Can I Get Out of the Annuity I Bought with My IRA?

can-i-get-out-of-my-annuityI’ve consulted many clients over the years who used their IRA funds to buy an annuity investment. The most common questions I get are as follows.

  1. What is an annuity? Now mind you, these are persons who already own an annuity.
  2. Can I cancel it and get my money back to invest in something else, and is there a penalty?

Most of our clients who own an annuity with an IRA are seeking to use those retirement plan dollars in a new investment opportunity with the goal of increasing returns. However, “getting rid” of an annuity owned by your IRA isn’t as easy as selling a mutual fund or stock investment.

WHAT IS AN ANNUITY?

An annuity is a contract with an insurance company whereby the person invests a lump-sum (or a series of payments) with an insurance company and the insurance company agrees to pay certain sums to the owner over their life. There are many variations of annuities but the simple explanation is that you give up money now to an insurance company and they promise to pay you money later. The longer you wait to get paid the more they will pay you later on.

CAN I CANCEL MY ANNUITY?

You can cancel an annuity but you may be subject to a surrender penalty. Most annuities have a surrender penalty whereby the owner of the annuity is penalized for requesting a return of the investment within a certain period of years of the initial investment. This time period is known as the surrender period and on average will last from 5 to 10 years. The surrender penalty on a 10 year surrender time period is usually 10% and decreases by 1% each year thereafter until it goes to zero after 10 years.

So, if you invested a lump-sum of $100,000 into an annuity and one-year later (in years 2) you wanted to get the entire $100,000 back out, you would be subject to a 9% surrender penalty of $9,000. That would mean you could get back $91,000 but would forfeit the remainder. Some penalty schedules are more punitive and they all vary. The surrender schedule is in the annuity contract documents and can also be requested at any time from the company holding the annuity.

KEEP IT IN AN IRA TO AVOID TAXES

Once you cancel an annuity owned by your IRA, the funds need to stay within an IRA (e.g. self-directed IRA) in order to avoid taxes and penalties from the IRS. You can request the annuity company to transfer the IRA annuity cash balance over to a new IRA custodian of your choosing.  Once you’ve taken these steps, you’re retirement plan funds will be in an IRA and available to invest in stock, bonds, mutual funds, real estate, private companies, precious metals, and all other investments available to IRAs.