04 Jan Should I get out of this annuity for higher interest rates?

Q. I am 66 years old and in year seven of receiving money from a 12-year variable annuity for which I pay .85% yearly for a lifetime income rider. The surrender value is $78,000, the accumulated value is $97,000 and the income rider is $114,000, and pays 4.75% for life and grows 3% a year. With money market, CD and fixed annuity rates climbing, does it make sense to cash out if I can get a 5+% in a principal protected fixed investment? Because of the 4% yearly fees associated with my annuity, I know once I turn the income rider on, it will gradually deplete my principal over the years.
— Investor

A. There’s a lot to consider when it comes to cashing out an annuity.

As you noted, your contract is within the surrender charge period.

Let’s go over some basics.

Most annuities have surrender charge periods, said Betty Thomas, a chartered financial consultant and certified financial planner with Peapack Private Wealth Management in Summit.

She said when signing up for an annuity, the surrender charges are higher at the start of the contract and decrease as it reaches the end of its charge period.

“In your case, the surrender charges could end in either the 12th or 13th year of contract. Once the contract is out of the surrender period, the surrender and accumulated values should be the same,” she said. “Refer to your contract for the term of the surrender charge period and penalty rate or discuss with the issuer of the annuity contract.”

Also, if your contract is a non-qualified variable annuity, if surrendered, any gains in the contract would be taxed as ordinary income, unless it is transferred to another annuity using a 1035 exchange, she said.

“A 1035 exchange allows you to transfer the funds to another annuity and continue its tax deferred status,” Thomas said. “If you were to do a 1035 exchange, you would ultimately sign a new annuity contract, which could start a new surrender charge period.”

As you noted, your contract also has an income rider.

Annuity income riders were designed to give peace of mind from outliving your money. The riders are designed to provide lifetime income payouts, she said.

The most common annuity income riders are the Guaranteed Lifetime Withdrawal Benefit (GLWB) and The Guaranteed Minimum Income Benefit (GMIB).

“The fee you are paying for this rider may reduce returns and could affect the value of the guarantee over time, but it should provide a payout over your lifetime, even if the principal has been depleted,” she said. “Again, refer to your contract or speak with the issuer of the contract to clarify any questions you might have about the income rider and how it works.”

There are a few things to consider before cashing out of this annuity.

Thomas said you should consider penalties, fees, and any tax obligations that could be incurred if surrendering the contract.

“Compare what it would cost to surrender the contract for a 5% rate of return now versus maintaining the annuity until it is out of the surrender period.

Also, think about how long will it take to break even from penalties, and fees,” she said. “Lastly, keep in mind that unless you are getting some type of guarantee on the 5% rate, it could change. Interest rates have been going up, but there is always the risk of them declining too.”

And you should speak to your own tax, legal and accounting advisors before engaging in any transaction.

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This story was originally published on Jan. 4, 2023.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.