If you have an annuity contract of any kind, you may have been approached about the idea of exchanging it for a new model or one with the latest features. A 1035 exchange could help you to achieve these objectives. 1035 refers to a provision in the federal tax code (“Code”) that allows you to transfer the accumulated funds in an existing annuity to another annuity without creating a taxable event. In other words, the earnings from your original investment continue to receive tax-deferred treatment until you take money out of the annuity. But the continuing tax benefit comes with some important conditions. First, the Code says the old annuity contract must be exchanged for a new contract. Therefore, you should have your current annuity company send the account funds directly to the new company. Secondly, the Code says you can make a tax-free exchange from: 1) a life insurance contract to another life insurance contract or an annuity contract or 2) from one annuity contract to another annuity contract. You cannot, however, exchange an annuity contract for a life insurance contract.

Why might you want to exchange or roll over an annuity?

Here are some questions to consider on this:

1. How safe is my annuity investment? For any annuity product, the safety of your money is backed by the claims-paying ability of the issuing insurance company, not any government agency. So you need to make sure that the issuing company, not any government agency. So you need to make sure that the issuing company is in sound financial health. Annuity owners will sometimes exchange to a company with greater financial stability.
2. How does the current interest rate compare to the original contract rate? Some fixed annuity products offer competitive initial rates to attract investors. However, the interest rate might only be guaranteed for a limited period of time, say one or two years. With this in mind, your current renewal rate could be lower than what you might otherwise get on a new annuity.
3. Is my annuity lacking some of the newer annuity benefits? In a highly competitive business, many annuity companies work to offer new insurance features, such as interest rate guarantees, bonuses, guaranteed death benefits, long-term care riders and guaranteed income payments to attract investors. Therefore, you could find that a new annuity may better meet your needs or provide you with the opportunity for competitive returns.

Whether or not an annuity exchange makes sense depends on your existing policy and your individual financial situation. Although the thought of switching annuities might, at first, appear to be in your best interests, you should always consider the costs that will often be involved to do this.

Your consideration of the consequences should also take into account the following additional questions:

4. What is the total cost to me of this exchange? Although income taxes continue to be deferred, there are some other costs to consider before making the switch. For example, will the annual fees or other charges assessed by the new insurance company offset the higher interest or bonus payments? Does the surrender charge justify the added benefits? What are comparative costs associated with the guaranteed benefits and investment options?
5. How do the surrender provisions compare? One of the biggest transactional costs that often comes into play for any annuity exchange is the surrender charge. For many companies, surrender charges eventually expire with an existing contract after a certain period of time. However, a new contract could increase these charges and could even increase the period of time in which the surrender charges apply.
6. What are the new features being offered and why do I need or want those features? For example, you might realize the life insurance guarantee or long-term care benefit rider is not really needed if other resources already exist. Of course, just the opposite could hold true if you need the coverage and cannot find a life or long-term care insurer to take you because of health reasons. You should also consider whether there are any limitations that apply to the features? For example, if there is a guaranteed interest rate, then how long does it last? Although the current interest rate for one company might be better, it’s also important to consider past payment history. Also, what are the relevant expenses? Do they justify the benefits?

Keep in mind that a 1035 exchange does not provide a permanent income tax exclusion for gains on such exchanges, but merely a deferral-since the basis of the contract given up is carried over as the basis of the new contract received.