The Variable Annuity Owner: Should You Switch — and How to Do It Tax-Free
An old variable annuity can quietly carry high fees and market risk. Here's how to evaluate it, and switch tax-free only if it actually makes sense.
Executive Summary
Many people own a variable annuity (VA) sold years ago — and quietly carrying high fees and market risk. But switching isn't automatically right: an old VA may also hold a valuable guarantee worth keeping. This study shows how to evaluate what you own and, if it makes sense, move tax-free to a lower-cost option.
01What's Actually Inside a Variable Annuity
Unlike a fixed indexed annuity, a variable annuity's money is invested in market sub-accounts — so it can lose value — and it often layers several fees: mortality & expense (M&E) charges, sub-account fund fees, and rider costs, which together can run 2%–4% a year.
02Step 1: Find Your All-In Cost and Guarantees
Two questions decide everything: What are the total annual fees? and Does it still carry a valuable guarantee? Some older VAs include rich living- or death-benefit riders — sometimes worth more than the contract's account value — that would be foolish to give up. You can't decide to switch until you know both numbers.
03Step 2: The 1035 Exchange (Tax-Free Switch)
If the fees outweigh the benefits and you'd prefer protection over market risk, a 1035 exchange lets you move from one annuity to another without triggering taxes — for example, from a high-fee VA into a lower-cost fixed indexed annuity that protects principal. The growth keeps its tax deferral; only the product changes.
04Step 3: Check the Traps First
- Surrender charges — exchanging during the surrender period can cost you; sometimes it's worth waiting.
- Valuable riders — don't surrender an in-the-money guarantee for a cheaper contract without counting what you're giving up.
- New surrender period — the replacement contract starts its own; make sure the trade is genuinely better.
05Educational Takeaways
- Variable annuities carry market risk and often high (2%–4%) fees.
- First find your all-in cost and the value of any guarantees.
- A 1035 exchange can switch tax-free to a lower-cost option.
- Don't switch reflexively — surrender charges and rich riders can argue for staying.
An old variable annuity may carry high fees — or a guarantee worth more than the account itself. Know both numbers first; a 1035 exchange can switch tax-free, but only switch if the trade is genuinely better.
06Questions Clients Should Ask
How do I switch annuities without paying taxes?
Use a 1035 exchange, which moves money from one annuity to another tax-free, preserving the tax deferral. It's the right tool for moving from a high-fee variable annuity to a lower-cost option — but check surrender charges first.
Should I always dump a variable annuity for lower fees?
Not always. Some older variable annuities carry valuable living- or death-benefit guarantees that may be worth more than the account value. Find your all-in fees and the value of any guarantees before deciding.
What should I watch out for when switching?
Surrender charges on the existing contract, giving up a valuable in-the-money rider, and the new contract starting its own surrender period. Make sure the trade is clearly better before moving.
07Advisor & Compliance Notes
Advisor Notes
- Document all-in fees and any in-the-money riders.
- Use 1035 exchanges to preserve tax deferral.
- Never recommend a switch that forfeits a richer guarantee.
Compliance Notes
- Education only; not a recommendation.
- Replacement suitability analysis required before any exchange.
- Surrender charges and rider values vary.
- Hypothetical scenario; not a real individual.