Important Questions to Ask When Considering an Annuity

Many of us have experienced recent downturns and volatility in the stock market.   This led the baby boomer generation to invest heavily in annuities.  Since all annuities are not the same, it is imperative to ask a lot of questions to assure that you understand the purchase of your annuity product precisely.  In this article, I will discuss the vital questions that you need answered in order to evaluate annuity products.  This article is not a substitute for a thorough discussion with both your financial advisor and the company that you select to provide you with annuities.  It is vital to understand the type of annuity you are buying and to determine if it is the best investment for you, paying close attention to your financial needs and the level of comfort that you have with risk.

1. What is an annuity and what types of annuities are available?

An annuity is an insurance company product that pays out income.  You place money into an annuity and then payments are made to you on an immediate basis, or on a future date usually monthly, quarterly, annually or in a lump sum.  Annuities can be paid over your lifetime or for a set number of years.  They can also be a guaranteed or fixed amount or determined by a variable annuity that you may choose.    A deferred annuity may also be converted into an immediate annuity.

2. What are the benefits of annuities?

Money that you invest in an annuity grows tax deferred.  When you withdraw the money, the amount you contributed is not taxed, but your earnings are taxed at your regular taxable income rate.  Thus, you are able to put away a larger amount of cash and defer paying taxes.  There is no annual contribution limit, as you have with 401K’s and IRA’s.  Therefore, you can put away larger amounts to catch up.  This is certainly a big advantage over taxable investments.  You can choose to take a lump sum or set up a guaranteed payment to create a steady stream of income.  Annuities can complement social security plans and pension plans.

3. What are the disadvantages of annuities?

Most annuities are sold by insurance brokers or sales people.  The commission may be high, as much as 10% or so.  Often there are also surrender charges for taking money out of an annuity with the first several years of purchase; surrender charges typically are approximately 7% of your account value if you leave after one year; this amount decreases each year.  Some annuities have a much greater surrender charge.  Thus, it is imperative to ask about these charges.  There may be high annual fees if you invest in variable annuities.  An annual insurance charge may run 1.25% or more and annual investment management fees may arrange from .5% to more than 2%; and fees for insurance riders may add .6% or more.  Again, bring a pad and pen to write down each of the charges that are associated with the expenses listed.  Compare these numbers to a regular index mutual fund that charges an average of 1.5% to .5% per year, some are only .05% (current charge for VTI, an ETF), .09% (Vanguard Small Cap Index Fund traded as an ETF).  Discuss the best course for you with your financial advisor.  Also, remember that if you withdraw money from a 401 (k), IRA or an annuity before you reach 59 ½, you will have to pay a 10% penalty for early withdrawal.

There are some investment companies that sell annuities without charging a sales commission or a surrender charges.  They are called direct-sold annuities; there is no insurance agent involved.  Some firms that sell low-cost annuities include Fidelity, Vanguard, Schwab, T. Rowe Price, Ameritas Life and TIAA-CREF.  Again, be prepared to ask for all related charges and write down the amounts that are provided to you.

You can choose a fixed-rate annuity, where the insurance company handles that job and agrees to pay you a pre-determined fixed return.  Or, you can opt for a variable annuity where you decide the sub-accounts (generally mutual funds) to invest your money into.  The value of your account depends on the performance of the selected funds.  Make sure to compare the annual expenses in comparison to regular mutual funds.

4. What are the payout options?

You can choose to receive income for a guaranteed period, for example five years or 30 years.  If you die before the end of the period, your beneficiary will receive the remainder of the payments for the guaranteed period.

You can receive a guaranteed income payout during your lifetime only; there usually is no survivor benefit.  The payouts can be fixed or variable.  The amount of the payout is based on how much you invest and the amount of the life expectancy.

You may receive a combination of a life annuity and a period certain annuity.  You receive a guaranteed payout for life that includes the period certain; thus, if you die during the period certain phase, your beneficiary will continue to receive the payent for the remainder of the period.  For example, if you die before the end of a ten year period certain, your beneficiary(ies) will receive the payments until the end of the period certain.

If you have a joint and survivor annuity, your beneficiary will continue to receive payouts for the rest of his or her life after you die.  This is frequently used with married couples.

5. What if you need to withdraw the money early?

You need to obtain information regarding both your annuity plan rules and federal law before withdrawing money early.  If you are under the age of 59 1/2, you will be required to pay a 10% penalty to the IRS.  If you make a withdrawal within the first five to seven years, you probably will owe a surrender charge of 7% (possibly less or more, depending on your policy rules).  Some annuities have initial surrender charges as high as 20% and some annuities allow you to withdraw up to 10% of your investment without having to pay a surrender charge.

6. Should I hold an annuity inside an IRA?

Generally, the answer is no.  An advantage of an annuity is that your money grows tax-deferred.  This is also true for an IRA.  Therefore, holding an annuity inside of an IRA is like using an umbrella indoors.  Your investment is already growing tax-deferred.  There are some advisors that recommend an annuity inside of  a retirement vehicle if you are retired or very close to retirement in order to provide more guaranteed income than social security will provide.

7. Do I need to check into the company that I am purchasing the annuity from?

Yes!  You are likely providing money to the company and may not receive payments for a number of years.  It is very important to check the insurer’s credit rating, usually provided by A.M. Best, Standard & Poor’s and Moody’s that provide you with information that expresses the company’s financial health.  It is best to go with companies that have ratings of A+ from A.M. Best or AA- or better from Moody’s and S&P.  Ask your insurance agent for the ratings in writing or get them online.  There are State Guarantee funds that protect annuity owners if an insurance company fails, but coverage is limited and varies from state to state.  Some funds are non-existent.

8. Should I exchange my existing annuity for a new one?

Be careful to read all sales documents and make sure you are aware of every potential fee.  Do not rely on the salesperson’s explanation alone.  Many 1035 exchanges that are suggested result in a large fee for the sales agent.  A new surrender period will likely result, which will probably re-instate the  surrender fee of approximately 7-9% (or so).  I would also recommend that you visit the Securities and Exchange Commission Website for tips on protecting yourself if you are considering purchasing a 1035 exchange.  For example, Section 1035 of the U.S. tax code allows you to exchange an existing variable annuity contract for a new annuity contract without paying any tax on the income and investment gains in your current variable annuity account. These tax-free exchanges, known as 1035 exchanges, can be useful if another annuity has features that you prefer, such as a larger death benefit, different annuity payout options, or a wider selection of investment choices.

You may, however, be required to pay surrender charges on the old annuity if you are still in the surrender charge period. In addition, a new surrender charge period generally begins when you exchange into the new annuity. This means that, for a significant number of years (as many as 10 years), you typically will have to pay a surrender charge (which can be as high as 9% of your purchase payments) if you withdraw funds from the new annuity. Further, the new annuity may have higher annual fees and charges than the old annuity, which will reduce your returns.

The Securities and Exchange Commission urge you to consider the following information regarding 1035 exchanges:


If you are thinking about a 1035 exchange, you should compare both annuities carefully. Unless you plan to hold the new annuity for a significant amount of time, you may be better off keeping the old annuity because the new annuity typically will impose a new surrender charge period. Also, if you decide to do a 1035 exchange, you should talk to your financial professional or tax adviser to make sure the exchange will be tax-free. If you surrender the old annuity for cash and then buy a new annuity, you will have to pay tax on the surrender.

Bonus Credits

Some insurance companies are now offering variable annuity contracts with “bonus credit” features. These contracts promise to add a bonus to your contract value based on a specified percentage (typically ranging from 1% to 5%) of purchase payments.

Example:  You purchase a variable annuity contract that offers a bonus credit of 3% on each purchase payment. You make a purchase payment of $20,000. The insurance company issuing the contract adds a bonus of $600 to your account.


Variable annuities with bonus credits may carry a downside, however – higher expenses that can outweigh the benefit of the bonus credit offered.

Frequently, insurers will charge you for bonus credits in one or more of the following ways:

Higher surrender charges – Surrender charges may be higher for a variable annuity that pays you a bonus credit than for a similar contract with no bonus credit.

Longer surrender periods – Your purchase payments may be subject to surrender charges for a longer period than they would be under a similar contract with no bonus credit.

Higher mortality and expense risk charges and other charges – Higher annual mortality and expense risk charges may be deducted for a variable annuity that pays you a bonus credit. Although the difference may seem small, over time it can add up. In addition, some contracts may impose a separate fee specifically to pay for the bonus credit.

Before purchasing a variable annuity with a bonus credit, ask yourself – and the financial professional who is trying to sell you the contract – whether the bonus is worth more to you than any increased charges you will pay for the bonus. This may depend on a variety of factors, including the amount of the bonus credit and the increased charges, how long you hold your annuity contract, and the return on the underlying investments. You also need to consider the other features of the annuity to determine whether it is a good investment for you.

Example:  You make purchase payments of $10,000 in Annuity A and $10,000 in Annuity B. Annuity A offers a bonus credit of 4% on your purchase payment, and deducts annual charges totaling 1.75%. Annuity B has no bonus credit and deducts annual charges totaling 1.25%. Let’s assume that both annuities have an annual rate of return, prior to expenses, of 10%. By the tenth year, your account value in Annuity A will have grown to $22,978. But your account value in Annuity B will have grown more, to $23,136, because Annuity B deducts lower annual charges, even though it does not offer a bonus.

You should also note that a bonus may only apply to your initial premium payment, or to premium payments you make within the first year of the annuity contract. Further, under some annuity contracts the insurer will take back all bonus payments made to you within the prior year or some other specified period if you make a withdrawal, if a death benefit is paid to your beneficiaries upon your death, or in other circumstances.


If you already own a variable annuity and are thinking of exchanging it for a different annuity with a bonus feature, you should be careful. Even if the surrender period on your current annuity contract has expired, a new surrender period generally will begin when you exchange that contract for a new one. This means that, by exchanging your contract, you will forfeit your ability to withdraw money from your account without incurring substantial surrender charges. And as described above, the schedule of surrender charges and other fees may be higher on the variable annuity with the bonus credit than they were on the annuity that you exchanged.

Example:  You currently hold a variable annuity with an account value of $20,000, which is no longer subject to surrender charges. You exchange that annuity for a new variable annuity, which pays a 4% bonus credit and has a surrender charge period of eight years, with surrender charges beginning at 9% of purchase payments in the first year. Your account value in this new variable annuity is now $20,800. During the first year you hold the new annuity, you decide to withdraw all of your account value because of an emergency situation. Assuming that your account value has not increased or decreased because of investment performance, you will receive $20,800 minus 9% of your $20,000 purchase payment, or $19,000. This is $1,000 less than you would have received if you had stayed in the original variable annuity, where you were no longer subject to surrender charges.

In short:   Take a hard look at bonus credits. In some cases, the “bonus” may not be in your best interest.

Ask Questions Before You Invest

Financial professionals who sell variable annuities have a duty to advise you as to whether the product they are trying to sell is suitable to your particular investment needs. Don’t be afraid to ask them questions. And write down their answers, so there won’t be any confusion later as to what was said.

Variable annuity contracts typically have a “free look” period of ten or more days, during which you can terminate the contract without paying any surrender charges and get back your purchase payments (which may be adjusted to reflect charges and the performance of your investment). You can continue to ask questions in this period to make sure you understand your variable annuity before the “free look” period ends.

Before you decide to buy a variable annuity, consider the following questions:

Will you use the variable annuity primarily to save for retirement or a similar long-term goal?

Are you investing in the variable annuity through a retirement plan or IRA (which would mean that you are not receiving any additional tax-deferral benefit from the variable annuity)?

Are you willing to take the risk that your account value may decrease if the underlying mutual fund investment options perform badly?

Do you understand the features of the variable annuity?

Do you understand all of the fees and expenses that the variable annuity charges?

Do you intend to remain in the variable annuity long enough to avoid paying any surrender charges if you have to withdraw money?

If a variable annuity offers a bonus credit, will the bonus outweigh any higher fees and charges that the product may charge?

Are there features of the variable annuity, such as long-term care insurance, that you could purchase more cheaply separately?

Have you consulted with a tax adviser and considered all the tax consequences of purchasing an annuity, including the effect of annuity payments on your tax status in retirement?

If you are exchanging one annuity for another one, do the benefits of the exchange outweigh the costs, such as any surrender charges you will have to pay if you withdraw your money before the end of the surrender charge period for the new annuity?

Remember:   Before purchasing a variable annuity, you owe it to yourself to learn as much as possible about how they work, the benefits they provide, and the charges you will pay.”


Posted in Blog Posts | Comments Off

Essentials Regarding 2013 Estate and Gift Tax Changes

In 2010, the tax-free amount that could be transferred during life or death was $5 million; this amount was raised to $5.12 million per person, as an adjustment for inflation, in 2012.  If Congress took no action in 2013, this amount was subject to revert back to $1 million, with tax rates increasing from 35% to a 55% for many estates.  Congress acted in 2013 and made this estate tax exclusion permanent; and on January 11, 2013, with an adjustment for inflation, Congress increased the amount to $5.25 million.

The 2010 tax law allowed for portability of the tax break from one spouse to the other, which the new law has also made permanent.  This allows spouses to transfer up to $10.5 million tax-free.  However, portability is not automatic.  The executor or trustee handling the estate of the spouse who died must transfer the unused exclusion to the surviving spouse by filing an estate tax return after the first spouse dies, even if no tax is owed.  This return is due nine months after death with a six month extension allowed.  The surviving spouse loses the right to portability if the executor doesn’t file the return; thus, be careful not to miss the deadline.  It is advisable to file the form even if they’re not wealthy currently, because future finances are unknown.

The lifetime gift tax exclusion and the estate exclusion are one amount – currently $5.25 million per person.  If this limit is exceeded, tax of up to 40% is due.  The IRS expects spouses to keep track and report these lifetime gifts.  For example if $1 million was given in lifetime gifts, the exclusion remaining will be 4.25 million in 2013.  However, there are lifetime gifts that don’t count.  Gifts can be given to another person up to $14,000 per year without counting against the lifetime exemption.  For example, a married couple with a child who is married with three children can make a joint gift of $28,000 to each of the five people and provide the family with $140,000.  Gifts that exceed the limit count against the lifetime exclusion.

The annual exclusion can be used to give assets to as many individuals as you desire or to put money into a Section 529 education savings plans to help relatives save for college.  However, review how this affects financial aid and other issues.


Posted in Blog Posts | Comments Off

How Should You Hold Title to Real Estate?

Your home is probably the most valuable asset you own. Yet most people don’t think about how to hold title until the title company poses the question when you buy or refinance. But this deserves careful consideration, because how you hold title to real estate has far-reaching effects. Let’s look at some common ways to hold title.

Individual Name: You can hold title in just your name even if you are married. However, there are some drawbacks you should know about.

First, what would happen if you become mentally or physically incapacitated due to illness or injury and the property needs to be refinanced, or a line of credit needs to be opened or increased? If you are unable to conduct business, the court will need to appoint someone to act for you.

“But, I have a will,” you say. A will can’t help; it only goes into effect after you die, not if you are incapacitated.

“But, I have a power of attorney,” you say. Most powers of attorney end at incapacity. A durable power of attorney is valid at incapacity. However, many financial institutions will not accept one unless it is on their form. And if accepted, it may work too well, giving the person the ability to do whatever he or she wants with your assets. You could recover to find the property mismanaged or even sold and the proceeds gone.

The court’s job is to provide supervision to protect your assets. But once the court gets involved, it will stay involved until you recover or die. The court, not your family or friends, will control how your assets are used to care for you. It is a public process that can be expensive, embarrassing, time consuming and difficult to end if you recover.

Next, what happens when you die? If yours is the only name on the title, the property will almost certainly have to go through the probate court system before it can be distributed to your heirs, even if you have a will. Think about it: if your name is the only one on the title, and you have died, you can’t sign your name to transfer title. While there can be exceptions, in most cases the only way to remove your name and put the new owner’s name on is through the probate court.

Joint Tenants with Right of Survivorship: This is how most married couples hold title, because it seems fair, it’s easy and it’s free. Parents and their adult children also often hold title this way, as do unmarried couples.

Indeed, when one owner dies, full ownership does transfer automatically to the surviving owner without probate. But usually this just postpones probate. If the surviving owner dies without adding another owner (which often happens), or if both owners die at the same time, the property will almost certainly have to go through probate before it can go to the heirs.

There are other problems, too. When you add a co-owner, you lose control. With real estate, all owners must sign to sell or refinance. If your co-owner disagrees with you, you could end up in court. If your co-owner is incapacitated, the court will probably get involved to protect your co-owner’s interest…even if the ill owner is your spouse.

You expose the property to your co-owner’s debts and obligations; you could even lose your home to your co-owner’s creditors if he or she is successfully sued. There could also be gift and/or income tax problems if your co-owner is not your spouse.

Finally, because a will does not control jointly owned assets, you could disinherit your family when your co-owner inherits your share. Sadly, and all too often, children from a previous marriage are disinherited when a new spouse is the surviving owner.

Tenants-In-Common: With this kind of ownership, each owner’s share will be distributed as directed in his or her will. If there is no will, the property will go to the owner’s heirs.

Community Property: Nine states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin) have a form of joint ownership between spouses commonly called community property. When you die, your share of community property automatically goes to your surviving spouse, unless your will says otherwise.

The problem with both tenants-in-common and community property is that you could find yourself with several new co-owners when your co-owner dies and the heirs inherit the property. Imagine how difficult it could be to get several owners to reach an agreement, especially if you are trying to sell the property.

You can also run into the other problems (incapacity, lawsuits, etc.) as explained under joint tenants with right of survivorship, but with several owners involved, your risks and problems are multiplied.

Tenants-by-the-Entirety: This form of joint ownership, available between spouses in some states, is similar to joint tenants with right of survivorship in that when one spouse dies, his/her share automatically goes to the surviving spouse, even if the will says otherwise. So you have many of the same risks, including unintentional disinheriting and court interference if one spouse becomes incapacitated.

However, as tenants-by-the-entirety, neither spouse can transfer his/her half to someone else without the other’s approval – something joint tenants with right of survivorship and tenants-in-common can both do.

Revocable Living Trust: When you have a living trust, the title of your real estate can be held in the name of the trustee of your trust. Usually you will be your own trustee, so you keep full control of the property. You can buy, sell and refinance real estate just as you can when the property is not in your trust.

If you become incapacitated, the successor trustee you named when you set up your trust will be able to step in and act for you. Because the title is no longer in your individual name (or joint names if married), there will be no need for court interference. If you are married, you and your spouse can be co-trustees, in which case your successor trustee would step in only after you have both become incapacitated or have died.

Your successor is legally obligated to follow the instructions you put in your trust. If you recover, your successor simply steps aside and lets you resume control. When you die, the property will be distributed without probate according to the instructions in your trust, so you don’t have to worry about unintentionally disinheriting someone.

SUMMARY: How you hold title to real estate should be given careful consideration. Check your titles, discuss them with an attorney and make any changes now while you can.

Compliments of

At Price Law, we review your real estate and account titles as part of the preparation of your Revocable Living Trust plan.  We assist you with making changes to reflect your goals.  We also provide you with the documents and funding instructions to help you complete your estate needs.

Posted in Newsletter | Comments Off