Named after Section 1035 of the Internal Revenue Code, a 1035 Exchange is the exchange of one insurance policy for a newer policy with no tax consequences. It offers an investor the opportunity to exchange an old, outdated insurance contract for a newer contract that offers beneficial features the investor now wishes to include. For example, a policy owner might choose a contract with lower costs, a higher death benefit, the drawing of monthly installments or different investment options.
A 1035 Exchange also offers tax advantages. Usually the surrender of an insurance policy is taxable, because the positive gain on the old contract is counted as income. However, a 1035 Exchange allows the nontaxable transfer of an old contract to a new contract, providing the IRS stipulations are met and the transaction is a direct exchange carried out between insurance companies.
A 1035 Exchange also preserves the adjusted basis of the original contract. The adjusted basis of a policy refers to the premiums that have been paid less any dividends or partial surrenders the policy owner has already received. Preserving the adjusted basis is advantageous to an investor when the original contract currently has a loss, because its adjusted basis is more than its current cash value.
A 1035 Exchange applies only under certain conditions. Both the old and new contracts must be held by the same policy owner and only certain types of contracts can be exchanged: life insurance, endowments and annuity contracts. An old life insurance policy can be exchanged for a new life insurance policy or a new annuity, an old endowment contract can be exchanged for a new annuity and an old annuity can be exchanged for a new annuity.
Contract holders may exchange two or more old contracts for one new contract, if the contracts belong to the same owner. Investors may also choose a Partial 1035 Exchange involving only a portion of the original contract’s amount, although any gain is subject to ordinary income taxes when withdrawn, and some insurance companies do not recognize partial 1035 Exchanges for tax reporting purposes.
The rules surrounding 1035 Exchanges are complex, and consultation with a tax professional is recommended. The cost and availability of insurance depend on factors such as age, health, and the type of contract. Make sure you are insurable before surrendering your old policy. Contracts have limitations, sales and surrender charges, administrative fees and charges for optional benefits. Annuities are not guaranteed by the FDIC or any other government agency. Annuities are not deposits of, nor are they guaranteed or endorsed by, any bank or savings association. The investment return and principal value of an investment option are not guaranteed. The principal may be worth more or less than the original amount invested when the annuity is surrendered, due to fluctuations in market conditions, and any guarantees are contingent on the claims-paying ability of the issuing insurance company.
Variable annuities are sold only by prospectus. Please consider the investment objectives, risks, charges and expenses before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.