Many may not be aware that IRS Section 1035 of the tax code permits you to obtain new annuities in exchange for an existing annuities without tax incidence. But, before availing this exchange offer, it is prudent to study the likely repercussions to determine whether the exchange will be advantageous to you or not.
Broadly speaking, annuities may be classified into three different kinds – Fixed Annuity (FA), Variable Annuity (VA) and Equity-indexed Annuity (EIA).
Fixed annuities, as the name indicates, offer a fixed income as per the guaranteed contract rates.
Variable annuities are funded in a variety of ways - stock, bond, and money market funds. Their accumulation and income will differ accordingly. The additional feature of VA is it is registered with the Securities and Exchange Commission (SEC) and their transactions are regulated by the SEC and FINRA.
Equity-indexed annuities are a hybrid of fixed and variable annuities but the income is less steady than a fixed annuity but not as fluctuating as a variable annuity. Additionally, the principal is guaranteed. It can be said that EIA carry more risk as compared with a fixed annuity and less risk in relation to a variable annuity.
If investing in variable annuities, please know you may have to pay different fees as outlined below:
(a) Surrender charges: applicable if you prematurely withdraw money from the annuity before a deadline period
(b) Mortality and expense risk charges: This charged by the insurance company for covering the risk under the contract;
(c) Administrative fees: This is towards documentation and administration costs.
(d) Underlying fund charges: This pertains to the investment options
(e) Special feature charges: This is for a likely death benefit or for providing guaranteed minimum income.
Though you may have your own reason for wanting to exchange a variable annuity contract for a new annuity contract, it may still be worthwhile to ponder over the merits and demerits of such an exchange. Note that any of the above annuities can be exchanged for the other type in a tax free transaction.
Merits
The present trend by annuity companies is to offer annuities that entice new investors with bonuses of 1 percent to 5 percent for each purchase you make. This apart, the other merits particularly in variable annuities are:
1. There is an increase in the number of investment options
2. There are today less expensive variable annuity contracts available.
3. There is a pronounced increase in both death as well as survival benefits.
4. Possible growth with stock market more promising
5. Various guarantees for incomer after 10 years or other living benefits
Demerits
1. Premium/ Bonus payments are usually negated by the company's levying surrender charges
2. The earlier contract provisions including surrender charges lapse with an existing contract.
3. New charges may become applicable with a new contract
4. There may be higher annual fees and other charges for the new contract
5. You may find some costly features of the new contract not worthwhile.
Points to ponder
When you are contemplating an investment in variable annuities you must study the investment objectives, the risk factors, the applicable charges, and other costs of the variable annuity as also its underlying sub-accounts. Try to obtain complete information about the variable annuity investment and ask for a prospectus from the concerned insurance company or the agent. Spend time to patiently read and understand the contents of the prospectus before finally investing.
Please note that premature surrendering of equity index annuities may not provide for market participation. Annuities investments will necessitate paying fees, expenses and surrender charges. Guarantees offered by the company are related to the claims paying capability of the concerned insurance company. The earnings are treated as ordinary income and withdrawals made prior to your attaining 59 ½ years will incur a ten percent penalty.
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A great guide to annuities, plenty of information