Financial Advice for Retirement, Social Security, IRAs and Estate Planning

Handling Unwanted Annuities

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A number of people bought annuities years ago that no longer suit their needs. Sometimes there has been a major life change relating to marriage, death, or inheritance. Other times a person’s financial needs have changed. They want money now instead of waiting for annuity payouts. Some simply are dissatisfied with the returns of the annuity. Most often, an annuity owner decides he or she has a more pressing need for money and does not want to wait to receive it.

There are good ways and bad ways to deal with an annuity you no longer want.

The first step is to consider one’s options with the annuity and the insurer that issued it. The insurer wants to keep the assets and will try to make the customer happy.

The first instinct of many owners is to surrender or cash in the annuity. This often is a bad move. If the annuity has not been owned for a number of years or the owner has not reached a minimum age, there could be a redemption fee or interest penalty for cashing in an annuity early. That reduces the cash received. In addition, the tax law will impose costs.

The accumulated interest and investment gains will be included in gross income and taxed at ordinary income rates. If the annuity owner is under age 59½ and does not fit one of the exceptions in the tax law, there will be a 10% early distribution penalty imposed in addition to the income taxes. A number of annuities are held in IRAs, which have a 10% early distribution penalty.

A better option is to talk to the insurer. While many annuities prohibit or limit the ability to tap them early, more flexible annuities have been making their way onto the market. In addition, an insurer might make an exception for an annuity holder in financial straits whose only other option is to cash out the annuity. The insurer might allow a partial distribution if that persuades the owner to keep the rest of the annuity. It is a route worth trying first.

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If the owner simply is dissatisfied with the annuity’s performance, it is possible to make a tax-free exchange of one annuity for another, at either the same insurer or another insurer. There still might be early redemption penalties imposed for an exchange, but income taxes will be avoided. Ask the current insurer first if it offers other annuities for which you can make an exchange. If there is not a satisfactory option, consider annuities at other insurers.

Another choice is the secondary market in which investors buy annuities. Major players in this market are J.G. Wentworth, Peachtree Settlement Funding, Settlement Capital, and Stone Street Capital. There also are local and regional firms and partnerships that buy annuities. This can be a cumbersome process. The annuity owner has to contact each firm to get a bid. Then, the bids have to be compared. It is possible to sell part of an annuity or the entire contract.

The secondary market will buy an annuity for a discounted rate, and the discount varies by the terms of the annuity and the buying firm. Because of the variations, it is important to get multiple bids for the annuity. The investors will consider features of your annuity such as the interest rate, when payments can begin, payout schedules, death benefits, the insurer’s financial rating, surrender charges, and other features.

A sale is a taxable transaction. You will pay taxes on the sale, most likely at ordinary income tax rates to the extent the amount received exceeds your investment.

Most advisors believe selling an annuity should be a last resort. Other options to consider first are talking to the insurer and borrowing against home equity if you need cash. You likely will receive only a fraction of the annuity’s value if you cash it out or sell it.

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