Here's a fearless forecast: The first word of the next sentence will make you want to turn the page. Annuities--tax-deferred investment plans that come with such discouraging terms as "surrender charge" and "mortality expense"--are the financial world's deadliest topic. If neither you nor a loved one owns one, have mercy on yourself and turn the page. For the rest of you, I have a question: Are you satisfied with your annuity?
Mary Sandrowski wasn't. A retired medical transcriber in Redlands, Calif., Sandrowski couldn't help but feel contempt for how little her Hartford Life fixed annuity paid--just 4%. "I thought, `I can do this on a bank CD any day of the week,"' she recalls. So she enlisted her son, Phillip Cook, a Torrance (Calif.) certified financial planner (CFP), to find a better deal. He put together a similar contract paying one-half percentage point more a year--but with a first-year, 4% bonus that more than offset a 1% surrender fee on the old contract.
Dumping an annuity isn't something to do lightly. Taxes and fees can kill you. But if the reasons you bought it no longer apply, then why not try to do better? "The annuity marketplace is so competitive right now, there are lots of deals," says Fort Worth CFP E. Kim Dignum. That's why I formed this four-step plan to help you see if it's worth switching.
STEP 1: Search your files, call your adviser, or phone the annuity company, but one way or another find two facts: the current value of your contract and the "surrender charge," or percentage fee, you would have to pay to end it. It likely ranges from nothing to 10%. Then call one of the firms offering no-load annuities without surrender charges--Scudder (800 225-2470), T. Rowe Price (800 469-5304), and Vanguard (800 522-5555) are three--and see what a comparable contract has been returning. Fidelity (800 544-2442) also offers low-cost annuities, but with surrender charges.
STEP 2: Do the worksheet below. It will give you a quick idea whether you should pay a surrender charge to flee your current annuity for a better one. While cases differ, Melbourne (Fla.) CFP Mary Ellen Baldwin suggests that if you're in a crummy annuity now and your surrender charge is 2% or less, a swap may put you ahead soon. You also should look at an annuity as part of your entire portfolio's asset allocation. You may make the most of your money in a fixed annuity by moving it into a variable annuity that you can invest in more volatile assets, such as small-company or foreign stocks, while using cheaper, higher-returning bond or money-market mutual funds for the fixed-income slice of your portfolio. Here's why: Annuities often come with a death benefit that guarantees against losing your initial investment--a feature you may as well use with your least stable holdings.
STEP 3: Make sure that if you switch, you do it via a "1035 exchange." That allows you to move your money without paying the tax that's due on withdrawn earnings at high, ordinary income rates. It's akin to rolling over an individual retirement account. Call the company where you want the money to go and say the magic words, 1035 exchange. The company will send you the paperwork, contact your current annuity issuer, and walk you through the swap. Keep a record of your investments, or "basis," in the old annuity. You'll need it to pay the lowest tax when you take your money out.
STEP 4: If you decide the surrender charge is still too high for a switch, be patient. These fees typically decline each year. Meanwhile, you likely can liberate some of your capital, often 10%, without paying a fee. Instead of taking income from a lower-cost or higher-return account, tap the annuity for cash--unless you're under age 59 1/2, which means you would be hit with a 10% penalty tax.
Rethinking your annuity is, in truth, a deadly bore. But it's a task with one clear beneficiary--you.
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