For an affluent couple, a variable annuity is commonly an asset in the marital estate. The average person, including family law attorneys, typically does not understand this form of investment or how lifetime income payments are determined. Because of that, substantial wealth is often destroyed when this asset is split between the spouses in a divorce.

Variable annuities vary widely from company to company and there aren’t any rules in the tax code saying how they should be split upon divorce. Insurance companies have adopted their own procedures and they protect themselves. First they want to limit their liability. Second, it is not financially advantageous for an insurance company to split the annuity and give each spouse the original benefits provided in that policy.

Splitting up a variable annuity is treated like a withdrawal from the original policy/contract. Therefore, early withdrawal penalties (if you are under age 59 ½) and taxation can be triggered upon a withdrawal. The tax codes don’t dictate who is responsible for the taxes and some insurance companies follow what the divorce agreement dictates (if the family law attorneys were aware enough to include that verbiage). But this is not always the case. Some follow their own internal rules.

Sometimes, the insurance company will allow the annuity to be split and the policy holder’s/owner’s portion transferred to another annuity in the non-owner spouse’s name, which can avoid triggering taxes. But, variable annuities often contain contract features such as death benefits that can be reduced. Also, the account value of the annuity and the basis upon which the annuity payments are based (the living income benefit base) are different, often very different. The amount transferred to a new annuity can lose the living income base and instead be based on its portion of the account value in the original annuity, severely deflating the monthly annuity payout for the non-owner spouse.

The best strategy when there is a variable annuity in the marital estate is to leave it in the contract owner’s name and use other assets to equalize the asset split. If that is not possible, the insurance company should be contacted prior to negotiations to find out what their procedures are and what the financial and tax ramifications will be so that the non-contract owner is not allocated a value that he or she will not ultimately receive.