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Making Lemonade with an Old Annuity

Making Lemonade with an Old Annuity

August 18, 2020

I’ve just recently been reminded of an update we did a few years back for a client. He came to us from several transactional relationships with “advisors” and had investments scattered everywhere. Of those investments he had one really old annuity that had drastically increased in value since he originally purchased it back in the early 1990s. Without doing anything different this annuity would have caused him extreme taxation when he began to take withdrawals from it, and his account value was vulnerable to market drops for both his withdrawals and his death benefit.

Annuities often get bad press, which is really a shame because there are many benefits that can only be offered by an annuity. You will see how we made some lemonade out of the lemons he had walked in with.

Let me paint the picture for you. Let’s say the annuity he walked in with was originally started with $100,000 and he’s been lucky enough to have $400,000 of growth on that account making his account total $500,000. This isn’t a bad situation to be in, but let me show you a few looming issues imbedded in this situation:

  • He didn’t have any long-term care insurance, which could easily liquidate this account if he had to start making taxable withdrawals to pay for care. The average annual nursing home cost in the Madison, WI area is $115,416 per year.1 That means he would need to withdraw as much as $137,194.76 from this account just to get the net of $115,416! Now that’s assuming he is lucky enough to stay in the 24% tax bracket, but making significantly large withdrawals of that size often could bump you up into the next tax bracket, making that even more of an extreme number.  


  • He didn’t have a way to spread out the tax ramifications triggered from withdrawals. This may surprise you but annuity withdrawals are generally set up to start withdrawing gain first (which is all taxable). In this situation the client would be stuck making many years’ worth of taxable withdrawals before he would finally reach the tax-free principal.


  • His account had a very low minimum death benefit. Most annuities have an added insurance benefit that pays beneficiaries a death benefit of the higher of either the account value or the amount invested in the account (less any withdrawals). In this case, his account value was drastically higher than his original purchase payment, so if the account were to drop in value significantly his death benefit will drop, too, down to as low as $100,000.

Fortunately we were able to easily solve these problems tax-free by using a part of the tax code called a Section 1035 transfer.  We ended up splitting the account into two separate plans, both annuities but serving different purposes.

The first account we moved him to was a hybrid annuity featuring investment growth potential as well as tax-free leverage that covers long-term care costs. The second account was invested in the market for gain with a patented income rider that spread his taxable gain over each withdrawal payment. Another feature of starting a new account is that his new starting account value became his minimum death benefit.

Visually, the strategy looked like this:

Now, fast forward a few years and know that this same client would be unable to do this same strategy now, if we had to do it all over again. He’s since had medical emergencies that would make him uninsurable for the long-term care program. In other words, depending on your situation, there’s no time like the present to get organized and be proactive. A 1035 exchange is not suitable for everyone.  There are a number of factors to consider.  If you have an old forgotten annuity that is not made up of retirement monies (like an IRA of sorts) we can potentially solve similar issues for you. In my experience, I often find little lurking “time-bombs” in new client’s portfolios and we work to diffuse them and sometimes even improve on them.


1 Genworth Cost of Care App. Madison, WI. August 12, 2020.