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.
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.
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?
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?
Surrender Fees or Limitations of the New Policy: What will be the new surrender fees with the new policy you purchase?
Interest Rate/Payout of the Old and New Policy: What’s the difference in rates between the new and old policy?
Financial Strength Ratings of the Insurer Issuing Both the Old and New Policy:
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.
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.
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.
Here is the process to exchange an annuity:
The 1035 process will vary depending on what kind of annuity you are exchanging from and into.
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.
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 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.
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:
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:
Multiple Contracts: Multiple contracts can be exchanged for one contract, however, one contract may not be exchanged for multiple contracts.
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.
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:
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.
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.
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