For retirement savers, one problem with getting into an annuity is that it can be hard to get out due to surrender charges or the prospect of paying taxes on gains. For annuity sellers, one of the problems with a retirement saver having an annuity is that it can be hard to sell another one.

An Internal Revenue Service rule allowing a 1035 exchange -- named for a section of the tax code -- promises to solve both problems. It lets someone who owns an annuity swap it tax-free for another annuity.

1035 exchanges can be useful for annuity holders who have built up large gains that would be subject to taxes if the annuity were simply cashed in. The same applies to cash-value life insurance policies, which can also exchange tax-free to annuities. However, 1035 does not allow exchanging an annuity for an insurance policy.

People are most likely to use 1035 exchanges to switch from type of annuity to another, says David Weinstock, a certified financial planner with WeiserMazars in New York. For instance, clients might switch from a fixed annuity to a variable annuity, or from an immediate annuity to a deferred annuity.

"Or it could be a change in features and benefits," Weinstock adds. For instance, a client with an annuity that provides a guaranteed income could decide that his or her other retirement assets are sizable enough that the cost of the guarantee is not worth it, and switch to an cheaper annuity without a guarantee.

Weinstock emphasizes that 1035 exchanges may have significant costs and disadvantages. For instance, an annuity may incur a steep surrender fee if exchanged before the end of the surrender period, which typically lasts several years after purchase. "It should be approached with caution always, in my view," Weinstock says.

Steve Azoury, a broker in Troy, Mich. who specializes in annuities, says one common 1035 exchange involves a fixed annuity purchased several years ago when it paid 5% but pays only 1% now. A variable-rate annuity could pay more, Azoury says, but if the existing fixed annuity has grown in value, the gain would be taxed when the annuity is simply cashed out and proceeds used to buy a new annuity.

Another example is someone who has a life insurance policy paying a death benefit to a spouse. If the spouse who is the intended beneficiary dies first, it may save on taxes to do a 1035 exchange into an annuity rather than cash out the life policy and invest the proceeds elsewhere.

Fees represent the major concern. In addition to surrender fees, variable annuities in particular may incur ongoing fees that cut steeply into future investment returns.

Annuity sellers earn commissions of up to 10% of purchase price, with variable annuities paying the highest commissions and fixed annuities paying the lowest. Annuity commissions can be significantly higher than other investment products. And purchasers ultimately pay commissions through reduced returns.

When a 1035 exchange isn't too costly, provides the return, features a buyer needs and offers a meaningful tax benefit, it can make sense. "If a person is happy with their account, they're happy," Azoury says. "If they want to go to a different account, they can do that and not be held hostage by taxable gain."

But tax concerns aren't always enough to justify a 1035 exchange. "You should weigh costs and do a careful analysis," Weinstock says. "There should always be skepticism, because many of the salespeople push them when they may not be the most suitable options and the commissions are very high."