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.
Unknown Tax Trap
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
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.
Getting From an Annuity To
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.
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:
Or, if you would prefer to speak directly with one of our Specialists, please call us toll-free at 1-800-239-0356.
amount will vary slightly from company to company and based on sex, health and
actual policy designed to fit your personal needs.
|¹ First year yield/rate reflects fixed rate
plus premium bonus or interest rate enhancement.|
Interest is based on current rates and subject to change without notice.
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