Can You Get Out of a Bad Annuity? How to Review, Challenge, and Unwind an Annuity Sale
If you were sold an annuity that you now regret, you may have more options than you think.
One of the most common misconceptions we hear is that once an annuity contract is signed, the decision is permanent. That is not always true.
Depending on the type of annuity, when it was purchased, how it was recommended, the client’s age and financial circumstances, and the terms of the contract, there may be ways to surrender, exchange, rescind, or otherwise unwind an annuity.
The important part is knowing what you own before taking action.
Simply cashing out an annuity can create surrender charges, taxable income, penalties, and other unintended consequences. If the annuity is held inside an IRA or another retirement account, additional retirement-plan rules may apply.
That means the first question should rarely be:
“How do I cash out my annuity?”
A better question is:
“Why was I sold this annuity, what are my contractual and regulatory options, and what happens for tax purposes if we unwind it?”
Were You Sold an Annuity That Doesn’t Make Sense?
Annuities are not inherently bad financial products.
They can serve legitimate purposes, particularly when someone wants to transfer longevity risk to an insurance company and create a guaranteed stream of retirement income.
The problem arises when the product does not appear to solve a meaningful problem for the person who bought it.
We become particularly interested when we encounter situations involving:
- An elderly client placed into a long-term or deferred annuity
- A substantial percentage of someone’s retirement assets placed into one annuity
- Significant surrender charges or long surrender periods
- A client who needed liquidity but was placed into an illiquid product
- An annuity purchased inside an IRA without a clearly understood reason for the insurance features
- An existing annuity replaced with another annuity that restarted surrender periods or increased costs
- A client who does not understand what was purchased
- A recommendation that appears inconsistent with the client’s age, objectives, assets, income needs, or time horizon
- Family members discovering an unfamiliar annuity after an elderly parent’s death
- Sales materials or explanations that do not match the actual contract
None of these facts automatically means the sale was improper.
They do mean the transaction may deserve a closer look.
Annuity Recommendations Are Subject to Standards of Conduct
Annuity sales do not occur in a regulatory vacuum.
State insurance regulators have adopted standards governing annuity recommendations. The National Association of Insurance Commissioners’ model regulation establishes a best-interest framework under which producers and insurers cannot place their financial interests ahead of the consumer’s interests when making a recommendation.
The framework calls for reasonable diligence, care, and skill and focuses on whether the recommendation appropriately addresses the consumer’s financial situation, insurance needs, and financial objectives.
For securities products such as variable annuities, additional federal securities and FINRA requirements may apply.
For example, FINRA’s rules governing deferred variable annuities specifically contemplate factors including:
- Age
- Annual income
- Financial situation and needs
- Investment experience
- Investment objectives
- Intended use of the annuity
- Investment time horizon
- Existing assets
- Liquidity needs
- Liquid net worth
- Risk tolerance
- Tax status
The important takeaway is simple:
A client’s signature does not eliminate the professional’s obligations surrounding the recommendation.
“But I Signed the Contract.”
Signing an annuity contract is obviously important.
But it does not necessarily answer whether the recommendation itself complied with applicable insurance or securities standards.
That distinction matters.
If a 55-year-old with substantial assets deliberately allocates a modest portion of a portfolio toward guaranteed lifetime income after reviewing the alternatives, that presents one set of facts.
Consider something very different:
An 88-year-old with ample liquid assets, Social Security, other retirement accounts, limited concern about exhausting retirement assets, and significant estate-planning objectives is placed into a large annuity with substantial restrictions on accessing the money.
The appropriate question becomes:
What financial or insurance problem was the annuity intended to solve?
There may be a perfectly legitimate answer.
But there should be an answer.
Can an Annuity Actually Be Unwound?
Sometimes.
There is no universal right to undo every annuity purchase. The available options depend upon the contract, product, timing, state law, account type, and circumstances surrounding the sale.
Potential outcomes can include:
Free-look cancellation.
Annuity contracts may provide a period after delivery during which the owner can return the contract. Applicable periods and requirements vary.
Contractual surrender.
Many deferred annuities can be surrendered, although surrender charges, market-value adjustments, taxes, or other consequences may apply.
Partial withdrawal.
Some contracts permit limited withdrawals without completely surrendering the contract.
1035 exchange.
Certain nonqualified annuity-to-annuity exchanges may qualify for tax-deferred treatment under Internal Revenue Code Section 1035. This does not mean an exchange is automatically a good idea, and replacing one problematic annuity with another can create an entirely new set of costs and restrictions.
IRA or retirement-account transfer.
An annuity held inside an IRA presents different tax considerations. Moving retirement assets incorrectly can turn what could have been a nontaxable transfer into a taxable distribution.
Complaint and compliance review.
Where there are legitimate concerns about how an annuity was recommended or sold, the consumer and their counsel may consider raising the matter with the firm’s compliance department and appropriate regulator.
Rescission or negotiated resolution.
Depending upon the circumstances, disputes over problematic annuity sales can result in surrender charges being waived, restitution, settlement, rescission, or other relief.
None of these outcomes should be assumed in advance.
That is precisely why the contract and transaction need to be reviewed before money is moved.
Don’t Surrender the Annuity Before Understanding the Tax Consequences
This is where we frequently become concerned as CPAs.
Someone realizes they own an annuity they no longer want and immediately thinks:
“Get me out of this thing.”
That reaction is understandable.
But pressing the surrender button first and asking tax questions afterward can be expensive.
The IRS has specific rules governing annuity distributions, retirement accounts, rollovers, and qualifying exchanges.
Depending upon the situation, surrendering or transferring an annuity could result in:
- Ordinary taxable income
- A Form 1099-R
- Loss of tax deferral
- An additional federal tax on an early distribution
- Surrender charges
- Market-value adjustments
- Unexpected state income taxes
- Problems with an IRA rollover or transfer
- Loss of basis information
- Loss of valuable contractual benefits
- Different consequences for beneficiaries
A properly structured Section 1035 exchange between qualifying annuity contracts, for example, can generally occur without recognizing the accumulated gain at the time of the exchange.
Receiving the money personally and then purchasing another contract is not necessarily treated the same way.
Likewise, an annuity held inside a traditional IRA is governed by retirement-account tax rules that are different from those governing a personally owned, nonqualified annuity.
The account registration matters.
An Annuity Inside an IRA Deserves Special Attention
Clients are sometimes surprised to discover that their IRA owns an annuity.
That arrangement is not inherently improper.
An annuity can provide insurance features that an ordinary investment account does not, such as guaranteed income or certain death or living benefits.
But an IRA already provides tax deferral.
Therefore, when an annuity is recommended inside an IRA, it is particularly important for the owner to understand what additional insurance benefit justified using the annuity.
Was the objective guaranteed lifetime income?
A particular death benefit?
A living-benefit rider?
Protection from a particular retirement risk?
If the answer is simply “tax deferral,” more questions may be warranted because the IRA itself already has tax-deferred treatment.
Elderly Parents and Annuities: What Adult Children Should Know
We also see another version of this problem during estate administration.
An elderly parent dies and the children discover an annuity they barely knew existed.
Now the family is trying to determine:
- Who is the beneficiary?
- Is this annuity inside an IRA?
- What is the death benefit?
- What was the decedent’s basis?
- Is the beneficiary receiving taxable income?
- Can the contract continue?
- Does it have to be distributed?
- What happens to the IRA?
- Is there a Form 1099-R?
- How does this interact with inherited IRA rules?
- What elections or deadlines apply?
This is one reason elderly clients should understand not merely that they own an annuity, but why they own it and how it fits into their broader retirement and estate plan.
A complicated financial product that nobody except the salesperson understands can become considerably more complicated after the owner’s death.
Warning Signs That an Annuity Sale May Deserve a Second Look
You do not need to conclude that someone committed wrongdoing before asking for a second opinion.
Consider obtaining an independent review when you cannot clearly answer basic questions such as:
Why did I buy this?
What percentage of my liquid assets went into it?
When can I access my money?
What does it cost to get out?
What guarantees am I actually receiving?
What happens if I die?
What did I give up by moving money from my previous account?
Why was this preferable to the alternatives available to me?
How was the person who recommended it compensated?
And perhaps most importantly:
Does this product still make sense given my financial objectives?
If nobody can explain those answers in plain English, obtaining an independent review may be worthwhile.
What Documents Should You Gather?
Before surrendering, exchanging, or challenging an annuity, gather the complete file.
Ideally, that includes:
- The complete annuity contract
- Original application
- Contract issue and delivery dates
- Initial premium and subsequent contributions
- Current contract value
- Current surrender value
- Surrender-charge schedule
- Income or withdrawal riders
- Death-benefit provisions
- Original illustration
- Sales presentation
- Emails and correspondence with the salesperson
- Financial-needs or suitability questionnaire
- Best-interest or recommendation documentation
- Replacement forms, if another annuity was replaced
- IRA transfer or rollover documents
- Recent account statements
- Forms 1099-R
- Prior tax returns when relevant
Do not rely exclusively on the salesperson’s description of the product.
Read the actual contract.
Who Should You Contact About a Questionable Annuity Sale?
The appropriate resource depends upon the product and circumstances.
For insurance-related annuity issues, your state insurance regulator is an important resource.
For securities products and registered representatives, FINRA and applicable securities regulators may also be relevant.
If substantial money is involved or you believe the product was misrepresented or improperly recommended, consider speaking with an attorney experienced in securities, insurance, or financial sales-practice disputes.
And before actually surrendering, exchanging, transferring, or restructuring the annuity, speak with a qualified tax professional who understands retirement accounts and annuity taxation.
These professionals perform different jobs.
An attorney may evaluate legal rights and potential claims.
A regulator may investigate conduct within its jurisdiction.
A financial professional may evaluate investment and insurance alternatives.
A CPA or tax advisor can evaluate what the proposed solution does to the client’s tax return, retirement accounts, basis, income, and estate.
Complex cases may require more than one professional working together.
The Goal Isn’t Just Getting Out. It’s Getting Out Correctly.
This distinction is critical.
Discovering that an annuity may not have been appropriate is only the first problem.
The second problem is figuring out what to do with it.
An impulsive surrender could potentially transform an undesirable financial product into an undesirable financial product plus a tax bill.
Before taking action, we want to understand:
- What exactly does the client own?
- How is the annuity titled?
- What is the client’s tax basis?
- Is it qualified or nonqualified?
- What happens under a surrender?
- Is a tax-deferred transfer or exchange available?
- What tax reporting will the transaction generate?
- What happens to required distributions, if applicable?
- Are there state income-tax consequences?
- How should the transaction be reported on the client’s tax return?
Only after those questions are answered can the client evaluate the real cost of the available options.
Corridor Consulting Can Help You Understand the Tax Side of an Annuity Exit
At Corridor Consulting, LLC, we help individuals and families understand complicated tax situations involving retirement accounts, inherited assets, estates, trusts, and financial transactions.
If you believe you or an elderly family member may have been placed into an inappropriate annuity, we can help evaluate the tax consequences of the options available to you and coordinate with your attorney or other professionals when appropriate.
We do not need to sell you another annuity to solve the problem.
Our role is to independently evaluate the tax consequences and help you understand what happens next.
Before You Surrender an Annuity, Understand What It Will Do to Your Taxes
If you have an annuity you regret purchasing, inherited an annuity you don’t understand, or are considering challenging an annuity recommendation, schedule a Discovery Chat with Corridor Consulting.
Bring the contract if you have it.
We’ll start by determining what you actually own, how it is held, and what tax questions need to be answered before you take the next step.
Start With Our Client Questionnaire
If you are concerned about an annuity you own—or one purchased by an elderly parent or family member—start by completing our client questionnaire.
When asked which services you are interested in, select Estate, Trust & Legacy Services and indicate that you are seeking estate tax planning services. In the questionnaire, briefly explain the annuity situation, including whether the annuity is held inside an IRA or other retirement account, if known.
This allows us to review your situation before the Discovery Chat and identify the tax, retirement-account, estate, or beneficiary issues that may need to be addressed.
Complete the Questionnaire to Get Started →
This article is for general informational purposes and does not constitute legal, investment, insurance, or securities advice. Corridor Consulting, LLC is a CPA firm and does not provide legal advice or act as a securities regulator. Consumers who believe an annuity was improperly recommended or sold should consider consulting qualified legal counsel and the appropriate insurance or securities regulator.
