Annuities are savings contracts issued by insurance companies. A major benefit of annuities is that the interest grows tax deferred until it is withdrawn from a contract. To avoid paying taxes, you can exchange one annuity contract for a new one, a process similar to an account rollover. However, you should consider several factors before swapping your annuity for a different contract.
Instead of being rolled over, annuities are exchanged under a provision in the tax code spelled out in section 1035. Thus, annuity exchanges are referred to as section 1035 or just 1035 exchanges. The 1035 exchange rules allow the tax-free exchange of insurance contracts of the same type. For example, a life insurance policy can be exchanged for another life insurance policy and an annuity can be exchanged for a new annuity contract.
To exchange a current annuity for a new one, you apply for a new annuity from an insurance company through a licensed insurance agent. The new insurance company is designated as the trustee of the current annuity and sends a request to the current annuity company to remit the value of the annuity to the new company. The existing annuity company is allowed a period of time to attempt to conserve your business and account. Eventually, the proceeds from the existing annuity will be sent directly to the new insurance company. The entire 1035 exchange process may take several months.
Reasons to Exchange
The primary reason to 1035 exchange an annuity contract for a new annuity is to earn a higher rate of interest. A new annuity will have an attractive interest rate guaranteed for a period of years. After the guarantee period ends, the insurance company will pay a rate based on the company's investment earnings. An older annuity may be earning a low rate and exchanging it may significantly boost the rate earned on that money. The new annuity may also offer other features not available with the older contract.
Consider account surrender fees and costs before doing a 1035 exchange. If the older annuity is still in the surrender fee period, those fees will reduce the amount transferred. The new annuity will have its own surrender fee structure, locking up some or all of the money for a multi-year period. Insurance agents earn attractive commissions by exchanging annuity contracts from one company to another. An agent may not always act in the customer's best interest, so it is important to understand all of the costs and consequences before initiating an annuity exchange.
- Free Annuity Rates: 1035 Exchange
- FINRA: Should You Exchange Your Variable Annuity
- U.S. Securities and Exchange Commission. "Variable Annuities: What You Should Know." Accessed July 10, 2020.
- Internal Revenue Service. "Publication 575 (2019), Pension and Annuity Income." Accessed July 10, 2020.
- Internal Revenue Service. "Section 1035." Accessed July 10, 2020.
- FINRA. "Variable Annuities." Accessed July 10, 2020.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.