Client Inherited Non-q Annuity from Mom-NEED HELP!

[rikwells]

I figured all you life guys would probably no the answer even though this is an annuity question.

I have a client who has a mom who just died at age 83 and he is the sole beneficiary of his mom's non-q annuity. The death benefit of the non-q annuity is 780k with a cost basis of 350k. He is 52 yrs old. He is not interested in taking the $ in a lump sum because he doesn't want to pay a lot of tax in one year and would like to stretch it out. Since it's a non-q annuity and it's non-spousal beneficiary doesn't the 5 yr rule apply or can he stretch the tax bill over his lifetime? Also, would it be possible for him to 1035 the annuity to a newer annuity with better investment options. If the 5 yr rule applies and he 1035s to a new annuity would he be subject to surrender charges and the 10% penalty prior to age 59 and 1/2 if he has to legally start liquidating?

Here's the bottom line: Client wants to defer tax for as long as possible and get into annuity with better options.

What do you guys think would be the best strategy for this situation? Thank you for your help!

Read more: Client Inherited NON-Q Annuity from Mom-NEED HELP!!!

 

[Tahoe Ray]

I figured all you life guys would probably no the answer even though this is an annuity question.

I have a client who has a mom who just died at age 83 and he is the sole beneficiary of his mom's non-q annuity. The death benefit of the non-q annuity is 780k with a cost basis of 350k. He is 52 yrs old. He is not interested in taking the $ in a lump sum because he doesn't want to pay a lot of tax in one year and would like to stretch it out. Since it's a non-q annuity and it's non-spousal beneficiary doesn't the 5 yr rule apply or can he stretch the tax bill over his lifetime? Also, would it be possible for him to 1035 the annuity to a newer annuity with better investment options. If the 5 yr rule applies and he 1035s to a new annuity would he be subject to surrender charges and the 10% penalty prior to age 59 and 1/2 if he has to legally start liquidating?

Here's the bottom line: Client wants to defer tax for as long as possible and get into annuity with better options.

What do you guys think would be the best strategy for this situation? Thank you for your help!

Read more: Client Inherited NON-Q Annuity from Mom-NEED HELP!!!

You can stretch a NQ annuity similar to how you would an IRA. The carrier will have to allow it (The IRS allows it but some carriers are not set up to administer it). A non-spouse bene would not be subject to the pre-59 1/2 penalty.

Unlike an IRA however, the stretch calculation is done a little differently with a non-qual annuity. Instead of using a new life expectancy factor each year, you just subtract 1 from the original number. This guarantees that the annuity will be paid out in a set number of years (since any bene of the bene is forced to use the original calculation.)

The second part of your question is a little more tricky. Not all carriers will accept an inherited NQ annuity and you may even get conflicting responses from CPAs as to whether it is allowed. I would seek guidance from a tax pro before pursuing this part...

If you do find a carrier that will accept the 1035, verify that the new carrier will accept the funds titled correctly and make sure that the carrier allows a free withdrawal % that is more than the required distribution.

Of course, you could always annuitize...

 

[rikwells]

You can stretch a NQ annuity similar to how you would an IRA. The carrier will have to allow it (The IRS allows it but some carriers are not set up to administer it). A non-spouse bene would not be subject to the pre-59 1/2 penalty.

Unlike an IRA however, the stretch calculation is done a little differently with a non-qual annuity. Instead of using a new life expectancy factor each year, you just subtract 1 from the original number. This guarantees that the annuity will be paid out in a set number of years (since any bene of the bene is forced to use the original calculation.)

The second part of your question is a little more tricky. Not all carriers will accept an inherited NQ annuity and you may even get conflicting responses from CPAs as to whether it is allowed. I would seek guidance from a tax pro before pursuing this part...

If you do find a carrier that will accept the 1035, verify that the new carrier will accept the funds titled correctly and make sure that the carrier allows a free withdrawal % that is more than the required distribution.

Of course, you could always annuitize...

Tahoe Ray:

Thank you very much for your timely response. He will probably not want to annuitize. If that is the case he will probably best off taking a little out each year over next 5 years. One other question: So, let's assume that the 1035 is possible and he does that and chooses not to annuitize, will he be subject to the 10% before 59 and a half penalty when liquidating in year 5?

Thanks!

 

[xrac]

Too bad she didn't use the money to buy a life insurance policy. If so her son wouldn't have this tax problem.

 

[Mattschmidt]

Too bad she didn't use the money to buy a life insurance policy. If so her son wouldn't have this tax problem.

very true...sometimes people mean well by leaving behind money for their loved ones, but don't structure the transfer properly...This creates huge tax liabilities to individuals...All the reason why people need our services more than ever

 

[Norwayguy]

Too bad she didn't use the money to buy a life insurance policy. If so her son wouldn't have this tax problem.

Screw the tax problem.....He has what 780K with a cost basis about half that. I understand minimizing taxes but even if he pulled 100% out today he is paying tax on 1/2 whats the current highest bracket 31% and he has what 660K or so....(I have not looked back at the original post so I am probably off on the numbers). I guess my point is I wish I had his problem

Granted had the mother used some of the funds to purchase a life policy or had she moved it into even a MEC policy the son would be sitting pretty.

If I was the son I would be thanking my mothers strategy of saving for savings sake even if the OP and son think the existing annuity is lacking in options going forward.

 

[rikwells]

it's my understanding that she had a heart problem and because of that the she couldn't get life insurance when she got older. So, I guess her agent at the time recommended annuity with guaranteed death benefit growth instead. I agree that the son is in a good place, sucks to pay a lot in taxes, but great to have $.

If he is willing to annuitize to spread the tax bill is he best off annuitizing the contract he inherits from mom or 1035ing to a new annuity and annuitize?

Also, I'm not sure but he thinks the annuity is from 1981, does this change how the withdrawals are taxed for the 5 year rule or the annuiting of contract?

Thank you everyone!

 

[Norwayguy]

it's my understanding that she had a heart problem and because of that the she couldn't get life insurance when she got older. So, I guess her agent at the time recommended annuity with guaranteed death benefit growth instead. I agree that the son is in a good place, sucks to pay a lot in taxes, but great to have $.

If he is willing to annuitize to spread the tax bill is he best off annuitizing the contract he inherits from mom or 1035ing to a new annuity and annuitize?

Also, I'm not sure but he thinks the annuity is from 1981, does this change how the withdrawals are taxed for the 5 year rule or the annuiting of contract?

Thank you everyone!

Just a question doesn't really make a difference here...But your post said he wanted better investment options...Is this a fixed annuity and what is the guaranteed minimum interest rate...I only ask because many companies had a 4% guarantee way back when and that would sound good to me today.

 

[Tahoe Ray]

it's my understanding that she had a heart problem and because of that the she couldn't get life insurance when she got older. So, I guess her agent at the time recommended annuity with guaranteed death benefit growth instead. I agree that the son is in a good place, sucks to pay a lot in taxes, but great to have $.

If he is willing to annuitize to spread the tax bill is he best off annuitizing the contract he inherits from mom or 1035ing to a new annuity and annuitize?

Also, I'm not sure but he thinks the annuity is from 1981, does this change how the withdrawals are taxed for the 5 year rule or the annuiting of contract?

Thank you everyone!

You don't need to annuitize to spread over the son's life expectancy. You take a distribution based on a 52yo's LE factor (you can find the table at IRS.gov) and then subtract one in each subsequent year. The distribution will be minimal and he can continue to defer the taxes for his life expectancy (or his bene can continue to defer the taxes based on his life expectancy if he dies prior to exhausting the funds).

If the son doesn't need the money right away, why go 5 year rule? Start the stretch payments this year and then if he needs a lump sum down the road, he can always take more.

If the annuity is pre-1982, the owner would have qualified for FIFO treatment so I would not exchange w/o talking to a tax pro who can verify that a non-spouse bene would be afforded that treatment as well.

I hope that this helps.

By the way, if the son is healthy there is no point in letting him make the same mistake as mom. If he wants to leave a legacy to his family, use the annual required distributions to fund a life insurance policy.....

 

[rikwells]

Just a question doesn't really make a difference here...But your post said he wanted better investment options...Is this a fixed annuity and what is the guaranteed minimum interest rate...I only ask because many companies had a 4% guarantee way back when and that would sound good to me today.

It's a variable annuity. Client says it only has 8 investment choices to choose from. I will be doing more research on this case, like what's the M&E charges, investment charges, and I am aware that there is a fixed rate available within the VA at a guaranteed 3% minimum which is what it pays now. However if he stays in this VA and moves towards the fixed account, wouldn't he be earning less than 3% because of the M&E? Am I right with that assumption or no? This client is very investment savy and thinks other annuities might have more investment options. He's an engineer and you know how they like to talk about their options.

Since I know he doesn't want to pay all taxes in this year he will want to either slowly take out $ over next 5 years or maybe he would be willing to annuitize to spread tax among life.

Do you think that it's best for him to stay in current VA for next 5 years or move to another with more options if he goes with the 5 year option?

If he goes with the annuitizing option, do you guys think it's best to annuitize this contract or do you guys think he could get a better deal 1035ing and annuitizing another contract?

I want to do what's best for this client. I work more on the wrap fee accounts, so these non-spousal NQDAs aren't something I deal with all that often.

Thanks again everybody.
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You don't need to annuitize to spread over the son's life expectancy. You take a distribution based on a 52yo's LE factor (you can find the table at IRS.gov) and then subtract one in each subsequent year. The distribution will be minimal and he can continue to defer the taxes for his life expectancy (or his bene can continue to defer the taxes based on his life expectancy if he dies prior to exhausting the funds).

If the son doesn't need the money right away, why go 5 year rule? Start the stretch payments this year and then if he needs a lump sum down the road, he can always take more.

If the annuity is pre-1982, the owner would have qualified for FIFO treatment so I would not exchange w/o talking to a tax pro who can verify that a non-spouse bene would be afforded that treatment as well.

I hope that this helps.

By the way, if the son is healthy there is no point in letting him make the same mistake as mom. If he wants to leave a legacy to his family, use the annual required distributions to fund a life insurance policy.....

Tahoe Ray,

That helps a lot! Thank you for all your input. I think it will make most sense for him to keep current annuity and do the stretch especially if he qualifies for FIFO withdrawals.-awesome point by the way! If he doesn't qualify for FIFO, then maybe 1035ing could make sense. I like the idea of not annuitizing and taking out whatever is required each year and if need be he can always take out more later. Can use some of the distributions for life insurance so his kids are in better situation than him. Thanks Tahoe Ray!