You may have heard that annuities are bad. That may or may not be true for any particular annuity. If you decide you want out of an annuity, you then need to determine when and how to do it. Surrender charges, taxes, and fees can make cashing in an annuity more expensive than keeping it. In this episode, we discuss what you need to know about exiting an annuity.
Speaker 1 (00:00):
And welcome back to 30 Minute Money, the podcast that delivers action oriented smart money ideas and little bite size pieces. Today, joining me in studio Steve Wershing from Focus Wealth Advisors, thank you for joining me again on your show, sir.
Speaker 2 (00:48):
. I'm welcoming me here. Yes. So nice to see you again, Scott.
Speaker 1 (00:53):
Um, so today we're, we're gonna talk about, uh, what you, what you would do with, with a bad
Speaker 2 (00:58):
Annuity. Bad annuity, bad annuity.
Speaker 1 (01:00):
Bad annuity, sit in
Speaker 2 (01:01):
A corner. That's right. Exactly. So, without going too much into detail about what annuities are and how they work, we can talk about that in a different episode, but Sure. But annuities are oversold my opinion. Many people would disagree with me. Annuities are oversold. In fact, there are people who have built their celebrity careers on mouthing annuities, and maybe they overdo it a little bit, but there are a lot of people who have annuities that just aren't doing what they need to do, or they're too expensive for them, or for one reason or another, they're bad. The problem with that is that the message that comes across is you shouldn't have annuities. You should get rid of 'em. And it's not that simple. If you,
Speaker 1 (01:41):
It's never that.
Speaker 2 (01:42):
It's never that easy. It's never that easy. So, um, so what we want to talk a little bit about today is, let's say that you think you might have a bad annuity. What do you do? So, um, you know, do
Speaker 1 (01:57):
I, do we want to first ask what makes an annuity bad, or is that Sure. Also another episode?
Speaker 2 (02:02):
No, we can, we can do that. Um, yeah, it's worth talking about that. So, to over to, the simple approach to it is to say an annuity is an investment contract with an insurance company. Mm-hmm. . So there are some benefits that can come to you because it's being issued by an insurance company. Um, there are a whole bunch of different flavors. Um, but one of the challenges with an annu, with with many annuities is the internal expenses. And once, you know, give, even with all the benefits that an annuity can bring, once you factor in all the expenses, then it may not be so good after all. Right? And, and I, I, I don't usually go at it like saying, this is good or this is bad. I say what the folks like in the Journal of Finance say, which is, there's a more cost effective way of accomplishing what you're trying to accomplish here.
Speaker 2 (02:51):
Nice. And that's the big problem, right? So if, if you have a variable annuity, for example, the kind of annuity that's got things that look like mutual funds in them, it's not that uncommon to, to see contracts that have three, four, even 5% expenses inside the contract. That's a heck of a drag on a portfolio. If, if your long-term return, you know, is, is gonna be 6, 7, 8, 9, 10%, 10% would be probably on the hairy edge of aggressive. But you know, the, whatever your long term return is, if you've got three or 4% expenses loaded into something, you're gonna give up a lot of growth. Mm-hmm. . And over the course of time, that means a lot of dollars. And that's one of the reasons why so many people talk about, talk about why annuities are bad. Now, we also want to take, you know, take it with a grain of salt, you know, because why do some of these big famous broadcasters spend so much time saying that annuities are bad?
Speaker 2 (03:45):
Well, first of all, cause it's a great marketing pitch, right? Because they want to convert those annuities into money they can manage. So it's popular to slam insurance companies. Um, but you can take it too far. So where I started in the financial business, one of the, one of the people who rose to fame from the company that I started with was one of the people who was behind the whole idea of buy term and invest the difference. Have you heard that one before? Yes. Yeah. That goes back a long ways. And one of the superstars of the company that I started with was one of the guys who really pop popularized that whole idea, buy term and invest the difference. And everybody grabbed a hold of, oh, buy term and invest the difference. Whole life is bad. And so they would run around the country terminating whole life contracts, and it's like, wait a minute, guys, wait a minute, , yeah, we buy term and invest the difference.
Speaker 2 (04:33):
Good idea. But that doesn't mean you just dump every whole life insurance policy you come across. And so that's why I wanted to talk about this today. Annuities are, in my opinion, oversold, many are more are, are too expensive. And so they're, they're, they're not an optimal solution for people. But if you've got one, the question is what do you do with it? Because it's not as simple as just dumping it, right? Here are some things that we need to consider. If you've got an annuity and you're concerned that maybe it's one of those bad ones that all those people are talking about, what do you do? Well, the first thing you do is take a look at not only the expenses inside the contract, but take a look at the, uh, any sales charges that you would incur by getting rid of one. So many contracts.
Speaker 2 (05:21):
If you, um, if they're new, they have a surrender charge that ta that might take five, even 10 years or more to gradually taper off and go away to zero. So if you have one, let, let's say that you invested in an annuity two years ago and now you're hearing this message and maybe you think that this is not a great annuity. If you terminated that, now you might pay five, six, 7% and surrender charges. Well, you know what? It's probably better to hold on to a one, an annuity, even one that charges high internal expenses for a few years while that surrender charge is gradually going away. It might be a good idea to get rid of it, but it might be the right idea to get rid of it a few years from now instead of right now. Does that make sense? Yep.
Speaker 2 (06:07):
The second thing that you wanna think about is taxes. So if you've got an annuity inside of a retirement plan, you don't have to worry about this, but a lot of annuities, and really the, the best place for an annuity is outside of a retirement plan. Because one of the big advantages is tax deferral. The problem is if you have an annuity and it's gone up in value since you bought it, if you just cashed it all in at once, you, you might potentially have a big taxable gain, and that needs to be factored in mm-hmm. before you go switching it off to something else. So one of the things that you want to consider is how much gain, how much profit is in this contract now, because if you, if you turn it right in now, then you'd have to pay tax all on all of that in one year, and if it's enough, it could push you up a bracket or two.
Speaker 2 (06:54):
Mm-hmm. So that's not good. We don't wanna do that. Now, some of these annuities bring along benefits that actually do have some value. There may be death benefits that come with it. There may be guaranteed minimum income or withdrawal riders that go with that. And a lot of those kinds of riders, um, the value of those gets fixed over time. So even if the value of the contract drops over time, the value of that benefit may stay high. So you might have a death benefit that's 50% higher than the value of the contract. Now, you might have a guaranteed income rider that provides you income based on an amount that's well above the market value, the, you know, the cash value of the contract. Now you wanna be sensitive and look at those things before you cash it in, because when you cash it in, all of those benefits go away.
Speaker 2 (07:46):
So these are all things that, that you need to consider before you turn one in. It's not, it's not clear that every everyone should be turned in right away. So, as an example, I, I just, I was working, I'm working with some clients now, working 'em through a financial plan. And like a lot of clients, they came in with a whole lot of different things in their portfolio, including a couple of annuities, a couple three annuities, and we took a look at each one. And what we determined was that one of them was just too expensive. I couldn't justify the e even with all the benefits written into the contract, I could not justify the expense level. We turned that one in and just moved it over into a, you know, into a regular portfolio that we managed. There was another one though that was, you know, pretty reasonable in cost and there was no good reason to get rid of it. And so we held onto it. All we did was we just readjusted the investments within it and we're gonna let it run just the way it is. So these things really do need to be taken on a case by case basis.
Speaker 1 (08:44):
Right. So when, when people are just giving you the blanket statement about what is good and what is bad, that kind of shows how, what you said at the beginning is that like there's different Yeah. Levels.
Speaker 2 (08:56):
Sure. Yeah, exactly. So the, the whole message of annuity is bad, right? Yeah. That's just, that's oversimplified, right? It's like, it's like anything that's that much of a simplification, it's not true all the time the same way, right? Right, right. So as an example, you know, there are, there are times when these things come in handy. So I, I think of one client I had years ago who, you know, through a series of unfortunate events, you know, there were, there were a bunch of unfortunate things that happened to her that really depleted her retirement savings. And I was in kind of a pickle because, you know, I really wanted to manage it like we would normally manage assets for long term, but she had no margin for error, she had no, no safety margin. And so I was really concerned about allocating a portion of her portfolio to growth because if the stock market tanked and she was pulling money out, it, you know, it could just start that death spiral of, you know, eventually depleting it to zero.
Speaker 2 (09:49):
So we found an annuity, low cost annuity, but it had one of those guaranteed income riders on it, and that way we could put that amount of money in as long as she did not take out more than a certain percentage per year, they would guarantee the insurance company would guarantee that they would pay her that amount per month for the rest of her life, even if the contract ran outta money. That's, that's a kind of a case where this could really work out. And so I think of annuities like that as a precision tool in the right situation, it's great, but there are a lot of situations that people, you know, get recommended these things that are not like that. So it's, it's like any, it's like any complicated instrument, you know, it needs in, in the right situation works like gangbusters, but there are only a few of those right. Situations. So we wanna be thoughtful about is it really bad after all, what are the benefits that are coming out of this? And, and then if it's bad, what do we do about it?
Speaker 1 (10:43):
And do they have a lot of different options? Like these riders are like options for the contract, right? Yeah, there are, there are a lot of things that people can get written into these contracts.
Speaker 2 (10:54):
There, there are a few categories of them there, there, so there are not a lot of categories, there are a lot of different riders, but, but here's what I'll say. There are things like, you know, minimum death benefit riders and, and return of premium riders. And, but the big ones, the, the most, the most popular ones today are, are ones that will give you sort of some kind of guarantee of how much you can get outta the contract. That could be a guaranteed income or a guaranteed withdrawal level, something like that. The one thing I will say about them is each company's rider is very different and all of them are fantastically complicated. , there's just no such thing as an easy guaranteed minimum income benefit. They're just isn't no such
Speaker 1 (11:32):
Thing as an easy rider.
Speaker 2 (11:34):
Hey, got it. Yeah. Right. Maybe there is, but, um, but that, but that's the issue is is, uh, there, there are, you know, it, are there a lot of kinds of riders? Well, not really, but are there a lot of different riders? Oh yeah. A guaranteed withdrawal or a guaranteed income rider. There, there are, there are more of them than there are insurance companies because every insurance company probably has two or three or four different flavors of the same basic idea, right. And they all have incredibly complicated rules and, and so it's, it's not the kind of thing that you can just look at and say, oh, here it is. In fact, you know, it it, I I used to supervise a lot of financial advisors and I can tell you even a lot of the advisors who may recommend these sometimes may not fully understand them. They're really complicated. So if you have one of those things, we'll say this again later, but if you have one of those things before you do anything, you really want to take it to somebody who understands these things for an analysis and a second opinion about it.
Speaker 1 (12:34):
Yeah, that's what I was gonna say. How do you know what, what if you don't know what, if you're not sure that right, it's a good or a bad
Speaker 2 (12:39):
One. Yeah. You, you, you want to go to somebody and, and you know, what you may do is just bring it to, to somebody who will charge you a fee to analyze it, somebody who doesn't necessarily have skin in the game. Yeah. And, and have them pull it apart and, and, and tell you, you know, what, what the real benefit is. Now let's just say that you have, let's say that, you know, you've gone through all that and you've looked at it and you've said, you know, you know what, this just is not the right thing for me. This is just too expensive, or for whatever reason it's bad. So what do you do? Well, what many people would say as well, get rid of it, get, get it outta your portfolio. But again, it's not, it's not that easy because you may be giving up benefits, you may be incurring taxes, you may be paying more in sales charges than you need to.
Speaker 2 (13:18):
So there are in fact alternatives. It's not, it's not necessarily totally this or totally that. It's not hang onto it or cash it all in. There are other things you can do. And again, this is something that somebody who analyzes one of these can tell you, but you do have options. And that's the, that's the great part about it. One of the, one of the best ones, one of one of the ones that I like the most is if it's one of these contracts that is expensive because of, of a guaranteed income or withdrawal rider on it, rather than cash it all in, you could just remove the rider. Many of these, many of these, you can call the insurance company and say, I no longer want this rider. Please take it off the contract. And in many cases, they can cancel the rider from the contract and then those fees go away. So you don't have to run the risk of paying the tax, paying the sales charge, those kinds of things. They can just remove a benefit that may not be benefiting you and the costs go down and it maybe then it's a more palatable kind of an arrangement.
Speaker 1 (14:14):
And what do they do? Do they have like some sort of a transaction fee or something when you make those changes?
Speaker 2 (14:20):
Not typically. No. No, not to. They, they'll just stop the benefit and then they'll stop charging you for it. So it's, it's not like a surrender, you know, if, if you give up a contract, you always have to be concerned about what's this gonna cost me? Mm-hmm. , because again, if, especially if it's, you know, in the first bunch of years of a contract, there are probably charges involved, right? But if you just remove the rider, you know, that's not, that's not changing the fundamental part of the contract. And so, you know, typically if they will do it for you, they won't charge you for it. They'll just stop charging you for the rider. Gotcha. Another, another thing that you can do, and again, this is specifically for those guaranteed income or guaranteed withdrawal charges. Um, one thing that you can do is to force, basically you can call the insurance companies question, call their bluff, um, because those riders don't have any value until you run out of money.
Speaker 2 (15:10):
Does that make sense? Yeah. Like it'll, the, the, the insurance company might say, we'll give you, you can, you can have this much income from this. This is not annuitizing the contract. That's a different story if you just keep the contract the way it is, but start pulling money out of it, withdraw it as opposed to annuitize it. Um, and if you want, you can ask about that in a minute. Um, if, if you wanna start pulling money out of it, and you have one of these riders, you know, the, the, the val the, the rider only has value when you run outta money, right? Right. Because you can withdraw. If you've got money, you can withdraw it and withdraw it and withdraw. And as long as you've got money, you can keep withdrawing it. What the rider kicks in is when you withdraw and you run outta money and then they say, well, you have this guarantee, you can keep withdrawing that even though there's no money in the contract. So one of the games that you can play, and I've done this a couple times with clients, is to say, okay, let's start taking the maximum we can out of the contract, we'll just take the, the guaranteed maximum and see how fast we can drain it and see if we can force the insurance company to start paying us money out of their bank account as opposed to our contract. So,
Speaker 3 (16:16):
Well that's pretty
Speaker 2 (16:17):
Cool. Yeah, I like that one. I mean, if it works. Now, a lot of, a lot of times the reason we get rid of these contracts is because if you go with the guarantee, you will never run outta money. So, I mean, you know, but, but, but I mean, if, if, if the, if the facts are, if the pattern is right, yeah, yeah, absolutely. That's, that's one way that you can really just force the insurance company to pony up and start, you know, start giving some, giving some benefit to it. Um, now we, I, I mentioned a minute ago that you could, you know, that this, this is different than annuitizing a contract. So there are two ways to get money out of a, out of a deferred annuity. One is you can withdraw the money and the other one is you can turn it into a monthly income for life.
Speaker 2 (16:57):
That's annuitization. That's when you annuitize the contract and they're different. So if you annuitize a contract, that's a guaranteed check for the rest of your life, period. That's, that's what that is. The guarantees only come in if you're not gonna annuitize the contract and you're just gonna withdraw from it. Annuitizing is another one of those ways that you can get rid of that contract. If you decide that you, this is not a good, this, you don't need this contract anymore, it's, it's not good. But if you are retired, if you're a retirement age, and if you, you could use another source of guaranteed income, then you could, annuitization is one of those things you can do. One of the things that we look at when we design retirement income strategies for folks is not only how much can they get, but how much of it is guaranteed.
Speaker 2 (17:40):
So if they have a pension, if they have social security, you know, those are all guaranteed sources of income and we'd like to see a certain proportion of someone's retirement income be, well, if you have an annuity and you wanna get rid of it and a relatively low proportion of your retirement income and, and you're, you're ready to take retirement income. Now this is not something a, you know, younger folk person would do, but if you're getting ready of your retire, if you're in retirement, um, you could take a look at how much of that income you're gonna get in retirement is guaranteed. And if, if that ratio is a little low, if you'd like, a little higher percentage is guaranteed. Well, one way to get rid of the contract is to annuitize it. You can annu either annuitize it by annuitizing that particular contract, or you can do a tax free swap into an annuity that immediately annuitize and starts paying you, uh, starts paying you every month.
Speaker 2 (18:30):
And, and it's worth comparing the two of those right now. It's not a bad time to annuitize a contract cuz interest rates are pretty high and, you know, we, we get effective distributions, you know, pretty high percentage, uh, by annuitizing the contract or buying one of those, you know, uh, contracts that immediately annuitize an immediate annuity. So that's another way, instead of just cashing it in you, you might want to consider annuitizing it if adding that income stream is something that would make sense in your retirement income plan. And then finally, the, the, the last thing that you can do is rather than just simply cashing it in, and again, this is specifically for one that is not in a retirement plan, if it's a non-qualified annuity, um, you can exchange it for another annuity on a tax-free basis. Now, you might say, Steve, if you've got a bad annuity, why would you just want to get another annuity?
Speaker 2 (19:23):
Well, the, the, the answer to that is what makes the annuity bad? Is it high internal expenses? Is it, you know, what is it about the annuity that makes it bad? Well, there may be a different annuity that doesn't have those problems and if you can get out of it without a sales charge, uh, but there would be a big tax implication. Well, maybe we find one of those, you know, uh, uh, contracts that does not have the problems that yours had and exchange 'em. Because if you exchange one annuity for another, it's a tax-free transaction. You don't have to pay tax on it Now.
Speaker 2 (19:55):
Make sense? Yep. Okay, good. So if you have, if you have an annuity and you've been listening to the radio and you've been hearing all these people slamming these things and you're looking at it saying, geez, I'm not sure, I'm not sure what I should do, um, we mentioned it before, get a professional assessment of it. Um, take it to somebody who does, who's not involved in the original one. Um, there are people who have some expertise in, uh, in understanding these things and you probably need to pay 'em a fee, but pay 'em a fee and have 'em analyze it and have 'em, have them take a look and, and quantify for you what all the expenses are and then just give you an assessment about whether or not this is on, on balance. If this is a, this is a cost effective solution to the kind of problem you're trying to solve.
Speaker 2 (20:40):
Um, inside those, uh, inside those contracts, specifically with variable annuities, you want to take a look at internal costs. You wanna take a look at contract fees, you wanna take a look at the insurance costs in the contract. Um, keep in mind that in those variable annuities, the ones that have things that look like mutual funds inside of them, each of those sub-accounts, each of those investment options has its own expense ratio. So you have the contract expenses, but then each of those investment options has its own expense ratio. And of course, if there are riders on it, especially guaranteed withdrawal, guaranteed income riders, they have their own expenses too. So when you go through and evaluate all that, you want to add all of those different things up so that you understand really what's, what, what are you paying all in, what are you paying when you add all of that kind of stuff up? And uh, and that's it. So if you have one of those, one of those annuities you think may be bad, don't jump to action too fast. Don't just get rid of it. Take a look at what you have, evaluate, you know, are there in fact benefits to this thing, but more importantly, what are the expenses? What are the downsides of turning it in? Because just, you know, turning it in annuities willy-nilly could just compound the problem that you find yourself in.
Speaker 1 (22:01):
Your retirement is at risk, not from the stock market, not from inflation. Taxes are putting your retirement at risk. I'm certified financial planner, Steve worshiping and I specialize in helping people create low tax retirements. Unmanaged taxes can take 30, 40, even 50% of your retirement income. Learn how to defend yourself against excess taxation. Our complimentary webinar will cover all the principles you need to know to protect your money for you and your family and keep it away from the government. This free webinar will cover how taxes are different in retirement, the taxes you pay in retirement that you don't have to pay during your working life. How to move tax savings into a tax free environment. The Widows Tax, the Secure Act, the Secure Act 2.0 and what they mean to you. The webinar is free, but you have to register to save your spot. So go to focused wealth advisors.com/webinars and find out more and sign up right there. Even if you're not planning to retire for the next five or 10 years, this information will be critical for you. The longer you have to put the strategies into effect, the more you can accomplish. That's focused wealth advisors.com/webinars to find out more and to sign up today.
So bad annuities, good annuities. We'll have to figure it out. What's your 30, 30 minute action
Speaker 2 (22:07):
List? 30 minute action item. If you have an annuity, calculate the fees in the contract or contract the fee advisor who can analyze it for you.
Speaker 1 (22:17):
There you go. You can find us, of course, at 30 minute.money. Thanks for listening. Give us a nice review on, uh, iTunes or the podcast platform of your choice and we'll catch you next time on 30 minute Money.