Is a Section 1035 Exchange Right for You?

When you first purchased your annuity or life insurance policy, you likely had specific goals in mind. Perhaps you were seeking guaranteed growth, aiming to take advantage of tax deferral, or wanting to provide a death benefit for your family. But does your original reason still hold true today?

A Section 1035 Exchange allows you to swap one annuity or life insurance policy for another without incurring immediate tax liability. This provision can be particularly beneficial if your current policy no longer aligns with your financial objectives or performs as expected.

What if You Discover a Better Annuity Option Later On?

Purchasing an annuity is a significant financial commitment, and it's not uncommon to eventually find that a different type of annuity might better align with your evolving financial goals. Surrendering your annuity early, however, can be quite costly. You could face a potential surrender charge of up to 15 percent, along with a 10 percent tax penalty if you're under 59½ years old. Additionally, you will owe income tax on any profits or annual returns you've accumulated.

But there's good news: you can avoid the tax consequences through a Section 1035 exchange. This provision allows you to exchange your current annuity for a new one with better terms, without incurring immediate taxes, as long as the contract holder remains the same.

Benefits of a 1035 Exchange:

1. Avoid Tax Penalties:

By using a 1035 exchange, you can sidestep the immediate income tax implications and potential tax penalties, preserving more of your investment for future growth.

2. Enhanced Features:

Newer annuities often come with improved features like higher interest rates, lower fees, or additional riders such as long-term care benefits or guaranteed lifetime income.

3. Better Alignment with Goals:

An exchange allows you to select a product that better meets your current financial objectives, whether you’re looking for greater growth potential, more flexibility, or enhanced security.

4. No Immediate Out-of-Pocket Costs:

While surrender charges can be high, a 1035 exchange allows you to defer these costs by transferring your investment directly to another annuity.

Things to Consider:

1. Surrender Charges:

Evaluate any surrender charges on your existing annuity and factor these into your decision-making process.

2. New Annuity Terms:

Carefully review the terms and conditions of the new annuity, including fees, interest rates, and any restrictions or penalties.

3. Financial Advisor Consultation:

It's essential to consult with a financial advisor to understand all the implications and ensure that a 1035 exchange aligns with your overall financial plan.

If you find a better annuity option after your initial purchase, a Section 1035 exchange can provide a practical solution to avoid hefty tax penalties and optimize your retirement strategy. By enabling you to transfer your annuity without changing the contract holder, this provision helps ensure that your investments continue to grow in alignment with your financial goals while minimizing unnecessary costs. To explore whether a 1035 exchange is right for you, consult with a trusted financial advisor who can guide you through the pros and cons, ensuring your decision supports your long-term financial well-being.

Section 1035

Section 1035 of the Internal Revenue Code, which also applies to life insurance policy exchanges, governs annuity exchanges. Named for the section that regulates them, Section 1035 exchanges also allow the exchange of a life insurance policy for an annuity — but not the exchange of an annuity for a life insurance policy.

There are important restrictions on 1035 exchanges. You may use it only to roll one annuity over into another annuity. If you try to cash out your annuity and use the money to purchase another annuity, the law won’t cover that exchange, and you will not be spared the tax consequences.

In 2013, the IRS ruled that people who inherit annuities may also qualify for a 1035 exchange, as long as they follow all the other rules for inherited annuities. For example, nonqualified annuities can’t be exchanged for qualified annuities.

The IRS allows the exchange of multiple annuity contracts for a single contract, one contract for multiple contracts, and a portion of an annuity for an alternate annuity.

Financial 411 offers a Free 1035 Exchange-Evaluation Service

that Compares Your Existing Annuity with Today's Newer Products.

A Section 1035 Exchange can be a powerful tool for optimizing your financial portfolio, but it’s essential to carefully evaluate whether it's the right move for your unique situation. Reflect on why you originally purchased your annuity or life insurance policy and determine if those reasons still apply. If not, exploring new options through a 1035 Exchange might offer substantial benefits. To find out more about how a 1035 Exchange could work for you, schedule a consultation with Financial 411 today. Together, we'll ensure your financial plan remains aligned with your goals and needs.