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My 90-year-old father has had an equity-indexed annuity for 10 years. He must decide in the next month whether or not to renew an income benefit rider which guarantees a 5% return if he chooses to begin taking regular lifetime withdrawals. The rider costs 0.25% annually. He doesn’t need the income, or the principal itself. He’s 10 years into a 17-year surrender schedule and would have a 10% penalty if he took all of the money out of the account right now. Should he renew the rider? We’re all a bit confused by the whole ordeal and whether or not this was a good investment for him. It’s gone up in value, and he’s made some free withdrawals. But, renewing the rider seems confusing. My dad never intended on taking income from the annuity. It’s just emergency money.
Answer:I’m going to answer your question in a moment, Don. But, I need some time to recover from being told an 80-year-old was sold an annuity with a 17-year surrender schedule. I’m sure there was a reason your dad felt comfortable committing his money to an investment which wouldn’t have given him unfettered access until he was 97 years old, but I’m not sure he wasn’t pressured or induced to make the decision.
My gut tells me your dad received a ‘signup bonus’ when he purchased the annuity. That means he received a fixed percentage bonus, let’s say 6%, for depositing money into the annuity contract. For instance, if he deposited $150,000 into the account, the starting balance was $159,000 ($150,000 deposit + $9,000 bonus). But for giving him a bonus, the insurance company (the type of entity which issues annuities) slapped on a giant surrender schedule.
A surrender schedule details the length of time and the percentage penalty for withdrawing the entire investment. At the beginning of the surrender period, he likely would have had a penalty in the 15% to 17% range, and as you mentioned, 10 years later, the penalty is still 10%. Surrender charges aren’t necessarily evil. They protect the insurance company from fickle customers who might bail on the contract before the company is able to become whole after paying agent commissions or extending guarantees or bonuses to the annuity owner. But at the same time, 17 years is a really long time. Your dad will have seen the Olympics four times between the date of purchase and the end of the surrender period.
Your question can also teach us the importance of investment objectives. No matter if an investor’s primary objective is income, growth, liquidity, tax advantage or something else, the investment must be able to deliver on the objective.
If I had to guess, your dad purchased this annuity during the chaos that was 2009. He was scared his money would get eaten by the market, so this equity-indexed annuity with downside protection and a healthy sign-up bonus caught his interest. His objective appears to have been capital preservation (not going backward).
What’s strange, is the annuity also had an income benefit rider slapped on it. Generally speaking, an income benefit rider is used when the owner wants to use the account for lifetime income. That would mean his objective for the money was income. But as you mentioned, he never intended on using the annuity for income. And, his current objective certainly isn’t income. Therefore, there’s no way he should renew the income benefit rider. It’s a giant waste of money.
You’ve also just learned a bit about the wishy-washy nature of suitability. The person who sold this annuity to your father was able to convince their suitability department this annuity was a suitable investment for your father. I disagree with their conclusion. Theoretically, two people had to agree that the deal made sense: the person earning the commission and an insurance company representative. The person who sold your father this product was clearly not a fiduciary (an individual required to act in the best interest of the client).
To answer your question as to whether or not this ended up as a good investment for your father, maybe. He got a nice bonus, enjoyed downside protection, received tax deferral on his growth and withdrew money along the way. Although he has been restricted from removing the entire investment, he hasn’t actually needed to remove the entire investment. The income benefit rider seems to have been a waste of money, but then again, maybe he considered income as a reasonable secondary objective at the time.
Just think, in seven more years this will have all worked out perfectly, as planned. Maybe.
Peter Dunn is an author, speaker and radio host, and he has a free podcast: “Million Dollar Plan.” Have a question for Pete the Planner? Email him at AskPete@petetheplanner.com. The views and opinions expressed in this column are the author’s and do not necessarily reflect those of USA TODAY.
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