Priya's Three Buckets: Which One Pays for the Kitchen?
Priya turned 65 in March and enrolled in Medicare Parts A and B. She retired in January from a $140,000 job. Her assets: a nonqualified deferred annuity bought in 2011 for $120,000, now worth $310,000, with surrender charges and a 2% market value adjustment that expire in July; a $620,000 401(k) at her former employer; and an $80,000 Roth IRA opened in 2018. She needs $30,000 this year for a kitchen renovation, wants to 1035 exchange the annuity into a new contract offering a 7% premium bonus with a 9-year surrender schedule and a 1.25% income rider, and wants to convert $150,000 of the 401(k) to a Roth in 2025. Her taxable income before any of this is about $45,000. She was born in 1960.
1. Priya needs $30,000 this year. Which account should it come from, and what does each option actually cost her?
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Rank the sources by marginal cost.
- Roth IRA - $80,000, opened 2018. She is over 59½ and the five-year clock started in 2018, so the withdrawal is a qualified distribution: entirely tax-free, and it adds nothing to AGI or MAGI. Cost: $0.
- Nonqualified annuity - $310,000 with $120,000 basis. Withdrawals are LIFO, so the first $30,000 out is $30,000 of ordinary income at her marginal rate, roughly $6,600–$7,200, plus the surrender charge and 2% MVA still in force until July. No 10% penalty because she is over 59½.
- 401(k) - $30,000. Similar ordinary income to the annuity, no surrender charge, but mandatory 20% withholding if the money is not a direct rollover, and it raises MAGI - which is exactly what drives IRMAA two years later.
Take it from the Roth. It is the only source that is free of tax and free of MAGI consequences, and she still has about $50,000 of Roth balance. Leave the 401(k) intact for the conversion strategy and leave the annuity alone until the July surrender window.
2. Evaluate the 7% bonus annuity with the 9-year surrender schedule. Should Priya make the 1035 exchange?
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What the file has to show.
- The bonus is priced, not gifted. Seven percent of $310,000 is about $21,700 of contract value, but bonus contracts typically carry lower caps or participation rates, a longer surrender schedule, and recapture of the bonus on early surrender. Compare the new contract's guaranteed and current rates against her existing contract net of the 1.25% rider fee before crediting the bonus at all.
- Timing is a quantifiable loss. Her surrender charge and 2% MVA expire in July. Exchanging in March, on a 'limited-time' bonus, pays a real and certain penalty for a contingent benefit. That is a pressure tactic, not a rationale.
- Shape mismatch. A 9-year surrender schedule runs to age 74. If she is already tapping savings for a kitchen, locking the annuity for nine more years is the wrong shape for this asset.
- Mechanics. A 1035 exchange must move carrier-to-carrier. If she takes a check she has constructive receipt and $190,000 of gain becomes taxable. Her $120,000 basis carries over; the bonus generally does not become basis.
- Suitability. Wisconsin's annuity best-interest standard requires documented grounds for an exchange that adds fees and a decade of lock-up.
Recommendation: wait until July, re-run the comparison, and if the new contract does not beat the old one after fees, do nothing - she has a Roth to fund the kitchen.
3. The $150,000 Roth conversion: is that the right amount, what is the correct sequence, and what could go wrong?
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Sequence. Roll the $620,000 401(k) to an IRA by direct trustee-to-trustee transfer - no tax, no 20% withholding. Then convert $150,000 from the IRA to the Roth. Never take a check.
The amount. Taxable income is about $45,000, so the $150,000 conversion lands her at roughly $195,000 - still inside the 24% bracket, which for a single filer tops out near $197,000. She converts as much as possible at 24% instead of paying 32% or more later.
What could go wrong.
- IRMAA. Medicare premiums two years forward are set by MAGI, and the next single-filer IRMAA step is around $200,000. At $195,000 she stays below it. Converting $160,000 would push her over, costing 32% on the excess plus a larger Part B and Part D surcharge.
- No do-overs. Conversions can no longer be recharacterized, so the number must be right the first time. Converting in tranches, or after a market dip, is safer than one lump sum.
- Penalty and clock. There is no 10% penalty on a conversion, and her Roth already satisfies the five-year rule.
- RMDs. She was born in 1960, so her RMD age is 75 (2035). The conversion shrinks future RMDs and the Roth itself has no lifetime RMDs.