In the annuity world, things are always changing: fees go up, interest rates go up or down, new benefits are introduced and more. When someone owns a non-qualified annuity and they want to exchange it for a new one, they need to do a 1035 exchange from product to product. This is similar to a 1031 exchange with real estate. The key to the 1035 exchange is that it maintains the current tax-deferral so no taxes are paid at the time of the transaction.
In a way, a 1035 exchange is like trading in your current vehicle for a new vehicle or refinancing a mortgage. While, there are benefits to making the move, you want to make sure the positives outweigh the negatives.
It’s very common for clients and even financial advisors to call any annuity exchange a 1035. This, however, is by mistake. A 1035 exchange is only for non-qualified annuities (or from life insurance to life insurance or life insurance to annuity). If a client has a qualified account that they want to move it from annuity to annuity or from an old 401k or brokerage account to an annuity, this is technically a transfer or rollover, not a 1035.
Now, just because you can 1035, doesn’t mean you always should. Almost all annuities have surrender charges, so if you move out of one annuity into another during the surrender period, you will pay a charge. Also, any additional benefits, like income values and death benefit values will not follow you to your next annuity.
Many carriers will offer an upfront bonus to encourage clients to move their money even when they have a surrender charge. It’s important to remember that if a carrier is giving a bonus, there is a trade-off. This could be higher fees or lower upside potential or less benefits.
Also, whenever you are doing a 1035 exchange, make sure to go from carrier to carrier. If you take possession of your money, you will be forced to pay all the taxes that you have deferred up today. Also, if you are under 59.5, you will be forced to pay the 10% tax penalty. When you go carrier to carrier, the cost-basis is sent over to protect the tax-deferral of the product.