Print

Email story

Comment

Letter to the editor

Columns

Annuities are tax time bombs

When Keith and Dolores Cutler sold one annuity and bought another last year, they thought they were doing a tax-free exchange that would give their income a boost without increasing their taxes. Then they got the bad news that they would have to pay income tax on nearly half the $71,267 they took out of the old annuity.

By Helen Huntley, Times Personal Finance Editor
Published March 9, 2008

Keith and Dolores Cutler, here working their booth at the Wagon Wheel Flea Market in Pinellas Park, say an insurance agent and misled them on the tax-free transfer of money from one annuity to another.
	[Lara Cerri | Times]

When Keith and Dolores Cutler sold one annuity and bought another last year, they thought they were doing a tax-free exchange that would give their income a boost without increasing their taxes. Then they got the bad news that they would have to pay income tax on nearly half the $71,267 they took out of the old annuity.

The costly lesson: Annuities are tax time bombs that require careful handling.

The New Port Richey couple was shocked to learn that taxes would be due on an extra $32,994 in unexpected income. They blame bad advice from their agent, Gregory Cates, 38, of Ameri-Life & Health Services.

"I'm concerned about having to pay these taxes, but I'm also concerned that he is doing this to other people," Cutler said.

Cates said he was "not at liberty to make any comment." The Florida Department of Financial Services said his record with the state does not show any disciplinary actions.

The Cutlers, who are 74 and 76, owned a motel in Michigan before retiring to Pasco County. Now they earn a little extra money selling pet ID tags at flea markets.

They met Cates in 2006 over pizza at a seminar he presented to attract new customers to a Medicare HMO. They signed up for the HMO, and when they had a problem they couldn't clear up with customer service, they went to Cates for help.

"He was such a nice young man, so personable," Mrs. Cutler said. "He really gained our confidence."

When Cates told them he sold annuities as well as HMOs, they were happy to listen to his pitch. Their old annuity was parked in a money market account earning just 3 percent interest. Cates was touting an index annuity with American Equity Life Insurance that paid a 10 percent bonus and promised returns tied to the stock market.

"He talked me into taking surrender charges" that turned out to be $2,573, Cutler said. "But I thought in the long run I'd be way ahead."

That was before he got the tax bill.

Annuities are investments inside a tax-deferred wrapper - no taxes are due on investment earnings until the money is withdrawn. Over time, interest earnings can grow to be more than the original investment, building up a substantial future tax liability.

The law allows you to swap one annuity for another without incurring income taxes by using what's known as a 1035 exchange. However, the old insurance company has to send the money directly to the new one for the strategy to pass muster with the IRS.

The Cutlers say Cates told them to get a check from the old insurance company, deposit it and write a new check for the new annuity. That counted as a withdrawal and triggered the tax.

The Cutlers say that after Cates got their money, he wouldn't meet with them; he broke two appointments before they even knew they had a tax problem. They have spoken to a manager at the insurance agency and complained to the state.

The Cutlers' experience offers a reminder that annuities and retirement plans require special handling. Before you take an action you can't take back, it's worthwhile to get a second opinion from someone with tax expertise. Or at least do some research. Salespeople aren't the best sources for important tax advice.

Annuities and taxes

- Taxes are deferred as long as the money stays in the annuity.

- When an annuity is purchased outside a retirement plan (with after-tax dollars), withdrawals are partly taxable/ partly tax-free return of principal.

- Withdrawals are taxed as ordinary income, not capital gains, even when they are invested in stocks.

- Taxes may continue to be deferred in a direct annuity-to-annuity transfer between companies, known as a 1035 exchange.

- An heir who inherits your annuity is taxed the same as you would be. There is no step-up in basis at your death.

[Last modified March 7, 2008, 22:35:20]