Inheritance Annuity Options

[larrybr45]

Hello, we received notice of an annuity benefit as beneficiary for an uncle. The amount is $52000, of which taxes have been paid on $14000. My wife is 47.

There appears to be 3 options...The current product is an annuity with a 5% guaranteed rate, no annual/monthly fees.

1.Lump sum check is sent to us, we pay Fed. and Michigan taxes as witholding I assume and annuity is closed. This will throw us into a much higher bracket but we get all the funds now.

2. Income option Election. Choose equal or period of time for payments to annuitant.

3. Systematic withdrawal option, she mentioned only as a Non-Qualified annuity. They will keep current annuity in place, and pay out mandated IRS withdrawals each year. We will pay taxes only on amounts withdrawn. It will continue at 5% earnings. Any amounts can be withdrawn at any time with no penalty so if rates rise a lot or we need money we can take out.

Any suggestions for sorting through these options?

[jpg7n16]

First off, I'm sorry for the unfortunate circumstance with your uncle. Never a good way to come into money.

To evaluate what you should do, it'd be better if we could get more info about the financial situation you are in.

• Do you have any CC debt? Other high interest rate debts?
• What does your retirement savings picture look like?
• How much wiggle room is there each month in your budget?
• What is your investing experience level?
• Regarding investment risk, would you say that you are super conservative, conservative, moderate, aggressive, super aggressive, or somewhere inbetween two of those?
• What would be your income without the lump sum withdrawal?

Those questions will help us see whether your needs favor the lump sum withdrawl, or the systematic withdrawals.

You always have the option of only withdrawing the amount that keeps you below the next bracket. Though just so you know, the brackets are marginal: meaning they don't apply to your entire income, only to the portion above where the bracket starts.

A lump sum withdrawal would only add $38k to your income - so you may only move up one bracket, if you move up one at all.

You are likely married filing jointly, so see the effect to your bracket here: Tax Brackets 2011 | taxbrackets2011.com


You can also effectively shift a portion into a retirement account if you haven't maxed out your contributions this year, and weren't planning to. More about that later if it's relevant to your situation.

[larrybr45]

We have $0 credit card balances, $11k in home equity, 60k mortgage.
We have maybe 350k in 401k's
There is a little wiggle room in monthly budget
Above average investing experience
Risk tolerance - for these funds likely conservative. Our 401k's are in stock funds
Income would be about $97 (taxable as we max out 401k's)

thanks for the review

[danieldroga]

From what country are you in? There might be some rules on countries policy towards that.

[larrybr45]

USA, state of michigan

[sandrark]

Why do you think you'll owe taxes on the inheritance? Taxes are paid by the estate, not the beneficiary....

If the answer is that the annuity has penalties for distribution linked to age, then I'd leave it be to avoid a 40%+ tax hit....

[jpg7n16]

Why do you think you'll owe taxes on the inheritance? Taxes are paid by the estate, not the beneficiary....

If the answer is that the annuity has penalties for distribution linked to age, then I'd leave it be to avoid a 40%+ tax hit....

Because the recipient of the inherited annuity is responsible for paying income taxes on withdrawals.

When taxes are inherited

We have $0 credit card balances, $11k in home equity, 60k mortgage.
We have maybe 350k in 401k's
There is a little wiggle room in monthly budget
Above average investing experience
Risk tolerance - for these funds likely conservative. Our 401k's are in stock funds
Income would be about $97 (taxable as we max out 401k's)

thanks for the review

IMO - this is how I view your factors.

No substantial debt, no high interst debt - lowers urgency
Good retirement savings, and high contributions - lowers urgency
Maxing 401k, and still having a little wiggle room - lowers urgency
Average investing experience - no real effect + or -, so neutral
Lower risk tolerance - tilts toward a secure annuity as opposed to self-directed investment
Income level puts you in the 25% bracket, and with deductions, would likely remain in the 25% bracket even if took lump sum withdrawal - favors withdrawal

Something you may consider would be your outlook on future taxes. If you expect rates to go up in the next few years, that would increase the urgency for a withdrawal.

Given the above, if I were in your shoes I would withdraw $10k/year and fully fund your Roths. That would keep me with a conservative tax-deferred investment for the next few years, and also maximize my retirement savings.