Withdraw First from t-IRA or Variable Annuity?

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Cyclesafe
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Withdraw First from t-IRA or Variable Annuity?

Post by Cyclesafe » Sat Jan 13, 2018 4:27 pm

Which would smarter in the long run, withdrawing from a $3M Vanguard traditional IRA (4bp/yr) or withdrawing earnings from a $3M Vanguard variable annuity (45bp/yr)? Both will incur full federal and state income tax rates.

Age: 63
  • Variable annuity created in 1989 and subsequently 1035'ed to Vanguard in '90's for lower costs
  • No surrender fees
  • No legacy interests
  • No charitable interests
  • Both tax deferred vehicles have the same asset allocation
  • Possible conversion of remainder of variable annuity at age 75 to a joint life SPIA
  • Permission required from insurer for Vanguard to commit to a SPIA "investment" > $1M
  • Basic cost of living adequately covered by drawdown of other taxable accounts

Objective: To have the chance of both being able to spend the variable annuity's earnings and $1M "basis" AND have the chance to spend my entire t-IRA in my (and my spouse's) lifetime/s - all in a tax efficient manner.

My challenge is to extract myself from this current difficult situation created under different (earned) income conditions and different tax laws that existed several decades ago. I know this is a pretty unique situation, but I would appreciate any thoughts....

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FiveK
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Re: Withdraw First from t-IRA or Variable Annuity?

Post by FiveK » Sat Jan 13, 2018 5:00 pm

Cyclesafe wrote:
Sat Jan 13, 2018 4:27 pm
Objective: To have the chance of both being able to spend the variable annuity's earnings and $1M "basis" AND have the chance to spend my entire t-IRA in my (and my spouse's) lifetime/s - all in a tax efficient manner.
SPIA considerations aside (because that leads to other questions), and given that RMDs aren't a problem because you want to spend it all anyway, reducing the balance on which you are charged 45 bp prior to reducing the balance charged 4 bp seems better.

Once you get down (or even close) to having only the $1M basis left in the VA, you can transfer it all (minus tax on any remaining gain) into one of your 4 bp funds.

The main guesswork comes in determining "over how many years?" you will deplete these accounts.

Happy spending!

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Cyclesafe
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Re: Withdraw First from t-IRA or Variable Annuity?

Post by Cyclesafe » Sun Jan 14, 2018 9:03 am

FiveK

Thank you for responding.

Yes reducing the higher cost fund to save 41 bp is one factor, but this, by itself, doesn't trump withdrawing from my t-IRA to reduce RMD's and their incremental taxation from a federal marginal rate of at best from 32%+3.8% to 35%+3.8% (or worse!), for a 200 bp incremental additional tax cost.

Even with moderately aggressive withdrawal rates of the variable annuity, I could still have a balance too high to permit annuitization. If I withdrew to a federal taxable income of $600k (total federal and state marginal tax of 38.5%+10.3%) from now until age 71, I would recoup my $1M basis at that time. If I withdrew at $400k (35.8%+9.3%) from now until age 81, I'd recoup then. The problem with the latter, is that at age 81 my utility of the basis has diminished.

I just can't figure out the best way of finessing these withdrawals. Any additional insight would be welcome.

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FiveK
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Re: Withdraw First from t-IRA or Variable Annuity?

Post by FiveK » Sun Jan 14, 2018 12:39 pm

What is your "unavoidable" taxable income, on top of which you would add annuity and/or IRA withdrawals?

E.g., if your taxable income base is $100K (and it is all ordinary income), then withdrawing $300K/yr from the annuity (for a total of $400K taxable), while the annuity returns 6%, would bring you down to $1M in only ~12 years, or age 75.

Similarly, withdrawing $500K/yr from the annuity (for a total of $600K taxable) would bring you down to $1M in only ~5.5 years, or age 68.5.

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Cyclesafe
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Re: Withdraw First from t-IRA or Variable Annuity?

Post by Cyclesafe » Sun Jan 14, 2018 1:58 pm

Yes, there is indeed more. An annuity and interest generating about $60k of federal taxable income.

The kicker is that if one assumes that equity and fixed within the variable annuity increases at 5% and 2% respectively, and that the total current value of the variable annuity is $3M (earnings) + $1M basis for a total of $4M (I guess I over-simplified my original post - sorry), I get the aforementioned 71 and 81 to get to my $1M basis.

So I can achieve my objective of drawing down the earnings of my variable annuity by exchanging within the vehicle into a money market rather than its current 75/25 equity/fixed allocation but......

It seems like though I should stop complaining and just pay the taxes. But I still want to pay a little tax as legally possible....

Again, thank you for responding.

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grabiner
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Re: Withdraw First from t-IRA or Variable Annuity?

Post by grabiner » Sun Jan 14, 2018 2:24 pm

Withdrawing from either one will get the same tax bill, unless you annuitize the variable annuity or use up all the gains. Therefore, it's likely better to withdraw from the variable annuity, because the money in that annuity will grow more slowly.

Once you have used up all the gains, you can choose whether to withdraw from the IRA or variable annuity in order to optimize your taxes; for example, you can withdraw from the IRA up to the top of a tax bracket, and then from the variable annuity (or Roth IRA if you have one) to avoid paying taxes at the next higher rate.

What the accounts are invested in is not relevant, since you can reallocate freely. If you want to sell foreign stock and you don't have any foreign stock in the variable annuity, you can sell bonds in the variable annuity, and move an equal amount from foreign stock to bonds in the IRA.
Wiki David Grabiner

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Cyclesafe
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Re: Withdraw First from t-IRA or Variable Annuity?

Post by Cyclesafe » Sun Jan 14, 2018 3:33 pm

grabiner wrote:
Sun Jan 14, 2018 2:24 pm
Withdrawing from either one will get the same tax bill, unless you annuitize the variable annuity or use up all the gains. Therefore, it's likely better to withdraw from the variable annuity, because the money in that annuity will grow more slowly.

In the short term, yes. But when the t-IRA's RMD's roll around and they start dramatically increasing after age 80 not doing something about the balance now (withdrawals, Roth conversions) will likely bump one up a bracket.

Once you have used up all the gains, you can choose whether to withdraw from the IRA or variable annuity in order to optimize your taxes; for example, you can withdraw from the IRA up to the top of a tax bracket, and then from the variable annuity (or Roth IRA if you have one) to avoid paying taxes at the next higher rate.

If the gains in the variable annuity are depleted, the better scheme is to just surrender the resulting basis and put it in a lower fee tax efficient fund in taxable.

What the accounts are invested in is not relevant, since you can reallocate freely. If you want to sell foreign stock and you don't have any foreign stock in the variable annuity, you can sell bonds in the variable annuity, and move an equal amount from foreign stock to bonds in the IRA.

That's the saving grace here. I have re-allocated among the funds of both of these two tax deferred vehicles as whim (early on) or Bogelhead tenets (more recently) dictated.
I have a spreadsheet that models these out to age 100. But I just can't seem to find a sweet spot. Squeeze the balloon in one place and it expands somewhere else.

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