Five tips for when you want to exchange your annuity
August 13, 2015 by Andrew Murdoch
It happens all the time. At some point, an annuity owner hears about a 1035 Exchange — a tax-free exchange from one annuity to another — and wonders whether he or she should swap their annuity for another, especially if they no longer face surrender charges..
If you can get better benefits or a higher fixed interest rate, this may make sense. More often, however, it does not. Once the hype is stripped away, the new annuity is commonly no better than your current annuity and, in fact, may be worse.
The key thing to bear in mind is that insurance companies are driven by interest rates. When rates are relatively high, insurance companies earn more on bonds and offer more generous annuity benefits. When rates are low, they do just the opposite — and rates today remain mired in the basement. Bottom line, you’re unlikely to get a better deal.
You may be able to upgrade your annuity to one that better meets your needs, and without paying taxes on any gains. You might buck the odds and get a better interest rate, better benefits, and higher caps in a fixed indexed annuity, and on a variable annuity, better subaccount investment options.
Still, there are two obstacles to overcome
The first, as mentioned, are depressed interest rates and their negative impact on any deal you are offered. The second is that too many annuity owners don’t bother to understand the relative quality of what they already own. They typically know the account value of their annuity and when the annuity jettisoned its surrender period, but often do not understand their benefits.
What they often don’t know is the relative strength of the product today, such as whether, in industry-speak, they are “in the money.” This means that their benefit base — the amount on which withdrawals are based — is bigger than the actual cash value of the annuity and isn’t uncommon if you’ve owned an annuity for a number of years. Usually, it means you should stay put.
For example, you do not want to be somebody who has a deathbenefit or living benefit of $200,000 but a contract value of only $100,000. Ifyou swap annuities, your benefits will almost always shrink by $100,000. That’s a big hurdle to overcome with the newannuity.
Here are five tips for those considering a 1035 Exchange:
- Make sure you are past your surrender period. You seldom come out ahead if you pay surrender charges
- Take the time to review your current policy and understand what you have and how it works. You can’t know whether something is better if you don’t know what you already own. Evaluate your living benefit,death benefit and your cash value. If your benefits are in the money, see how much the new product has to grow to catch up.
- If you place a high priority on your death benefit, make sure you know what it is. A standard death benefit is the greater of purchase payments minus withdrawals or current contract value. An enhanced death benefit, on the other hand, offers guaranteed step-ups or growth rate or both, and is almost always higher and can sometimes be substantially in the money.
- If the cash value of your annuity has increased significantly because of market gains but your living benefits have plateaued,this may be a good reason to swap annuities. Doing so could increase your income.
- If you’re interested in a fixed, indexed or variable annuity, assess future prospects for the stock market. If you are bullish, you may want to find an annuity with more growth potential. If you are bearish, you may want to make sure you have the proper guaranteed benefits in place.
