Avoiding 10% early withdrawal penalty on non-qualified investments

[garya505]

I'm looking for ideas on avoiding 10% early withdrawal penalty on non-qualified investments. My wife is under 59 1/2 and I want to use some type insurance product (MYGA,SPIA,FIA w/GLWB,WL/IUL cash value, etc) for that part of our fixed income side.

I believe the SPIA would qualify under the IRS 72(q) SEPP provision. However, I don't want to start income now, but in about 5 years. To qualify for 72(q) SEPP, I believe the income must start within 1 year, so the FIA w/GLWB is out.

I am splitting the non-qualified investments between me and my wife because she will outlive me by many years. I am also trying to minimize taxes on SS, so using a MYGA-2-SPIA strategy will work for my part of it as I'm over 59 1/2. For my wife's side of the FI I can't use the MYGA-2-SPIA strategy because the 1035 transfer from MYGA to SPIA would disqualify it for the 72(q) SEPP exclusion. Cashing out the MYGA and then buying the SPIA would work, but would resultion a large tax bill on the MYGA interest.

Got any ideas?

 

[Al18]

I believe SPIA distributions are penalized if you are under 59 1/2.


How about CD's and sales from a brokerage account to cover the distributions before age 59 1/2.



If your wife has a 401K, she should be able to withdraw funds without penalty if she is 55 or older when she retires from that job, though IRA Federal withholding is 20% on distributions.

 

[pb4uski]

I think you mean qualified (tax-deferred) not non-qualified (taxable). There is no early withdrawal penalty for non-qualified money.

Qualified plans have tax-deferred contributions from the employee, and employers may deduct amounts they contribute to the plan. Nonqualified plans use after-tax dollars to fund them, and in most cases employers cannot claim their contributions as a tax deduction.

You could set up a 5 year MYGA or 5 year agency bonds (currently yielding 4.27% and have more flexibility than a MYGA) and then either annuitize the MYGA or buy a SPIA that meets the SEPP requirements.

Or you could just have a revolving 5 or 10 year CD/UST/Agency ladder and do SEPP compliant withdrawals.

 

[garya505]

I believe SPIA distributions are penalized if you are under 59 1/2.


How about CD's and sales from a brokerage account to cover the distributions before age 59 1/2.



If your wife has a 401K, she should be able to withdraw funds without penalty if she is 55 or older when she retires from that job, though IRA Federal withholding is 20% on distributions.

Thanks for the response.

SPIA payments are exempted from early withdrawal penalties because they are an "immediate annuity" under section 72(u)(4) of the IRS Code. However, the SPIA will lose this exemption if funded by a 1035 exchange from a tax deferred annuity such as a MYGA.

We have enough assets to cover needed income. It's currently in MUNI nutual funds, which are of course tax-free but impact taxation of SS. I am looking for a more tax efficient strategy. I might not find one.

My wife doesn't have a 401K or IRA.

 

[garya505]

I think you mean qualified (tax-deferred) not non-qualified (taxable). There is no early withdrawal penalty for non-qualified money.



You could set up a 5 year MYGA or 5 year agency bonds (currently yielding 4.27% and have more flexibility than a MYGA) and then either annuitize the MYGA or buy a SPIA that meets the SEPP requirements.

Or you could just have a revolving 5 or 10 year CD/UST/Agency ladder and do SEPP compliant withdrawals.

Yes, the early withdrawal penalty applies non-qualified income from tax-deferred contracts like annuties, unless they qualify as an "immediate annuity" under under section 72(u)(4) of the IRS code. A SPIA would work unless it was funded with a 1035 exchange from a MYGA.

Annuitizing a MYGA would result in payments that would not qualify under 72(u)(4) becuase the starting date would be the purchase date of the MYGA, more than a year before the payments start.

A lifetime SPIA bought from cash assets would work, as it would qualify under 72(u)(4). But, we don't need immediate income, as required by 72(u)(4).
EDIT: We could wait on the SPIA purchase, but meanwhile earnings on those assets will not be tax-deferred.

 

[garya505]

This is the case that shows what happens when you are under 59 1/2 and you fund a SPIA by a 1035 exchange from a deferred annuity:
https://www.taxnotes.com/research/federal/irs-guidance/revenue-rulings/swapped-annuity-contract-was-subject-to-premature-withdrawal-penalty/dgmm

 

[oldtimer]

I not familiar with the details of the insurance products, but can't they be set up so the spouse inherits them upon death? That way you (over 59.5) can now fund a greater portion now and spouse can fund the greater portion of the growth portion of your financial pie. Once spouse is 59.5 you can "rebalance" the split between you.

 

[pb4uski]

...I am looking for a more tax efficient strategy. I might not find one. ...

I think that you are probably right.

 

[garya505]

I not familiar with the details of the insurance products, but can't they be set up so the spouse inherits them upon death? That way you (over 59.5) can now fund a greater portion now and spouse can fund the greater portion of the growth portion of your financial pie. Once spouse is 59.5 you can "rebalance" the split between you.

For a MYGA you can do that, but it's not annuitized. A SPIA with cash refund would pay the remaining balance to the beneficiary. For a FIA there is a death benefit which is just the remaining balance. Cash value whole life or indexed universal life are different beasts and they would do that, but I'm too old to get an acceptable policy.

A surviving spouse can't receive lifetime annuity payments, unless it's a joint contract.

 

[garya505]

I think that you are probably right.

I might consider buying multiple MYGAs. Then I could exchange some of them using a 1035 exchange into a SPIA for me. The remaining ones could be kept until we need the cash, then cashed out (and taxes paid). I might even consider doing the 1035 exchange into a SPIA for my wife as she gets closer to age 59.

 

[garya505]

This might be the solution.

OK, I may have a solution. An FIA+GLWB would probably qualify for the 10% penalty tax exception for "distributions made as part of a series of substantially equal periodic payments".

I believe this would apply even if a MYGA was exchanged into the FIA+GLWB. In the case of the MYGA-to-SPIA exchange, that doesn't satisfy the IRS because the "immediate annuity" exception requires that the payments to start within 1 year, and the IRS will take the starting date from the MYGA. In the case of the FIA+GLWB, there is no such requirement for the payments to be immediate, only that they are "substantially equal periodic payments".

 

[garya505]

It looks like the FIA+GLWB will work. SEPP isn't required unless she wants to take distributions before age 59 1/2.

So, buy the FIA+GLWB now, or buy a MYGA and then exchange into the FIA+GLWB later. Then trigger the GLWB at age 59 1/2 or later.