Although the stock market has been strong for the last several years, some investors are still showing losses on variable annuities and life insurance policies, due to the 2000-2002 crash. If you don’t need the annuity or insurance any more, or if you are tired of paying the high fees, you may be tempted to cash it in.
Instead of just surrendering the contract, consider an exchange to a lower-cost annuity. Such an exchange is tax-free, under Section 1035 of the tax code.
Suppose you have a life insurance policy with a $50,000 cost basis (the premiums you’ve paid) and only a $30,000 cash surrender value. You can do a 1035 exchange into a low-cost variable annuity, which carries over your $50,000 cost basis. When the annuity contract has gained enough to reach $50,000, you can surrender it.
With a $50,000 basis and a $50,000 cash surrender, you’ll owe no tax. In effect, you’ll be $20,000 ahead of the game, compared with a $30,000 surrender, and you’ll owe no tax on this added wealth.
