When considering annuity rollover options, an investor may learn some new terms. Like 1035 exchange. Or Fixed Index Annuity. Or caps, spreads, etc. BLEH!
However, in this article, I put together a concise overview of the landscape you face today. For the layman. Not the annuity geek. When considering options for money invested in an old annuity. Or Life insurance policy.
Annuity Rollover Options – Getting the Terms Straight
When considering annuity rollover options, know that there are likely 2 types of money that could be in an annuity. IRA money and non IRA money. Which technical people call non-qualified money. Qualified vs non-qualified is a tax term. You’ll see this on the IRS site and elsewhere. Don’t let it scare you. Non-qualified just means it’s not an IRA, 403b or 401k.
If you are moving IRA annuity money, then the move would be called a transfer. Rollover is another specific term used for moving IRA money in a way that passes through your bank account first.
If you are moving non-qualified money tax-free then that is technically called a 1035 exchange.
Just to be clear on terms here. So you don’t feel left out when your annuity agent starts talking technical jargon with you and you’re thinking “lets just call it a transfer.”
The Annuity Landscape Today
Today you can choose among fixed and variable annuities. Or an immediate annuity if that makes sense. And then there are options in each camp. Let me try to be as succinct as possible with this so you get maximum information in s few a words as possible!
These are technically what the term annuity means. A series of payments typically over your life. Or some guaranteed period or both. Another word that is basically synonymous is “pension.” An immediate annuity is a pension, a series of payments over a time period. Often your lifetime.
These are still the basic deferred annuity. Deferred means we’re not taking payments. We’re just earning interest. Fixed annuities fall in two major categories these days:
- Fixed annuities offering a guaranteed interest credit of some kind (e.g. 3% per year for 5 years)
- Fixed Index Annuity. Offering a return that is based on the performance of a stock market index (usually)
Fixed Guaranteed Interest Annuities
These come in variations but look out for 2 basic structures. One is where you get a flat interest rate for the entire term of the annuity. Over 5. 7 or more years. The other typical structure is one where the annuity pays a higher first year rate then a lower rate for years 2-5 or 2-6 etc.
You have to do some math on the second kind to determine average interest rate to objectively compare to the flat interest rate products.
Fixed Index Annuity
These products typically offer the guarantees of regular fixed annuities as far as principal is concerned. They differ in that they credit interest to the investor using a method that tracks some major market index. Typically this index is the S&P 500. Though some more creative indices have been dreamed up lately.
One word of caution. Don’t entertain any fantasy that you will earn anywhere close to market returns with these products. They offer principal guarantees which cost the insurance company big money to honor.
And the potential of these products often follow their fixed rate brethren in that, low interest rate environments will hold back return potential on this product. That is my opinion and is evidenced by the terms on these annuities now vs just 6 years ago.
Variable annuities differ from their fixed cousins in that they offer the opportunity to diversify in market sensitive investments. Like stocks, bonds, real estate and commodities. Hence they offer a variable return. This is often enough to scare the typical annuity shopper. Who is often looking for something safe.
The Main Area of Concern with Variable Annuities – the Costly and sometimes Gimmicky Riders
And if that’s you, the person looking for something safe, then the industry has responded to you. After the 2000 market crash, the industry developed all sorts of guaranteed benefits to variable annuities.
Some of these annuity rollover options were too generous. As the 2008 crash brought a few of these companies to their
knees trying to cover the guarantees.
In a typical market, these guarantees are a huge boon for the insurance company. A contract with these riders in place can cost you 3-4% per year in fees. If that isn’t enough to deter you, the guarantees are in some cases quite gimmicky and offer nowhere near what they offered in earlier times.
I have used these guarantees only a few times in my career (literally 3 or 4). One of them was with a risk averse client and the product, a first generation guarantee from the early 2000’s offered full principal guarantee. It was straightforward.
In the product I recommended, anytime after the purchase the client could get their full principal back no matter where the market was.
I don’t see this offered anymore. It’s typically some kind of guaranteed withdrawal benefit or income benefit.
To reiterate, if you are considering these products, check the fees closely. 3-4% is ENORMOUS over the long term. And check for lower cost alternatives in this space, such as advisor annuities (see my write up on that here).
The Transfer Process & Paperwork Involved
After you’ve review your annuity rollover options, and chosen a product, it’s time to execute. This is often the easiest part. The paperwork is simple. You would complete an annuity application and a transfer form if it’s an IRA/403b annuity. And an exchange form for non-qualified assets. You should now know what “non-qualified means from our explanation above.
If you are changing annuities you will have to complete some other forms including a notice to the commissioner form. Completing this form notifies your current annuity provider with news that you plan to transfer your funds. This gives them an opportunity to “conserve” the business.
Why this form exists involves many issues. But that’s not material here. Just know that in a few cases, your existing annuity company may contact you to try to keep you from transferring.
Overall, annuity rollover options related paperwork should not be too difficult.
Conclusion – You Should Follow Your Plan
Even though this article is supposed to be an outline walking you through annuity rollover options and things to consider, we can’t let you go without discussing planning. A proper financial plan including strategies and tactics should precede the movement of any funds.
I would be unprofessional if I were not to mention this. So this section should be at the beginning. But hey you didn’t come originally looking for financial planning Q&A. You were worried about your annuity. So I had to put this at the end.
Make sure you have drafted at least a working version of your financial plan. Then nail down some strategies and tactics. For example, one of your tactics might be to lower your overall investment costs by switching out of a high cost variable annuity. That’s a tactic. But there should be a plan and strategy that dictated that tactic. Understand?
I hope you found this article helpful. best of luck to you.
If you’re looking to develop a plan, strategies and tactics, consider talking to a comprehensive financial planning team like ours and review our definition of financial planning. Here are some further steps to take:
- If you’d like to consider working with a planner, try reviewing Chris’ guide: 5 Questions to Ask Before Choosing an Advisor
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As always, seek professional advice before making money decisions. Especially decisions that could have major tax and/or legal consequences.