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Named after Section 1035 of the Internal Revenue Code, a 1035 exchange allows life insurance policy owners (and annuity contract owners) to exchange an old policy (or contract) for a new one from a different insurance company without tax consequences. Of course, the exchange must meet the requirements of Section 1035 in order for the transaction to be tax-free. This strategy can be especially beneficial to a person who purchased a life insurance policy or annuity contract many years ago that has less favorable contract stipulations than those available today.
A 1035 exchange applies only when it involves the same contract holder and the same type of contract. It gives the contract owner the flexibility to find another contract that features lower costs, a higher death benefit, or more investment choices. The cost and availability of insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before surrendering your "old" life insurance policy, it would be prudent to make sure that you are insurable.
Investors can also do partial 1035 exchanges for a portion of the total contract amount. In this case, the transferring company should notify the new company of the exchange amount that is investment versus gain, because any gain is subject to ordinary income taxes when withdrawn. Some companies do not recognize partial 1035 exchanges for tax reporting purposes. A tax professional should be consulted to properly track these amounts in the contract.
Nonetheless, a 1035 exchange can be an effective tool for contract holders who want to exchange older contracts for current, more useful ones.
The rules governing 1035 exchanges are complex, and you may incur surrender charges from your “old” annuity contract or life insurance policy. In addition, you may be subject to new sales, mortality and expense charges, and surrender charges for the new contract or policy.
Annuities have contract limitations, fees, and charges, which can include mortality and expense risk charges, sales and surrender charges, investment management fees, administrative fees, and charges for optional benefits. Annuities are not guaranteed by the FDIC or any other government agency; they are not deposits of, nor are they guaranteed or endorsed by, any bank or savings association. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company. Withdrawals reduce annuity contract benefits and values. The investment return and principal value of an investment option, also called subaccounts, are not guaranteed. Because variable annuity subaccounts fluctuate with changes in market conditions, the principal may be worth more or less than the original amount invested when the annuity is surrendered.
Variable annuities are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity contract and the underlying investment options, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
The information in this newsletter is not intended as tax, legal, investment, or retirement advice or recommendations, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek guidance from an independent tax or legal professional. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Broadridge Advisor Solutions. © 2022 Broadridge Financial Solutions, Inc.
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Categories: Annuity Education, Annuity Strategies, Finance
Are you interested in upgrading your annuity to one with better features and/or a higher interest rate? In most cases, the IRS allows what is known as a 1035 exchange of non-qualified annuity contracts between insurance companies. A 1035 exchange lets you switch companies while continuing to defer taxes, ensuring that your annuity stays up-to-date with the latest advantages and benefits available to you.
Please watch this short video that provides additional insight and details you may find helpful:
Section 1035 is one of the few parts of the tax code that actually works in your favor. For example, when you sell shares of stock to buy shares of a different company, the profits on your investment are subject to taxes. By contrast, utilizing a
1035 exchange allows you to exchange one non-qualified annuity contract for another, with the accumulated interest earnings from your original policy remaining tax-deferred until, at a future date, you permanently withdraw the funds from your new annuity. A non-qualified annuity is one that is funded with money not
associated with a tax qualified retirement account, such as an IRA or 401k plan.
Generally, when not utilizing 1035 exchange rules, the surrender of an existing insurance contract is a taxable event since the contract owner must recognize any gain from the old contract as current income. However, under IRC Section 1035, when annuity contracts are 1035 exchanged for a new contract from a different insurance company, the transfer is considered nontaxable, provided certain requirements are met.
The full text of the law, as well as a direct link, is provided below. For the purposes of this article, we are primarily focused on item, “(a) (3) an annuity contract for an annuity contract.”
U.S. Code > Title 26 > Subtitle A > Chapter 1 > Subchapter O > Part III > Section 1035
(a) GENERAL RULES – No gain or loss shall be recognized on the exchange of—
(1) a contract of life insurance for another contract of life insurance or for an endowment or annuity contract or for a qualified long-term care insurance contract;
(2) a contract of endowment insurance (A) for another contract of endowment insurance which provides for regular payments beginning at a date not later than the date payments would have begun under the contract exchanged, or (B) for an annuity contract, or (C) for a qualified long-term care insurance contract;
(3)
an annuity contract for an annuity contract or for a qualified long-term care insurance contract; or
(4) a qualified long-term care insurance contract for a qualified long-term care insurance contract.
AnnuityAdvantage offers a free 1035 exchange evaluation service to all annuity owners, whether or not they are current customers. With this service, an AnnuityAdvantage specialist examines your existing annuity to let you know how it compares to newer products on the market. There is never any obligation or pressure, and the decision to move forward with any recommendation is always left to you.
All 1035 exchanges require serious consideration. Only after careful examination of available alternatives can you decide if a 1035 exchange makes sense for your individual situation. To get your free 1035 exchange evaluation, just give us a call; we look forward to being helpful.