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When Your Annuity Becomes a Tax Time-Bomb

Tax Deferred Annuities issued by life insurance companies have for years been a popular alternative for people who want high interest and tax relief for their savings. In the last 20 years, billions of dollars have been moved into these contracts by savers seeking safety and predictability, competitive interest rates and favorable tax treatment. If you currently own a tax deferred annuity or are contemplating investing in one, there is something you should know that is seldom mentioned by the company or the agent who presents it.

One of the most important features of a tax-deferred annuity is that it allows you to compound yearly interest earnings free of current tax. By eliminating the current tax cost of accumulation, you can build a much larger account value than with a typical interest bearing account such as a bank CD. When you combine this feature with a slightly higher interest rate than is typically found in bank savings, it is easy to see why tax-deferred annuities are so popular.

Annuities are great for safely accumulating money to be used at some future date to enhance income; as long as it is understood that when you begin to withdraw money from the annuity, you must then pay taxes on your gain. The manner in which you chose to take income will determine the method used to calculate taxable income. A simple partial withdrawal is usually the most desirable method, but it is treated as interest first, which often means the entire withdrawal will be taxable. Only if you set up a systematic annuity income payment, will you get some tax relief by spreading out the taxable gain over the anticipated number of years that annuity payments will be made. This does not reduce the amount that will ultimately be taxable, but it does spread it out and make the burden more palatable.

The Unknown Tax Trap
It is at the time of the total withdrawal of funds, which most often occurs upon the death of the annuitant/owner, that the surprise occurs.

A deferred annuity is the only asset you can own that does not get a “step-up in basis” at the time of your death. It is quite common today to see real estate and stocks that have been owned for years and that have appreciated ten fold to a hundred fold be passed on to heirs upon the death of the owner with no income tax whatsoever. But an annuity does not enjoy this tax feature. Specifically excluded from the step-up in basis rule, the entire gain in the annuity is subject to income tax when received by the beneficiary.

Since a vast majority of the $Billions now residing in annuities is destined to be passed on to the children of the annuitants, the tax bills will come as a tremendous shock to all concerned. In fact, it is not uncommon to see proceeds from an annuity that has been accumulated and tax deferred in a relatively low tax bracket (15% or 20%), incur taxes of 33% or more when added to the existing income of the beneficiary. This clearly was not the intent of the contract owner. But it occurred because of the failure to recognize the ultimate purpose for the money on deposit in the annuity and to choose the most appropriate strategy.

The Better Strategy
There is an alternative to the annuity that will satisfy the new objectives of saving money for an emergency and passing any unused balances to our heirs. This alternative provides tax deferral, safety and immediate liquidity. It has the same tax provisions for partial withdrawals as annuities but when it passes to a beneficiary upon the death of the owner, there is a major difference. The entire tax-deferred accumulation passes income tax-free to the named beneficiary.

The product is a special life insurance policy designed for maximum cash value growth to duplicate as close as possible the level of accumulation typical of an annuity. People who are planning on passing their savings on to their children at death will find that the after-tax benefits will be substantially higher if the money is accumulated in a life insurance policy rather than an annuity when they die. Not only does it include the money which accumulated in the cash value account, but an additional amount of life insurance benefit that is paid to the beneficiary. This combination, paid income tax free, is the most desirable way to pass savings to children or other named beneficiaries.

For a complete unbiased analysis of your specific situation, simply go to our Tax Time-Bomb Form, supply the requested information and we will provide you with a FREE detailed Illustration/Evaluation via email, fax or U.S. Postal Service, to help you determine if this strategy is right for you:

Tax Time-Bomb Form

Or, if you would prefer to speak directly with one of our Specialists, please call us toll-free at 1-800-239-0356.

Getting From an Annuity To Life Insurance
Once most people realize the benefit of using life insurance, they seek the most efficient way to transfer the money from the annuity. Unfortunately, there is no way to make a tax-free transfer of the gain from an annuity to a life insurance policy. In other words, the tax must always be paid. But the sooner you recognize the income, the less deferred tax you will be accumulating.

If the life insurance approach matches your desire to transfer your money to your loved ones, move the money as soon as possible. The sooner this transaction occurs, the less taxes will be paid. It’s really OK to pay these taxes now because they will ultimately be recouped by the life insurance element that will be paid to the beneficiary in addition to the cash value.

Assume a lady (Sally) who is 70 years old owns a deferred annuity into which she originally deposited $50,000 and it is now worth $70,000. If it continues to accumulate until she is 78 years old when she dies, it will have a value of approximately $111,569. But when her beneficiary receives it, income taxes will be due on $61,569 ($111,569 - $50,000 original deposit). At 33% the taxes would be $20,318 leaving a final balance of $91,251 for the heirs. State income taxes will further reduce this amount.

Sally Saver - Female, Age 70
Original Deposit $  50,000 Surrender Annuity $  70,000
Current Balance $  70,000 Taxable Gain $  20,000
Accumulated @ 6% Tax @ 33% $    6,600
Value @ Age 78 $111,569 Annuity Proceeds:
Death Benefit $111,569    $70,000-$6,600= $  63,400
Tax @ 33% $  20,318 Premium Deposit $  63,400
Initial Death Benefit $135,000
Proceeds to Heirs: Proceeds to Heirs:
$111,569-$20,318= $  91,251 $135,000-$0= $135,000
(Increase to Heirs $  43,749)
Total Paid in Taxes $  20,318 Total Paid in Taxes $    6,600

If instead she were to cancel the annuity now, her taxes would be approximately $6,600 or less, leaving $63,400 to deposit into a life insurance policy. This would purchase a contract with a death benefit of approximately $135,000*. Now if she died at age 78, her children would receive $135,000 instead of $91,251.

As you can see, the added benefit available from the life insurance policy more than compensates for the current taxes Sally must pay now to cancel her annuity and move the money. The money in the cash value of the insurance policy continues to grow tax deferred (like the annuity) and is available should it be needed for an emergency.

Of course, there are several ways to address this situation and depending on your individual needs, current health, and other personal factors the benefits could be greater or less than this example. There are special versions of these policies that can also provide benefits to cover nursing home and convalescent care by making the larger death benefit available to the insured (prior to death) to help pay for these costs.

It is best to consult with a qualified advisor to evaluate your personal options to determine if this is a better option for you than the annuity. Further exploration of the life insurance alternative could be a very valuable step for you as well as your loved ones.

For a complete unbiased analysis of your specific situation, simply go to our Tax Time-Bomb Form, supply the requested information and we will provide you with a FREE detailed Illustration/Evaluation via email, fax or U.S. Postal Service, to help you determine if this strategy is right for you:

Tax Time-Bomb Form

Or, if you would prefer to speak directly with one of our Specialists, please call us toll-free at 1-800-239-0356.

*This amount will vary slightly from company to company and based on sex, health and actual policy designed to fit your personal needs.

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