How Do I Know Which Foreign Annuity Is Right For Me?
I am asked this question frequently in my practice. For the sake of this article I am going to take a slightly different approach. There are many many articles that have been written on the benefits of a foreign annuity covering asset protection, privacy and greater investment diversification but I haven’t really found any that talk about how do you know which one is right for you.
This is actually a very important question, far more important than many investors realize because the wrong decision can lead to disastrous consequences.
The first question is:
Is it really an annuity?
This is the MOST important question yet it is the one I see overlooked 99% of the time, and it has the most potential for disaster.
The Internal Revenue Code contains certain requirements an annuity or life insurance contract must contain to actually be treated as an annuity or life insurance contract. They are spelled out in detail in sections 817 and 7702 of the IRC for the technically minded
The first question you must always ask is; Do you have a legal opinion from a substantial U.S. Law Firm detailing your policy is “compliant” and therefore would receive the appropriate treatment by the IRS?
Now you might be saying to yourself does this really matter, isn’t this the reason I am going offshore and an annuity is tax-deferred anyway so who cares. This is where you step on a landmine. Just because a company says it sells an annuity or insurance policy doesn’t mean the IRS treats it the same way and if they don’t recognize it as a compliant policy it is treated as a “PFIC”, or passive foreign investment company. There is a lot of information available regarding just how big of a problem PFIC’s are but suffice to say it is a tax nightmare you may never recover from. If you are lucky enough to dig your way out it is going to cost you a lot of time and money. (For a great explanation of this problem visit Mark Nestmann’s site, http://nestmannblog.sovereignsociety.com/2008/02/us-taxpayers-be.html)
An important example of this is many legal advisors feel fixed rate Swiss Annuities are NOT compliant and are treated as a PFIC.
Reminder: Insurance laws vary from country to country and a policy that is compliant in one jurisdiction may not be compliant in the U.S.
The second question is:
What are the fees?
Obviously keeping your fees to a minimum is very important for many reasons. Lower fees put more of your money in your pocket where it belongs and ultimately it affects the performance of your policy.
Is there a subscription fee, placement fee or commission? Is it taken in advance or does the insurance company try to spread it out over a number of years.
Is there a surrender penalty to get out of the annuity if you haven’t held it for a certain number of years? This is frequently a method employed by insurance companies to recover a commission that has already been paid or to provide an extra layer of profit.
What is the annual fee charged by the insurance company to maintain the policy and what is the annual fee charged by your investment advisor? These two fees are what I call the “drag” on your policy. Keeping them to a fair level is critically important, as it will affect your annual performance.
Are you dealing with the insurance company or its representative directly or are you going through a broker? Remember if you are going through a broker then he is obviously making a fee or commission to establish the policy. You should request a full and fair written disclosure of all fees including the broker compensation. If you are using an advisor rather than a broker they should also provide you with a written disclosure detailing the same. In some cases an advisor may not be compensated for the transaction, would only be acting as your investment advisor and would be compensated in an advisory capacity only.
Reminder: Buy wholesale not retail and keep your fees down to a fair level.
The third question is:
How much investment flexibility do I have?
Section 817 of the IRC basically says you must maintain a certain amount of investment diversification in your policy and it clearly states that you May Not self direct the policy. This is a big one that can really trip you up. If you self-direct the policy as far as the IRS is concerned you have disqualified the policy and we are back to the PFIC nightmare.
You can hire and fire your investment advisor at will in a well-designed policy. This ensures you can be certain your advisor is acting in your best interests.
In my company, Sovereign International Asset Management, we like to take this a step further by preparing both you and the insurance company a written investment proposal in advance of adoption of the policy. Once we have an agreed upon strategy and proposed allocation we then solidify this with a Scope of Engagement Letter identifying what we will be investing in, the time horizon, and risk tolerance of the policy. The good news is an advisor who knows how to manage these types of policies can invest in virtually any investment on a global basis.
Reminder: Stay away from companies who tell you it really is possible to self-manage your policy or they tell you don’t worry and give you the wink wink nod.
Foreign annuities can be a great structure for asset protection and international diversification when done right. If you go to the trouble of establishing one, make sure it is compliant or instead of being a great investment vehicle it may become your own worst nightmare. There are probably few things more painful than paying a big commission or fee for a horrible investment……..
I should disclose not only can Sovereign International Asset Management manage foreign annuities but also Sovereign International Pension Services is one of the few IRA Administrators who can help you invest your retirement plan in a compliant foreign annuity.
As always feel free to contact my office for additional information or questions on foreign annuities or asset management.
Larry C. Grossman, CFP®, CIMA®
Sovereign International Asset Management
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