Be Careful When Withdrawing Money From Annuities and SIMPLEs

This week, Gail recommends that you check out all investment choices in your variable annuities or SIMPLE plans before you do anything drastic... like cash them out.


Dear Ms. Buckner,

My wife and I have a substantial amount of money invested in both qualified and non-qualified variable annuities as well as four SIMPLE plans. Can we consolidate all of our accounts into a government insured account, such as T-bills, or any other similarly guaranteed investments ? We are both 57 years old.




Dear Ed,

Yikes! These are all "retirement" accounts and, as you may know, withdrawing your money before age 59 1/2 can mean stiff penalties. Let's start by separating the "wrappers" from what's inside them.

As I've written about hereherehere and here before, a variable annuity (VA) is essentially a life insurance policy with investments that are managed in a way that is similar to mutual funds inside it. Annuities have insurance related fees, charges and tax considerations. In its most basic form, an annuity guarantees that when the owner dies, his/her beneficiary will receive an amount that is at least equal to the original investment, less any withdrawals.

More importantly, an annuity gives the owner the option of "annuitizing." This means you turn your account over to the insurance company which, in exchange, is obligated to pay you income based on your account value for as long as you live, a certain period of years or a combination of both. In essence, you create your own private pension.

Congress approved annuities years ago as a way for people to save additional money for retirement. Because of this, VAs get special tax treatment: you pay no tax on any gains that could be generated by the investments in an annuity account until money is withdrawn.

A "qualified" annuity is one you invest in with pre-tax dollars through your employer-sponsored retirement plan, such as a 403(b). The federal regulations which cover company plans apply, meaning, for instance, that you must begin mandatory withdrawals from this type of annuity once you reach age 70 1/2.

On the other hand, money invested in a "non-qualified" annuity comes from after-tax dollars. These accounts are not governed by federal law concerning retirement plans, so withdrawals do not have to start until you are 90 or 95 years old (depending upon the insurance company). This gives you the potential for decades of additional tax-deferred growth.

The price you pay for the potential tax-deferred growth you get with an annuity is that you have to keep your hands off the money until you are at least age 59 1/2. If you make withdrawals prior to this, you can be slapped with ordinary income tax, plus an additional 10% federal penalty.

However, according to attorney Amy Floyd, who heads up the Advance Planning and Support Group at Allstate, this penalty only applies to the money in your account that you didn't already pay taxes on. In a qualified annuity, this would be the entire amount -- because your money was contributed on a pre-tax basis.

Nevertheless, you can avoid this problem by rolling over your qualified annuity into an IRA. "You can surrender the annuity and have the trustee transfer the money in a direct trustee-to-trustee transfer," says Floyd.

Then you would instruct the new trustee of your IRA to invest your money in government bonds. The key is for you to never take possession of the money.

If your non-qualified annuities are worth less than what you originally invested -- that is, you have no "gains" -- then there is no tax on your withdrawal and no 10% penalty.

But be careful! Insurance companies that sponsor annuities have their own requirements about how long you're expected to remain invested. If you withdraw your money too soon, you could be subject to a "surrender charge." This is independent of whatever the federal government assesses.

Mike DeGeorge, general counsel for the National Association of Variable Annuities, says you can probably find less volatile places for your money without leaving your annuities and potentially incurring penalties or taxes.

"Look at the investment options withIN the annuity. Most offer a choice of more conservative bond funds and even a fixed account. You can switch assets between accounts within an annuity tax-free." It's also penalty-free.

SIMPLEs are retirement plans sponsored by small businesses. As with qualified annuities, these also offer pre-tax contributions, and the potential for tax-deferred growth -- generally through mutual fund investments. And like all retirement plans, SIMPLES also have penalties on withdrawals made prior to age 59 1/2. In fact,if you take your money out of a SIMPLE plan within two years, there is a 25% (!) penalty.

I suggest that you and your wife take the same approach with the SIMPLEs as I have recommended with the annuities: check out the investment choices in the plans before you do anything drastic like cash them out. I'd bet you'll find government bond funds offered. Moving your money from one mutual fund inside the SIMPLE to another is tax and penalty-free.

Like the mutual funds in a SIMPLE, the investments inside the variable annuity will go up and down in value, depending upon what they are invested in. From the sound of your inquiry, I have a feeling most -- if not all -- of your money has been in stocks. No doubt about it, the past three years have been rough for equity investors.

However, to be honest, most experts agree that now is probably not a good time to chuck all your stocks and run for the supposed "safety" of bonds -- whether they're issued by the federal government or corporations. For one thing, a number of economists and market strategists see signs that this could actually end up being a decent year for the stock market.

In addition, interest rates are at a 41-year low. Since bond prices move in the opposite direction of yields, this means fixed income investments are currently very pricey.

So if you follow your gut instinct you'll be "selling LOW (stocks) and buying HIGH (bonds). Not only that, at some point, when interest rates and yields head higher, the value of your bonds is guaranteed to go down.*

I strongly advise you and your spouse to sit down with an experienced financial advisor to review your options and their consequences. Try to agree on an asset allocation in all of your retirement accounts that allows you to sleep at night.

Best wishes --



*Note: Although bonds and notes issued by the federal government are "guaranteed," the only thing you're sure to get back is the "face value" of the instrument, provided you own it individually and hold it to maturity.

Depending upon the maturities you choose, right now you'd be locking in a return of 1-4% per year for as long as you own these securities.


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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.