Suggestions for my mother's annuities

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KlingKlang
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Suggestions for my mother's annuities

Post by KlingKlang » Sun Jun 18, 2017 2:40 pm

Back in the 2000's when CD rates were declining precipitously my parents were directed by their "friends at the bank" to talk to the nice life insurance salesmen renting desks there. The following is the information on two of the annuities that they purchased (I don't know how many more there are).

Non-Qualified Single Premium Deferred Fixed Annuity
Contract Date 09/07/2001 Initial Payment $80,000
09/07/2016 Balance $145,733 Current Interest Rate 3.00%

The insurance salesman had us come to the bank a couple of years ago regarding this policy and told us that we should cash it in and buy whole life insurance. Neither of us were thrilled by this suggestion.

Non-Qualified Classic Fortifier Flexible Premium Deferred Annuity
Contract Date 06/13/2008 Initial Payment $38,680
06/12/2016 Balance $49,937 Current Interest Rate 2.00% (may increase to 3.00% in 2018)

My mother who was widowed in 2009 turned 90 this May. I thought that the maximum age maturity dates on these type of policies were age 90, but both insurance companies claim that my mother can keep them until she is age 100. She will probably live that long but I won't. Her deceased husband is the primary beneficiary on both of these and I am the secondary beneficiary.

My mother is worried about what to do with them but doesn't really understand the difference between annuities and bank CDs. Every conversation ends with her saying that she will call her 'friends at the bank' and ask what to do. Her friends at the bank have started hanging up on her.

Both of these are past the withdrawal penalty date. The options for using them are:
· Payments for a fixed period (or single payment)
· Payments for life - guaranteed period
· Payments for a monthly fixed amount
· Life annuity - no guaranteed period

My mother has enough income from interest, IRA RMDs, and SS that $2000 of her SS is being taxed. Her basic financial philosophy is:
· Money is for saving not spending
· Pay taxes later rather than sooner

My concern is that these annuities have already built up $77K in untaxed income and may trigger an excessive tax bill if my mother dies.

Suggestions?

bsteiner
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Re: Suggestions for my mother's annuities

Post by bsteiner » Sun Jun 18, 2017 3:24 pm

KlingKlang wrote:... My concern is that these annuities have already built up $77K in untaxed income and may trigger an excessive tax bill if my mother dies.


While we hope she'll live as long as possible, death is a certainty.

The $77,000 of income is also a certainty (unless the value declines).

There's often no good solution to an annuity. If she cashes it in, she'll bunch the income into a single year. If she keeps it, she'll continue to incur the expenses of the annuity, and she'll convert future dividends and capital gains to ordinary income and give up the basis step-up.

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ThePrune
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Re: Suggestions for my mother's annuities

Post by ThePrune » Sun Jun 18, 2017 8:41 pm

KlingKlang wrote:My concern is that these annuities have already built up $77K in untaxed income and may trigger an excessive tax bill if my mother dies.
Since one of your questions has to do with death benefits, do you have and understand the details of who are listed in the two contracts as primary and contingent beneficiaries? I'll assume that your mother doesn't have enough assets ($5.49 million in 2017) to be subject to federal Estate Taxes (but you can correct that assumption in a future post, if needed.) With this assumption the taxation of the built up $77K in gain will (1) be paid by the beneficiaries (not your mother) when they actually withdraw funds, and (2) will depend on the type of withdrawal chosen by the beneficiaries from the list of options offered by the original contracts. It is possible that the beneficiaries my have a choice that allows them further delay withdrawal and associated taxation.

By the way, if folks aren't happy with the current beneficiaries listed on the annuity contracts, have your mother IMMEDIATELY work with her insurance agent to make changes while she is still mentally sound! Don't wait.

KlingKlang wrote:My mother has enough income from interest, IRA RMDs, and SS that $2000 of her SS is being taxed. Her basic financial philosophy
· Money is for saving not spending
· Pay taxes later rather than sooner
Since your mother doesn't need the annuity funds (at this point in time) to cover living expenses, she is very wise to "Pay taxes later rather than sooner." I am very thankful that you mentioned that your mother has a portion of her Social Security benefits subject to taxation. That means that she is subject to the so-called "SS Tax Torpedo", meaning that the marginal tax rate on unneeded annuity withdrawals will be much larger than her nominal federal tax rate. (Confused? Refer to the Wiki article Taxation of Social Security benefits.) Nevertheless, it might still be better for your mother to take partial (non-periodic) annuity withdrawals ... IF (notice that it's a BIG IF) .... her full marginal tax rate is going to be less than the marginal tax rate paid by the beneficiaries of her annuities after her death. But you can't determine the beneficiaries' marginal tax rate(s) until you understand the withdrawal options offered them by the contracts (per last paragraph).

One detail about the taxes your mother would pay on partial (non-periodic) annuity withdrawals. (Tax rules for annuitized withdrawals are much different and more complicated.) If the annuity contracts were purchased before Aug. 14, 1982, then the funds being withdrawn come out principal first, earnings afterwards. Otherwise the earnings come out first followed by the principal. Only the earnings (your $77K) would ever be subject to taxation, and it is always as ordinary income. (Income from annuity earnings never get special dividend / capital gains treatments because the earnings are tax-sheltered until withdrawn.)

KlingKlang wrote:Non-Qualified Single Premium Deferred Fixed Annuity
Contract Date 09/07/2001 Initial Payment $80,000
09/07/2016 Balance $145,733 Current Interest Rate 3.00%
A compound interest rate of 3.00%, with no risk of capital loss due to rising interest rates, is still looking very attractive today. I see no reason to recommend your mother doing anything other than leaving this alone, at least until you begin to see 1-2 year CD rates rising above 3.00%.

KlingKlang wrote:Non-Qualified Classic Fortifier Flexible Premium Deferred Annuity
Contract Date 06/13/2008 Initial Payment $38,680
06/12/2016 Balance $49,937 Current Interest Rate 2.00% (may increase to 3.00% in 2018)
This 2.00% interest rate is not as good as the other annuity, but still not bad since there is no risk of capital loss with rising interest rates. If it makes sense for you mother to make partial (non-periodic) withdrawals, I'd take them out of this annuity first. Otherwise you could leave it alone also.
Investment skill is often just luck in sheep's clothing.

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Peter Foley
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Re: Suggestions for my mother's annuities

Post by Peter Foley » Sun Jun 18, 2017 8:51 pm

Based on the fact that some but not all of your mother's SS benefits are being taxed, any withdrawal will be at a relatively high tax rate until all her SS benefits are taxed.

One way to simplify this a bit IF your mother regularly gives to charity.

1. Have your mother donate a portion of her RMDs to a charity.
2. Take payments for a fixed period (10 years) on the smaller of the two annuities. Each payment will be part interest and part return of initial investment. Ballpark this would be $5000/year with about 77% return of investment and 23% interest (ordinary income). $5000 X .23 = $1,150 in additional taxable income each year.

So if your mother already gives $1,150 to charity every year and she does not itemize deductions, the RMD is effectively replacing her charitable deduction and her taxable income will remain the same.

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KlingKlang
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Re: Suggestions for my mother's annuities

Post by KlingKlang » Mon Jun 19, 2017 9:04 am

bsteiner wrote:There's often no good solution to an annuity.


Thank you to those that responded. It looks like there is no 'silver bullet' solution to this problem.

ThePrune wrote:That means that she is subject to the so-called "SS Tax Torpedo",


I was aware of this but thank you for the link with the details.

Peter Foley wrote:IF your mother regularly gives to charity.


:shock: Not only does my mother not GIVE to charity but she is signed up to GET every bit of charitable aid, property tax and utility discounts imaginable, including many that she is not eligible for due to her income and net worth.

Besides the tax situation two other concerns that I have are:

Her getting another call from a "friend at the bank" life insurance agent insinuating that she needs to cash in these annuities and purchase some new high cost/commission product.

The large number of accounts that her investments are scattered among. These include many accounts that she will not touch due to the source of the funds, ie. "That's your father's money" (deceased 9 years), "my mother's money" (deceased 32 years), and "Aunt Viola's money" (deceased 40 years).

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ThePrune
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Re: Suggestions for my mother's annuities

Post by ThePrune » Mon Jun 19, 2017 6:46 pm

KlingKlang wrote:Besides the tax situation two other concerns that I have are:

Her getting another call from a "friend at the bank" life insurance agent insinuating that she needs to cash in these annuities and purchase some new high cost/commission product.

Because of your mother's advanced age (you said she turned 90 in May), your state may have regulations that will prevent her from being bothered by any insurance agents! For example, I believe that no insurance company will allow a 90 year old to be sold an annuity (but I'm not 100% certain).

Here what you should do: contact the Office of the Insurance Commissioner for your mother's state
. Ask them if a 90 year old can be legally sold either a new annuity contract or a new life insurance contract. If they answer "no" to both questions, then I think you have a lot less to worry about.

If it should turn out that her state allows either annuity or life insurance sales to a 90 year old, then ask about the "Elder Financial Abuse" laws for her state. (Almost every state has adopted these over the last 10 years.) Perhaps there will be something there that you might use to preemptively "discourage" the insurance salesman at this bank.
Investment skill is often just luck in sheep's clothing.

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