Once you have purchased an annuity, moving or reclaiming those funds before the end of the contractual term can be challenging. However, sometimes circumstances change, and you realize that you need a different product. In this situation, consider a 1035 exchange with your insurance company.
Here is an overview of how 1035 exchanges work, including the benefits, process, and potential risks to be aware of.
What Is a 1035 Exchange?
A 1035 exchange is a non-taxable exchange on life insurance policies. In other words, instead of prematurely receiving the money from the policy and therefore paying taxes on it as income or accumulation, the money is transferred directly from one policy to another without contact.
How Does a 1035 Exchange Work for an Annuity?
A 1035 exchange can work for any two similar policies offered by a life insurance company which includes not only life insurance, but also includes annuities. In order to use a 1035 exchange for an annuity, the two annuities under comparison must be of like kind—such as a non-qualified annuity to another, different non-qualified annuity.
Benefits of a 1035 Exchange for an Annuity
Conducting a 1035 exchange for an annuity offers substantial benefits; the main advantage is that the exchange allows the contract owner to upgrade to an annuity with better features without triggering tax consequences.
If they have held their money in an annuity for many years, current annuities may come with more advantageous terms, such as better rates, that an exchange can allow them to capitalize on.
Navigating the 1035 Exchange Process
Submitting a 1035 exchange requires that you contact the insurance company currently managing your annuity. They will provide the proper paperwork to initiate the process. However, before committing to a 1035, be sure that you consider the advantages and risks.
How to Qualify for a 1035 Exchange
A 1035 exchange cannot be used for all types of annuities. Only non-qualified funds—those that you have already been taxed for—can be transferred using the 1035 process.
You must also transfer only to a like product; you cannot move a non-qualified annuity into a life insurance policy. If a product has already been annuitized and is producing payments, it is no longer eligible for 1035 exchange.
Deferrals for Tax-Free Transfers
Many annuities offer the advantage of tax deferral, thanks to which contract owners do not pay taxes until they receive their annuity accumulation as income, typically at the end of the term.
Because 1035 exchanges move directly from one annuity to another, this accumulation is never collected, and tax deferral remains intact. Thus, 1035s are non-taxable transfers.
Which Annuities Are Not Compatible With a 1035 Exchange?
Only non-qualified funds may be moved using a 1035 exchange. Annuities held in qualified retirement plans (such as 401ks) may not be transferred. Immediate annuities are similarly not compatible, because any product that has already begun annuitization may no longer be exchanged.
What to Consider Before a 1035 Exchange
Before a 1035 exchange, consider two important elements: any applicable fees and the new annuity’s terms. There is no reason to exchange if the previous annuity still aligns well with your financial goals.
Additionally, although a 1035 is not a taxable event, it does not exempt the policy owner from any applicable surrender fees or other charges associated with the original annuity.
Risks of a 1035 Exchange
The primary risk associated with a 1035 exchange comes to those who do not properly research the relevant surrender charges before initiating the process. This extra cost can come as a surprise. Additionally, if the process is not properly navigated, a tax liability may be generated.
Should the market fluctuate, your new annuity selection may no longer be the best option available, or it may not align with your goals anymore.
If you conduct a 1035 exchange from a limited liquidity annuity to one that does not contain a withdrawal provision, you also lose access to the liquidity offered by your previous product. Be sure to fully understand each element of the 1035 exchange before committing to the process.
Contact Pillar Life to See if a 1035 Exchange Is Right for You
A 1035 exchange can be an effective way to alter your financial holdings without incurring a tax bill. However, the process must be done correctly and with careful consideration to ensure favorable results.
Pillar Life Insurance offers annuities such as MYGAs that can help you organize your finances for the future without the hassle of working with a middleman. Contact Pillar Life Insurance to see if a 1035 exchange is a good option for your situation and explore annuities that may suit your goals.