When Exchanging, Surrendering Or Selling A Variable Annuity May Be Called For

Here is why: It is well established that the surrender of an annuity where the contract value is less than the purchase price can result in a deduction of the amount of the loss on the contract owner?s federal income tax return. An exchange of an ?under water? VA causes the contract owner to keep the same basis in the new contract as was in the old one. There is no tax deduction that results from an exchange. On the other hand, a surrender or sale of such an annuity "locks in" the tax loss and can enable the contract owner to buy a new annuity, with the features she desires, for a lower cost after having secured a valuable tax write-off.

It should be noted that although there does not seem to be any precedent that we have found that says the sale of an ?under water? annuity gives rise to a tax loss, there does not seem to be any logic for a contrary conclusion. After all, the surrender of an annuity is, in fact, merely a sale of the contract back to the insurer that issued it.

VA owners also should be advised that they may want to defer the purchase of a new annuity for a sufficient time to avoid having the transaction treated as a "wash sale" that would void the ability to take the tax deduction.

We are aware that a number of firms have begun buying ?under water? VAs. These firms are interested in maintaining the contract in force in order to obtain the guaranteed minimum death benefits than many VAs contain. In effect, if these firms hold the VAs until the death of the contract owner or the annuitant, they will receive more than they paid for the contract.

Generally, these firms that buy such VAs pay a premium over the amount the contract owner could get with a surrender or an exchange. Therefore, a contract owner may be better off financially by selling her contract instead of surrendering or exchanging it.

Obviously, contract owners should take the value of the guaranteed minimum death benefit into consideration before they exchange, surrender or sell their VAs. This is particularly true if the existing contract has a guaranteed minimum death benefit that has increased over the original purchase price of the contract.

In this context, the insurance agents and brokers who advise clients with respect to the exchange, surrender or sale of ?under water? VAs should be sure to take into consideration the tax consequences of the transaction.

Locking in tax losses may be a valuable addition to a contract owner?s ability to plan for retirement.

For some contract owners, the tax deduction may be worth as much as 35% of the amount of the loss. (Note: It is likely that losses on annuity contracts are subject to the 2% floor applicable to "miscellaneous other deductions." Therefore, the deduction would not equal the complete amount of the loss.)

Failure by an insurance agent or broker to consider and advise customers regarding tax losses in an exchange transaction may well cause the entire transaction to be suspect as being suitable for the contract owner. Certainly, the casual exchange of an ?under water? VA may not be in the best interests of the contract owner.

Norse N. Blazzard, JD, CLU, and Judith A. Hasenauer, JD, CLU are attorneys in the Pompano Beach office of Blazzard, Grodd & Hasenauer, P.C. Their e-mail address is: [email protected].

Reproduced from National Underwriter Life & Health/Financial Services Edition, September 3, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.