Top 10 Annuity Mistakes

As the annuity specialist at TampaBayInsuranceAdvisors.com, I come across many mistakes people make when investing in annuities. While they may seem trivial, some of these mistakes if left unchanged can undermine the overall effectiveness of the annuity. The following are some of the more common annuity mistakes we come across, rank #1 being the most serious:

#10) Not using Section 1035 Partial Tax-Free Exchanges

Some of you may have what's called an ‘underwater' annuity, which is an annuity that has taken substantial losses, usually variable. Most variable annuities have a death benefit that is greater than or equal to the principal. One of the unique rescue techniques we use is to make a partial exchange of these assets to a guaranteed principal safe fixed or indexed annuity.

You can do a partial exchange of the variable annuity, keeping the minimum necessary in the variable contract to satisfy the death benefit guarantee. This does two things, it not only preserves the remaining dollars in the fixed or indexed annuity, but is also preserves the additional death benefit of the variable annuity. The mistake that is made is transferring the entire amount and losing the valuable death benefit provided in the variable annuity.

In 1998, the U.S. Tax Court ruled in Conway v. Commissioner that “IRC Section 1035 (a)(3) was not specifically limited to an entire annuity contract exchange.” Partial 1035 exchanges are also useful where cumulative free withdrawals are available or 10% free withdrawals are substantial in amount.

#9) Not transferring 1035 Exchange funds directly from carrier-to-
carrier

Some clients assume that a tax-free 1035 exchange is accomplished by signing over the check from the old company to the new company. The requirements for tax-free exchanges state that non-qualified funds must go directly from the current carrier to the new carrier. The same is true for partial 1035 tax-free exchanges. Making a surrender request to have the check sent directly to you may speed up the transfer process and may also avoid the hassle from the old company's conservation department. But unless funds are not sent directly from carrier to carrier, it will trigger a 1099 and you will be forced to pay income taxes on the gains of the old annuity.

Another item to remember with 1035 exchanges is you must keep ‘like-to-like.' This means in order for the transfer of an annuity to be a tax-free 1035 exchange, the owner and the annuitant must remain the same during the transfer. Once the transfer is completed, you can then change the owner and annuitant.

#8) Not understanding the settlement options

Many of our clients initially think their beneficiaries will want to receive the annuity settlement as a lump sum. However, we have found a high percentage would rather receive the funds as an income payout once they are shown how the income is distributed over time and how much income taxes are reduced.

Many annuity products today, especially those with high bonuses, require that the death benefit be received as an income payout. While this may limit some of your options, it is not entirely a bad thing. These forced income payout plans enable carriers to offer annuities plans to older people that they otherwise could not participate in.

#7) Not exploring the “Split-Funded Annuity” concept

A great way to create both an ‘income security blanket' and a ‘replacement income security quilt' is to use a combination of an immediate annuity for income and one or more deferred annuities for safety of principal and tax-deferred accumulation. On one hand you receive the guaranteed income you might need, often with income tax advantages, and on the other, you retain most of the principal for growth and additional penalty-free withdrawals if necessary.

We have found that many of our clients define financial security as being assured they will receive income for the rest of their lives. This “Split-Funded Annuity” concept is an excellent way to accomplish this objective.

#6) Making annuities payable outright to minor children or grand-
children

In many cases, state laws will tie up the proceeds of an annuity if a minor is the named beneficiary. The state will require you to name a custodian or guardian.

One solution we recommend is to set up a trust for your minor children or grandchildren naming the trust as the recipient of the proceeds. Another option is to name a “Trustee” on behalf of your minors to receive and manage the annuity proceeds. Still, another approach is to instruct the insurer how to pay out the proceeds. For example, you can request the funds be doled out to your beneficiaries over an extended period of time instead of all at once. Setting up a formal trust can cost up to a thousand dollars, but that might be the best thing to do. If a significant sum of money is involved or you would like to maintain more control, consider setting up a formal trust.

#5) Failing to name contingent “Back-up” beneficiaries.

Preeminent elder-law attorney Stephen Leimberg describes what he calls the “Rule-of-Two.” This rule of thumb suggests you have named back-ups for both your primary and contingent beneficiaries and review them at least every two years. More often than you might think, a Primary and/or Contingent Beneficiary predeceases the owner. We have found that many of our clients have not stayed on top of their beneficiary designation. Making certain your beneficiaries, including back-ups and back-up back-ups, are named, will insure that you avoid the ultimate insult, making your annuity subject to the costly probate process.

#4) Not funding the annuity with the right monies

Annuities are long-term savings and accumulation vehicles (5 – 10+ years). They are not designed to be used as short term funds for items such as groceries, rent or even emergency funds. While they may have similar guarantees to CD's and money market accounts, the surrender periods and penalties are a bit different. Before investing, be sure to have a good understanding of all the costs associated with liquidating the annuity.

If you are investing with money held in a qualified retirement account such as a 401k or pension plan, it is also important to pay attention to how required minimum distributions will be treated as these distributions may also be penalized.

#3) Naming your estate as the beneficiary

What an expensive tragedy this is. This mistake changes a normally probate-free resource and makes the asset part of the deceased owner's probate settlement. The annuity now is exposed to the costs and delays of probate and you will have lost all the privacy that an annuity can provide. Why throw away this important benefit of an annuity? It's unnecessary and can be costly.

Furthermore, in 40 of 50 states, annuities are totally creditor proof. Meaning, annuities cannot be claimed in a lawsuit against you. This alone makes annuities even more desirable in today's litigious society.

#2) Naming an older owner with a younger annuitant

Another common mistake we come across is with annuities where the owner is older than the annuitant. The problem with this scenario is it creates a ‘surrender charge trap.'

Here's how it happens:

Federal law requires, if the beneficiary is not a spouse, when the annuity owner dies there is a forced distribution. This forced distribution is often accompanied with surrender charges. We recommend you purchase annuities that don't have surrender charges upon death. But if you happen to own one, please make certain you are also the annuitant.

#1) Owning or purchasing the wrong kind of annuity

As of April 2004, there were 471 different index annuities and thousands of fixed and variable products. With so many annuities available, choosing the right one on your own can be a daunting task that can lead to several mistakes.

At TampaBayInsuranceAdvisors.com. our full-time staff is dedicated to making certain you invest in the annuity that is designed to best suit your specific circumstances.

Call us at 727 945 9700 and we'll help you find the plan that's best for you. We'll also help you fix any mistakes you may currently be making with your annuity investing.

Mistakes can easily be corrected. All it takes is one call to 727 945 9700