Roth SPIA and it’s pre 59.5 “distributions”
I am considering doing an insurance arbitrage on my mother where I get a SPIA on her, receive annual payments from the SPIA, pay taxes on the payments (if required) and use the remainder to purchase life insurance on her. Even though the “ROI” is not realized until her passing it is rather impressive. My agent claims the following Roth scenario could be used as an option if I wanted and I was hoping someone could confirm;
I get the SPIA as a Roth account by transferring trustee to trustee, say $100k. Then the Roth SPIA pays me approx $7k per year and I use all of it to purchase the life insurance (approx $300k) without having to pay tax on the SPIA payment. I say without tax because while I am only 45 my Roth is over 10 years old and I have sufficient withdrawable basis (contributions and 5+ year old conversions) so that the annual SPIA payments would never exhaust the basis keeping the SPIA “distributions” tax free. In addition, the eventual tax free life insurance payment would not be associated with the Roth so I would retain much of the basis over the years.
Does all this sound correct?
Permalink Submitted by Bruce Steiner on Sun, 2011-06-12 16:56
Wouldn’t the arbitrage work in the insurance company’s favor? If you buy life insurance, you win if you die early, and the insurance company wins if you live a long time. If you buy an annuity, you win if you live a long time, and the insurance company wins if you die early. If you buy both, isn’t it like betting on both teams in the same football game? Presumably the insurance company has priced each product so it will earn enough money to cover its expenses and make a profit. So you would buy life insurance if you needed to protect against dying too soon, or you would buy an annuity if you needed to protect against living too long. But you wouldn’t buy either of them as an investment. And it’s unlikely that you’d buy both.
Permalink Submitted by joe fotz on Sun, 2011-06-12 17:03
I appreciate your response but I think you may have missed that both the SPIA and the life insurance policy would be purchased by me on my mother and not on me. This arbitrage creates a rather nice ROI.
Permalink Submitted by Bruce Steiner on Sun, 2011-06-12 17:34
How does the identity of the insured/annuitant affect the expected return?
Permalink Submitted by joe fotz on Sun, 2011-06-12 17:45
It affects both the SPIA payment amount and cost of insurance. In this case the after tax annualized return would be almost 200% in year one and it would still exceed 10% even if my mother lived another ten years (which her family history would make unlikely). My questions are not really about whether this is a good plan or not as the ROI is what it is, but rather whether the Roth ins and outs outlined by my agent are accurate.
Permalink Submitted by Alan Spross on Sun, 2011-06-12 23:02
Taxation of Roth IRA distributions trumps the annuity rules, therefore the annuity payments are tax free until your basis has been recovered for all your Roth IRAs, not just the amount transferred to purchase the Roth annuity. You could do this without an annuity in your Roth, with a period certain annuity for a higher annual distribution, or a life annuity for a lower annual payout. Either way, the annual distribution must be reported on Form 8606 showing your basis recovery of regular Roth contributions first and conversions second on a FIFO basis for conversions. There is no penalty unless you tap conversions under 5 years.
Just be aware that if you have another Roth IRA account that is not annuitized, that account is also considered when completing the 8606 to report the distributions, since all your Roth accounts are considered combined for taxation of distributions. I don’t see any problem with doing this, but the ROI is to be determined.
Permalink Submitted by joe fotz on Mon, 2011-06-13 00:25
Thank you Alan. I understand your response except for one portion that I would like to clarify if possible. When you say “not just the amount transferred to purchase the Roth annuity” I dont know if you are saying that the trustee to trusee transfer of the Roth dollars to secure/purchase the SPIA would be considered a distribution (ie. going against my basis and sufficient to require an 8606 on its own)? My agent has not mentioned this if this is what you are indicating.
Permalink Submitted by Alan Spross on Mon, 2011-06-13 01:10
No, the method of transfer was not an issue. I only mentioned it because it appeared that there could be another Roth IRA, ie the amount used to purchase the Roth annuity was only a partial transfer from a prior Roth IRA account. In that case, there would be at least 2 Roth IRA accounts to be considered in reporting any Roth distributions such as annuity payouts.
Permalink Submitted by joe fotz on Mon, 2011-06-13 12:16
Thank you. You have indeed clarified everything I was originally seeking clarification on. However, you have triggered one last follow-up question. I understand that the Roth SPIA payments would be Roth distributions requiring an 8606 to be filed and that all my Roths would be pertinent for that. Regarding the transfer of Roth funds from one custodian to another where it would be used to purchase a SPIA (still being in a Roth I am told) I am curious about whether the transferred funds ($100k in this example) would at any time be considered a distribution (like upon the purchase of the SPIA or upon the passing of the annuitant)?
Permalink Submitted by Alan Spross on Mon, 2011-06-13 15:32
If the check is made out to you and then you wrote your own check within 60 days to the insuror providing the Roth annuity, it would be a reported distribution and rollover on Form 1040. There is only one such rollover allowed within a 12 month period from any IRA to another IRA, but if rolled within 60 days it would have no tax consequence other than simply reporting it on your 1040.
However, if the transfer is done by direct trustee transfer, there is no 1099R generated and the transfer is non reportable. In addition, there is no limit to the number of these direct transfers you can do.
In purchasing the annuity, you just need to be sure that it is a ROTH IRA annuity and not a non qualified annuity. That avoids a taxable distribution, except for the annuity payouts of course.