The 9-Year Surrender Schedule Sold to a 74-Year-Old
Walter, age 74, is a widower with $300,000 in a CD maturing next month at 4.2%, and $180,000 in a variable annuity he bought in 2016 that carries a 3% surrender charge ($5,400) that disappears in 14 months. He has $2,400 per month of Social Security and a $1,100 monthly pension, and says he needs about $1,500 more per month starting next year to stay in his home. A producer recommends putting the entire $300,000 CD into a fixed indexed annuity with a 9-year surrender schedule (8% in year one), a 1.25% annual income rider fee, and an agent commission of 6.5%. The producer also proposes exchanging the existing variable annuity into the same contract now, before the surrender charge expires.
1. Evaluate the proposed exchange of the existing $180,000 variable annuity. What is the cost, and what does it buy Walter?
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The exchange costs $5,400 in surrender charges and buys nothing he needs.
- 3% × $180,000 = $5,400 paid today purely to exit early. Fourteen months of patience eliminates it entirely.
- The exchange resets him into a fresh 9-year surrender schedule on $180,000. He would be 83 before he could reach that money penalty-free - precisely the years in which long-term care or home-modification needs are most likely.
- A 1035 exchange preserves tax deferral but preserves nothing else: not the surrender-charge-free status, not the old contract's guarantees, not the old contract's death benefit.
- The 1.25% income rider fee compounds on top of the new surrender schedule, and if he dies during the surrender period the beneficiary typically receives account value less the surrender charge unless the contract waives it.
Correct sequencing: leave the variable annuity in place until the charge expires, then reassess whether a transfer into a new contract is actually better than what he owns. If the producer still wants the exchange in 14 months, it must be justified on the contract's merits, not on the size of a commission.
2. Applying a best-interest/suitability standard, what factors make the full $300,000 allocation to a 9-year contract unsuitable, and what would a suitable design look like?
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Factors weighing against the recommendation:
- Liquidity need: he needs $1,500/month ($18,000/year) beginning next year. That is 6% of the $300,000 - sustainable as an income stream, but not if the money is locked behind an 8% first-year surrender charge.
- Age and horizon: a 9-year schedule on a 74-year-old reaches to age 83. Suitability review must ask whether a surrender period extends beyond the period in which the consumer may reasonably need access.
- Existing assets and objectives: he is not accumulating; he is converting principal into income. A long deferral product is mismatched to that objective.
- Conflict of interest: 6.5% commission (about $19,500 on $300,000) plus a 1.25% rider fee must be disclosed, and the transaction must survive supervisory review.
- Replacement stacking: replacing both the CD and the in-force annuity in one transaction magnifies every one of the above.
A defensible design:
- Fund the immediate income need with a portion of the CD - a single premium immediate annuity or a short-surrender (3–5 year) multi-year guaranteed contract - sized so that $1,500/month is covered.
- Keep a liquid reserve in a CD or money market for home repairs and medical costs.
- Leave the existing variable annuity alone until the surrender charge expires.
- Document the client's income need, health status, other resources, and the reasoning in the file.
Standard applied: the producer must have reasonable grounds to believe the recommendation is suitable based on the consumer's age, income, financial situation, needs, objectives, risk tolerance, liquidity needs, and existing assets - and must document it. "It pays a better rate" is not a suitability analysis.
3. Walter signs anyway. What consumer protections exist after the sale, and what should the producer tell him before he signs?
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Protections after the sale:
- Free look. Annuity contracts carry a statutory free-look period (commonly 10 days, longer in some states and for replacement transactions). In that window Walter can return the contract and get his money back, including any premium paid, without surrender charge.
- Replacement rules. An annuity replacement triggers the same notice-and-disclosure machinery as life insurance replacement - a signed replacement notice and notice to the existing insurer.
- Suitability review and record retention. The insurer must maintain the suitability information and the basis for the recommendation; regulators can and do examine it.
- Surrender-charge disclosure. The schedule must appear in the contract and be explained.
What must be disclosed before signing - in writing and orally:
- That the existing variable annuity would cost $5,400 to surrender today and $0 in 14 months.
- The 9-year surrender schedule, with the 8% first-year charge, and what it means if he needs nursing-home care in year three.
- The 1.25% annual rider fee and its drag on account value.
- The commission the producer will be paid.
- That the CD principal is a fixed, guaranteed asset and the indexed annuity is not a CD: credited interest depends on index performance, subject to caps and participation rates, and principal is returned only if the contract is held and surrender charges are avoided.
If any of that is missing, the sale fails the disclosure prong of the best-interest standard even if Walter signed.