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Understanding Section 1035 Treatment of Exchanges
By Dr. David Edward Marcinko MBA CMP™
www.CertifiedMedicalPlanner.org
[Publisher-in-Chief]
With the passage of the Tax Equity and Fiscal Responsibility Act, back in 1982 (TEFRA), insurance companies were required to report the payment of all surrender proceeds, forcing physicians and all individuals to be more compliant in reporting gains on the surrender of an old policy. As a result, insureds took advantage of IRC Section 1035 and made tax-free exchanges of insurance, endowment, and annuity contracts. If the exchange is structured properly, gains (and losses) on the surrender of an old policy must be deferred beyond the life of the policyholder.
Section 1035 Treatment
The following types of exchanges qualify for tax-free treatment:
1. A life insurance contract for another life insurance, annuity, or endowment contract
2. An endowment contract for an annuity contract or for another endowment contract in which the payments begin at a date no later than the date that payment would have begun under the original contract
3. An annuity contract for another annuity contract
However, to the extent that money or other property (“boot”) is received by the insured in a 1035 exchange, gain may be recognized to the extent of the “boot.” The new policy received takes the basis of the old contract exchanged, decreased by the value of boot received, and increased by any gain required to be recognized.
Limits
Unlike exchanges subject to Section 1031, in which there is a 180-day limit, there is apparently no statutory time limit for completing an exchange under Section 1035. However, be careful in the case of an exchange of immediate annuity contracts in which the annuity starting date must begin no later than one year from the date of the purchase of the annuity. When an exchange has occurred, the holding period of the original contract attaches to the new contract. Therefore, the insured may not have begun to receive the annuity within one year from the date of the annuity’s purchase, and therefore, the 10% premature withdrawal penalty may apply.
Section 403(b) Annuities
The IRS has even allowed tax-free exchange of Section 403(b) annuities provided the new contract’s distribution restrictions are at least as stringent as those of the old contract. And, distributions from financially troubled life insurance companies, if reinvested within 60 days of receipt, can qualify for 1035 treatment. But, in most cases, a doctor or taxpayer should undertake a direct exchange whenever possible.
Note: “Nontaxable Exchanges of Insurance Contracts and Annuities Under Section 1035,” John C. Zimmerman and Tamara K. Kowalczyk, Journal of Taxation of Investments, Summer 1997, pp. 307–315, Warren, Gorham & Lamont, (800) 950-1205.
Conclusion
And so, your thoughts and comments on this ME-P are appreciated. Have you ever made this sort of exchange; successful or not? Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.
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Filed under: CMP Program, Financial Planning, Insurance Matters | Tagged: david marcinko, IRS Section 1035 Exchanges, IRS Section 1035 Treatment, Section 1035, Section 403(b) Annuities, TEFRA, www.certifedmedicalplanner.com |
The Leading Business Education Network for Doctors, Financial Advisors and Health Industry Consultants 
I would like to meet you and discuss our opportunity in multiline / financial services.
We are growing in Ga and have an attractive comp.
Andy Tipaldos
American National
Managing Gen Agent
912-267-9884
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Andy,
American National opportunity – Is this a fiduciary position of trust?
Ann Miller
It is an Insurance Agent/Agency position; 1099, marketing auto, home, life and other financial products. See http://www.anpac.com for more info.
Call me if this is a fit.
Thank you
Andy Tipaldos
912-267-9884
Ann Miller
It is an insurance agent position, requires GA insurance license. Agents do business in position of trust and responsibilities. I tried to call you to explain and left voice mail.
Call me I can answer fully. Not sure what you are asking.
Thanks
912-398-6507
Andy
Very simply, is an insurance agent a fiduciary? Does he/she work for the company, or the client? Whose interest is put first?
Ann Miller
The client. We protect what the client values most.
See http://www.anpac.com
If further interest to contract:
Step 1, test
Step 2, app, credit/background
Do you have GA lic, series 6 , 63?
Thanks
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Andy,
Sorry, but you are misinformed. So, please let me see if I can clearly help you understand a few things that apply here:
First, Registered Investment Advisors (RIAs), who are entities that charge fees to give advice to clients, are legally bound to act as fiduciaries and always put the clients interests before their own.
Second, Brokers, who earn commissions, are currently not held to this standard, whether they give advice or not, if they are selling a product for a commission.
Insurance Agents, who sell products for a commission, are not held to the standard of acting as a fiduciary.
Ann Miller RN MHA
[Executive-Director]
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Update on 1035 Exchanges
Named after Section 1035 of the Internal Revenue Code, a 1035 exchange allows life insurance policy owners (and annuity contract owners) to exchange an old policy (or contract) for a new one from a different insurance company without tax consequences. Of course, the exchange must meet the requirements of Section 1035 in order for the transaction to be tax-free. This strategy can be especially beneficial to a person who purchased a life insurance policy or annuity contract many years ago that has less favorable contract stipulations than those available today.
A 1035 exchange applies only when it involves the same contract holder and the same type of contract. It gives the contract owner the flexibility to find another contract that features lower costs, a higher death benefit, or more investment choices. The cost and availability of insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before surrendering your “old” life insurance policy, it would be prudent to make sure that you are insurable.
Investors can also do partial 1035 exchanges for a portion of the total contract amount. In this case, the transferring company should notify the new company of the exchange amount that is investment versus gain, because any gain is subject to ordinary income taxes when withdrawn. Some companies do not recognize partial 1035 exchanges for tax reporting purposes. A tax professional should be consulted to properly track these amounts in the contract.
Nonetheless, a 1035 exchange can be an effective tool for contract holders who want to exchange older contracts for current, more useful ones.
The rules governing 1035 exchanges are complex, and you may incur surrender charges from your “old” annuity contract or life insurance policy. In addition, you may be subject to new sales, mortality and expense charges, and surrender charges for the new contract or policy.
Annuities have contract limitations, fees, and charges, which can include mortality and expense risk charges, sales and surrender charges, investment management fees, administrative fees, and charges for optional benefits. Annuities are not guaranteed by the FDIC or any other government agency; they are not deposits of, nor are they guaranteed or endorsed by, any bank or savings association. Any guarantees are contingent on the claims-paying ability of the issuing insurance company. Withdrawals reduce annuity contract benefits and values. The investment return and principal value of an investment option are not guaranteed. Because variable annuity subaccounts fluctuate with changes in market conditions, the principal may be worth more or less than the original amount invested when the annuity is surrendered.
Chester
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MetLife Annuities
MetLife has been fined $20 million by Wall Street’s policing body for misleading customers in switching them from variable annuities contracts into more expensive ones.
http://www.msn.com/en-us/money/companies/metlife-fined-dollar20-million-for-misleading-annuity-customers/ar-BBsASwb?li=BBnbfcN&ocid=U348DHP
Chet
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