Tax-Free 1035 Exchanges

Key Points

-A life insurance policy may be exchanged tax free for another life insurance policy, of any type. -A deferred annuity contract may be exchanged tax free for another annuity, of any type. -A life insurance policy may be exchanged tax free for an annuity. -an annuity cannot be exchanged tax free for a life insurance policy.

Quiz

Question 1 In accordance with Section 1035 of the Tax Code, which of the following exchanges is permitted on a tax-free basis? An equity-indexed annuity for an equity-indexed life insurance policy. -A deferred market-value adjusted annuity for an immediate variable annuity. A market-value adjusted annuity for a whole life insurance policy. A variable annuity for a variable life insurance policy. Sec. 1035 permits the exchange of any type of annuity product for any other type of annuity product. Question 2 Which of the following sections of the Tax Code deals with the exchange of life insurance policies and annuities? Section 2525 Section 1515 -Section 1035 Section 1045 Section 1035 of the Tax Code deals with the exchange of life insurance policies and annuities. Question 3 Which of the following best explains why Section 1035 of the Tax Code does not permit a tax-free exchange of an annuity for a life insurance policy? Allowing a tax-free exchange of an annuity for life insurance would jeopardize the financial strength of insurance companies. Allowing a tax-free exchange of an annuity for life insurance would result in the life insurance death benefit becoming taxable. The IRS wants to encourage people to own annuities, not life insurance. -Allowing a tax-free exchange of an annuity for life insurance would enable taxable annuity gain to escape taxation via the life insurance death benefit. Section 1035 prohibits the exchange of any type of annuity product for any type of life insurance product, because to do so would enable taxable annuity gain to escape taxation via the life insurance death benefit. Question 4 Grace owns a fixed annuity and wants to exchange it for a variable annuity. What must she use to be sure no taxes are imposed? -Section 1035 exchange a qualified conversion a free exchange an annuity exchange Provided the transaction complies with Section 1035 of the IRC, the exchange will avoid taxation. Question 1 Grace owns a fixed annuity and wants to exchange it for a variable annuity. What must she use to be sure no taxes are imposed? a free exchange a qualified conversion -Section 1035 exchange an annuity exchange Provided the transaction complies with Section 1035 of the IRC, the exchange will avoid taxation. Question 2 In accordance with Section 1035 of the Tax Code, all the following exchanges are permitted on a tax-free basis EXCEPT A universal life insurance policy exchanged for a whole life insurance policy. A variable life insurance policy exchanged for a deferred fixed annuity. -A fixed deferred annuity for a universal life insurance policy. A deferred variable annuity for an immediate fixed annuity. Sec. 1035 prohibits the exchange of any type of annuity product for any type of life insurance product, because to do so would enable taxable annuity gain to escape taxation via the life insurance death benefit. Question 3 In accordance with Section 1035 of the Tax Code, a deferred fixed annuity may be exchanged on a tax-free basis for all the following types of products EXCEPT a deferred variable annuity -a whole life insurance policy an immediate fixed annuity a market-value adjusted annuity Sec. 1035 permits the tax-free exchange of an annuity for any other type of annuity, but not for a life insurance policy. Question 4 The tax-free exchange of a life insurance policy for an annuity is sometimes called a Section 401(k) Exchange Section 403(b) Exchange Section 79 Exchange -Section 1035 Exchange Section 1035 of the Tax Code deals with the exchange of life insurance policies and annuities

Section 1035 Exchange

Through Section 1035 of the federal Tax Code, life insurance policies and annuity contracts can be exchanged without any gain being recognized or taxed. Such a transaction is called a 1035 exchange. For example: -A life insurance policy may be exchanged tax free for another life insurance policy, of any type. -A deferred annuity contract may be exchanged tax free for another annuity, of any type. Also, a life insurance policy may be exchanged tax free for an annuity (but not vice versa)

Allowable 1035 Exchanges

Under Section 1035, the following tax-free exchanges are allowed: -an annuity for an annuity -a life insurance policy for an annuity -a life insurance policy for another life insurance policy -a life insurance policy for an endowment policy -an endowment policy for another endowment policy (as long as the maturity date of the new policy is no later than the maturity date of the original policy) Notice that an annuity cannot be exchanged tax free for a life insurance policy. That is because annuities are eventually taxed (on their gain) while life insurance policy death benefits are exempt from taxation. Were such exchanges allowed, a person could avoid taxation on the annuity's gain by exchanging it for a life insurance policy.