Annuity stop-loss strategies

Stan Haithcock for MarketWatch writes: If you own a deferred annuity, you should consider a “stop-loss” strategy. Just as you might set a mental stop on a stock, you should have triggers in mind that would get you out of your annuity if circumstances warrant it.

The majority of annuities sold are deferred annuities. Variable annuities, fixed-indexed annuities and fixed-rate annuities represent over 75% of all sales on an annual basis. Except for true no-load variable annuities, these deferred annuity strategies all come with surrender charge periods as short as one year to as long as 10-plus years, depending on the specific product.

If you already own or are considering the purchase of a deferred annuity that has surrender charges, it is important to always have a stop-loss strategy in place just like you would with a stock. Below are some deciding factors for the possible implementation of an annuity stop-loss strategy.

Annuity stop loss considerations

High annual fees

It might make sense to get out of a deferred annuity if the annual fees over time far exceeds the surrender charges to get out. This is especially true with variable annuities where the average annual fees can exceed 3%. For example, if your annual fees are $10,000 per year with four years left in the surrender charge period, and it would cost you $15,000 to fully surrender the policy ... it might make sense to implement a "stop loss" and get out before that surrender charge period is over.

Poor performance

For example, if your variable annuity separate accounts (i.e. mutual funds) are not performing well or the investment choices are limited ... or if you realize that your fixed-indexed annuity isn't growing like you thought it would, it might be time to pull the "stop loss" trigger and move on to greener investment pastures.

Opportunity

This is especially going to come into play if interest rates ever start moving up, or if you decide to invest in other areas like real estate or hard assets. The bell never rings at the top or bottom of a market or potential opportunity, but you probably already know if your deferred annuity isn't performing as planned. A "stop loss" could free you up to pursue a better alternative.

Carrier stability

If you already own a deferred annuity with surrender charges, you need to constantly be reviewing the carrier's COMDEX ratings and company financials to make sure that they can back up the contractual guarantees of the policy. Even though annuities are regulated at the state level and policyholders receive limited protection by their state’s guaranty association, your primary concern should always be the financial status of the carrier. If your current annuity carrier's stability comes into question, that might be reason for a "stop loss" in order to move to safer grounds.

Annuity policy factors

Accumulation value

This is the “walk away” amount that any surrender charge “stop loss” will be applied to. This amount would be the separate account (i.e. mutual funds) total with a variable annuity, or the index option returns of a fixed-indexed annuity. Any rider calculation totals are NOT part of the “walk away” amount.

Surrender charge percentage

Most deferred annuities have a declining surrender charge period over time. For example, if an annuity has a 7 year surrender charge period, the penalty percentages might be 7, 6, 5, 4, 3, 2, 2, 0%. So if you used your stop loss in year three, you would have to pay 5% of the accumulation value to get out.

Attached rider valuations

This one here can be a major problem. Any attached rider benefit, like a guaranteed death benefit or future income calculation, can be much higher than the accumulation value. Some annuity conspiracy theorists believe that the carriers design these deferred annuities for this to happen in order to prevent you from transferring out. Remember that the accumulation value (”walk away”) amount is the amount that your “stop loss” will be based on, not the rider amounts.

IRA or non-IRA

The status of your account is also important with your “stop loss” implementation. If you have a deferred annuity within an IRA, it’s a much easier decision because capital gains don’t come into play like it does when your annuity is not within an IRA.

Annuity “stop loss” strategies can be applied to all or a portion of the annuity in question. In addition, you can always take out 10% of the accumulation value on an annual basis penalty free and not be subject to sales charges. If a partial “stop loss” makes sense, then you would only pay sales charges on the amount that exceeds the 10% penalty free amount.

For example, if your deferred annuity has a current 6% surrender charge with a $200,000 accumulation value, you could take out $20,000 penalty free, and any amount above that would be subject to the 6% surrender charge. In this instance, if you took out $30,000, you would only pay a 6% surrender charge on $10,000.

Implementing a “stop loss” strategy for your deferred annuity should not be used by your agent/adviser to sell you out of an annuity to go into another one — or worse, apply an upfront teaser bonus to “cover” for any surrender charges.

Like any investment decision, sometimes it makes sense to cut your losses and move on. Just because an annuity has a sales charge to get out is not a good reason to stay for the duration, so it’s always a good plan to have an “annuity stop loss” strategy in place.