By Kimberly Lankford
Soon after Marjorie Marquis' father left her a $40,000 inheritance, she sought investment advice from a financial planner recommended by a friend. In 1995, the planner suggested that she place her small windfall in a deferred variable annuity, even though Marquis, of Albuquerque, didn't have an IRA and hadn't been making maximum annual contributions to her 403(b) employer retirement plan. The product cost Marquis 2% a year in expenses, much higher than the typical no-load mutual funds she could have bought for a retirement plan. To make matters worse, the account lost more than 13% of its value because the planner invested the annuity in risky stock funds. "I was totally ignorant and went into it blindly," says Marquis, now 61.
Eventually Marquis sought help from another planner, who switched her into a lower-cost annuity. If you find yourself in the same boat -- trapped in an annuity that's not right for you -- there may be steps you can take to make the best of a bad situation.
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Although deferred variable annuities are legitimate products, they're not suitable for many seniors. With a deferred annuity, you invest a chunk of money that grows tax-deferred until you withdraw it as retirement income. Deferred annuities often impose long surrender periods, of perhaps ten years or more. If you want your money sooner, you could end up paying up to 7% or 10% of your account balance in penalties.
Why the hard sell? Agents can earn commissions of 4% to 7% up front for selling variable annuities, and even more from selling equity-indexed annuities, another type of deferred annuity whose returns are partially linked to the stock market.
Trimming Your Losses
If you're still stuck in the surrender period, it's rarely worth taking a 7% to 10% hit just to get out. It's best to sit tight for a while. Most annuities let you withdraw up to 10% a year without a surrender charge. You can invest some of those withdrawn assets in safe investments, while leaving a diminishing balance in the annuity.
Contact your state insurance department or securities regulator if you believe the agent or broker misled you about long surrender charges or other features. The government's involvement may motivate the company to let you withdraw the money without penalty. Most states also have a free-look period, allowing you to get out within the first month without any charges.
When the surrender charges start to dwindle -- they're usually just 1% to 2% in the last few years -- think about your next step. Even if a small surrender fee remains, you could still come out ahead by switching to another annuity or another investment with lower fees.
Your options will depend on your tax situation. If the annuity is in an IRA, you can roll the assets into mutual funds or other investments without a tax hit, if the money remains in the retirement account.
If the annuity isn't in a retirement account and has increased in value, then you would pay income taxes on the gains if you cashed it out entirely. Annuity holders who don't need the money yet and want several more years of the annuity's tax-deferred growth can switch to another annuity without incurring taxes, a process known as a 1035 exchange.
Be careful when you switch annuities. Not only must you watch out for new surrender charges, but you need to compare fees and make sure you aren't paying for guarantees that you don't need. For those who want to switch to a variable annuity with the lowest fees, Donna Skeels Cygan, a fee-only financial planner in Albuquerque, usually recommends Vanguard and Ameritas, which don't have a surrender period and have annual fees of 0.30% to 0.55% (plus fund-management fees).
In 2002, Marquis turned to Cygan, who switched her client to a Vanguard variable annuity with total expenses averaging 0.52% a year, compared with 2% fees on her other annuity. "The difference in fees each year is huge over time," says Cygan. The surrender period on Marquis' first annuity was over by the time she made the switch.
Besides lower fees, Marquis' new annuity has better investment options. Her annual returns have averaged 12.13% over the past three years.
Cygan also recommended adding a 0.02% fee for a stepped-up death benefit. If Marquis dies before withdrawing the annuity money, her beneficiaries will receive the highest balance the annuity has reached through the years, even if the account value has declined since then.
Other guarantees can be worth the extra costs as well. Mark Cortazzo, a certified financial planner with Macro Consulting Group, in Parsippany, N.J., recommends several variable annuities with guaranteed minimum income benefits for retirees in their fifties and sixties who need immediate withdrawals.
These annuities let you take out 6% of your original investment every year until you decide to convert the investment to a lifetime string of payments. Regardless of market performance, those payments will be based on no less than the value of your original investment but are calculated at your current age, boosting the payout even higher.
The annuities he recommends carry a commission of 1.5% to 2% the first year, followed by 1% annually, and a short surrender period of up to three years. The guaranteed minimum income benefit costs 0.55% of the account balance per year.
Work with a financial planner who specializes in this area. Cortazzo and his staff spend about 2,000 hours every year poring over variable annuity contracts to find the very few that provide good value.
If you're older and you need to make withdrawals from the annuity right away, you can roll some of the money into an immediate payout annuity. You can't gain access to the principal after the payouts begin, so don't invest too much. But it will provide guaranteed income for the rest of your life, no matter what happens to the stock market.
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