There are several ways to get out of an annuity. If it is an IRA, you can roll it over or transfer it. If it is not an IRA, you can use a 1035 exchange or surrender it. If it is an income annuity, you have to find someone to buy you out.
The first two options apply to annuities that are not yet paying out a monthly income. The third applies if the annuity is paying out income. Here's how each of these options works.
- If you need to get out of an annuity, your options depend on the type of annuity it is.
- If it's in an IRA, you can roll it over or transfer it into a regular IRA. However, you may have to pay a fee.
- If it's not in an IRA, find out whether your annuity has a gain or a loss, as this will impact the tax implications. An income annuity can be difficult to dissolve.
- Be sure you understand all the guarantees before you get out of an annuity.
Getting Out of an Annuity When It's an IRA or Retirement Account
If you have a variable annuity that is owned inside an IRA account, you can roll your funds out of the variable annuity and into a regular IRA at a bank, mutual fund company, or brokerage firm. Since the funds are still inside of the IRA wrapper, it is considered a transfer or rollover, and no taxes are owed.
Some annuities will assess a surrender charge if you withdraw money from it during the surrender period. The surrender period is typically between six and eight years from your purchase date, but some may last up to 10 years. The surrender charge is a percentage of the total amount withdrawn and will gradually decline as time goes on. For example, an 8% charge may apply the first year and decline by 1% every year until it no longer exists.
Before you cancel or exchange any variable annuity, check on any fees that may be applied. If the surrender charges are high but will be lower in a few years, it may be best to wait a few years before rolling over your IRA annuity to a different account.
Assuming there are no surrender charges, or they are quite low (2% or less), then in many cases you can reduce your expenses from 2%–3.75% per year down to .5%–1% per year by moving a variable annuity inside of an IRA to a portfolio of index funds. These lower ongoing fees can result in significant savings over time. If you can reduce fees by 2% per year on a $100,000 investment, you will save well over $20,000 over a 10-year time frame.
Getting Out of an Annuity That Is Not an IRA
If you own a variable annuity that is not inside of an IRA or another type of retirement account, such as a 403(b), before you cancel the annuity, for tax purposes, you will need to find out whether your annuity has a gain or a loss. To do this, you will first need to know your annuity’s cost basis. The cost basis is the total amount of money you put into the annuity. If you don’t know the cost basis, call the customer service number on your statement and ask. Next, compare your cost basis to the current value of your variable annuity.
If your annuity has a profit, you will pay ordinary income taxes on any gain. If there is a large gain in your annuity, instead of cashing in the annuity, you can exchange it (called a 1035 exchange) for a no-load variable annuity with lower expenses. Transamerica, for example, offers such a low-fee annuity. If your annuity has a minimal gain, you may wish to cash in the annuity and use the funds to invest in other lower-cost alternatives by opening a mutual fund or brokerage account.
If the current value of your variable annuity is lower than the cost basis, you have a loss. If you cancel the annuity, you may be able to claim that loss on your tax return. Be cautious of canceling a variable annuity that has a loss, as in these cases, the death benefit on the annuity may be at least equal to your cost basis. By canceling the annuity, you would be foregoing some level of the death benefit.
Getting Out of an Income Annuity
An income annuity is an annuity that is paying out a monthly benefit to you. This type of annuity can be difficult to dissolve. You have to find someone to estimate what the ongoing stream of payments is worth, and offer you a lump sum. Compare several companies before deciding on an offer.
An annuity is a contract with an insurance company. Some annuities guarantee a particular level of retirement income, so be sure you understand all the guarantees before you get out of an annuity. You could be canceling an insurance benefit that you would not be able to replace. If you understand the benefits, and they are not valuable to you, then getting out of your annuity is likely your best course of action.