Annuity Exchange Definition

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The problem with getting out of an annuity is that from the moment you invest you've been accumulating interest that his been untaxed.  So if you cash in the annuity, you will have quite a tax bill.  IRS has provided some relief for this by allowing you to trade one annuity for another without taxation.  The annuity definition of this trade, called an exchange, follows.

You may not be aware that IRS Section 1035 allows you to trade one annuity for another without tax impact. But, before pursuing an exchange, it is prudent to analyze the consequences.

there are three different types of annuities you could own and desire to exchange:

Fixed Annuity (FA), Variable Annuity (VA) and Equity-indexed Annuity (EIA).

Definition of Fixed Annuity Exchange

Why do people exchange fixed annuities? Primarily because they can get a higher rate with another annuity company OR they desire a different type of annuity such as a variable annuity or indexed annuity.  Obtaining a higher rate from another fixed annuity might include an attractive bonus rate being paid by another company.  But be careful about making a change for the reason of bonus rates.  The second reason is because of better terms or features.  As an example, some annuities now have a long term care insurance benefits built into the contract.  Hopefully, you are getting some insight into the reason to exchange annuities. The third reason might be for safety. If the safety rating of the original annuity company has been downgraded, the annuity holder may wish to exchange to a better rated company.

Definition of Variable Annuity Exchange

Let's take a look at exchange of variable annuities. By far, the number one reason someone would exchange one variable annuity for another is unacceptable investment performance.  In other words, the investor seeks to have a different menu of investment options that they believe will hopefully perform better.  The second annuity definition for a variable annuity exchange could be the availability of enhanced riders on the new annuity. In the last 10 years, many variable annuity companies have introduced riders like the guaranteed minimum income benefit rider or guaranteed minimum payment rider.  These riders provide guarantees that mitigate the biggest criticisms of variable annuities (VAs).  The inherent annuity definition of a VA is that money is invested in investment sub-accounts which could gain or lose money.  These aforementioned riders provide guarantees of income and or principal.

Keep in mind, that when ever a variable annuity exchange is undertaken, the following must be considered:

New Surrender charges. if the new annuity has a ten-year term, then there will be 10 years of surrender charges.

Mortality and expense risk expenses: charged by the insurance company for the mortality risk

Management fees: the fees that cover the management of the sub-accounts

Unique feature charges (riders): This is for providing guaranteed minimum income

Annuity Definition of an Index Annuity Exchange

Let's consider the trade of one indexed annuity contract for another of the same type. First, be aware that premature surrendering  of indexed annuities will negate any accrued index related gain. Therefore, never close an indexed annuity prior to the end of the term no matter how good the offer from a new annuity company.  Exchanges should be made only at the end of the term to an indexed annuity that may have better features for one or more of these parameters:

  • a superior participation rate which provides more of the index gain to enhance your contract
  • a higher cap which lessens any limitation on how much your annuity can gain during a year
  • or other features that allow you as the investor to earn more by enhancing the return or reducing charges

There you have the annuity definition of three kinds of annuity exchanges.

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