- A 1035 exchange can’t be undone. Read the contract before you recommend one.
- The biggest risks are guarantees worth more than the account: death benefits, income benefit bases, and old minimum rates.
- Sometimes the best recommendation is to keep the contract or change how it’s used. Document the analysis either way.
Many client households hold annuities bought years ago, often before the client started working with you. They sit off your statements, carrying fees nobody has looked at in a while.
Replacing them can be the right move: lower cost, a better fit with the plan, and assets you can see and advise on. But an older contract can also hold guarantees that nothing sold today will match. A 1035 exchange is permanent. The only way to know which situation you’re in is to check the six items below.
1. Is the death benefit worth more than the account?
Many variable annuities carry a guaranteed minimum death benefit: return of premium, periodic step-ups that lock in a high-water mark, or a roll-up at a stated rate. After a market decline, or after years of step-ups, the guaranteed death benefit can be well above the contract value. A surrender or exchange usually gives up that difference.
Check: current death benefit versus contract value, how the benefit is calculated, and whether withdrawals reduce it proportionally or dollar for dollar.
2. Is the income benefit base above the contract value?
Living benefit riders track a benefit base that is separate from the account value. Riders issued in earlier years sometimes carry roll-up rates and withdrawal percentages more generous than what carriers offer today.
Check: benefit base, rider fee, the withdrawal percentage at the client’s current age, whether income has already started, and what an excess withdrawal would do to the guarantee.
3. Does the fixed account carry a guaranteed minimum rate?
Some older contracts guarantee a minimum crediting rate on the fixed account that was set in a different rate environment. That floor can be valuable to a conservative client.
Check: the guaranteed minimum rate, current crediting rate, and any limits on moving money into or out of the fixed account.
4. What will it cost to leave?
Remaining surrender charges are the obvious cost. Less obvious are market value adjustments on fixed or indexed components, recapture of any premium bonus, and rider fees already paid for guarantees the client would walk away from.
Check: the remaining surrender schedule by year, available free withdrawal amounts, and whether waiting until the next contract anniversary changes the math.
5. What happens to cost basis and taxes?
A properly executed 1035 exchange carries cost basis over to the new contract. A full surrender instead taxes any gain as ordinary income, and may add a 10% federal tax if the owner is under 59½. Contracts funded before August 14, 1982 can carry favorable tax treatment on withdrawals, so confirm how an exchange would affect that with a tax professional.
Check: cost basis, current gain or loss, owner age, and any pre-1982 investment in the contract.
6. Would the client qualify for the same thing today?
New contracts and riders have issue-age limits, and some death benefit features require health questions. Older contracts may also include guaranteed annuitization rates that current products don’t offer. If the client can’t buy a comparable guarantee today, the one they own is worth more.
Check: owner and annuitant ages against the new contract’s issue limits, underwriting requirements, and any guaranteed annuitization rates in the existing contract.
A 71-year-old client owns a variable annuity bought in 2008. Contract value is $310,000. After several step-ups, the guaranteed death benefit is $365,000, and the surrender period has ended. A lower-cost advisory annuity would reduce annual expenses, but an exchange would give up $55,000 of death benefit that the client’s estate plan counts on.
Recommendation: keep the contract, and revisit if the client’s legacy goals change.
This example is hypothetical and for illustration only. It does not represent any actual client, contract, or product, and results for any client will differ.
Replace, modify, or keep
Replace when fees are high, the guarantees are well out of the money or no longer needed, and the surrender period is over or nearly over.
Modify when the contract is worth keeping but not as it’s being used: drop a rider the client no longer needs if the contract allows it, reallocate subaccounts, make a partial exchange, or start income from a benefit base that’s already in the money.
Keep when the guarantees are worth more than any savings from switching, or when the client couldn’t buy them again.
Whichever answer you reach, document the comparison. State replacement rules require specific forms and disclosures, and the file you build now is what supports the recommendation later.
If you’re deciding how to handle these reviews across your whole book, our guide to choosing an annuity model for your RIA walks through the options.
We’ll return a complimentary keep, modify, or replace analysis with the guarantees, costs, and math shown, so you can make the call with your client.
Start a contract reviewQuestions advisors ask
Does a 1035 exchange restart the surrender period?
The new contract carries its own surrender schedule, if it has one. Many advisory-class annuities have short schedules or none, but check the specific contract before recommending an exchange.
Is a bulk annuity review tool enough?
Bulk tools are useful for sorting a large book and flagging high-cost contracts. Rider guarantees, benefit bases, and old minimum rates often need a contract-level read before any replacement.
What paperwork does a replacement require?
Most states require replacement forms and disclosures, and the recommendation must meet the applicable suitability or best-interest standard. The exact requirements depend on the state and the product.
