Dear Rick:
I’m helping my 80-year-old father with his finances and I have some questions. My dad, a number of years ago, purchased a non-IRA annuity. He paid $100,000 and today it’s worth about $150,000. The annuity matures in another month or so and the agent has been hounding my dad to roll the annuity into a different annuity. He told my dad that if he cashed out the annuity he would have to pay taxes on the entire $150,000. My first question is, is that true? My dad wants to withdraw about $25,000 a year from the annuity to use that money to help his grandchildren through college. The agent informed my dad that the most he could take out of any annuity would be 10 percent without penalty. My second question is does my dad have other options? The annuity that the agent wants my dad to transfer into has a 12-year penalty provision and the penalty starts at a ridiculous 12 percent.


Dear Mark:
In looking at the tax consequences of cashing out the annuity, the agent is plain and simply wrong. Since this annuity is a non-IRA annuity it means that you have a basis. Your basis is no different than if you had bought a stock, and that is what you originally paid for the annuity. In the situation at hand, since your father paid $100,000 for the annuity, that would be his basis. Therefore, if he cashed the annuity out in its entirety and received $150,000, the only amount he’d be subject to tax on would be the $50,000. The other $100,000 is his money coming back to him, and that is tax free.

When your agent suggested that the most you Dad could pull out of annuity without penalty is 10 percent; once again, he was wrong. There are many annuities that have no penalty provisions and thus, you could pull out as much as you want on a year-by-year basis. Fidelity, Schwab and Vanguard all offer penalty-free annuities. Therefore, what you father can do is to have the annuity directly transferred into one of the aforementioned annuities. By doing this transaction there are no penalties and you are not locking your money up. You can withdraw all or a portion of the annuity when ever you want without penalties. Therefore, on a year-by-year basis your dad can withdraw the $25,000 penalty free.

The way taxation on annuities work is the first money that comes back to you is the taxable portion. Therefore, in the situation with your father the first $50,000 he receives he would have to pay tax on; after that, the money he withdraws would be tax free.

I hear this frequently when annuities mature where agents are trying to re-up people in annuities with crazy penalty provisions. My philosophy is why should you have to pay penalties to take back your own money? The answer lies in the commission and fees the agents are receiving. The higher the penalties and the longer the penalty provision always go hand-in-hand with high commissions. Annuity owners should know that there are other options. Therefore, if you have an annuity that is maturing, before you automatically roll it over into a new annuity with penalties, you need to explore your options. As I mentioned earlier, companies like Fidelity, Schwab and Vanguard all offer commission-free and penalty-free annuities which give investors a great amount of flexibility. I believe in today’s world it is extremely important to have flexibility, and that is why it doesn’t make sense to me to lock money up for long periods of time. After all, the only one who benefits by you locking your money up for long periods of time is the agent who is selling you the annuity. Therefore, if you get approached by an agent who is selling an annuity, one of the first questions you need to ask is how long you are committing your money for and what are the penalty provisions. As far as I’m concerned, locking money up for anything longer than five or seven years doesn’t make sense in this environment. Therefore, to make sure you have flexibility and use of your money, don’t be afraid to say no to the salespeople, and always make sure you shop your options around.

Good luck!



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