What to do with my parents' variable annuity?

[leed68]

Good evening. I wanted to run this by folks who've had experience with these products and know which way is up.

My folks are retired and asked me to take a look at this prudential variable annuity that they purchased 10 years ago with post-tax dollars. I was surprised that they have this product, considering that they don't quite understand it other than the fact that it's a vehicle where they've elected to park their money and have it grow tax-free with a guaranteed annual return of 6 percent - it's not quite that having read the contract: the lifetime income basis (not the principal) will contractually grow by 6% annually until the first withdrawal (to date, they haven't touched this). At this point in time, they've had for over a decade and will not incur any surrender charges if they elect a lump-sum payout. Currently, the account value is ~$500k and the lifetime income basis is $600k. As an alternative to a lump-sum payout, they can elect to tap into the annuity and receive a $30k payout annually (5% of $600k).

My mom doesn't like the fees and has noticed that the market has been fairly robust the past two years.

For context, my folks are in their late 70s and are in great shape financially: they own their house and have no major expenses, and their current income (pension, IRA withdrawals) is more than enough to fund their wants/needs.

Given some of the other threads/comments on the forum, I'm thinking there are three options looking forward.

1) Let it ride: they don't need the income and they're not incurring any taxes on the investment, but the fees are high - this alone makes me want to suggest that they move on

2) Turn on the income stream ($30k annually) and park this in a low-fee balanced fund of sorts

3) Take the lump-sump, pay taxes on the gains, and re-invest the resources and/or encourage them to enjoy it in some fashion.

I'd appreciate any thoughts or considerations that you might think of when evaluating this situation.

Thank you.

[David Jay]

Welcome to the forum!

What is their basis (how much did they invest originally)? This will determine the taxes due and a schedule for withdrawal if they choose to go that route.

A quick check at immediateannuities.com shows that a joint life SPIA for a 78 year old couple is $36,000 a year for a 500K contract so the VA annuitizing formula ($30,000 a year with a “600K” income basis) is, to put it gently, nothing to write home about.

If they do not expect to use these funds and expect the asset to go to heirs then They should get the money out as early as makes sense from a tax standpoint. All gains inside the annuity are taxable as regular income (not even capital gains rates) including by any heirs. Gains in mutual funds outside of the annuity (in a regular old brokerage account) get capital gains rates for qualified dividends and a step-up basis at time of inheritance. So it is much better to grow the assets outside the annuity than inside the annuity.

[TierArtz]

Get out of it. I helped my widower father exit several smaller annuities by 1035 transfer to Vanguard (now fully TransAmerica) for the sake of simplicity and lower fees, and embarked on a three year surrender plan to keep him from entering the 22% tax bracket (a partial surrender above the basis is taxable income). Each partial surrender is used to purchase shares of a mutual fund. As previously mentioned, mutual funds offer a stepped-up basis (under current law) and the gains from an annuity do not - gains would be taxed at the beneficiaries' marginal rate. By the end of January we should be rid of the darn thing

[softwaregeek]

I’ve heard a radio call in show call whole life insurance they payday loan of the middle class. Variable annuities are the payday loan of the upper middle class.

[venkman]

They have a VA with an income rider. Income riders can be useful if you plan to use them for lifetime income (generally, you can draw out a certain guaranteed amount every year for life, even if the account value drops to zero). But the added fees come out of the accumulation value (the amount you can withdraw as a lump sum); so income riders are usually a bad deal unless you're sure you plan to use them.

A couple in their late 70's can buy a joint-life annuity paying $30k a year for about $500k, so activating the income rider to get the same $30k isn't a particularly compelling option. If the taxes aren't going to be prohibitive, it probably makes sense to just take the lump sum. If the taxes would be a problem, they can opt for a period certain annuity, to get the lump sum spread out over a number of years. If Prudential won't do it, they can do a 1035 exchange to a company that will.

[Stinky]

Welcome to the Forum! Glad that you posted your question.

My mom doesn't like the fees and has noticed that the market has been fairly robust the past two years.

Your mother is pretty smart, and has hit on a primary reason for doing something with this turkey of a product. Between base policy fees, rider fees, and fees on underlying mutual funds, they are paying maybe 3% or so per year in fees. That is really impairing their return compared to investing in a taxable account.

Given some of the other threads/comments on the forum, I'm thinking there are three options looking forward.

1) Let it ride: they don't need the income and they're not incurring any taxes on the investment, but the fees are high - this alone makes me want to suggest that they move on

2) Turn on the income stream ($30k annually) and park this in a low-fee balanced fund of sorts

3) Take the lump-sump, pay taxes on the gains, and re-invest the resources and/or encourage them to enjoy it in some fashion.

You've outlined the options well. I'd pick Option #3. As David Jay mentioned above, they can determine their taxable income if they know their "basis" in the contract.

I'd do this sooner instead of later, as the excess fees continue to pile up ($1,250 per month if the account value is $500k and the excess annual fee is 3%).

I’ve heard a radio call in show call whole life insurance they payday loan of the middle class. Variable annuities are the payday loan of the upper middle class.

This is a really good line. I'll file it away for future use.

[leed68]

Thank you all for taking time to reply. I appreciate it.

FWIW, my folks are in the 24% tax bracket and they're looking at roughly ~$200k in gains.

Letting things ride is clearly a bad choice, so it seems like a primary consideration at this point are taxes liabilities and how to schedule withdrawals. The one thing I did pick up on from the comments was the idea of doing a partial withdrawal/1035 exchange over time so as to avoid a step up into a higher tax bracket. I'll have to investigate. If you have any thoughts on considerations to make, please weigh in.

Thanks again.

[Stinky]

Thank you all for taking time to reply. I appreciate it.

FWIW, my folks are in the 24% tax bracket and they're looking at roughly ~$200k in gains.

Letting things ride is clearly a bad choice, so it seems like a primary consideration at this point are taxes liabilities and how to schedule withdrawals. The one thing I did pick up on from the comments was the idea of doing a partial withdrawal/1035 exchange over time so as to avoid a step up into a higher tax bracket. I'll have to investigate. If you have any thoughts on considerations to make, please weigh in.

Thanks again.

Here’s a couple of options for you to push the tax hit out over several years -

1. You could pull money out of the VA over time. For tax purposes, earnings are presumed to be pulled out first. So they could pull out, say, $100k this year, all of which should be taxable, and the remainder of the policy next year, for another $100k of taxable income (assuming no growth in the VA this year).

This may be not optimal, because they will be in the VA for another year. The $400k remaining after this year’s withdrawal will cost them $12k in excess costs at a 3% rate.

2. Do a 1035 exchange of the VA into multiple multi year guaranteed annuities (MYGAs). Buy the MYGAs so that they will mature in multiple future years.

Following is a link that says that one annuity can be 1035ed into multiple annuities. I do not know how the tax basis would be carried over to the MYGAs, but I would think it’s proportional.
https://www.annuity.org/annuities/1035- ... -exchanges

Under this scheme, they will owe taxes when each MYGA matures. So they could buy (for example) a ladder of MYGAs from 2 years to 7 years and spread the taxes over 2023-2028. Further, they could do a further 1035 when each MYGA matures.

To learn more about MYGAs, check out the wiki article. Also search for “MYGA” on be Forum, as there have been several recent threads on the topic.

I suggest blueprintincome.com to see a large selection of MYGA providers. I have bought from them, and they’re good folks.

You could presumably do a 1035 into any type of annuity. But a MYGA may be best for them.

Post back if you have questions.

[leed68]

Stinky, you are the man. Appreciate the quick reply and suggested considerations. Thank you.

[Stinky]

Stinky, you are the man. Appreciate the quick reply and suggested considerations. Thank you.

Let us know what they decide to do, and if you have any more questions.

Best of luck to you.

[softwaregeek]

The MYGA seems like a good option. But not all states give the same guarantee