What to do With your Annuity Investment in Retirement Plan?

Last time we talked about some do’s and don’ts of annuity investment.  Here’s a story about what to do with your annuity investment, if you are looking for some alternative. Let it be clear that if you are looking to rollover your annuity investment in to an IRA, you can only do it if your original annuity was bought under an IRA investment. Else you can’t roll over this in to an IRA account. Here’s an expert advice from CNN Money explaining the process.

I do not have any annuity in my retirement portfolio. I was planning to buy one but figured out that we are better served with employer 401(k) and TD Ameritrade IRA account that we have. We are young couple now and we can risk investing in variable return investment in our retirement account. We do not particularly want assured minimum fixed return that a typical annuity offers. If you have an investment already made in annuity and you want to cash out it, may this article help you.

First of all, there are various charges and taxes you should be aware of before you sell off.

1. Surrender charges – If you withdraw your money from the account in the first 6 to 8 years. The surrender charges generally vary between 6% to 10% in the first few years and decline over time to 0, in some cases they run as high as 20%. If you cash out of annuity early, you could pay a steep price.

2. 10% penalty tax – If you cash out of your annuity fund, you need to pay normal taxes on the gain. You don’t pay taxes on the original investment as it was made with after tax income. If you withdraw money from an annuity prior to reaching 59 1/2 years of age, you pay a 10 percent tax penalty on top of the regular income taxes. Which means if you are in the 25 percent tax bracket, you would end up paying an effective tax rate of 35 percent on your annuity gains.

If you convert the value of your annuity into regular payments based on your life expectancy the 10 percent tax penalty is waived on payments you take. You’ll still have to pay income tax on the payments, but annuitizing gives you a little tax break there as well in the form of what’s known as the exclusion ratio.

I would say if you are still in lock-in period, do not sell out of annuity. Once you are out of it and you can avoid the surrender charges, you can look for fixed annuity to variable annuity conversion, known as 1035 tax-free exchange. Let’s see some comparison between a fixed and variable annuities.

Fixed rate annuity – Fixed annuities similar to CD’s, they pay guaranteed rates of interest, often higher than bank CDs. Fixed annuities can be deferred or immediate. The deferred annuities accumulate regular interest and the immediate annuities make fixed payments – determined by your age and size of your annuity after your retirement. They produce guaranteed return and supplement a part of your pre-retirement employment income.

Pros: Guaranteed rate and not subjected to market fluctuation. Even if stock markets goes in to doldrums, your income is assured.
Cons: You get way less rate than a long-term stock market gain rate. Income from fixed rate annuities typically trail inflation rate. Value of your money will go down over time.

Variable rate annuity – A variable annuity allows you to choose from a selection of investments, and then pays you a level of income in retirement that is determined by the performance of the investments you choose. If market performs well you expect to receive a better return than a fixed rate annuity. You get options of selecting individual stocks and funds to invest in.

Pros – They generally have higher return than fixed rate annuity over time.
Cons – This investment in subjected to market risk. You pay higher fees towards administration charges for investment managers who manage your investments.

A 1035 exchange can’t save you from surrender charges but, it can avid the penalty tax for early withdrawal. Some annuity providers offer sign-up bonuses to compensate for the early withdrawal charges (you can never fully compensate though). But, keep in mind that when you are exchanging to a new annuity you are going in to a new lock-in period. Before you actually do an exchange do read this SEC publication carefully.

Before you decide to sell off your annuity, do remember that there’s the insurance feature in it that makes it different from any other type of retirement investment. Annuities make sure that you do not outlive your investments. With this insurance feature you are assured of your regular income even if funds under variable rate annuity tanks due to market forces.

You really sleep well with a variable rate annuity with insurance feature, with an additional fee you can get yourself isolated from even recessions and prolonged market downturn. Think before you get out of annuity investment you already have made. This WSJ article accurately describes why annuities are possibly the most secured retirement investment available to us today.

Disclaimer – I am not a certified financial planner, the content in this article is written for entertainment purpose only. I strongly suggest readers consult financial planners before deciding on buying/selling/exchanging annuity investment.