I rolled over my 401(k) to two variable annuity IRAs; are the total proceeds taxable as they are withdrawn or is the cost of the annuity tax free?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?
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 As such, all funds in the annuities, both the original investments and any growth, will be taxable when withdrawn.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.
my advice to you would be not to cash the annuities in once they are out of surrender. You could do a 1035 exchange from your existing annuity into another variable annuity with no surrender period once the five years is up and not have the giant tax burden. All of the money in the IRA's would be fully taxable. If they are Roth IRAs then the money would likely not be taxable. Another option would be to roll the annuities over into an IRA account that is actively managed and 100% liquid. I would be happy to review this and any other retirement or income scenario with you via Skype or zoom meeting at no charge no obligation. I believe you can schedule a time with me through investopedia below.
Reading your question, I’m not sure if both annuities are qualified or non-qualified. Qualified means you transferred an IRA/401k to the annuity; non-qualified means you transferred a taxable account to the annuity. As you can see, depending on where the original sources were, the tax treatment can be very different.
In the case of a qualified account, if you “cash out” in five years, you will pay the tax on the entire amount, which could potentially put you in the highest tax bracket. In addition, if you have any income riders that associated with the annuity, you lose them all when you cash out. You can’t deduct any loss or fees associated with annuity.
If you used the regular investment account to fund the annuities, you still have to pay tax but not on the entire amount. You only pay the tax on the earning portion of it.
As for the death benefit, you need to read your annuity contract to find out what kind of death benefit you have, either the original premium amount, account balance, or an enhanced death benefit. At my firm, we offer a free annuity review to give you the pros and cons of what you have. If you have a really good one, we will let you know upfront that we can’t beat what you have, and you need to keep it. Or, we can offer you one or two alternatives to show what a better option you could have given the goals and current condition you have. So, you do have options. Please feel free to reach out for a second opinion. Best!
Yes, mercifully, the cost of a variable annuity inside an IRA is tax-free. Still, the expense of a VA is steep. Your plan to redeem the annuities and roll over the proceeds to an IRA brokerage account is a good one. Also, an IRA rollover is not a taxable transaction.