The Process of Making a 1035 Exchange
A 1035 Exchange is a way to utilize a section of the IRS tax code that allows the owner of an annuity contract, endowment, or life insurance policy to exchange it for a new one, without tax consequences.* The money is passed from the old company to the new one and the policy maintains its tax-favored status. For example, let’s say you aren’t satisfied with the progress of your current annuity and would like to retrieve your funds in a lump sum. The money you receive would suddenly be subject to applicable taxes. However, if you want to maintain your tax-deferred status while replacing your current policy, you can exchange one company’s annuity for another’s using the money gained from the original annuity. So how does one go about the process of a 1035 exchange?
Step 1: Qualifications
Not every situation qualifies for a 1035 exchange. According to IRS regulations, Section 1035 applies only to exchanges in which the policies involved relate to the same insured individual. This policy doesn’t apply to the exchange of an endowment contract or annuity contract for a life insurance contract, nor an annuity contract for an endowment contract. Although such an exchange is still possible, it will recognize all gains and losses.
Step 2: Documentation
As it is with every financial decision that concerns the IRS, you’re going to have to fill out some paperwork. First, you'll need to sign documents that authorize the new insurance company to obtain your non-tax qualified money. Following this, you will sign a 1035 exchange form that designates the new insurance company as the holder of your money. Finally, you will generally need to sign a disclosure indicating that you have conducted a careful comparison of the costs and benefits of the existing policy and the proposed policy in order to determine whether the replacement is in your best interest.
Step 3: Fund Request
After all paperwork has been evaluated and approved by the necessary parties, your new insurance company will request the funds from your former company. The new insurance company will complete and send out its own paperwork, along with your signed 1035 exchange form.
Step 4: Breakup Period
Upon learning that you want to replace your existing policy your insurance company may contact you to understand your reason for replacing the policy. In an attempt to keep your business, the company may be aggressive in its attempts to convince you to keep your existing policy. Moreover, depending on state law your current insurance company may be allowed to delay the payout of the existing annuity by up to six months.
Step 5: Final Processing
Once your former insurance company officially approves your request, it will send the proceeds of your old annuity to the new insurance company along with any relevant tax reporting information (i.e., the original amount deposited). Following this step, the new insurance company will review all final documents for compliance and once everything has been approved, will issue your new contract.
Step 6: Free Look Period
Even after the new policy is issued you will still have some period of time to return the new annuity should you change your mind. Although all insurance policies come with this free look period, they vary from state to state. During this period, you can cancel your new policy and receive your money without incurring penalties or fees from the company. However, if you don't place the money into a new annuity policy, the IRS will likely charge penalty fees.
Get help from Crown Atlantic's local agents
Crown Atlantic's Nationwide Network of Independent Agents are experienced and can help you navigate through the 1035 process. Contact us today if you have questions about this process.
*We suggest that you consult with your financial advisor, tax advisor, or other financial professional before making any decisions that could impact your tax situation.