June 9, 2020
Non-Qualified Variable Annuities – Time for a Review
By Clete Albitz, CFP®
If you own a non-qualified variable annuity, a confluence of events has made it a worthwhile time to review your contract.
A brief review of this type of account: A non-qualified variable annuity is typically setup by an individual who has already maximized contributions to other retirement accounts and is interested in saving in another tax-deferred vehicle. It is funded with after-tax money with the earnings growing tax-deferred until withdrawal where they are subject to tax as ordinary income. The account is designed to be long-term in nature with earnings withdrawn prior to age 59 ½ assessed a 10% early withdrawal penalty. Non-qualified variable annuity costs tend to be high relative to other types of accounts due to additional frills built into the insurance contracts. However, this is changing.
In recent years, variable annuity providers have developed new contracts for those primarily interested in using the vehicles for tax deferral. The emphasis of these contracts is to provide the tax benefits of annuities while minimizing the ongoing contract expenses. If you own an older contract without special riders, it may be worth comparing your contract to a newer contract to see if you can own the same or similar investments via the same type of account at a favorable cost.
Furthermore, despite the recent market decline, following the past decade’s bull market, many contracts have large embedded gains. Typically, a variable annuity will provide a death benefit equal to the higher of the net investment in the contract or the current contract value. If your current contract value is well above your net investment, your death benefit will be reduced during the next market decline as the contract value will fall, but potentially not below your net investment. One strategy to better protect the death benefit inherent to the annuity is by doing a 1035 exchange to a new contract. This will step-up your net investment to your contract’s current market value. Should the market decline in the future, your beneficiaries will receive the new higher net investment as a death benefit rather than the reduced contract value.
Finally, the SECURE Act was passed at the end of 2019 and it eliminated the ability of most non-spouse beneficiaries to stretch out inherited IRA distributions over their life expectancy. Inherited IRAs must now be depleted within a 10-year period causing an acceleration of both income taxes and depletion of the account. However, some variable annuities still offer beneficiaries the ability to stretch distributions over their life expectancy via what is termed a “non-qualified stretch”. It is a means for families to continue to take advantage of tax deferral through stretch provisions. It is important to check with the provider and ask what distribution options are available as not all companies offer the non-qualified stretch provision.
If you own a non-qualified variable annuity you may have the ability to improve things for yourself and your beneficiaries. These three events make it likely that you can lower your contract’s ongoing expenses, step-up the contract death benefit, and provide additional tax deferral for your family. Now is a great time to review your specific situation.
Variable annuities may have a surrender charge imposed during the first 5 to 7 years that you own the contract. Withdrawals prior to age 59 ½ may result in a 10% IRS tax penalty, in addition to any ordinary income tax. The guarantee of the annuity is backed by the financial strength of the underlying insurance company. Investment sub-account values will fluctuate with changes in market conditions.
Investors should consider the investment objectives, risks and charges and expenses of the variable annuity carefully before investing. An investment in a variable annuity involves investment risk, including possible loss of principal. Variable annuities are designed for long-term investing. The contract, when redeemed, may be worth more or less than the total amount invested. Variable annuities are subject to insurance-related charges including mortality and expense charges, administrative fees, and the expenses associated with the underlying sub-accounts. The prospectus contains this and other information about the variable annuity. Contact your agent or financial advisor to obtain a prospectus, which should be read carefully before investing or sending money.
For a comprehensive review of your personal situation, always consult with your legal or tax advisor. Clete Albitz CA Insurance License #OK94729. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.