The Bonus Annuity and the Seventy-Two-Year-Old
Dorothy is 72, widowed, and holds $280,000 in a variable annuity inside a traditional IRA. She is in year 6 of a 7-year surrender schedule; the remaining surrender charge is 4%. An agent is urging a 1035 exchange into a fixed indexed annuity that pays a 10% premium bonus, carries a 10-year surrender schedule (9% in year one), has a 3% cap on index credits, and charges a 1.25% annual contract fee. Dorothy withdraws $14,000 a year from the account for living expenses and has no other savings beyond Social Security and a small pension. She was born in 1953.
1. Quantify the immediate cost of the exchange and explain why the 10% bonus is not $28,000 of free money.
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Surrender charge: 4% × $280,000 = $11,200 - a certain, immediate loss.
The bonus: it is normally credited on the amount actually deposited, so 10% of about $268,800 ≈ $26,880. On paper the account rises to roughly $295,700. But:
- It is paid for. A 3% cap with a 1.25% annual fee means the credited return, not the account value, is what compounds. Two flat index years at 0% still cost her 1.25% - roughly $3,500 a year on $280,000 - which consumes the bonus in about eight years.
- It is often recaptured. Many contracts vest the bonus against the surrender schedule, so leaving early forfeits both.
- It buys illiquidity. She is 72; a 10-year schedule matures at 82, and she needs $14,000 a year now.
Net: she trades $11,200 of certain loss plus a decade of restriction for a credit she may never fully keep. The bonus is a marketing number until you net it against cap, fee, and surrender schedule.
2. Identify the suitability problems and explain what the agent must be able to document under Arizona standards for annuity sales to a consumer in this position.
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The red flags, in order of severity:
- Liquidity mismatch. $14,000 a year is 5% of the account and her only discretionary money. A 9% year-one surrender charge means the first three years of withdrawals sit inside a penalty zone.
- Surrender period beyond life expectancy of the need. A 10-year schedule on a 72-year-old with no other assets is the classic unsuitable sale, whatever the product's merits.
- Replacement. A 1035 exchange is a replacement; it must be justified by a comparison, and the existing contract's 4% charge is a cost the exchange itself creates.
- Senior consumer. Enhanced disclosure and heightened scrutiny apply to sales to older buyers.
What must be documented: the fact-finding (income, liquid net worth, time horizon, existing annuity, withdrawal needs), the specific reason the exchange benefits her and not just the agent's commission, the comparison of surrender charges and fees, and the client's signed acknowledgment. “The bonus made it a good deal” does not survive a market-conduct review.
Also flag: if she is sold the product anyway, the free-look period is only days - it is not a suitability cure, and the agent should not present it as one.
3. Dorothy's required minimum distributions begin soon, and she intends to keep taking $14,000 a year. How do RMDs interact with the 10-year surrender schedule, and what should she get in writing before signing?
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RMD start date: born in 1953, her required beginning date is age 73 - roughly a year away. She cannot avoid RMDs, and they are calculated on the IRA value, including any new annuity.
The interaction: a carrier must permit RMDs to be taken without a surrender charge, and most do - but “must” and “does, correctly, on the right schedule” are different questions. Without that provision, the RMD would trigger the 9% charge and the shortfall would itself be a 25% excise tax on the undistributed amount.
Get in writing, before signing:
- That RMD withdrawals are exempt from surrender charges, in what amount, and whether they count against her free-withdrawal allowance.
- Whether the 10% free withdrawal applies to the $14,000 systematic withdrawal - and that systematic withdrawals do not waive the charge in later years.
- How the bonus is recaptured on any early withdrawal.
- The exact free-look window and the address to send a rescission.
Bottom line: the RMD provision is the one feature that can make an otherwise marginal contract survivable for her. Absent it in writing, the exchange should not happen - the 4% charge she pays today is smaller than the charges she would face at 73.