Unintended Consequences Of Dividing Variable Annuities During A Divorce

 

Dividing assets during the divorce process can be challenging; there are so many issues to consider.  One of my recent cases involved a division of assets that included several variable annuities, and highlighted the complexity of dividing these types of investments.  It can be confusing to make decisions during the divorce and splitting complicated investment assets like annuities without complete information can result in dire financial consequences.  Attorneys and mediators provide guidance and direction as best they can but the outcome is not always as intended.  Each annuity has differing characteristics in regards to short term liquidity and in how it can be divided.  Here are a few (but not all) of the issues to consider:
Surrender charges:  Annuities are contracts and the provisions of these contracts vary between annuity providers and between each individual annuity.  Distributing or cashing in an annuity can result in charges deducted from the cash value of the distributed amount.  A detailed review of the provisions affecting each specific annuity and the applicable surrender period can provide a more accurate value of the funds as they are taken out of the annuity to divide between spouses.  Make sure the value used to determine your portion of the annuity is based on the actual amount that will be withdrawn, with or without surrender charges.
Taxes:  Annuity companies (insurance companies) follow the directions outlined in the decree.  The wording in the decree should specifically note that any transfers or splits of annuities into new contracts are in the context of divorce and are nontaxable.  As always, tax consequences of dividing assets should be considered.
Income:  If the annuity is currently being used for income by the divorcing couple, the wording in the divorce decree can be especially significant.  Depending on the annuity contract provisions, the annuity can be divided as an asset (a portion of the annuity value transferred into a new annuity owned individually by the recipient spouse) or as income stream (a portion of the income received from the annuity is forwarded to the recipient spouse).  For instance, if the husband is the owner and annuitant of the contract to be divided, many attorneys draft the decree to name the husband as trustee of the annuity income for the wife.  This can result in the husband being required to forward a portion of the annuity monthly income to the divorced partner for life – a potential bookkeeping (and emotional!) mess for both parties.  Verifying the options for dividing the annuity contract with the insurer can help the attorney build flexibility into the decree so the best option for division can be utilized.
Valuing the Contract:  Many annuity contracts provide living income benefits that may provide an actuarial value beyond the stated contract value of the annuity.  In other words, taking an income stream from the annuity may offer greater value long term than the value of the amount available if the annuity is cashed in and divided.  It might be better for one spouse to take the annuity and the other spouse take another asset of equivalent value.
If possible, it is best to work with a Certified Divorce Financial Analyst before the asset division settlement is finalized.  Working with a financial adviser like me who is experienced with variable annuities can be critical to an equitable distribution.  I can contribute education on the characteristics of the annuities to be divided and help my client understand the complexities associated with the options available.  How, or even if, you should consider dividing these types of assets can mean substantial differences in the long term financial consequences for both parties and adding a professional CDFA™ to your team can save money in the long run.

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