Quick Question About IRA Tax Deduction
by Milano » Mon Mar 03, 2014 4:58 pm
I am trying to get out of an annuity sold to me in 2011. I can withdraw free of penalties 10% every year, to minimize the damage that this annuity is doing to my prtfolio I am planning to to put this amount into my IRA account, it is March now, can I claim a deduction if I transfer the funds now? Or is this deduction good for the '14 tax return?
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Re: Quick Question About IRA Tax Deduction
by DSInvestor » Mon Mar 03, 2014 5:09 pm
It is not too late to contribute to Traditional IRA or Roth IRA for 2013. The deadline for 2013 contributions is April 15, 2014.
Before making the contributions, make sure that you can get the tax deduction. The tax deduction for Traditional IRA is a little tricky. If you're not covered by an employer plan, you can fully deduct the Traditional IRA contributions. If you are covered by an employer plan, there are MAGI limits that may phase out or eliminate the tax deduction. See IRS Pub 590 How much can I deduct? Limit if covered by an employer plan. Pay attention to tables 1-2 and 1-3:
If you cannot take the Traditional IRA tax deduction, see if you're eligible for Roth IRA contributions. Roth IRA contributions do not offer tax deduction but once in the Roth IRA, your investments will grow tax free and can be withdrawn tax free. Roth IRA would be a far better investment container than a non-qualified variable annuity.
If you're in a high cost annuity, you may just want to rip the bandaid off in one shot and pay the surrender charges. The surrender charges are a sunk cost that you agreed to the moment you signed up for the annuity. If you stay in the annuity to avoid the surrender charges, you're paying very high expense ratios and mortality and expense fees. They get the money from you either way.
Here's a link to a thread where another poster is considering leaving a high cost variable annuity and ran some numbers. Looking at some prospectus for Ameriprise VAs it was possible that he may be paying close to 3% in expenses to stay in that VA. Compare that to 0.10 -0.2% for moving to a low cost fund(s) at Vanguard and he'd come out ahead in just a few years even after paying surrender charges.
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Re: Quick Question About IRA Tax Deduction
by Milano » Mon Mar 03, 2014 5:23 pm
DSInvestor wrote:It is not too late to contribute to Traditional IRA or Roth IRA for 2013. The deadline for 2013 contributions is April 15, 2014.
If you're in a high cost annuity, you may just want to rip the bandaid off in one shot and pay the surrender charges. The surrender charges are a sunk cost that you agreed to the moment you signed up for the annuity. If you stay in the annuity to avoid the surrender charges, you're paying very high expense ratios and mortality and expense fees. They get the money from you either way.
Here's a link to a thread where another poster is considering leaving a high cost variable annuity and ran some numbers. Looking at some prospectus for Ameriprise VAs it was possible that he may be paying close to 3% in expenses to stay in that VA. Compare that to 0.10 -0.2% for moving to a low cost fund(s) at Vanguard and he'd come out ahead in just a few years even after paying surrender charges.
Thank you for your very useful reply, considering that this sale is by ML and Prudential I do need to gain an understanding of the costs and tax implications.
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Re: Quick Question About IRA Tax Deduction
by DSInvestor » Mon Mar 03, 2014 5:29 pm
Milano wrote:
DSInvestor wrote:It is not too late to contribute to Traditional IRA or Roth IRA for 2013. The deadline for 2013 contributions is April 15, 2014.
If you're in a high cost annuity, you may just want to rip the bandaid off in one shot and pay the surrender charges. The surrender charges are a sunk cost that you agreed to the moment you signed up for the annuity. If you stay in the annuity to avoid the surrender charges, you're paying very high expense ratios and mortality and expense fees. They get the money from you either way.
Here's a link to a thread where another poster is considering leaving a high cost variable annuity and ran some numbers. Looking at some prospectus for Ameriprise VAs it was possible that he may be paying close to 3% in expenses to stay in that VA. Compare that to 0.10 -0.2% for moving to a low cost fund(s) at Vanguard and he'd come out ahead in just a few years even after paying surrender charges.
Thank you for your very useful reply, considering that this sale is by ML and Prudential I do need to gain an understanding of the costs and tax implications.
Is your annuity qualified or non-qualified? In the case of the other thread, his Variable Annuity was inside a SIMPLE-IRA so there would be no tax consequences to rollover to a Traditional IRA or Rollover IRA.
If your annuity is non-qualified (outside of IRA, 401k, 403b etc), there would be tax consequences to take the money out. I believe earnings come out first when you withdraw from non-qualfied annuities and 10% early withdrawal penalty may apply if younger than 59 1/2. Have you heard of 1035 exchange? That's a tax free transfer from one non-qualified annuity to another preferably one with lower costs. Vanguard offers a variable annuity that may have much lower costs than ML or Prudential.
Vanguard Annuities:
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Re: Quick Question About IRA Tax Deduction
by Milano » Mon Mar 03, 2014 5:48 pm
Is your annuity qualified or non-qualified? In the case of the other thread, his Variable Annuity was inside a SIMPLE-IRA so there would be no tax consequences to rollover to a Traditional IRA or Rollover IRA.
If your annuity is non-qualified (outside of IRA, 401k, 403b etc), there would be tax consequences to take the money out. I believe earnings come out first when you withdraw from non-qualfied annuities and 10% early withdrawal penalty may apply if younger than 59 1/2. Have you heard of 1035 exchange? That's a tax free transfer from one non-qualified annuity to another preferably one with lower costs. Vanguard offers a variable annuity that may have much lower costs than ML or Prudential.
Vanguard Annuities:
The annuity is in a taxable account (non qualified?). I was 'switched' or 'twisted' into this by a ML advisor in 2011 from a previous annuity, many complaints over this on my part towards ML. I had to pay taxes in 2013 when I withdrew the penalty free 10% as I needed the money. I am below 59-1/2" years old, so yes a 1035 exchange to a lower cost product makes sense, I need to understand the expenses, the PRU website is basic, not very informative. I have a lot to learn.
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Re: Quick Question About IRA Tax Deduction
by DSInvestor » Mon Mar 03, 2014 5:58 pm
You may want to give the Vanguard annuity group a call. 800-357-4720. They may be able to describe their offerings and explain their fees. Mortality and Expense fees etc. Once you understand the fee structure at Vanguard's annuities, it may shed some light on the fees charged by ML and Prudential and help you understand the ML and Prudential annuity prospectus which I'm sure is over 100 pages long!
Here's a link to a Vanguard page showing investment options with total expenses which includes Mortality and Expense Risk Charge in the Vanguard Variable Annuity:
Vanguard Variable annuities do not charge sales load and do not have surrender charges.
I have seen some mention of Jefferson National for low cost variable annuities but I have never spoken with them.
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Re: Quick Question About IRA Tax Deduction
by Milano » Mon Mar 03, 2014 6:30 pm
Thanks for the valid responses.
The greater question here is if I should eek my way out of the annuity by withdrawing and investing the 10% each year into my IRA and take the tax deductions for then years or take the plunge and 1035 int a lower cost annuity. Doing the math is what I need to learn.
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Re: Quick Question About IRA Tax Deduction
by DSInvestor » Mon Mar 03, 2014 6:51 pm
Milano wrote:Thanks for the valid responses.
The greater question here is if I should eek my way out of the annuity by withdrawing and investing the 10% each year into my IRA and take the tax deductions for then years or take the plunge and 1035 int a lower cost annuity. Doing the math is what I need to learn.
Let's assume that you can take the Traditional IRA tax deduction for $5,500. If you withdraw $5,500 from Non-Qualified Annuity, earnings come out first so that's $5,500 income to you assuming it's all earnings. This withdrawal will probably lower your annuity balance by more than $5,500 due to the surrender charge. The TIRA tax deduction of $5,500 negates the withdrawal income of $5,500 but you still have to pay the IRS 10% early withdrawal penalty on the earnings withdrawn at tax time.
If you do the full 1035 exchange to a low cost annuity, you pay the surrender charge to your old annuity and then invest the remaining assets in the new low cost annuity. The bigger the difference in expense ratios, the more it makes sense to do the exchange.
Let's say you have 100K in the annuity subject to 7% surrender charge ($7000). The annuity charges 1.5% M&E charge and expense ratios average 1.5%. Total expense is 3%. Might be higher than what you're paying. I imagine you're paying 2-3%.
The Vanguard VA would have total expense of around 0.6% depending on what you're holding.
Let's also assume that both annuities invest in the same asset allocation and get the same gross returns. The net return will be gross return minus expenses.
Let's see what happens in 10 years if gross returns are 5% per year for 10 years.
In the high cost cost VA, Net return = 5% - 3% = 2%
In 10 years, 100K grows to: 100,000 X (1.02 ^ 10) = $121,899
You transferred out and paid 7K in surrender charge investing 93K in lower cost annuity. The net return = 5% - 0.6% = 4.4%
In 10 years, 93K grows to: 93,000 X (1.044 ^ 10) = $143,050.
Low expenses makes a huge difference.
Run your own numbers after you find out a) what you're paying in expenses to stay in the annuity and b) what your full surrender charge would be.
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