'Should I Cash Out My Annuity?' Suze Orman Reveals Why This Listener's Investment Isn't As Good As It Seems

Annuities are a popular financial product that can provide tax-deferred growth and guaranteed income. However, as Suze Orman explains on a recent episode of her Women & Money podcast, they aren’t always the best solution for everything. 

A listener named Janet wrote into the show and shared her experience with an annuity she purchased six years ago with an inheritance. Now, Janet is asking Orman about the best way to move the funds from her annuity. "Do I have to cash out the annuity or can a brokerage firm have the money transferred for me?" Janet wrote. 

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Here's a breakdown of Janet's situation and Orman's recommendations for those who wish to cash out an annuity. 

Janet invested $50,000 in a variable and index-linked deferred annuity. Over six years, her investment grew to $68,300 – a little over 36% for the total increase. Janet felt like that was a pretty good return, but Orman calculated that the annualized growth rate was only 5.4%. "That is horrific," Orman said. 

Janet's annuity was tied to the S&P 500 index, which Orman explained had significantly stronger returns over the same period. However, the nature of index-linked annuities meant Janet only received a percentage of the index's gains, not the full amount.

Orman also emphasized the tax drawbacks of annuities. If Janet cashes out, the $18,300 in growth will be taxed as ordinary income, which could place her in a higher tax bracket. This is a key difference from other investments like mutual funds or ETFs, which are taxed at a lower capital gains rate upon sale.

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Additionally, annuities do not offer the "step-up in cost basis" other investments provide. If Janet's beneficiaries inherit the annuity, they would owe ordinary income tax on any gains above her original $50,000 investment. In contrast, inheriting a mutual fund or ETF would mean the beneficiaries pay no taxes on gains due to the step-up in basis.

Orman advised Janet to carefully plan her annuity withdrawal to minimize taxes. Assuming Janet is no longer subject to surrender charges – a fee many annuities impose for early withdrawals – Orman suggested splitting the withdrawal over two years.

• Before Year-End: Janet could withdraw $9,150 (half the gain) and pay taxes in 2024.
• After Jan. 1: She could withdraw the remaining $59,150, which includes the rest of her gain and the original principal, spreading the tax liability over two years.

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By staggering the withdrawals, Janet could reduce her immediate tax burden and avoid a potential spike in her tax bracket.

Orman's advice to Janet illustrates the importance of fully understanding an annuity’s terms and potential drawbacks before purchasing one. While annuities can be useful for certain situations, they may not be the best investment for everyone, particularly compared to other options like mutual funds or ETFs.

If you're considering cashing out an annuity, evaluate the tax implications and consult with a financial advisor to ensure it aligns with your long-term goals.

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