More on Variable Annuity Losses

Dear Readers,
Now that we're down to the 11th hour (or is it 11:45?) in terms of the tax filing deadline, I've received several inquiries about whether it's possible to take a loss on a variable annuity. The answer is "yes" and I covered this issue in some detail in my column dated Nov. 15, 2002 .

A few recent questions have taken the issue further.

For instance, Dale in Montana wanted to know how to figure your gain/loss in a variable annuity if you have switched your money from one annuity contract to another in what's known as a "1035 exchange."

The key is to remember that your original cost basis (generally the purchase price of an asset) carries over, or lives on, in such a transaction.

Here's what I mean: Suppose you invest $25,000 in a variable annuity and, over time, it increases in value to $40,000. At this point, you decide to exchange your original annuity contract for one with, say, more up-to-date features. If you follow the procedures outlined in Section 1035 of the tax code, this can be done without any tax consequences. That is, you can continue to defer taxes on the $15,000 in gains your account has earned.

Now, let's say the investments in Annuity #2 decline in value to $30,000. Do you have a loss? No, according to Joe Stenken with the National Underwriter Company, a major provider of tax information. Stenker says that's because it doesn't matter what your account was worth at the time you exchanged into Annuity #2. To calculate where you stand, take the value of your current contract and subtract your original investment. In this example, you have a profit of $5,000 ($30,000 - $25,000).

Just remember that under Section 1035, the gain/loss accounting is done as if you have owned a single contract all along, no matter how many exchanges you make.

Audrey in Florida wanted to know if you can take a loss by selling part of an annuity contract. This is really getting esoteric. John Fenton at NUA says the short answer is "No." Read on if you really like this stuff.

In their simplest form, variable annuities consist of a life insurance policy that includes investments managed in a style similar to mutual funds. These are called "sub-accounts." Instead of "shares" they are divided into "units." As with mutual fund shares, the price of sub-account units goes up and down based on the value of the underlying securities.

In Audrey's case, she invested in a variable annuity via multiple contributions. For instance, let's say her first investment was made when the "units" in the growth stock sub-account were at $25. When she made her next investment in the same sub-account the units were valued at $40. Then the stock market went into retreat and her final investment was made at a unit price of $15. Currently, the units are all worth $20.

Audrey would like to sell the units she paid $25 and $40 for and write them off as an investment loss.

If this had happened with a mutual fund, there would be no problem. You could sell only the shares that are worth less than you paid for them. This is done by instructing the mutual fund sponsor to sell those specific shares .

Unfortunately, Fenton says this is not possible with a variable annuity. While the insurance company does track the return you earn on each individual investment in the contract, it does not track gains or losses for tax purposes.

If you wanted to take a loss on your variable annuity, you would have to close the entire account. In Fenton's words, "That's the downside of trying to take advantage of tax deferral. Like an IRA, they [the government] make it hard to take losses."

One final note: it's too late to sell a variable annuity and have it impact your 2002 tax return. You needed to do that by December 31 of last  year.

Please seek the help of a professional advisor on this issue, folks. You can get into trouble if you make a mistake. There's no "Oops" clause in the tax code.


I've read that if I'm a sole proprietor and I'm the only one in the business and I set up a Keogh plan, those assets may not be covered under ERISA.



Dear Chris -

A "Keogh" is a retirement savings plan for a self-employed person. Frankly, it's not used much anymore since the introduction of SEPS (Simplified Employee Pensions) and SIMPLEs (Savings Incentive Match Plan for Employees).

Nevertheless, your information is correct: in general, a Keogh does not enjoy the protection from creditors that a "qualified" retirement plan, such as a 401(k), has. Thus, if you were sued and lost the case, your retirement account would be at risk if you didn't have other assets to cover damages, court costs, etc.

Here's where the "in general" part comes in: While Keoghs typically just cover the self-employed business owner and, perhaps, a spouse who works for the business part-time, they can be expanded to include other, non-family, employees. Once a Keogh includes what are called "common law" (non-blood-related) participants, then it is subject to all of the reporting, non-discrimination, and coverage rules of the Employee Retirement Income Security Act passed in the 1970s. In addition, it would receive the same level of creditor protection as a "qualified" plan.

But if you are the only employee of your company, Chris, this is not available.

I think it's time for you to expand your business!

Take care,


P.S. Remember, contributions to a Keogh or SEP for a year must be made by the employer's tax filing deadline for the year.

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