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Annuity Transfer Rules: How to Avoid Tax Penalties


If you purchased an annuity but later decide that it no longer fits your financial plan, you may be wondering what you can do with it. You could surrender it or cash it out but that could trigger fees and taxes. Transferring the annuity to a new annuity company or to one of your heirs is another possibility. If that’s something you’re interested in, it’s important to be aware of annuity transfer rules set by the IRS.

Consider working with a financial advisor as you weigh the pros and cons of annuities, as well as taxes on such policies.

What Is an Annuity?

In simple terms, annuities are insurance contracts. When you buy an annuity, you agree to pay a premium to the annuity company. Premiums may be paid as a lump sum or in installments. The annuity owner pays the premiums in exchange for eventual payments from the insurance company. The annuitant is the person whose life expectancy is used to calculate those payments. The owner and the annuitant can be the same person.

The annuity company agrees to make payments back to you, according to the terms of the contract. If the annuity is immediate, those payments may begin within one year of purchasing the contract. If the annuity is deferred, you may be waiting several years for payments to kick in.

Fixed annuities offer a guaranteed rate of return. Variable annuities generate returns based on the performance of an underlying mix of investments. Annuities can be used to build wealth and create additional streams of income for retirement.

What Is an Annuity Transfer?

Annuity Transfer Rules: How to Avoid Tax Penalties

Annuity transfers are transfers of either the contract itself or ownership of the contract. Examples of annuity transfers include:

  • Moving an existing annuity contract to a new annuity company
  • Granting ownership of an annuity to your former spouse when you divorce
  • Swapping out one annuity contract for another with the same company
  • Transferring annuities held in one IRA to another IRA

Transferring an annuity is different from naming a beneficiary. An annuity beneficiary has the right to receive funds from the contract once the primary owner passes away. So, you might name your spouse or an adult child as a beneficiary to your annuity.

When you transfer an annuity, you’re typically making some type of material change with regard to where the contract is held, the terms of the contract or who is listed as the owner.

What Types of Annuities Can Be Transferred?

Annuity transfer rules govern which types of annuities can be transferred. There are two key rules to understand:

It you have a deferred annuity it doesn’t matter if it’s a fixed or variable contract. As long as you haven’t started receiving payments from it yet you can transfer it. If you’re not sure what you have, it may be helpful to contact your annuity company to learn more about your contract.

When Does Transferring an Annuity Make Sense?

Whether transferring an annuity is a good idea or not can depend on the specifics of your situation. Before making a move, it’s important to weigh what you stand to gain or lose and your end goal for initiating an annuity transfer.

For example, say you’re contemplating transferring your annuity to a different annuity company. That could be a good move if you:

  • Are interested in getting an annuity product that offers more competitive rates so your money can grow at a faster pace
  • Would like to pay fewer annuity fees
  • Have concerns about the stability of your current annuity company and its ability to make annuity payments to you when the time comes
  • Don’t have the best relationship with your annuity agent or broker and are hoping to have a better customer service experience elsewhere

On the other hand, transferring an annuity might do more harm than good if it means paying steep surrender charges or losing some of the benefits included in your current contract. If you’ve included riders with your annuity, it’s important to know whether those benefits will transfer if you decide to move your annuity elsewhere.

Talking to a financial advisor can help you decide if transferring an annuity is a good option and if so, where you might want to consider transferring it. Your advisor may also be able to offer help if you have a special situation, such as a division of assets during a divorce that might require you to transfer an annuity.

Do Annuity Transfer Rules Allow for Tax-Free Transfers?

Annuity Transfer Rules: How to Avoid Tax Penalties

Yes and no, depending on how you’re transferring an annuity. If you’re simply trading out one annuity contract for another, you can do without a tax penalty if you’re following the IRS rules for 1035 exchanges.

A 1035 exchange allows you to swap one annuity contract for another, as long as the contracts are similar. In order to complete a 1035 exchange to transfer an annuity into a new contract, you would need to:

  • Select a replacement annuity that’s similar in nature to the one that you already have
  • Apply for the annuity with the company that offers it
  • Pay any surrender charges that may be due for moving the contract

You’ll need to report a 1035 exchange of annuity contracts on your federal tax return. The annuity company that’s transferring the contract should issue you a Form 1099-R that you can use to report the exchange on your taxes. Time is of the essence when completing a 1035 exchange. The entire process must be completed within 30 days. Additionally, annuity transfer rules require that the account owner must be the same.

What does that mean if you’re hoping to transfer ownership of the annuity to someone else? You could still do that but it wouldn’t qualify as a 1035 exchange. In that instance, any transferred amounts are typically treated as taxable distributions. That means you would owe income tax on any earnings and if you’re under age 59 ½, you’d also pay a 10% early withdrawal penalty.

Annuity transfers between spouses may qualify for an exception to that rule. If you’re transferring an annuity to your spouse because you’re divorcing, and the transfer occurs within one year after the marriage ends it would be tax-exempt. However, your former spouse would be responsible for any tax implications if they decide to withdraw money from the annuity early once the transfer is complete.

Bottom Line

Annuity transfer rules can be complicated and it’s important to understand how they work in order to avoid tax consequences. If you have yet to purchase an annuity but are considering buying one, you may want to give some thought to whether transferring the contract is something you might need to do down the line.

Retirement Planning Tips

  • Consider talking to your financial advisor about annuity transfer rules and what they might mean for you if you decide to exchange an annuity contract you currently own. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Annuities are just one way to create a solid financial plan. If you’re interested in an annuity for a specific goal, it’s helpful to consider other ways you might be able to fund it. For example, you could purchase an annuity in anticipation of needing long-term care, but a long-term care insurance policy or hybrid life insurance policy may offer better value for your money. Hybrid life insurance can be particularly useful since your beneficiaries can still collect a death benefit, regardless of whether you use the long-term care portion of the policy.

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