Some savers go into retirement with a fixed or variable annuity in their retirement savings plans, particularly teachers who have 403(b) plans. Because many school districts are reluctant to negotiate with financial services firms to manage their retirement plans, they turn the job over the sales agents, who promote annuity products because they deliver large commissions. Unlike immediate annuities, which are fairly straightforward—you give an insurance company a lump sum in exchange for guaranteed monthly payments—these types of annuities can be quite complex. For example, with variable annuities, your money is invested in mutual-fund-like accounts, and the value of your account can rise or fall depending on the performance of the underlying investments. In most cases, the insurer guarantees that after you retire, you can withdraw a certain amount of money every year for the rest of your life, even if the investments you chose lost value or you ran out of money. But these benefits come at a cost. Basic annuity fees (called mortality and expense fees) can run 1.2% or more per year. You could also pay more than 1% in investment fees for the underlying funds. If you decide to cash out the annuity, you may pay a surrender charge, which generally starts at 7% to 10% and gradually decreases over the first seven to 10 years you own the annuity.
Supporters of adding annuities to a retirement savings plan say that they offer workers a way to convert their savings into guaranteed income in retirement, reducing the risk they’ll run out of money. The SECURE Act, which was signed into law in late 2019, makes it easier for 401(k) plan sponsors to offer annuities and other “lifetime income” options to plan participants by taking away some of the associated legal risks.
If you have an annuity in your retirement savings plan when you retire, converting your investment into a stream of monthly payments may not be the most profitable choice. Income from a fixed annuity is based on prevailing interest rates at the time you annuitize, which means “now is the worst possible time to annuitize a fixed annuity,” says Clark Randall, a certified financial planner in Dallas. With a variable annuity, on the other hand, you can receive monthly payments that are based on the performance of the underlying investments, such as stocks and bonds; you can also add a rider that will guarantee a minimum level of income no matter what happens to the market.
But another option is to skip annuitization altogether and take withdrawals when you need the money. If you already have sufficient income from a pension and Social Security to cover basic expenses—which may be the case if you’re a public school teacher—you may not need an additional source of guaranteed income, says Scott Dauenhauer, a CFP with Meridian Wealth Management and founder of The Teacher’s Advocate blog. As is the case with immediate annuities, once you annuitize a fixed or variable annuity, you are usually locked into the payments and can’t get your money back.
Retirees who aren’t interested in generating a stream of income don’t have to keep an annuity that is hobbled by high fees and low returns. Once you roll over a 403(b) or other retirement plan into an IRA, you can exchange your annuity for a mutual fund or exchange-traded fund without triggering a tax bill. Depending on how long you’ve owned the annuity and the terms of the contract, you may have to pay a surrender charge. But if you move from an annuity with high fees to a low-cost fund or ETF, you’ll probably recover those costs in a couple of years.
If you own a variable or fixed annuity in a taxable account, your options are more limited, Clark says. Cashing it out will trigger taxes on any tax-deferred earnings, plus a 10% early-withdrawal penalty if you’re younger than 59½. However, if you’re unhappy with your annuity’s fees or investment options, you can exchange it for a lower-cost annuity through what’s known as a 1035 exchange and maintain tax deferral of your gains.
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