Your multi-year guaranteed annuity is maturing: the choices ahead

A letter arrives from the insurer, a few weeks or a couple of months before the guarantee period of your multi-year guaranteed annuity ends. It says the contract is reaching its maturity date, quotes a new renewal rate and tells you what will happen if you do nothing. The letter is easy to set aside, and that is the first mistake. For a short window the money is free of the surrender charges that held it in place, and the decision you make now sets the next several years.

This post walks through three hypothetical households, each facing the same date with different needs. The people and numbers are invented to show the mechanics; the rates are round illustrations, not quotes, and they say nothing about what any insurer is offering today. For the basics of how the product works, see the guide on multi-year guaranteed annuities.

What the maturity date actually changes

A multi-year guaranteed annuity is a fixed annuity with one rate guaranteed for a set number of years. The guarantee period usually matches the surrender period, the years during which pulling money out costs a charge. When the term ends, three things generally change at once:

• The surrender charge falls away. You can usually take out all of the money, with no charge, though income tax may still apply.
• The old rate stops. After the term, the contract either renews at a new declared rate, moves to a default rate set by the company or waits for your instructions, depending on its terms.
• A decision window opens. Contracts commonly give a period around the maturity date, often about thirty days, in which you can act without penalty. The window is in the contract or the notice, and a few contracts also waive any market value adjustment during it. The length varies, so read yours.

If nothing is done, many contracts renew automatically into a new guarantee period, sometimes with a new surrender schedule starting from zero. Some move the money to a lower-yielding holding option. Neither result is necessarily bad, but both are choices made for you.

The four routes available are the same in every household:

1. Renew with the same company, for the same or a different term, at the rate the company declares for renewals.
2. Exchange the balance to another annuity, through a 1035 exchanges: swapping policies without tax, which moves it without tax on the gain.
3. Withdraw some or all of the money and pay income tax on the earnings.
4. Annuitize, converting some or all of the balance into a stream of income payments.

Household A: Rosa and Luis, 64, deciding between renewing and moving

Say Rosa and Luis put $100,000 of savings into a five-year MYGA in a non-qualified contract (money that is not in an IRA), at an illustrative 4% a year, compounded. Five years later the value is:

$100,000 × 1.04⁵ = $100,000 × 1.2166529 = about $121,665

The gain is about $21,665, which they have not yet paid tax on. They do not need the money for another five to seven years; they plan to retire fully at around 70.

The renewal letter offers an illustrative 3.5% for another five years. Another insurer's five-year MYGA is illustrated at 4.0%. If the numbers were exactly what they appear, the difference after five years looks like this:

The difference is about $3,520 over five years, or roughly $700 a year. That is real money, but it is not the whole comparison. Rosa and Luis should also check:

• The new surrender schedule applies to the whole $121,665. If the new contract's schedule runs seven years rather than five, their money is locked in for two years longer than the renewal would hold it. A seven-year commitment is fine if they will not need the money, and a poor fit if they might.
• Whether the new contract has a market value adjustment, which can raise or lower the amount they receive on an early exit.
• The strength of the new company. A higher illustrated rate sometimes reflects a company that takes more investment risk or has a lower financial rating. The guaranty association backs both companies only up to a limit, which differs by state; the lookup tool and the state guides show the figure.
• Whether the rate is the whole picture. Some contracts credit a high first-year rate and a lower one afterward. Compare the effective rate over the full term.
• Bonuses. A bonus annuity paid on an exchange may come with a longer schedule or recapture terms.

They also ask whether a 1035 exchange is the right way to move. If they close the old contract and send a check to the new company, the $21,665 gain is taxable that year. If the two companies exchange the money directly under section 1035, the gain carries over and tax is deferred. The step-by-step process is in how to do an annuity 1035 exchange, step by step. The exchange must also be timed within the maturity window, so the paperwork for the new company should start before the notice period ends.

In this case Rosa and Luis decide the gap is real but modest and check the new company's rating, schedule and adjustments. If the new contract holds up, they exchange. If any of the checks fails, they renew, and they mark the next maturity date on the calendar. Neither decision is wrong. A reasonable alternative that also fits their situation is splitting the balance: half renewed, half exchanged, so that no single choice carries all of the risk. Our guide to laddering explains why people stagger maturity dates in this way.

Household B: Marcus, 52, who needs cash for a repair

Marcus put $60,000 into a MYGA seven years ago. It matures at an illustrative value of $72,000, so the gain is $12,000. He needs $30,000 for a roof and some urgent home repairs, and he wants to know what a withdrawal costs. He is 52.

The tax rules for a non-qualified annuity treat withdrawals as coming out gains first. Only after all the gain has been taken does the money start to come out of what he paid in. So a $30,000 withdrawal works out as follows:

• The first $12,000 is the gain, taxed as ordinary income.
• The remaining $18,000 is a return of his own money, which is not taxed.
• Because Marcus is under age 59½, the $12,000 of gain generally also carries a 10% additional tax, which is $1,200, unless an exception applies. The exceptions are listed in IRS guidance and tax professionals can say whether any fits.

Say, for illustration, that his federal tax rate on the extra income is 22%. The income tax on $12,000 is $2,640. The total tax cost, before any state tax, would be $2,640 + $1,200 = $3,840. After tax, the $30,000 withdrawal leaves him with about $26,160 of usable cash. The extra income could also push part of his earnings into a higher bracket, which a tax preparer can check against his actual return.

The balance left in the contract is $72,000 − $30,000 = $42,000. Because the gain has now been used up, the whole remainder is his own money, and future withdrawals of that $42,000 would not be taxed as gains, although new interest would be.

Marcus has other options to compare with the withdrawal, and the arithmetic of each is worth running:

• Other cash. If he has a savings account or a taxable investment account that he could use instead, the cost may be lower. Annuity gains are taxed as ordinary income, but selling stock held more than a year may be taxed at lower rates.
• A loan or a home-equity line. Borrowing keeps the annuity intact, though interest has to be paid and the loan has to be repaid.
• A smaller withdrawal. Taking $12,000 from the annuity and the rest elsewhere reduces the taxable gain taken this year, but the same 10% additional tax applies to whatever gain he takes.
• Spreading the gain over years. Taking part of the gain in January and part in December of the next year can keep each year's income lower, if the repair can wait.

Whichever he picks, Marcus should expect a Form 1099-R from the company the following January showing the withdrawal and the taxable amount, and should give his tax preparer a copy. The guide on how annuities are taxed explains how basis and gains are treated.

Household C: Helen, 71, who wants dependable income

Helen holds a non-qualified MYGA that put in $80,000 years ago. At maturity it is worth an illustrative $96,000, so $16,000 is gain. She is 71, her Social Security and a small pension cover most bills, and she would like a monthly amount she cannot outlive to cover the rest.

The fourth route, annuitization, converts the balance into payments. Helen asks the company, and one or two other insurers, for quotes on a single premium immediate annuity using the $96,000. The annuity payout calculator on this site shows how payouts vary with age, sex, and the options chosen, without naming any company's rates.

Say a quote comes back at $480 a month for life, or $5,760 a year. This is a made-up quote used to show the tax mechanics. For a non-qualified annuity, each payment is part return of her own money and part taxable earnings, according to an exclusion ratio. The ratio is her investment in the contract divided by the expected total of payments, using life expectancy tables the IRS prescribes. Say that, for illustration, the expected return is $5,760 × 17 years = $97,920. Then:

• Exclusion ratio: $80,000 ÷ $97,920 = about 81.7%
• Excluded each year: $5,760 × 0.817 = about $4,706
• Taxable each year: $5,760 − $4,706 = about $1,054

So most of each payment is not taxed, until the whole $80,000 has been recovered. After that point, every payment is taxable. If Helen lives well beyond the table's expectation, the tax picture changes later in life. A tax professional or the company's reporting statement will confirm the actual ratio.

What she gives up is just as important as what she gains.

• Access. Once she annuitizes, the money is no longer an account she can draw on. The payments are the arrangement. If a large expense comes up, there is nothing to withdraw.
• Legacy. With a life-only payout, payments stop at death and nothing passes to heirs. Refund and period-certain options pay something to a beneficiary, but each lowers the monthly amount.
• Inflation. A level payment buys less each year; see a flat annuity check and inflation: how purchasing power erodes.

Because annuitization cannot usually be undone, Helen may prefer a middle path: annuitizing only the portion needed to cover the gap in her monthly budget, and keeping the rest in a renewed MYGA or other liquid savings. Not every contract allows partial annuitization, and not every company offers the same conditions, so she asks. She could also take the $96,000 to a different insurer through a 1035 exchange into an immediate annuity, if its quote is better; the exchange rules cover that route too.

The household that did nothing

Consider a fourth, brief case. The notice went to an old address, or sat in a pile, and the window passed. What happens next depends entirely on the contract:

• If it renews automatically, the balance rolled into a new guarantee period at the declared rate, with a surrender schedule that may start again from year one. Exiting now could mean paying a charge on money that was free a few weeks earlier.
• If it moved to a holding option, the money may be earning a lower rate than other choices, but may be freely accessible.
• Some contracts have a grace window after maturity for changing the choice, sometimes with the same benefits as the original.

If you miss the date, call the company at once, read the contract's maturity provision, and ask in writing whether the window can be reopened. Do not assume it can. A simple prevention is to put the maturity date and the start of the notice period into your calendar on the day you buy, and to keep your mailing address and e-mail current with the company. Also tell your beneficiary where the contract is.

A short process for your own maturity

1. Find the contract and the maturity provision. Note the maturity date, the notice window and the default action.
2. Get the renewal terms in writing: rate, term, new surrender schedule, any adjustment, and what the company will do if you do not respond.
3. Calculate the gain and the tax. Ask the company for the current value and your cost basis, and work out what a withdrawal of each size would cost.
4. Shop the alternatives. Compare other fixed annuities, bank CDs and Treasury securities on rate, term, access and safety. See Fixed annuity or bank CD: how safety, tax and access really differ for the structural differences.
5. Check the strength and the limits of any new company, and the guaranty association limit in your state.
6. Decide on the money you may need soon. Keep that part liquid, whatever you choose for the rest.
7. Start paperwork early for an exchange; transfers between companies can take weeks.
8. Put the new maturity date in the calendar on the day you act.

If the amounts are large, or your tax situation is complicated, an hour with a fee-only planner or tax professional is a small expense next to the possible cost of a poor choice. The state insurance department can answer questions about your contract's rights.

Key takeaways

• The end of a MYGA's guarantee period usually opens a short, penalty-free window; the contract and the notice say how long, and silence often means automatic renewal.
• Compare renewal with alternatives on the rate over the whole term, the new surrender schedule applied to the full balance, adjustments and the company's strength, not just the headline rate.
• Withdrawals from a non-qualified contract come out gains first, taxed as ordinary income, with a 10% additional tax on gains before age 59½ unless an exception applies.
• Annuitizing trades access and legacy for income you cannot outlive, and is generally irrevocable, so consider converting only part.
• Put the maturity date in your calendar when you buy, and start any exchange paperwork before the window closes.