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Author: jtmitch Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75649  
Subject: Variable Annuity Question Date: 7/22/1999 2:54 PM
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With all the recent discussion about variable annuities, would appreciate it if you could play devil's advocate and find the holes in my logic below. (Warning: this is a pretty long post).

Have a variable annuity with Fidelity worth about $100K of which about half represents my contributions; the remainder is growth. Bought it and continued to contribute to it when I was on active duty in Navy and had no access to 401(K)s. (I had maxed out my IRA and my thinking at the time, right or wrong in retrospect, was that it would provide a 401(K)-like tax deferred retirement vehicle.) I have long since stopped regular contributions to it(as I'm now retired from Navy and in a real 401(K) plan). I've run the numbers and see no advantage to cashing out before 59 1/2 and paying the penalties. It's invested in a moderately aggressive mix of funds within the annuity. I'm 54 and want to retire within a couple of years. (I have assets other than the annuity as well as a Navy pension).

The conventional ("wise") advice is that an annuity is the last investment vehicle you access since you don't have to begin drawing from it as early as with an IRA and you therefore have more years for it to grow tax-deferred.

One thing I didn't realize when I bought the annuity is that when it becomes part of my estate upon my death, its value will not be stepped-up as with mutual funds and IRAs, so my heirs will pay income tax on the "capital gains".

So here is what I think makes sense and I would appreciate finding any flaws in my thinking:

- At age 59 1/2 I immediately begin accessing the money (which, at a 10% growth rate) could be worth $160K or so. That amount would be 4 - 6 years living expenses on top of my pension.

- I do this by converting the current moderately aggressive mix into a very conservative cash-centric mix, perhaps with a bond fund and a small amount of Growth and Income in the mix.

- I EITHER
A. Annuitize it over a 4 - 6 year payout period to take advantage of the fact that annuity payments are considered to consist of a portion of my contributions plus a portion of growth (meaning that I only pay taxes on the growth) OR
B. Self manage the withdrawals over the same period, realizing that if I do so, the above small tax benefit disappears.

- My 4 - 6 years of living expenses are thus covered meaning that I can now safely take other cash assets (which I had been holding to cover the first several years of living expenses) and invest them in non-retirement equities for growth.

The advantages, as I see them, in this approach are:
1. I cover 4 - 6 years of living expenses relatively painlessly.
2. I get the annuity out of my portfolio at a relatively young age. If I am lucky enough to live long enough, I have thus eliminated an asset which would be passed to my children at a relatively high cost in favor of retaininig those that will be passed at a relatively low cost.
3. I have the opportunity to redeploy cash assets to growth equity investments and later to access those assets at a capital gains tax rate rather than at the ordinary income rate.

What have I missed?
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Author: dharmadollars Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12487 of 75649
Subject: Re: Variable Annuity Question Date: 7/22/1999 9:20 PM
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You don't say what your housing situation is. Here is some speculation.

If you have a house with a mortgage, or a house without one on which you can create one, some other options present themselves.

Withdraw an amount equal to the interest payments on the mortgage. This taxable income (since all non-annuitized distributions are growth first, basis last [LIFO]) will be offset by the interest deduction. That washes out the tax hit. As it does so it will also free up additional currently available or income-generated dollars for investment. It also argues for creating a mortgage if you don't have one. That will create a lump sum to be invested for a longer time horizon, which will build up your capital gains treatment asset.

In connection with this, reposition the present value of anywhere between 12 and 24 months interest payments in the fixed account. This will give you stable dollars for distribution. Diversify the remainder, keeping a portion positioned for major growth and a portion positioned in more balanced positions. Replenish the fixed account periodically. If you do so when the aggressive account is showing above mean returns, do so from those funds; that will force you to lock in gains before regression to the mean. If the aggressive funds are producing returns lower than the mean, replenish from the balanced funds. That will give the aggressive funds more time to regress to the mean (recover their temporary loss in historical earnings).

Once you draw down the value to your basis you have solved your tax-treatment-at death dilemma. The remainder will throw off neither income nor capital gain liabilities. Just keep drawing it down to near basis at times when the funds are showing returns above their mistorical mean returns.

This may help you to accumulate more assets, while leaving the annuity basis available for withdrawal as needed without tax implications.

Hope this adds to your elegant planning endeavors.

Regards--dharmadollars

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Author: rjm1 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12549 of 75649
Subject: Re: Variable Annuity Question Date: 7/25/1999 9:12 AM
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With all the recent discussion about variable annuities, would appreciate it if you
could play devil's advocate and find the holes in my logic below. (Warning: this is a
pretty long post).

Have a variable annuity with Fidelity worth about $100K of which about half
represents my contributions; the remainder is growth. Bought it and continued to
contribute to it when I was on active duty in Navy and had no access to 401(K)s.
(I had maxed out my IRA and my thinking at the time, right or wrong in retrospect,
was that it would provide a 401(K)-like tax deferred retirement vehicle.) I have
long since stopped regular contributions to it(as I'm now retired from Navy and in
a real 401(K) plan). I've run the numbers and see no advantage to cashing out
before 59 1/2 and paying the penalties. It's invested in a moderately aggressive
mix of funds within the annuity. I'm 54 and want to retire within a couple of years.
(I have assets other than the annuity as well as a Navy pension).

The conventional ("wise") advice is that an annuity is the last investment vehicle
you access since you don't have to begin drawing from it as early as with an IRA
and you therefore have more years for it to grow tax-deferred.

One thing I didn't realize when I bought the annuity is that when it becomes part of
my estate upon my death, its value will not be stepped-up as with mutual funds and
IRAs, so my heirs will pay income tax on the "capital gains".

So here is what I think makes sense and I would appreciate finding any flaws in
my thinking:

- At age 59 1/2 I immediately begin accessing the money (which, at a 10% growth
rate) could be worth $160K or so. That amount would be 4 - 6 years living
expenses on top of my pension.

- I do this by converting the current moderately aggressive mix into a very
conservative cash-centric mix, perhaps with a bond fund and a small amount of
Growth and Income in the mix.

- I EITHER
A. Annuitize it over a 4 - 6 year payout period to take advantage of the fact that
annuity payments are considered to consist of a portion of my contributions plus a
portion of growth (meaning that I only pay taxes on the growth) OR
B. Self manage the withdrawals over the same period, realizing that if I do so, the
above small tax benefit disappears.

- My 4 - 6 years of living expenses are thus covered meaning that I can now
safely take other cash assets (which I had been holding to cover the first several
years of living expenses) and invest them in non-retirement equities for growth.

The advantages, as I see them, in this approach are:
1. I cover 4 - 6 years of living expenses relatively painlessly.
2. I get the annuity out of my portfolio at a relatively young age. If I am lucky
enough to live long enough, I have thus eliminated an asset which would be passed
to my children at a relatively high cost in favor of retaininig those that will be
passed at a relatively low cost.
3. I have the opportunity to redeploy cash assets to growth equity investments and
later to access those assets at a capital gains tax rate rather than at the ordinary
income rate.


Sounds like you know what you are doing.
You are correct that you do not want the annuity in your estate when you die.

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