See if this situation sounds familiar…
I recently had a call from an individual who had left his job, and he needed to roll over his 401(k). Not having a financial advisor, he relied on the referral of a neighbor on who he should work with.
Without doing any more research, he met with the advisor, and the advisor recommended that he roll over his 401(k) into an IRA annuity (note: this isn’t an actual product, just a term for buying an annuity inside an IRA).
Upon learning more about the advisor, the individual felt uncomfortable working with him, and he began to wonder if the annuity was in his best interest, or the advisor’s. Wanting to know his options, he called me.
When it comes to wanting to cash out or cancel an annuity, this might not be every situation, but it does bring up an interesting discussion: what it takes to get out of an annuity.
Before I start, I should make a point that there are many types of annuities: fixed, variable, indexed, immediate, etc. This post is to be more general in nature, so some or all of the information may or may not apply, depending on the type of annuity we’re talking about.
Let’s review our options:
1. I would like to return this please…
Some annuities offer what’s called a “return of premium option,” or they’ll offer an additional rider at additional cost that allows for a return of premium. That basically means whatever you put in, you can take out at any time. This isn’t super common, but I am seeing more carriers offer this option. I asked this individual to inquire if his annuity contract offered that. If so, great. If not, on to option 2.
2. Give me a free look.
All annuity contracts offer what’s called a “free look period.” This means that you’ll have 10 days (or more depending on the carrier) to review the contract, and then decide if you’re still interested in purchasing the annuity.
If you decide to change your mind after the 10 day pre-look period, it’s just like the return of premium, where you can get your money back without a hitch. If you’re locked into an annuity with gains beyond what you’ve put in, proceed to option 3.
3. Can I exchange that?
A 1035 exchange allows you to move from one annuity to another without having to incur any tax liability. In the case of the gentleman above, a 1035 didn’t make sense, since his annuity was brand spanking new. While it does avoid potential tax consequences, with a 1035, you’re still under obligation for the contract period of the initial annuity.
Say, for example, your annuity had a seven-year contract period, and you decided to do a 1035; you would still have to pay a surrender charge to the initial annuity company.
Other things to consider if and when doing a 1035 exchange is that you’ll be starting a new contract with the new annuity company, which will be suspect to a new surrender schedule. Make sure you understand the length of the new contract period that you will be entering.
Last note on doing a 1035 exchange: be aware that doing a 1035, you may be giving up certain income and/or death benefit guarantees. As an example — I once had a client who wanted to get out of an annuity that had a contract value of $275,000.
When I was reviewing the contract, I found that since it was purchased several years ago, although the contract value was down, the death benefit had kept accruing interest. If the client, who was in his early 70s and not in the best of health, were to 1035 the contract, he would be giving up the $330,000 death benefit.
Considering his health and the unlikelihood of replacing that $55,000 with a new annuity or a regular investment portfolio, it made sense just to leave the annuity as it was.
4. Cash it out.
This may be the least desirable option of the ones that we just mentioned. Typically, if you’re going to cash out an annuity, you’re going to have to pay a pretty hefty surrender.
Every annuity contract is different, but some of the typical surrender schedules I’ve seen with a seven-year annuity product are as follows: 7,7,7,7,6,5,4. That means if you were to liquidate or cash out the annuity in the first, second, third, and fourth year, you’d be paying a 7% surrender charge on your principal. Having to pay a surrender charge on a bad annuity is never a fun feeling. That’s why it’s so important to understand what you’re getting into before signing the dotted line.
Most annuities do offer a free withdrawal each year that eases the pain, though. You’re typically allowed to withdraw 10% each year (plus interest) without being hit with the surrender charge. It’s not great, but it at least saves you some money.
5. File a complaint.
I hate even bringing this option up, but it should be mentioned. If you ever feel that you were sold an annuity by an advisor who did not have your best interests at heart, you do have the option of filing a complaint, either with the company that represents the advisor or through your state’s insurance commissioner. I would only suggest this if the advisor agent blatantly misrepresented the annuity.
If you sign the dotted line, but it’s your own fault that you didn’t take the time to read the contract or ask the appropriate questions, then please don’t go this route.
That being said, I once was working with some clients who were in their early 80s and were sold an annuity. Is that horrible? Not always, but in this case, the clients had no idea that their annuity had a 10-year contract.
That’s different.
The advisor didn’t feel the need to explain the length of the contract to the clients, and the elder law attorney who was representing the clients decided it was best to file a complaint with the State Insurance Commissioner.
Other Annuity Cash Out Considerations
I want to thank
Josh Garland, ChFC®, Director, Annuity Marketing for Financial Professional Group for emailing me about something else to consider.
“Does the contract have an MVA?”
Here’s what Josh had to add on MVA:
More and more annuity contracts are being issued with a Market Value Adjustment (MVA). If you surrender your contract before the surrender charge period has ended and your contract has an MVA this can have either a positive or a negative result at the time of surrender.
Here’s how MVA contracts work:
When you purchase an annuity, the insurance company pools your premium together with all of the premium(s) from other annuity contracts that are being purchased. The carrier will then have specific buying dates throughout the month and when they reach that buying date they will use all of that pooled premium to purchase bonds.
Because they are buying in bulk they will receive a better rate than the rest of us, so they will factor out their expenses and profit and return the rest of the interest to the client.
That being said, if you purchase a 10 year annuity and the carrier purchased a 10 year bond with those funds but 2 years later you decide that you want out of the contract, then the carrier has to sell those bonds to generate the funds to return to the client. This is where the MVA comes into play, if interest rates have gone up then the value of the bonds will have gone down which will essentially cost the carrier and they will charge that back to the client.
However, if interest rates have gone down then the value of those bonds will have gone up resulting in a positive return to the carrier and the will credit that back to the client as well. Last year (2013) I saw a number of contracts that were surrendered early in their surrender charge period and that resulted in positive returns for the client.
They actually made money over and above the surrender charges. This is because most of those clients had purchased their contracts prior to 2010 when interest rates were substantially higher than they are today and so when the carrier sold their bond at a gain it was credited back to the client. (Note that this is very basic description and MVA’s only exist on Fixed & Fixed Index Annuity contracts.)
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Thanks Josh for the additional info!
Annuities are not bad products for the right person in the right situation. Like any investment, you need to know what you’re buying BEFORE you commit.
