A 1035 Exchange

The Free Guide in Plain English

A 1035 exchange allows you to use an existing annuity to buy another annuity policy without creating a taxable event.

In this guide, we’ll tell you everything you need to know about 1035 exchanges – how they work, the different types, and how to evaluate whether a 1035 exchange makes sense for you.

If you are interested in exchanging an annuity, you can shop our marketplaces of fixed annuities and income annuities. Our annuity professionals will help make sure your exchange makes sense and is a success.

 

What Is a 1035 Exchange

A 1035 exchange allows you to use an existing annuity to buy another annuity policy without creating a taxable event. By conforming to the rules of 1035 exchanges, you’re maintaining the tax deferred status of your annuity policy. The policy owners and annuitants will typically have to stay the same in order to comply with IRS regulations.

1035 exchanges only make sense when your existing policy isn’t optimized for your goals, if a new policy can provide a greater benefit for the same or less cost or your existing policy is maturing. The policy owner decides in the end whether to conduct the 1035 exchange after understanding the pros and cons of the choice in light of the other available options.

Some policies (such as income annuities) are irrevocable and therefore cannot be used in a 1035 transaction.

This guide describes the factors to consider when deciding if a 1035 annuity exchange makes sense, provides a step-by-step process for how to do a 1035 exchange, and answers some of the most frequently asked questions regarding a 1035 exchange.

 

Factors To Consider When Assessing a 1035 Exchange

Goals for the Annuity: Why did you buy the annuity or life insurance policy in the first place? Was it for guaranteed growth? Or were you looking to use it for tax deferral? Or to provide a benefit to your family at death? Does your reason for buying the annuity policy still apply?

  • Before considering a 1035 exchange, it’s important to look back to what your goals were when you purchased the policy and to what extent those are still your goals. Doing this first will orient you towards whether a new annuity solves your problems and which type will be most effective at doing so. A newer policy may have better rates, lower costs, be more optimized to your present predicament, have a higher death benefit, or offer more investment choices.

Surrender Fees or Limitations of the Existing Policy and Assessment of Whether Now Is the Right Time to Do the 1035 Exchange: Does your existing annuity have surrender charges? If so, what is the surrender fee schedule in the coming years?

  • Most annuities carry some kind of surrender fees, at least at the beginning. You’ll want to know your surrender fee schedule because even if your existing policy, for example, pays a lower rate of return than newer products, it may still not make sense to undertake a 1035 exchange depending on how large the surrender fee is on the old product, how much better the rate is on the new product, and how large the surrender fees are on the new product are (including how long they will remain in place).

Surrender Fees or Limitations of the New Policy: What will be the new surrender fees with the new policy you purchase?

  • You’ll probably have a new surrender fee schedule that’s longer than the one from the policy you’re replacing. You’ll want to understand this.

Interest Rate/Payout of the Old and New Policy: What’s the difference in rates between the new and old policy?

  • You’ll want to factor in the surrender fee for the forfeited policy into this calculation.

Financial Strength Ratings of the Insurer Issuing Both the Old and New Policy:

  • This is an important variable in the case of a guaranteed annuity — is the financial strength rating of the insurer better or worse with the new policy relative to the old policy?

Tax Implications of a 1035 Exchange

When conducting a 1035 exchange, there’s no tax due on the gain in the original policy when you transfer into the new policy. If you were to surrender the policy without a 1035 exchange, on the other hand, the gain from the original contract would be taxed as ordinary income.

The contract owner cannot take constructive receipt of the funds and then place them into a new policy. The money must be transferred directly from the holder of the existing product to the holder of the new one.

A 1035 exchange also allows a policyholder to preserve his or her basis, even if there are no gains to be deferred. For example, if an annuity policy purchased for $100,000 has a current of $90,000 can be transferred utilizing a 1035 exchange and have a basis of $100,000.

 

Life Insurance and Annuity 1035 Exchanges

1035 exchanges must occur between products of “like kind,” such as life insurance for life insurance, non-qualified annuity for non-qualified annuity, and life insurance for non-qualified annuity. However, a non-qualified annuity cannot be exchanged into a life insurance policy.  

Life insurance can be exchanged into another life insurance policy or into an annuity. An annuity can only be exchanged into an annuity.

For more information about using a 1035 exchange to buy a life insurance policy, refer to this article that goes into detail on the topic. 

 

1035 Exchange Fees

There are no specific fees for a 1035 exchange. But there may be fees for getting out of of your existing annuity in the form of surrender fees are typically not waived for 1035 exchanges. However, if exchanged from one product to another within the same company, it’s possible that your fees would be waived. It’s worth contacting your existing insurer to see if this is an option. Typically, 1035 exchanges between products within the same insurance company don’t need to be reported to the IRS.

Not all 1035 exchanges involve a surrender fee. For example, if a 5 year fixed rate annuity (MYGA) policy is in the renewal window or the policy is more than 10 years old, it typically will not have a surrender fee associated with the 1035 exchange.

 

Steps of the 1035 Process

Here is the process to exchange an annuity:

  1. Decide if it makes sense to 1035 your existing policy.
  2. Choose a policy to 1035 into.
  3. Contact the insurer that holds your existing policy so you understand their paperwork requirements.
  4. Fill out and submit the application for the new annuity, including a 1035 transfer request form.
  5. New contract issued.

 

Information from Your Existing Policy That Is Helpful

  • Name of the product and insurance company⇒ this may help us track down additional information
  • Surrender fee schedule⇒ this will help us determine whether a 1035 makes sense
  • Cash value or account value⇒ depending on the type of policy you have  
  • Any riders or annuitization options you know about
  • The contract, policy number, or any recent statements

 

Different Kinds of Annuity 1035 Exchanges

The 1035 process will vary depending on what kind of annuity you are exchanging from and into.

Using Proceeds from a Fixed Indexed Annuity

You can 1035 your fixed indexed annuity (FIA) into an income annuity, fixed annuity, variable annuity or another fixed indexed annuity. There are many factors to consider when deciding among these products and you should speak to a licensed representative with experience in these transactions. You could have surrender charges associated with exchanging the contract.

  • If you’re looking at an income annuity you want to compare it to specifically to your income rider (if you have one) from the fixed indexed annuity in order to understand how much income you’re going to get with the FIA vs. how much income you will get from the income annuity.  
  • If you’re looking at a fixed annuity you’ll want to ensure you are getting a rate of return guarantee that is higher than your existing policy and that if you are doing a 1035 with surrender charges, that you’re still better off.

Using Proceeds from a Variable Annuity

You can 1035 your variable annuity (VA) into an income annuity, fixed annuity, fixed indexed annuity, or another variable annuity. There are many factors to consider when deciding between these products and you should speak to a licensed representative with experience in these transactions. You could have surrender charges associated with exchanging the contract.

  • If you’re looking at an income annuity you want to compare it to specifically to your income rider (if you have one) from the variable annuity in order to understand how much income you’re going to get with the VA vs. how much income you will get from the income annuity.  
  • If you’re looking at a fixed annuity you’ll want to ensure you are getting a rate of return guarantee that is higher than your existing policy and that if you are doing a 1035 with surrender charges, that you’re still better off.

Using Proceeds from a Non-Maturing Traditional Fixed Annuity 

If your fixed annuity isn’t about to mature, you’re going to have a surrender charge. Make sure to compare how much money you’re going to have at the end of your existing policy with the amount net of the surrender charge applied at a potentially higher rate with the new policy. Unless rates have risen from the time you purchased the policy, it will make sense to wait until the policy matures before buying a new policy.

Using Proceeds from a Maturing Traditional Fixed Annuity 

If your fixed annuity is about to mature, you have the option to do a 1035, pull your money out or have it renew. If you don’t need the capital and want to keep growing your money, compare a 1035 into a new fixed annuity to a renewal with the current provider.

This is the basic process for a 1035 with a maturing policy:

  1. Know when your policy matures: Important to know exactly when it’s going to mature.
  2. Know how long you have to tell your carrier you’re doing something.
  3. Know what your renewal rate and term is: Some will put you on a month to month renewal rate (usually really low) until your policy automatically renews.
  4. Get prepared a month in advance: Your company needs to have the paperwork to do your 1035 within a set period of time after your maturity. In most cases your interest rate will fall during that time, which means if you haven’t started the process already you may be giving up money.

 

Additional Topics

Partial 1035: IRS rules allow for a partial 1035, but you’ll need to make sure that the insurance company with whom you currently have your policy will allow it. Some do not. You’ll also want to understand the tax consequences of a partial 1035. In general, a portion of the cost basis is allocated to the new product rather than all of it. The easiest way to do is to consult with a tax professional.

Owner/Annuitant: Neither the owner(s) or the annuitant(s) can be changed when doing a 1035 exchange.

All Transactions That Qualify as Like-Kind: There are several different types of exchanges that qualify for 1035 treatment, including:

  • Life insurance for life insurance
  • Life insurance for endowment
  • Life insurance for non-qualified annuity
  • Endowment for endowment, with a maturity not later than the original endowment
  • Endowment for non-qualified annuity
  • Non-qualified annuity for non-qualified annuity

Multiple Contracts: Multiple contracts can be exchanged for one contract, however, one contract may not be exchanged for multiple contracts.

 

Blueprint Income’s Role in the 1035 Process

Blueprint Income has assisted numerous clients in collecting information to assess whether to conduct a 1035 exchange into a new policy that better met their stated objectives. The process is more cumbersome and time-consuming since you have to comply with two different insurers’ business processes. The incentive for your existing annuity provider to make the process easy is especially low, which presents its own unique challenges. The Blueprint Income team can help navigate different insurers in order to ensure you provide the required information to both insurers so the transaction goes smoothly.

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Annuity Online Buying Tips

It’s now possible to make your annuity purchase online. Instead of in-person meetings and paper applications, we’ve built the technology to provide you real-time income annuity quotes and fixed annuity rates online and we generate your application for the insurer digitally. Despite our tech-enabled approach, we’re still fiduciaries, licensed to provide these products to you, and available via chat, email, or phone to provide personalized assistance.

Buying an annuity is easier when you’re equipped with the right information. In addition to being available to help walk you through the process, Blueprint Income has compiled a list of things to keep in mind:

Where to Buy a Fixed Annuity

Fixed annuities are sold via insurance agents, brokers, and financial advisors. It’s also possible to shop online for a fixed annuity via our website. Our Fixed Annuity Marketplace allows you to easily compare fixed annuities side-by-side and filter them for the specifications that meet your needs.

Get Fixed Annuity Rates

Where to Buy an Income Annuity

Income annuities are sold via insurance agents, brokers, and financial advisors. It’s also possible to shop for an income annuity online via our website. We limit our product offerings to only those sold by top-rated insurers (A.M. Best rating of at least A), and our Income Annuity Quote Tool allows you to run custom immediate annuity, longevity annuity, and QLAC quotes online in seconds.

Get Income Annuity Quotes

Help yourself to any other information in our resource center:

 

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