Inherited Annuity question(s)

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malujerry
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Inherited Annuity question(s)

Post by malujerry » Tue Sep 10, 2019 10:06 am

My mother passed away and left me an annuity with Lincoln. Non-qualified, variable, already in distribution mode. Value is $750k, cash/cost basis/non taxable amount is $461k.

1) Should I cash out and be subject to NY and federal taxes to pay off my house, $520k left, 26 years at 4.2%?

2) Should I cash out and place the money into other investments?

3) Leave it in Lincoln with i4life rider (3.61% fees) that gives me guaranteed income, with part of that income non-taxed for life? This was recommended from my mom’s financial advisor, not sure if I can trust him.

4) do a 1035 exchange to a cheaper annuity company like Nationwide or Jackson? I spoke to 3 other financial advisors and they recommended switching to those companies because of lower fees, around 1.5%. Not sure if I can trust them.

I’m 37, no other debts, do not need the money, have one child. I’d like to make the best long term decision.

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David Jay
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Re: Inherited Annuity question(s)

Post by David Jay » Tue Sep 10, 2019 10:36 am

Welcome to the forum!

Well, taking the cash will add add some $290,000 to your taxable income for the year. That is a high price to pay (perhaps $100,000 - $150,000) to take the money out, but it is a choice.

Doing a 1035 to a lower cost VA is an option. Do your research (including here at BH) thoroughly as a few tenths of a percent per year makes a huge difference over decades. Don’t be in a hurry.

The one thing I would not do is leave it at Lincoln with 3.6% fees/expenses “forever”. That will likely cost you close to a million dollars in gains over a lifetime.

[edit]. Oh, and you are correct, can’t trust a “financial advisor”. Up to half of that 1.5% per year goes to pay advisor commissions. You can get a VA for less than 1% through a low cost brokerage like Vanguard or Fidelity (direct). Again a half of a percent sounds small but over decades it becomes huge - hundreds of thousands of dollars.
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Re: Inherited Annuity question(s)

Post by bsteiner » Tue Sep 10, 2019 10:45 am

There's usually no good solution to an investment-type annuity.

If you keep it and take distributions over your lifetime or life expectancy, in addition to continuing to incur the costs of the annuity (which as others have pointed out you can probably reduce), you'll convert the future qualified dividends and capital gains to ordinary income. If you cash it in all at once you'll bunch the income into a single year.

There may be another choice. Many insurance companies will let you take it over 5 years. That will get you out from under the annuity without bunching all the income into a single year. That's sometimes the least bad of the choices.

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Re: Inherited Annuity question(s)

Post by 123 » Tue Sep 10, 2019 11:04 am

malujerry wrote:
Tue Sep 10, 2019 10:06 am
...4) do a 1035 exchange to a cheaper annuity company like Nationwide or Jackson? I spoke to 3 other financial advisors and they recommended switching to those companies because of lower fees, around 1.5%. Not sure if I can trust them...
Of course the 3 other financial advisers recommended switching because that's how THEY make their money.
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Re: Inherited Annuity question(s)

Post by not4me » Tue Sep 10, 2019 11:20 am

There are a dizzying array of these products & so anything said may not be right for your specific, but here's what I'd do.

1st, I'd place a call to Vanguard and/or Fidelity & ask them about your specific. Vanguard has recently been shifting their VA business, but I think they still may provide this. They have a broad understanding of the products & can talk you through what you have & what else is available.

I doubt seriously that the one you have is best, so I'd 1035 away. Not thru an FA though.

I'd look at my tax situation to determine how best to get out. So, let's say you 1035 as suggested based on earlier phone call -- making sure you won't have any surrender fees. Then in addition to the required distribution I think you'll be able to take a withdrawal of the amount you choose. Distributions may include mostly taxable amounts, with a sliver of the cost basis for which you wont be taxed. The withdrawal would all be taxed as ordinary income until only cost basis left. Based on your situation, map out how best to draw that down over the next few years. Once you draw down to just the cost basis, close it out (that part won't be taxed then).

Whether you deploy those funds into paying down mortgage or added to your investments in a separate matter really (to me).

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Re: Inherited Annuity question(s)

Post by malujerry » Tue Sep 10, 2019 11:34 am

Thank you for the responses!

Yes, there is a 5 year option. My income is over $400k annually so I figured I’m going to get taxed heavily either way when it comes to all at once versus 5 years. But maybe over 5 years and pay off the house if that is the best option? I haven’t done the hard math yet but thought it wasn’t worth paying the mortgage interest over the next 5 years versus just paying it off compared to the taxes.

But if I’m keeping the annuity...

The lowest fee so far I found is Nationwide and Jackson at 1.5%, I’ll keep looking for something with a lower cost if that’s the better option in the long run. Since mortgage interest is still tax deductible and maybe the long term payout will be much more than cashing it out now...

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Re: Inherited Annuity question(s)

Post by informal guide » Tue Sep 10, 2019 12:12 pm

Both Fidelity (direct) and Vanguard offer 1035 exchanges into products at an annualized 0.60% or less, including both annuity and investment fees. If you choose to keep the annuity to cash out over several years, either would be a much better option. If you cash it out over time, the income comes out first, taxable as ordinary income at the Federal and usually the state level. On the other hand, cashing out at once would allow you to invest at an annualized 0.10% or less.

I concur that where you put the proceeds is an independent issue. My personal belief (not necessarily BH philosophy) is that I don't want to have the bulk of my net worth tied up in my residence.

My quick take is to take a look at your 2019 tax situation and withdraw at least the amount to the top of your current tax bracket. Then I'd withdraw the rest in January 2020. That saves the hassle of a 1035 annuity move to Vanguard or Fidelity.

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Re: Inherited Annuity question(s)

Post by Stinky » Tue Sep 10, 2019 2:56 pm

informal guide wrote:
Tue Sep 10, 2019 12:12 pm

My quick take is to take a look at your 2019 tax situation and withdraw at least the amount to the top of your current tax bracket. Then I'd withdraw the rest in January 2020. That saves the hassle of a 1035 annuity move to Vanguard or Fidelity.
If your income is in the $400k range, and you're married filing jointly, then you're likely near the top of the 32% tax bracket. The 35% tax bracket encompasses just over $200k from the bottom to the top.

If you want to get at the money, I'd rip the bandaid off and do what "informal guide" says. Take up to the break point this year, and then take the rest next year. If you string it over 5 years, your tax bill won't be appreciatively less.
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Re: Inherited Annuity question(s)

Post by David Jay » Tue Sep 10, 2019 5:32 pm

Stinky wrote:
Tue Sep 10, 2019 2:56 pm
informal guide wrote:
Tue Sep 10, 2019 12:12 pm

My quick take is to take a look at your 2019 tax situation and withdraw at least the amount to the top of your current tax bracket. Then I'd withdraw the rest in January 2020. That saves the hassle of a 1035 annuity move to Vanguard or Fidelity.
If your income is in the $400k range, and you're married filing jointly, then you're likely near the top of the 32% tax bracket. The 35% tax bracket encompasses just over $200k from the bottom to the top.

If you want to get at the money, I'd rip the bandaid off and do what "informal guide" says. Take up to the break point this year, and then take the rest next year. If you string it over 5 years, your tax bill won't be appreciatively less.
Cash it out and pay the tax bill. Pay off your mortgage and put the remainder into your portfolio.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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malujerry
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Re: Inherited Annuity question(s)

Post by malujerry » Tue Sep 10, 2019 9:13 pm

informal guide wrote:
Tue Sep 10, 2019 12:12 pm
On the other hand, cashing out at once would allow you to invest at an annualized 0.10% or less.
I’m not sure if I follow, are you stating by taking the money, either lump sum or over the 5 years (to save on taxes) I should reinvest it into another type of fund with much lower expenses and let it grow? What kind of account would have 0.10% or less?

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Re: Inherited Annuity question(s)

Post by malujerry » Tue Sep 10, 2019 9:16 pm

[/quote]
Cash it out and pay the tax bill. Pay off your mortgage and put the remainder into your portfolio.
[/quote]

Lump sum or over 5 years?

What’s your train of thought for doing this? Just curious what your thoughts are on trying to let the money outgrow the cost of the mortgage. (Hope that makes sense)

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Re: Inherited Annuity question(s)

Post by David Jay » Tue Sep 10, 2019 9:32 pm

malujerry wrote:
Tue Sep 10, 2019 9:13 pm
informal guide wrote:
Tue Sep 10, 2019 12:12 pm
On the other hand, cashing out at once would allow you to invest at an annualized 0.10% or less.
I’m not sure if I follow, are you stating by taking the money, either lump sum or over the 5 years (to save on taxes) I should reinvest it into another type of fund with much lower expenses and let it grow? What kind of account would have 0.10% or less?
I’m not “informal_guide” but you can build a 3-fund portfolio with Fidelity, Vanguard or Schwab funds with an average cost well below 0.1%, here is a link to a list from the Wiki for each of the fund families: https://www.bogleheads.org/wiki/Three-fund_portfolio

[edit] If you type the ticker into Google, an early link will be Morningstar. The summary page on M* will display the expense ratio (ER) of the fund. For instance, in Vanguard here are the ERs: VTSAX 0.04%, VTIAX 0.11%, VBTLX 0.05% so depending on mix of these 3 funds your net ER could be between, say, 0.06 and 0.07

You can do the same with the Schwab or Fidelity (or another family) funds.
Last edited by David Jay on Tue Sep 10, 2019 9:48 pm, edited 1 time in total.
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Re: Inherited Annuity question(s)

Post by David Jay » Tue Sep 10, 2019 9:37 pm

malujerry wrote:
Tue Sep 10, 2019 9:16 pm
Cash it out and pay the tax bill. Pay off your mortgage and put the remainder into your portfolio.
Lump sum or over 5 years?

What’s your train of thought for doing this? Just curious what your thoughts are on trying to let the money outgrow the cost of the mortgage. (Hope that makes sense)
After hearing your income, I was reinforcing Stinky’s comments that your tax bracket is high enough that you don’t save much in taxes (3%?) by staying in high cost funds for 5 years. Just lump sum it.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: Inherited Annuity question(s)

Post by smectym » Tue Sep 10, 2019 10:40 pm

Contra several posters above, Vanguard is exiting the annuity business and is probably no longer accepting new accounts. Check out doing a 1035 to Fidelity, though: Fidelity’s VA lineup has become more competitive, with the addition of several low-cost index funds.

https://www.forbes.com/sites/mattcarey/ ... 17623554e9


https://www.google.com/search?q=vanguar ... efox-b-1-m

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Re: Inherited Annuity question(s)

Post by smectym » Tue Sep 10, 2019 11:00 pm

smectym wrote:
Tue Sep 10, 2019 10:40 pm
Contra several posters above, Vanguard is exiting the annuity business and is probably no longer accepting new accounts. Check out doing a 1035 to Fidelity, though: Fidelity’s VA lineup has become more competitive, with the addition of several low-cost index funds.

https://www.forbes.com/sites/mattcarey/ ... 17623554e9


https://www.google.com/search?q=vanguar ... efox-b-1-m
I would add: carefully vet the benefits of a tax-free 1035 exchange to a lower-cost provider like Fidelity vs. accepting the “cash it out and pay the massive taxes” advice. You’re 37; the VA you’ve inherited is an asset that could grow tax-deferred for decades.

Even if you do the 1035, as an heir to a VA, you’re required make certain distribution options, among which the obvious call is to take RMD’s from the VA based on your own life expectancy. Despite the RMD’s, remaining assets continue to grow tax free indefinitely. It can be a game-changer for you in the long run. I’d think long and hard, and get knowledgeable advice, before cashing out. My advice would be 1035 to Fidelity and take it from there.

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Re: Inherited Annuity question(s)

Post by informal guide » Tue Sep 10, 2019 11:23 pm

Stinky wrote:
Tue Sep 10, 2019 2:56 pm
informal guide wrote:
Tue Sep 10, 2019 12:12 pm

My quick take is to take a look at your 2019 tax situation and withdraw at least the amount to the top of your current tax bracket. Then I'd withdraw the rest in January 2020. That saves the hassle of a 1035 annuity move to Vanguard or Fidelity.
If your income is in the $400k range, and you're married filing jointly, then you're likely near the top of the 32% tax bracket. The 35% tax bracket encompasses just over $200k from the bottom to the top.

If you want to get at the money, I'd rip the bandaid off and do what "informal guide" says. Take up to the break point this year, and then take the rest next year. If you string it over 5 years, your tax bill won't be appreciatively less.

Good view of my sentiments. You can get all the cash by early January 2020. Just decide the tax year where you prefer to take the gain.

For the OP, Yes I am suggesting a 3=4 fund index fund portfolio, which, at Fidelity/Vanguard/Schwab will be at an expense ratio of 0.10% or less. My bias for taxable accounts is Vanguard funds/ETFs, because they, unlike Fidelity, have not paid capital gains on the equity funds (the capital gains would mean tax payments, over and above the taxes on dividends).

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Re: Inherited Annuity question(s)

Post by smectym » Tue Sep 10, 2019 11:34 pm

informal guide wrote:
Tue Sep 10, 2019 11:23 pm
Stinky wrote:
Tue Sep 10, 2019 2:56 pm
informal guide wrote:
Tue Sep 10, 2019 12:12 pm

My quick take is to take a look at your 2019 tax situation and withdraw at least the amount to the top of your current tax bracket. Then I'd withdraw the rest in January 2020. That saves the hassle of a 1035 annuity move to Vanguard or Fidelity.
If your income is in the $400k range, and you're married filing jointly, then you're likely near the top of the 32% tax bracket. The 35% tax bracket encompasses just over $200k from the bottom to the top.

If you want to get at the money, I'd rip the bandaid off and do what "informal guide" says. Take up to the break point this year, and then take the rest next year. If you string it over 5 years, your tax bill won't be appreciatively less.

Good view of my sentiments. You can get all the cash by early January 2020. Just decide the tax year where you prefer to take the gain.

For the OP, Yes I am suggesting a 3=4 fund index fund portfolio, which, at Fidelity/Vanguard/Schwab will be at an expense ratio of 0.10% or less. My bias for taxable accounts is Vanguard funds/ETFs, because they, unlike Fidelity, have not paid capital gains on the equity funds (the capital gains would mean tax payments, over and above the taxes on dividends).
OP faces not just fed but, unless I misread, NY state (& city?)? taxes. “Smash and grab” isn’t usually the best or most tax-efficient approach. OP can simply do a 1035 to Fidelity to escape the onerous fee structure of his current annuity, and then take his time figuring out what to do next. But absent compelling arguments based on OP’s personal situation to the contrary, my advice on what to do next would be to keep the VA corpus in place, avoid current tax entirely, and let the corpus grow tax-deferred indefinitely

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Re: Inherited Annuity question(s)

Post by malujerry » Wed Sep 11, 2019 7:47 am

Thank you all again for these great responses. Just to clear up the financial situation further, yes I file jointly/married and no city taxes, just federal and state on $400k W2, an extra $50-$100k in 1099 as a PC.

I haven’t considered the option to withdraw the money and reinvest without the cover of an annuity. Since I’m 37 I wonder if the savings of doing it that way, paying the taxes, will be beneficial in the long run versus switching to a VA with the lowest cost/fee possible.

If I did stay within an annuity, I would like just take the minimum payments and apply it to the mortgage principal and try to allow the annuity grow as long as possible.

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Re: Inherited Annuity question(s)

Post by Stinky » Wed Sep 11, 2019 8:34 am

malujerry wrote:
Wed Sep 11, 2019 7:47 am
Thank you all again for these great responses. Just to clear up the financial situation further, yes I file jointly/married and no city taxes, just federal and state on $400k W2, an extra $50-$100k in 1099 as a PC.

I haven’t considered the option to withdraw the money and reinvest without the cover of an annuity. Since I’m 37 I wonder if the savings of doing it that way, paying the taxes, will be beneficial in the long run versus switching to a VA with the lowest cost/fee possible.

If I did stay within an annuity, I would like just take the minimum payments and apply it to the mortgage principal and try to allow the annuity grow as long as possible.
In order to determine what makes the most sense for you, you'll need to do some calculations to see how you minimize your tax and expense hits.

Scenario 1 - you roll the annuity to a the lowest cost provider, take minimum payments, apply to mortgage principal
Scenario 2 - you withdraw all funds from the annuity relatively quickly, and apply to mortgage principal and your overall investment program

While it may seem unattractive to close the annuity soon and pay large taxes now (Scenario 2), there are two drags on Scenario 1 that you should factor into your calculation. First is the expenses ratio (mortality and expense, fund management, etc.) compared to what you could get in mutual funds. Second is the fact that all of the income on your investments within the annuity will ultimately come out as ordinary income for tax purposes, rather than at the preferential tax rates allowed for qualified dividends and capital gains. These two factors eat away at any perceived advantage of the annuity over time.

You need to do a spreadsheet to fully model this out. Scenario 1 may end up being more attractive to you, but you can't definitely know that without modeling it out because of expenses and less-favorable tax treatment.
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Re: Inherited Annuity question(s)

Post by malujerry » Thu Sep 12, 2019 12:27 pm

Thanks again everyone.

I contacted Fidelity, unfortunately they do not offer a 1035 exchange for a non-spousal but Vanguard still does for now with 19 funds in the 0.4-0.6ish% range. Is there a downside of not having a single financial advisor? Or in other words, is there something positive I’m really giving up by being “cheaper”?

So basically now I have to sit down and do the math between:

1) cashing out, paying taxes, reinvesting that amount entirely with lower overall fees

2) cashing out, paying taxes, pay off mortgage, invest any remainder

3) 1035 exchange to Vanguard

Sound right?

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Re: Inherited Annuity question(s)

Post by Stinky » Thu Sep 12, 2019 12:39 pm

malujerry wrote:
Thu Sep 12, 2019 12:27 pm
Is there a downside of not having a single financial advisor?

.........

So basically now I have to sit down and do the math between:

1) cashing out, paying taxes, reinvesting that amount entirely with lower overall fees

2) cashing out, paying taxes, pay off mortgage, invest any remainder

3) 1035 exchange to Vanguard

Sound right?
While many Bogleheads just have one investment provider, that's certainly not a requirement. I personally have money with both Vanguard and Fidelity, with good reasons for being with each firm. My suggestion is to simplify your financial relationships as much as possible, but not at the expense of paying significantly higher expenses than necessary.

........

On your comparison - I'd focus primarily on your options 1 (surrender annuity and reinvest) and 3 (roll annuity to Vanguard). Those are "apples to apples" situations, where you're remaining fully invested. I don't know which option will look better.

Then, if you decide to surrender the annuity, then you can decide separately on whether to reinvest (option 1) or pay down mortgage (option 2). To the extent that your investments earn more than your mortgage interest rate, reinvesting the entire proceeds should look better financially. However, there can be considerable psychic benefit in paying down your mortgage, and only you can decide what feels best to you.
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Re: Inherited Annuity question(s)

Post by FoolStreet » Thu Sep 12, 2019 9:33 pm

malujerry wrote:
Thu Sep 12, 2019 12:27 pm
Thanks again everyone.

I contacted Fidelity, unfortunately they do not offer a 1035 exchange for a non-spousal but Vanguard still does for now with 19 funds in the 0.4-0.6ish% range. Is there a downside of not having a single financial advisor? Or in other words, is there something positive I’m really giving up by being “cheaper”?

So basically now I have to sit down and do the math between:

1) cashing out, paying taxes, reinvesting that amount entirely with lower overall fees

2) cashing out, paying taxes, pay off mortgage, invest any remainder

3) 1035 exchange to Vanguard

Sound right?
Implied in #3 is modeling the eventual cash out also. 1&2 have gains at cap gains rates, 3 is ordinary income.

98% of us think that using a financial advisor is more difficult and painful. We enjoy making and earning money and find that advisors get in the way of that. How many financial advisors have recommended A mega backdoor Roth or using I bonds? How many advisors recommend low cost index funds. These don’t make money for the advisor.

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Re: Inherited Annuity question(s)

Post by malujerry » Fri Sep 13, 2019 12:47 pm

Ok, I did some math, am I doing this correctly?

First scenario - take $750k with cost basis of $461k out of the inherited NQ VA, pay taxes, reinvest.

1) $750k minus $461k leaves $289k to be taxed at 43.85% (37% fed + ny 6.85% of $400k plus the taxable VA) which leaves $162k. So the $461k plus the $162k provides $623k to grow. I picked 4% at 34 years (until I hit age 70) which gives 2.3 million. Over 46 years (RMD run out of money date for 4% if I elected to keep in annuity) is 3.7 million.

Second scenario - do a 1035 exchange into Vanguard, grow at 3.5% (4% minus fees of 0.5%) and continue RMD (which I have to do starting immediately)

2) $750k at 3.5% net, I’ll have taken out $730k in RMD by age 70 (34 years later) , and by age 83 (46 years later) I’ll have taken 1.7 million. That annual payment I guess I would pay off the mortgage or reinvest again.

Does this seem right? It seems it’s better if I take out the money and reinvest in scenario one?

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Re: Inherited Annuity question(s)

Post by Stinky » Fri Sep 13, 2019 1:33 pm

malujerry wrote:
Fri Sep 13, 2019 12:47 pm
Ok, I did some math, am I doing this correctly?

First scenario - take $750k with cost basis of $461k out of the inherited NQ VA, pay taxes, reinvest.

1) $750k minus $461k leaves $289k to be taxed at 43.85% (37% fed + ny 6.85% of $400k plus the taxable VA) which leaves $162k. So the $461k plus the $162k provides $623k to grow. I picked 4% at 34 years (until I hit age 70) which gives 2.3 million. Over 46 years (RMD run out of money date for 4% if I elected to keep in annuity) is 3.7 million.

Second scenario - do a 1035 exchange into Vanguard, grow at 3.5% (4% minus fees of 0.5%) and continue RMD (which I have to do starting immediately)

2) $750k at 3.5% net, I’ll have taken out $730k in RMD by age 70 (34 years later) , and by age 83 (46 years later) I’ll have taken 1.7 million. That annual payment I guess I would pay off the mortgage or reinvest again.

Does this seem right? It seems it’s better if I take out the money and reinvest in scenario one?
A simple question - if the VA is non-qualified, why are you assuming RMDs are necessary?

There’s probably a simple answer, but I don’t understand that.
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Re: Inherited Annuity question(s)

Post by malujerry » Fri Sep 13, 2019 1:41 pm

I was told since it already started in distribution mode for my mom, it must stay in RMD according to my life expectancy (even if it passes to my wife or child) and I cannot add to it. This seems the same info no matter what company I received a quote from.

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