A fixed annuity generally pays a set yield for a given time period. After the initial term, the yield will be re-set. If the annuity issuer re-sets the new yield below the market rate, you can exchange your old annuity for another one, tax-free, under Section 1035 of the tax code.
Such an exchange may trigger a surrender charge, which typically remains in effect for several years after the initial purchase. However, there are annuities offering an upfront “bonus” payment, which may offset any surrender charge.
Not only are exchanges tax-free, the annual income earned by a fixed annuity also escapes income tax. Moreover, this accumulation within a fixed annuity does not count as income, when calculating whether Social Security benefits will be taxed. Therefore, holding fixed annuities may enable you to reduce the tax you’ll owe on Social Security benefits.
