Annuity already in place - options

[Z3Dreamer]

DW inherited $15k in 1994. Had maxed on 401ks. Kids college funding was good. Debt was fine. Decided to put it in an annuity. It is still there and has grown to $100k. It is in the "accumulation" phase. Overall, it has earned a net of around 8%. Some observations:

1. In theory, when the money is taken out, we will be paying ordinary taxes on captial gains. Bad.
2. Tax rate is lower than when we were working. Good.
3. There are fees such as mortality, but I only look at net return. Good.
4. DW does not have to take the money out until her 90's. No RMD. Good.
5. If she gifts to the kids during her lifetime, we are taxed on the build up. Bad.
6. If it were in a taxable index fund (instead of the annuity), I would have been more tempted to spend as there was little downside. So, the complexities of the annuity made it untouchable. This is a good outcome.

Best option I see is to leave it forever (assuming we don't live into our 90's). When kids inherit, they can choose best of the many available options.

Anyone else care to opine?

 

[pb4uski]

A couple others. When you do withdraw, it is taxed as income first and then principal... so your first $85k of withdrawals would be ordinary income and the last $15k would be principal. Also, if kids inherit then there is no stepped up basis like most other taxable account investments.

 

[MarieIG]

My thoughts are to trigger it, as a joint and survivor, when the first spouse needs some extra home or medical care.

Sort of like a little LTC policy. Let a Roth go to the kids instead.

 

[Souschef]

A couple others. When you do withdraw, it is taxed as income first and then principal... so your first $85k of withdrawals would be ordinary income and the last $15k would be principal. Also, if kids inherit then there is no stepped up basis like most other taxable account investments.

I am sorry, but I do not think that is correct. When I was doing taxes as an AARP volunteer, there was a formula, based on life expectancy of how much each withgrawal was taxable and how much was return of principal.

 

[pb4uski]

I am sorry, but I do not think that is correct. When I was doing taxes as an AARP volunteer, there was a formula, based on life expectancy of how much each withgrawal was taxable and how much was return of principal.

That is for a payout annuity... for an deferred annuity (not in payout) it is gain/income first, then principal.

https://www.kiplinger.com/article/insurance/T003-C001-S001-how-annuities-are-taxed.html

.... There are two types of annuities: immediate and deferred. With an immediate annuity, you hand over the principal to an insurance company and in return receive income for life. If you buy the annuity with after-tax money, then a portion of every payout represents a return of your original investment, and a portion is considered to be taxable earnings.

The money you invested in the immediate annuity is returned in equal tax-free installments over the payment period. If you have a life annuity with payouts that will stop when you die, for example, then that payment period is the IRS's life-expectancy number for someone your age. You'll owe taxes only on any portion of each payout beyond the tax-free return of principal. ....

If you cash out a deferred annuity in a lump sum, then you'll have to pay income taxes on all of the earnings higher than your original investment. If you take several smaller withdrawals from the account, however, then the IRS considers your first withdrawals to come entirely from interest and earnings. That means you'll be taxed on all of your withdrawals until you take out all of the interest and earnings. Only after that can the principal be withdrawn without taxes.

 

[Z3Dreamer]

I forgot to put this in perspective. My brother would say that this is a first world problem.

 

[MichaelB]

I forgot to put this in perspective. My brother would say that this is a first world problem.

True, but that doesn’t make it any less relevant. If you don’t need the money, how does leaving it to be inherited compare with cashing it out now and investing the after tax proceeds in an index fund, where the beneficiaries would get a stepped up basis?

 

[pb4uski]

^^^ That's a good idea.... the tax will be paid eventually at either your marginal rate or your beneficiaries' marginal rate so it might be better to surrender, pay the tax and invest the proceeds in a taxable account investment that wil get a stepped up basis... or convert to a 10, 15 or 20 year payout, pay the taxes as they are due but reduce your withdrawals from taxable accounts so they get more taxable account money.

If your beneficiaries include tax-exempt charities I think you could leave it to them tax-free (double check that though).... so that might be a good way to handle some of it.

 

[imoldernu]

Suggestion... Request from the corporation, annuity payout dollars using time options, ie. 5 year, 10 year, life, and a copy of the documents required to be signed to exercise those options. A good way to decide the tax options. Gives a clearer view of the dollars involved and the alternate recipient requirements. Not as simple as it sounds.

 

[Z3Dreamer]

True, but that doesn’t make it any less relevant. If you don’t need the money, how does leaving it to be inherited compare with cashing it out now and investing the after tax proceeds in an index fund, where the beneficiaries would get a stepped up basis?

Looks like a good idea. I just ran:1) take the money out today, pay 25% taxes and invest the rest in an index fund earning 7%. vs 2) keep it where it is. Invest at 7% less the mortality charge. At my demise, in say 30 years, the beneficiaries cash it out and pay 30% tax.

I played with my life expectancy, rate of return and taxes. In all cases, taking the money out and investing in the index fund works out.

I will let you know if I do it.

Thanks.

 

[Bruno]

Another option might be to call the Vanguard annuity division and ask for their recommendation. It might be possible to do a 1035 exchange. They say low fees and no surrender charges. It was my understanding they could 1035 into a Variable annuity and at any time you could move it to a SPIA or annuitize it without any surrender charges.

 

[gauss]

I am sorry, but I do not think that is correct. When I was doing taxes as an AARP volunteer, there was a formula, based on life expectancy of how much each withgrawal was taxable and how much was return of principal.

This is indeed confusing

I think that these four cases apply in the majority of cases. There are exceptions.

Annuitized, Non-Qualified annuities - Use "General Method"

Annuitized, Qualified annuities - Use "Simplified Method"

Non-Annuitized, Non-Qualified annuities - LIFO (all growth comes out first and is taxed until only the original cost ie principal remains which then comes out tax free -- kind of the opposite of under 59 1/2 Roth IRA withdraws)

Non-Annuitized, Qualified annuities - ratio of (cost in plan / total plan value)

-gauss

ref: IRS Pub 575 Pension and Annuity Income

 

[pb4uski]

^^^^ or read Kiplinger link in post#5.