How To Trade Your Annuity For Life Insurance

Many people have annuities and are unsure what they should do with them. You might be one of those looking for a way to trade your annuity for life insurance. If you’re looking for guidance, you’ve come to the right place! This guide will discuss how to trade your annuity for life insurance and help you decide what’s best for your situation.

Why Trade Your Annuity For Life Insurance?

The best reason to purchase life insurance rather than annuities is your beneficiaries can inherit a death benefit tax-free. Other reasons include:

• Maximize an estate plan for beneficiaries
• Fulfill unwanted required minimum distributions (RMD)

How To Exchange An Annuity For Life Insurance

Under normal circumstances, you can not transfer or exchange an annuity directly into a life insurance policy. However, that doesn’t mean it can’t be done. Here are two methods to trade your annuity for a life insurance policy.

• Method #1: Withdraw from the annuity, and fund a limited-pay life insurance policy.
• Method #2: Purchase an Annuity/Life Insurance Hybrid Plan.

Limited Pay Life Insurance Policy

1. Purchase limited-pay life insurance. Depending on how long you’ve had the annuity, you can purchase a 7-pay, 10-pay, or 20-pay life insurance policy. The policy will be guaranteed as long as the policy is funded.
   • Note: A full medical underwriting process might be required.
2. Contact the annuity company and set up systematic withdrawals to fund the life insurance policy.

Annuity/Life Insurance Policy

What is an annuity life insurance policy? This hybrid plan combines an immediate annuity and permanent life insurance policy. If approved, the tax-free death benefit is guaranteed for life, starting on Day 1.

1. Direct Transfer or 1035 Exchange your current annuity into the hybrid plan, so there is no taxable event.
   • Both non-qualified and qualified annuities (IRA annuities) are accepted.
2. Once the plan is issued, the insurance company will distribute equal installments from the annuity portion of the plan into the life insurance policy’s cash value for a set length of time (period certain). Once the annuity has exhausted all distributions, the hybrid plan converts into a paid-up life insurance policy.
   • Generally, there is limited medical underwriting involved. Primarily a telephone interview, medical background check, and a prescription drug history review.
   • These hybrid plans are designed for older clients up to age 85.
   • Note: All owners will report annuity distributions as income to the IRS each year until the annuity has been exhausted.

How Is Trading The Annuity For Life Insurance Taxed?

In almost every case, the owner will be taxed on a portion or all of each payout from the annuity.

Non-qualified Annuities

Systematic withdrawals from a non-qualified deferred annuity (after-taxed money) are considered to come first out of earnings, then out of the contract’s initial investment premium. This tax method is called Last In, First Out, or LIFO. The earnings portion of the withdrawal is considered taxable income to the annuitant.

When non-qualified annuities are 1035 exchanged to a hybrid plan, part of each immediate annuity payout will be a non-taxable return. The remaining portion of the payout represents a taxable gain. For each SPIA payout, your client will receive a 1099 form stating the taxable portion from the company. The insurer will also report the taxable amount to the IRS.

Qualified Annuities

All systematic withdrawals from an IRA annuity are subject to ordinary income taxes.

For the hybrid plan, the SPIA payout will be taxable as ordinary income. The annuity will receive a 1099 form for each year’s taxable amount, and the company will report the taxable amount to the IRS.

Hybrid Plan Sample Rates

$50,000 of pre-taxed premium could equal a tax-free death benefit equating:

When considering these sample rates, understand the $50,000 has not been taxed yet. So what would the $50k be worth after federal and state income taxes are taken out. Then, after considering this reduction, compare it to the tax-free sample rates above.

What Annuities Can Not Be Replaced?

• Immediate annuities
• Any annuities that have been annuitized.

Find Out If Trading Your Annuity For Life Insurance Makes Sense

Related Reading

• What Does Life Insurance Cover?
• Can I Sell My Term Life Insurance Policy For Cash?

Frequently Asked Questions