1035 Exchanges: Should You Switch Variable Annuities?

1035 Exchanges: Should You Switch Variable Annuities?

Section 1035 of the Internal Revenue Code is a provision that allows the tax free exchange of some types of financial instruments for another one of like kind. This allows owners of poorly performing annuities to transfer funds to a product with better performance and more features without tax consequences. Annuity companies are always looking to sell their new products and would like investors to believe that Section 1035 means that their is no cost to exchanging an annuity.

It’s important to remember that Section 1035 can preserve the tax-deferred status of your annuity, but there can be other costs and detrimental consequences of an exchange that must be carefully considered before going forward. If you’ve been talked into exchanging your annuity, only to discover that you’ve lost substantial amounts of money due to the transaction, you may be a victim of financial fraud.

Good Reasons To Switch Your Annuity

Just because you can exchange your annuity under Section 1035 without incurring tax liability, doesn’t mean you should do it. However, there are many good reasons to consider exchanging your annuity, including:

  • Choosing a new annuity that has a better performance record;
  • Your new annuity pays a bonus or premium;
  • The fees are lower;
  • You would rather have a fixed annuity than a variable one (or vice versa);
  • There are features that benefit you financially;
  • Your financial circumstances have changed; and
  • You’re concerned about the financial health of your current annuity company.

Avoid Sales Pressure

When you’re young and enjoying a substantial income, it makes sense for the growth of your annuity to be a high priority, but as you get older you may want to switch to an annuity that’s more focused on providing income. If you were single and had no children when you purchased your annuity and now you’re married and have three children, switching to an annuity with higher death benefits could make sense, but you might be better off simply adding a riding to your existing annuity. If you’re concerned about market volatility, you might consider switching from a variable annuity that includes stocks, bond and money market instruments to a fixed rate annuity that offers a stated return over a period of time. What your reasons are, don’t neglect your due diligence is assessing whether the totality of the exchange is a wise choice.

How To Make Sure You’ll Benefit From The Exchange

The Financial Investment Regulatory Authority (FINRA) warns people considering a Section 1035 to carefully scrutinize every aspect of the swap to ensure that it’s beneficial overall. These are some important things to watch out for when exchanging annuities:

  • Consider Your Surrender Schedule: Your exchange is tax free, but if you exchange your annuity before it’s surrender period has ended, you’ll have to pay a large penalty which could wipe out any benefits you would receive from a higher income or interest rate. You could even end up with a net loss.
  • Check The Rate For Your Current Annuity: If you’re motivated to do the exchange because your new company is offering higher rates, it’s wise to check with your current annuity company to confirm your current rate. It’s also helpful to find out the circumstances that could cause your rate to change.
  • Carefully Time The Exchange To Avoid Penalties: Most fixed annuities give you about thirty days after the surrender period to do an exchange penalty-free, but most variable annuities are more flexible. The exchange process can take from one to three weeks, so it’s best to begin the exchange immediately after the surrender period expires.
  • Consider What Will Happen Automatically If You Do Nothing: Before considering an exchange, it’s wise to know what will happen to your annuity if you take no action at all. You could find out that it will renew at a rate similar to the annuity you were considering, making it more advantageous to simply stay put.
  • Define Your Goals: For example, if your goal is guaranteed income, be sure compare what you’d get from an exchange to what you might be able to achieve with an income rider added to your current product.
  • Calculate The Total Cost: Be sure to include all the fees and penalties involved before making your decision about exchanging your annuity. If your exchange is from one product to another at the same company, the fees will be much lower, so before you switch companies, research whether your existing company has a similar product.

Gather all the Information You Need

Insurers are hungry for new business and won’t always give you all the information you need to make the best decision about making an exchange. It’s also important to know that the law contains safeguards to protect you, so an insurer that’s trying to lure you into a bad deal may be liable to you for compensation for losses you suffer as a result of their advice.

The Section 1035 Exchange Process

If you decide you’re going forward with an exchange to a product with a new company, Section 1035 requires you to provide the following details to the incoming company to initiate the exchange:

  • The name of your insurer;
  • Your product type: variable, fixed or indexed;
  • Contract with your insurer;
  • Policy number;
  • Annuity funding – qualified pre-tax funds such as an IRA or non-qualified post tax funds from a regular account;
  • Cost basis (initial premium);
  • Date of purchase;
  • The surrender charge, if applicable;
  • Cash value;
  • Life and Death Benefits and
  • The reason for the exchange.

Contact Us If You Lost Money in An Annuity

If you lost money because your financial institution misrepresented the benefits of exchanging your annuity, you may be entitled to compensation. MDF LAW is the leading NYC investor protection law firm – call (800) 767-8040 for a free consultation.

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