What to do when your client wants to cash out their annuity

At some point in time, a client may tell you they’re ready to surrender an annuity.

This may be because their financial situation has changed and they now need the funds. Or they may simply have buyer’s remorse or want to chase market returns when the market is hot.

“Clients usually start thinking about cashing out an annuity because something has changed whether that is an immediate need for liquidity, a shift in their financial priorities, or uncertainty about whether the annuity still fits their plan,” said Phil Caminiti, head of third-party sales at New York Life.

Regardless of a client’s reasoning, it’s your job as an advisor to help them understand the benefits and drawbacks of going this route. While you can’t control what a client ultimately does, you can point them in the right direction.

What to do when a client is ready to pull their cash

When a client says they want to cash out, the first step is to understand what has changed and what they’re trying to accomplish.

“If a client needs $25,000, for example, you should focus on the best way to generate that $25,000 rather than assuming the entire annuity needs to be surrendered,” Caminiti explained.

Once you understand their need, you can look at the role the annuity is playing in the broader financial strategy and the options available to address it.

This means revisiting why the annuity was purchased in the first place. Maybe it was intended to generate guaranteed retirement income, provide tax-deferred accumulation, address longevity risk or leave a benefit to beneficiaries.

For guarantees intended to support a client years or even decades into the future, the financial strength and track record of the insurer standing behind them are part of the value the client originally chose.

“If those objectives remain priorities, you should consider how they will be addressed if the client moves forward with the surrender,” Caminiti said.

It’s also important to review the client’s annuity contract thoroughly and identify potential surrender charges, tax consequences and benefits they could lose.

“At the end of the day, the goal is to determine how a client’s financial situation will change if they surrender the annuity,” explained Caminiti.

Surrender charges and taxes are part of that analysis, along with the income, guarantees and other benefits the client may be giving up.

You should also help a client understand where they are in the surrender charge period and whether waiting 12 or 24 months could materially change the economics.

“Don’t forget to clarify tax consequences, including the treatment of gains as ordinary income in a nonqualified annuity, the impact a sizable surrender could have on the client’s tax picture and the potential additional tax that can apply to taxable withdrawals before age 59½,” added Caminiti.

The decision should be viewed in the context of the client’s full financial picture, including income, liquidity, taxes, guarantees and risk.

Alternatives to a full surrender

In some cases, a partial surrender can make sense.

“Fortunately, many providers allow partial surrender up to a certain percent of the contract value without any surrender charges,” said Roland Chow, financial planner and portfolio manager at Optura Advisors.

If the need is liquidity, a partial surrender may provide the funds the client requires while preserving the remainder of the annuity.

“It’s also essential to determine any free-withdrawal amounts, hardship provisions or accelerated-access features available under the annuity,” explained Caminiti.

If the existing annuity no longer fits but the client still values the role an annuity can play in the plan, a 1035 exchange may be worth exploring.

Before recommending the exchange, weigh the benefits, costs and surrender period of the new annuity along with the financial strength and stability of the carrier.

“With a product designed to deliver guarantees over many years, who stands behind those promises can be every bit as important as the features or rate being compared,” added Caminiti.

Timing also matters. If a client is relatively close to the end of a surrender period, waiting may be the way to go. Looking across the client’s entire balance sheet can also help determine which available asset is the most appropriate source of liquidity.

When surrendering is a good idea

Sometimes, moving forward with a surrender may be the right choice.

“If the client is older and their contract is out of surrender, cashing out an annuity could help them fulfill their bucket list,” Chow explained.

Surrendering may also be reasonable when the annuity no longer serves the client’s objectives, surrender charges are minimal or have expired, the tax consequences are manageable and there is a better solution for meeting the client’s needs going forward.

“That decision should be evaluated across the client’s full financial picture rather than through any single variable, whether that is the surrender charge, a current rate or the potential return available elsewhere,” Caminiti said.

Comparing the client’s position before and after the transaction across income, liquidity, taxes, guarantees and risk provides a clearer view of the trade-offs and any unintended consequences. If the client is moving to another annuity, that same comparison should include both the new product and the insurer standing behind it.

Remember, a request to surrender an annuity is an opportunity to revisit the plan.

“Your role as the advisor is to help the client understand what has changed, weigh the trade-offs and make a decision in the context of their broader financial picture,” Caminiti added.

Anna Baluch is a finance reporter and writer with more than a decade of experience. Contact her at anna.baluch@innfeedback.com