Annuity Penalty Question

[SirLurkAlot]

I have a non-qualified "Flexible Premium Deferred Annuity Policy" originally purchased through Hawkeye National Life but now with Jackson National Life. It has matured but has a guaranteed interest rate of 5% even on new money contributed.

We were told when it was sold to us that this type of annuity is not subject to the 10% early withdrawal penalty for age prior to 59 1/2. We have spoken to Jackson Life three times now and each time they have told us that it is NOT subject to the penalty.

However, our financial advisor insists that it IS subject to the 10% penalty. I tend to believe our advisor because she is very knowledgeable. Appreciate expert input! Thanks!

 

[Tahoe Ray]

I have a non-qualified "Flexible Premium Deferred Annuity Policy" originally purchased through Hawkeye National Life but now with Jackson National Life. It has matured but has a guaranteed interest rate of 5% even on new money contributed.

We were told when it was sold to us that this type of annuity is not subject to the 10% early withdrawal penalty for age prior to 59 1/2. We have spoken to Jackson Life three times now and each time they have told us that it is NOT subject to the penalty.

However, our financial advisor insists that it IS subject to the 10% penalty. I tend to believe our advisor because she is very knowledgeable. Appreciate expert input! Thanks!

I would side with your advisor on this one...the only thing that I can think of is your basis is higher than your current value (for instance, you moved a variable annuity that had significant losses into this product) and Jackson has that information whereas your advisor does not.

Otherwise, I don't know why Jackson would say that...

 

[scagnt83]

I cant think of why it would not be other than what Ray mentioned.... unless you are over 59.5 and they are just saying you are no longer subject to that penalty...

Did you actually ask them why?? There is a reason behind it if it is really not subject to it. Always ask why in situation like this.

 

[DHK]

You've been very clear in your post... but could it be that they are confusing penalty with surrender charge?

The only way I know of to avoid the 10% penalty on a NQDA... is to take 72q distributions for 5 years or until age 59 1/2... whichever is longer. There is a specific formula for it, and your advisor will know how to calculate it, and if it would make sense for your situation.

I have also searched for other ways to avoid the 10% penalty for NQDA, but I'm not sure if there's even any IRS Hardship provisions to avoid the penalty.

If anyone has a government resource that answers that question, I'd appreciate it. So far, I haven't found anything.

 

[scagnt83]

You've been very clear in your post... but could it be that they are confusing penalty with surrender charge?

This is a very likely scenario. Some companies call them surrender penalties, not surrender charges.

I would specifically say the "IRS pre 59.5 distribution penalty".

 

[SirLurkAlot]

Thanks so much for the answers! My limited knowledge had me agreeing with the advisor which is why I have called Jackson three times and asked the question every way possible so thanks for confirming as you helped us avoid a $20k mistake.

Follow-up question: I am getting ready to close on the sale of my home and want to put $200k into an account I can access sometime within the next 12 month when we decide to purchase our next home. Thus my reason for wanting to put it in the 5% annuity. It has been suggested that a CD would be the most logical but obviously wouldn't pay squat in interest. Any other suggestions on something that would be a better option?

 

[DHK]

For NQDA, gains are withdrawn first. It's 'LIFO' - last in, first out. The last thing in it, will be the interest credited... and it will be taxable upon withdrawal... as well as a 10% penalty on those gains.

This is for disclosure purposes, not that it would necessarily be a big deal.

So, let's work out some hypothetical numbers:

$200k (plus your current balance) + 5% = $10,000 interest.

When you withdraw $210,000..., this will include $10,000 taxable interest + $200,000 basis (just to keep the math simple) + 10% penalty on the growth ($1,000).

$10,000 taxable at your top tax bracket. Will that be a big deal? You'd have to talk with your tax advisor &/or financial advisor to determine how it may affect your taxes for the current year.

But let's assume you're in the 25% tax bracket: 25% of $10,000 = $2,500. You'll NET $6,500 in growth ($7,500 - $1000 penalty).

$6,500 net gain / $200,000 balance = 3.25% net return.

If you're in the top tax bracket (39%): 39% of $10,000 = $3,900. You'll NET $5,100 in growth ($6,100 - $1,000 penalty).

$5,100 net gain / $200,000 balance = 2.55% net return.


In short, it depends on your tax situation... and if you'll be turning 59 1/2 next year.

Still better than any CD.


IMPORTANT EDIT: Make sure that new contributions are not subject to a new surrender charge period. If so... that'll make a big difference in your returns, and then I would NOT recommend that course of action.

 

[scagnt83]

If anyone has a government resource that answers that question, I'd appreciate it. So far, I haven't found anything.

Section 72 (q) (2) of the tax code is your answer.



Paragraph 1 shall not apply to any distribution—

(A) made on or after the date on which the taxpayer attains age 59 1⁄2,

(B) made on or after the death of the holder (or, where the holder is not an individual, the death of the primary annuitant (as defined in subsection (s)(6)(B))),

(C)
attributable to the taxpayer’s becoming disabled within the meaning of subsection (m)(7),

(D)
which is a part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the taxpayer or the joint lives (or joint life expectancies) of such taxpayer and his designated beneficiary,

(E)
from a plan, contract, account, trust, or annuity described in subsection (e)(5)(D),

(F) allocable to investment in the contract before August 14, 1982

(G) under a qualified funding asset (within the meaning of section 130(d), but without regard to whether there is a qualified assignment),

(H)
to which subsection (t) applies (without regard to paragraph (2) thereof),

(I)
under an immediate annuity contract (within the meaning of section 72(u)(4)), or

(J)
which is purchased by an employer upon the termination of a plan described in

section
401(a) or 403(a) and which is held by the employer until such time as the employee
separates from service.


The only hope is that it was bought before 8/14/1982. Then it would not be subject to it.
(the disability exception is related to employer plans)

 

[DHK]

I wouldn't dare put it in any kind of securities... except possibly a money market fund.

 

[Tahoe Ray]

Thanks so much for the answers! My limited knowledge had me agreeing with the advisor which is why I have called Jackson three times and asked the question every way possible so thanks for confirming as you helped us avoid a $20k mistake.

Follow-up question: I am getting ready to close on the sale of my home and want to put $200k into an account I can access sometime within the next 12 month when we decide to purchase our next home. Thus my reason for wanting to put it in the 5% annuity. It has been suggested that a CD would be the most logical but obviously wouldn't pay squat in interest. Any other suggestions on something that would be a better option?

The CD is likely your best bet with that time horizon. You might be able to get a better rate from an online bank (they are still FDIC insured) than your local Wells, BOA, Citi, Chase, etc. Shop around.