Tax Implications of 1035's, SC's and WD's

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I have a prospect that has a older NON QUALIFIED fixed annuity with a 10yr SC. They are currently in year 7. The MVA has positively affected the SC by lowering it significantly, however due to the size of the contract the remaining SC cannot be ignored.

The owner is under 59 1/2, disabled and is considering an exchange because the interest credited has been declining every year since he passed his guarantee period. He is also very interested in guaranteed lifetime income benefits. He plans to use the annuity for income purposes but does not want to lose control of the principle (this, his age and current IR environment rule out immediate annuities). He has no proclivity for leaving anything to his heirs who are successful themselves. I was brought in as a second opinion to his first recommendation.

The prospect does not want to lose any money from any exchange and was shown a bonus product by another agent who suggested they exchange the entire contract.

The client will need to take $20k from the contract by Jan to pay for an expense for an adult child.

After rigorous fact finding and planning analysis, I am considering the following recommendation as I believe this is in the best interest of the client and fits appropriately with his goals and income requirements:

A) Exchange part of the contract into a new bonus fixed annuity with a GLWB and begin income in 10 years.
B) Exchange part of the contract into a new bonus fixed annuity with a GLWB and begin income in 5 years.
C) Leave a portion in the existing contract sufficient to pay for the known expenses and extra for emergencies (Approximately 18 months of expenses to remain + 20k)

The current basis in the contract represents approximately 75% of the entire contract value (25% is gain).

My question is regarding my understanding of the tax consequences:

A) The SC captured in both exchanges will result in taxable events for each exchange.
B) The SC captured in both exchanges AND ANY FUTURE WITHDRAWALS FROM THE REMAINING CONTRACT WITHIN 6 MONTHS OF THE EXCHANGE will be aggregated with respect to the total gain of the original contract.
C) The bonus attributed to the exchanged products will be considered GAIN.

Is my understanding correct, and if so does anyone see any other issues that I may have missed or should consider?

Thank you!

 

[jmhalvo]

I have a prospect that has a older NON QUALIFIED fixed annuity with a 10yr SC. They are currently in year 7. The MVA has positively affected the SC by lowering it significantly, however due to the size of the contract the remaining SC cannot be ignored. The owner is under 59 1/2, disabled and is considering an exchange because the interest credited has been declining every year since he passed his guarantee period. He is also very interested in guaranteed lifetime income benefits. He plans to use the annuity for income purposes but does not want to lose control of the principle (this, his age and current IR environment rule out immediate annuities). He has no proclivity for leaving anything to his heirs who are successful themselves. I was brought in as a second opinion to his first recommendation. The prospect does not want to lose any money from any exchange and was shown a bonus product by another agent who suggested they exchange the entire contract. The client will need to take $20k from the contract by Jan to pay for an expense for an adult child. After rigorous fact finding and planning analysis, I am considering the following recommendation as I believe this is in the best interest of the client and fits appropriately with his goals and income requirements: A) Exchange part of the contract into a new bonus fixed annuity with a GLWB and begin income in 10 years. B) Exchange part of the contract into a new bonus fixed annuity with a GLWB and begin income in 5 years. C) Leave a portion in the existing contract sufficient to pay for the known expenses and extra for emergencies (Approximately 18 months of expenses to remain + 20k) The current basis in the contract represents approximately 75% of the entire contract value (25% is gain). My question is regarding my understanding of the tax consequences: A) The SC captured in both exchanges will result in taxable events for each exchange. B) The SC captured in both exchanges AND ANY FUTURE WITHDRAWALS FROM THE REMAINING CONTRACT WITHIN 6 MONTHS OF THE EXCHANGE will be aggregated with respect to the total gain of the original contract. C) The bonus attributed to the exchanged products will be considered GAIN. Is my understanding correct, and if so does anyone see any other issues that I may have missed or should consider? Thank you!

of course his credited rate keeps declining - we are bottoming out. I know what I would do: wait.

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of course his credited rate keeps declining - we are bottoming out. I know what I would do: wait for SC to be gone or almost gone

 

[golfnut]

The surrender charges are not taxable events, just a reduction of the funds that are 1035 exchanged. NQ annuity withdraws are always gain first, basis second. Bonus is just earned interest, so it was last in money, first out gain plus future earned interest. There will not be a 10% penalty on withdraws since the Client is disabled, which is a hardship provision in the tax code for NQ annuities. I would question whether the existing carrier will allow multiple 1035 exchanges. It appears from your post that you may not fully understand then rules regarding NQ annuities, so do some research and ask the potential and existing carriers questions, they can tell you the cost basis, 1035 exchange options, whether you can do multiple 1035 exchanges, etc. Keep case notes to protect your future if you proceed with this case.

 

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of course his credited rate keeps declining - we are bottoming out. I know what I would do: wait.

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of course his credited rate keeps declining - we are bottoming out. I know what I would do: wait for SC to be gone or almost gone

Thanks, my first suggestion was to wait until the SC was gone, but the prospect wants to make a move this year while the MVA has compressed his SC down between 1-2%

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The surrender charges are not taxable events, just a reduction of the funds that are 1035 exchanged. NQ annuity withdraws are always gain first, basis second. Bonus is just earned interest, so it was last in money, first out gain plus future earned interest. There will not be a 10% penalty on withdraws since the Client is disabled, which is a hardship provision in the tax code for NQ annuities. I would question whether the existing carrier will allow multiple 1035 exchanges. It appears from your post that you may not fully understand then rules regarding NQ annuities, so do some research and ask the potential and existing carriers questions, they can tell you the cost basis, 1035 exchange options, whether you can do multiple 1035 exchanges, etc. Keep case notes to protect your future if you proceed with this case.

Thanks you. I was definitely confused regarding the tax treatment of SC's. In 6 years in the business I have never 1035'd a product with a SC (it was seriously frowned on by my old B/D). I checked with the existing carrier already and multiple 1035s are allowed from that particular contract. I also spoke with a advanced markets division of a larger carrier and they confirmed that there will be no taxable distribution via 1035 with a SC. Thanks for your response!

 

[SWM]

You mentioned disability. Call the carrier as many waive surrender charges due to full disability.