The Bonus Annuity, the Surrender Charge, and the Roof in Eighteen Months
Clara is 63 and retiring in June. Thirty-four months ago she moved $300,000 into a fixed deferred annuity through a 1035 exchange. The contract has a seven-year surrender charge schedule starting at 7% and dropping one point each year, a 10% annual free-withdrawal provision, a 3% guaranteed minimum rate, and a current rate of 3.25%. An agent now proposes moving the entire balance into a new fixed annuity with a 6% premium bonus, a fresh seven-year surrender schedule starting at 8%, a 2.5% guaranteed minimum, and a current rate of 3.0%. Clara wants reliable income beginning at 68, and she expects to need about $40,000 in roughly 18 months for a new roof and dental work.
1. Clara is in the third contract year. Calculate the cost of a full transfer today and whether the 6% bonus makes her whole. Should she move the money?
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Math first. Third contract year on a 7-6-5-4-3-2-1 schedule means a 5% surrender charge:
- Surrender charge: 5% × $300,000 = $15,000
- Net transferred: $285,000
- 6% bonus: 6% × $285,000 = $17,100
- New contract value: $302,100
On paper she is ahead by about $2,100, or 0.7%.
Why that is not "made whole":
- The bonus is recycled money. It is roughly the surrender charge she just paid, returned to her - and it is usually subject to its own vesting or recapture if she leaves early.
- Her guarantees get worse, permanently. Guaranteed minimum falls from 3.0% to 2.5%; the current rate falls from 3.25% to 3.0%.
- She restarts the clock. A fresh 8% seven-year schedule means the year-one surrender charge is 8% × $302,100 = $24,168, leaving a surrender value of about $277,932 - less than the $285,000 she transferred and less than the $300,000 she holds today.
- Liquidity dies at the worst time. Free access is pushed out to age 70, exactly when she says she needs money.
Conclusion: on these facts the replacement is not suitable. A 1035 exchange does defer tax (and she is past 59½, so no 10% federal penalty on withdrawals), but tax deferral does not fix a worse guarantee, a lower rate, and a seven-year lockup at 63. If a change is desirable later, consider a partial 1035 of only the portion she will not need, after the existing charge steps down.
2. How can Clara meet the $40,000 need in about 18 months without paying a surrender charge?
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Use the free-withdrawal window twice, straddling the contract anniversary.
- 10% of accumulation value is available each contract year without charge. On roughly $300,000 that is about $30,000 now.
- After the anniversary, another 10% of the then-value (roughly $30,000+) becomes available.
- Two withdrawals across the boundary cover $40,000 with no surrender charge and leave the contract's guarantees intact.
Tax mechanics she must be told about:
- Withdrawals from a nonqualified annuity are gain-first (LIFO); the taxable portion is ordinary income, not capital gain.
- She is over 59½, so the 10% early-withdrawal penalty does not apply.
- A 1035 transfer would not be a withdrawal, but it also would not generate cash - the cash still has to come out of a contract, and under the proposed contract that withdrawal would be subject to the new 8% schedule.
Suitability point: the $40,000 need is the decisive fact. Any recommendation that puts a surrender charge between a 63-year-old and money she has already told you she needs in 18 months is unsupportable, regardless of the bonus.
3. If Clara does want guaranteed lifetime income at 68, compare her three realistic routes and say what you would recommend.
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Route 1 - Annuitize the existing contract. Converts principal into a guaranteed income stream, typically producing the highest guaranteed payment per dollar because there is no insurer charge layered on top. Her current contract's guaranteed annuitization purchase rates are already locked in and may beat anything the new contract offers. Costs: irrevocable, no liquidity, and the death benefit is limited to whatever payout option she picks (life-only pays the most and leaves nothing).
Route 2 - Add a guaranteed lifetime withdrawal benefit to the existing contract. Keeps control of the account value, keeps a death benefit, allows continued access to the remainder. Costs a rider fee (commonly 0.75%–1.25% per year) and produces a lower guaranteed income than annuitization. Good fit if she may need the money for long-term care or wants a legacy.
Route 3 - Systematic withdrawals. Maximum flexibility, no fees, no guarantee. The real risk is longevity: at 3% rates, a withdrawal rate she sets at 68 may not survive to 95.
Recommendation: fund the $40,000 need from free withdrawals first, then compare the existing contract's guaranteed payout quote against the GLWB alternative before considering any exchange. Do not annuitize the entire $300,000 - irreversibility is the enemy of a 63-year-old with unquantified health costs. Annuitize or add the rider on a portion, keep the rest liquid, and document the comparison in the file.