Tax-Free Annuity Exchange: What You Need to Know.


Did you purchase an annuity and discover it wasn’t what you wanted? Don't worry just yet. You may be able to exchange the annuity for a product that suits your needs, tax-free. Want to learn more? Continue reading; we've got you covered!




What is an Annuity?

An annuity is a type of insurance contract that is issued and distributed by financial institutions with the goal of paying out invested funds in the future in the form of a fixed income stream. Annuities are purchased or invested in by individuals who receive monthly or lump-sum payments. The holding institution issues a future stream of payments for a set amount of time or the rest of the annuitant's life. Annuities are primarily used for retirement planning and assist individuals in mitigating the danger of outliving their resources.


Understanding Annuities

Annuities were established to offer a constant income stream for people in their retirement years and alleviate anxieties about outlasting one's assets. The purchaser of an annuity is known as an annuitant.


The accumulation phase is when regular contributions to the investment are made. The contract enters the annuitization phase once payments commence. The annuitization phase of an annuity is the time when the annuity owner starts to receive money from the annuity investment. Also, the majority of annuities have a surrender period. This is the period in which an investor may not withdraw funds from an annuity without paying a surrender charge or fee. If the invested funds are taken after the end of the period, they will not be subject to a penalty.


Annuities can be a suitable investment option for persons seeking a consistent, assured retirement income. The fact that annuity holders cannot outlive their income stream reduces longevity risk. The product is appropriate as long as the customer understands that they are trading a liquid lump sum for a guaranteed series of cash flows. Some purchasers intend to sell an annuity at a profit in the future. However, this is not the intended use of the product. Because the lump sum invested in the annuity may be illiquid or subject to withdrawal penalties, this product is usually not suggested for younger investors or those who demand liquidity.


What Is a 1035 Exchange?

What if you buy an annuity and then discover that a different form of annuity is better for you after the surrender period has passed? A 1035 exchange is a provision in the Internal Revenue Service (IRS) law that allows for the tax-free exchange of one annuity contract, life insurance policy, long-term care product, or endowment for another similar sort.1 The contract or policy owner must also fulfill certain other conditions to be eligible for a Section 1035 exchange. The main advantage of a section 1035 exchange is that it allows the contract or insurance owner to trade one product for another without incurring any tax consequences. In this approach, investors may replace obsolete and ineffective products with newer ones that provide more appealing features, such as greater investment opportunities and fewer restrictive limitations. Furthermore, a section 1035 exchange allows policyholders to keep their original basis.


Steps of the 1035 Process

First and foremost, do not cash out your previous annuity with the intention of utilizing the profits to purchase a new annuity. This would render the transaction ineligible for 1035 tax protection. The IRS would consider the cash from your former annuity to be realized income, or money that has been transformed into cash flow, rather than a transfer. Because realized income is taxable, it is not eligible for exchange treatment. Instead, take the following steps:

  • Determine if it makes sense to 1035 your current policy.

  • Select a policy to 1035 into.

  • Contact the insurer that owns your current insurance to learn about their documentation needs.

  • Fill out and submit the new annuity paperwork, which includes a 1035 transfer request form.


Benefits & Disadvantages to Consider

Before you decide on whether to exchange your existing policy for a new one, consider a few benefits and disadvantages of this decision. For example, there are several reasons why you would wish to replace an old policy with a new one. Such as:

  • You discover that a matching policy is available at a lesser cost.

  • You have worries about the solvency of the company that issued the original policy.

  • A new life insurance or annuity policy may provide more appealing features or perks.

There are also several fundamental reasons why changing current insurance, or annuity coverage may not be wise. Such as :

  • The new organization can apply first-year expenses to the new policy. This has the potential to diminish the cash value of your insurance.

  • The new policy will likely have its own surrender charge schedule, which may go beyond your old one.

  • Surrendering an existing policy may result in adverse tax repercussions, such as a possible tax on outstanding policy debts.


Schedule A Consultation with an Experienced Financial Advisor

At Fourth Avenue Financial, our priority is your overall financial success. Whether you have questions about your annuity or long-term financial plan, we’re here to help. We want to aid you in developing, implementing, and monitoring a strategy designed to address your situation. If you are ready to start planning for your financial future, contact us today at (304) 746 7977 to schedule a meeting with one of our experienced financial advisors or schedule online: https://calendly.com/fourthavenuefinancial/introductory-zoom.


Securities are offered through J.W. Cole Financial, Inc. (JWC) Member FINRA / SIPC. Advisory Services are offered through J.W. Cole Advisors, Inc. (JWCA). Fourth Avenue Financial and JWC/ JWCA are unaffiliated entities.


  1. https://www.irs.gov/pub/irs-drop/rr-07-24.pdf

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