Cash Out Variable Annuity - Tax consequences?

[grumpy]

Need advice from the tax guru's here:

I inherited my mother's variable annuity when she died in 2002. At the time I decided to keep it because I was in a relatively high tax bracket, therefore it seemed attractive to permit continued tax deferred growth, and the investment choices were quite broad.

Over the ensuing years the value of the account nearly doubled. But over the past year the value has fallen to slightly less than what it was when I inherited, thus my cost basis is lower than the current value.

The period which involved surrender charges is long since over. I am now retired and in a lower tax bracket.

Am I correct in my understanding that if I cash this annuity out, I will not owe any income tax, since the value is less than my cost basis (the value at the date of my mother's death)?

This seems like a good idea at this time, since there has been no benefit of tax deferral (zero or slightly negative growth over 7 years), the annuity carries higher fees than comparable funds at Vanguard, and I have a need to replenish my cash reserves that I use to augment our pension income. This seems like a better approach than selling equities or funds from my taxable accounts which have gains.

What do you think?

 

[kaneohe]

Unlike a capital asset (stocks/funds/real estate), annuities and IRAs do not step up in basis when inherited. Your basis would be the same as the person that you inherited from so the fact that it worth less now than when you inherited it is not relevant.
You might still have a taxable gain (or not) depending on what the original owner's basis was.

 

[2B]

I agree. That wonderful tax benefit for annuities is currently screwing me and my siblings cashing out a VA my father bought. Another reason that justifies all VA salespeople being put to the sword.

 

[saluki9]

I agree. That wonderful tax benefit for annuities is currently screwing me and my siblings cashing out a VA my father bought. Another reason that justifies all VA salespeople being put to the sword.

Just curious, do you feel the same about companies like Vanguard that offer IRAs?

 

[2B]

Just curious, do you feel the same about companies like Vanguard that offer IRAs?

Let's see.....

Roth IRAs put in after tax money and when it comes out it is all tax free.

Conventional IRA's put money in pre-tax resulting in immediate tax savings to the individual even though tax is due when withdrawn.

Compare this with VAs....

Here after tax money is put in and 5% or more is taken annually in fees and then any gains after the fees is taxed when withdrawn.

You get the disadvantages of both types of IRAs but pay a much higher level of fees.

I liked the recent attempt to force VA salespeople to become "brokers" although the insurance companies have filed suit to block this. I can't see how someone selling mutual funds inside a high fee structure is somehow under different legal responsibilities than my local AG Edwards rep.

 

[brewer12345]

I can't see how someone selling mutual funds inside a high fee structure is somehow under different legal responsibilities than my local AG Edwards rep.

Easy to spot the difference: the standards to become an insurance agent are much lower than for someone who sells securities (broker).

 

[2B]

Easy to spot the difference: the standards to become an insurance agent are much lower than for someone who sells securities (broker).

I agree which is why the insurance company trade group is suing. They are selling the same thing -- mutual funds. They need to be on a level playing field. Of course, I don't think brokers are trained adequately to do much more than sell anything to anybody. Of course, this is what the annuity sales people do.

The standards for most people that direct other people's investments and financial well-being are terribly inadequate.

 

[saluki9]

My point was that IRAs also create some messy situations, especially with estate taxes.

Also FYI, you DO need to be securities licensed (series 6) to sell VA in addition to having an insurance license.

http://www.finra.org/web/groups/industry/@ip/@comp/@regis/documents/industry/p011068.pdf

Compare this with VAs....

Here after tax money is put in and 5% or more is taken annually in fees and then any gains after the fees is taxed when withdrawn.

You get the disadvantages of both types of IRAs but pay a much higher level of fees.

I liked the recent attempt to force VA salespeople to become "brokers" although the insurance companies have filed suit to block this. I can't see how someone selling mutual funds inside a high fee structure is somehow under different legal responsibilities than my local AG Edwards rep.

 

[saluki9]

I don't think brokers are trained adequately to do much more than sell anything to anybody. Of course, this is what the annuity sales people do.

The standards for most people that direct other people's investments and financial well-being are terribly inadequate.

If you've never been trained as one how would you know? There are some firms that do a lot of training for new brokers. The problems you are referring to relate more to survivorship bias.

There is so much free training available to licensed reps that you could do nothing but go to training classes all day. The problem of course is that the people who actually survive in the business tend to be good salespeople.

Certainly the financial services industry has earned a lot of it's poor reputation. However, I think a lot of the hatred directed towards the reps themselves is misplaced. Part of that has to due with the type of people this site naturally draws. However, you would have to have worked in the industry to see how the average American manages their portfolio. It makes even the highest of VAs seem like a bargain.

 

[grumpy]

Unlike a capital asset (stocks/funds/real estate), annuities and IRAs do not step up in basis when inherited. Your basis would be the same as the person that you inherited from so the fact that it worth less now than when you inherited it is not relevant.
You might still have a taxable gain (or not) depending on what the original owner's basis was.

I have no information on the original cost basis of the annuity. It was originally bought by my father, was inherited by my mother when he died, and I inherited half when she died and my sister inherited the other half. I will have to contact the VA provider to see if they can determine my cost basis.

 

[2B]

If you've never been trained as one how would you know? There are some firms that do a lot of training for new brokers. The problems you are referring to relate more to survivorship bias.

I stopped using "conventional" brokers as soon as discount brokers came into existence. I had already figured out by that time that the people I was dealing with didn't know as much about the stock market or personal financial planning as I did. What's more important is that they didn't care very much about it. I was only of interest to them if I'd buy or sell something. They had the "latest" recommendation from their analysts but eventually stopped calling when I repeatedly didn't react to the great opportunity. They were commissioned salesmen and nothing more.

If that is the"survivorship bias," I agree that if they weren't good sellers they wouldn't last long. If they could sell well but knew nothing about anything else, they'd be making big bucks. Knowledge in any topic only had/has value in enhancing their ability to sell.

 

[2B]

I have no information on the original cost basis of the annuity. It was originally bought by my father, was inherited by my mother when he died, and I inherited half when she died and my sister inherited the other half. I will have to contact the VA provider to see if they can determine my cost basis.

Good luck. You've got a worse deal than I had trying to figure out the cost basis of my FIL's scattered investments. Do your best investigation into it even if you have to estimate the purchase date and look up share prices back decades. Document what you get as best you can, cheat a little and hope for the best.

 

[FinanceDude]

Need advice from the tax guru's here:

I inherited my mother's variable annuity when she died in 2002. At the time I decided to keep it because I was in a relatively high tax bracket, therefore it seemed attractive to permit continued tax deferred growth, and the investment choices were quite broad.

Over the ensuing years the value of the account nearly doubled. But over the past year the value has fallen to slightly less than what it was when I inherited, thus my cost basis is lower than the current value.

The period which involved surrender charges is long since over. I am now retired and in a lower tax bracket.

Am I correct in my understanding that if I cash this annuity out, I will not owe any income tax, since the value is less than my cost basis (the value at the date of my mother's death)?

This seems like a good idea at this time, since there has been no benefit of tax deferral (zero or slightly negative growth over 7 years), the annuity carries higher fees than comparable funds at Vanguard, and I have a need to replenish my cash reserves that I use to augment our pension income. This seems like a better approach than selling equities or funds from my taxable accounts which have gains.

What do you think?

There are aseveral factors involved. This may be a good time to consult a CPA, as tax laws are changing annually or sooner.

 

[brewer12345]

This may be a good time to consult a CPA, as tax laws are changing annually or sooner.

SOmething you could probably have said to just about anyone, any time over the last 50 years...

 

[FinanceDude]

SOmething you could probably have said to just about anyone, any time over the last 50 years...

True, but mishandling this would send red flags to the IRS and possibly trigger an audit, so a CPA would be money well spent........

 

[brewer12345]

True, but mishandling this would send red flags to the IRS and possibly trigger an audit, so a CPA would be money well spent........

No argument from me. I am waiting for my eventual audit, since although I try very hard to be as straight an arrow as you will find, I have enough of the usual triggers.

 

[2B]

True, but mishandling this would send red flags to the IRS and possibly trigger an audit, so a CPA would be money well spent........

Sometimes the situation is so screwed up you can only do the best you can. He really has a "simple" situation. He needs to find out what the cost basis is. That's probably going to be a mess. It certainly was for my FIL's crap. Once you "guess" a number, that's the best you can do. If you (or I) get audited, you can only show them your basis and look at them with a dull expression and say "what can you do to get a better number?"

All the CPAs in the world can't really help.

BTW, my FIL always had his taxes done by "his" CPA. We were screwdding stuff this weekend and found a "worksheet" my FIL filled out before his taxes were done by the CPA. It was the complete tax form with extra spaces for mutiple entries. He filled it out and the guy charged him $600 to enter it into his version of TaxCut. I was appalled.

 

[FinanceDude]

Sometimes the situation is so screwed up you can only do the best you can. He really has a "simple" situation. He needs to find out what the cost basis is. That's probably going to be a mess. It certainly was for my FIL's crap. Once you "guess" a number, that's the best you can do. If you (or I) get audited, you can only show them your basis and look at them with a dull expression and say "what can you do to get a better number?"

All the CPAs in the world can't really help.

BTW, my FIL always had his taxes done by "his" CPA. We were screwdding stuff this weekend and found a "worksheet" my FIL filled out before his taxes were done by the CPA. It was the complete tax form with extra spaces for mutiple entries. He filled it out and the guy charged him $600 to enter it into his version of TaxCut. I was appalled.

You certainly have bad luck with anyone in the financial world.........

 

[saluki9]

BTW, my FIL always had his taxes done by "his" CPA. We were screwdding stuff this weekend and found a "worksheet" my FIL filled out before his taxes were done by the CPA. It was the complete tax form with extra spaces for mutiple entries. He filled it out and the guy charged him $600 to enter it into his version of TaxCut. I was appalled.

I have news for you, that is what most CPAs do.

I am always amazed to see what people pay to have their taxes done compared to the amount of work that goes into it.

 

[2B]

I have news for you, that is what most CPAs do.

I am always amazed to see what people pay to have their taxes done compared to the amount of work that goes into it.

I couldn't believe how much he paid for almost nothing. He had the most basic of returns. He had a couple pensions, small amount of interest, a few dividends, charity and property tax deductions just barely enough to itemize. It took me 15 minutes to put all of his stuff into TaxCut and that included having to put in their medical bills.

I could see hiring a CPA if you've got more involved taxes and can use some of the more exotic wrinkles in the tax code. His biggest decision came down to whether it was worth itemizing deductions.

 

[FIRE'd@51]

I couldn't believe how much he paid for almost nothing. He had the most basic of returns. He had a couple pensions, small amount of interest, a few dividends, charity and property tax deductions just barely enough to itemize. It took me 15 minutes to put all of his stuff into TaxCut and that included having to put in their medical bills.

I could see hiring a CPA if you've got more involved taxes and can use some of the more exotic wrinkles in the tax code. His biggest decision came down to whether it was worth itemizing deductions.

I totally agree. It probably took more time to get the records together than for the CPA (or more likely, his secretary) to enter them into the software. Besides, when you do the taxes yourself, it is possible to estimate your tax liability "on the fly" throughout the year. I built my own tax estimation spreadsheet in Lotus 1-2-3, which I continually update throughout the year, paying close attention to bracket thresholds, etc. My spreadsheet has always agreed with TaxCut to within a dollar or two (probably round-off). One of the benefits of not having a pension and living off portfolio income is the ability to control your tax liability very tightly.