Underwater Annuities

Michael Kirsh
May 13, 2009 — 1,778 views  
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Based on the number of calls we are receiving from advisors, clients are looking for advice on what to do with underperforming variable annuities.

Variable annuities are complex financial instruments, and the advisor needs to be familiar with the minute details within the annuity contract. Many of these contracts were purchased for guaranteed income and death benefits, and you need to consider what happens with the annuity death benefit and living benefit and the way they relate to one another.

For example, a 62 year old client has an annuity that had fallen in value to $350,000 from $500,000. The annuity provided a $780,000 death benefit and the client was uninsurable. Our solution was to "strip" the annuity, withdrawing all but $1,000 from the contract. Since the death benefit was dollar-for-dollar, the withdrawal from the account reduced the death benefit by an equal amount. Be careful, as many contracts use "pro rata" formula, which wipes out the death benefit. The withdrawn funds were used to buy another annuity with a death benefit that has a guaranteed 6% annual increase until age 85. The client's goal was to maximize what would be left for his kids. Without making any changes, the death benefit would remain at $780,000 until the value exceeded this amount. In effect, we found a way to increase the death benefit, beyond the current amount.

In some cases, "tax-loss" selling may be a good idea, much the same as you would do with a traditional investment portfolio. However, losses on annuity contracts are "ordinary losses", not a capital loss (Rev. Rul. 61-201). Thus, those losses are not limited to $3,000, or subject to "wash-sale" rules. However, you may not be able to duplicate the various guarantees in the current contract, so you need to be aware of what you're giving up.

More than ever before, clients need actionable advice, to regain confidence by taking control of their financial futures.

Michael Kirsh


Michael Kirsh Founding principal of Kirsh Financial Services, Inc. Has been solving the problems of closely held business owners in the areas of business succession and retirement planning since 1977 Recognized authority on the subject of sophisticated insurance planning with many publishing credits to his name Has addressed numerous seminars and workshops on these subjects around the country Certified financial planner, accredited estate planner and charted life underwriter Listed in Who's Who in Finance and Industry, and Who's Who in the World.