How do I Convert an Annuity to a Mutual Fund?

by Jay P. Whickson, Demand Media

    You can convert an annuity to a mutual fund, but you may not want to do that. There are expenses, which vary by the amount of gain you have in your annuity, your age and the length of time you've held the annuity. Some of these are penalties and taxes from the federal government and some are charges triggered by the annuity contract. Before you switch you need to find how much the transaction costs and weigh it against the benefit of the switch.

    Items you will need

    • Annuity statement
    • Original deposit amount

    Step 1

    Estimate the federal tax and penalty on the annuity. If you're under 59 1/2, you'll pay a 10 percent penalty on any growth and the taxes on that growth the year you cash out the annuity. If the annuity is an IRA and you're transferring the funds to a mutual fund IRA, the tax and penalty does not apply as long as you do a custodian-to-custodian transfer or complete a rollover into the mutual fund IRA. If you have no growth, you have no penalty or tax either, even if it's not an IRA.

    Step 2

    Look in your annuity contract to see if there are still surrender charges. Insurance companies often charge a 7 to 10 percent penalty that decreases the longer you hold the annuity. If you cash out the contract before the surrender period ends, you pay a percentage of all the money in the annuity.

    Step 3

    Consider the type of annuity you have. If you have a fixed annuity and want the potential growth of mutual funds, you can avoid the federal penalties and tax by doing a 1035 tax-free transfer into a variable annuity that offers mutual fund type investment options.

    Step 4

    Check for penalty free amounts each year. Most annuities offer a certain percentage of money you can remove without an early surrender penalty. If you still are in the penalty phase, remove only the penalty free portion. You won't avoid federal tax and the 10 percent penalty if you're under 59 1/2. If you're in a fixed annuity and simply want the benefit of the funds, you'll avoid both federal and company penalties by switching to a variable annuity that allows partial 1035 transfers. Slowly transfer the money to the new contract, transferring only the penalty free amount each year.

    Step 5

    Surrender the annuity contract if you've decided that it's worth the cost of the penalties. Request a surrender form from the insurance company, fill it out and mail it back to the company. They'll send you a check for the value of your annuity less any company penalties within two weeks. If you open a brokerage account to hold the mutual funds, your broker can fill out an account transfer form, ACAT. This form requests the annuity transfer and you can specify the company liquidate it and send the cash to the brokerage firm.

    Step 6

    Fill out the forms for the mutual fund(s) you wish to purchase. If you're dealing directly with the mutual fund company, you can send a check to them with the forms. If you're holding the funds in a brokerage account, once the mutual fund company opens the account, the broker purchases the shares with the funds held in the brokerage.

    Tip

    • If you know you'll have penalties and taxes on the surrender of the annuity, don't forget to send a quarterly estimate payment to the IRS in order to avoid underpayment fees at tax time. You might want to keep some of the funds for this purpose.

    About the Author

    Jay P. Whickson worked as an insurance rep, financial planner and stockbroker from 1979 until her retirement in 2007 when she began writing about the field of finance. Whickson has both a Bachelor of Science and a Master of Science in education from Indiana University. She also has post Masters courses in science and a number of different insurance and investment designations and degrees.