Investment account annuitized?

Hi, Steve.

Annuities require us to adjust our mindset. They are not really mysterious, but they involve concepts that most of us never think about, so we have to adjust our thinking when we are confronted with one.

You probably got a pile of paper explaining all the details, but those papers may be hard to interpret. Much of it is technical, and we can't even guess at the details without knowing what is in those papers. For example, we don't know who gets the annuity check if you die before the "10 years certain" is up: your spouse or some other named survivor or a charity or your estate. We don't know your age or your life expectancy. We don't know if you are married, or if your wife (or some other survivor) will collect the annuity for some period after your death, and the age of that survivor. All those factors are important.

Even when we know all those facts, we still need to figure out how to record it in Quicken. And how to report it on your tax return - both for this year of conversion and for each future year as you collect the benefits. For

In the simplest view, you sold your investments and now must reckon with any gains or losses on the disposition (after recording the current year's transactions before the disposition). Then we need to record your "purchase" of the annuity. And then we need to calculate how much of each future check received will be a partial return of your "investment in the contract" (not taxable) and how much is a gain (taxable) in the nature of interest, although it won't be called that. If the payout period is based on your life expectancy, you will need to consult IRS-approved charts to make such calculations.

I've been retired too long to remember all the annuity rules off the top of my head, and I no longer have a tax library to look them up. Heck, the rules I can't remember might not be worth remembering anymore, anyhow. :>( But there are some well-established formulas for allocating future receipts between the taxable and non-taxable portions.

I'm not familiar with the term GRIP. There may be a tax code section that allows special treatment of any accumulated gains when annuitized, but I am not aware of any such provisions.

Perhaps all those details are in the papers that you probably received - or maybe not, if your fund/annuity company is lax in helping you understand the situation. Do you have a local CPA who can help you with this problem? If you can spell out the details, the tax experts in the newsgroup: misc.taxes.moderated may be able to help you.

It is probably not as complicated as I'm making it sound, Steve. Trouble is, when we don't know the facts, we have to imagine all sorts of "what ifs", most of which you don't really need to worry about. Once we know the actual situation, we can discard all those contingencies and concentrate on just the real facts. If you give us more details, I'll try to help, but I can't promise that I'll actually be helpful. Maybe someone more familiar with current annuity and tax rules will jump in.

RC

RC,

Thanks for responding. Now that you said you're not familiar with the term GRIP, I pulled the original paper work out. The account was with Manulife and they were bought out by John Hancock. I didn't realize or had forgotten the account was an annuity investing in their family of funds and not truly an investment account. GRIP, "Guaranteed Retirement Income Program", when I opened the account for $30k, I had an option to purchase a GRIP which cost a quarter point annually that guaranteeing the original amount at a 6% growth rate. It required a 7 year holding period to pay out.

I bought it in the height on the dot.com period, it dropped like a rock and never recovered. Of my $30k, when I just annualized it, the funds cash value was only $21k. However, the GRIP value was $45k with the 10 year certainty. The account also had a guarantee $30k payout as an insurance policy until cashed. Cheap insurance and that's why I held on to it this long.

At this point, I don't have the foggiest idea on how to properly migrate the account in Quicken as a fixed cash stream. It might be as simple as leaving it as an investment as is and just transfer the monthly check to checking account. But at some point down stream it will become a negative balance. And that doesn't seem right. The other idea I had was to transfer the cash balance over to an asset account and pay it out from there because I could inflate the balance some how. As you can see I'm just guessing. As for rolling it into taxes, distribution, capital returns I'm even more lost. I haven't found any clear explanation on how to deal with this.

I would appreciate and advice you might have.

Thanks,

Steve

Hi, Steve.

That still doesn't ring any bells, but your description reminds me of the "Universal Life" policy that I bought in the late '80s by converting my ages-old whole life policy from John Hancock. Its guaranteed-yield feature kept it from dropping too badly in the early 2000s, and I actually had a small gain when I cashed it in last year.

My situation is somewhat the reverse of yours: You sold investments and bought an annuity. I sold my life insurance policy, which I could have annuitized.

In the 1970s and '80s, I taught courses to other CPAs on the taxation of annuities and other estate planning subjects. A couple of my favorite topics were Federal Estate and Gift Taxes, and Federal Income Taxation of Estates and Trusts. But those topics are so complex and change so often that you don't want to rely on advice from someone who is even one year out of date, and I'm over 15 years behind now - and getting more obsolete all the time.

An "annuity", of course, is a stream of annual payments; these days, most are actually paid monthly. An annuity based wholly or partly on the life expectancy of one or more people is a form of life insurance, even if it is not called that. The "expected return" of the annuity must be calculated from tables based on actuarial statistics showing how long a 65-year-old (for example) might be expected to live - and to collect payments. If there is a named survivor, then the tables get more complicated to recognize that the "survivor" may or may not survive the original annuitant, and may or may not survive for a long time. The expected return must be compared to the "investment in the contract" (generally equivalent to the "cost" or other basis - the total premiums paid over the life of the contract). The ratio of the expected return to the investment determines the "exclusion ratio": how much of each payment received is essentially a non-taxable return of capital and how much is taxable income that must be reported annually.

Here is Example 1 (the simplest) from the latest reference work I have on this subject, which is the 2000 edition (for 1999 returns) of the U.S. Master Tax Guide from CCH (Commerce Clearing House) (as reformatted by Windows Live Mail):

In 1999, X purchases for $8,000 an annuity that provides for payments to him of $50 per month for life. At the annuity starting date, his age at his nearest birthday is 64 years. Table V (gender-neutral) must be used since all investment in the contract is post-June 1986; it shows that for an individual of X's age, the multiple to be used in computing the expected return is 20.8. X's expected return and annual exclusion, therefore, are computed as follows:

Annual payment ($50 per month X 12 months) $ 600 Table V multiple

Annual exclusion (64.1% of $600) $ 385

CCH points out that you'd get the same annual exclusion ($385) if you just divided $8,000 by 20.8, but that doesn't fit all cases.

So, X would report $215 ($600 - $385) as taxable income each year.

In your case, Steve, you must first calculate the gains and losses on the investments you sold to generate the cash to buy the annuity (after recording 2007 dividends and other transactions to the liquidation date). Then record the purchase of the annuity. The purchase does not need to be reported to the IRS, but you'll need to determine and record the numbers for future reference.

In your books (or Quicken), you could simply record the purchase of the annuity in a new Asset Account, called something like My Annuity. Then, when you start receiving the annuity payments, you can make a single split entry for each check. For Mr. X in the example:

Cash $ 50.00 My Annuity (64.1% of $50) $32.05 Annuity Income 17.95

Eventually, if you live long enough, the Annuity account balance will drop to zero. Thereafter, the whole monthly check will be taxable. If you die before the balance reaches zero, the balance will be deductible on your final income tax return.

These are only a few of the rules, Steve, and neither my memory nor my references are current, so please check with your own CPA before you file your 2007 tax return.

RC

RC,

Thanks, I was on the right track but didn't know the reason why. I'll get hold of my CPA to work out the details. While I understand the concept of what you are saying the actual number crunching requires more than my lay knowledge. And I don't believe your getting more obsolete as time passes. Your a great knowledge base for us, the lost...

Steve