What is an IRS approved 1035 Exchange?
An annuity exchange, also known as a 1035 exchange, is a tax-free way to replace an annuity contract with a new one:
How it works
Funds are transferred directly from the old contract to the new one, without the owner receiving a check for the old contract. The owner and annuitant on the new contract must be the same as the old contract, but can be changed after the exchange.
Benefits
A 1035 exchange allows you to trade in an old policy for a newer one with better features, while keeping the original cost basis and tax-deferred status.
When to consider
You should consider how the exchange may impact your financial plan. For example, you might want to think about whether the new policy offers better features, or if there are any waiting periods before benefits can be paid.
When to act
Insurers typically send a letter with a 30-day window to make an exchange. The 1035 exchange process can take 1–3 weeks, so it's best to act early in the window.
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. NOTE: tax is due on interest gain only when you withdraw money.. Not exchanging
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of the exchange amount that is investment versus gain, because any gain is subject to ordinary income taxes when withdrawn.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 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. © 2024 Broadridge Financial Solutions, Inc.
