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Should You Exchange Your Variable Annuity?


Are you considering exchanging a variable annuity that you currently own with a new one? Before you rush into an exchange, be aware that replacing one variable annuity with another should involve an analysis and comparison of the complex features of each security.

There can be good reasons to consider an exchange—and there can be situations where an exchange is generally not a good idea. You should exchange your annuity only when it is the smartest move for you.

Some Background

An annuity is a contract between you and an insurance company in which the company promises to make periodic payments to you, starting immediately or at some future time. You buy the annuity either with a single payment or a series of payments.

All annuities are regulated by state insurance commissioners; however, as securities, variable annuities are also regulated by the SEC and FINRA.

With a variable annuity, the amount that will accumulate and be paid varies with the stock, bond and money market funds that you chose as investment options. Variable annuities may impose a variety of fees when you invest in them. Fees generally include:

  • surrender charges, which you owe if you withdraw money from the annuity before a specified period;
  • mortality and expense risk charges, which the insurance company charges for the insurance risk it takes under the contract;
  • administrative fees, for recordkeeping and other administrative expenses;
  • underlying fund expenses, relating to the investment options; and
  • charges for special features, such as a stepped-up death benefit or a guaranteed minimum withdrawal benefit.

The Internal Revenue Service allows you to exchange one variable annuity contract for a new one without paying tax on the income and investment gains earned on the original contract. This can be a substantial benefit—and is often used as a selling point. Governed by Section 1035 of the Internal Revenue Code, these types of replacements are called "1035 Exchanges."

When to Consider Exchanging Your Variable Annuity

There are some good reasons to consider exchanging an existing variable annuity contract. One is if the investment options available to you in the new variable annuity are better suited to your investment goals and objectives. This will require due diligence. You will want to read the fund prospectuses and compare such things as fund strategy, investment risk, diversification and other important factors.

Another factor is cost. The new variable annuity may indeed be less expensive. Determining whether the new contract is indeed less costly may take a conscientious side-by-side analysis to determine, ideally in cooperation with your sales representative.

Finally, various benefits of the new variable annuity may be more robust or better suited to you than your existing contract. For instance, the new contract might offer enhanced death and living benefits that will help you achieve a financial goal.

When Not to Make an Exchange

Generally, the exchange or replacement of insurance or annuity contracts is not a good idea if:

  • You are offered "bonus" or "premium" payments as a major or primary enticement to make an exchange. A bonus credit is the extra amount an insurance company agrees to add to the value of your contract. It's usually a specified percentage, typically ranging from 1 – 5 percent of the payments you make during a certain time period. While this may sound like a good deal, variable annuities with bonus credits may have higher expenses that offset any gain.
  • You think you might need money from the annuity in the short term. Another way of saying this is, know the impact of surrender charges, which can be very expensive if you withdraw money early or decide to sell your annuity. Check when your surrender charges expire with your current annuity, and consider how comfortable you are with a potentially longer a surrender period that may come with the new contract. Some variable annuity contracts include a free withdrawal provision, up to a certain percentage, or offer a rider to waive surrender charges, but these are generally not standard features.
  • You pay higher charges, such as annual fees for the new contract or for new features, or you pay for features that you don't really need.

You should exchange your annuity only when you determine, after knowing all the facts, that doing so will position you better to achieve your financial goals.

Just because you can exchange your variable annuity doesn't mean you should.