Annuity Questions for a friend

[CardsFan]

No, I don't have any annuities, this is really for a friend. I actually know next to nothing about them, but through my reading here, I apparently still know more than my friend.

He and his wife are retired, they both have SS and pensions that provide more than their expenses. They also have some IRA's, and she has a 401k, and some investments from a recent inheritance. They have an FA that has worked with family, particularly the wife's mom, for years. They apparently have several (3-4?) annuities. The one in question now is reaching the 7 year point, and that, I guess is the trigger for making the next decision. This is not an inherited annuity. They bought it based on the FA's recommendation. This annuity is after tax, so taxes are due on the earnings. They do not need the income, and are looking at this money as a buffer for LTC. Value is around $100k, half being earnings.

My buddy is not dumb, but also not investment savvy. He asked for advise. His first thought was to cash it out, pay the taxes, and re-invest. This sounds like it could be the right move, but has tax consequences he has not really considered (could move him into a higher bracket).

That is about the extent of what I know. So my request to this esteemed group is:

What questions should he ask to get a better understanding of what he has?

And, what actions would be recommended, based on potential answers?

Thanks in advance for your thoughts.

 

[flintnational]

........What questions should he ask to get a better understanding of what he has?........

CardsFan, I will take a stab at your first question. We know nothing about the annuities purchased by your friend. Clark Howard summed up annuities sold by FA's nicely the other day on the radio. He indicated you should never invest in anything you do not understand. His problem with many annuities is the contracts can be hundreds of pages long. So to answer your question, if the investment cannot be explained in simple terms in a paragraph or two, its not a keeper. And, based on your question, it sounds like your friend does not understand what he has. So, assuming it has a lengthy contract, he should get out. Obviously the exit strategy should minimize penalties and taxes. That is your second question. Others can probably help with an exit strategy.

The exception to the above would be a single premium immediate annuity (SPIA). But this should have a short contract and would be easily understandable.

 

[Souschef]

To minimize the tax bit, instead of cashing it all in, take out the maximum allowed each year with a surrender charge.

 

[CardsFan]

CardsFan, I will take a stab at your first question. We know nothing about the annuities purchased by your friend. Clark Howard summed up annuities sold by FA's nicely the other day on the radio. He indicated you should never invest in anything you do not understand. His problem with many annuities is the contracts can be hundreds of pages long. So to answer your question, if the investment cannot be explained in simple terms in a paragraph or two, its not a keeper. And, based on your question, it sounds like your friend does not understand what he has. So, assuming it has a lengthy contract, he should get out. Obviously the exit strategy should minimize penalties and taxes. That is your second question. Others can probably help with an exit strategy.

The exception to the above would be a single premium immediate annuity (SPIA). But this should have a short contract and would be easily understandable.

This definitely not a spia. Investment was made 7 years ago, and I think the seven year period means no surrender charges going forward.

I agree with not investing in something you do not understand. Too late here, but maybe a lesson learned.

To minimize the tax bit, instead of cashing it all in, take out the maximum allowed each year with a surrender charge.

No surrender charges, I think (past the 7 year period). I suggested taking out everything over several years, to minimize the tax bite, but I don't know enough about annuities to know if this is possible. He does not really want to annuitize, but could this actually be the best option?

Thanks for the comment so far.

 

[pb4uski]

If they have SS and pensions then they are probably in a high tax bracket and will be for the rest of time.

As you may know, annuity redemptions are interest first and then principal... so the last $50k will not be taxed. I wouldn't withdraw any more than what they can to stay in their current tax bracket.... IOW, don't put yourself in a higher tax bracket.

That said, if the $50/$100/7 years is right then it has grown well.... 10.41%/year so it may be good to find out why and consider keeping it... especially if it has any unique aspects.

 

[Independent]

You don't describe the annuity. The "7 year point" suggests that it could be a simple guaranteed interest contract. Interest accrues (or is distributed through partial withdrawals) for the first 7 years at a guaranteed rate.

If he keeps it beyond the 7 years, interest will continue to be paid, but at a lower (probably also guaranteed) rate. There is no surrender charge after the first 7 years. IMO, this is no more complicated than a CD that automatically rolls into a savings account.

If your friend wants some of his money in a guaranteed interest instrument, there is nothing wrong with rolling it into a new annuity with similar terms. (a 1035 exchange) He needs to shop for the best guaranteed rate/surrender charge period combination.

(If the interest rate paid after the end of the surrender charge period is attractive, he could even keep the current contract. That is unlikely, since the company backs the post-surrender charge contracts with short term assets, and he has a long term horizon).

It's a matter of comparing interest rates and tax consequences with other options like CDs and bonds.

OTOH, it's possible that his current product is an indexed annuity of some sort. In that case, the interest crediting mechanism is quite complex and I'd suggest getting out of that, based on your description of his investing knowledge. Again, it would be possible to roll an indexed annuity into a fixed guaranteed rate annuity on a tax deferred basis, if he can find one he understands that fits his goals.

---------------

I agree with b4uski that doubling money in 7 years looks odd. That suggests an indexed annuity where he hit a fast rising market, or that this annuity arises from a series of 1035 exchanges of prior contracts.

 

[iloveyoga]

I would want to know the costs and all fees associated with the different options being considered.

 

[CardsFan]

Thanks all for your insights. Sorry I could not provide more details, but I think you gave me a starting point to help him ask some questions.

There are a few additional details that popped into my mind as I was reading the responses:
My buddy described the annuity as a variable annuity, and he did say it had a guaranteed interest component (minimum?)
During the 7 year period, he could withdraw up to 10% per year without incurring a surrender charge.

pb4uski: My friends were not high earners, so I think they are still in the 12% bracket, but probably near the top. Just concerned that a cash out could move them into 22%. And yes, they are quite pleased with the return.

Independent: My buddy does want a "safe" guaranteed investment return. I'll suggest he consider rolling to a fixed guaranteed rate annuity, if that is not what he has (and it sounds like it isn't)

 

[haha]

Thanks all for your insights. Sorry I could not provide more details, but I think you gave me a starting point to help him ask some questions.

There are a few additional details that popped into my mind as I was reading the responses:
My buddy described the annuity as a variable annuity, and he did say it had a guaranteed interest component (minimum?)
During the 7 year period, he could withdraw up to 10% per year without incurring a surrender charge.

pb4uski: My friends were not high earners, so I think they are still in the 12% bracket, but probably near the top. Just concerned that a cash out could move them into 22%. And yes, they are quite pleased with the return.

Independent: My buddy does want a "safe" guaranteed investment return. I'll suggest he consider rolling to a fixed guaranteed rate annuity, if that is not what he has (and it sounds like it isn't)

Your friend is not an expert, and as you say neither are you. Looking back on any decision can look many ways. Tell your friend it's best for him to make his own investigations and decisions. It's easy enough to be wrong even if you know the facts, and are familiar with the instruments. And none of those things are present here.

Ha

 

[CardsFan]

Your friend is not an expert, and as you say neither are you. Looking back on any decision can look many ways. Tell your friend it's best for him to make his own investigations and decisions. It's easy enough to be wrong even if you know the facts, and are familiar with the instruments. And none of those things are present here.

Ha

Very good point. The last thing I want to do is hurt a friendship by giving "bad" advice. I think I will sit on this unless further questions arise from him, and then only to steer him to the resources for investigating.

 

[Seagirt]

This is a useful overview of the Guaranteed Annuity landscape https://www.nytimes.com/2015/06/20/...d-income-riders-require-careful-scrutiny.html

"We needed two Ph.D.’s in math and some of their grad students to use their software normally used to analyze collapsing stars to figure it out,” he said, only half-jokingly. “I purchased it because I did the math and it looked like it was a good deal relative to other products.”

 

[Souschef]

I would want to know the costs and all fees associated with the different options being considered.

Absolutely! DWQ had an annuity from her late husband. When it was time to roll it over, she was offered a 9% bonus to take a certain annuity. I looked through the fine print, and the expense ratio was much higher. I ran it out on a spreadsheet, and she was break even at 7 years, and in the hole after that.
You really have to be careful. my broker suggested I put some of my IRA in a QLAC to lower my RMD's.(remember-if you do not understand it-do not invest in it), I did some research and found I would be lucky to get my principal back at age 85!

 

[Bruno]

For sure no expert on Annuity's but trying to figure out a couple i have. There are SO many different types of annuity's. He might want to look into annuitization. If you do this only a portion of the taxes will come out with each payment. I just did one for 5 years and the only 15% of the payment was taxes. Vanguard has low cost annuity dept. liked mention you can do a 1035 exchange to their index or SPIA but if you take money out of them its last in first out. So all your payment starting out will be 100% taxable income.

 

[Badger]

Maybe you could introduce your friend to this website so he could ask the questions and provide his information. You may even suggest to him to look for several members whose opinion you hold in high regard.


Cheers!

 

[Z3Dreamer]

OR, he could be in the same situation I am in. Don't know without reading the paperwork. About 24 years ago, with $15,000 of extra funds I invested in an annuity. Today, it is worth about $100,000. This is about an 8.5% compounded return. Over 24 years!

The product is backed by investments (mutual funds) that I or an advisor choose. I would never do a GIC (Guaranteed Investment (interest) Contract).

I don't think I have to touch the money until mid to late 90's. No RMD's.

At some point, when the tax stars align, I will take it out in one or two lump sums. Maybe 3. I will not annuitize as I think I could get a better return by taking it out, paying the tax then investing. Remember, the rate quoted by annuity companies, when annuitizing, is the payout rate, not the return. Nothing is left for my heirs, in their scenario.

Having read about annuities for about 30 years, they don't scare me. I can read the fine print. Although I will not invest in any more annuities, I am staying in this one.

We all have our areas of expertise and have fears of the unknowns. If your friend doesn't understand annuities and doesn't want to understand them, they should transition (in a tax wise way) to something more to their liking.

Here is the analogy that won't make sense. I am not scared of annuities but am scared of climbing up that 30 foot ladder to fix my roof. Others on this site will scale that ladder like it was no big deal, but would tremble while putting their hard earned money in an annuity.

 

[LOL!]

What questions should he ask to get a better understanding of what he has?

Who is he going to ask? I don't think the FA is the person to ask.