annunity rules

[TAXMAN]

Can some one check me on this. TP age 59(not591/2). tp's wife died 2 years ago left him 400k in life ins. TP took and bought an annunity with this money. TP lost his job June 2015. Continued to pay cobra ins thru rest of year. Not enough medical to exceed haircut #. I know he owes the tax on the wd (1 wd of 8k after losing job) but would he owe the penalty?

[Abby Normal]

Pretty sure the over 55 exception is only for 401k's so I think penalty applies.

[Catherine]

Annuities have some odditites built in.  They are a contract between the buyer and the insurance company; read the contract.  There may be provisions allowing what might be termed a "partial surrender" for specific needs.  Those provisions, if they exist, may be a way out of penalties.

[Gail in Virginia]

I am not an expert on annuities (or any insurance product, for that matter) but I thought that there were two different types of annuities.  If he invested $400,000 from life insurance proceeds at one whack, I would not think that this is the type of annuity that behaves like an IRA/qualified plan.  In which case, I would have thought that he could recover his investment without tax penalty although there might be penalty from the insurance company for early withdrawal.  But I am quite willing to be corrected on that since I really don't know much about how annuities are structured.

[Catherine]

Yes; I was thinking along the lines of @Gail in Virginia.  Non-qualified annuity is NOT a retirement vehicle; it's just a contract "give us money now and we'll give you money later and you hope it's more".  Early withdrawals subject to penalty form the insurance company, not the IRS.  But there are sometimes exemptions to those penalties.

Read the contract.

[FDNY]

I wish I could report differently but yes, there is an IRS early withdrawal penalty on Non-Qualified annuities.

Too bad TP didn't wait a few months.

As far as his withdrawing money in the future the contract probably limits (Ins co.)penalty free withdrawals to 10% of the original investment, subject to a maximum amount.  I hope he didn't buy one with a long surrender period, like Catherine said, read the contract.

[FDNY]

Edit to above post, the common penalty free withdrawal feature is annually, sometimes subject to a maximum # of years or % of original investment.

[TAXMAN]

The ins co did not charge a penalty. The 5329 is kicking in and I was looking for a way out of some of the penalty. Tried looking at all the exceptions but don't believe he will be able to meet any of these. Thought exception 1 might work but cannot read this to apply in this case because it tends to read distribution from a Qualified annunity not a nonqualified annunity. Does this seem to be right?

[FDNY]

You are correct.  I've been down this road a few times and exception 1 applies to 401Ks, and other qualified plans as Abby Normal indicated and in my practice qualified plans for public safety officers at age 50.

Non qualified plans don't have this advantage.  I admire your efforts to research and help your client. 

[Catherine]

But it's not a "non-qualified plan" in that those are usually for highly compensated employees.

He took life insurance money, not retirement funds, and bought a contract for future income.  By withdrawing funds, he is not using retirement funds early.  It's more like a Roth distribution of principal (but not subject to Roth 5-years-in rules).  The only penalty should be from the insurance company according to their contracts.  In fact only any growth withdrawn should be taxable income; the rest was non-taxable life insurance proceeds.

[windmill]

What does the 1099-R show?  The insurance would issue one if applicable. Otherwise, return of investment.

 

 

[FDNY]

To me it looks like he went out and bought a new non qualified annuity, he doesn't have a non qualified deferred compensation plan for the highly compensated (not us).

IRS is strict on this, yes it's your own funds, but since you have the benefit of deferring earnings they place the early withdrawal penalty on these.  I wish there was a free lunch in this.

[FDNY]

47 minutes ago, Catherine said:

But it's not a "non-qualified plan" in that those are usually for highly compensated employees.

He took life insurance money, not retirement funds, and bought a contract for future income.  By withdrawing funds, he is not using retirement funds early.  It's more like a Roth distribution of principal (but not subject to Roth 5-years-in rules).  The only penalty should be from the insurance company according to their contracts.  In fact only any growth withdrawn should be taxable income; the rest was non-taxable life insurance proceeds.

Sorry, I meant non qualified annuity.   I had wine for dinner, I mean with dinner, I forget.

[MDEA]

If this was life insurance money the only tax is on the money the annuity made. You are not taxed on removing your own money. Since it was only in 2 years how much could it have made. Look at the contract to make sure this was not 401k money.

[SaraEA]

Agree with MDEA.  If this was life insurance money invested in the annuity, it was after tax money.  Only the earnings should be subject to penalty.  This should be apparent in box 2 of the 1099.

[Max W]

The tax questions aside, annuities are always subject to withdrawal penalties in the first six to eight years.  This protects the insurance company so that it can recover the commission paid to the salesperson.  Let's say the commission was 6%.  Then the penalty for withdrawal in the 1st year is 6%; 2nd year 5%, and so on.  After the 6th, no penalty.

[FDNY]

8 hours ago, SaraEA said:

Agree with MDEA.  If this was life insurance money invested in the annuity, it was after tax money.  Only the earnings should be subject to penalty.  This should be apparent in box 2 of the 1099.

This is true but the first monies to come out may only be the interest as LIFO basis is required.    All of it could be taxable and subject to the 10% penalty.  2 years of interest even at 2% is way over his withdrawal amount.

[MDEA]

What 10% penalty it is not deferred money?

[Abby Normal]

Most distributions (both periodic and nonperiodic) from qualified retirement plans and nonqualified annuity contracts made to you before you reach age 59½ are subject to an additional tax of 10%. This tax applies to the part of the distribution that you must include in gross income.

Additional exceptions for nonqualified annuity contracts.   The tax does not apply to distributions from:

• A deferred annuity contract to the extent allocable to investment in the contract before August 14, 1982,

• A deferred annuity contract under a qualified personal injury settlement,

• A deferred annuity contract purchased by your employer upon termination of a qualified employee plan or qualified employee annuity plan and held by your employer until your separation from service, or

• An immediate annuity contract (a single premium contract providing substantially equal annuity payments that start within 1 year from the date of purchase and are paid at least annually).

[SaraEA]

"This tax applies to the part of the distribution that you must include in gross income."  And what part is that?  Taxman, what does Box 2 of the 1099R show?  That amount is subject to penalty.

[TAXMAN]

Thanks to all. 1099r shows all taxable and a code 1d in box 7. I looked at the statement that the TP brought in last night. Annunity earned about twice as much as being taxable. My understanding with the help from everyone tp is in no mans land and no place to run and hide. If only he had waited about 4 more months. Oh well can't undo what he already did.

Any way thanks to all who helped as differed annunities have their own set of rules.

[Catherine]

4 hours ago, TAXMAN said:

Oh well can't undo what he already did.

Ain't that the truth!  We can't save our clients from themselves, sigh.  If only they would learn to ask FIRST.

Maybe we should send RitaB to hug them all...   

[FDNY]

These situations are always tough, because when a client really needs the money and they don't realize they could lose nearly half of the withdrawal due to Fed & St taxes and penalty it is really depressing to them when we tell them the reality.

The sales people should tell them what could happen, and to be sure they have plenty of money in reserve, especially in the early years of the contract when mostly interest is paid out.    But I am sure it may only be mentioned briefly or not at all, why jeopardize a sale and a larger commission.  Those are the people who need Rita's special hug.