Over the past decade or so, annuities have become an increasingly popular investment for IRA and Roth IRA owners. Despite the fact that there is no additional tax benefit to holding an annuity inside an IRA, many of today’s annuity contracts offer certain benefits or guarantees that appeal to clients.
Whether you recommend annuities to clients or not, annuities in IRAs pose some traps not found with other types of IRA investments, or not found as frequently. Advisors should know the rules in order to keep clients from being ensnared.
Using the Wrong Value to Calculate Roth Conversion Income or RMDs
IRA valuation is critical when determining clients’ required minimum distributions (RMDs), which are based on the prior year-end fair market value (FMV) of IRA assets. It is also critical for Roth conversions, because the resulting tax bill is based on the FMV of the IRA assets on the date of the conversion.
Valuing certain deferred annuities can be tricky, though. Many of the deferred annuities offered today have a number of different values associated with them, all of which may be important for clients to know about and understand. For instance, many annuities have an accumulation value which might represent the fair value of the assets held within the annuity (which might differ from the fair value of the entire annuity). There may also be a separate value tied to an added benefit, sometimes referred to as the benefit base or rider value. Neither of these values may be acceptable for an IRA valuation.
Example:
Ron holds a deferred annuity in his traditional IRA that, after a significant market decline, has an accumulation value of $20,000. Ron’s annuity also has a rider that promises to pay him $10,000 a year for life if he begins to take distributions from his annuity.
Clearly the annuity rider has some value in and of itself, so while $20,000 may be the maximum Ron can withdraw from his contract in one lump sum, it’s not the FMV of his annuity as a whole. In this case, it’s easy to see that the FMV will be some value higher than the $20,000 accumulation value. But how much higher?
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