Three Options for Retirees with an Old (Forgotten) Annuity

If you’re retired with an annuity that was purchased between 2000 and 2015, it’s likely sitting in the financial equivalent of a junk drawer, uncovered and remembered only when you go looking for something else.

I spent six years of that period registered with ING Financial Partners. At the time, ING was one of the biggest providers of variable and fixed annuities. Today, ING doesn’t exist in the U.S., and its insurance and annuity arms have been sold. This is representative of the massive shift in the market during the past 25 years. The companies that once dominated have moved on to new things. The products have also significantly changed and, in many cases, have improved.

This article is a nudge to dust off that old contract and use it for something you care about. After all, you worked hard for the money, so you should get something out of it. Here are three options that will cover most, but not all, situations.

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1. Surrender the annuity

I recently met a husband and wife with about $1 million in annuities purchased in the early 2000s. Despite having the annuities for this length of time, the couple had made only about $100,000 in the accounts. Reasons: a combination of poor investment choices, expensive products and a low-interest-rate environment.

Evan T. Beach, CFP®, AWMA®

At age 26, I earned my CERTIFIED FINANCIAL PLANNER™ certification. I also hold the IRS Enrolled Agent license, which allows for a unique approach to planning that can be beneficial to retirees and those selling their businesses, who are eager to minimize lifetime taxes and maximize income.

The surrender option makes sense for those who are looking for liquidity over income. It does not make sense for anyone in the surrender period and likely does not make sense for anyone with large, unrealized gains. That’s why it was important to point out that their gains weren’t significant relative to the surrender or account value.

Unlike a taxable investment account, annuities are tax-deferred until withdrawn. At that point, they are taxed on a LIFO (last-in, first-out) basis, as income, not capital gains. In plain English, that means the clients would show $100,000 in additional income in the year surrendered on the front page of their income tax return.

2. Turn on the income

This is often referred to as “annuitizing,” which is also often an incorrect characterization. While annuities allow you to turn on income via annuitizing, most people turn on an income stream via a guaranteed minimum income benefit (GMIB). These are “riders” that you pay for and that guarantee you income for the life of the income beneficiary. It is important to understand guarantees are subject to the claims-paying ability of the issuing insurance company.

Many of the deferred variable annuities that we have come across with prospective clients are underwater. This means that the income benefit is higher than the account value. In this case, the best option may be to elect to start income from the current annuity contract. If the account value and income value are similar, you may be able to get more income from a new annuity.

3. Exchange the old annuity for a new one

In the example I gave earlier, the poor performance of the couple’s annuities was due in part to expensive products and low-interest-rate environments. Deferred variable annuities were plagued by the former. Fixed annuities, by the latter.

Many of the deferred variable annuities of the early 2000s came with all-in expenses of over 3%, annually. These types create quite a hurdle for even the best underlying investments. In the past decade, costs and structures of variable annuities have come down significantly.

If you are just looking for tax-deferred accumulation, the odds are that a new product would be less expensive. The IRS allows you to exchange an old annuity for a new one, deferring the gain until you take money out. This is referred to as a 1035 exchange.

Fixed annuity guarantees move up and down with interest rates which means the period from 2010 to 2022 was quite painful. However, in the past two years, the guarantees have moved up significantly. We have had clients who were able to generate more than 30% more income by exchanging their old annuity. Those rates have decreased since the Fed started to cut, but are still quite a bit higher than they were previously.

Look at different scenarios before taking action

One cool thing you can do within most financial planning software is run “what if” scenarios that can illustrate surrender vs income vs exchange. Your odds of success will go up or down based on the choice you make. You can access a free version of the software we use.

Lastly, you may have noticed that I didn’t mention leaving the annuity to your kids as one of the options. Nine times out of 10, this is not a good move. I’ll cover why in a forthcoming article.

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• Annuities: What They Are and How They Work
• What You Should Know About Annuities
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• 10 Inefficiencies I Look for on Rich Retirees' Tax Returns