Financial Q&A: A tax-free way to transfer annuities

Submit your questions to Steve at: money@CSMonitor.com

from the November 17, 2008 edition

Q: I have a little over $100,000 in a fixed annuity that pays 5 percent, guaranteed. I can withdraw any amount at any time with no penalty, but the taxable interest is payable first. AM Best rated the company A+ last year, but I can't find the current rating. I am considering transferring to an FDIC-insured bank account, getting either 4 percent from a CD or 3.5 percent from money market checking or Treasury bills. Can I transfer "in kind"? Or must I pay the taxable $22,000 in interest up front? I also have 75 percent of my IRA in a money market mutual fund that's paying 2.51 percent. And I have a separate money market with the same company that's paying 4.51 percent. Both are insured by SIPC. Are these money markets safe and covered over $100,000?

A.A., via e-mail

A: Look some more for a rating on the annuity. Because if there isn't one, that indicates to San Francisco-based financial planner Barry Taylor that there's a potential problem with the annuity provider.

In that case, he says, you may want to transfer the annuity. You most likely won't be able to transfer it in kind, but you should be able to make a tax-deferred exchange, he says.

Essentially, Mr. Taylor explains that you could exchange the existing annuity contract with one in another company – a swap that qualifies for a tax-free exchange under IRS Section 1035. That means you won't have to pay taxes on the taxable interest portion, and you can set it up as an immediate annuity, allowing it to continue to pay.

Make sure to check the rating of the new provider, Taylor says. Also, terms of the new contract will be different, so you'll need to review them and decide whether you can accept their guaranteed rate, fees, and charges – including potential surrender fees.

As to insurance on your money market mutual fund: SIPC protection still has a $100,000 limit for cash.