In my last blog post, I compared variable annuities to the Total Gym. Where I fell short is that it’s easier to get rid of a Total Gym than it is to get rid of a variable annuity. Unfortunately, you can’t just unload one on Craigslist. Today, I want to go over four ways to get out of a variable annuity.
If you’ve purchased a variable annuity, don’t feel ashamed. On the surface, these investment products sound amazing. Guaranteed income with downside protection? What’s not to like? Well, the devil is always in the details, especially when it comes to these products. It’s no easy task to evaluate them.
Why Is It So Hard To Get Out Of An Annuity Contract?
The main reason annuities have onerous surrender charges is because most of them pay a handsome commission to the salesperson when he or she sells you the product. These commissions can range between 4% and 7% (or more) of the annuity value.
At 7%, that’s a $35,000 commission on a $500,000 annuity. It’s no wonder why an annuity salesperson would be eager to sell you one. Thirty-five grand could go a long way toward that yacht purchase.
If you decided to withdraw your money in year-one, the insurance company would take a big loss because of the commission paid to the agent. Hence, surrender charges were created to keep you locked in.
However, there are a few alternatives available if you want out. Let’s get started on the four ways to get out of a variable annuity.
1. Withdraw The Penalty-Free Amount Each Year
Most variable annuities allow you to withdraw a certain amount that is free from surrender charges each year. Typically, that amount is 10% of the value of the policy. If you’re stuck in an annuity while you still have high surrender charges, a good strategy is to take out the maximum, surrender-free amount each year until the surrender charges go away.
I’ve used this strategy with many clients over the years. It’s a bit of a P.I.T.A. Quite often, the insurance company will not be forthcoming with the paperwork in a timely manner.
I’ve also seen the insurance company change the distribution form each year, so you can’t be ready with the paperwork on the anniversary date. Since an old, out of date distribution form will be rejected when it’s sent in, this stretches out the process.
Finally, I’ve even seen the agents send paperwork that does not have an option for a penalty free withdrawal. After being questioned about it, they simply say that it’s too early – the penalty free date hasn’t come up yet, so the computer omitted that option when it printed the paperwork.
I believe they make it hard on purpose.
Simply put, the insurance companies don’t make any of this easy. If it’s too difficult, many people will simply give up and leave their assets in the annuity.
Once you’re in the 8th or 9th year of your contract, the surrender charge may have dropped to 2% or 1%. At that point, it may make sense to just go ahead and cash out the contract. This leads us to our next method.
2. Cash It Out
If your surrender charges have gone away (or are low enough that it makes sense), you might want to go ahead and cash it out the annuity contract. When I say, “cash out”, I am specifically talking about removing the assets from the annuity and transferring them into another account.
Given that many variable annuity investments have extremely high internal expenses (sometimes 2% or more), there may be a point where the total annual expenses are lower, even with a 1% surrender fee reducing the principal upon transfer.
Of course, it’s important to ensure that the assets are transferred into a like-typed account. For instance, if your annuity is inside an IRA, ensure that the assets are transferred to another IRA account.
Once you’re in a better place, your investments can start growing without the massive drag of all those annuity fees. If ripping off the band-aid isn’t an option, there are two more alternatives left to consider.
3. Transfer It Into A Better Annuity
If you’re going to be stuck in an annuity, you may as well be stuck with the least terrible one you can find. While I’m not a huge fan, there are at least a couple of reasonable options that exist.
The variable annuities to consider should have very low overall expenses, no surrender charges and investment options with low expense ratios. Here are two variable annuities that, at the time of this writing, seem to be decent options. While this is by no means an exhaustive list, please review the details of these or any annuity you consider, as these may change over time.
If you’re not excited about moving to a new, slightly less cringe-inducing variable annuity, I have one last option for you.
4. Annuitize It
If you’re old enough to annuitize your variable annuity, then this may be a decent option. Once you annuitize it, you’re locked-in to the lifetime income stream that was promised to you when you bought it.
When you annuitize it, depending on your contract, you may have a few choices to make. Do you annuitize it over your lifetime? Do you annuitize it over the joint lifetimes of you and your spouse? What about your death benefit options?
Details aside, taking the lifetime stream of cash flow payments is one way to solve this problem. You don’t have to deal with any of the sub-accounts, onerous fees and annoying rules.
You essentially turn this investment into something that the insurance company actually does well. But before you pull the trigger, consult with your CPA to understand the tax impact of these payments.
Don’t Feel Bad
Please don’t feel ashamed if you’ve bought a variable annuity. These are confusing products with a beguiling sales pitch; millions of people have purchased them over the years. You don’t have to beat yourself up, but you don’t have to stick around either.
Getting out of these investments can be a huge pain. That being said, you’ll be much better off in the long run if you do. The insurance company is counting on you to get frustrated and give up. They’ll certainly make a lot more money if you’re stuck.
With a little discipline, you can create your own lifetime income stream with a reasonable investment strategy and a dynamic retirement withdrawal plan – all while saving a ton of money in fees and expenses.
If you still need help getting out of your variable annuity, click here to set up a quick, complementary introduction call to see if Prana Wealth is a good fit. We do still have capacity to take on new clients this year.
As a fee-only financial advisor in Atlanta, we can (and do) work virtually with clients all across the U.S. We’ve helped plenty of clients get out of their variable annuities in the past and we’re happy to help when you need us.