We have long believed that “one size does not fit all” when it comes to annuities, or to any financial product, for that matter.
This concept applies equally to tax-free exchanges of annuities.
The Internal Revenue Code, in Section 1035, permits the exchange of one annuity for another or one life insurance policy for another, or of a life policy for an annuity, without any recognition of gain for federal income tax purposes. The IRC does not permit the tax-free exchange of an annuity for a life policy.
The Internal Revenue Service has, from time to time, changed its interpretation as to how 1035 exchanges must take place, but the basic legal principle has not changed.
Recent years have seen greater regulatory scrutiny of 1035 exchanges. The goal is to ensure such exchanges benefit the annuity owner and don’t merely generate new commissions for sales people.
Currently, state insurance regulators are monitoring 1035 exchanges of fixed annuities; the Financial Industry Regulatory Authority and the Securities and Exchange Commission are monitoring 1035 exchanges of variable annuities; and they are all involved in 1035 exchanges of fixed to variable and variable to fixed annuities.
Many regulators seem to take the position that, since annuities are essentially “long-term” retirement investments, the products should always be held until annuitization or until a surrender attendant to retirement.
This position seems to require that once the annuity is purchased, the owner is “locked-in” to that annuity until retirement, even if the annuity may have become obsolete. In our view, such a position is overly simplistic and fails to take into consideration the constant evolution of annuity products–an evolution that regularly affords consumers new product features that enhance annuity ownership.
Take VAs, for example. In the last 40 years, VAs have undergone radical changes, making today’s products far more appealing and consumer-friendly than ever.
In their early days, all VAs had a single investment pool–usually a non-aggressive common stock portfolio managed by the insurer’s investment department. Multi-manager investment options were unheard of, let alone availability of the huge variety of different orientations that are available in today’s VAs. There were front-end sales charges, usually 8.75%. If there was a minimum death benefit, it was for return of premium alone, with no step-ups, no enhancements and none of the death benefit options available today. Moreover, there were no guaranteed minimum income or minimum guaranteed withdrawal benefits.