Section 1035 Exchange
What Is a Section 1035 Exchange?
A 1035 exchange is a provision in the Internal Revenue Service (IRS) code considering a tax-free transfer of an existing annuity contract, life insurance policy, long-term care product, or endowment for another of like kind. To fit the bill for a Section 1035 exchange, the contract or policy owner must likewise meet certain different requirements.
Both full and partial 1035 exchanges are permitted, albeit a few rules will shift by company. Normally, 1035 exchanges between products inside a similar company are not reportable for tax purposes as long as the IRS models for the exchange are fulfilled.
Section 1035 exchanges generally expect that the transaction include a similar type of insurance product.
How a Section 1035 Exchange Works
The primary benefit of a section 1035 exchange is that it lets the contract or policy owner trade one product for one more with no tax outcome. Like that, they can exchange obsolete and failing to meet expectations products for fresher products with additional attractive elements, like better investment options and less restrictive provisions.
Moreover, a section 1035 exchange allows policyholders to safeguard their original basis, even on the off chance that there are no gains to be deferred. For instance, Joe Sample invested a total of $100,000 (cost basis) in a non-qualified annuity and consequently took no loans or withdrawals. But since of poor investment performance, its value dropped to $75,000. Disappointed, Joe chose to transfer his funds into one more annuity with another company. In this scenario, the original contract's cost basis of $100,000 turns into the new contract's basis, albeit just $75,000 was transferred.
In spite of the tax benefits, 1035 exchanges don't acquit contract owners of their obligations under the original contract. For instance, insurance companies commonly don't defer surrender charges for 1035 exchanges. In any case, assuming the owner exchanges one product for one more inside similar company, the fees might be postponed.
A 1035 exchange must generally happen between products of like kind, like life insurance for life insurance or a non-qualified annuity for a non-qualified annuity. Life insurance can be exchanged for a non-qualified annuity, yet a non-qualified annuity can't be exchanged for a life insurance policy. The 2006 Pension Protection Act (PPA) additionally modified IRC section 1035 to incorporate exchanges from life insurance policies and non-qualified annuities into traditional and hybrid (life insurance or annuity) qualified long-term care (LTC) products.
The new product for which a modified endowment contract (MEC) was exchanged will likewise be a MEC. The 1035 exchange doesn't change that status.
Under a 1035 exchange, the contract or policy owner can't take constructive receipt of the funds and afterward use them to buy another policy. The money must be transferred straightforwardly. To additionally qualify, the annuitant or policyholder must continue as before. For instance, a 1035 exchange from an annuity owned by Joe Sample can't be exchanged into an annuity owned by Jane Sample or into a joint annuity owned by Joe and Jane Sample.
Tax treatment contrasts for partial exchanges in that a portion of the cost basis is allocated to the new product as opposed to every last bit of it.
Features
- The 2006 Pension Protection Act modified the law to permit exchanges into long-term care products.
- Life insurance policyholders can utilize a section 1035 exchange to trade an old policy in on another one with better elements.
- Section 1035 of the tax code takes into account tax-free exchanges of certain insurance products.
