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inherited variable annuity question
Old 08-14-2012, 11:13 AM   #1
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inherited variable annuity question

I inherited a variable annuity a while back and at the time I didn't want to deal with it so I was able to leave it with the company (Hartford) for up to 5 years. I didn't want to cash it in b/c I don't want to take the tax hit as it's worth 4x my cost basis (which we all know isn't stepped up on these things). My plan was to wait the 5 years, or see if a year came around where my income was substantially low enough to get a lower tax hit. As of 2014, it will be paid out either way.
Anyway, I was looking at the fees today, they are pretty impressive. If I read it right I have:

Annual fee of $30
fund expenses of around 1% for each fund
mortallity and expense risk charge (?) of 1.4%
optional rider fees (not sure about these)

After looking at this, part of me says to suck it up, cash it in, pay the taxes and put the money in vanguard with everything else.
Another part of me says wait till you HAVE to take the tax hit, and don't worry about the expenses (it's not a major % of my overall portfolio).

From what I understand there is virtually no way to avoid or substantially lower the tax hit on this, correct?

Wutchya'll think?
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Old 08-14-2012, 11:46 AM   #2
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Quote:
Originally Posted by panhead View Post
I inherited a variable annuity a while back and at the time I didn't want to deal with it so I was able to leave it with the company (Hartford) for up to 5 years. I didn't want to cash it in b/c I don't want to take the tax hit as it's worth 4x my cost basis (which we all know isn't stepped up on these things). My plan was to wait the 5 years, or see if a year came around where my income was substantially low enough to get a lower tax hit. As of 2014, it will be paid out either way.
Anyway, I was looking at the fees today, they are pretty impressive. If I read it right I have:

Annual fee of $30
fund expenses of around 1% for each fund
mortallity and expense risk charge (?) of 1.4%
optional rider fees (not sure about these)

After looking at this, part of me says to suck it up, cash it in, pay the taxes and put the money in vanguard with everything else.
Another part of me says wait till you HAVE to take the tax hit, and don't worry about the expenses (it's not a major % of my overall portfolio).

From what I understand there is virtually no way to avoid or substantially lower the tax hit on this, correct?

Wutchya'll think?
The taxes may not be as horrible as it first appears.

The person whom you inherited the annuity from paid something for the annuity. As I understand it, that will be the cost basis of the inherited investment. You'll only pay (ordinary income) taxes on the gains over the cost basis. if you only withdraw a partial amount then taxes on appreciated assets will be paid first before any recapture of your inherited (non taxable) cost basis is paid out.

Note that there is no step-up in cost basis for an inherited annuity.

You may want to consider transferring the variable annuity to a Vanguard variable annuity. They will have significantly lower fees. But as with all variable annuities there is a life insurance componenet that adds that extra fee. But that fee will be significantly less at Vanguard.

watch out for any surrender charges and other fees from the original account. I suspect though that surrender fees on an inherited account are waived.
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Old 08-14-2012, 12:51 PM   #3
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Thanks for the comments Masterblaster. The breakdown is basically this, my cost basis (same as purchaser) is about 12k and the annuity is about 40k so my gains are 28k and at 28% is about $8k. It's not horrible, I just hate giving up my $8k.

From what i understand, and I may be wrong, I am unable to transfer this annuity anywhere. It either get's paid out immediately, or it stays put till 2014 and gets paid out. It doesn't appear I can roll it over into an annuity at another company. So my options seem to be, take the tax hit now and stop paying huge fees, or take the tax hit later and pay the fees.

As for surrender fees, yeah, they were listed too, but as you said, they are waived. They were like 6% for the first 4 years!!! Yikes!

My understanding of the cost basis and taxation is the same as yours, just wish there was a way to reduce it.
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Old 08-14-2012, 01:33 PM   #4
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How about annuitizing it and creating an income stream? At least you can spread out the tax liability over more years but it will increase your AGI too.
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Old 08-14-2012, 01:56 PM   #5
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My initial conversation with Hartford, which admittedly was quite a while ago, was that this wasn't an option either. I could take the lump sum immediately or leave it with Hartford for a maximum of 5 years. Both of you have valid points tho. It appears I need to re-clarify with Hartford if I have any other options. I am pretty sure I don't tho....

EDIT:

I just looked into it and at this point the only the options I have are as follows:

1) Leave all money in the annuity until 2014
2) Take a lump some distribution at any time up to and including 2014
3) Take money out as I desire in any increment I desire (wasn't aware I could do this)

This looks to be a high-earnings year for me so my thinking is I probably ought to leave it in the annuity for the remainder of the year. It appears I am paying about $1000/yr in fees and expenses on $40k (2.5% * 40k), and I don't like that. I guess I could pull it all out now, take the hit on taxes, but save myself $3k over the next 3 years as well. However, my desire to not pay taxes has me wanting to leave it there possibly waiting for a low income year, which at this point, seems a little unlikely to happen before 2014 anyway.

What ya'll think?
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Old 08-14-2012, 08:33 PM   #6
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I think you should contact Fidelity or Vanguard and see what options are available to you, tell them you're thinking about switching over to them and they'll be glad to give you a 2nd opinion. From what I've read about this, you should be able to do an exchange, so it my be Hartford limiting you. I don't know if you can cash out, not pay the tax and then do the exchange over to another company. It can't hurt to call them to find out for sure.
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Old 08-14-2012, 09:49 PM   #7
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No idea which way to go but "don't let the tax tail wag the invesment dog".
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Old 08-15-2012, 12:13 AM   #8
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from Section 1035 Exchange Definition | Investopedia
Note the last statement with the NOT. I don't know how inherited annuities work but for non-spousal inherited iRAs (is this a non-spousal inherited annuity?), titling is very important and specific........you can't have
it in your name alone (must be in deceased name w/ you as beneficiary).
Also can't move by rollover but must be by direct transfer.


Definition of 'Section 1035 Exchange'
A tax-free exchange of an existing annuity contract for a new one.

Investopedia explains 'Section 1035 Exchange'
In order for the new contract to qualify as a Section 1035 Exchange, the policyholder must have exchanged his or her existing contract for an equivalent new contract. The annuitant or policyholder must also remain the same. Application of a check received for the old contract against the new contract does NOT qualify.


Read more: Section 1035 Exchange Definition | Investopedia
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Old 08-15-2012, 07:12 AM   #9
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No idea which way to go but "don't let the tax tail wag the invesment dog".

This is an excellent point that I may have lost track of, I will DEFINITELY keep this in mind....0

Dimsumkid:
Good point. I will contact Vanguard or Fidelity today to see if they can help.

kaneohe:
Thanks for the link and reference. This at least gives me some hope that it might be possible to roll it over....and yes, this is a non-spousal annuity.

If there are any other suggestions please keep them coming. I'm hoping to find some info on this today and will update the board with whatever I find.

Thanks!
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Old 08-15-2012, 08:20 AM   #10
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Quote:
Originally Posted by panhead
Thanks for the comments Masterblaster. The breakdown is basically this, my cost basis (same as purchaser) is about 12k and the annuity is about 40k so my gains are 28k and at 28% is about $8k. It's not horrible, I just hate giving up my $8k..
I agree with kumquat about dogs and tails. The way I would look at this is that you inherited 32k after tax. If I would not have invested in the annuity independently, I would cash it in and start afresh.
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Old 08-15-2012, 11:03 AM   #11
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Meadbh, yeah, this is what I'm thinking too, but I believe this year it may push me up a tax bracket....even tho I shouldn't be considering that, lol!

Anyway, I spoke to Vanguard. They repeated exactly what Hartford told me. Uncle Sam wants to get his money eventually and there is no way to avoid that. Now, this is because it is a non-spousal annuity, there are differences for spousal annuities.
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Old 08-15-2012, 06:22 PM   #12
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I am dealing with a similar problem. In my case there were three annunities which were split equally between myself and my two sisters. My share was about 40k. am just taking the proceeds from one account this year. the other two will be taken in future years and I will pay taxes. There is not much of an alternative.
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Old 08-16-2012, 07:01 AM   #13
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Hi FreeAtLast. My situation was similar, the original annuity was split equally between myself and my sister. Why are you splitting the withdrawals up instead of taking it out all at once? Are you concerned about it putting you into the next tax bracket, possibly triggering AMT as well? That's my only concern here, and is why I am hesitating to pull the $$ out.....but the dogs and tails argument is the one I should be adhering to. I'm thinking about pulling about $10k out for the next two years, then the last $20k in 2014 as half of that would be the initial investment. I need to do calculations about tax brackets and AMT.
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Old 08-16-2012, 10:36 AM   #14
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Something else to ponder...

My crystal-ball income tax forecast shows income tax rates rising in the very near future. Along those lines, my Swami suggests it would be wise to take the money now, take your tax licks and have certainty of what you get to keep ?

- just something to chew on...
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