When Exchanging, Surrendering Or Selling A Variable Annuity May Be Called For
Judith A. Hasenauer
We are not sure who first made the statement that getting old is not for sissies, but truer words were never spoken. If gravity does not get your body, the confusion about how to provide for retirement security can surely get your mind.
Unfortunately, the only alternative to getting old is not one that we particularly care to contemplate. Even those who have done the right thing and attempted to protect their “golden years” by purchasing a variable annuity may find themselves in a quandary caused by the effect of market fluctuations on the value of their contracts.
Thus, even when taking the recommended course of action, people may still have the need for additional retirement planning and for consideration about whether they still have the right products to meet their retirement needs.
Most modern VAs contain valuable death benefit features that protect against loss to contract value if premature death of the owner occurs when market fluctuations have decreased the contract value below the purchase price. We think of such annuities as being “under water.”
Many newer VAs may even contain protections against market fluctuations for annuity payments or for making withdrawals. However, owners of the older contracts may not be able to take advantage of some of these newer enhanced contract features unless they somehow terminate the old annuity and obtain a new one with the new features.
So-called “1035 exchanges” are very common in the VA business. In effect, Section 1035 of the Internal Revenue Code permits the owner of an annuity to exchange it for another annuity without any recognition of gain for federal tax purposes. The advantages of such an exchange for a VA where the contract value exceeds the purchase price for the contract is obvious. It permits the contract owner to exchange an annuity for one that may have better contract features, or that may have better underlying investments, or that may have been issued by a stronger insurer, without having to worry about adverse tax consequences.
Regardless of the contract owner?s motivation for making such an exchange, the ability to conclude the exchange without adverse tax consequences is a valuable retirement planning tool. Properly done, a tax-free exchange can help the contract owner ensure that the policy is always the most current product available.
Needless to say, care should be taken to consider surrender charges, new sales charges and other factors that will impact the usefulness and the cost of the exchange.
If 1035 tax-free exchanges are useful when VA contract values are in excess of the purchase price, what about when contracts are under water? This is a good example that “one size does not necessarily fit all.” A contract owner of an ?under water? VA might well want to consider surrendering or selling the annuity rather than making an exchange.