Annuities in IRA's....Tax Free benefits to heirs if Death Benefit is higher than account balance...Convert a small amount to roth and roll the rest to an ira.

[Guest duckchow]

It has come to my attention that if you bought a variable annuity sometime prior to 2000 inside of an IRA and your account balance is lower than your death benefit you can reap huge tax savings for your heirs...It doesn't help the account holder all that much but it really helps the kids later down the road.

It works like this... Many people bought variable annuities during the late 90s and in most variable annuities your premium payment becomes your death benefit. Some have annual ratchets and other bells and whistles that boost your death benefit on each anniversary date. Like most stocks, many of these annuities got crushed when the market went down but what most insurance companies didn't realize was that when you took some money out of your IRA or rolled part of it over to another IRA the death benefit didn't go down on a pro rata percentage basis, it was just reduced by the dollar amount that you withdrew. Bad deal for the insurance companies when Roth IRA's came into the picture... Finally after getting scathed, the insurance companies changed the wording in their contracts to reflect if you moved any money out, the death benefit drops by the same percentage. (IE.. You have 50K in account balance and you move 10K your death benefit drops by 20%)

Now that you are fully confused let me give you an example of real world example of what I did for a client.

The client invested 100K in an annuity(within an IRA) in 2000. The client mismanaged their investments and the account balance fell to 50K in 2 years...Bad deal for the client. However, after careful consideration we rolled over 45K to another IRA where we bought a mutual fund. We then reduced the death benefit of the IRA annuity to 55K with only 5K in account balance. We then converted the annuity IRA to a Roth IRA. My client now has 55K in death benefit that when he passes away will go to his heirs tax free in the Roth IRA and also has a 45K IRA for himself. Granted the client had to pay regular income taxes on the 5K he converted but he is essentialy giving his heirs 55K income tax free upon his death(provided he lives 5 Years). Their is obviously no monetary benefit for the client but he figured at least he could help his kids. There are thousand upon thousand of these cases out there and you won't hear one insurance company talk about them.

Now the insurance company hated this but had to do it based upon how the policy was written and I am sure when the IRS sees this, they won't be happy either because of all the tax revenue they will lose as a result of this, but it is completely legitimate until they change the law. The client is happy, I am happy, and well the government and insurance company...SO SORRY!

[joel]

What was the VA expense ratio---about 3 percent? Was he subject to a Contingent Deferred Sales Charge in order to get out? Did he buy a no-load mutual fund with the 45k or one that subjects him to another schedule of Contingent Deferred Sales Charges? Is the 45K managed any differently than when it was 100K? The guaranteed death benefit will be the difference (if any) between the $55,000 (adjusted cost of the annuity) and the value of the Roth annuity at the time of your client's death.

[Guest duckchow]

The VA expense ratio was high. I did not sell him the annuity. Personally, I hate annuities. It was close to 3%. There was no contigent sales charge as long as the client had the annuity for a year...It was a no load annuity. The 45K bought him an American Fund which he already had plenty of so he did pay 2.5%... As far as the Roth goes, that is merely there to go to his kids tax free....The account value will never get to 55K so obviously that won't ever grow again in his lifetime. So, to your assumption, the client improved his situation for his kids and I did not get rich if that is what I think you were inferring...There are honest people out there.

[Guest duckchow]

As far as the death benefit goes, it cannot go below 55K. Many annuities guarantee your initial premium payment.. He took out 45K so he is left with 55K in death benefit regardless of the account value...Now since this has been happening insurance companies are stating if you take out 45K they take a pro rata percentage off the death benefit in regards to current account value... Therefore 45K would represent 90%of account value so the death benefit(50K in account value) under current contracts would be reduced by 90% therefore leaving a death benefit of 10K...You are right though that there are several annuities out there that are account value only as far as death benefit is concerned however many more were sold under my example and other annual ratchet up death benefits.. In what you were saying there would be no benefit to the Roth but most annuities sold by the big insurance companies were sold under the premise that your death benefit could be no less than premuim payment minus withdrawls no matter how the subaccounts performed. The insurance companies have covered themselves going forward but have left themselves open under contracts in IRA's issued before 2001.

[joel]

As far as the death benefit goes, it cannot go below 55K. Many annuities guarantee your initial premium payment.. He took out 45K so he is left with 55K in death benefit regardless of the account value...

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It seems that you are saying that if he still had the VA and died with an account value of $50K the return of premium death benefit would be 100k for a total dispersement of $150K. Please clarify.

[Guest duckchow]

The account balance of the annuity after the market tumbled was 50K....It started at 100K...We took 45K and rolled to an IRA where he bought the American Fund...That left 5K in account balance however the death benefit was still 55K. Premium was 100K and we took out 45K therefore reducing the death benefit to 55K. We then rolled the annuity into a Roth. If the client died 5 years later and everything stayed flat the beneficiaries would get the 45K we rolled into the IRA and have to pay taxes on that. They would also receive 55K in death benefit from the Roth IRA, however this money would be income tax free. I don't know where you got the 150K from? Obviously the client does not benefit personally at all. The only reason for this is to get a portion of the IRA to his kids tax free. If the client would have left everything alone, the kids would have gotten 100K fully taxable. Also in 5 years you would hope that the 45K you rolled into the American Funds would appreciate. I realize this is a very specialized case, but there were alot of people that invested their rollover from employers into Annuity IRA's....Personally I think they stink but this is one way for the client to help his kids from the throngs of a bad situation.