ORP and Variable Annuities

[sengsational]

"My name is sengsational and I'm a variable annuity owner..."* (in the style of an AA meeting).

In the i-orp FAQ it says:

A variability annuity is an after-tax investment providing tax-deferred returns. Insurance companies are custodians for and promote variable annuities.

The tax consequences are that capital gains and dividend tax rates are lower than personal income tax rates, which is the tax rate on the withdrawal of investment returns of the variable annuity.

Insurance company charges are a significant drawback to variable annuities.

Most ORP users are sophisticated and manage their own retirement plans. Many people use ORP to plan their withdrawals in such a manner as to simulate an annuity without the charges.

Thus up to this point there has been no demand to add the complexity of variable annuities to the model.

The SEC provides a readable description of variable annuities.

So there's no suggestion for how to account for them if you are holding them. In my case, these are Vanguard mutual funds wrapped by the insurance company. There is no requirement to annuitize; I can just pull money out, whenever, and pay tax on the gains (and penalty, if at an early age).

It sounds like I can just lump this in with my traditional IRA's and that should keep the calculations working right?




* A couple years before my kids were applying for college financial aid, I made some after tax assets into retirement assets by putting them in a variable annuity. I know (and knew) that the tax treatment wasn't great (no access to capital gains treatment), but that was offset by the huge discount my older daughter got, especially this year, with two kids in college. These are basically just Vanguard mutual funds wrapped by the insurance company, there is no requirement to annuitize.

 

[Alan]

It sounds like I can just lump this in with my traditional IRA's and that should keep the calculations working right?

That is exactly is what I would do. IIRC, the only functional difference to an IRA after age 59.5 is that when you make withdrawals the taxable amount comes out first.

e.g. if you had put $50k into the VG annuity and it is now worth $70k, the first $20k of withdrawals will be fully taxable (which is not how withdrawals from a tIRA work).

 

[sengsational]

That is exactly is what I would do. IIRC, the only functional difference to an IRA after age 59.5 is that when you make withdrawals the taxable amount comes out first.

e.g. if you had put $50k into the VG annuity and it is now worth $70k, the first $20k of withdrawals will be fully taxable (which is not how withdrawals from a tIRA work).

Thanks for the confirmation. Given that I have plenty of tIRA funds, I could follow the model's recommendations for a long while, but I'd be paying more tax pulling money out of the VA during the out years.

This brings up another question though...I never told ORP how much of my tIRA was original investment vs gains, so I'm not sure the model puts a fine point on that factor anyway?

 

[Alan]

Thanks for the confirmation. Given that I have plenty of tIRA funds, I could follow the model's recommendations for a long while, but I'd be paying more tax pulling money out of the VA during the out years.

This brings up another question though...I never told ORP how much of my tIRA was original investment vs gains, so I'm not sure the model puts a fine point on that factor anyway?

I think that ORP assumes all tIRA money is tax deferred as I don't see anywhere you can enter a basis. I ER'ed 2010 and the first thing I did was convert my tIRA, which had a large basis, to a ROTH. Following year I rolled my 401k to an IRA so I now have no basis in my IRA

 

[Rustward]

I think that ORP assumes all tIRA money is tax deferred as I don't see anywhere you can enter a basis. I ER'ed 2010 and the first thing I did was convert my tIRA, which had a large basis, to a ROTH. Following year I rolled my 401k to an IRA so I now have no basis in my IRA

I think you are right about this. We have some basis but not much -- maybe just over 2% of our combined IRA totals.

 

[sengsational]

I think that ORP assumes all tIRA money is tax deferred as I don't see anywhere you can enter a basis. I ER'ed 2010 and the first thing I did was convert my tIRA, which had a large basis, to a ROTH. Following year I rolled my 401k to an IRA so I now have no basis in my IRA

This post got me thinking more about this and I came up with another idea.... What if I split the variable annuity into basis and gains, then put the gains into the model as tIRA and put the basis in as Roth? Oh wait a minute! After I started typing, I realized that the model would grow the Roth money, and the basis in the variable annuity would not grow. So that simple split wouldn't work. But it sounded good at first, because the model has me pulling traditional IRA funds first, and then Roth, which is a lot like how one must pull from a variable annuity. I suppose I could run the account balance forward in a spreadsheet, look at the basis fraction, then put that split into the model. That would be about as close as I could get.