After dealing with great amounts of frustration and an inability to arrive at concensus regarding a critical accounting question, I've decided to move ahead and cash in my insurance policies with cash value.
As I've mentioned before, the majority of policies are variable insurance policies with mutual fund sub-accounts. Obviously not the most inexpensive funds at that. There is also a small whole life policy.
The great question was this:
If one of the policies with a cost basis of over $50k, has a cash value of $35k due to insurance and surrender charges, can I do a 1035 exchange into a low cost variable annuity. Let the new, better mutual funds grow until the $15k net loss is eliminated and then cash out the annuity with zero capital gains / taxable income.
My CPA and my friend's CPA have both insisted we will pay a 10% penalty for cashing out an annuity before the age of 59 1/2. The 10% penalty would erase most of the capital gains offset benefits. The insurance people I talked with disagreed - but it's the CPAs who have to sign off on my tax return. This one went to the CPAs, though I'm not happy with it.
I contacted the insurance companies and learned that if I cashed in all the policies, they would report about $1500 in gains, which are reported on a 1099 form as ordinary income. I'll owe about $600. Also, I'll lose the hypothetical, but unproven, capital loss.
In the end, I'll have about $70,000 in cash, freed from the expensive and opaque constraints of the variable and whole life policies.
My plans are to put the money in low cost balanced index funds at Vanguard until I resume investment planning with my investment advisor Summer 2007.
Even if the investments perform the same as within the variable insurance policies (which I doubt), the mutual fund fees will probably drop from 1.x% to 0.2 - 0.5%. Possibly a drop of more than 1% in expenses - huge difference over the next 30 years!
Most importantly, I'll be able to integrate the funds into my overall portfolio allocation strategy and rebalance as needed - though judiciously as they will be in a taxable account.
Regards,
makingourway
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2 comments:
You probably have already one more research than most, but I would just point to a few links for people in similar situations to consider.
You should evaluate the insurance portion for its insurance value, after all the fees/charges are somewhat front-loaded. This would especially be true depending on how long you want the insurancce.
You can have you current policy evaluated by the Consumer Federation of America at http://www.evaluatelifeinsurance.org You need a Current Illustration.
As for exchanging to an annuity, see http://www.glenndaily.com/bookstore.htm - He has a couple articles on cash value and annuity exchange (but a bit dated). Glenn also does fee consulting.
I don't know all your details, but I might do different than you:
The fees in an annuity can be minimized in one of the low-load annuities. You mentioned already the tax status, but since the annuity is tax deferred, take that into account when comparing options and growth. You can find a lot of recommendations for low-load annuities, like Vangaurd.
Also aren't your policies inside a ILIT? Not sure how to formally handle that but be sure it doesn't change the ownership of your other policies.
You mentioned in another blog entry at 20x income in policies for both you and your wife - That is a bit high in my book but might consider ways to reduce some premiums like a joint-life ("first to die") policy, which can have some drawbacks (i.e. how to handle after a divorce for instance). I also might consider tiering several policies (a 10 year with a 30 year, or something like that). I am a bit paranoid myself around insurance and have life, LTC, disability plus health, home, auto, umbrella plus travel and excess medical -- Scary number when I add all the premiums!
I am not an insurance expert so don't rely on my opinion.
It's foolish to question professional help but I always thought the 10% penalty on early withdrawal from variable annuity is 10% on the taxable amount, not 10% of the total withdrawal. If the withdrawal is below your cost basis, there is no taxable amount, and therefore 10% of zero is zero. Can you share what the CPAs said and clear up this misconception? Thanks!
TFB
The Finance Buff
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