Should I exchange my acquired funds or annuitize?
My advisor told me to purchase a NQ Variable Annuity in 2008 for $100,000. They recently moved all my finances, except for the annuity, to "fee only" due to high fees. Nine years after the purchase, it has reached $135,000. I am retired and need money. My new advisor says to take $4,000 a month from the annuity. I am in the 25% tax bracket so it will cost $1,000 each time I withdraw. I am feeling crazy and confused. I read about annuitizing, but I am not sure if I get it. The surrender period is on June 2018. The surrender fee is around $2,000. I am 62 years old and they want me to wait until I'm 65 years old. In those three years, I will have paid them about $1,500 in fees (that I'm aware of). Maybe I should get a home equity loan? I have lots of remodeling and repairs going on right now!
You have a lot going on and I can't answer all of your questions, but I wanted to address your calculation on the taxes you'd owe monthly on the annuity payout. If it's a non-qualified annuity (meaning you didn't purchase it with IRA or 401(k) money), you only owe taxes on the profit the account has made, or the $35,000. Generally, the distributions are taxed on a pro-rata basis. For example, you have made 35% on the investment, so only 35% of the $4,000 contribution would be considerd taxable. So that's $1,400 profit taxed at 25% would be $350 owed in taxes for each $4,000 withdrawal. So, not so bad as you thought.
You would want to verify this with at CPA (I am NOT one).
Hope that helps!
Interesting situation and it makes sense for you to do your homework before taking your advisors guidance outright.
First, I want to preface my comment by saying that there are some additional details needed to give a wholly definitive answer, such as: annuity features/riders, income need/desire, asset allocation, other assets available for withdrawal, other income sources (i.e. pension, have you already elected SS), etc.
Now, as to my comment. I'm going to assume, based off of the note from the new advisor on how much to withdraw, that your income need is at least $4k/mo., meaning you need about $48k+ for the year. So, with that being said, from what I see, I'd suggest you take out the max amount available to withdraw without a surrender charge (many annuities allow, for example, 10% to be withdrawn pre-surrender period ending without actually incurring a penalty) in early 2018. So if it's 10%, you could take $13k-$14k, which will cover your income need for the first few months of 2018. Supplement the next couple months of income need - until you are out of surrender - from your other assets. Then, in June, 2018 you liquidate the annuity. You'll have roughly $35k of Ordinary Income from the annuity - give or take gains/losses from now until then - plus possible taxable income from the distributions from your other assets or other income sources.
All told, NQ annuities are more often inappropriate than appropriate for most people due to tax inefficiency (gains are taxed as Ordinary Income instead of Capital Gains), inflexibility of withdrawals, and generally high fees.
Sorry to hear that you are confused about what you need to do with your money. It is really important that you feel comfortable and understand what your advisor is suggesting.
1) What is annuitizing?
Annuitizing is basically transforming your account into a pension. You give your asset away to the insurance company and it promises an amount of income for a period that you have chosen. It could be 5-10-20 years or a lifetime. Annuitizing your account would also help with taxes. Only a small portion of your gains would be included on the distribution which would help you spread your taxable income.
For about 20 years, insurance companies also sold policies with income benefits. For a fee, you can guarantee an amount of income for life. This benefit normally has a guaranteed growth feature until you turn it on.
In either cases, you can expect the lifetime income to be about 4.5-5% of your asset. Therefore, you would be able to get about $6,500/year for the rest of your life. If you would go with your current advisor's recommendation, you wouldn't annuitize nor use the income benefit. The account would more than likely be eventually drained. If you still decide to use it this way, I would recommend that you take the money out of the annuity to reduce cost. You would save the 2-3% fees that you are paying for benefits you won't be using.
About taxes, your first $35,000 out of your annuity (if not annuitized) will be gains and taxed at ordinary income. Once all gains are out of your account, the rest is plainly return of premiums and are not taxable.
If you need income and rest on equity from your home, you might want to take a look at a Home Equity line or a Reverse mortgage. You might be able to get the income you need while avoiding future payments. Reach out to a local expert for more information.
I hope this helps.
If you annuitize, you will lose control of your principal. While monthly payments may sound nice, you are only getting a portion back of what you are paying in. Once you are out of the surrender period, I would move your principal to an individual taxable account with a low-cost ETF portfolio so you can make withdrawals as needed without penalty. Leave what you can in the new individual account to help fight inflation and grow wealth until you need it again.
You may have several options for taking money out of an annuity.
- The first option is a full surrender where you take a lump sum withdrawal of the entire amount. You will be subject to ordinary income tax on your gain and any surrender penalty. This may not be the most tax efficient way to get income because it might push you up into a higher tax bracket by taking all the money out in one year.
- The second option for taking money out of an annuity is exchanging it to another annuity. This is known as a 1035 exchange. The benefit of this is that the transfer is tax free. You could potentially exchange to a new annuity that allows immediate income. However, you may restart a new surrender charge period that may last several years and still have surrender penalties on your original annuity as well.
- A third option would be taking smaller (perhaps monthly) withdrawals without actually annuitizing. These could be one time or systematic withdrawals. Usually annuity providers will allow you to take out money that is not subject to surrender penalties first. However, you will still owe ordinary income taxes on your gains.
- A fourth option is annuitizing. When you annuitize, you normally give up access to your funds in exchange for monthly withdrawals for life. The benefit of doing this is income that you cannot outlive (guaranteed by the insurance company’s ability to pay) which provides protection from longevity and over spending. However, with annuitizing, you will no longer have access to your principal. So if you need a lump sum for a home remodel, a big trip, or a medical bill, you will have to have liquid assets elsewhere. Another drawback of annuitizing is that often the monthly income stays the same which means less purchasing power over time due to inflation.
Really these decisions are best made in the context of a holistic financial plan that takes your entire financial picture into account.
Please be aware that withdrawals from an annuity before age 59 1/2 may be subject to a 10% IRS penalty.
Denton Olde, CFP®