Daily Gains Letter

Should You Trust Your Insurance Company’s Annuity Buyback Offer?

By for Daily Gains Letter |

DL_John_3You have an annuity. Now what?

Variable annuities have become a major part of the retirement and investment plans of many Americans. Over the last number of years, insurance companies have been urging customers to buy annuities in an effort to provide tax benefits and a steady stream of income during their retirement years.

For an extra fee, annuities provided steady income for the buyer’s lifetime, even if the fund account was wiped out. Not surprisingly, annuities have made insurance companies a lot of money. All of this made sense to the insurance companies when they raked in $187 billion in sales in 2007…just before the financial housing bubble burst and the stock markets crashed.

With that in mind, those with annuities should be a little suspect to hear that insurance companies are offering to buy back the guarantees, offering more than they’re worth.

In November, The Hartford Financial Services Group, Inc. (NYSE/HIG) announced a plan to ask some customers to trade in their annuities. (Source: “Hartford Offers Buyouts to Annuity Clients to Trim Risk,” Bloomberg, November 2, 2012.) This after AEGON N.V. (NYSE/AEG), AXA Equitable Life Insurance Company, and Transamerica Life Insurance Company made similar offers.

The crashing markets and promised payouts ate into corporate earnings; raising capital to cover costs also diluted shareholder value. In an effort to hedge against further losses, the companies have been asking customers to cash in.

For starters, customers should ask themselves why an insurer would want to offer more than the investment is worth. To selflessly reward their loyal customers? Insurance companies do not have a rich history of looking out for their clients.

That said, who is most likely to take a buyout offer? For starters, if the annuity no longer fits your needs, you may want to consider a buyout. Those with short-term cash needs and/or those who do not expect to live very long will also likely take a buyout. But, if you and your nest egg are healthy, there’s virtually no incentive to cash out.

While the return rates on guaranteed annuities are varied, if you did take a buyout, you would have to ensure the reinvested money would deliver the same kind of annual returns that the annuity promised you. That could be as low as a few percentage points, or as high as seven percent; with today’s interest rates, the latter is a near impossibility. You could park all of your money into the stock market, but that’s a risk those nearing retirement are not willing to make.

If you’re still not sure whether you should accept an annuity buy-back offer, consider the following:

How safe is your insurance company? As the recent past has shown, your annuity is only as strong as the insurance company. Whenever an insurance company is declared insolvent, policyholders can find themselves in limbo. If an annuity is held by the insurer, or scheduled pay-outs are in process at the time of failure, those funds can be frozen and the so-called guaranteed payments are called into question. If you already have an annuity, or if you are interested in getting one, look for companies with an “A” rating—the safest are rated “A++.”

Many healthy individuals can expect to spend several decades in retirement. Do you have enough reliable income from other sources to make up for the loss of your variable annuity income? Those planning for retirement should have a variety of sources of income, in case one revenue stream dries up. Most Americans will receive monthly payments, which are guaranteed to keep up with inflation, from the Social Security Administration when they retire.

With 401(k)s and Individual Retirement Accounts (IRAs), you can defer taxes on your retirement savings and investment earnings until you withdraw the money in retirement.

Bonds provide a relatively safe, predictable stream of retirement income. Some bonds, including Treasury Inflation-Protected Securities (TIPS), increase with inflation and decrease with deflation.

Many retirees try and keep one or more years’ worth of living expenses in CDs (Certificates of Deposit), which are backed by the Federal Deposit Insurance Corporation (FDIC). Although interest rates are low, your retirement money will be there when you need it.

And, of course, you may want to keep some of your savings in the stock market in retirement to ensure continued growth in your portfolio and to keep up with inflation.

How will cashing in the annuity impact your taxes? Earnings on annuities are treated as ordinary income; you’ll end up paying income taxes on any earnings when you cash out an annuity. That’s in addition to the 10% federal tax penalty you’ll pay on earnings if you’re under age 59½.

How much in additional benefits from your annuity do you anticipate in the future versus what your insurance company will offer you? If you accept an annuity pay-out, will you be able to use that cash to generate an equal amount of income over the same period of time? Or will you burn through the lump-sum pay-out at a faster rate?

Has your variable annuity outperformed its annual charges? Do you want to stay with an annuity that underperforms the annual fees? The total annual fee charged on variable annuities can be as high as three percent of the overall value of the variable annuity; and it can negatively impact long-term performance. How does that compare to other investments? The average annual fee for an actively managed mutual fund is one percent, and 0.45% for passively managed mutual funds.

There are a number of financial avenues you can take to help you ease into your retirement years. Having an annuity might be one of them. Taking an annuity buyback offer may or may not be part of the equation. No matter which side of the fence you fall on, there are a number of issues you need to consider. After all, it’s your retirement and your retirement dollars.

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