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.

Advertisement

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

11 Dividend-Paying Stocks You Should Think Twice About
dividend stocks

11 Dividend-Paying Stocks You Should Think Twice About

Dividend-paying stocks often can be a store of safety, but 2020 has been difficult on income equities. These 11 picks look like shaky plays despite th…
September 21, 2020
Medicare Basics: 11 Things You Need to Know
Medicare

Medicare Basics: 11 Things You Need to Know

There's Medicare Part A, Part B, Part D, medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare --…
September 16, 2020
Where You Should Invest Now
investing

Where You Should Invest Now

Kiplinger.com senior investing editor Kyle Woodley joins our Your Money's Worth podcast to answer investor questions about tech stocks, the election a…
September 22, 2020

Recommended

The Annuity With a Tax-Planning Twist
Financial Planning

The Annuity With a Tax-Planning Twist

A qualified life annuity contract helps retirees with guaranteed payments to last their entire lives.
September 21, 2020
10 Reasons to Own Life Insurance in Every Decade of Your Life
life insurance

10 Reasons to Own Life Insurance in Every Decade of Your Life

With competing financial priorities throughout your lifetime, it could be easy to overlook life insurance, especially in your younger years. But life …
September 21, 2020
Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy in trouble, tax policy takes on added importance in the 2020 presidential election. So, let's take a look at what Joe Biden has said …
September 18, 2020
Most-Overlooked Tax Breaks for the Newly Divorced
tax deductions

Most-Overlooked Tax Breaks for the Newly Divorced

Filing taxes after a divorce can add yet another problem to an already long list of challenges. But here are some tips to make your return to single l…
September 18, 2020