By Warren S. Hersch
“Clients want to be more aware of the liquidity features in their annuities so that, if there is a need to tap into these vehicles, they know about the different options available to them,” says Michael Mullen, a principal of Michael G. Mullen & Associates, Mashpee, Mass.
“They’re definitely inquiring more about these features than in past years.”
This desire to be in the know has largely not translated into actual policy withdrawals, however. The inaction has been most pronounced with respect to variable annuities. Sources tell Annuity Sales Buzz that most clients are not withdrawing from their VAs because to do so would risk putting their portfolios at risk, given the depressed valuations of mutual fund-based subaccounts in which the VA funds are invested.
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“Pulling additional funds out during a market downturn will prevent a recovery of the account value when the market rebounds and will negatively impact the clients earnings potential and ability to meet retirement goals,” says Kimberly Genovese, a VA product analyst for retirement solutions at Lincoln Financial Group, Hartford, Conn. “Depending on the amount of the withdrawal, it can also have an impact on the living benefit and death benefit amounts on the contract.”
Those contemplating a draw-down also have to factor in the prospect of tax hit. If the client taking a withdrawal is under the age 59 1/2 , then the IRS will impose a 10% tax penalty. The Service additionally assesses an income tax on withdrawals which, depending on the amounts taken out and other sources of income received, may actually put the client into a higher tax bracket.
Also to consider are restrictions imposed by the insurer. Most contracts, observers say, limit annual withdrawals to 10% or 15% of the account value. Withdrawals exceeding these percentages, as Genovese notes, could adversely impact guarantees. (Some products do, however, allow annuity holders to exceed the annual limit if they forgo withdrawals in any given year. If, for example, the client does not take withdrawals in years one and two, then the person can increase the withdrawal amount to 30% in year three.)
Should the client opt to withdraw funds or cancel the contract during the surrender period, then a surrender charge will also be paid. The surrender period typically lasts 6-8 years after annuity purchase, though observers note the charge may decline over those years.
What is more, the surrender charge might only be nominal if there is a market value adjustment to the contract. Mullen points out that if interest rates are lower at time of surrender than those in force when at policy issue, then the MVA can actually add value to the annuity and offset the surrender charge. Still, the client would do well to think twice before surrendering an annuity.
“Yes, you might be able to walk with $40,000 to $50,000 extra value, but any new contract purchased will probably have a lower interest rate, too,” says Mullen. “So is it worth it to move the funds? In most cases, I would say ‘no,’ unless the client’s situation has changed and we’re looking at a different purpose for the money.”
Contraction restrictions and penalties aside, the client may indeed need to secure a ready source of cash to cover basic living expenses or other short-term needs. Question is, where in the pecking order does the annuity fit when there are assets available to tap?