Whether they realize it or not, clients considering the surrender of an annuity product have many factors to weigh before determining whether walking away is the wisest course of action, and the scenario is becoming more common each day.
Clients who are locked into variable annuity products may find themselves evaluating buyout offers from insurance companies that want to escape the guarantees that are often attached to these products. In other cases, clients may simply have buyer’s remorse and wish to escape themselves. In either case, professional guidance is crucial to navigating the decision-making process—to ensure both that the client receives the best possible deal upon surrender and that the recovered funds are allocated in a manner that best suits the client’s current needs.
To Surrender or Not to Surrender
Clients who purchased variable annuities with a view toward generating retirement income may be facing buyout offers, notices that their investment choices are being limited to those that are very conservative, or may simply find themselves facing changed circumstances so that the product no longer makes sense.
For example, a client who has recently been diagnosed with a disease that is likely to shorten his life expectancy may find that surrendering the annuity in exchange for a lump sum payout may better serve his reduced need for lifetime income. Other clients may be facing unanticipated expenses and see the buyout as a way to meet those expenses.
Clients facing the need for an immediate lump sum of cash should also be aware that it may be possible for them to withdraw a portion of the annuity’s assets, keeping only a small part of the initial investment in the annuity to maintain the contract’s death benefit. Clients who are simply unhappy with the variable annuity’s investment performance may also find this strategy appealing, as they can then invest in another income-producing product while preserving some value in the original annuity.
For clients who are still attracted to the income-producing feature of a variable annuity, however, it might be best to hold onto the product in the face of a buyout offer, especially if the product offers guaranteed returns that may be unavailable in a replacement product.
Considerations Upon Surrender
After a client has determined that his best bet is to surrender the product, the surrender charges associated with the annuity still must be taken into account. If the client has a buyout offer on the table, it is likely that the insurance company has already offered to waive any surrender charges. If the client has independently decided to surrender, however, he may be able to negotiate a waiver, especially if the client agrees to reinvest the recovered annuity funds with the same firm that issued the surrendered product.
It is important that clients realize they will owe taxes upon any gain realized at the time of surrender. If the client has only held the annuity product for a few years, this gain might not be substantial—in fact, many variable annuity products that were issued just before the economic downturn in 2008 are just now returning owners to the break-even point. Still, for clients who have owned the variable annuity for many years, the tax liability can be substantial—especially when the new 3.8% investment income tax for high-earning taxpayers is taken into account.
For clients who purchased the product within an IRA, the funds can be transferred in a trustee-to-trustee type rollover transaction, which allows the client to defer taxation until the funds are withdrawn from the IRA. Taxation can also be deferred if the client exchanges the undesirable annuity for another annuity product in a tax-free exchange under IRC Section 1035.
In some situations, surrender of the annuity product may, in fact, be a smart course of action—but if this is the case, it is important that the client be apprised of all consequences that will accompany the decision to surrender.
Originally published on National Underwriter Advanced Markets. National Underwriter Advanced Markets is the premier resource for financial planners, wealth managers, and advanced markets professionals who provide clients with expert financial and retirement planning advice.
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