What Happens at the End of an Annuity Contract?

What options do I have when my Fixed Indexed Annuity matures? What happens at the end of my fixed-indexed annuity contract? What should I invest in? What other annuities can I invest in?

You ever buy a product or service without fully understanding all the bells and whistles, as well as rules, cool features, those that aren’t so cool, and the fine print that’s inevitably included?

That’s rhetorical. The answer is yes, you’ve done so many times. We all have.

We all concentrate on one to as many as several features or benefits when we purchase products or services.

Why?

Because we focus on the feature, advantage, or benefit delivered by the product or service that fulfills our needs. Everything else is generally just noise that often goes unnoticed.

Today we are going to focus on just such a scenario involving Fixed Index Annuities.

Most believe that at the end of an FIA contract, they must annuitize or take a lump sum distribution. Fortunately, that’s not the case – there are options.  

As annuities are contracts between an insurance company and an individual, they have certain provisions, stipulations, and general rules. These elements can vary considerably from one insurer issuing the contract to another.

One of the important elements in any annuity contract is that of maturity or the contract end date. This can range from short-term, such as five years, to longer-term, such as 15 years or more.

Once the contract period ends, decisions must be made. The insurer doesn’t keep the money originally invested to fund the annuity – it’s yours.

Something must be done with the principal and the gains earned.

Options at Maturity

We’ve found that with FIAs, there is often confusion at this point as people believe they must take a payout or annuitize their contract.

That’s generally not true. They usually have several options from which to select that can be utilized to best fit their situation.

Invest in Something Else

This is a great option for people who don’t want to start taking distributions or don’t need the income, and instead wish to continue to accumulate through some sort of retirement savings vehicle.

This type of scenario may be due to changes in life issues or goals (in which case the current annuity may no longer fit your needs well), a change in the rate environment, or overall economic conditions, as well as changes in terms of products (new FIAs introduced since the one originally purchased), and more.

Whatever the reason, you have two ways to invest in something else upon the maturity of the existing FIA.

If you originally funded the FIA with qualified money from an Individual Retirement Account or IRA, you would have the option to either transfer or rollover the funds into a new annuity contract, such as another FIA, without any penalties or tax consequences, if done timely and correctly.

If instead you initially funded your FIA with after-tax dollars (making this a non-qualified annuity), you can elect to do what is referred to as a “1035 exchange” without incurring any type of penalty or tax consequences (referred to as a tax-neutral event), if done timely and correctly.

1035 Exchange

To do a 1035 exchange you must use the correct form, and the exchange can only go from one insurance company to another. Importantly, the exchange of funds must go directly from the previous insurer to the new insurer issuing the new contract.

If the funds were to be in some manner distributed to you directly to then be invested with the new insurer, you could end up with tax consequences.

Keep in mind that there are limitations to a 1035 exchange. The only allowable exchanges are for a different annuity, life insurance policy, or modified endowment contract.

In the case of an individual wishing to invest in a new FIA with another insurer when their existing FIA matures, and assuming the funds were after-tax or non-qualified, the 1035 exchange would potentially be the best alternative.

Given there can be some major tax consequences when doing either an IRA transfer or rollover or utilizing a 1035 exchange, it’s best to work through a financial advisor or retirement planner if you are considering opting for another investment when your FIA matures.

Other Options

There are other options regarding your existing FIA when the contract expires, including:

Keep money in the existing contract

If you do nothing or elect to simply let the money sit in the existing FIA contract, the contract will in essence remain in place, but you will no longer be guaranteed the specific rate that was stated in your FIA upon purchase.

Interest would simply accrue and you could receive less, or even more, depending on what occurs with interest rates at that time.

You’ll want to check with the insurer to ensure all other benefits remain in place regarding the contract.

Renew your contract

Another alternative is to renew your contract with the insurer. In this case, you are in essence extending the fixed-indexed annuity contract.

But it would help if you kept in mind that depending on different factors, such as where interest rates are at the time, the contract may contain some key differences, such as the rate it pays, the length, index options in terms of linking (which indices are available to be pegged to in terms of performance), and more.

Also, surrender charges and periods will likely restart and may be different compared to the original FIA contract.

Cash-out the FIA

You can elect to take your funds out of the annuity in the form of a lump-sum distribution all at once. In doing so though, you can expose yourself to serious tax consequences.

If you used qualified (pre-tax) funds to invest originally, you could owe tax on the entire lump-sum distribution.

If the funds invested in the FIA were after-tax dollars, the returns or interest earned could be taxable.

Also, if you are less than 59.5 years old when you take the lump sum, in addition to taxes due, you could be subject to the IRS 10-percent early withdrawal penalty.

Annuitization

Depending upon your FIA and the terms covering annuitization (for example – set period, lifetime, spousal, and more) you can elect to annuitize and turn the annuity into a stream of payments for a fixed period or even for the rest of your life, and possibly that of your spouse.

You want to talk with an advisor as this decision is irreversible once it starts. We normally don’t recommend going this route. A big reason we don’t is the fact you can build lifetime income through a rider in the contract without ever annuitizing.

So, What do I Do Now?

When it comes to FIAs, they generally offer plenty of features and benefits that make them a potentially good tool for addressing an individual’s retirement needs, goals, and overall situation.

But as with many products and services, people often aren’t aware of the options available when it comes to their FIA maturing.

Finally, it’s important to consider the fact that with FIAs and other annuities, they do have many working parts and can get a bit complicated. Some issues must be considered to avoid serious tax consequences.

As such, we believe you should work with a qualified investment advisor or retirement planner to help guide and advise on all the tools and assets you own in your portfolio.

We’d be happy to review your FIA and entire portfolio or existing plan to provide our insights.

Our overall approach is to incorporate a holistic model that considers all your assets, tools, and accounts, with the goal of providing a comprehensive plan built specifically to your needs and goals in retirement.

If you’re ready to take the next step and talk to a team of financial advisors and retirement planners who put your interests first, Schedule a call today!