If you’ve got your retirement needs covered without the use of that deferred annuity you purchased, you may want to cash it in for a life insurance policy on you to leave your beneficiary even more with no taxes.
When you purchase a deferred annuity all taxes on its earnings are tax-deferred. If you don’t need your deferred annuity, you can leave it for your beneficiary upon your death. Unless the beneficiary is your spouse, he’ll have the option of cashing it some time within a 5 year period, or taking if over his remaining life expectancy. But he’ll have to pay tax on the earnings at his income tax rate.
Life Insurance Option
If you feel he’ll want to convert your annuity all to cash right away, he’ll have to pay the tax at his potentially high marginal income tax rate. This can produce a significant loss to taxation. But, if you can convert that deferred annuity into a life insurance policy on you, your beneficiary may receive more in the death benefit which will also be tax free.
Unfortunately you can’t make a tax-free exchange of a deferred annuity for a life insurance policy. All you can do is cash in the deferred annuity and pay the tax on its earnings. You may do this all at once or over a short ‘period certain’ payout (to reduce your marginal taxes).
With the proceeds you can purchase a paid up life insurance policy on you that may leave your beneficiary with more net cash than he’d get for cashing in your deferred annuity. Let’s look at some numbers. This is a hypothetical case and fees are not included in it. If fees had been included, results would have been reduced.
Suppose you’re 70 and have a deferred annuity you bought for $50,000 that’s currently worth $70,000. If you die at 78, it may be worth about $110,000. Your beneficiary would have to pay tax on the $60,000 earnings over and above your $50,000 purchase price. At a 25% tax bracket, your beneficiary would have to pay $15,000 in taxes leaving himself with $95,000 (= $110,000 less $15,000 taxes).
But if you cancelled your deferred annuity now, and paid taxes of $5,000 (at your 25% marginal tax rate) on the current $20,000 earnings, you’d have $65,000 to put into life insurance policy. The policy’s death benefit will be tax free to your beneficiary. With such a deposit you need to find an insurance contract with a death benefit that’ll beat out the $95,000 your beneficiary would get after he cashed in your deferred annuity.
If you qualify, you may find a life insurance policy with a higher death benefit than the $95,000 potentially leaving your beneficiary with more. Give us a call so we can determine if this strategy will produce a benefit for you.
Note: Annuities once annuitized cannot be surrendered for value. Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty. Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses. Surrendering the annuity may involve surrender charges and a new surrender period will begin with the purchase of the insurance policy. Investors should consider fees, expenses and any penalties carefully before initiating such a transaction.The purchase of life insurance involves costs, fees, expenses and potential surrender charges and depends on the health of the applicant. Not all applicants are insurable. If a policy is structured as a modified endowment contract, withdrawals will be subject to tax as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty. For 2015, the 25% tax bracket applies to single filers with taxable income from $37,450 to 90,750 and married joint filers with taxable income from $74,900 to $151,200.