More on Variable Annuities and Retirement Accounts

This week, Gail stresses the importance of knowing the details of your variable annuity plans -- and encourages you to roll money from your previous employer's retirement plan into your new employer's plan.

Ms. Buckner,

I enjoyed reading your piece on variable annuities very much. Of particular interest was your reference to annuities with provisions for nursing home expenses. I already own a substantial annuity and would like to know how to find out if it offers this coverage. If not, what do you recommend?

Thank you for your time and kind assistance.

Bruce

Dear Gail --

I hope you can help me. In 1998, the company I was working for was sold. I got myself a financial advisor who moved my 401(k) money -- about $250,000 at the time -- to a 7-year annuity with a major insurance firm. The value today is $148,000.

I'm 59 years old and want to retire in 3 years, but I'm worried about my account losing so much. You mentioned that some variable annuities give you either the actual return your investments earn or a guaranteed minimum of 5%. Why is mine not doing that? Can you please advise me of what can I do? Can I move this money somewhere else w/o any penalties? I am really worried, since this is my only savings.

Thank you,

Brunny

Dear Bruce and Brunny --

I'm afraid it's impossible for me to know what benefits your annuities offer because every annuity sponsor is free to include whatever features it wants to. In fact, you can have different contracts, with different options, from the identical insurance company! So even though you and a friend have an annuity issued by the same provider, you could have very different terms.

To find out what your contract offers, dig out your policy and read the fine print you probably glossed over when you bought the annuity. Annuity contracts are full of jargon that's difficult for the average person to understand. Don't hesitate to call your financial advisor or the company which sponsors your annuity if you have any questions. It could very well be that the benefits you want are, in fact, part of your contract, but you just don't realize it. Perhaps it is something that could be added. Ask!

Bruce, if your contract doesn't include a provision which waives the surrender charge if an annuity owner enters a nursing home and needs access to his money, then you don't have it. The same is true for the "minimum guaranteed return" feature, Brunny.

The good news is, provided you have a "non-qualified" annuity (not issued through a company retirement plan), you can upgrade your current contract by switching to a new policy via what's called a "1035 exchange." This way, the proceeds of your old annuity transfer directly into a new one, enabling you to avoid paying tax on the gains. Your old annuity company will issue IRS Form 1099-R, which shows you liquidated an annuity. However, this will be offset by Form 5498, issued by your new provider, showing you never took receipt of the proceeds.

Because annuities were established primarily as retirement savings vehicles, there is a 10% penalty if you take any withdrawals before age 59 1/2. However, a "1035 Exchange" will also enable your to avoid this "early withdrawal" penalty.

Keep in mind, if you change annuity sponsors, your current provider could levy a "surrender charge" if you have not owned the contract for a minimum number of years. Both the amount of the surrender charge and the minimum holding period also vary from contract to contract, so this is definitely something to consider. (In your case, Brunny, you are in the fourth year of a seven-year contract.)

Usually, when a company adds features to a basic annuity contract, there is an increase in the annual fees it must charge to cover these additional benefits. A number of firms now price each feature separately, allowing an investor to select from a "menu" of benefits and only pay for those he wants.

As with most insurance-related products, many people balk at paying more for extra benefits because they don't think they'll ever need them. Until they do. It's only after you discover your "bare bones" annuity doesn't provide the flexibility or the guarantees you need, that you wish you had chosen another provider.

Other features you might be interested in include a death benefit that is "stepped up" each year on your anniversary date. This guarantees that upon your death, your heirs will receive either an amount equal to what you invested or the highest anniversary value -- whichever is higher.

In addition, some annuities offer an additional death benefit paid to your beneficiary to offset any estate tax that might be due when the annuity is inherited.

As with everything, you get what you pay for. While I certainly don't advocate buying a fancier annuity than you need, I also strongly recommend you think carefully about what features you want for yourself and your heirs. Don't let price be your sole priority.

Best wishes-

Gail

Dear Gail-

I recently changed jobs and left the money in my company retirement account with my previous employer. My new firm does not have any retirement plan. Can I move that money into something else as the mutual funds in my old plan are doing poorly, and I would like to be completely separated from my previous employer?

Sincerely,

Donna

Dear Donna --

Most definitely! In fact, I'm a big fan of NOT leaving your money in your old employer's plan. First of all, recent changes in the tax code have made it much easier to consolidate your retirement money. In theory, you should be able to roll money from one employer's plan into your new employer's plan.

The hitch is you cannot do this unless your new employer's plan allows it -- and many companies don't. In your case, your new firm doesn't even have a retirement plan to roll into. So this is completely out of the question.

However, the one place you can ALWAYS move your retirement plan money is your IRA. If you have an existing tax-deductible IRA (where your contributions are allowed to grow tax-deferred), you can simply instruct your old company to roll the money into that account. Your IRA trustee can provide you with the necessary forms.

If you don't already have an IRA, contact a mutual fund, brokerage firm or bank and set up an IRA so you have an account number. Then have the assets from your former employer's plan rolled into that account.

DO NOT TAKE POSSESSION OF THE MONEY YOURSELF!!! By law, if your old employer makes a check out to you, they must withhold 20% of the money. This is just in case you have second thoughts about depositing it into an IRA and spend it instead.

You'll eventually get this money back after you file your income tax return. But the kick-in-the-pants is this: if you roll over just 80% of the balance in your company plan to an IRA, the IRS will assume you spent the other 20% (even though your company withheld it) and you will get hit with income taxes on this amount and possibly a 10% penalty if you are under age 59 1/2.

To avoid this, you've got to come up with the money to make up for the 20% the company withheld! It's not worth the aggravation.

There's a simple solution: instruct your former employer that you wish to do a "trustee-to-trustee" transfer of your account balance. The money will go directly from your old retirement plan to your IRA.

The key to this is "Keep Your Mitts Off the Money".

Once the money is in your IRA, it can be invested in mutual funds, individual stocks and bonds and even certain gold coins -- whatever your IRA trustee permits. Be sure to name a primary and contingent beneficiary so your IRA doesn't end up in probate court.

The only time you might want to think twice about leaving your money in your former employer's plan is if you think you'll be sued. "Qualified plans" such as 401(k)s and similar retirement plans (403(b), 457, Keogh) are protected from creditors by federal law.

On the other hand, IRAs are protected by state law and this varies. While many states have simply used the federal government's protections as a blueprint and extended this to IRAs, others -- such as California and Vermont-- have not. If you get sued and your IRA is the only asset available to settle the claims of your creditors, they can wipe out a big chunk of your IRA. If the money's left in your company plan, in all probability they couldn't touch it.

However, if this is not a likely scenario for you, then by all means roll your retirement account balance into an IRA, which gives you more control over how it is invested and how it is distributed upon your death.

Hope this helps!

Gail

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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.