Question: I am 74 and my wife is 73. Our income consists of Social Security, my pension, and distributions from my IRA’s. In addition to a modest portfolio, I have had a single-premium deferred annuity for three years that has lost 15% of its value.

My financial advisor has suggested I do a “1035 exchange” and trade in my “broken annuity” for a new type of universal life and immediate annuity. He says that if I convert the $100,000 balance, I will pay no taxes on the exchange, have a $175,000 death benefit to increase my estate by $75,000, and the new annuity will also pay for my long-term care if I need it. In addition, if I act now, the annuity company will add 5% to my investment from their money. From what he says, there are no fees.

We have enough income to live on, and it seems to me this is a good way to make sure my wife gets more money when I die. This sounds very good to me, but are there pitfalls that I am missing?

Answer: Based on your description of the benefits, it appears that you have not read the prospectus, as there are more pitfalls than a haunted house on Halloween. There are far too many to fully discuss here, but here are a few:
First, let’s talk about what you are buying. You say that you have enough income, but with an immediate annuity, you are getting ready to get some more. An immediate annuity begins paying you immediately after you purchase the product. Since there is no accumulation stage, you must decide how you want to receive the payments – monthly, quarterly, etc. You must also decide whether you want the payments to last over an indefinite period -- your life, or a definite period (say ten years), or the greater of your life or ten years. Once you establish the payout terms, depending on the language of the policy, you will not be able to make changes, so if you or your wife needs cash later, it may not be available to you.

Second: Even if the insurance company uses mutual funds or stocks to generate capital gains, you will be taxed on your distributions at ordinary income tax rates, rather than the lower capital gains rates. So your tax bite may be greater than if you did the investing yourself.

Third: If you take the time to read the prospectus, we believe that you will find fees stumbling over other fees and expenses that may significantly reduce what you receive.

For example, you will be charged fees for the stepped-up death benefit because you will be paying an insurance cost at your age to give someone that extra $75,000 when you die. And since you will also be paying a long-term care insurance premium that, at your age, will be costly, find out how long and how much this coverage will protect you. Then compare the cost to what it would cost you to buy long-term care coverage separately. And ask about your wife’s long-term care needs.

Check to see if you are being charged with a mortality and expense risk charge that generally runs in excess of one percent per year. And what are the administrative fees that the company charges to offset administrative expenses? Are there indirect fees that you will be charged due to someone making the underlying investment decisions? The promise to add a percentage bonus also carries fees.

Lastly, the “1035 tax-free exchange” should be inapplicable to you because your deferred annuity has lost money, and there should be no taxes; however, the balance in your current deferred annuity will probably be reduced by the remaining surrender charges should you withdraw the money early. Generally, insurance companies assess a sales charge that is used to repay the company for the commission paid to the person who sold the contract to you. This charge will depend on the language of your contract, and may be from 6% to 10%, which reduces over the time you keep your deferred annuity. In other words, if 5% remains on the penalty, your $100,000 will be reduced to $95,000.

Taking the NextStep: Permanently tying up your money may not be in your or your wife’s best interests. At your ages, we believe you should get a lot more information before you take this plunge, given the fact that annuity sales to seniors have been criticized as abusive. For more information, click helpful links above.