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As mentioned, sometimes annuities are perfectly appropriate, fairly priced, and important components of sound retirement strategies.
All too often—and most of the time in my professional experience—annuities are improperly sold and poor choices for many investors. They can increase taxes over comparable non-annuity investments, reducing net wealth. Costs often run much higher than other portfolio options, also reducing wealth. Both tax and internal costs are typically hard to spot, and investors may not know what is happening to them. Frequently expensive riders are layered onto policies, greatly increasing costs—and agent commissions in many cases!—to sometimes unbelievable levels. While riders can provide valuable income features, in many cases they are not great matches for client needs or goals, cutting growth for no good reason. For instance, I recently met a doctor who had sufficient pension income and did not need income from annuities, but had most of his money in them with expensive income riders. Since his main wealth goal was to pass money on to his son, the riders worked at cross-purposes for him. Worse, income and estate tax treatment differences over alternate investment like stocks or mutual funds will result in a big chunk of potential inheritance needlessly going to taxes instead.

There are a lot of good reasons to own annuities, but at least just as many to not own them, or to own more appropriate or less expensive ones.

Assuming it makes sense to get out, qualified annuities (those in things like IRA’s or 401ks) can be surrendered (the term for cashing in a life insurance product) without fear of tax impact. Provided the product was a poor choice and the surrender charges are not onerous, you may wish to consider other products like mutual funds or individual stocks or bonds. Even when surrender charges are high, it pays to get a detailed examination of total product costs. With some products costing in the 5% range each year just for the privilege of owning them, it may not take long to recover even a 10% range surrender charge, and your ultimate wealth may be much higher taking the hit to reap lower ongoing costs and, perhaps, better investment management and performance. As mentioned above, actually discovering all the “hidden” costs in multiple documents is sometimes a challenge, and the skeptical may wonder if this is a coincidence. It may be helpful to have a professional review by someone who deeply understands these matters, to help ferret out the many potential costs and put them in context for you. My firm—Camarda Wealth Advisory Group—offers this service for free as part of our Portfolio Stress Test program, and you can call us at 1-888- CAMARDA if you want one.

For non-qualified annuities (those not in IRAs and qualified plans), tax treatment is a little trickier. For those who actually have losses—far too many in my experience—you have the opportunity to write off an ordinary loss, which is much more valuable in most cases than the more common capital loss. In some cases, nearly twice as valuable, even before you consider the time value of money (capital losses by themselves are not meaningfully deductible unless you have offsetting capital gains, but ordinary losses come off your other income, right now, at your highest marginal bracket). If you have us do the Portfolio Stress Test, we can help you determine your tax opportunities, or exposure. For those with significant gains in annuities, there are two basic strategies: 1035 exchanges and what I call tax bracket arbitrage. 1035s let you “rollover” an annuity like an IRA, deferring any tax until you actually take money out. As mentioned about, a lot of low-cost, high quality, and no-commission products have emerged that make destinations for money from expensive annuities. 1035s are painless, but one must remember that annuities carry perhaps the highest potential tax rate of all investments. So, deferring more gains to ultimately just pay more tax may not be the best plan. Tax arbitrage, which is not unique to annuities, just means pulling as much money out in low brackets as you can. Take a look at the tax table below, courtesy of the IRS for the 2016 tax year.

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