Annuity Tax Bomb Saving Idea for Legacy

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One of our best high net worth clients to discuss options for an annuity owned by her mother. Her mother was age 84 diagnosed with dementia and the family was considering moving her to an Alzheimer’s care facility. Mom was described as very healthy otherwise. Her Daughter and son-in-law were her only close family and both Mother and Daughter (beneficiary) didn’t need income from the annuity now or later – this was a true legacy asset.

The Annuity was a Variable Annuity purchased by mom 12 years earlier from another advisor and the original deposit was $200,000. Our analysis showed the base fees on the VA were almost 2.0% and she had an income rider and guaranteed death benefit rider for another 90 basis point cost. In short, the total fees including the sub accounts were close to 4% and with this fee drag, she had averaged only about 2.4% return over the last 12 years.

Current Annuity Value was $259,000 & Death Benefit was $259,000

Income Value account was only $190,000 and had a special 10% income option – Last In First Out (LIFO). This means that interest would be distributed first with a withdrawal request and be taxable.

Mom was in a net 15% tax bracket and Daughter (beneficiary) was in a 35% tax bracket.

After analysis, we set on a plan to annuitize the annuity for Mom with a 10 year period certain. This would spread the tax due over those 10 years and would be paid at Mom’s rate until her death. Hopefully Mom will be around for most or all of those 10 years. Since Mom didn’t need the income, an investment account would be set up to dollar cost average the income payments at an assumed net yield of 5%.

Expected Hypothetical Results after 10 years.

Current tract: In 10 years, Variable Annuity would have been worth about $330,000 and $130,000 would be taxable to the daughter at her higher tax rate and paid out subject to IRS rules.

Recommendation: Annuitize and create Investment account to accept funds over time. In 10 years, Investment Account should be worth about $340,000 with no tax due.

Summary – Our client- the daughter, would much rather receive an investment account from mom worth about $340,000 after tax rather than $330,000 tax deferred account with tax due on $130,0000.

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