What happens When You Buy An Annuity And Find Another Type That Best Suits You?

A 1035 Annuity Exchange is a rule in Section 1035 of the Internal Revenue Code that allows the exchange of life or tax policies for a differed annuity contract that best suits the needs of an investor.

What happens if you buy an annuity and then find that another type of annuity is best for you? The initial payment of the annuity can be costly. In addition to reimbursement fees of up to 15%, you may also receive a cancellation fee of 10% if you are not yet 59 and a half. Also, you must pay income tax for any annual income or profit you make on your annuity.

But you can at least avoid the tax consequences with a 1035 exchange. If you purchase a pension and later find annuity with better conditions, there is a provision in the law that allows you to change one annuity from another, to provide that the person holding the contract is not changing.

Federal Tax Law Applies To Exchanges

Section 1035 of the Internal Revenue Code, which also applies to the exchange of life insurance policies, regulates the exchange of annuities. Named for the section that governs them, section 1035 exchanges also allow the exchange of a life insurance policy for an annuity, but not the exchange of annuity for a life insurance policy.

There are significant restrictions on 1035 exchanges. You can only use it to transfer one annuity to another. If you try to withdraw the annuity and use the money to buy another annuity, the law will not cover this exchange and will not be exempt from tax consequences.

In 2013, the IRS established that people who inherit annuities could also benefit from a 1035 exchange, provided that they respect all the other rules relating to inherited annuities. For example, unqualified annuities cannot be exchanged for qualified annuities.

The IRS allows the exchange of several annuity contracts for a single contract, a contract for several contracts, and part of an annuity for an alternative annuity.

According to the Internal Revenue Bulletin, "the legislative history of section 1035 indicates that the exchange of treatment is suitable for people who have changed their insurance policy to one adapted to their needs and that in reality, they did not make a profit."

The exchange treatment includes the clause according to which "the exchange, without recording a profit or loss, of an annuity contract for another annuity contract per article 1035 (a) (3) is limited to cases where the same the person or persons are bound in accordance with the contract received, as in the initial contract."

In short, if you go by the rules described in section 1035, you can take advantage of the tax reductions and transfer the base price of the existing annuity to the new contract. The cost base is the main value of the annuity: the initial purchase price of the contract, in the form of a fixed amount or regular premiums.

Therefore, if, for example, you bought the initial annuity with $100,000, you keep the principal of $100,000 in the new contract, regardless of the current value of the first annuity.

And if you used after-tax dollars to buy the annuity, you won't have to pay tax on a $ 100,000 principal that was transferred to your new contract when you withdrew the funds.

The advantages of 1035 Annuity Exchange

A 1035 exchange could be an option for someone who no longer needs a variable annuity and may now prefer a deferred fixed-rate or a fixed rate index. Also, annuity companies are continually changing and expanding the options for their products. Many now offer:

• Up to 10% bonus for each prize
• Several investment options, such as those used by global markets.
• Fewer expenses
• Improved lifetime benefits, such as guaranteed retirement benefits.
• Improvement of death benefits, such as life benefits paid to beneficiaries.

An exchange of 1035 can also help when changing from an obsolete variable annuity contract to a more current and efficient contract, while income tax continues to differ.

The disadvantages of 1035 Annuity Exchange

Changing a variable annuity may not be a good idea if:

• The bonus is eliminated with additional costs by the annual company.
• The new contract has additional resources.
• The costs for the new contract are higher than for the previous contract.
• The contract holder is over 59 and a half years old and implies a tax loss.
• Economic changes, such as low interest rates, make the conditions of the previous annuity more beneficial to the owner than the conditions of the new annuity.o
• The current contract has a lower value than that originally paid.

In the latter case, the owner of the contract could better deliver the annuity, assuming the redemption fees are gone.

Also, keep in mind the following: A broker or financial planner may receive a high commission for the sale of a new annuity when a low-commission product, such as stocks, bonds, or mutual funds, also works. Or the annuity company could pressure homeowners to pay pensions established many years ago when interest rates were higher than they are today.

Also, any investment in variable annuities must be made knowing that the insurance part of the contract will be paid. Otherwise, it would be better to guarantee a fixed or fixed income.