If you find yourself in an annuity that no longer meets your financial planning needs, you may find yourself asking, “What is the best way to escape a dreadful annuity? You do luckily have a few options to choose between.
There are a variety of reasons you may want to get out of a bad annuity (or even a good one for that matter), ranging from lack of service, high fees, or lack of good investment options. Your best bet to get out of a bad annuity will depend on how terrible the annuity your purchased happens to be.
Over the past few weeks, I’ve posted a few articles on annuities, covering things from why you might want to own one, to discussing all of the hidden annuity fees you probably have no idea you are paying and even the benefits of a guaranteed income rider available on some variable annuities.
While a majority of people who own annuities with some type of lifetime income guarantee are happy with their purchase, there is still a large number of people who would be better off doing something else with their retirement investments. Some will need to go through what I call Annuity Rescue; others can transfer their fund to another account, others may wish to pull all the money out and run.
Bad Annuity of Bad Financial Advisor?
There are times when the annuity is right for the client, but the financial advisor is not. A new client (Ryan) recently came in complaining about an annuity he’d purchased a year ago. Ryan’s big issue with the annuity was that his so-called financial advisor wouldn’t return his calls or emails. The annuity salesman had seemingly dropped off the face of the place once the annuity had been delivered.
He has been a client of this advisor for over a decade and was rightly pissed off. Things were great until Ryan agreed to move his million-dollar IRA into a variable annuity pushed by the financial advisor. We reviewed the annuity, while not what I would have recommended, it did meet some of Ryan’s retirement planning needs. That being said, the lack of service and literally no financial guidance from his old investment broker were not up to par.
The lesson here is that you may benefit from your annuity more if you get good financial guidance about it from a fiduciary financial planner. The old broker likely earned a big (we are talking $75,000+) commission selling the annuity, but little to no ongoing compensation for keeping Ryan as a happy client.
When an Annuity is Misused:
A few years back, I met Suzie Security (not her real name) she was a successful TV producer in her forties and was afraid of investing after being killed in the great recession of 2008-2009+. She sat down in my office for our first financial planning meeting on a referral from her CPA, looking to have me help her set up a Cash Balance Pension plan as well a Solo 401(k) to help her shelter more of her large income from taxes. She also had questions about a large annuity with all the bells and whistles that she already owned.
Similar to Ryan above, Suzie hadn’t spoken with the insurance broker who sold her the annuity in years.
Her annuity came with a special managed portfolio (with extra fees on top of the fees for the underlying funds). The annuity also had an enhanced death benefit rider. There was also an accumulation benefit. Lastly, she also had chosen a lifetime income rider. The rider expenses are on top of the mortality and expense fee on the policy.
Here are the total Annuity Fees of 7.0% per year broken out:
-M&E Fee 1.35%
-Enhanced Death Benefit Rider 1.15%
-Lifetime Income Rider 1.55%
-Accumulation Benefit 1.30
-Underlying Fund expenses Ave 1.25%
-Managed Portfolio Expense 0.50%
In this case, I say Susie Security was misusing an annuity. She was supposed to be working with a stockbroker who should have been able to help her pick an investment allocation without the extra 0.50% professional management fee. Lastly, combining a death benefit, accumulation benefit, and an income rider was a bit of overkill, not to mention extremely expensive.
There are a few options to get out of a Crappy Annuity. The rules are similar whether you own a fixed annuity, variable annuity, or equity-indexed annuity.
However, what do you do if you own a variable annuity and have buyer’s remorse? There are a few options to get out of a bad variable annuity.
Just Close the Bad Annuity and Take the Money
A lump-sum distribution from an annuity is likely the worst option. Cashing out an annuity will like have some major tax consequences that will far outweigh any benefit you receive for getting out of even the most dreadful annuity. If you have not owned the annuity long enough, you will probably get hit with a large surrender fee. Also, some if not all of your withdrawal will be taxable. Taxation depends on how the account is titled. Do you own a Non-Qualified Annuity? Alternatively, is your annuity an IRA? 403(b), SEP? Or another type of retirement account?
Your age will also play a role; if you are under 59 ½, you will get hit with a 10% early withdrawal penalty above and beyond the other cost of closing the policy.
Side note: annuities often come with a “free look” period, lasting from a week to around a month. If you get buyers remorse this quickly, you can get out of the annuity during this period without any surrender charges.
Transfer to a Better Annuity or Rollover to Another Retirement Account
If your account is not an IRA or another type of retirement account, it will need to stay in some type of annuity if you want to keep the tax deferral on your investments. Under Section 1035 of the IRS tax code, you are allowed to exchange one annuity contract for another annuity contract. This annuity rescue strategy can help you find a better annuity that fits your current financial planning needs. There are specific IRS rules to follow, so talk with a trusted fiduciary financial planner during this process to avoid costly mistakes.
You may look to move from a high fee annuity to a lower fee annuity. Annuity sales are still dominated by traditional annuities that pay a large commissions, often upfront, to the person selling it to you. Luckily there is a new wave of fee-only annuities that will work more like your other investment accounts, where your financial advisor doesn’t earn a commission for selling you a product but receives a fee for ongoing service. I often call this option an Annuity Rescue.
Companies like Nationwide have fee-only annuities with mortality and expense fees as low as 0.25% compared to the more typical 1.25%+ found of many variable annuities. Fee-only annuities typically don’t come with surrender charges, or if they do, they are much shorter than the seven to ten-year surrender charges on many traditional fixed or variable annuities. Some fixed annuities or Equity Indexed Annuities can have surrender charges of over twenty years. OUCH!
If you own an annuity within an IRA (or Roth IRA, 403(b), etc) you can simply rollover or transfer these policies an IRA at your preferred custodian, or where your fiduciary financial planner holds their client’s assets. This could be at places like TD Ameritrade, Charles Schwab, Fidelity, SEI, Pershing or even Vanguard, to name a few. This is assuming you are out of the surrender charge period.
How to get out of a bad annuity if you still have a surrender charge?
Before moving an annuity, you need to know what the surrender charges will be. If there is no surrender charge, you are good to go. If there is a large surrender charge, then things get more complicated. There are few moves to make to avoid paying to much in fees to get out of that terrible annuity you no longer want.
Free Withdrawal Provisions:
Many annuities will come with some type of free withdrawal provision. This could be 10% of the account balance each year can be withdrawn without a penalty. Alternatively, it could be something like you can pull all of the growth out of the policy each year. In these cases, you may want to just move the free withdrawal each year until the surrender charge has dropped off the policy.
This may be a hassle, and take a few years to accomplish, but it can be worth it, especially if you are in an annuity with extremely high fees or a large account balance.
Drop Extra Policy Riders:
One issue people have with annuities is what can often be seen as the high cost of ownership. While they may provide more benefits and guarantees than an Exchange Traded Fund (ETF) or a mutual fund, these extra perks will come with extra fees. If you know you are going to be getting out of an annuity, look at any extra benefits or riders that you are paying fees for, and then contact the annuity provider to drop these benefits. This could save you a few percent each year in unnecessary annuity fees.
Just be aware that you understand what benefit and guarantees you will be giving up.
Revisit Investment Choices:
Most variable annuities will come with a long list of investment options to choose from. These investments will likely come with a variety of fees and internal investments expenses. If you are stuck holding the annuity until the surrender charge is gone look to re-balance your portfolio towards some of the lower-cost investment options offered in the annuity.
When to Keep Some Money in the Annuity:
Every so often, I will speak with someone who says, “David, can you take a look at this annuity, it just doesn’t seem to be doing very well.” If they have owned it for some time, the investment performance may be lagging their other retirement accounts. There is no arguing with bad performance, but the policy may have some valuable guarantees that can’t be ignored.
For example, some annuities come with a what is often called something like a “Guaranteed Lifetime Withdrawal Benefit” rider. These riders allow you to make periodic withdrawal up to a specific amount (say 5% of the benefit base each year). As I’ve written about previously, these riders often come with high fees (say 0.5-2% every year) the benefit base may be substantially higher than the current account balance. This is often the case during a market drop, or if they underlying investment have performed poorly, they often do.
In certain cases, I’ve run the math for clients, and it made sense to keep the annuity. Even a terrible annuity, to take advantage of the income rider that they had been paying on for years.
If you are at retirement age, this may be a part of your retirement income stream. If you still a few years from retirement, we may turn on the guaranteed income stream and have the proceeds sent to another account with lower fees, or more appropriate investment options.
What did I recommend Susie Security do with her Bad Annuity?
The annuity that Susie was sold came with a nice surrender charge that started at 9% and dropped each year she owned the annuity. We took advantage of the free withdrawal benefit and moved 10% of the policy each year to an IRA, investing in a diversified portfolio of low-cost index funds.
With the knowledge that we were planning on closing out this annuity in the future, we adjusted her additional benefits. We dropped the accumulation and lifetime income riders, saving her 2.85% in annuity fees per year. We adjusted the investment allocation, dropping the “professional management,” saving an additional 0.50% per year.
We ended up keeping the Enhanced Death Benefit rider, as Susie has two daughters in high school, and this expense was still worth it to her for the foreseeable future.
Adjust Your Annuity Or Annuity Rescue?
While annuities can be costly to own and difficult to understand, they also can provide some income guarantees that you cannot get with an investment like stocks or bonds. All annuities are not created equal, and sometimes a move or change is necessary and likely to improve your overall financial picture. Talk with a fiduciary fee-only financial planner to help find the best route to financial freedom.
Some of you may need an Annuity Rescue; others may just need to find ways to make your annuity work hard for you and your specific financial goals. If you are unsure if your annuity is right for you, get a second opinion from a fee-only Certified Financial Planner™