I would jump at any opportunity to start getting the money out of that annuity. The purchase of an annuity typically results in a wealth transfer of 15 - 20% from the investor to the insurance company and agents who push them. And yes, she was sold this annuity by a salesman who legally worked for himself or his company -- not a fiduciary registered investment adviser working in the best interests of her.
The sales agent was paid many years ago. Those were all sunk costs. Right now, 3% is not such a bad deal.
The problem with annuities are numerous. For one they are taxed at the higher ordinary income tax rate and so distributions must be tightly controlled depending on your tax situation.
So are CDs, bonds, and all fixed income instruments except for munis. Unlike those fixed income instruments, annuities are tax deferred, which make things a little more fair.
Heirs pay taxes on gains that they inherit. Heirs pay no taxes on gains from other normal investments like stock and bond ETF's.
Same as with a 401k or traditional IRA.
3% before taxes is not investing. That's actually doing worse than inflation after you pay ordinary income taxes at the time of distribution. The normal way to invest is with a mix of stock and bond ETF's. The older you get the more you favor bonds obviously.
Then why are people buying corporate bonds with LESS convexity (the annuitant here gets a lot of optionality with this 3% return) right now? Are they all foolish for lending at 2.5% to IBM for 5 years- and granting IBM a call feature which allows them to buy the bonds back?
The insurance company will simply spit out facts about their product. Don't expect to get any type of personalized advice from them. Same thing with brokers, insurance agents, and other non-fiduciaries. Whoever is listed on her quarterly statements cannot be trusted either. He earns a 1/4% trailer fee for every year she remains invested. Only a paid fiduciary can really advise you on what to do.
My advice here is that annuities may not make great investments, but this is an annuity worth keeping. For now. If interest rates hit 6% and this is still paying 3%, ok, cash it out.
The trailer fee is a sunk cost. She could have gotten 3.25% somewhere else.
Here's another way of thinking about this:
You bank with Citi. Citi is a horrible bank. It's 1980, and Citi decides to roll out a 40-year CD. Interest rates are 20%, but Citi, being an unfair bank that offers horrible interest rates, offers it at 10%.
It's now 2013. Someone goes online and asks "Uhh, I have this old CD with Citi paying 10%. What do I do with it?" Everyone offers their knee-jerk reaction "CASH IT OUT! YOU'RE GETTING SCREWED! CITI IS MAKING 10% OFF OF YOU." Only though now interest rates are 1% and when OP goes to Ally to get a new 7-year CD, he/she now gets 1.5% instead of 10% and loses 60% over the next seven years.
So yes. Annuities- if they're not designed to address longevity risk- are often a bad deal. In this case, because the annuity was bought many years ago in a different market, it's a GREAT DEAL. Cashing out would be sub-optimal.