In this Section:

A Split Annuity Strategy Can Cut Tax Impact on an IRA

The money in your client’s retirement account has grown substantially thanks to the dual benefits of tax-deductible contributions and tax-deferred growth. Congress provided your clients with these advantages as a way to encourage them to save for retirement. However, as is often the case with tax legislation, the advantages that seemingly save your clients from paying taxes will be offset one day by taxes that they ultimately will be required to pay.

By taking advantage of the tax breaks provided through your client’s individual retirement account (IRA), 401(k), tax-sheltered annuity (TSA), 403(b) or other tax-qualified retirement plan, your clients accomplished two things:

[1] They accumulated a great deal of money.

[2] They also accumulated a fairly large future tax liability.

The Internal Revenue Service (IRS) will not allow your clients to defer paying taxes on this money forever. That is why it strictly enforces the minimum distribution requirements that force your clients to start making taxable withdrawals at age 70½.

Some people are in the fortunate position of not needing income from their IRAs or other retirement plans to support their retirement lifestyle. Many of these people would just as soon not touch this money. They would prefer to leave it in the IRA and not pay the taxes. But they can’t! They must start taking at least the minimum distribution amount at the required time. 

Consider how much the IRA or other plan could have grown if they had not been required to take any distributions. These IRS-forced minimum distributions might erode the IRA’s principal down to 50 percent or more over their projected life expectancy. And every penny they were forced to withdraw will be subject to income taxes.

Any remaining balance will one day be passed on to their heirs, but the tax burden is passed on to their heirs as well. 

The beneficiaries might defer these remaining taxes by stretching out minimum IRA distributions over their lifetimes (often referred to as a stretch IRA). However, even when stretching the inherited IRA results in the balance growing over future years, the ultimate tax burden grows as well – a burden that one day could present a tax nightmare for the heirs.

These are problems faced by people who have enough other assets that they don’t need income from their IRAs. What about those who are counting on their IRAs to provide the supplemental income they know they will need throughout their retirement? Their income needs might force them to withdraw amounts greater than the IRS-forced minimum distributions and thus increase the amount subject to current taxes. Over the years, many of these retirees will see their IRA balances decline significantly because they will need to increase withdrawals by an amount necessary to pay the taxes.

If only there was a plan that:


» Didn’t require your clients to take minimum distributions – unless that was their choice.


» Allowed your clients to receive any distributions they choose to take – 100 percent tax free (under Sec. 408a(d)(1) and if the Roth IRA account has been established for five years and the owner is at least age 59½).


» Passed any remaining balance on to your clients’ heirs – 100 percent tax free.


Fortunately, there is: the Roth IRA. Many already are familiar with the advantages of the Roth IRA. They already know that the Roth IRA allows wealth to accumulate and ultimately be distributed entirely free from income taxes.

Those with adjusted gross incomes less than $110,000 also know that they can convert all or a portion of their traditional IRA to a Roth IRA. Yet many have chosen not to convert to a Roth IRA. 

The main reason is that current income taxes must be paid on the amount converted. For many people, this “conversion tax” can seem to offset the tax advantages of converting to a Roth IRA.

This is precisely why the split annuity Roth conversion strategy may be suitable for your client.

The use of this strategy effectively can reduce the conversion tax down to a more acceptable amount, and still allow the IRA owner and his or her heirs to enjoy the many advantages of a Roth IRA.

To illustrate this concept, let’s consider a hypothetical IRA owner who is age 65. He has an adjusted gross income of less than $110,000 annually, so he qualifies for a Roth IRA conversion. 

He pays tax at the rate of 28 percent, and has a total of $100,000 in his IRA. Currently, he doesn’t need any additional income. However, starting at age 70½, he plans to begin taking withdrawals from his IRA. While future income is important to him, he would also like to know that there might be some money left in his IRA so that it could be passed on to his heirs.

At first, he decides against converting when he learns that a tax of $28,000 will be due if he converts his entire $100,000 IRA to a Roth IRA. In his mind, this is simply too much of a price to pay to gain the advantages of the Roth IRA.

Fortunately, you have done a full fact-finding and educated him on the split annuity Roth conversion strategy. He discovers how he can use this strategy so that the conversion tax becomes a much more acceptable amount of $10,149. Here is how he does it.

He splits the $100,000 that is in his IRA into two parts. He places a total of $63,755 into one annuity. The remainder of $36,245 is placed into a second annuity.

Instead of the $28,000 tax owed in his 28 percent tax bracket, he would pay a much more affordable $10,149.  (We will assume that the money to pay this tax would be borrowed or paid from sources other than from the money in the original IRA.)

The next step in this strategy (after the Roth conversion) would be to place the $36,245 that is in the new Roth fund into an indexed annuity (IA). Instead of crediting a company-declared interest rate of say 3, 4 or 5 percent, the gains are linked or indexed directly to the performance of a leading market index.

As with other fixed annuities, your client has a 100 percent guarantee of principal plus interest. He cannot lose a penny, as long as he stays in the contract for the full contract term. Unlike other fixed annuities, however, he also has the potential to make money if the index goes up.

It is planned that no withdrawals would be made from this Roth IRA (IA) fund for a period of 15 years (from age 65, when he first utilized the split annuity Roth conversion strategy, to age 80). All the withdrawals received by the owner during this period would come from the single premium deferred annuity (SPDA) that was in the first traditional IRA annuity. Not taking distributions from the Roth IRA (IA) fund for 15 years menas the balance would be allowed to benefit from compound growth.

Assuming a hypothetical growth rate of 7 percent, the Roth/IA bucket would have a balance of $100,000 by the end of 15 years (again, when the man in our example reaches age 80). 

So, he started with an IRA that had a balance of $100,000. He used the split annuity Roth conversion strategy and divided this $100,000, placing one part into the SPDA annuity (which stayed in the original IRA) and the second part into a Roth IRA (IA) annuity. After 15 years, the entire amount of the traditional IRA bucket was distributed to him (a total of $93,120), and now (15 years later at age 80) the Roth IRA (IA) bucket has grown to $100,000. Instead of $100,000 in a traditional IRA (with its IRS-forced minimum distribution requirements and 100 percent taxation), now he has $100,000 that is 100 percent income tax free in a Roth IRA.

In addition, this Roth IRA has no distribution requirements. The owner may take any amount of distributions that he wants or he may choose never to take a distribution at all. It is entirely up to him. Not a penny of income taxes will be paid on any amount he might take out. And, at his death, any amount remaining in his Roth IRA bucket will go to his beneficiaries income tax free.

The split annuity Roth conversion strategy allowed him to escape the IRS-forced minimum distributions and allowed him – and his heirs – to receive all further distributions 100 percent free from income taxes. Plus, it reduced his conversion tax to an amount that he could afford much more comfortably.

So, this strategy provides the right clients with an alternative while offering other important benefits, including safety and peace of mind.


Lloyd Lofton is managing partner of 7 Figure Sales Tools, Marietta, Ga. Lloyd may be contacted at [email protected] [email protected].

More from InsuranceNewsNet