I get this question rather frequently and another one came up last week. Should you keep an old variable annuity? Of course it all depends on your goals but I plan to show you why it’s not an easy decision to make, especially when someone is trying to sell you another product.
Variable annuities are the most complex insurance products on the market. The basics are simple but there are so many details that a lot of contracts can end up being close to 200 pages. Raise your hand if you’ve ever read one of those entirely. VAs are the most popular annuities so a lot of people have them and many don’t know what to do with them.
In spite of high fees in most cases, VAs have done very well because the stock market has been on a hell of a roll for the past several decades. But this isn’t about whether you should get one, it’s about what to do with it now if you have it. So I have three cases that are all a bit different and I’m going to show you what each person needs to consider. In the examples below, one couple should change how they use it, another should keep what he has and the last one should be switched out for something new.
Case Study #1:
First is a nice couple I met a few months ago. The husband is 80 and wife 75 years old. Their income needs amount to roughly 6% of total portfolio value each year. That is a manageable number past age 70 but strategies for doing that are very specific. They have a variable annuity worth $472K and it comes with a guaranteed lifetime withdrawal benefit. The contract is non-qualified, meaning it was purchased with after-tax money. It was purchased several years ago and has appreciated nicely but this couple has not touched the money yet.
They need to start using the money to take pressure off their investment portfolio. But the guaranteed lifetime income amount is only about $20,000 per year. With a 6% income goal, something paying just over 4% annually will not cut it. So I pointed out a feature that is available with all annuities: annuitization. This allows the contract owner to commute the cash value for guaranteed lifetime income. It’s different than the guaranteed lifetime withdrawal benefit because it offers no residual value.
The option to annuitize would provide these guys with more than $30,000 annual income with a joint life payment. Just knowing how to use the contract resulted in a 50% income increase, although they would have no control over the money. The payout rate on this asset also increased to more than 6% so it takes even more pressure off the investment portfolio. In this case I recommended that the couple annuitize this variable annuity. They need to maximize income so they should maximize income.
Case Study #2:
The next case is a man about the same age who I’ve worked with for several years. He’s 81 and his wife is a fair bit younger than him. His variable annuity is in an IRA and he has been taking income from it for several years. Initial purchase price was $600K and current account value is $612K after he has taken roughly $350K in total income to this point. The contract has done very well.
He is currently taking about $44,000 per year via a guaranteed lifetime withdrawal benefit. He doesn’t “need” the money but is spending it so it falls in the discretionary category of spending. RMDs are necessary at his age so he’d have to be taking money out no matter what. But, the income from the contract is higher than the required distribution amount so this variable annuity helps in another way. Not only does the guaranteed income meet the requirement for this account, the additional can be used to reduce the required withdrawal from another part of his portfolio.
He has everything else taken care of from a planning perspective. His wife has income covered if he passes away first and his legacy has been assured so he will have plenty left for the next generation. Principal protection is not a concern because he doesn’t need the money for anything else and the income guarantee gives him plenty of opportunity to get his money out of it. In this case he should keep the variable annuity since no other problems need to be solved. The contract is doing its job so it should stay that way. He has everything taken care of so there’s no need to complicate his situation with a big stack of new paperwork.
Case Study 3:
The last example is from another guy who is about 75 years old and has owned a non-qualified annuity for well over 20 years. There is no additional income or death benefit rider but fees on the contract for fund management etc. still run to about 2% each year. That’s not the end of the world but it is meaningful. I forgot exactly how much he started with but it has grown substantially and is worth almost $700K now.
His goal is to leave these assets to his kids when he passes away and the biggest concern is market volatility. There are plenty of other assets available for inheritance so losing some of this wouldn’t ruin his plan but the rest of his assets are in market-based investments as well. If he wants to protect a portion of his portfolio then this is the perfect place to do it. Let me tell you why.
Again, this is a non-qualified contract so the money has already been taxed. I believe 80% or so of this contract value would be taxable gain if he liquidated the contract. If he doesn’t want to pay taxes then this has to be transferred to another annuity. That way taxes are deferred, fees are eliminated and the account value is preserved. The only other options available would be a fixed or fixed index annuity. The variable annuity has performed well but if he wants to eliminate market risk then he has to go with another annuity. I’ve met with this guy several times over the past eight years but we’ve never done business. He wants something different than he has so he should make the change.
Each of these could have been a full case study on its own. In every case there were more personal details that led me to recommend what I did. Taxation, income goals, risk tolerance, legacy wishes etc. all make a difference for each individual situation. If you find yourself in any of these scenarios you must first understand all the things you can do with an annuity. And if you can’t figure it out then seek qualified assistance. If you don’t know anyone else then go ahead and give me a call.
Enjoy your weekend!