Mike Giefer, private wealth manager, Creative Planning, St. Paul, Minnesota
We just worked with a client through the process of a 1035 exchange for a new annuity contract. The primary driver for this decision was switching to a much lower cost annuity. Most variable annuities purchased a few decades ago have very high internal expense ratios. ... In this particular instance, we were able to reduce the annual cost of the annuity by close to 2% of the annuity’s value! This allowed our clients to keep more of their money each year, which over the next 30 years we calculated could add $150,000 in value just through cost savings alone.
Other important factors to consider: Is there a guaranteed minimum death benefit in the newer annuity? Are there any other existing benefits or features you might lose in an exchange?
Sergio Garcia, associate planner, Quest Capital Management, Dallas
Advisors should regularly review their client’s annuities as the products available are constantly changing. In the last several years we have seen a rise in low cost and more flexible products. A client may want to reduce the expense paid on their annuity, but also want to avoid the tax impact of surrendering the policy. Making an exchange to a lower cost annuity with little or no extra riders and features can considerably reduce the cost while maintaining the arrangement so no taxes are due at the time of the exchange.
J. Christopher Boyd, chief investment officer, Asset Management Resources, Hyannis, Massachusetts
[Make the switch] if the VA is loaded with riders that are not intended to be used. Many VAs were sold with the promise of income guarantees, that many people never intend to exercise for income, but the costs are often 0.50-0.65% embedded costs. Death benefit features can also add expenses. If managing for risk with investment design, we may be able to cut out material costs. (Even with RIA management fees, if cost savings on 1 & 2 can be realized, an investor might save 1%/yr or more.)
With new hybrid products designed to help manage LTC costs, in some instances, despite long surrender charges, it could make sense to exchange to obtain LTC benefit features.
Cody Williams, senior consultant, DPL Financial Partners, Louisville, Kentucky
As clients age, their financial goals, needs and preferences change. ... For example, a client may have bought a variable annuity to help grow their wealth when they were in the accumulation phase, and now they are in or near the decumulation phase when they depend upon their portfolio to provide income. A product that was designed for growth may no longer meet their needs as they transition into retirement, so 1035’ing to another product that is built to provide secure income may be the best choice for the client. It’s important to consider the annuity within the context of the person’s financial plan and risk tolerance rather than to think of it as a standalone asset.
Thomas Rindahl, advisor at TruWest Wealth Management Services, Scottsdale, Arizona
The bad reason to exchange is because an annuity salesman told the client to do so!

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Yes, you and your clients can exchange one variable annuity contract for another. But should you?

The Financial Industry Regulatory Authority recently warned investors about making such a move, urging them to be aware that replacing one VA with another involves “a comparison of the complex features of each security.”

FINRA, as well as advisors polled by ThinkAdvisor, stress that there are good reasons to consider an exchange — as well as situations when an exchange is generally not a good idea.

The Internal Revenue Service allows clients to exchange one VA contract for a new one without paying tax on the income and investment gains earned on the original contract through a 1035 exchange, FINRA notes, which “can be a substantial benefit — and is often used as a selling point.” However, this tax benefit comes with “some important strings attached,” as FINRA notes in a recent investor alert.

Read the gallery above for advisors’ advice on when it may be a good idea to make the switch — and when it’s probably best to stay put.

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