Annuity Suitability and a 1035 Exchange at Age 72
Evelyn, age 72, is a widow with a $250,000 certificate of deposit maturing next month. She also owns a variable annuity with a $180,000 account value and a $12,000 surrender charge that declines to zero in three years. Evelyn wants guaranteed lifetime income beginning at age 75 and says she cannot tolerate market losses. A producer recommends a fixed indexed annuity with an 8% premium bonus, a 10-year surrender charge, a 6% cap, and a 50% participation rate. The producer proposes a 1035 exchange from the variable annuity and using the CD proceeds. Evelyn's Social Security covers her basic expenses, and she has $60,000 in savings.
1. Assess the suitability of the recommended fixed indexed annuity for Evelyn's stated objectives and time horizon.
Read the worked answer
The recommendation is hard to justify. Evelyn is 72, wants guaranteed lifetime income at 75, and cannot tolerate market losses. A fixed indexed annuity with a 10-year surrender charge would lock her money until age 82, past her stated income start date. The 6% cap and 50% participation rate mean her credited interest is limited, and the 8% bonus is often recovered through lower caps or a recapture charge if she surrenders early. The variable annuity's $12,000 surrender charge also argues for waiting three years unless the new product clearly outweighs that cost. A short-surrender-period product, a SPIA, or a deferred income annuity with a guaranteed lifetime income rider would better match her need for guaranteed income and liquidity.
2. Explain the tax and cost consequences of the proposed 1035 exchange and the premium bonus.
Read the worked answer
A 1035 exchange from the variable annuity to a fixed indexed annuity is generally tax-deferred, so Evelyn would not owe income tax on the $180,000 transfer. But the $12,000 surrender charge is a real cost; it reduces the amount that actually transfers or must be paid from other funds. The 8% premium bonus is taxable as ordinary income when withdrawn, and many contracts impose a bonus recapture charge for early surrender. The 10-year surrender charge schedule must be disclosed in dollars, not just percentages. If she needs income at 75, she should compare the guaranteed income from the new contract with the cost of surrendering the old one.
3. What alternatives or modifications should the producer consider, and what disclosures are required?
Read the worked answer
The producer should consider: (1) waiting three years for the variable annuity surrender charge to disappear; (2) using the CD to buy a SPIA or deferred income annuity starting at 75; (3) a MYGA with a shorter surrender period; (4) keeping some liquidity in savings. Required disclosures include surrender charges, bonus recapture, index caps and participation rates, mortality and expense charges, free-look rights, and the fact that the bonus is not free. The producer should document Evelyn's income needs, risk tolerance, and time horizon and recommend only if the product is in her best interest.