A 1035 annuity exchange is a tax code provision that enables you to transfer funds from annuities to a new policy tax-free.
Read our article on annuities for general information on how annuities work.
So, if you have annuities and are interested in a 1035 exchange, read on. In this article, we will cover:
In general, you can utilize tax-free annuity exchanges between products of the same type.
For example, you can exchange a life insurance policy for another life insurance policy. Or, you can exchange a non-qualified annuity for another, and so forth. This is why they are often referred to as a “like-kind exchange”. “1035 exchange” refers to the fact that it is section 1035 of the IRS code.
To conduct an exchange of your annuity contracts, you generally will have to follow the following steps.
For the last step, you will have some more paperwork to do. Your former annuity issuer will send you a Form 1099-R which you will need to fill out. Your new annuity issuer will also send either a Form 1099-R or a Form 1099-Q.
These will need to be included in your tax returns for the financial year during which the exchange took place. So if the 1035 exchange took place on January 1st, 2023, you will report it in your 2023 tax returns.
The most important rule is that you change one contract for a like-kind contract, as we explained.
This applies to fixed vs variable annuities as well. You cannot exchange a fixed annuity for a variable annuity.
In the same way, you cannot exchange an immediate annuity for a deferred annuity. An immediate annuity sees payments commence immediately after purchase. A deferred annuity, however, sees contributions spread out over a specified period. Payments are received later, often in retirement.
Apart from the “like-kind rule”, there are a few others.
The funds must always be transferred from the former issuer to the new one.
You, as the holder cannot receive any money or other property from the exchange.
There are few immediate incentives for a 1035 exchange, so they should not be viewed as a short-term path to money.
You cannot exchange ownership over the contract.
The exchange is undertaken by you, and you are thus the owner of the new contract as well. A 1035 exchange is for the actual contract, not for ownership.
You must report each exchange as a part of the tax year during which it took place.
The former issuer will send a 1099-R and the new one will send you either that or a 1099-Q.
Yes.
The 1035 annuity exchange was created in part as a way to enable you to avoid taxes and penalties.
Normally, you would have to pay a 10% early withdrawal penalty on an early annuity withdrawal. For the IRS, “early” means before age 59½.
In some cases, the issuer will also charge a surrender charge for early withdrawals, under specified circumstances. Read your contract for more information on surrender charges.
All in all, a 1035 exchange is an exception to a general rule: you aren’t meant to withdraw early.
One benefit is that there are no limits on the number of 1035 exchanges you can do in one year.
So long as you follow the rules, you may make as many as you’d like.
A 1035 annuity exchange is a complex process, however. You probably won’t look forward to the idea of going through the process multiple times. But if you need to make many exchanges, you can take as little or as much time as you need.
A 1035 annuity exchange is a great way to exchange an annuity contract you have for another of the same type without incurring penalties.
The process takes some time and there are some rules you need to follow. But if you want to make an exchange, this is the way you can avoid the heavy penalties that would normally be incurred.
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