Tax consequenses of annuity surrender.?

My wife, age 56, is the owner of a variable annuity. My son, age 28, is the annuitant. The surrender charge on the policy is zero percent as of 2008.

What are the tax consequences of cashing in the policy? Would it be smart to wait until my wife is age 59 1/2? Thanks

Gary,

If this variable annuity is held outside of an IRA, which I will assume it is, then your wife would be paying a penalty to withdraw the money prior to 59 1/2 of 10% on top of the tax burden of the gains. Yes, it would be smart to wait until your wife is over 59 1/2.

If you don't like your current policy, but still like the idea of the Variable Annuity, you can do a tax-free exchange, which has been popular given the newer features of VAs issued in the last 5-7 years. Of course, you'd be subject to a new surrender charge, so this might not be an option for you.

If this is in an IRA, you could surrender the policy, but still keep it from being a taxable event by continuing to hold it in the IRA.

Editted to add - looks like somebody beat me to it. But you definitely can avoid the taxes if it is in an IRA as long as you surrender the contract without taking the proceeds out of the IRA, and that wasn't mentioned in the preceding response.

Michael
moneyguy976@gmail.com

First of all, it depends on whether the annuity is "qualified" or "non-qualified." Your quarterly statement will tell you. If it is qualified, meaning that it is an IRA, 402b or similar account, then all of the money is taxable as ordinary income and, in addition to the income tax, is subject to a 10% federal (and 2.5% California penalty, if you live in Calilfornia) penalty.

If it is a non-qualified annuity, then your wife has basis equal to the contributions to the annuity. The growth or earnings in the annuity will be subject to ordinary income tax and the early withdrawal penalty of 10%. The basis comes out tax free.

If your wife waits until she is over 59 1/2 to take the money out, she will avoid the 10% early withdrawal penalty.

Here are the exceptions to the 10% penalty:

1. Made after the annuitant turns 59 陆 years old
2. Made after the death of the holder
3. Attributable to the disability of the annuitant
4. Periodic payments (made no less frequently than annually) are 鈥?substantially equal鈥?and are made for the life or life expectancy of the annuitant

Your wife can begin periodic payments over her lifetime that will not be subject tothe 10% penalty. She must continue those payments until age 59 1/2 or for 5 years, whichever comes later. So she could begin payments now and then 5 years from now liquidate the annuity without incurring the 10% penalty. The payments now would be in the range of 6% to 8% per year but should be calculated by a professional.

Jim Kirby, CPA/PFS, CFP, CFS