Annuity Surrender Fees Are Not a Big Deal

How Annuities Handle Interest Rate Risk

Those are just a couple of the ways I’ve always explained it, but I’m not sure it resonates. It’s justified to want a better explanation for how commissions and state premium taxes affect the contract, and there is more to it. Consider that the insurance company invests in long-term bonds to back an annuity. If you bail out early, the company would have to sell assets in a potentially unfavorable environment. Within an annuity, the insurance company bears the interest rate risk, which is one of the primary threats of income planning. The fact that you can get 10% per year without fees, penalty, or risk of loss is actually a pretty good deal.

Growth in Early Years: A Stronger Argument Against Surrender Fees

Aside from the mechanics, there are other reasons that might make sense. Two things I’ve seen consistently over the years actually give you more control over the outcome. The first is the fact that most index annuities have growth in the first few years that exceeds the surrender fee. The account goes up, and the fees decline, meaning a person could walk away with more than the initial investment. This is the point where most realize they have a pretty good deal. Because they realize it’s a good deal, no one walks away.

Maximizing Free Withdrawals During the Surrender Period

The second one is something I have mentioned in passing for several years. I always told people that you can maximize the withdrawal from a potential contract and get a substantial amount of money out of it before the surrender period ends. I was recently running numbers on an income scenario for one couple. We thought about maximum withdrawals so retirement income could be combined with Roth conversions in the first ten years of retirement.

I looked at the illustration and did some basic math. At the guaranteed minimum, meaning no growth in the account, this couple could maximize free withdrawals each year, and at the end of ten years would have drained more than 68% of the initial contract value. If consistent growth of 4% is achieved, the withdrawals would be bigger and amount to almost 80% of the initial value, plus leaving behind an even larger remainder value.

Using Liquidity and Adjustments to Your Advantage

Take a second and think about how big a change you’d need to make in order to shift +/- 70% of an account over the first ten years of retirement. If you end up with an annuity you don’t like, then don’t just sit there. Doing nothing is the worst thing. Or maybe you should just start with a good one. There are all sorts of opportunities with that kind of liquidity on safe assets. I showed you all an example last week of what can happen using withdrawals and incremental investments. There’s a link to last week’s video near the bottom if you missed it.

Cost-Effective Retirement Planning with Annuities

There are all sorts of examples and ways to improve an annuity. Eliminate fees and use the protection and liquidity to your advantage. Yes, I make money if you buy an annuity from me, but I don’t make money for writing this letter every week. You may have a surrender fee on the annuity, but my advice is free. As long as you get a plan that works, then I’d say it’s a pretty cost-effective way to plan for retirement. All things considered, surrender fees are really not a big deal.