1035 Exchange of Life Insurance or Annuity polices
IRS 1035 Exchange of Annuity or Life Insurance
Maryland Annuity Resource offers 1035 Exchange services for resident that currently own either a Life Insurance policy or Annuity contract in Maryland, Washington D.C. and Virginia. IRS regulation 1035 allows for the tax free exchange from one like kind policy to another like kind policy but there are some things to consider before jumping the gun to a newer policy.
How to avoid tax on the gain of the older contract
If you surrender of an existing insurance contract it is considered a taxable event since the contract owner must pay tax on any gains received in the old contract. According to IRC Section 1035 when one insurance like kind policy is exchanged for another, the transfer will be nontaxable, as long as you follow the rules. There are very strict rules to follow and the exchange must take place between the two insurance companies. You as the policy owner cannot request a check, then open a new account with a different insurance company. If you already closed another account or requested a check, you will most likely not qualify for a 1035 exchange and be subject to taxation on any gains within the cancelled contract.
Guidelines and Requirements for 1035 Exchanges
The policy owner of the old contract must be the same as the new contract. This applies if it is a life insurance policy or an annuity. This does not exclude any additional owners being added in the future to the new contract. The types of contract that are exchanged must be issued by an insurance company and the policies have to be like kind. You can exchange a life policy for a life policy but cannot exchange a life policy for an annuity contract.
You are allowed to take multiple policies and combine them all into one contract but again they have to be like kind. They also have to have the same owner for each policy that intends to be exchanged. The death benefit of the new policy can be lower than the old policy but beware of lowering your overall protection level.
When exchanging a deferred annuity for a newer immediate annuity does qualify qualify for 1035 exchange but avoiding the 10% penalty would require payments made after a taxpayer reaching age 59.5 years of age. There also are substantially equal periodic payments made during the life expectancy of either one owner or two will also avoid the penalty. Any payments made for less than the life expectancy of a taxpayer will most likely not avoid the penalty.
The process starts with the notice of assignment and change of beneficiary form and a notice with intent to surrender the old policy. Some carriers have specific 1035 exchange forms to handle the changes so please check to make sure you inform me that the new policy will be from a surrender or 1035 exchange from an old policy. The parts or parties of the transaction are:
- The owner of the old Life or Annuity contract
- The insurer of the old Life or Annuity contract
- The new insurer of the new Life or Annuity contract
The owner will make an absolute assignment of the old contract to the new insurer by notifying the old insurer in writing. The new insurer then surrenders the old policy to the old insurer, then applies the proceeds of the life or annuity contract to a newly issued contract with the same owner as the old contract. That is the process and it is just a bunch of forms but relatively simple.
If you want to find out if you are eligible for a 1035 exchange, please contact us and we will do our best to help you.