There are a wide variety of variable annuities on the market. While the Planner does not have a section for variable annuities, as long as you know the value and taxation of the annuity the Planner's flexibility will allow you to account for your variable annuity in your plan.
Variable annuities generally are not taxed until you withdraw the money and the taxation will depend on how you made your initial investment and how you take withdrawals.
If you invested pre-tax or tax-deductible dollars (for example, if you bought the annuity within a 401k or traditional IRA), all of your withdrawals will be subject to income tax.
If you invested after-tax dollars, the earnings will be taxed as income, and the rest will be a tax-free return of principal. However, the way your earnings and principal are calculated depends on when you take withdrawals and how you take the withdrawals.
If you purchased an annuity with after-tax dollars, partial withdrawals in the accumulation phase are taxed on a last in, first out (LIFO) basis. In other words, withdrawals from an annuity are made earnings first, and the owner is taxed on the payments until all of the earnings have been distributed.
If you cash in the entire annuity for a lump sum you’ll have to pay income taxes on all of the earnings in one year. But if you withdraw some of the money and keep the rest growing in the account, your first withdrawals will be considered taxable earnings. Once you’ve withdrawn all of the earnings, any further withdrawals will be considered a tax-free return of principal. Your insurer will calculate the portion of principal and earnings for each withdrawal.
If you purchased an annuity with after-tax dollars, a portion of each annuity payment represents a return of non-taxable investment in the contract and the balance of each payment is considered taxable income in the annuitization period.
* If you are in the annuitization phase, you have the ability to set your cost basis to represent the percentage of the payments that will be taxed.
Accounting for a Qualified Variable Annuity as an asset in your Plan
If you invested pre-tax or tax-deductible dollars, enter the Variable Annuity as an Other Pre Tax account. The Planner will model RMDs on the account.
If you invested after-tax dollars, enter the Variable Annuity as an after-tax account using the steps provided below. This will not account for any Income tax or Capital Gains tax, it will simply allow you to include the account value in your plan and also model withdrawals from the account.
STEP 1: Navigate to MyPlan > Accounts and Assets
Add ➕ an Investment/Savings/Checking account
Select manual entry
Give the account a descriptive name, "ABC Variable Annuity," for example
Enter the Account Balance
Select Capital Gains as your tax treatment
Enter a Cost Basis above your Account Balance. This will ensure that there are no taxes applied to withdrawals.
Select your optimistic and pessimistic rates of return
Select 0 as your turnover rate
Your next step will be deciding whether to include this account in the Planner's default withdrawal strategy or model withdrawals using the Transfer feature in Money Flows.
Please reach out to the Service Desk if you need guidance modeling withdrawals or income streams from your Variable Annuity.