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.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
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.
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.
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.
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

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. Interest rates from dozens of insurers are constantly updated on its website. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. More information is available from the Medford, Ore., based company at www.annuityadvantage.com or (800) 239-0356.
-
The $33,000 Retirement: One Man's Surprising Path to Financial Freedom at 61
Forget what society tells you, even with less than $1 million, you can be happy in retirement.
-
The Best Aerospace and Defense ETFs to Buy
The best aerospace and defense ETFs can help investors capitalize on higher government defense spending or hedge against the potential of a large-scale conflict.
-
Roth IRA Conversions in the Summer? Why Now May Be the Sweet Spot
Converting now would enable you to spread a possible tax hit over more than one payment while reducing future taxes.
-
A Financial Expert's Three Steps to Becoming Debt-Free (Even in This Economy)
If debt has you spiraling, now is the time to take a few common-sense steps to help knock it down and get it under control.
-
I'm an Insurance Expert: This Is How Your Insurance Protects You While You're on Vacation
Here are three key things to consider about your insurance (auto, property and health) when traveling within the U.S., including coverage for rental cars, personal belongings and medical emergencies.
-
Investing Professionals Agree: Discipline Beats Drama Right Now
Big portfolio adjustments can do more harm than good. Financial experts suggest making thoughtful, strategic moves that fit your long-term goals.
-
'Doing Something' Because of Volatility Can Hurt You: Portfolio Manager Recommends Doing This Instead
Yes, it's hard, but if you tune out the siren song of high-flying sectors, resist acting on impulse and focus on your goals, you and your portfolio could be much better off.
-
Social Security's First Beneficiary Lived to Be 100: Will You?
Ida May Fuller, Social Security's first beneficiary, retired in 1939 and died in 1975. Today, we should all be planning for a retirement that's as long as Ida's.
-
An Investment Strategist Demystifies Direct Indexing: Is It for You?
You've heard of mutual funds and ETFs, but direct indexing may be a new concept ... one that could offer greater flexibility and possible tax savings.
-
Q2 2025 Post-Mortem: Rebound, Risks and Generational Shifts
As the third quarter gets underway, here are some takeaways from the market's second-quarter performance to consider as you make investment decisions.