will be companies that use permanent life policies to fund executive compensation plans and other business arrangements.

Elsewhere, permanent life insurance policies have been eliminated or never introduced. Example: New Zealand, where cash value products — whole, universal and variable life — were phased out of within the past two years. Why so?

"There's no market for any permanent life insurance product in New Zealand anymore," says AdviceFirst's Chote. "We're a nation of just 4.5 million people and the market for these products has always been small. Given the lack of demand, many insurers decided to exit the space."

In South Africa, regulation is the chief reason for the products' demise. Tracey Devonport, a co-founder and principal of Tracey Devonport Financial, says government rules restricting the size of the contracts' savings component rendered the products of little or no use as a wealth creation tool.

"At the end of the day, the cash value you can build is so small as to be of any real consequence for retirement or estate planning," says Devonport. "If you're trying to grow people's money in South Africa, you do it with other investment products."

Most forms of permanent insurance — universal life, indexed universal life and variable universal life products — also are not available in the United Kingdom. The one exception is whole life, which can be funded with "surplus" (unused) income and provide an inheritance for heirs without triggering an estate tax for individuals in the "nil rate band:" those with up to £325,000 or $422,000 in assets.

(The estate tax-exempt amount rises to £500,000 in April 2017.) Forte Financial's Alessandro says about 15 percent of his clients use whole life insurance contracts for retirement income and estate planning needs.

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Navigating the compliance minefield

Advisors interviewed by LifeHealthPro say they're all doing a brisk business in retirement space, both for pre-retirees aspiring to build a nest egg and (increasingly) those needing an income distribution strategy to provide a lifetime income stream while also protecting invested assets against equity market volatility. The one wildcard that can disrupt their practices is regulation.

By all accounts, the regulatory vise is tightening across western countries. The U.S. Department of Labor fiduciary rule, finalized last April, is the most recent evidence of authorities' strengthening grip on retirement investment advisors.

To a remarkable degree, the Labor Department rule also is emulating government initiatives abroad that share common aims. These include increasing transparency and disclosures about commissions and fees; reducing transaction costs; and ratcheting up the educational requirements and standard of care to which advisors are held when recommending products and plans.

Perhaps the most widely reported (and criticized) of the regulatory efforts is the U.K.'s Retail Distribution Review. While availing retirement savers of more flexible savings and investment accounts, the Retail Distribution Review also increased professional qualifications and eliminated commissions on insurance sales. The changes prompted an exodus of an estimated 9,000 U.K. agents and advisors from the field.

One who hasn't budged, Forte, says he has the systems, procedures and expertise in place to comply with the new regime. But he questions whether he can adequately satisfy future client needs if regulators impose new rules — reactively and without adequate forethought — in response to a rapidly changing marketplace.

New Zealand, whose strict regulatory environment is comparable to the United Kingdom's and Australia's, has boosted compliance costs for AdviceFirst by an estimated 10 percent. Chote notes also that rules respecting disclosures and compensation have forced many formerly solo producers to join a Qualifying Financial Entity: An insurer or bank where they can provide retirement investment advice, in addition to selling insurance on commission, but only for Qualifying Financial Entity-manufactured products.

South Africa, too, has implemented regulations that mirror the United Kingdom's Retail Distribution Review requirements — and that have prompted advisors to leave the profession. But Tracey Devonport Financial's co-founder and principal says that advisors who are committed to their careers will achieve success.

"You'll get through it," says Devonport, in reference to U.S. advisors now contending with the Labor Department rule. "It's tougher and you work harder. But you can survive and thrive — as we have. It's a great industry to be in."

Devonport's comments echo the optimism of other advisors, who note that insurance and financial service professionals have always had to adapt to a changing marketplace and regulatory landscape. What hasn't changed are the foundational components for making it in the business: integrity and a desire to serve others; superior products, expertise and servicing capabilities; and the discipline needed to overcome obstacles. If you have these, you can go anywhere — without or with a fiduciary rule.

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