Advertisement
retirement

Annuity Exchanges, Full or Partial, Boost Flexibility without Creating Taxes

1035 exchanges let you trade up for a better annuity or trade in unneeded life insurance.

Cashing in an annuity usually produces taxable income. Additionally, if you surrender your annuity before the contract term is up, often there’s a surrender charge.

But you aren’t stuck for years if you have a low-paying annuity or even a type of annuity, such as a variable annuity, that no longer meets your needs. You can make a tax-free 1035 annuity exchange. You can trade in an entire annuity or part of it for a better annuity at a different insurance company.

A 1035 exchange lets you switch companies while continuing to defer taxes, ensuring that your annuity stays up-to-date with the latest advantages, benefits and best rates available.

Advertisement - Article continues below

It’s one of the few parts of the tax code that work in your favor. Accumulated interest earnings from your original policy remain tax-deferred until you withdraw the funds from your new annuity sometime in the future. In contrast, surrendering an annuity is a taxable event and you must recognize any gain as current income.

A full 1035 exchange most often involves exchanging one fixed-rate annuity at the end of its surrender term for a better-paying fixed annuity. You can often get a higher interest rate than the renewal rate offered by your current insurer.

Advertisement
Advertisement - Article continues below

And you can exchange among types of annuities. For instance, if you want to lower your risk profile, you can exchange a variable annuity for a fixed annuity that guarantees principal. It’s a simple process. The funds go directly from the current insurer to the new one.

Partial 1035 exchanges

Partial exchanges provide additional flexibility. Anyone unhappy with a current annuity that’s still subject to a surrender charge can usually take advantage of the penalty-free withdrawal provisions of their existing contract. Most annuities let you withdraw 10% annually without penalty. Instead of taking receipt of the penalty-free withdrawal amount, you can move it to a new annuity via a partial 1035 exchange.

Advertisement - Article continues below

Many fixed-rate annuity owners move their penalty-free amount annually from a lower-interest-rate product bought years ago to a higher-paying current annuity. Some are doing partial exchanges from variable and fixed-indexed annuities into fixed-rate multi-year guarantee annuities (MYGA).

Caution must be exercised when executing a partial 1035 exchange. There’s a special IRS rule when using non-qualified funds (money not in a retirement plan) in a partial exchange. If any withdrawals are made from either contract within 180 days of a partial exchange, the exchange is invalidated and becomes a taxable event.

Life insurance policy can be exchanged for an annuity

Many older people have paid-up cash-value life insurance policies that they no longer want or need. Section 1035 lets you exchange such a policy for an annuity tax-free.

You could use the cash value to buy any type of annuity. One good choice is a deferred income annuity, which will pay an individual or a couple a guaranteed lifetime income starting at a date the owner chooses.

As with any 1035 exchange, the insured or annuitant and the owner(s) of the life insurance policy and the new annuity must be the same. This IRS rule prevents someone from passing their tax liability on any untaxed gain in the policy to another person.

All 1035 exchanges, whether full or partial, require serious thought. Only after careful examination of available alternatives can you decide if a 1035 exchange makes sense for your individual situation.

My firm offers a free 1035 exchange-evaluation service that compares an existing annuity to newer products on the market.

About the Author

Ken Nuss

CEO / Founder, AnnuityAdvantage

Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. It provides a free quote comparison service. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities.

Advertisement

Most Popular

Chiropractor Trying to Get Business the Wrong Way – Illegally
careers

Chiropractor Trying to Get Business the Wrong Way – Illegally

A new chiropractor’s fledgling business plan to attract patients may sound reasonable at first look, but it’s actually against the law, and the same p…
June 30, 2020
What Are the Income Tax Brackets for 2020 vs. 2019?
tax brackets

What Are the Income Tax Brackets for 2020 vs. 2019?

The IRS unveiled the 2020 tax brackets, and it's never too early to start planning to minimize your future tax bill.
June 20, 2020
2020 Stock Market Holidays and Bond Market Holidays
Markets

2020 Stock Market Holidays and Bond Market Holidays

Is the market open today? Take a look at which holidays the stock markets and bond markets take off in 2020.
July 1, 2020

Recommended

20 IRS Audit Red Flags
tax returns

20 IRS Audit Red Flags

There's no sure way to avoid an IRS audit, but these red flags could increase your chances of drawing unwanted attention from the IRS.
July 1, 2020
10 IRS Audit Red Flags for Retirees
retirement

10 IRS Audit Red Flags for Retirees

Watch out: These things can increase the chances that the IRS will give your tax return a closer look.
July 1, 2020
10 Tax Breaks for the Middle Class
tax deductions

10 Tax Breaks for the Middle Class

Tax breaks aren't just for the rich. There are plenty of them that are only available to middle- and low-income Americans.
June 30, 2020
What to Do If You Get a Stimulus Check for a Deceased Person
taxes

What to Do If You Get a Stimulus Check for a Deceased Person

The IRS sent more than 1 million stimulus checks to dead people. If you received one for a family member who passed away, there are certain steps you …
June 25, 2020