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If you have an annuity, it’s important to understand exactly what you’ve got and why you own it.
After my last column explaining some annuity traps. one of my readers pointed out that he’s read a lot of articles about annuities, both pro and con, but he’s seen nothing on how to evaluate an annuity that you may already own.
With over $200 billion in annuity contracts purchased each year in the U.S. chances are you have one. So, with a hat tip to Kevin Monahan. let's take a look at some key points in evaluating an annuity that you already own.
Below are the first three foundational steps that you need to take and the questions that need to be answered:
1. What type of annuity do you own?
This is the starting point for your annuity detective work and is vitally important in determining if you have options — and what they are. If you own a deferred annuity, then you need to find out exactly what kind. Variable? Indexed? Fixed? Most of these deferred annuities are flexible contracts.
If you have an immediate annuity, or have already annuitized (created irrevocable contractual payments) a deferred contract, then you can't transfer or cash the annuity in. If you’ve turned on an income rider attached to a deferred annuity, then you probably should stay with your current policy.
2. Is the annuity inside an IRA or not?
This is important to know from a taxation standpoint. IRA rules apply concerning both age and distribution with annuities inside a qualified account. Taxation of a non-IRA annuity is LIFO (last in first out or gains first) at ordinary income levels.
To transfer an old annuity to a new annuity in a non-IRA account, you would use the IRS approved 1035 transfer rule. This is a non taxable event, with the cost basis of your old annuity transferring to the new one. Transferring an annuity within an IRA is a direct transfer to another IRA, which also has no tax consequences.
3.Verify the policy specifics with the carrier, not an agent
On the top of you annuity statement, or within the actual policy is an 800 phone number of the issuing carrier. Always call the annuity company to get the policy specifics because their internal customer service people have no agendas other than to fully educate you on the annuity you own. Surrender charges, total fees, investment options, and any attached riders should be clarified along with any other questions or concerns you may have.
At this point, you are now ready to start getting to the details of whether you should keep your current annuity, or move on to greener pastures. Here are some of the main points you need to cover.
What do you want the annuity money to do?
This is the most important step, and the main question that needs to be answered. What do you want the annuity asset to solve for? What is it solving
Do you want a fixed rate along with principal protection? Is legacy, or leaving money to your heirs important? Do you need income, and if so when? Will any benefits be set up jointly with your spouse? How about long-term care? What type of guarantees do you want in place contractually?
These answers, along with the facts provided by your current annuity carrier, will allow you to compare the annuity that you have to newer annuities to see if a contractual upgrade is possible.
Keep what you have, cash it in, or transfer to another annuity?
These are the three options if you own a deferred annuity. Cashing it in has tax ramifications outside of an IRA, but an annuity can be liquidated inside of an IRA with those cash assets not taxed if no money is taken out. Whether your annuity is inside of an IRA or not, you can transfer it to another annuity without tax consequences. Also, any remaining surrender charges with your current policy can prohibit transferring or cashing in the annuity.
Transferring to another annuity has to make mathematical sense
If you have been shown an annuity with the recommendation of transferring your current annuity to that new policy, the contractual math has to make sense in your favor — not the agent's. In other words, the new policy has to be better using a side by side comparison to the one you already own.
In most cases, transferring your annuity because of an upfront bonus from the receiving carrier makes no sense at all. Never be convinced to transfer based on promised (i.e. non contractual) return numbers, or any too good to be true scenario that has been pitched.
Old annuities = drooling agents
Most of us are familiar with the Pavlov's dog experiments where he could make them drool by ringing a bell. In the annuity world, too many agents start drooling at the mere mention of you having an older annuity. Don't be swayed by their 1035 transfer pitches, or upfront-bonus sizzle to justify moving into their "perfect" annuity product.
The hardest part of deciding if you should stay with your current annuity or possibly moving to another one is finding an agent that will tell you the truth and not just pounce on the potential sale. The fact is that most people that call me with this question, I usually end up telling them to stay with their current annuity because there is no contractual or mathematical upgrade available.
There is no perfect answer to this type of annuity evaluation. Besides the math calculations being the primary focus, you also have to trust your gut instinct on what the correct decision would be for your specific annuity situation. Always use the issuing carrier and comparison carriers as your main resource for having the annuity details explained in full, and the options available to you.
Be prudent, go at your pace, and you might be surprised to find out that the annuity you already own might be worth keeping.