Help a Reader: Stuck with a Variable Annuity

I recently received this question from a reader on my post titled Variable Annuities Are Money Traps. I told him I'd post it for all of you to answer. Here goes:

I was talked into rolling my 401(k) from a previous job into a variable annuity within an IRA. I realize this is my own fault for not doing my research before hand, but the sales pitch was too tempting (which should have been my first clue). Everything I read seems to say that this is the worst idea. I have two questions I'm looking for help on: (1) are there any cases where the variable annuity is a good choice, and (2) If not, is there any way to get out of a variable annuity in an IRA? Background if this helps, I'm 33, married, with one child. I've had the annuity for about 4 years, and it has about $50k in it. Any help would be appreciated!!!

So, what would you tell this guy to do?

Comments

[segfault]

A variable annuity is never a good idea inside an IRA. Outside an IRA, it may be a good idea for investors in a high tax bracket, who will be in a lower tax bracket later, but only for asset types that are taxed as ordinary income (REITs, bond funds, and interest), and when the expenses of the variable annuity are reasonable.

Vanguard offers some VAs with reasonable expense levels. Watch out! If you buy stock or equity mutual funds inside a variable annuity, the gains are taxed as ordinary income when withdrawn--not at the lower capital gains tax rate! Also, with any type of annuity, you can never withdraw your "principal" (initial investment amount) in the annuity until you have withdrawn ALL of the appreciation.

[Brad Ford]

Consider filing an arbitration against the person that sold you the product? A VA in an IRA is NEVER a good idea an unsuitable for everyone.

[Fred]

I'm guessing that the variable annuity taxation rules get ignored when the variable annuity is inside an IRA, because the tax treatment is determined by the IRA rules. If so, the person should be able to do an IRA custodian to custodian transfer to get the funds out of the annuity into a more reasonable investment such as a mutual fund in the new IRA. It may also be possible to do a reverse rollover from the existing IRA back to the 401(k).

The variable annuity likely has a large back-end load that declines over time, but may allow 10% per year to be removed without penalty. In that case, doing a partial IRA custodian to custodian transfer of 10% per year might be the least expensive approach, if threatening the insurance company with legal action is not sufficient to get them to waive the back-end load for this clearly unsuitable investment.

The person might want to ask Vanguard or Fidelity about the possibility of a custodian to custodian IRA rollover involving a variable annuity, but probably should double check the answer by consulting a tax attorney that specializes in retirement plans.

Some years ago we were in a similar situation with a high cost variable annuity in a 401(a) plan with 3 years of back-end loads remaining. We did a custodian to custodian partial transfer of the funds no longer subject to the back end load each year to an IRA without difficulty until the back-end load would be gone allowing the remaining funds to escape without penalty. When we complained about the annuity being an unsuitable investment, the insurance company got sufficiently nervous to let us complete the transfer from the annuity to the IRA without paying the back-end load about a year early.

[segfault]

Fred,

I was speaking about VAs in general in my later statements. Thanks for making it more clear!

[Max F]

I think the advice is good to try to get out as cheaply as possible. As for a lawsuit, this may be difficult as you aggreed to the plan, however I believe there are rules about laying out options based on the intentions of the client. Also you can use the NASD (Now FINRA) broker check to see if this has happened other people who worked with this planner/broker, as if they have had complaints in the past you might have some ammo.

Broker Check:
http://www.finra.org/InvestorInformation/InvestorProtection/p005882

But I guess the overall point is to explore all your options to get out.

[Embarrassed]

Thanks FMF for posting this, and thank you all for your comments. I was the one who posted the question. I've just recently started getting into the ins and outs of personal finance, and was trusting others with their advice before. Now I need to get my arms around all the terminology and figure out how to get out of this. Thanks again!!!

[Fred]

You shouldn't feel "Embarassed" as almost the entire investment industry is geared to tricking you in this way and almost everyone gets "taken" until they figure out what's up (many, perhaps most, never do figure it out). The "secret" is simply to stay away from sales people (usually called "brokers", "agents" or "advisors") and not buy the 99% of investment products that are way overpriced (where you'll pay in expenses about 25 times too much!) ... and also to realise that anyone telling you that they can beat the market is conning you.

Spending some time learning about personal finance will save you a fortune! To get started, the Welcome at the diehards.org website has an excellent list of books. It's really not all that complicated once you realise that Vanguard index mutual funds and Fidelity Spartan index funds are low cost, and most everything else for sale by the financial services industry is so hugely overpriced that over a lifetime of componding investment earnings minus losses to excess expenses, they (the ones who create and sell high priced mutual funds and insurance products), not you will wind up with most of your savings. Jack Bogle's excellent "Little Book" explains how this works in great detail. The prescription for success is to save at lot, learn to decide on an asset allocation appropriate for your risk tolerance, buy and hold mostly ultra low cost total market index funds, and "stay the course" (avoid timing the market which can't be done successfully, and don't panic and sell when prices drop dramatically, as they will, i.e. when your investment "goes on sale").

[rick]

In the land of the blind the one eyed man is king. First of all you should seek out a fee only registered investment advisory. The advisor should have their own corporate RIA. RIA's are not under the NASD or FINRA they fall under the SEC or the state they can go to prison if they screw you. FINRA gives them a time out and a slap on the hand. If you want to do it on your own here are the steps: first select the new company/custodian Next contact the VA company in ask them what is the shortest annuitization period available, then here is the tricky part you will annuitize your annuity directly into the new account with out taking a distribution
80% of sales people do not know this method if you do not get a RIA, i would use TD Ameretrade i did this with a travelers annuity had a 7 year surrender but a three year min annuatization period. If you do that 10% free withdrawal it will take you forever.