If you’re new to annuities, start with our comprehensive annuity guide to understand the basics. Often, annuities are regarded as “set it and forget it” investments. You sign the contract, fund the account, and wait for the money to come in. Unfortunately, most retirees treat annuities like fossils, static and unchanging.
To put it another way, your annuity is a living part of your financial ecosystem. Let’s say you bought an annuity five years ago. In that time, the economy changed, tax laws evolved, and you adjusted your family and personal goals. What made sense five years ago might no longer make sense today. Just like you wouldn’t miss a physical or a car tune-up, your retirement income plan needs regular check-ups.
To make sure your annuities continue to serve their primary purpose of protecting your lifestyle, learn how to manage them over time.
1. The Timing: When Should You Audit Your Annuity?
There are certain “trigger events” that should prompt a professional review of your annuity, but you don’t need to obsess over it daily.
The end of the “surrender period.”
Annuities are long-term commitments. Insurance companies set a surrender period, usually 5 to 15 years, to discourage early withdrawals. If you withdraw too much too early, you’ll pay a “surrender fee.”
- The declining fee. These fees typically start high (around 8%) and drop by 1% each year until they hit zero.
- The 59½ rule. Withdrawing funds before age 59½ can trigger an additional 10% IRS penalty.
- Check-up tip. Once your fee reaches 0%, your money is “liquid,” making it perfect for comparing interest rates.
Reaching “RMD” age (73).
At age 73, the IRS requires you to start taking Required Minimum Distributions (RMDs) from your retirement accounts. If your annuity is inside an IRA, you must withdraw a certain amount each year. If you don’t do this, you could face a steep 25% penalty. By checking your payouts, you’ll automatically ensure they comply with these IRS regulations.
Major life changes.
Life moves fast. A health diagnosis, the loss of a spouse, or a move to a cheaper state can change your financial needs. To make sure your income benefits (the amount you get paid) and death benefits (what you leave behind) are still aligned with your current situation, you can adjust your Income Rider or Death Benefit during a check-up.
2. Evaluating Performance vs. Expectations
With a Variable Annuity (VA) or Fixed Indexed Annuity (FIA), you will receive returns based on the performance of the market or a specific index.
As part of your check-up, ask the following questions:
- Is the “cap” still fair? There may be a “cap” on how much gain you can credit in an FIA. It may be time to find another provider if they lower your cap from 8% to 3% during a booming market.
- Are the fees eating into the gains? The costs associated with variable annuities, such as M&E (Mortality & Expense) (1-1.5%), investment fees (0.5-2%), and admin fees (0.1-0.3%), can quickly add up. As a result, it’s necessary to carefully examine these layered costs. These fees can erode your principal if your sub-accounts perform poorly.
- Is the “Income Rider” being utilized? Often, people purchase income riders that guarantee a certain income but never use them. Unless you have triggered the income at age 70, you may be paying for a feature you don’t need.
3. The Modern Exchange: Exploring the 1035 Option
You are not necessarily “stuck” if your old annuity fails to perform or is overpriced. The IRS allows a procedure called a 1035 Exchange. By doing so, you can transfer your current annuity funds to a new, more modern annuity without triggering a taxable event.
- Why do this? There are usually fewer fees with modern annuities, better participation rates in the S&P 500, and a variety of long-term care riders available.
- The caveat? You should never exchange a 1035 if you’re still in your surrender period or if your current annuity has a high “guaranteed minimum death benefit”.
4. Maximizing the “Living Benefits”
Modern annuities are essentially retirement Swiss Army knives. As such, if you have a Long-Term Care (LTC) Rider, check it during your review.
If you reside in a nursing home or require home health care, some annuities allow you to double or triple your monthly income. These “living benefits” become your most valuable asset if your health has declined since you bought the policy. To avoid scrambling during a crisis, your check-up should determine exactly what documentation is needed.
5. Tax Efficiency and the Beneficiary Audit
Taxes on annuities are based on ordinary income, not capital gains. In other words, a poorly timed withdrawal can increase your Medicare premiums (IRMAA) or push you into a higher tax bracket.
- The beneficiary review. Most people overlook this part of the check-up. Have you updated your beneficiaries? An outdated beneficiary form can be a nightmare if you’ve gone through a divorce or lost a loved one.
- The “stretch” rules. Don’t leave your heirs in the dark about how the money will be distributed. In most cases, non-spouse beneficiaries must empty their accounts within 10 years. By planning for this “tax bomb” now, you can save your children tens of thousands of dollars in the future.
Conclusion: From Static to Strategic
An annuity is more than a contract; it is a promise of future security. However, as the financial landscape shifts, that promise needs to be verified. As you carry out an Annuity Check-Up every 2–3 years, you become a manager of your legacy rather than a passive observer of it.
Examine the fine print now, before the market crashes or when you are experiencing a life crisis. Take a look at the folder, contact your advisor, and make sure your income plan is as resilient as you are.
FAQs
Can I change my mind after I start receiving payments?
Usually, no. When you “annuitize” a contract (make the payments permanent), the decision is usually irrevocable. This is why a check-up is so important before flipping the income switch.
What happens if the insurance company goes bust?
Unlike other investments, annuities are backed by the company issuing them. The Guaranty Associations in each state, however, provide coverage (up to certain limits, often $250,000) if an insurer fails. During your check-up, you should verify your carrier’s “AM Best” or “Standard & Poor’s” rating.
My annuity value hasn’t grown at all this year. Should I be worried?
Not necessarily. In the case of fixed or fixed indexed annuities, the trade-off for “no losses” is usually “slower growth.” If the market were down, your annuity would protect your principal.
How do I find out what my current surrender fees are?
If you close the account today rather than next year, ask the insurance company for a “Surrender Value Statement.”
Are there “fee-only” annuity reviews?
Yes. If you don’t trust your original agent (who may have been interested in selling you a new product), you can hire a fee-only Certified Financial Planner (CFP) to audit your contract.
Image Credit: Albert Costill/Gemini
