Exchanging a Variable Annuity
Gerri Walsh, President, FINRA Foundation and Senior Vice President, Investor Education
March 11, 2021
Making a Change in Contracts Requires a Close Study of Underlying Fees, Benefit
Perhaps you spoke with an investment professional about an existing variable annuity (VA) you own, and the possibility of exchanging your current VA with a new one came up. Before you rush into an exchange, be aware that replacing one VA with another involves a comparison of the complex features of each security.
As with so many decisions in life, there can be good reasons to consider an exchange — and there can be situations where an exchange is generally not a good idea. We’ll help you sort through both scenarios. In any case, you should exchange your annuity only when it is the smartest move for you.
An annuity is a contract between you and an insurance company, where 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. In the case of 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 VA 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.” But this tax benefit comes with some important strings attached, described in FINRA’s investor alert on variable annuity 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 VA 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 VA may indeed be less expensive. Determining whether the new VA 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 VA 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% 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 too much 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 surrender period that may come with the new contract. While you are generally allowed to withdraw 10 percent of your contract value each year free of surrender charges, you may be charged six percent or even more on amounts beyond this allowable amount.
- 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 doesn’t mean you should.
This article was originally published in the December
2020 issue of BetterInvesting Magazine.
FINRA is the largest independent regulator for all securities firms doing business in the U.S. Its role is to protect investors by maintaining the fairness of the U.S. capital markets.