What is a 1035 Exchange?
A 1035 exchange allows you to use an existing annuity or life insurance policy to buy another annuity policy without creating a taxable event. To qualify as tax-free, the funds must move directly from one insurance company to another. If the money is paid to you first, the transaction may become taxable.
Some policies (such as income annuities) are irrevocable and therefore cannot be transferred within a 1035 transaction.
1035 Exchange Considerations
When does a 1035 exchange make sense?
- Your existing policy is reaching the end of its guaranteed investment term
- Your existing policy isn't optimized for your goals
- A new policy can provide a greater benefit for the same or less cost
What's important to review before completing a 1035 exchange?
- Potential surrender charges on your current contract
- Whether you'll lose existing benefits or riders
- The terms of the new contract
- Any changes to withdrawal rules or guarantees
Should I do a full or partial 1035 exchange?
A partial 1035 exchange occurs when only a portion of an annuity’s value is transferred into a new annuity while the remaining balance stays in the original contract. When done correctly, the transferred amount can retain its tax-deferred status. Partial 1035 exchanges apply to non-qualified annuities only.
One of the most important rules is the IRS “180-day rule.” If you take a withdrawal from either the original annuity or the new annuity within 180 days of completing the partial 1035 exchange, the IRS may treat the transaction as a taxable distribution rather than a tax-free exchange. The IRS adopted this rule to prevent investors from using partial exchanges as a way to access gains tax-free.
1035 Exchange Taxation
A 1035 exchange allows you to transfer funds from one annuity or insurance contract to another without paying taxes at the time of the exchange. The primary tax advantage is that any gains in your existing contract continue to grow tax-deferred rather than becoming immediately taxable.
Key Tax and Financial Considerations
No Immediate Tax
If completed properly, a 1035 exchange does not trigger current income taxes. To qualify for tax-deferred treatment, the funds must move directly from one insurance company to another. Taxes are generally deferred until you begin taking withdrawals from the new contract.
Like-Kind Requirement
The IRS only permits certain types of tax-free exchanges. You can exchange life insurance for life insurance, life insurance for an annuity, or an annuity for another annuity. You cannot exchange an annuity for a life insurance policy tax-free.
Carried Over Cost Basis
The cost basis (amount invested) from the old policy transfers to the new policy, keeping future tax liability deferred.
Loans and "Boot"
If a loan on the old policy is not carried over, it is often considered "boot" (taxable income) and may be taxed as ordinary income.
Surrender Charges
Even though the exchange may be tax-free, your current annuity or insurance policy may impose surrender charges or other fees for transferring funds before the contract term ends.
Ownership Requirements
The owner and insured person must remain the same on both policies to maintain tax-free status.
What to Avoid
Receiving the Funds Yourself
The funds must go directly from the old insurer to the new one to preserve tax-deferred treatment.
Early Withdrawals After a Partial Exchange
A partial 1035 exchange allows you to move a portion of an existing annuity into a new annuity without immediate tax consequences, provided no withdrawals are made from either contract within 180 days. If this 180-day rule is violated, the IRS may treat the transfer as a taxable distribution.
Failing to Report a 1035 Exchange on a Tax Return
Even though a 1035 Exchange is tax-deferred, it must be reported on a tax return. When funds are transferred between insurance companies, the transferring carrier will typically issue Form 1099-R to document the transaction. If the exchange occurs within the same insurance company, the carrier may not issue a 1099-R. Even in this case, it's important to maintain records of the exchange and ensure it is properly reflected on your tax return if required.
Existing Policy Information Needed for an Exchange
When applying with Blueprint Income online, you will be expected to provide funding source information. With a 1035 exchange, we will ask for the following:
- Product Name
- Issue Date (the date you purchased the annuity you're replacing)
- Contract/Policy Number
- Fund Type (specify if the annuity you're replacing was purchased with retirement or personal funds)
- Annuity Owner and Joint Owner (if any)
- Current Annual Interest Rate
- Minimum Guaranteed Rate
- Initial Premium
- Current Value
- Death Benefit Available (if any)
- Surrender Charge Amount (if any)
- Reason for Replacing Annuity
- Designate Partial or Full Transfer
With Blueprint Income, you can compare options and apply online today. You can also connect with a licensed annuity specialist who can answer any questions.
Need help?
Schedule a call with one of our annuity specialists to learn about your options and determine which annuity may be right for you. Also see our full list of FAQs.
For assistance with your online experience, please call (888) 867-7620.