Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

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iim7V7IM7
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Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by iim7V7IM7 »

As part of my company compensation, I receive company stock RSUs each May. When they are issued, they are taxed at 22% as income and some shares are liquidated to pay this (my effective Federal tax rate is about 24% so some additional is owed) and the remaining shares are sold on or near their issuance date (so while they qualify short-term capital gains there are nearly none).

I am debating two options to invest this taxable money over a 5-to-7-year time horizon when I will need to liquidate this money to purchase a new retirement property. Our tax deferred investments will cover our retirement income beyond social security and my pension. I currently maximize my 401k investment with a company match and mega-back door into a Roth after tax dollars. We make too much for traditional IRAs and Roth IRAs. So the options to invest the RSUs are limited to a few options.

We are 60 and 61 years old and are in the 35% Federal Tax Bracket and 6.37% State Tax brackets. I am trying to understand the pros and cons of investing about $200k now and contributing about $70k/year over the next 5-to-7-years (2026-28) either in:

Option A) Taxable brokerage account invested in low cost, tax efficient stock and bond funds

o 30% Vanguard Total Stock Market Index Adm Sh (VTSAX) 0.04% ER
o 45% Vanguard Intermediate-Term Tax Exempt Adm Sh (VWIUX) 0.009% ER
o 25% Vanguard New Jersey Long-Term Tax Exempt Adm Sh
o Rebalancing through directed investment, ability to tax loss harvest
o Taxes paid annually and loss harvesting along the way

Option B) Tax Deferred Fidelity Personal Retirement Annuity (FPRA)

o Annual annuity charge of 0.25% plus underlying fund fees
o Can be self-managed in a variety of 55 available funds
o 24% - Fidelity VIP Total Market Index (FTMJC) 0.012% ER (so 0.37%)
o 06% - Fidelity VIP International Index (FFISC) 0.17% ER (so 0.42%)
o 70% - Fidelity VIP Bond Index (FBISC) 0.14% ER (0.39%)
o Rebalancing by both investment and inter-fund transfers
o No surrender fee, distributions are deferred and reinvested, taxed as income when withdrawn (expect to still be in a high tax bracket)

My default position is to be extremely cautious at entertaining any annuity product. What I am trying to get my head around is whether a taxable brokerage account or the more expensive, (e.g., 0.37%-0.42% vs. 0.04% to 0.09%) albeit tax deferred annuity. I anticipate our deaccumulation tax bracket may be slightly lower than today, but not substantially so. In 5-to-7-years with Option A it would be mostly long-term capital gains (currently 20% + State) and with the Option B it would be taxed as income at current Federal and State brackets as income. With the annuity, I can rebalance and invest in different types of bonds other than munis for example.

Using Portfolio Visualizer using assets and not tickers I don’t see a small difference in outcomes between the taxable and tax deferred options. When you add the expenses, the differences get even smaller.

• Option A: 4.8% (3.2%-8.5%)
• Option B: 5.5% (3.9%-10.7%)

I know that there have been a number of threads on a similar topic, but my particular tax bracket and time horizon to use this money seems to differ.
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Stinky
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Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by Stinky »

I’d choose the brokerage account.

—- Fees are less.
—- Tax treatment is more favorable on stock fund (qualified dividends and capital gains taxes, vs ordinary income tax rates on the annuity).
—- Step up in basis at death (in the unlikely event of death during the holding period)

In my mind, the brokerage account advantages outweigh the annuity benefit of deferring taxable income until funds are withdrawn.
Former life insurance company financial officer who sincerely believes that ”It’s a GREAT day to be alive!”
Topic Author
iim7V7IM7
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Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by iim7V7IM7 »

Thanks for your advice…
Stinky wrote: Thu Jan 13, 2022 3:27 pm I’d choose the brokerage account.

—- Fees are less.
—- Tax treatment is more favorable on stock fund (qualified dividends and capital gains taxes, vs ordinary income tax rates on the annuity).
—- Step up in basis at death (in the unlikely event of death during the holding period)

In my mind, the brokerage account advantages outweigh the annuity benefit of deferring taxable income until funds are withdrawn.
Topic Author
iim7V7IM7
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Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by iim7V7IM7 »

After reviewing the costs associated with the annual annuity fee of 0.25% and the expenses of the underlying mutual funds, this tax deferred vehicle create a 0.35% drag that looks rather unappealing aside from avoiding annual tax work/payment until withdrawal.

The Brokerage account annual distributions between Total Stock Market, Intermediate-Term Tax Exempt and NJ Long-Term Tax Exempt should be minimal. Even using the lowest price funds (and they have many in the options >0.5% and >1%!!!), it is difficult for me to believe that the annuity’s underlying returns can overcome this handicap.

Also am I correct in 5 to 7 years when I sell these assets on the taxable brokerage account, I will owe mostly LT cap gains (20% Federal and 6.37% State) whereas the tax deferred annuity would be taxed as income (base income + a large withdrawal income at the top 37% bracket)? This could be between $750,000 to $1,000,000 withdrawal in a single year.
Rex66
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Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by Rex66 »

Rare for annuity to be the best choice

You usually only pick an annuity for tax deferral if you for some reason want to invest in very tax inefficient products like reits and willing to hold for decades

Then maybe it works out
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Stinky
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Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by Stinky »

iim7V7IM7 wrote: Fri Jan 14, 2022 9:52 am After reviewing the costs associated with the annual annuity fee of 0.25% and the expenses of the underlying mutual funds, this tax deferred vehicle create a 0.35% drag that looks rather unappealing aside from avoiding annual tax work/payment until withdrawal.

The Brokerage account annual distributions between Total Stock Market, Intermediate-Term Tax Exempt and NJ Long-Term Tax Exempt should be minimal. Even using the lowest price funds (and they have many in the options >0.5% and >1%!!!), it is difficult for me to believe that the annuity’s underlying returns can overcome this handicap.

Also am I correct in 5 to 7 years when I sell these assets on the taxable brokerage account, I will owe mostly LT cap gains (20% Federal and 6.37% State) whereas the tax deferred annuity would be taxed as income (base income + a large withdrawal income at the top 37% bracket)? This could be between $750,000 to $1,000,000 withdrawal in a single year.
I’m not surprised that you’re seeing that the fee drag on the annuity makes it less attractive than the taxable account. Even a very low cost variable annuity like Fidelity has a fee drag.

I think that you’re interpreting the tax situation correctly. It’s definitely not attractive to pay taxes at ordinary income rates on all annuity earnings.

I believe that a taxable account is more attractive than a variable annuity for most folks, including you.
Former life insurance company financial officer who sincerely believes that ”It’s a GREAT day to be alive!”
Topic Author
iim7V7IM7
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Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by iim7V7IM7 »

Indeed...

To make things worse, I cannot buy either of the muni funds at Fidelity and I need to transfer the money to Vanguard and set up a brokerage account. I just tried to set it up using their online system only to have it fail. I called the # and it gave me the option for a call back which I accepted. It called me back but when it did their automated system did not recognize the touch tone from my iPhone. I am currently on a 45 minute queue to speak with a representative (their new website is having problems and not allowing for online sign-up).

Not a good introduction....
Stinky wrote: Fri Jan 14, 2022 10:03 am
iim7V7IM7 wrote: Fri Jan 14, 2022 9:52 am After reviewing the costs associated with the annual annuity fee of 0.25% and the expenses of the underlying mutual funds, this tax deferred vehicle create a 0.35% drag that looks rather unappealing aside from avoiding annual tax work/payment until withdrawal.

The Brokerage account annual distributions between Total Stock Market, Intermediate-Term Tax Exempt and NJ Long-Term Tax Exempt should be minimal. Even using the lowest price funds (and they have many in the options >0.5% and >1%!!!), it is difficult for me to believe that the annuity’s underlying returns can overcome this handicap.

Also am I correct in 5 to 7 years when I sell these assets on the taxable brokerage account, I will owe mostly LT cap gains (20% Federal and 6.37% State) whereas the tax deferred annuity would be taxed as income (base income + a large withdrawal income at the top 37% bracket)? This could be between $750,000 to $1,000,000 withdrawal in a single year.
I’m not surprised that you’re seeing that the fee drag on the annuity makes it less attractive than the taxable account. Even a very low cost variable annuity like Fidelity has a fee drag.

I think that you’re interpreting the tax situation correctly. It’s definitely not attractive to pay taxes at ordinary income rates on all annuity earnings.

I believe that a taxable account is more attractive than a variable annuity for most folks, including you.
Topic Author
iim7V7IM7
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Joined: Sun Nov 21, 2021 1:26 pm

Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by iim7V7IM7 »

Finally got through after about 50 minutes and things went smoothly from there so I am now good to go. I cannot imagine what Vanguard colleagues must have been going through with a failure of their online system that day! I think they rolled out a new website at the beginning of the year and they have some IT bugs to still work out.

I wish Vanguard was more explicit that you cannot buy certain of their funds from other brokerage accounts. Interestingly, from my Fidelity account I could purchase VTSAX but not VWIUX or VNJUX.
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Eagle33
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Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by Eagle33 »

iim7V7IM7 wrote: Sat Jan 15, 2022 8:48 am I wish Vanguard was more explicit that you cannot buy certain of their funds from other brokerage accounts. Interestingly, from my Fidelity account I could purchase VTSAX but not VWIUX or VNJUX.
Is it Vanguard's decision not to make those funds available to other brokerages, or the decision of the other brokerages not to offerer them because of the interbrokerage fee that Vanguard is demanding for those funds?

Why not wish Fidelity was more explicit that you cannot buy certain of their funds from other brokerage accounts, nor exchange them to other brokerages? The following does not rule out purchase at other brokerages or can't transfer to another brokerage.
Fidelity now offers the Fidelity ZERO Large Cap Index Fund (FNILX), Fidelity ZERO Extended Market Index Fund (FZIPX), Fidelity ZERO Total Market Index Fund (FZROX) and Fidelity ZERO International Index Fund (FZILX) available to individual retail investors who purchase their shares through a Fidelity brokerage account.
Rocket science is not “rocket science” to a rocket scientist, just as personal finance is not “rocket science” to a Boglehead.
Topic Author
iim7V7IM7
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Re: Taxable Brokerage Account or Tax Deferred Annuity. What are the things to think about when deciding?

Post by iim7V7IM7 »

Fair points on “transparency” with both firms. Both should be clear up front. I just thought it would be of value to Vanguard to be explicit about it as a benefit, whereas being a limitation to Fidelity. It is more understandable for a business to promote a benefit vs. highlighting constraints.

I am fine having this account back at Vanguard. This is a discrete investment that has a separate goal from our primary retirement savings. Depending on how things go there in terms of service over the next 5 years, I will decide whether to roll my 401k to an IRA there or leave it with Fidelity. My partner’s IRAs are already with Vanguard.
Eagle33 wrote: Sat Jan 15, 2022 10:17 pm
iim7V7IM7 wrote: Sat Jan 15, 2022 8:48 am I wish Vanguard was more explicit that you cannot buy certain of their funds from other brokerage accounts. Interestingly, from my Fidelity account I could purchase VTSAX but not VWIUX or VNJUX.
Is it Vanguard's decision not to make those funds available to other brokerages, or the decision of the other brokerages not to offerer them because of the interbrokerage fee that Vanguard is demanding for those funds?

Why not wish Fidelity was more explicit that you cannot buy certain of their funds from other brokerage accounts, nor exchange them to other brokerages? The following does not rule out purchase at other brokerages or can't transfer to another brokerage.
Fidelity now offers the Fidelity ZERO Large Cap Index Fund (FNILX), Fidelity ZERO Extended Market Index Fund (FZIPX), Fidelity ZERO Total Market Index Fund (FZROX) and Fidelity ZERO International Index Fund (FZILX) available to individual retail investors who purchase their shares through a Fidelity brokerage account.
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