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What Is a 1035 Exchange?
Named after Section 1035 of the Internal Revenue Code, a 1035
exchange allows life insurance policyowners (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, it 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.
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gain, because any gain is subject to ordinary income taxes when withdrawn.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 and surrender charges
for the new contract or policy.
Annuity withdrawals are taxed as ordinary income and may be
subject to a 10% federal income tax penalty if made prior to age 59˝.
Surrender charges may also apply during the contract’s early years. Variable
annuity subaccounts fluctuate with changes in market conditions; when the
annuity is surrendered, the principal may be worth more or less than the
original amount invested.
Variable annuities are sold only by prospectus. Please
consider the investment objectives, risks, charges, and expenses carefully
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.
© 2007 Emerald Publications
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