Seek Advice On Large Variable Annuity Contracts

By Terrence R. Gaertner

For those of you who are variable annuity contract holders, the life of your variable annuity contract can be divided into two phases.

First there is the accumulation phase. This is where you invest into the variable annuity (either with after-tax money, which is a "non-qualified" annuity or with qualified plan monies, which is a "qualified annuity) and the interest, dividends and capital gains all grow tax-deferred until withdrawn. There have been volumes written about the accumulation phase of annuity contracts.

In this article, I would like to explore the second phase of variable annuity contracts, the withdrawal phase.

Most investors understand the tax-deferred accumulation phase of variable annuity contracts but few understand all the options available for withdrawing monies out of the contract at retirement time.

When it is time to start withdrawing monies out of your variable annuity, you need to think about what type of income you need and for what period of time you need it. There are two basic choices that you have.

First you can choose a lifetime income option. This is called "annuitization." Most variable annuity contract holders who choose the lifetime income option select one of three approaches. You can choose a fixed option. This will pay you a monthly income that will never change and will continue until you die. That being the case, you need to assess your health when making this decision.

If you have a terminal illness, for example, the lifetime income option will not make sense. This option may make sense if you are in reasonably good health, and you would like to guarantee a fixed amount of income to cover your fixed expenses. The older you are when you "annuitize" the contract, the higher the fixed income payments will be. The downside of this option is that there is no protection from inflation and that once made, the decision is irrevocable.

Option two under the lifetime approach is to set up a variable income stream. This ties your income to the performance of the investment sub-accounts within the variable annuity. But because the value of the funds fluctuate, the amount you will receive will rise and fall. You still have the option with this approach to change your investment choices within the annuity contract.

This approach will give you a rising income stream in rising markets and a declining income stream in declining markets. You can always convert a variable income stream into a fixed income stream. However, a fixed income stream can never be converted into a variable income stream.

The third lifetime option allows you to blend the fixed and variable payments. This will give a stable base of income and a portion of your income will be tied to the market's performance.

The other basic withdrawal option in a non-lifetime based option permits you to take periodic withdrawals as you need to or set up monthly withdrawals that you can change in the future.

There are also tax differences to the withdrawal options if your annuity contract is a "non-qualified" contract (ie: funded with after-tax monies). If you utilize the lifetime income approach, part of each withdrawal is considered a return of your principal and that portion is not taxed.

If you utilize a non-lifetime income approach, all of the withdrawals are considered taxable until you have withdrawn all of the "gain" in the contract. Only then are the withdraws considered return of principal and therefore non-taxable.

If you have significant balances built up in your variable annuity contracts, I recommend that you seek the advice of a professional financial planner who specializes in retirement planning before making any withdrawal decisions. The decisions that you make will be far reaching and may be irrevocable.

#

Terrance R. Gaertner, CPA and CFP, is president of Chicago Financial Advisors. He is a member of Certified Financial Planners and the International Association for Financial Planning. He has been admitted to the Registry of CFP Practitioners and is one of less than 500 advisors who have earned a Master of Science degree in Financial Planning. You can reach him at 773/327-8200.