Where Would a VA Fall in My Withdrawal Sequence?

[Trooper]

DW has a variable annuity held at Vanguard. We moved it there a number of years ago from a higher cost one sold to us by a less-than-fiduciary financial advisor. Had I known then what I know now...

Anyway, the VA was opened with after-tax dollars. It has a balance of $390K and a cost basis of $315K, and is invested in a "Moderate Allocation" (60% stocks/40% bonds). DW turn 59 1/2 soon, so I'm wondering whether I should start withdrawing on the VA to meet living expenses. My withdrawal strategy is taxable, then tax-deferred, then tax free. We have about $530K in other taxable investments spread across 4 Vanguard index funds.

As I understand the tax ramifications, the IRS assumes the appreciated portion of the VA ($390K - $315K = $75K) comes out first when withdrawing. Therefore the first $75K of withdrawals would be taxed as ordinary income, and the rest would be tax free, correct?

Any thoughts on whether to start taking $ out of this VA? It has an expense ratio of 0.41%, which is a main factor in my wanting to pare it down.

 

[friar1610]

DW has a variable annuity held at Vanguard. We moved it there a number of years ago from a higher cost one sold to us by a less-than-fiduciary financial advisor. Had I known then what I know now...

Anyway, the VA was opened with after-tax dollars. It has a balance of $390K and a cost basis of $315K, and is invested in a "Moderate Allocation" (60% stocks/40% bonds). DW turn 59 1/2 soon, so I'm wondering whether I should start withdrawing on the VA to meet living expenses. My withdrawal strategy is taxable, then tax-deferred, then tax free. We have about $530K in other taxable investments spread across 4 Vanguard index funds.

As I understand the tax ramifications, the IRS assumes the appreciated portion of the VA ($390K - $315K = $75K) comes out first when withdrawing. Therefore the first $75K of withdrawals would be taxed as ordinary income, and the rest would be tax free, correct?

Any thoughts on whether to start taking $ out of this VA? It has an expense ratio of 0.41%, which is a main factor in my wanting to pare it down.

Just curious whether or not you've considered annuitizing vs withdrawing. Or letting it ride for a while, the ER notwithstanding. I ask because I have a VG VA as well, although it's a smaller one with a much higher percentage of earnings than yours (owned it longer). So I've considered some of the same questions. We don't need the money for living right now so my plan is to let it sit for now. If I predecease my wife, she, as the beneficiary, will become the owner. She can then use it to make up for the loss of one SS check and a large portion of my pension. If she goes first I'll have several options, none of which likely involve annuitizing: 1) charitable contributions; 2) gifting to kids/grandkids; 3) holding in case needed for long-term care; 4) travel and/or debauchery. I just mention these options because they're the result of a lot of thought about how best to use an investment that, with 20-20 hindsight, I wish I hadn't gotten into.

Your assumption re: the taxation of the earnings is correct. I believe that if I had lower earnings/higher basis, as you do, I'd just bite the bullet, pay the taxes and then reinvest the untaxed basis into my taxable account. Depending on your tax situation, you could take the earnings out over a couple of years if taking it all at once would increase your taxes too much.

Good luck with your planning/decision.

 

[Trooper]

Thanks for your response!

Just curious whether or not you've considered annuitizing vs withdrawing. Or letting it ride for a while, the ER notwithstanding.

Like you, we don't need to annuitize for living expenses right now, so I suppose I could either "let it ride" or take the CG hit and convert it to tax-friendly mutual funds in my taxable account. I would need to stop my Roth conversions in the second option, to minimize the tax hit.

If I predecease my wife, she, as the beneficiary, will become the owner. She can then use it to make up for the loss of one SS check and a large portion of my pension.

True, but your wife could alternatively purchase a SPIA (immediate annuity) with the funds that were freed up upon liquidation of the annuity, rather using the VA for that correct? I guess that would involve an extra step, at a time in our lives that we may not be thinking clearly (or at all, LOL). I like the liquidate now then SPIA at age 80 option in a perfect world.

If she goes first I'll have several options, none of which likely involve annuitizing: 1) charitable contributions; 2) gifting to kids/grandkids; 3) holding in case needed for long-term care; 4) travel and/or debauchery. I just mention these options because they're the result of a lot of thought about how best to use an investment that, with 20-20 hindsight, I wish I hadn't gotten into.

I like the debauchery option And...totally agree on the hindsight!

Your assumption re: the taxation of the earnings is correct. I believe that if I had lower earnings/higher basis, as you do, I'd just bite the bullet, pay the taxes and then reinvest the untaxed basis into my taxable account. Depending on your tax situation, you could take the earnings out over a couple of years if taking it all at once would increase your taxes too much.

Yep - I guess it's a question of paying taxes now, versus higher fees now, then taxes later. If I annuitize the VA later on then its taxes would be spread pro rata over the annuity's payments. Thanks again for your response.

 

[friar1610]

Thanks for your response!


True, but your wife could alternatively purchase a SPIA (immediate annuity) with the funds that were freed up upon liquidation of the annuity, rather using the VA for that correct? I guess that would involve an extra step, at a time in our lives that we may not be thinking clearly (or at all, LOL). I like the liquidate now then SPIA at age 80 option in a perfect world.

I haven't analyzed the numbers in detail, but I'm not sure that would be the way to go, at least in my case. About 75% of the current value of mine is earnings, so a 22%-24% tax hit on the earnings (if I were to liquidate) would seriously reduce the amount available to buy an SPIA. I have looked at SPIA payout rates to see whether or not they would provide more monthly income to my wife than what's guaranteed in the VG VA contract. So far it looks pretty much like a wash. But, if she were to go that route, I think a 1035 exchange to te SPIA would be a better way to go as that would transfer the entire amount tax-free.