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Annuity Tax/penalty Question
Old 06-21-2008, 07:44 PM   #1
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Annuity Tax/penalty Question

I have a question concerning an immediate annuity. A 56/57 year old ER's and buys an immediate annuity using IRA money. This is for current income. It's understood that taxes will be due on the payout quarterly. Due to their age being under 59.5, will he also have to pay a 10% penalty?

I recently reached the 1.5mm mark, and am planning on pulling the trigger early next year. My FA suggests taking 30% of the 1.5mm and buying an immediate annuity to cover the basic costs of living.

Your thoughts/opinions are appreciated.
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Old 06-21-2008, 08:01 PM   #2
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Old 06-21-2008, 08:03 PM   #3
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That's a big chunk of your nest egg to put into a SPIA (and at a younger age than is common), but hopefully you have made that decision thoughtfully. Not saying it's bad or wrong but definitely runs counter to the usual, at least in this online community.

My understanding is that if you purchase the SPIA with qualified money and begin withdrawals before the age which would apply in the original IRA, you will pay ordinary income tax on the distributions received prior to age 59.5 as well as penalties on the amount distributed before you attain that age. But note that certain 401k's and 457s have different minimal ages for penalty-free withdrawals, so read the fine print.

I'd check with your accountant before you make that decision - it could be an expensive mistake. Any reason you can't tell your advisor to cool his jets, wait til you're 60 and decide then?
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Old 06-21-2008, 08:04 PM   #4
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Quote:
Originally Posted by bentley View Post
I have a question concerning an immediate annuity. A 56/57 year old ER's and buys an immediate annuity using IRA money. This is for current income. It's understood that taxes will be due on the payout quarterly. Due to their age being under 59.5, will he also have to pay a 10% penalty?

I recently reached the 1.5mm mark, and am planning on pulling the trigger early next year. My FA suggests taking 30% of the 1.5mm and buying an immediate annuity to cover the basic costs of living.

Your thoughts/opinions are appreciated.
I don't think you will have to pay the 10% penalty, somebody wll surely help you with that question. The 30% plan seems to be in line with some current FA thinking although many do not like annuities at all.

I have another annuity question. If I have a Variable Annuity, can I do a 1035 exchange into a SPIA? How about something like Variable Life?

Thanks, in advance.
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Old 06-21-2008, 08:42 PM   #5
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If the annuity is held within the IRA, don't the payments meet the requirements for 72t
and therefore won't be penalized the 10%? Sorry....for some reason couldn't copy and paste the URL, but try googling something like : immediate annuity IRA early distributions penalty".
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Old 06-21-2008, 08:43 PM   #6
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Consider a 72T, maybe ?
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Old 06-21-2008, 09:09 PM   #7
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found this;
Annuity Purchase and Avoiding 10% Tax Penalty by Meeting the "Substantially Equal" Test


anyone care to interpret?
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Old 06-21-2008, 09:56 PM   #8
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Early Withdrawal (Pre 59-&#189 Penalty Tax Exceptions and Annuities

Try this one......I think it says no penalty.
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Old 06-23-2008, 12:04 PM   #9
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Quote:
Originally Posted by bentley View Post
I have a question concerning an immediate annuity. A 56/57 year old ER's and buys an immediate annuity using IRA money. This is for current income. It's understood that taxes will be due on the payout quarterly. Due to their age being under 59.5, will he also have to pay a 10% penalty?

I recently reached the 1.5mm mark, and am planning on pulling the trigger early next year. My FA suggests taking 30% of the 1.5mm and buying an immediate annuity to cover the basic costs of living.

Your thoughts/opinions are appreciated.
If you take systematic withdrawals over your life expectancy (the IRS defines your LE) you may avoid the 10% penalty. I use this for some of my clients.
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Old 06-23-2008, 01:25 PM   #10
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Originally Posted by Rich_in_Tampa View Post
That's a big chunk of your nest egg to put into a SPIA (and at a younger age than is common), but hopefully you have made that decision thoughtfully. Not saying it's bad or wrong but definitely runs counter to the usual, at least in this online community.

My understanding is that if you purchase the SPIA with qualified money and begin withdrawals before the age which would apply in the original IRA, you will pay ordinary income tax on the distributions received prior to age 59.5 as well as penalties on the amount distributed before you attain that age. But note that certain 401k's and 457s have different minimal ages for penalty-free withdrawals, so read the fine print.

I'd check with your accountant before you make that decision - it could be an expensive mistake. Any reason you can't tell your advisor to cool his jets, wait til you're 60 and decide then?
Thanks for the input from eveyone.
Rich; I have the majority of my retirement money in tax sheltered instruments; IRA, 401k, roth, etc.. Naturally, I am wanting to avoid any 10% penalty, but also did not want to do a 72T if possible. I saw the annuity as a possible way around that. After reading all the posts, and a few links, I'm still unsure. I agree that it could be an expensive mistake, so when I get ready to pull the trigger, I'll check with my CPA first.

Our 401k 'plan' (the plan) does not allow periodic distributions. You have one chance to get money out of it sans penalty, and at the same time, you have to roll over the balance.
I am looking closely at a joint life annuity with a 20 yr minimum distribution. I acknowledge that it's not the best return, but it does bring stability to my income stream.
How are other ER's under 59.5 getting their income? Is most everyone using the 72T ? Or did they do a better job of saving after tax money?

Thanks again everyone.
b
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Old 06-23-2008, 02:45 PM   #11
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You can roll funds from your 401k (etc) to a Lifetime Income Annuity and satisfy the 72t distribution issue and not pay the 10% penalty.
Once you elect the payout schedule it's fixed. The bad news is you can't change it. The good news is it can't change due to bad economic situations. It's a guaranteed income stream.
You can't use a joint income annuity since it's qualified money.
Using part of you capital to create a guaranteed lifetime income stream might make sense for part of the money in the overall plan.

Peter in Boston
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Old 06-23-2008, 02:55 PM   #12
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How are other ER's under 59.5 getting their income? Is most everyone using the 72T ? Or did they do a better job of saving after tax money?
Can't speak with any numbers here (might make an interesting poll) but my impression is that most under age 59.5 rely on after-tax income, defined benefit plans, spousal or own part-time income, etc.
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Old 06-23-2008, 02:57 PM   #13
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How are other ER's under 59.5 getting their income? Is most everyone using the 72T ? Or did they do a better job of saving after tax money?
Retired a few months after turning 59. Purchased 28-year guaranteed term SPIA with 10% of our then current retirement portfolio value at age 59.5 (portfolio is all tax-deferred) so the 10% penalty never came up. Have very little after tax $$$ (other than Roth's, but probably will never touch those).

As to the question of "buying early", in our case, SPIA acts like a "short term gap insurance". That is, I'm not as much concerned about loss due to inflation, but rather as a way to delay my SS for 11 years (till age 70) when my SS will be "worth" 2.5x my wife's (taken at her age of 62). The SPIA acts as a pension for this period of time, and to ensure my DW get's the maximum SS benefit (assuming I pass first).

If I die first, my DW continues to get the monthly payment; if we both pass before the 28-year period is up (now 27 years), remainder payments (or lump sum, with all remaining payments) goes to our estate. If either/both live beyond the 28 year guarantee period, the payments continue.

- Ron
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Old 06-23-2008, 03:05 PM   #14
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The critical issue ER's needed to consider is longevity. Right now the probability that a Couple both at 65 will have one member living into their 90's is 90% +.
Figuring out income now, in ER, is one thing. Having it last 40 years is another.
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Old 06-23-2008, 05:22 PM   #15
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Annuities are mathmatically inferior to the return you can expect with a conservative, diversified, asset allocated portfolio. Your FA will certainly appreciate your $500K purchase because he can use the ~$25K for his kid's college tuition. Now he'd make even more with a variable annuity. I'm surprised he didn't suggest one.

I understand the attraction of "income for life" but it comes at a steep price. I don't recommend you sink your money into a SPIA at all and definitely not at your tender age. Your purchasing power will plummet as inflation eats into your payout.

If you can't stand the temptation, price an "equivalent" option from Vanguard's website. They are still an inferior product not worthy of being called an investment but their fees are significantly lower than what you'll probably stumble upon from the typical FA.

Remember you are buying an insurance product. The minute you sign on the dotted line your money is gone.
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Old 06-24-2008, 02:16 PM   #16
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How are other ER's under 59.5 getting their income? Is most everyone using the 72T ? Or did they do a better job of saving after tax money?
I'm not ER'd yet...but plan to in about 6 years at age 52. I have been saving in After-Tax (AT) accounts to allow for ER without having to get into 72t (although I have absolutely no issues with 72t...just a bit complicated if you can avoid it).

For me the saving grace is that my wife is 4 years older than me. We plan to work part-time in relatively low-wage jobs for fun...I'm sure you've heard the term "rehirement". If we make even $40k/year (gross) combined doing this vs. our current $160k/year (gross), it will help a lot. In addition we have AT savings, and as soon as my wife is 59 1/2 we can get to her 401k without penalties.

Added note: We plan to have about $150,000 in AT money at my age 52. Not a huge amount, but enough if spread over 4-5 years along with the part-time work.

Dave
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Old 06-24-2008, 03:23 PM   #17
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Thanks for the input from eveyone.
Rich; I have the majority of my retirement money in tax sheltered instruments; IRA, 401k, roth, etc.. Naturally, I am wanting to avoid any 10% penalty, but also did not want to do a 72T if possible. I saw the annuity as a possible way around that. After reading all the posts, and a few links, I'm still unsure. I agree that it could be an expensive mistake, so when I get ready to pull the trigger, I'll check with my CPA first.

Our 401k 'plan' (the plan) does not allow periodic distributions. You have one chance to get money out of it sans penalty, and at the same time, you have to roll over the balance.
I am looking closely at a joint life annuity with a 20 yr minimum distribution. I acknowledge that it's not the best return, but it does bring stability to my income stream.
How are other ER's under 59.5 getting their income? Is most everyone using the 72T ? Or did they do a better job of saving after tax money?

Thanks again everyone.
b
I took an early retirement offer at age 54. First year pension: ~$25000. Increased to ~$30000 second year of retirement. Still spending less than the pension.
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Old 06-24-2008, 04:02 PM   #18
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I took an early retirement offer at age 54. First year pension: ~$25000. Increased to ~$30000 second year of retirement. Still spending less than the pension.
What's a pension?

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Old 06-24-2008, 04:16 PM   #19
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What's a pension?

- Ron
pen·chant Audio Help/ˈpɛntʃənt; Fr. ̃ˈʃɑ̃/Pronunciation Key - Show Spelled Pronunciation[pen-chuhnt; Fr. pahn-shahn]Pronunciation Key - Show IPA Pronunciation–noun a strong inclination, taste, or liking for something: a penchant for outdoor sports.
[Origin: 1665–75; < F, n. use of prp. of pencher to incline, lean < VL *pendicāre, deriv. of L pendére to hang]


Oh wait...that's not right.
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Old 06-24-2008, 04:35 PM   #20
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Early retirement was never part of the thought process when the government began in the 1970's setting up what's become the big variety of tax qualified retirement vehicles. Hence the delema here.

Producing income from retirement money prior to age 591/2 will have a cost. The most significant cost is the opportunity lost of allowing it to grow tax deferred.

The expensive mistake of one using a an immediate income annuity is the loss potential for future growth. The benefit is that you're not suseptible to market corrections, especially if you have to draw down income during those corrections. If you choose the correct payout choice you, or your hiers, always get at least all your money back. If you live long enough, perhaps twice your money back. Check the accumulted payouts into age 90's. Lots of boomers will live well into their 90's.

The other portion of your capital needs to grow. Thus, the well divisified portfolio. But as evidenced by the past 9 months, even well managed diversified portfolios have tanked. So, if you were drawing down money for income from from a declining portfolio since last summer you'd be taking money at substantially less than you originally paid for it.

There's a need for both guarantees and monety at risk for growth.
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