Annuities

Did you invest in an equity indexed annuity  a few years back? If you bought it seven years ago, the maturity date may be approaching fast, and you might only have a small window of time to decide whether to renew the annuity or place your money elsewhere.

If you look at what has happened to annuity rates and the markets since you bought your equity indexed annuity, you may understand why the specifications for a new contract might differ. Interest rates are at a four-decade low, and the markets have swung wildly. Therefore, there’s a good chance that you will see lower market participation rates and lower maximums (caps) on amounts credited to your equity indexed annuity. In addition, you may have to make a longer-term commitment on your new contract.

The company might now have the ability to change participation and cap rates on the annual anniversary dates, whereas, your original contract may have kept the same numbers throughout the term. However, this could work in your favor. Because if the equity markets become less volatile, there’s the chance that index option premiums will decrease, thus allowing annuity companies to offer higher annual participation levels and caps.

Times have changed and many of our investments have as well, and a new equity indexed annuity might not be identical to the one you bought before. Nevertheless, it will still provide the same opportunity for tax-deferred growth and the other features that encouraged you to make your original purchase. 

Remember that you don’t need to stay with the same annuity company or the same type of annuity.  You can 1035 exchange your annuity with surrender charge at maturity for an equity indexed annuity with another company, a traditional fixed annuity or a variable annuity.

 Note: There may be risks with equity index annuities that include, but are not limited to, the fact that the return is calculated at the end of the vesting period; often, the investor cannot access cash prior to the end of the vesting period without restriction; if the index performs well, low interest rates are irrelevant; each annuity is subject to fees and charges; and withdrawals may be subject to surrender charges. These restrictions have an impact on performance and must be considered when deciding to purchase or exchange the annuity.

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You can exchange one retirement annuity for another, but you as a retiree need to watch out for what you may lose in the process. Often when you have one investment and see a similar but better version of it, you wonder if you can ‘upgrade’ to the new and improved version. Generally, whenever you liquidate an investment or retirement annuity, you need to pay taxes on any gain. If you buy another investment, your cost of the new investment will be its tax basis until it is sold in the future to determine gain.

However, in the case of two retirement annuities of ‘like kind’, the U.S. tax code, section 1035, allows you to simply exchange the two ‘like kind’ contrcats–if circumstances allow–so as not to have to pay tax until the latter investment is sold or pays out. In the case of retirement annuities, you need to be aware of what/how your ‘new and improved’ annuity may be different from your ‘old’ annuity.

Section 1035 allows you to exchange an existing annuity contract for a new annuity contract without paying any tax on the income and investment gains in your current retirement annuity. These tax-free exchanges, known as 1035 exchanges, can be useful if another annuity has features that you prefer, such as a larger death benefit, different annuity pay-out options, or a wider selection of investment choices.

You may, however, be required to pay surrender charges on the old retirement annuity if you are still in its surrender charge period. In addition, a new surrender charge period generally begins when you exchange into the new annuity. This means that, for a significant number of years (as many as 10 years); you typically will have to pay a surrender charge (which can be as high as 9% of your purchase payments) if you withdraw funds from the new annuity prior to term, and if the withdrawals exceed the annual allowance.
Further, the new retirement annuity may have higher annual fees and charges than the old annuity, which will reduce your returns.

So if you are thinking about a 1035 exchange, compare both retirement annuities carefully. Unless you plan to hold the new annuity for a significant amount of time, you may be better off keeping the old annuity because the new annuity typically will impose a new surrender charge period.

Also, if you decide to do a 1035 exchange with your retirement annuity, get the right retirement help and talk with a qualified tax professional to make sure you don’t violate the provisions of IRS section 1035. While insurance agents sell retirement annuities, few are well schooled in the more esoteric tax aspects.

Note: Annuities once annuitized cannot be surrendered for value. Income from retirement annuities is taxed as ordinary income and withdrawals prior to age 59½ are subject to a 10% penalty. Income from annuitization is taxed partly as ordinary income and partly as return of capital. The purchase of annuities incurs commissions and potential surrender charges. Any guarantees are based on the claims-paying ability of the insurance company. Retirement annuities should be considered long-term investments.

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