Annuities Fixed Index Annuities

How Will Withdrawals Affect Your Premium Bonus?

How will withdrawals from my fixed index annuity affect my premium bonus?

Five weeks ago, ten fixed index annuity (“FIA”) income calculation variables were introduced in the January 23, 2012 post by the same name. The January 30th post delineated the ten variables between contractual vs. situational variables. The first contractual variable, premium bonus availability, prompted the February 6, 2012 post, 8 Questions to Ask Yourself When Analyzing Premium Bonuses which kicked off a series of posts.

The February 6th post answered the first three questions. The February 13, 2012 post, What’s a Reasonable Premium Bonus Percentage?, addressed questions #4 and #5. Question #6 was the subject of last week’s post, How Will a Premium Bonus Affect a Fixed Index Annuity’s Value?

This brings us to question #7: How will withdrawals affect my premium bonus? The answer to this question depends on your contract’s withdrawal charge, free withdrawal, and premium bonus recapture provisions, the latter of which is the sixth contractual variable listed in the January 30, 2012 post.

It’s important to keep in mind that while a premium bonus increases the accumulation value and income withdrawals from a FIA when an income rider has been purchased, there are costs associated with this feature. Two of the costs, potential longer terms and potential lower cap rates, were discussed in last week’s post.

Whenever you take a withdrawal from the accumulation value of a FIA that isn’t a required minimum distribution (“RMD”) assuming your FIA is inside an IRA, it’s subject to a withdrawal charge if (a) your withdrawal is taken during the contract’s specified surrender period and (b) the amount of your withdrawal exceeds the allowable free withdrawal amount, which is generally 10% of the accumulation value after the first contract year.

In addition to the withdrawal charge, your withdrawal may also be subject to a premium bonus recapture charge if you were credited with a premium bonus and your FIA has a premium bonus recapture provision. The recapture charge will be a percentage of your premium bonus for any withdrawals during a specified period, generally the first 10 years of your contract. The percentage may decrease the further into the contract you get.

Let’s look at an example to see the affect of a withdrawal charge and premium bonus recapture provision on a withdrawal from a FIA. Suppose you were credited with a premium bonus of 5% of your initial investment of $100,000, or $5,000, your contract has a free withdrawal provision of 10% of the contract value, and you took a withdrawal of $18,000 in the third contract year when your accumulation value was $120,000, the withdrawal charge was 12%, and the premium bonus recapture charge rate was 6%.

In addition to the withdrawal charge of $720 that would be deducted from your withdrawal, (withdrawal of $18,000 less $12,000 (10% of $120,000), or $6,000, multiplied by 12%), you would also be assessed a recapture charge of 6% of your premium bonus of $5,000, or $300. In this example, a total of $1,020 ($720 + $300), or 5.67% of your withdrawal amount of $18,000 would be deducted, leaving you with a net withdrawal of $16,980 before any further potential reduction for income taxes.

By Robert Klein

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.