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.
“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?
Paul Messiter, a certified financial planner and senior investment adviser at StanCorp Investment Advisers, Ann Arbor, Mich., says he generally counsels clients to start with other fixed accounts, such as certificates of deposit, money market funds, bonds, treasury notes and savings accounts. In contrast to annuities, which enjoy tax-deferred treatment, funds invested in these fixed accounts have already been taxed.
“Clients need to first consider low-yielding alternatives that don’t enjoy the tax-deferred treatment,” says Messiter. “The tax-deferral is a very important feature. To the extent you draw down account, you lose that benefit. Also, you want to avoid tapping accounts that offer higher yields. So both returns/yields and taxes have to be considered.”
Only after taxable accounts are exhausted, say experts, should clients turn to their annuity holdings, drawing on their fixed accounts first (once again, to avoid tapping VAs that might be negatively impacted by withdrawals). Jason Lea, a principal at Brokers’ Service Marketing Group, Providence, R.I., says many of his clients are particularly attracted to the liquidity features of fixed indexed annuities that, like their VA counterparts, offer lifetime guaranteed minimum withdrawal benefits.
Lea cites two such products which incorporate an actual account, the value of which is tied to an index (such as the S&P 500), plus a hypothetical account value (or benefit base) that provides a guaranteed annual rate of return, such as 7%. When the policyowner is ready to take withdrawals, the annuity will pay the greater of the two account values.
“The GMWB rider on fixed indexed products is by far the greatest liquidity story over the last two years,” say Lea. “Most fixed indexed products in the market today are being sold on this basis. For this added benefit, the client will typically pay from 35 to 65 basis points.”
Of course, the GMWB option is also available on VAs, as is the equally popular guaranteed minimum income benefit. David Duffrin, a principal and managing partner at Northern States Brokerage, Brookfield, Wis., says that some older clients who enjoy the GMIB rider are in fact electing to take withdrawals despite the economic downturn.
The reasons: The amounts these clients can withdraw, thanks to the rider, often substantially exceed their actual account values. Also, because they are advanced in age (most are over age 70), these people do not expect to live long enough to enjoy a recovery in equity values.
“They’re looking at their accounts statements with shock and horror and saying, ‘I have a $150,000 withdrawal value, but my actual account value is only $82,000,’ so I’ll take the income now,’” says Duffrin. “These clients feel that hardship is coming and they want to have a beefier income.”
Yet another liquidity option available to some clients, sources say, is to take a loan against the annuity. Though not available with most non-qualified annuities, loans are a standard fixture in many qualified annuities available through 403(b) plans offered by non-profits, says Christine Tucker, a vice president of marketing in the Annuities and Mutual Fund Division at Pacific Life, Newport Beach, Calif.
“The loan can be great for meeting short-term needs, so long as you adhere to a schedule for repaying the loan,” she says. “And, unless you fail to pay back the loan, there are no tax consequences.”