by rlenich » Mon Aug 02, 2010 02:08 pm
my husband has an endowment due, he is age 65. Ins.Co. wants us to convert to an anuity. Policy states we can convert the original amount $5K to whole life policy. the taxable gain is $6643. Maturity value is $8,140. If he converts to $5K whole life and takes the balance in cash what are tax liablities?
$5K endowment policy
Taxable gain $6642
maturity value$8K
$5K endowment policy
Taxable gain $6642
maturity value$8K
Posted: Wed Aug 04, 2010 09:25 pm Post Subject:
Is the conversion original issue age or attained age? If original I don't see where there would be a premium change, especially if conversion option is for a CSO 2001 policy since endowment on the whole life contract would be set at age 121. Even if a CSO 1980 policy then endowment on the whole life policy is age 100.
If, however the conversion is for actuall age, then there's the potential for an increase in premium requirement from you. Here's what you'll want to look at. Whole life policy type, if converting to a participating (means it pays dividends) policy and keeping some of the money in the new policy (you'll have to remove some otherwise you'll have a modified endowment contract, which is different from your endowment contract) you'll likely be required to pay higher premiums, but you'll be able to keep the taxable "growth" part of the endowment contract in the WL policy since you can draw your basis out of the endowment contract first. You'll need to decide if the new premium seems worth it to you. Careful on conversions at original issue age as these also have a tendency to create modified endowment contracts.
With respect to the annuity option. You'd be performing a 1035 exchange and preventing yourself from owing any taxes on the gain. You'd lose the death benefit, and the money would sit inside the annuity, which will increase at whatever the rate of interest in the annuity is (unless we are talking about moving it to a variable or indexed annuity where it will be subject to investment performance or moves in a stock index respectively).
Moving it to a life insurance contract means potential avoidance of ever having to pay taxes on this money. Moving to an annuity means preventing taxes owed now, but having a taxable event at death--death benefit on an annuity is taxable beyond your basis at death.
Alternatively, you could just let the contract endow, collect the money, and pay taxes on the $6642. Time is likely of the essence here since the insurance company will have to pay out the benefit (endow the contract) once that date comes.
Posted: Thu Aug 05, 2010 06:44 am Post Subject:
Well BNTRS, this is certainly a fine explanation from you. Am I right if I see considerable risk while moving it to a variable or indexed annuity? I'm not sure if it would be wise for a senior citizen to depend on the investment performance (perhaps you could explain that too). Also, I'm confused if it would be good for the beneficiary to have a death benefit that's taxable beyond the insured's basis after death.
Posted: Thu Aug 05, 2010 05:03 pm Post Subject:
A variable life policy is potentially an unsuitable choice of options, as would be a variable annuity. Depends on your experience as an "investor" and a complete understanding of the products and their inherent risks. All life insurance/annuity products provide protection against "current income taxation" while the money remains in the contract. Cash value life policies (not annuities) permit loans which can be received without a current tax liability, but could eventually lead to a taxable event if the policy later lapses.
As I responded to your identical earlier post in a different thread, if money is placed in an annuity, there is no way to receive money from the annuity without a taxable event, and this includes the taxation on death benefit proceeds to a beneficiary in the event the owner dies prior to the contract being annuitized. The taxable amount would really only be a problem for the beneficiary if it caused them to be moved up into a higher tax bracket, thereby subjecting ALL of their income to the same tax rate. Otherwise, a small portion of the payment would be used to pay the additional tax the benefit creates.
If your principal concern is avoiding income taxation (which I get the sense it is), then a 1035 Exchange to another life policy would probably be the proper decision, since the eventual death benefit, even if derived from positive performance in an insurer's separate account, would not be subject to income taxation.
The choice of product -- whole life, universal life, indexed universal life, variable universal life, or variable life insurance -- depends on what you would want the policy to be able to do beyond providing a death benefit, and your ability to do what it takes to make that happen (managing the policy).
Traditional whole life insurance merely requires that you pay the periodic premium. All other policies require a greater degree of policyowner involvement in making sure the policy does not lapse. Only the so-called "no lapse guarantees" mitigate against that role, but still require that 100% of the periodic payments are made on time and without fail.
Posted: Thu Aug 05, 2010 10:10 pm Post Subject:
Am I right if I see considerable risk while moving it to a variable or indexed annuity?
A variable annuity yes, an indexed annuity not so much. Indexed annuity will have, most likely, significantly higher surrender charges (charge assessed if taking out more money than the free withdrawal--usually between 10 and 20% of account value--during the first 5 to 15 years--in some cases as many as 20).
The indexed annuity will ensure principal preservation whereas a variable annuity will not. A regular fixed annuity will also preserve your principal with usually lower surrender charges and definitely higher guarantees on credited interest year over year.
A surrender charge of not more than 10% and lasting no longer than 10 years is usually a good contract.
A Flexible Premium Deferred Annuity might also be desired since it allowd additional payments to the annuity. The alternative is a Single Premium Deferred Annuity which can only take one payment. If going the indexed route, the singe premium deferred annuity will have a higher guaranteed rate due to forfeiture laws.
I'm not sure if it would be wise for a senior citizen to depend on the investment performance (perhaps you could explain that too).
This really depends on how much risk you want your money exposed to. You are currently in an endowment contract, which is one of the lowest risk contracts (formally) available for your money. Moving to a variable product is quite a shift in risk exposure.
Also, I'm confused if it would be good for the beneficiary to have a death benefit that's taxable beyond the insured's basis after death.
Not having to pay taxes would likely be more ideal. The taxable portion would be increase over your basis (what you actually contributed to the policy) which would be paid by the beneficiary. Also, would be paid by you if you surrendered the contract (cashed it in) or began taking money out of it (you have to take out the interest first before you can take out basis in an annuity, so the reverse of a life contract). You will have to decide which you like more.
Usually participating whole life insurance will outperform the credited interest on an annuity, but you'll have to be ok with a requirement to continue at least some premium payments for the next couple of years.
Or, you could intentially create a Modified Endowment Contract by moving the money into a small death benefit whole life contract and immediately use cash surrenders to pay for premiums and eventually use dividends and cash surrenders to continue paying premiums (any life company can run a calculation ot project if it is possible at varying death benefits for the amount of cash you have in your current endowment contract). But note, this is not guaranteed and could require additional premium payments at some point in the future.
You could also look for a single premium whole life contract, which would also be a modified endowment contract but would require not additional premium payment from you. The death benefit paid on the modified endowment contract would be tax free, but money taken out of the policy would be taxable just like an annuity (money taken out by you, a beneficiary would receive a tax free death benefit).
Posted: Fri Aug 06, 2010 04:27 am Post Subject:
Or, you could intentially create a Modified Endowment Contract by moving the money into a small death benefit whole life contract and immediately use cash surrenders to pay for premiums
Although he mentions taxation in his second paragraph about MECs (you might think it doesn't apply in the first instance), I'm sure it was merely an oversight on BNTRS' part not to mention that when any MEC is created, regardless of how additional premiums are paid, there is no way to unwind it. The policy will always be a MEC. This means that there will be a taxable event any time money is taken from the contract (like an annuity, the gain must come out first, and is taxable as ordinary income -- because your husband is past age 59-1/2, there is no early withdrawal penalty tax).
The only difference in taxation between an annuity and a MEC, and the reason you might consider the MEC vs. an annuity, is the death benefit, which as BNTRS stated, is not taxable when paid from a MEC.
All of his information is on target. If the intent is to leave money for heirs (one or more), then the most favorable way is from a life policy of some kind rather than from an annuity.
If the objective is to have money to use as if it were income to your husband, then the annuity may make more sense, since it is the only product that can promise a lifetime of payments. Life insurance only works as long as there is money in the contract, which is also true of an annuity if it is not annuitized.
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