An individual retirement account allows you to invest for the long term without paying taxes on your earnings. You receive a tax deduction for traditional IRA contributions and pay ordinary income tax on the money you take out. You can own many different types of investments, including CDs, mutual funds, stocks, bonds and annuity contracts. An annuity is qualified if it resides in a traditional IRA, Roth IRA, or employer pension plan such as a 401(k) or 403(b). You can exchange one IRA annuity for another using rules established in the tax code.
A qualified annuity is a contract that allows you to exchange one or more cash payments, or premiums, for a steady stream of income. The annuity income continues for a set number of years or for your entire lifetime. A survivor annuity continues payments to your beneficiary. An IRA annuity must meet Internal Revenue Service requirements. For example, you can’t transfer the annuity to another owner, although you can transfer the annuity to a different account. The premiums must be flexible, your annual contribution can’t exceed IRA limits, and you must start taking annuity payments after reaching age 70 1/2. An annuity provider can't cause you to forfeit your IRA annuity.
Changing Annuity Provisions
During the phase when you are building up the cash value of your annuity, you might be able to negotiate some changes in the contract's provisions. For example, the insurance company may agree to larger premiums and payouts. You also might be able to add riders to the contract for an additional fee. Unless the contract states specific available options, don't assume that the provider will approve any changes. You can exchange the annuity for one more to your liking.
Section 1035 of the Internal Revenue Code recognizes that you may want to exchange your old annuity for a new model. For example, you might find a new policy that offers a higher interest rate or lower fees. A 1035 exchange is tax-free. This means that you don’t have to recognize any gain or loss on the exchange, but you must follow the correct procedure. If you simply cash in your old annuity and use the money to buy a new one, the IRS will treat it as a taxable distribution. You must instead assign the old annuity to the new provider in a trustee-to-trustee transfer. The new provider then issues you a new policy and cashes in old one. The name of the annuitant must remain the same.
Enhanced Living Benefits
One reason to change annuity contracts is to obtain an enhanced living benefits rider. Insurance companies have recently developed these riders to provide extra value in return for higher premiums. For example, you can get an income rider that guarantees a fixed return without reducing your principal. In this way, you receive steady income for life and bequeath the entire principal to your beneficiary. Another rider provides for extra payments when you are confined to a long-term care facility or are unable to take care of yourself.
You can do a partial exchange from an old annuity to a new one tax-free. For example, if you assign 60 percent of an annuity’s cash value to a new annuity, your total investment is split 40/60 between the old and new annuities. If your old annuity provider becomes insolvent or is otherwise subject to a state proceeding, you can invest a distribution check in an annuity tax-free without arranging a trustee-to-trustee transfer. You must reinvest the distribution in a single contract from another provider within 60 days of receiving it.
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.