A 1035 exchange to an FIA: A smart choice in today’s environment

For those who purchased variable annuities between 2001 and 2015, today’s financial landscape presents a unique opportunity to revisit the terms of these contracts. The financial environment has changed significantly over the past 25 years, with interest rates now at their highest levels since the early 2000s. As a result, many retirees are finding that the growth-oriented, high-fee variable annuities they purchased years ago are no longer aligned with their income-focused needs in retirement.

Therefore, a 1035 exchange from a variable annuity to a fixed indexed annuity might be a smarter choice for protecting principal, reducing fees and securing guaranteed lifetime income.

The changing landscape of retirement income needs

In the early 2000s, retirement planning often emphasized accumulation. With interest rates at historic lows, growth-oriented variable annuities with equity-based investment options appeared attractive to investors looking for higher returns. However, variable annuities typically come with significant drawbacks, including market risk, high fees and potential fluctuations in income. For many retirees today, these factors are no longer advantageous, as their focus has shifted from growth to income stability and protection.

As retirees shift their priorities to income stability, higher-interest-rate products such as FIAs offer a compelling alternative. An FIA provides principal protection with a guaranteed floor, meaning you won’t lose money if the market drops. FIAs also offer income riders with potentially lower costs and better features than the lifetime income benefits of older variable annuities. Given these advantages, a 1035 exchange from a variable annuity to an FIA can be a powerful strategy for retirees looking to optimize their income while protecting their principal.

The hidden costs of holding on to older VAs

Variable annuities typically carry high fees due to their complex structures. These contracts often include mortality and expense fees, administrative fees, and additional charges for optional riders, which can erode gains over time. A study by Wade Pfau, professor of retirement income at The American College of Financial Services, found that these fees can be as high as 3% annually, significantly impacting returns.

Moreover, the growth focus of variable annuities may no longer align with the current market environment or retirees’ needs. These contracts were designed when interest rates were low and equity growth seemed more appealing for future income. However, with today’s high interest rates, there are more attractive options available that can deliver reliable income with lower costs and greater security.

Why FIAs are a smart choice in today’s market

FIAs offer several advantages over traditional VAs, especially for retirees who prioritize principal protection and income stability. FIAs are linked to market indices, meaning they allow growth when markets rise but protect against losses when markets fall. This means that retirees can participate in market gains without exposure to downside risk.

Additionally, today’s FIAs often come with lifetime income benefit riders at  costs lower than those offered on older VAs. These income riders can provide a predictable income stream, which many retirees find valuable in a high-interest-rate environment. With lower fees and the opportunity for more consistent income, FIAs align well with the needs of retirees who want to minimize volatility and preserve capital.

Retirees can also benefit from high participation rates and caps on FIAs, which allow reasonable growth potential. Although these products may not provide the same upside as equities in bull markets, they do offer a balance of safety and growth that is especially attractive in retirement. When using a 1035 exchange, retirees can take advantage of these benefits without facing immediate tax consequences, making it an efficient strategy for rebalancing retirement portfolios.

The benefits of a 1035 exchange for income security

A 1035 exchange allows annuity holders to switch from one annuity to another without triggering a taxable event. For retirees looking to shift from variable annuities to FIAs, this tax-free transfer is a valuable tool. By exchanging a high-cost, market-dependent variable annuity for an FIA, retirees gain a more stable, predictable income source aligned with their current retirement goals.

In today’s high-interest-rate environment, FIAs can offer more attractive income guarantees than VAs purchased during the low-rate era between 2001 and 2015. This income predictability can be particularly valuable for retirees looking to budget effectively and protect themselves against longevity risk. Furthermore, with lower fees and reduced exposure to market risk, FIAs provide a financial buffer that’s difficult to achieve with older, growth-focused variable annuities.

Moving forward: Is a 1035 exchange right for your client?

For retirees considering whether a 1035 exchange is the right move, it’s important to weigh the benefits of an FIA’s principal protection, income stability and lower fees against the continued market risk and high fees of older VAs. 

Given the tax-free transfer option, the process is generally straightforward, though consulting with a financial advisor is crucial to evaluating each retiree’s unique financial situation.

With interest rates higher than they’ve been in over two decades, now is an opportune time for retirees with older VAs  to consider a 1035 exchange to a fixed indexed annuity. By taking advantage of this opportunity, retirees can shift from growth-focused, high-fee products to low-cost, income-stable solutions that offer both security and peace of mind. Work with your retired clients to make the most of this strategy, aligning their retirement income with their priorities and paving the way for a more secure future.

Derek Miser is founder, Miser Wealth Partners in Loudon and Knoxville, Tenn. Contact him at [email protected].