Annuity Transfer Rules: How to Avoid Tax Penalties

If you’ve purchased an annuity but later decide it no longer aligns with your financial goals, you might consider moving the contract rather than cashing it out. Surrendering the annuity could result in fees and a taxable event. In some cases, transferring the annuity to another provider or to a beneficiary may be an option. To do so without triggering tax penalties, it helps to understand the IRS rules that govern annuity transfers.

Consider working with a financial advisor as you weigh the pros and cons of annuities, as well as the tax implications of these products.

What Is an Annuity Transfer?

Annuity Transfer Rules: How to Avoid Tax Penalties

An annuity transfer generally refers to moving the value of an existing annuity contract to another annuity or insurance company without immediately triggering taxes or penalties.

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
Exchanging 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:

Deferred annuities can be transferred if they haven’t yet been annuitized, meaning payments have not begun.
Immediate annuities cannot be transferred under any circumstances.

If 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 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, help identify suitable alternatives. 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?

Your ability to avoid taxes on the annuity transfer depends on how you’re transferring the contract. 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:

Choose a replacement annuity with similar characteristics
Apply for the annuity with the company that offers it
Be aware of any surrender charges that may apply when 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 1035 exchange 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.

Some annuity transfers between spouses may qualify for an exception. 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.

Can You Transfer a Portion of an Annuity?

It’s sometimes possible to transfer part of an annuity rather than the full contract through a partial 1035 exchange. This allows you to move a portion of funds from one non-qualified annuity to another without triggering taxes, as long as IRS requirements are met. The ownership must stay the same, and both contracts must be of a similar type.

IRS guidance (Revenue Procedure 2011-38) outlines rules for partial exchanges. To avoid having the transfer treated as a taxable distribution, no withdrawals should be made from either contract within 180 days of the exchange.

Not all annuity providers allow partial transfers, and those that do may impose limits. You’ll also want to consider whether moving part of the balance will affect benefits such as guaranteed income riders or death benefits. A partial transfer can provide more flexibility, but it’s important to evaluate how it could impact your contract terms and tax treatment.

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. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with 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.