Is a Step Up in Basis Critical for your Deferred Annuity?


By Maurice Stouse, Branch Manager and Financial Advisor

Maurice StouseAnnuities are not for everyone. If however you are considering one or perhaps already own one, this article will address a few key takeaways for you. This is intended to speak to deferred annuities (letting it grow over time vs taking out the income now). Annuities come in all shapes and sizes these days and they have taken on increased interest from the financial media and investors and savers alike in 2020. Cost is a significant factor when examining an annuity and finding out just what you get for the costs is critical, especially if you want to make sure you are locking in any appreciation year over year.

Annuities mainly come in two different types: Fixed and Variable. The fixed type is simply getting a fixed rate of return each year on the amount you have invested in the annuity. And the earnings or growth is tax deferred until withdrawn. The variable type simply means it is invested in sub accounts, similar to mutual funds, so the rate of return varies with the performance of the subaccounts in your annuity.

Annuities can also have features or benefits added to them and those are called Riders. A rider usually comes at an additional annual cost stated as a percentage of the amount in the annuity each year. One of these Riders is a step up in basis of the death benefit of the annuity. An example of that might be your beneficiary receives no less than your original contribution or the stepped up basis, the appreciated value of the deferred annuity. This is usually of added importance to the variable annuity holder because she or he typically wants to lock in any appreciation from year to year (assuming there is appreciation) and not have the death benefit be worth less than the amount invested should the market and the subaccounts decline.

In the interest of managing cost and innovation, many issuers of annuities might offer riders a la carte or eliminate them all together. The good news is that will get your investment cost down. The components of cost are usually the annual mortality and expense charge, the management fee of the subaccounts (if it is a variable annuity) and any riders. Investors would want to make sure they know what they are being charged for each year and that there is benefit to them for the charges. And it is usually a seen as a good idea to comparison shop as well.

There are choices available today that make the cost of annuity much less than it has been in the past, which had been a main criticism of them. Investors should take note that when managing costs, they are willing to give up the associated benefits. One of the most often cited by investors is the annual step up of the death benefit. The reason this is so is that many variable annuity holders would want to indemnify their beneficiaries with any growth the subaccounts have experienced. As cost innovation has taken hold over the past decade many issuers offer to eliminate the cost of that benefit or rider and make the variable annuity more of a no-frills annuity. This results in greater cost efficiency which can be a key component to long term returns. They do however give up that benefit. If someone has held a variable annuity for several years and it has appreciated they may not want to lose that opportunity.

What if someone is already in a no-frills variable annuity that does not offer the step up for beneficiaries? They should check to see if they have choices: Can they add that rider if possible? Or, does the issuer offer alternatives that have the rider so that they maintain the increased value if any? Or, they might want to consider a lower risk annuity, the fixed annuity but also making sure that it offers the benefit they are seeking.

Changes to these types of investments should be thoroughly researched as there may be cost considerations (such as early withdrawal charges) in doing so. Investors would want to be sure they have conducted an analysis of the cost benefit and it meet their needs. Check with your issuer or advisor and be sure to review your options and any associated cost and if it is to your benefit. With variable annuities, any withdrawals may be subject to income taxes and, prior to age 59 1/2, a 10% federal penalty tax may apply. Withdrawals from annuities will affect both the account value and the death benefit. The investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. An annual contingent deferred sales charge (CDSC) may apply. A deferred fixed annuity is a long-term, tax-deferred insurance contract designed for retirement. It allows you to create a fixed stream of income through a process called annuitization and also provides a fixed rate of return based on the terms of the contract. Fixed annuities have limitations. If you decide to take your money out early, you may face fees called surrender charges. Plus, if you’re not yet 59½, you may also have to pay an additional 10% tax penalty on top of ordinary income taxes. You should also know that a fixed annuity contains guarantees and protections that are subject to the issuing insurance company’s ability to pay for them.

Maurice Stouse is a Financial Advisor and the branch manager of The First Wealth Management and Raymond James and he resides in Grayton Beach. He has been in financial services for over 33 years. His main office is located at First Florida Bank, a division of the First, A National Banking Association, 2000 98 Palms Blvd, Destin, FL 32541. Branch offices in Niceville, Mary Esther, Miramar Beach, Freeport and Panama City, Pensacola, Tallahassee, and Moultrie, GA. Phone 850.654.8124. Raymond James advisors do not offer tax advice. Please see your tax professionals. Email: Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC, and are not insured by bank insurance, the FDIC or any other government agency, are not deposits or obligations of the bank, are not guaranteed by the bank, and are subject to risks, including the possible loss of principal. Investment Advisory Services are offered through Raymond James Financial Services Advisors, Inc. The First Wealth Management First Florida Bank, and The First, A National Banking Association are not registered broker/dealers and are independent of Raymond James Financial Services. Views expressed are the current opinion of the author, not necessarily those of RJFS or Raymond James, and are subject to change without notice. Information provided is general in nature and is not a complete statement of all information necessary for making an investment decision and is not a recommendation or a solicitation to buy or sell any security. Past performance is not indicative of future results.

Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Investors should consult their investment professional prior to making an investment decision. Please note, changes in tax law may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we do not provide advice on tax matters. You should discuss tax or legal matters with the appropriate professional.