Dump down annuities. We’ve rarely been a fan of variable annuities. They generally have high fees (because of the internal expenses), surrender charges, and more importantly, they turn capital gains and qualified dividends into ordinary income. In fact, when you die, the gain in an annuity is taxed as ordinary income to your beneficiaries, as opposed to the step-up in basis heirs get from appreciated assets which results in zero income taxes. Lately, with the big market declines, we’re seeing two situations that present a nice opportunity. The first is when you have a variable annuity that has declined significantly and the death benefit has also declined (VA’s will sometimes set the death benefit at the highest market value: we tend to leave those alone). An example would be a variable annuity that you bought for $30,000, went up to $52,000, and then went back down to $29,000 (and the death benefit went down to $29,000). You can cash it in with no tax consequence. You could then re-buy the exact same mutual funds that the variable annuity had and get the full value of recovery. Actually, you’d get a higher value of recovery because you wouldn’t be paying the insurance company fees. Oh yeah, and now the appreciation is taxed at capital gain rates instead of ordinary income rates. Oh, and no surrender if you want to get out of the investment and buy a cruise or a boat or a cup of coffee.
The second scenario involves equity indexed annuities (which we really didn’t like) that have reset their cash value to the last year’s index value. Here the solution is simple: If you have a guaranteed cash value at last year’s index value (which was higher), you can cash in the annuity, even paying the surrender charges, and be up dramatically from current market levels. It will probably will take quite a while to get back to last year’s value, so this option would let you cash in the indexed annuity and buy an index. Now the gain is capital gain, rather than ordinary income. Oh, and now you actually get the dividends paid by the index. Oh, and no annuity fees. More importantly, most index annuities cap your percentage gain in any given month, so when the markets recover you may not participate fully in the recovery.
Take IRA distributions in- kind in declined equities. This is a fascinating opportunity that presents itself in this ugly market. You can take an IRA distribution in specific securities. If you have a stock or fund you really like, you could take the distribution in that security and reap any future appreciation as a capital gain, having taken the IRA distribution at the lower fair market value. If the stock goes down, you could at least deduct the loss. Here’s an example: Suppose you held some GE stock in your IRA and you were over age 70 ½ and are required to take minimum distributions. If you took your distribution in GE stock, you’d receive the shares (or transfer them into your trust account or whatever. You would now have GE stock and receive the dividend (which is pretty nice) at preferential dividend tax rates (for now at least). Any appreciation would be at capital gain rates (which will likely stay lower than ordinary rates in any case). If GE goes down further and you sell it, you would get to deduct the loss.
Use in-kind distributions for Roth conversions. Similarly, but not quite as compelling is to take individual securities and convert those into a Roth. This basically entails identifying the securities you want and getting them into your Roth IRA conversion. In the above example, you could take the GE and put it in another IRA and convert that to a Roth IRA (pending income limitations or 2010). Now your GE appreciation and dividend are tax-free, and you paid a very small amount of tax to get it into the Roth.
Know anyone at Ford or GM? If you know anyone at Ford or GM with company stock in their 401(k) plan (called the SSIP, SSPP, TESPHE, or PSP), they may be able to use this one. If you’re retired or over a certain age, you can make withdrawals from the plan. If you own company stock (GM or Ford stock), you can take that out and pay tax on the lower of cost or market. With the automaker’s stocks in the toilet, the market value is lower. So if you had 10,000 shares of Ford and you took it out and it was all-pretax, you’d pay tax on about $19,000 (assuming the price is $1.90). If Ford goes up to $6, you have a capital gain of $41,000, which would be a lower tax rate than if you left it in the plan. If Ford went down and you sold it, you have a capital loss that you could deduct against your regular income. Stock goes up, you win with capital gains, stock goes down, you at least get a subsidy for the loss, that you would not get if you left it in the plan.
There you have it. 5 more rounds of Bear ammunition. Feel free to pass along these tips to your friends and co-workers. In our next blog/communication installment, we’ll be looking at past recessions and bear markets. Stay tuned!
Suzanne Antonelli and your team at LJPR