I need your help. I am in my early 60s and because of health issues, I have to retire. From reading your past columns, I have decided to delay social security for a few years. My wife is going to continue to work, but her salary won’t cover all our living expenses. My strategy was to close out an annuity that I have and use that to cover my living expenses. I bought the annuity last year after the election. I had gone to a seminar and quite frankly they scared me into buying the annuity. At the time I bought the annuity, they told me that I can close it out whenever I wanted to. However, they did not tell me the whole story. It appears that if I close out the annuity now, I have to pay a hefty penalty. If fact, to my chagrin, I found out that the annuity has a 15 year penalty. I feel I was duped, and my brother-in-law, attorney, told me that there is virtually nothing I can do about it. I don’t want to deal with the sales person again, because I believe that they were less than honest with me. My question to you is do you have any ideas? The annuity is worth about $300,000 and I’m going to need about $1,000 to $1,500 per month.
I agree, it appears that you were duped. Unfortunately, when you go to those seminars, they make it appear that annuities are the best thing since sliced bread. Although some annuities, in certain situations, make sense, rarely is it beneficial for an investor to lock their money up for 15 years. Typically, the only one who benefits from this is the salesperson because the longer they get you to tie up your money, the greater the commission. That being said, I do believe there is a work-out that would make sense for you.
In reviewing the information you sent me, the annuity you purchased, like the great majority of them, allows a penalty-free withdrawal on a year by year basis. Your annuity provides that you can withdraw 10 percent of the value of the annuity year by year without penalty. Therefore, this year you can withdraw $30,000. My advice is that every year you withdraw the full 10 percent. Even though you do not need that money for living expenses, it will give you flexibility down the road.
There will be a tax issue with the withdrawals, although I think it will be minor in the situation at hand. The way annuities are taxed is that the interest earned comes out first and any excess is return of principal. You pay tax on the interest, not the return of principal. Therefore, in your situation, if the interest you earned since the inception of the annuity was $3,000 and you withdrew $30,000, the $3,000 would be added to your ordinary income and the $27,000 would be tax free.
It is important to realize that annuities can be a very high commissioned product and, thus, it is subject to aggressive sales tactics. If you are approached about buying an annuity, it is important that you take your time and don’t rush into the purchase. Don’t fall for their sale’s rhetoric that you have to buy it today, because you don’t. It is important that before you sign on the dotted line, you understand all the terms of the annuity. Annuities in today’s world are very complex and you must do your research. Many times an annuity company will offer five or ten different annuity products. Some of these products are much more investor friendly than others.
If you are considering an annuity, one thing that you need to focus on is how long the annuity contract is. In the great majority of situations, I think it is mistake to tie money up long term. We live in an ever-changing world and we have no idea what interest rates or tax laws will be down the road. When you tie your money up in annuities for ten or fifteen years, you are surrendering your flexibility and getting virtually nothing in return. Of course, the annuity salesperson is handsomely rewarded, but not you, the investor.
Seminars can be a valuable place to learn and get information; however, they have to be educational seminars. When you go to seminars where they are giving you a free lunch or dinner, the goal is not to educate you but rather subject you to their sophisticated high-pressured sales tactics. In my view, it certainly is not worth a free lunch or dinner.
If you would like Rick to respond to your questions, please email him at Rick@bloomassetmanagement.com.