Non-qualified variable annuity

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AmyandHernia
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Non-qualified variable annuity

Post by AmyandHernia »

My wife has an annuity (long story) from 2007. It is as described above, and started in 2007 with $300K. It’s current value is $495,415. Cash surrender value is $490,418. There is a GMIB rider with an annual increase percentage of 6% and a death benefit feature. She is now 36 years old so this was from a while ago that her parents set up. I am new to all of this annuity stuff but have been hearing really bad things about annuities. Is this something that we should be looking to get out of and take a tax hit now for growth later or just leave it be? If any other information is needed, I will try to answer that.
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Stinky
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Re: Non-qualified variable annuity

Post by Stinky »

AmyandHernia wrote: Sat Oct 16, 2021 10:01 am My wife has an annuity (long story) from 2007. It is as described above, and started in 2007 with $300K. It’s current value is $495,415. Cash surrender value is $490,418. There is a GMIB rider with an annual increase percentage of 6% and a death benefit feature. She is now 36 years old so this was from a while ago that her parents set up. I am new to all of this annuity stuff but have been hearing really bad things about annuities. Is this something that we should be looking to get out of and take a tax hit now for growth later or just leave it be? If any other information is needed, I will try to answer that.
You don't indicate what type of investments she has in the VA. But, presuming that the majority of the investments are in equities, she's getting a pretty raw deal.
--- She's probably paying about 3% or so in annual fees on the variable annuity. Roughly 1% each are probably going to the "mortality and expense" (or "administrative") charge, the rider cost for the GMIB, and the excess mutual fund fees over what she would pay at Vanguard/Fidelity/Schwab, etc.
--- Whatever gains after left after the 3% annual cost will be taxed at ordinary income rates, rather than the preferred rates available for qualified dividends and capital gains in a regular taxable account.
--- The annuity will not receive a step-up in basis at her death. Her beneficiary will end up paying the taxes on the accumulated gain.

It's probably going to be several decades until she can exercise the GMIB rider. Even though there ultimately might be some value in the rider, the potential value is far outweighed by the decades worth of 3% annual fees that she'll pay to get there.

I'd get out of the annuity as soon as is reasonably possible. It looks like she currently has a surrender value that is $190k greater than the basis, so if she surrendered today she would have $190k of taxable income (and $490k of cash with which to pay the taxes).

Alternatively, she could take the money out of the annuity over a few years to reduce the current tax bite if the full $190k would push you into a higher bracket. Annuity withdrawals are taxed "interest first". For example, if you were to take out $95k this year, and the remaining $400k or so next year, you would have roughly $95k of taxable income in each year. Just remember, every additional year that you leave money in the annuity is costing you that awful 3% fee.

A 1035 exchange into another annuity is a possibility, but not one that I would advise. She could go into either a low-cost VA like the Fidelity product, or a fixed annuity like a MYGA.

Please post back with questions.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
Robert20
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Re: Non-qualified variable annuity

Post by Robert20 »

AmyandHernia wrote: Sat Oct 16, 2021 10:01 am My wife has an annuity (long story) from 2007. It is as described above, and started in 2007 with $300K. It’s current value is $495,415. Cash surrender value is $490,418. There is a GMIB rider with an annual increase percentage of 6% and a death benefit feature. She is now 36 years old so this was from a while ago that her parents set up. I am new to all of this annuity stuff but have been hearing really bad things about annuities. Is this something that we should be looking to get out of and take a tax hit now for growth later or just leave it be? If any other information is needed, I will try to answer that.
vow. If you had invested 300K in VTI in 2007 it would have been 1.3M.
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David Jay
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Re: Non-qualified variable annuity

Post by David Jay »

Yes I agree, you will want to "unwind" this VA but do it in a cost-efficient manner.

For comparison, the growth of the annuity is 1.36%, whereas even a relatively conservative 60/40 portfolio would have grown at 5%. Over the next 3 decades the difference will be huge.
Last edited by David Jay on Sat Oct 16, 2021 7:00 pm, edited 1 time in total.
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Soon2BXProgrammer
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Re: Non-qualified variable annuity

Post by Soon2BXProgrammer »

Stinky wrote: Sat Oct 16, 2021 10:35 am A 1035 exchange into another annuity is a possibility, but not one that I would advise. She could go into either a low-cost VA like the Fidelity product, or a fixed annuity like a MYGA.

Please post back with questions.
I haven't done many 1035 exchanges.. Could one 1035 exchange it into say 7 MYGA's and (1,2,3,4,5,6,7) build a ladder of them? Then the person could treat it as their bond allocation. And if something horrible happened, they could access 1/7th of the money each year without penalty.
Earned 43 (and counting) credit hours of financial planning related education from a regionally accredited university, but I am not your advisor.
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Re: Non-qualified variable annuity

Post by David Jay »

Soon2BXProgrammer wrote: Sat Oct 16, 2021 6:54 pm
Stinky wrote: Sat Oct 16, 2021 10:35 am A 1035 exchange into another annuity is a possibility, but not one that I would advise. She could go into either a low-cost VA like the Fidelity product, or a fixed annuity like a MYGA.

Please post back with questions.
I haven't done many 1035 exchanges.. Could one 1035 exchange it into say 7 MYGA's and (1,2,3,4,5,6,7) build a ladder of them? Then the person could treat it as their bond allocation. And if something horrible happened, they could access 1/7th of the money each year without penalty.
Not before age 59.5 (and the OP is only 36)
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
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Stinky
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Re: Non-qualified variable annuity

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Soon2BXProgrammer wrote: Sat Oct 16, 2021 6:54 pm
Stinky wrote: Sat Oct 16, 2021 10:35 am A 1035 exchange into another annuity is a possibility, but not one that I would advise. She could go into either a low-cost VA like the Fidelity product, or a fixed annuity like a MYGA.

Please post back with questions.
I haven't done many 1035 exchanges.. Could one 1035 exchange it into say 7 MYGA's and (1,2,3,4,5,6,7) build a ladder of them? Then the person could treat it as their bond allocation. And if something horrible happened, they could access 1/7th of the money each year without penalty.
Yes, I believe that breaking it into multiple MYGAs through 1035 exchanges would work.

I believe that the basis and cumulative earnings would be allocated evenly across the new MYGAs, so it would spread that it the taxable income.

A couple of comments -
—- I’m not aware of any 1 year MYGA products, and the selection of 2 year products is pretty sparse.
—- OP says that his spouse is 36 years old. MYGAs are by definition fixed income investments. I don’t know if the spouse wants to have such a heavy allocation to fixed income at that age.
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Stinky
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Re: Non-qualified variable annuity

Post by Stinky »

One more thing I should have mentioned, which applies to either a straight surrender of the VA or a 1035 exchange into another product. On a taxable annuity, there is an additional 10% tax penalty for surrender before age 59.5. So on the $190k or so of gain, there would be an additional $19k of taxes if it were surrendered now.

Whoever put $300k into a high fee taxable annuity for a person age 21 was absolutely nuts. Or maybe that person was snookered by an shifty salesman, who may have made $25k or so on the sale. But, at this point, that’s all water under the bridge.

Take steps now to unwind this turkey!
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
Soon2BXProgrammer
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Re: Non-qualified variable annuity

Post by Soon2BXProgrammer »

David Jay wrote: Sat Oct 16, 2021 7:01 pm
Soon2BXProgrammer wrote: Sat Oct 16, 2021 6:54 pm
Stinky wrote: Sat Oct 16, 2021 10:35 am A 1035 exchange into another annuity is a possibility, but not one that I would advise. She could go into either a low-cost VA like the Fidelity product, or a fixed annuity like a MYGA.

Please post back with questions.
I haven't done many 1035 exchanges.. Could one 1035 exchange it into say 7 MYGA's and (1,2,3,4,5,6,7) build a ladder of them? Then the person could treat it as their bond allocation. And if something horrible happened, they could access 1/7th of the money each year without penalty.
Not before age 59.5 (and the OP is only 36)
is this a statement of fact?

random website: https://www.annuity.org/annuities/1035- ... %20annuity.

The IRS allows the exchange of multiple annuity contracts for a single contract, one contract for multiple contracts, and a portion of an annuity for an alternate annuity.
--edit i miss interpreted what you said... of course they would owe taxes on the contract (and penalties for pre 59.5)... i meant penalties for surrendering an annuity early. they could use the 1/7th to 1035 back into a VA if they needed to buy stocks was my line of thinking
Last edited by Soon2BXProgrammer on Sat Oct 16, 2021 8:36 pm, edited 4 times in total.
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Soon2BXProgrammer
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Re: Non-qualified variable annuity

Post by Soon2BXProgrammer »

Stinky wrote: Sat Oct 16, 2021 7:04 pm
Soon2BXProgrammer wrote: Sat Oct 16, 2021 6:54 pm
Stinky wrote: Sat Oct 16, 2021 10:35 am A 1035 exchange into another annuity is a possibility, but not one that I would advise. She could go into either a low-cost VA like the Fidelity product, or a fixed annuity like a MYGA.

Please post back with questions.
I haven't done many 1035 exchanges.. Could one 1035 exchange it into say 7 MYGA's and (1,2,3,4,5,6,7) build a ladder of them? Then the person could treat it as their bond allocation. And if something horrible happened, they could access 1/7th of the money each year without penalty.
Yes, I believe that breaking it into multiple MYGAs through 1035 exchanges would work.

I believe that the basis and cumulative earnings would be allocated evenly across the new MYGAs, so it would spread that it the taxable income.

A couple of comments -
—- I’m not aware of any 1 year MYGA products, and the selection of 2 year products is pretty sparse.
—- OP says that his spouse is 36 years old. MYGAs are by definition fixed income investments. I don’t know if the spouse wants to have such a heavy allocation to fixed income at that age.
completely fair. maybe not applicable to the OP. it was more of a hypothetical question, and of course product availability would limit options. etc. I was more thinking through what options might be available in general.
Earned 43 (and counting) credit hours of financial planning related education from a regionally accredited university, but I am not your advisor.
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David Jay
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Re: Non-qualified variable annuity

Post by David Jay »

Soon2BXProgrammer wrote: Sat Oct 16, 2021 8:28 pm…of course they would owe taxes on the contract (and penalties for pre 59.5)...
Yup, that’s what I was thinking
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
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AmyandHernia
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Re: Non-qualified variable annuity

Post by AmyandHernia »

Wow thanks for all of your responses. If it matters, we file jointly and are already in the highest tax bracket. I will look into more details of this annuity hopefully today and post them when I have a min. Thanks again for your helpful replies.
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Re: Non-qualified variable annuity

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AmyandHernia wrote: Sun Oct 17, 2021 6:17 am Wow thanks for all of your responses. If it matters, we file jointly and are already in the highest tax bracket. I will look into more details of this annuity hopefully today and post them when I have a min. Thanks again for your helpful replies.
If you're already in the highest tax bracket, and expect to be in the same bracket in 2022, then there's no tax reason to delay your surrender.

The only possible reason to delay is that you might be able to reduce the surrender penalty, which is currently about $5k (the difference between the account value and the surrender value). On most annuities, the surrender charge reduces each year on the policy anniversary.

But, if I'm correct and the annuity excess fees are 3% per year, your $400k annuity is costing you $12k per year in excess fees. So I would expedite the surrender process unless the next policy anniversary is imminent.
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AmyandHernia
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Re: Non-qualified variable annuity

Post by AmyandHernia »

So here are some more details of the annuity. I really do not understand this stuff so I apologize in advance and once again am very thankful for all of your help.

Holdings: Brighthouse Asset Allocation 80 Portfolio

Withdrawal charge went down to 0% after 8 years, and it has been 14 years since it was purchased.

It is saying we can currently withdraw $30-40K per year (Remaining Annual Free Withdrawal Amount). Does this mean we can take out this amount without any charges whatsoever? Penalty if before 59.5? Taxes? Capital gains?

Under Fees and Charges it says the following:
Admin Fee: 0%
Mortality and expense fee: 0%
Account fee: $30 (annually)
On October 9, 2021: Fees and charges were $5,426.17; the previous year it was around $5K and the year prior around $4.5K per year.

"GMIB Plus" Details:
Annual increase rate: 6%
Income base: $678,921.18
Last available exercise date: 10/9/2070
Withdrawal rate: 6%
Rider Charge: 0.80%
Guaranteed Principal Option End Election Date: 11/8/21
Annual Increase Amount: $678.271.19
Highest Anniversary Value: $493,667.04
Annual $4$ Withdrawal Amount: $40,696.27
Remaining annual withdrawal amount: same as above
Guaranteed principal option start election date: 10/10/21

Would be nice to maybe take out $40K per year until it's gone rather than take it all out in one chunk. Not sure!
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Re: Non-qualified variable annuity

Post by Stinky »

AmyandHernia wrote: Sun Oct 17, 2021 8:09 am So here are some more details of the annuity. I really do not understand this stuff so I apologize in advance and once again am very thankful for all of your help.
Don't worry about "not understanding this stuff". Very, very few people truly do understand it fully. I think that the complexity obfuscates the reality, which is to get you to pay fees that are hidden from you.

Holdings: Brighthouse Asset Allocation 80 Portfolio

Withdrawal charge went down to 0% after 8 years, and it has been 14 years since it was purchased.
That actually makes sense, since few variable annuities have surrender charges that go as long as 14 years. That being said, I don't understand why there is a $5k or so difference between the current account value and surrender value.

It is saying we can currently withdraw $30-40K per year (Remaining Annual Free Withdrawal Amount). Does this mean we can take out this amount without any charges whatsoever? Penalty if before 59.5? Taxes? Capital gains?
I suspect that the "Remaining Annual Free Withdrawal Amount" is a defined term in the contract, that relates to the GMIB.

The fact of the matter is that you could take out the full $490k surrender value right now without any charges or fees from the insurance company. However, that statement in no way mitigates the fact that you will owe income taxes, plus a 10% tax penalty if withdrawals happen before age 59.5, on any income withdrawn. As stated above, withdrawals from annuities are treated as income first, then basis, for the purposes of tax calculation.

One more item of yours to correct - there are no "capital gains" taxes on an annuity. All taxes on annuity earnings are based on ordinary income rates, not capital gains rates. That's one of the disadvantages of annuities in a taxable account - there is no preferential tax treatment of qualified dividends or capital gains as there would be if the investments were outside of an annuity.


Under Fees and Charges it says the following:
Admin Fee: 0%
Mortality and expense fee: 0%
Account fee: $30 (annually)
On October 9, 2021: Fees and charges were $5,426.17; the previous year it was around $5K and the year prior around $4.5K per year.

The good news is that the admin fees and M&E charges were zero.

But the bad news is that the charges on the GMIB rider were based on the "income base", rather than the account value. I did the math - 0.80% times $678,921 (from below) equals your $5,426 in charges.

Shifty, shifty, shifty. If the insurance company had been more upright, they would assess that GMIB charge against the account value. In my view, this is entirely underhanded.

And, this doesn't include an important charge that almost certainly exists on your contract. Look carefully at the funds that the account value is invested in. Dig around to find out the expense charges on those funds. I'll bet that the funds are running somewhere in the range of 0.75% to 1.25% annual expense ratios. Realize that you can get index funds at Vanguard/Fidelity/Schwab for less than 0.10% per year. This is a "hidden charge" to you which is costing you big bucks.

All in, I'm guessing that the rider and fund load charges are costing you 2.00% to 2.25% per year. Every year. From now to eternity.


"GMIB Plus" Details:
Annual increase rate: 6%
Income base: $678,921.18
Last available exercise date: 10/9/2070
Withdrawal rate: 6%
Rider Charge: 0.80%
Guaranteed Principal Option End Election Date: 11/8/21
Annual Increase Amount: $678.271.19
Highest Anniversary Value: $493,667.04
Annual $4$ Withdrawal Amount: $40,696.27
Remaining annual withdrawal amount: same as above
Guaranteed principal option start election date: 10/10/21
If your wife were older, there might be some value in this rider. But many riders like this can't be "elected" until the annuitant reaches a certain age, like 50.

If that's the case for your wife, then she would have 14 more years of paying high fees until she could even consider electing to take benefits under the rider. And I don't know if the benefits she would get at that time would be attractive.

Presuming a $490k current surrender value, it would grow to $1,108,000 in 14 years at a 6% compounded rate. But if she's paying 2.25% fees and therefore netting only 3.75% per year, her $490k will grow to only $820,000. That's almost $300,000 in excess fees that she will pay to get her to the place where she could elect the rider.


Would be nice to maybe take out $40K per year until it's gone rather than take it all out in one chunk. Not sure!
Hopefully all of the comments above will tell you that it's a really, really bad idea to keep this annuity. It's costing you over $10k per year in fees right now, and the fee drag will just increase as the annuity grows in value.

You said above that you're in the top marginal tax bracket. Presuming that you will still be in that bracket next year, I'd surrender the policy NOW.
It's costing you about $1,000 per month in fees. Stop the bleeding.
Comments embedded above.

Post back with questions. I hope that you get out of this turkey soon.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
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