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I rolled over my 401(k) to two variable annuity IRAs; are the total proceeds taxable as they are withdrawn or is the cost of the annuity tax free?

I am retired. As of Dec 31, 2018, my annuity's values were $255,000 and $162,000, respectively. I will start RMD withdrawals this year. Both annuities still have five years surrender fees attached. My plan is to only take the RMDs for the next five years and cash the annuities in and open an investment account. At that time, will the full amount be taxable or can I deduct the cost of the annuity? The reason I want to cancel the annuities is that I have to start taking regular payments at age 80 and I am not sure the death benefit will apply after that. I want my family to have whatever is left, if anything. At this point my pension, Social Security, and my remaining balance in my 401(k) should be enough for me to live off. Is the tax impact worth dissolving the annuities?

Financial Planning, Retirement, Pensions, Social Security, 401(k)
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April 2019

Because all the funds in the annuities were pre-tax, coming from your 401(k), and rolled into annuity IRAs, they remain pre-tax. As such, all funds in the annuities, both the original investments and any growth, will be taxable when withdrawn. However, there may be a way to deal with the annuities more efficiently than what you are thinking.

First, let's try to avoid paying surrender charges. There is a provision that allows you to take all IRA RMDs, to which you are subject, from any IRA you may have. That means that an RMD for one IRA need not be taken from that particular IRA, but may be taken from another IRA if you wish. This provision does not extend to RMDs from a 401(k). Therefore, I would suggest that you first roll over your 401(k) to a third IRA. Then you will be able to take all the RMDs, for both annuity IRAs and the new IRA, all from the new IRA. Hopefully, there will be sufficient funds in the new IRA to cover all RMDs for the next five years. If not, however long it lasts will have saved you something in surrender charges.

Next, contact the company that issued these annuities and get some clarification. Annuity contracts are complex and vary greatly. First clarify if you are required to begin taking payments at age 80 or if that is simply an option you will have. Also, you still have the RMDs on these annuity IRAs and I'm not sure how much beyond the surrender period you may be able to continue to take all RMDs from the new IRA. So you also want to clarify what the payout will be if you began to take withdrawals beginning in five years. And you want to verify if the death benefit applies, and how it may be reduced, once withdrawals begin. If you still want to cash out the annuities at that time, with no surrender charges, then simply transfer the annuity IRA money to your non-annuity IRA and it will continue to be pre-tax and not subject to taxation until withdrawn from the IRA.

At any time, any RMDs that are in excess of what you need for living expenses may simply be reinvested in a non-retirement account and left to your heirs. Any money remaining in the IRA will also pass to your designated beneficiaries.

I hope this helps and I wish you well.

April 2019
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