Annuity question

[klrjaa]

Hi Jim, my mom passed, and my dad now owns an annuity that was in her name. The annuity is a type where it grows tax deferred, but no RMDs are required. My dad does have other money requiring an RMD, and I use the main input window for that (tax deferred) and the RMDs are correct in the detailed window. And he also has taxable money due to the sale of a home. I use Misc Income in the additional settings because I can control the year of sale. No issues there either. But for the annuity money, I also enter into the additional inputs, but I can't set it to tax deferred cash flow since RMDs then get taken out, which is not case here. So which cashflow type should I use? I've chosen both Annuity Income and Misc Income, both with taxable % at zero because the money is real and sitting in an account as tax deferred with no taxes owed. But I think both cashflow types treat any investment income as taxable from the get-go, which it is not. Hope that makes sense, thanks Kevin
and fwiw I went thru the help stuff but did not see this question asked previously

[jimr]

The first decision you have is whether to model the annuity as an investment asset or as a cash flow. To model it as an investment asset you'll need to value it (as a lump sum) and place that lump sum in one of the three portfolio types (taxable, deferred, tax free). For this to work, you have to be ok with how FRP handles both the investment growth and taxation for whichever investment portfolio type you choose. With this approach, you shouldn't create any "income" cash flow entries because the income from the annuity will already be accounted for within the investment portfolio you added it to. The FRP withdrawal logic will just use up the annuity value over time based on the normal FRP withdrawal rules.

The other approach is to model the annuity purely as a series of income cash flows (using additional inputs). This requires you to estimate the exact amount of income you'll get from the annuity each year between now and the end of the plan. Income cash flows can be set up to stay constant over time, to grow at the rate of inflation, or to grow at a rate different from the inflation rate (greater or less). Each year's income cash flow can be set up to be taxed partially or in full at the plan's income tax rate.

The goal with all of this is to choose the approach that allows you to model the annuity's net cash flows over the life of the plan as closely to reality as possible. Usually, either of the approaches above can be made to work with enough tinkering. But to be clear, this is as much of an art as a science and getting it right will be tricky since you'll have to make assumptions about how the annuity performs over time and these assumptions may turn out to be incorrect. (btw - in all of this I'm assuming this is a variable annuity with an investment component that delivers income cash flows that are based on investment performance).

[klrjaa]

Hi Jim, thanks for the detailed response.
To be clear, I'm not double booking anything as I know if I use the main window, I know I cannot double count it in the additional inputs.
The annuity type, however, do not automatically pay anything out. It's a weird type of product. It's simply controlled as the owner can keep it in cash or use any of the asset classes at fidelity. It grows tax deferred but requires no RMDs. As I'm trying to conservative with all the buckets of money, I am using 3% average return in the main screen with no standard deviation with stable spending policy. The intent is to grow the annuity money at 3% just like the other 2 buckets and use the taxable house sale money first for expenses, then the annuity money, which upon withdrawal would be taxed. Plus take the RMDs as required from the true tax deferred value I plug into the main window. Hope that makes sense. Thanks Kevin

[jimr]

I think that all makes sense. Based on what you've described it might make sense to just add a lump sum to the tax deferred or tax free portfolio that's adjusted to account for any tax discrepancies. You could check the impact of RMDs by going into settings and turning off RMDs just to see how much of a difference RMDs or no RMDs make in terms of the plan's chances for success.

The only thing you might want to double check is your assumption about return and standard deviation. At a high level these should be based on the overall portfolio investment mix. I'm not an investment guru of any sorts, but I think building a portfolio with an expected standard deviation of zero with any positive return is a bit tough to do, even with a low return assumption like 3%. If it was me, I'd probably want to include some variability in the returns, at least in a test scenario.

[klrjaa]

Hi Jim thanks for the reply. Given the true tax deferred income requiring RMDs is small compared to the other 2 buckets, and that the annuity stream has no RMDs, I had previously decided not to turn off RMDs as that's overall a small part of the equation thankfully. In terms of return and standard deviation, my dad is 93 with life expectancy of 102 probably best case. I see the risk free cash return nearer term as being higher than the 3% I'm using return wise, which is why I'm ignoring standard deviation. I could invest in 5-year non callable CDs if needed with no risk. I'm also using 7% inflation which I hope is conservative. FWIW I fully understand all this is not a one time set it and forget it, so I look at this yearly for my dad as well as me/wife.Thanks again Kevin

[jimr]

Got it That makes total sense. I didn't realize you were dealing with such a relatively short time period.

[klrjaa]

All good, thanks again. Kevin