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Why There's No Flowchart For Your Annuity Taxes · How to Retire on Time

• 0:00
  Mike: Hey, thanks for joining. Here's a question I was recently asked on my show, How to Retire On Time. Take a look. Let's go to our questions, David, shall we?
• 0:07
  David: Yeah. Okay. So here here's the question that's come in. Hey, is it better to fund an annuity with IRA money or your taxable money?
• 0:18
  Mike: Okay. So defining taxable real quick, if it's after tax money, you've already paid taxes on it. If it grows, typically you'll pay a capital gain tax when you sell it or when you realize the assets. If you pass it to your beneficiaries in normal investment environments, that's gonna be legacy, right? They get step up in basis.
• 0:35
  It's basically tax free to them. Okay? So like the money in your savings account. That's kind of what we're talking about when we say taxable or brokerage. So now that we have that definition, the answer is it depends.
• 0:48
  If you are looking for cash growth, so like chapter four of the book, How to Retire on Time, we talk about your reserves. If you're looking for growth with protection, I would typically favour your IRA assets.
• 1:01
  David: Okay.
• 1:02
  Mike: Not the Roth. Roth is long term, but IRA assets. You want to spend it down somewhat in the near future, ten to fifteen years at the latest. But annuities, a lot of people don't realise this, are taxed as ordinary income.
• 1:16
  David: Okay.
• 1:16
  Mike: So if it's in an IRA, it's not that big of a deal. Everything's taxed as ordinary income. It's a mechanism inside an IRA. But if you buy a bunch of annuities with non qualified assets and it grows, you're gonna pay ordinary income on something that you could have done long term capital gains with. That's a tax inefficiency.
• 1:36
  Right. And so net of tax, you might consider buffered ETFs in your non qualified, your brokerage funds for cash growth with protection. And you need the max buffers, by the way, to do this. So look for the ones that have 100% buffer in them. And then IRA is more on the annuity side.
• 1:56
  Now, we don't wanna say, well, I've got this much in this account, this much in that account. So I'm just gonna arbitrarily like, don't do that. Don't just go buy a bunch of these things. Plan first. Strategy second.
• 2:08
  Then you explore the right investments or products. Because sometimes the sequencing will influence what should go where and so on. But generally speaking, if you're looking for cash growth and control on your cash, IRA is gonna be on the indexed annuity side. Non qualified or brokerage can be on the buffered ETF side. Now, you're looking for lifetime income, that changes.
• 2:31
  This gets more complicated.
• 2:33
  David: Okay.
• 2:34
  Mike: So if you were to put, let's say 500,000, okay? Hypothetically into a non qualified annuity, and then you turned on income a year later. Okay, these are indexed annuities, for example. There's other versions like a SPIA, single premium instant annuity, and so on. There's different versions of this.
• 2:51
  But if with an indexed annuity, you put the money in, you get the payout for life. Okay? Your taxable income is a bit different. Some of it is quote unquote the basis, which will not be taxed. And then the other part is a calculation.
• 3:08
  This is line, or article 72 of the IRS code. So 72a, 72t, 72t, like there's all these different parts of it. But it says that you're looking at what is the expected growth of it or the returns of the lifetime income, and then they tax the top of it as ordinary income. That's a complicated tax conversation because you have to ask yourself, well what's your expected taxes gonna look like? Do you want the majority, it's usually the majority, the majority of it to be tax free with some of it taxes ordinary income.
• 3:43
  Does that push into a unfavorable tax situation? Does it not? Does it open up you to do more IRA to Roth conversions because the majority of the basis is tax free? You have to ask all these other questions of what are the other strategies you may or may not want to do in that moment. Sometimes it makes sense to do IRA for lifetime income and sometimes it makes sense to do non qualified.
• 4:08
  But then you have to ask yourself, where's the money coming from? Cause if you invested just in the S and P 500, let's say for a long long time, it probably doesn't make sense to sell an asset with a lot of gains and put it in something that's then gonna get taxed as ordinary income. So some people say, well I've got the cash here. Great. Some people say, well I just invest in these things and we can harvest a lot of losses and move it over there.
• 4:33
  And that might make sense. For other people, they're just sitting on a lot of cash because they've always just had a lot of cash because they were CD investors and they stopped rolling over the CD and they're looking for something new. Everyone's different. And I say that because too many people are saying, well I want that, and they don't care about the cost to get the thing that they want. So
• 4:57
  David: do That was a mouthful, wasn't it? What's the executive summary here then on that? So two options, either qualified or non qualified money, right?
• 5:08
  Mike: Generally speaking, if you want cash growth, dynamic reserves, flexibility, index annuities would be on the qualified or the IRA side, buffered ETFs on the non qualified side. Generally speaking, that's typically what we see from a tax standpoint, from a portfolio design standpoint. But when you look at lifetime income, you need to ask more questions. And there are layers upon layers upon layers of questions of where the assets are. What do you want your plan to look like, what strategies are you looking to implement, what's the withdrawal sequencing, and then you can start to shape what it could be.
• 5:46
  David: Okay.
• 5:46
  Mike: Let me say it this way. I'm not a sculptor, but I assume when you start to sculpt a large lump of clay, you don't get granular first. You kind of have to like say, okay, well we wanna carve another Michelangelo. So you carve out a little bit, you know, the arms, they're kind of there, and then the legs, and the body, the torso, and the head. And you get close.
• 6:10
  And then you say, okay, let's get a little more detailed. And then you start shaping the arms a little bit more. Every iteration brings in more detail. Mhmm. That has to be how planning is done.
• 6:21
  And every layer has to acknowledge the tax ramifications of those decisions.
• 6:27
  David: Yeah.
• 6:28
  Mike: I joke, well you know this internally, we joke. Most of our job is really tax planning and tax coordination. The investment side's easy. This is the investment tool. This is what it does.
• 6:41
  How do the taxes play a factor? That is most of our conversations. Right. Because it's such a big deal. Yes.
• 6:48
  We got a question that popped in here. If I already have a pre tax fixed indexed annuity, is the beneficial advisable to convert that to a Roth within the annuity? Well, that depends on the annuity and your IRA to Roth conversion schedule. But generally speaking, if you're doing IRA to Roth conversion schedule, then you're gonna look at, okay, well when do you what's the purpose of the annuity? Is it a part of your reserve strategy?
• 7:13
  Is it not? Is it a part of your income strategy or not? And then you've got to break down, okay, do they allow you to do partial conversions or is it all or none? If you've already turned on the income, could they do partial conversions or none? Usually it's all or none at that point.
• 7:26
  And then, I mean, Chris, it's a great question. But man, is a complex It's a decision tree that's kind of difficult to do. But generally speaking, my opinion is that you want to favor your long term growth vehicles, like your ETFs, to do more IRA to Roth conversions. Because your reserves, if you follow the protocol in the book, you want to spend down your annuities sooner than later. Annuities are not a good, if you're using them for cash, they're not as good of a long term growth vehicle.
• 7:59
  The day you retire is the day your reserves are the highest. The greatest allocation. And then as the market crashes happen, as you're spending down income, you want to lower your reserves. And I'll say it as simply as I can. The day you retire, let's say you're 60 years old, you might have three or four market crashes left.
• 8:18
  That's the purpose of the reserves, to get you through those market crashes. But now you're 86 years old, you might have one market crash left. You don't need as much money in your reserves.
• 8:28
  David: Right.
• 8:29
  Mike: Now you may want less risk, more of a preferential position, but you don't need as much in the reserves to get you through. So I would favor liquidity and long term growth on the IRA to Roth conversions, knowing that you might spend down your IRA assets sooner for tax planning purposes. Chris, I hope that helps. And if you've got additional questions, just put in the chat. We'll keep going, keep things humming along here.
• 8:55
  There's another response here I got. Do you have a graphic or flow chart of when to use the Buffered ETF versus an annuity for a retiree that has minimum income needs? No. We should. But I don't know how to create that flowchart because you're asking multiple questions at the same time.
• 9:16
  David: Yeah. There's not one right answer for sort of the masses to create a flowchart.
• 9:20
  Mike: Well, and part of it too is the factor of what's the prepared reaction that you want. Mhmm. And so, you're answering emotional suitability with financial suitability, and those are technically different, though they kind of, they share space sometimes. Plus the tax planning, your lifestyle planning, your legacy planning. There's multiple questions asked at the same time.
• 9:47
  And I haven't figured out how to do a proper flowchart for this yet. It's not binary. I wish it were. That'd be really nice. Yeah.
• 9:57
  But you're having to weight certain things and then the consequence of it. And I'll say it kinda this way. And I say this in gist. This is a joke. Okay.
• 10:07
  Okay? This is hyperbolic. Do not do what I'm about to say. But if you wanna pay the government the least amount of money in taxes, convert everything you have from your IRA assets to your Roth. Uh-huh.
• 10:18
  It's gonna destroy your plan, but you're gonna pay the government the least amount of dollars. Yeah. Because if you're smart about your taxes, you're gonna slowly do IRA to Roth conversions over a longer term period of time while managing your tax brackets and your effective tax rate. You keep more of your money, but more dollars technically go to the government too at the same time. So, don't get greedy, but also make sure that you have the right goals in mind.
• 10:47
  If you have the right goals and you work backwards, it starts to kind of lend a better understanding of the right path for you. Because really what we're all doing is just we're, every plan is walking a fine line, not a tight rope, but a fine line of balancing how to get the most out of your money. Yeah. And it's all about having a series of strategies, protocols, that dictate what are you gonna do for your income, tax planning, health care preparation and so on, when the markets are up and when the markets go down. When your health is good and when your health changes, and so on.
• 11:28
  You've got to have that kind of depth. That's why we do comprehensive planning, not just, hey, here's a portfolio and good luck. Hey, here's an annuity, buy that. We've solved your income. You're welcome.
• 11:39
  Good luck. No, that's just ridiculous. Mhmm. Now David, I wanna pause real quick and just ask you something here. If your retirement had a leak, okay?
• 11:47
  So let's say money was quietly draining out through fees or tax inefficiencies, maybe the social security time was gonna put an unnecessary burden on the plan for one way or the other. Maybe you're just paying more in health care premiums because you didn't know how to optimize all of this. How would you know? And how would your AI even know? You have to have the right questions to ask.
• 12:05
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• 12:19
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• 12:39
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• 12:56
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• 13:18
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• 13:46
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• 14:07
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• 14:24
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• 14:41
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• 14:51
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