Annuities in an IRA

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May 19, 2006 12:07 am

Situation:


Client recently retired, sold his home, and moved to an area with a lower cost of living (my town, they are coming here like moths to a flame ).  With the proceeds from the house and the rollover from the retirement plan, his total investments with me will be pretty much equally split between non-qualified and qualified.  He is interested in putting some of this money into an annuity with a GMIB rider. 


Question:


I know that conventional wisdom (and my compliance department) frowns on the idea of putting an annuity in an IRA, but doesn't it make more sense from a tax standpoint to put the annuity in there with the other tax-inefficient investments like bonds, REITs, etc. and use the non-qualified money for more tax-efficient investments?


Talk amongst yourselves.

May 19, 2006 12:24 am

Annuities are risk management tools. Use them accordingly.   If the client

wants guarantees (and is willing to pay for them) use the annuity. If not,

don't. It's that simple.



The double tax deferral argument is old and plain stupid.

May 19, 2006 12:24 am

I think you are coming at this from the wrong angle.  An annuity inside an IRA has no impact on a client's tax situation whatsoever. 


May 19, 2006 12:29 am

If you use the words "annuity," "tax-efficiency," and "IRA," in the same sentence, the compliance department will stop the trade on that basis alone. 


The only time I use a VA is if it's the only way to get a suitable but risk-averse client to particpate in the market with a living or death benefit (for example, a 50 year-old that needs to build up a retirement account but wants guarantees or else they'll just stick it in an IRA CD).  Otherwise, VAs are expensive compared to other investments and that negates some of their benefits. 

May 19, 2006 8:30 am

they're only 50 bps -75 bps more and with guarantees. I don't call that expensive when you're able to protect principle and income stream.

May 19, 2006 8:43 am

With the new riders coming out, the client does not even have to annuitize to get a guaranteed life payout for him AND his spouse.  The heck with the grown groveling kids.

May 19, 2006 10:22 am
Visigoth:

Annuities are risk management tools. Use them accordingly.   If the client
wants guarantees (and is willing to pay for them) use the annuity. If not,
don't. It's that simple.

The double tax deferral argument is old and plain stupid.


I agree that annuities are primarily a risk management tool, and that is exactly why this client wants to put some of his money there.  My question was more about step two - once you have determined that an annuity is appropriate, where do you put it?

May 19, 2006 10:24 am
lawsucks:
Visigoth:

Annuities are risk management tools. Use them accordingly.   If the client
wants guarantees (and is willing to pay for them) use the annuity. If not,
don't. It's that simple.

The double tax deferral argument is old and plain stupid.


I agree that annuities are primarily a risk management tool, and that is exactly why this client wants to put some of his money there.  My question was more about step two - once you have determined that an annuity is appropriate, where do you put it?



In the annuity cabinet?

May 19, 2006 10:31 am
iconsult100:

I think you are coming at this from the wrong angle.  An annuity inside an IRA has no impact on a client's tax situation whatsoever. 




Sure it does.  Assume the client I described above wanted half his money in an annuity with a GMIB and half in stocks.  If I use the non-qualified money for the annuity and the qualified money for the stocks, every dollar pulled out during retirement will be taxed as income.  If I flip the scenario, and us the non-qualified for the stocks, half of his money will be taxed at the capital gains rate.  It seems to me that the first scenario makes more sense for the client, but I thought I would post here to see if there was something else I wasn't considering.

May 19, 2006 11:05 am
lawsucks:
iconsult100:

I think you are coming at this from the wrong angle.  An annuity inside an IRA has no impact on a client's tax situation whatsoever. 




Sure it does.  Assume the client I described above wanted half his money in an annuity with a GMIB and half in stocks.  If I use the non-qualified money for the annuity and the qualified money for the stocks, every dollar pulled out during retirement will be taxed as income.  If I flip the scenario, and us the non-qualified for the stocks, half of his money will be taxed at the capital gains rate.  It seems to me that the first scenario makes more sense for the client, but I thought I would post here to see if there was something else I wasn't considering.



Mr. Lawsucks, are you even a broker yet?

May 19, 2006 11:30 am
remotecontrol:

Mr. Lawsucks, are you even a broker yet?



Yes.  I started back in '02.  I am strictly a one investment guy - the fantabulous Jackson National annuity using UIT's.  I have a 4 year track record of beating the S&P (who can argue with a long track record like that ). 


I've posted quite a bit on here before, but I keep getting banned for being a prick so I have to change my screen name - maybe you remember topgun and Dirk. 


Oh wait, that's you, never mind.


May 19, 2006 1:47 pm

There are several things we don't know so it is hard to determine what exactly to do.  How old is the client, what income need from his portfolio if any, when would he be needing or wanting to take from his IRA, what other sources of income, cash flow, net worth, risk tolerance etc. 


However, in the scenario you have presented, I would use an annuity with the GRIB for some of the qualified money.  The guarantees of the annuity allow the client to invest at a possibly more appropriate level.  I hate to see individual stocks in an annuity because of the loss of the ability to use cap losses (which we hope we never have ) against capital gains.    As someone else remarked the tax deferral redundancy of the VA in an IRA is outweighed by the guarantees that give the client peace of mind.  I haven't had any compliance problems in this area.  Now a fixed or EIA is something else. Those should never ever be in an IRA.. IMHO


I am also of the mind that a client shouldn't have a portfolio of mainly stock positions unless they have at least 150 to 200 K to invest and a relatively high risk tolerance and net worth.  They will not be able to get proper diversification and would be much better of in a grouping of mutual funds with different investment objective.  Unless they are in a fee program trading costs will erode gains and why should you take the risk of managing a stock portfolio for such a small amount, not to mention the amount of time you would be spending on research and monitoring.  Let the mutual fund managers do that...that's what they get paid to do.

May 19, 2006 9:10 pm
lawsucks:
remotecontrol:

Mr. Lawsucks, are you even a broker yet?



Yes.  I started back in '02.  I am strictly a one investment guy - the fantabulous Jackson National annuity using UIT's.  I have a 4 year track record of beating the S&P (who can argue with a long track record like that ). 


I've posted quite a bit on here before, but I keep getting banned for being a prick so I have to change my screen name - maybe you remember topgun and Dirk. 


Oh wait, that's you, never mind.




Yep, it's me. I'm still riding the same pony as you. It just keeps ticking and never takes a licking.

May 20, 2006 3:07 pm
lawsucks:
iconsult100:

I think you are coming at this from the wrong angle.  An annuity inside an IRA has no impact on a client's tax situation whatsoever. 




Sure it does.  Assume the client I described above wanted half his money in an annuity with a GMIB and half in stocks.  If I use the non-qualified money for the annuity and the qualified money for the stocks, every dollar pulled out during retirement will be taxed as income.  If I flip the scenario, and us the non-qualified for the stocks, half of his money will be taxed at the capital gains rate.  It seems to me that the first scenario makes more sense for the client, but I thought I would post here to see if there was something else I wasn't considering.



One of the major benefits of an annuity is its tax sheltered nature. The reason why the practice of placing them in an ira is frowned upon is that there is essentially double tax deferral on the investments. The tax efficiency of an equity portfolio has to do with the turnover of the portfolio and the nature of the capital gains it produces (long or short term). if the equity portfolio is low turnover and low dividend, it is probably best to place the equities in the taxable account and the fixed income investments in a tax deferred account (the IRA). This also allows one to invest in a broader (and thus more diversified) portfolio of fixed income instruments (agencies, preferreds, REITs, HY, Intl bonds (potentially- depends on tax issues) and  that allows for a higher rate of income and a greater withdrawal rate. It also allows excess income returns to be reinvested - one of the primary disadvantages of taxable bond portfolios.


All things being equal (and yes, they rarely are), bonds are more tax inefficient than equities and should be preferred in tax deferred accounts.

May 20, 2006 9:13 pm
lawsucks:

Sure it does.  Assume the client I described above wanted half his money in an annuity with a GMIB and half in stocks.  If I use the non-qualified money for the annuity and the qualified money for the stocks, every dollar pulled out during retirement will be taxed as income.  If I flip the scenario, and us the non-qualified for the stocks, half of his money will be taxed at the capital gains rate.  It seems to me that the first scenario makes more sense for the client, but I thought I would post here to see if there was something else I wasn't considering.


Hopefully everyone realised that this was a typo.  I meant to say the second scenario. 

May 21, 2006 8:09 pm
san fran broker:
lawsucks:
iconsult100:

I think you are coming at this from the wrong angle.  An annuity inside an IRA has no impact on a client's tax situation whatsoever. 




Sure it does.  Assume the client I described above wanted half his money in an annuity with a GMIB and half in stocks.  If I use the non-qualified money for the annuity and the qualified money for the stocks, every dollar pulled out during retirement will be taxed as income.  If I flip the scenario, and us the non-qualified for the stocks, half of his money will be taxed at the capital gains rate.  It seems to me that the first scenario makes more sense for the client, but I thought I would post here to see if there was something else I wasn't considering.



One of the major benefits of an annuity is its tax sheltered nature. The reason why the practice of placing them in an ira is frowned upon is that there is essentially double tax deferral on the investments. The tax efficiency of an equity portfolio has to do with the turnover of the portfolio and the nature of the capital gains it produces (long or short term). if the equity portfolio is low turnover and low dividend, it is probably best to place the equities in the taxable account and the fixed income investments in a tax deferred account (the IRA). This also allows one to invest in a broader (and thus more diversified) portfolio of fixed income instruments (agencies, preferreds, REITs, HY, Intl bonds (potentially- depends on tax issues) and  that allows for a higher rate of income and a greater withdrawal rate. It also allows excess income returns to be reinvested - one of the primary disadvantages of taxable bond portfolios.


All things being equal (and yes, they rarely are), bonds are more tax inefficient than equities and should be preferred in tax deferred accounts.



You just let your ignorance slip out of the bag. How much do annuity companies charge for this "major benefit", tax deferral? I'll give you a hint...there is NO charge for tax deferral.

May 21, 2006 8:56 pm

"One of the major benefits of an annuity is its tax sheltered nature. The reason why the practice of placing them in an ira is frowned upon is that there is essentially double tax deferral on the investments"



Are you a moron?  A stock (with no dividends) is tax deferred too.  Should we not buy a stock in an IRA, because it's essentially double tax deferral. 


That's just plain stupid.  An annuity is a risk management tool not a gain maximizer/minimizer start using it for what it was inteded for transferrring risk.


Remember risk -  Retain, avoid, transfer = (annuity w/riders)

May 21, 2006 10:14 pm
remotecontrol:

You just let your ignorance slip out of the bag. How much do annuity companies charge for this "major benefit", tax deferral? I'll give you a hint...there is NO charge for tax deferral.



Ignorence? That's a rather combative and unnecessary word..


As I understand it, an insurance contract is the only vehicle that IRS regulations give tax deferral to other than the retirement accounts (401k, IRA, Roth, etc).


While I am generally of the opinion that annuities are not the best retirement vehicle, the reality is that the official rulings only allow for tax deferral on these contracts unless they are legitimate life insurance vehicles (as I recall, all of the "private placement" policies of a few years back were invalidated if the IRS found that they were not legitimate insurance contracts.)


So, if someone wants to save in a tax deferred way and has already maxed out their retirement plans, then they would have to use an annuity or VUL or some insurance - type vehicle. Right?


The question appears to be whether tax deferral is worth the cost of the insurance....

May 21, 2006 10:28 pm
bankrep1:

"One of the major benefits of an annuity is its tax sheltered nature. The reason why the practice of placing them in an ira is frowned upon is that there is essentially double tax deferral on the investments"



Are you a moron?  A stock (with no dividends) is tax deferred too.  Should we not buy a stock in an IRA, because it's essentially double tax deferral. 


That's just plain stupid.  An annuity is a risk management tool not a gain maximizer/minimizer start using it for what it was inteded for transferrring risk.


Remember risk -  Retain, avoid, transfer = (annuity w/riders)



Calling me a moron because you disagree with what I have to say? Very classy.


Eventually you may sell a stock and reinvest the proceeds. This means that there could be taxes if you have made money on it (this may not be a concern for your clients). So, yes, there are substantial benefits to holding stocks in IRAs.


The variable annuity option component includes both a life insurance risk and market / asset class risk. By definition, the risks are distinct and thus, cumulative. There are other alternatives to managing asset class and market risk - particularly these mysterious things called "Portfolio Management", "Duration Risk Management" and "Asset Allocation". Depending upon the asset, futures contracts, forwards, options or other derivatives typically cost substantially less to use than a variable annuity to accomplish a risk management objective.


But you would have to have a Series 3 to do that and your firm would have to allow you to use futures and options, wouldn't you?


Of course, you can't get an upfront commission of 7% on a futures contract transaction, can you? And, isn't that what it's really all about?

May 22, 2006 8:17 am
san fran broker:
remotecontrol:

You just let your ignorance slip out of the bag. How much do annuity companies charge for this "major benefit", tax deferral? I'll give you a hint...there is NO charge for tax deferral.



Ignorence? That's a rather combative and unnecessary word..


As I understand it, an insurance contract is the only vehicle that IRS regulations give tax deferral to other than the retirement accounts (401k, IRA, Roth, etc).


While I am generally of the opinion that annuities are not the best retirement vehicle, the reality is that the official rulings only allow for tax deferral on these contracts unless they are legitimate life insurance vehicles (as I recall, all of the "private placement" policies of a few years back were invalidated if the IRS found that they were not legitimate insurance contracts.)


So, if someone wants to save in a tax deferred way and has already maxed out their retirement plans, then they would have to use an annuity or VUL or some insurance - type vehicle. Right?


The question appears to be whether tax deferral is worth the cost of the insurance....



If you don't like what you think you know about annuities, don't sell them.