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1035 Exchange: Tax-Free Transaction for Your Fixed Annuity

A 1035 Exchange is a process of replacing an insurance-related asset with another. The term was derived from Section 1035(a) – (d) of the IRS code, which sets the ground rules for the 1035 Exchange.

Section 1035 of the IRS Code

When applied to fixed annuity, 1035 Exchange refers to the tax-free transfer of an annuity contract from an insurance company to another insurance company.  Under the Internal Revenue Service Code (IRS), individuals are allowed to make a tax-free transaction in which they exchange insurance-related assets that are of “like and amount” for each other.

Thus, if one already has a fixed annuity contract but he/she wants to make a new fixed annuity contract with another insurance company, he/she should apply for a 1035 Exchange. The value of his/her old annuity account will be transferred over to his/her new annuity contract.

The 1035 Exchange Process

FindAnnuitiesAlthough participants in a 1035 Exchange do not have to worry about paying tax, they have to go through a lengthy process.

1.  The consumer must apply for a new annuity plan. In the application, the consumer indicates a new company as the trustee of his/her annuity funds.

2. The new insurance company sends the 1035 Exchange application to the consumer’s previous annuity company. The company also attaches a letter requesting for the transfer of the consumer’s funds.

3. In the next step, which is termed as a period of conservancy, the previous company attempts to win back the patronage of the customer.

4. When these attempts are proved to be in vain, the old company directly transfers the consumer’s funds to the new company. The old company also provides information about the consumer’s previous annuity contract. This information will be used to compute taxes when the consumer withdraws income from the new annuity.

5. In the compliance stage, the new company confirms that

the owner and the beneficiaries of the previous annuity and the applicant of the new annuity are the same individuals.

6. The new annuity contract can be issued once compliance has been confirmed.

The 1035 Exchange as a Benefit

The 1035 Exchange gives consumers more power over their right to a high quality and profitable annuity. It makes them more powerful against insurance companies that take advantage of consumers and that do not give them the proper annuity rate and income. Because the provision enables consumers to transfer over their accrued annuity value to their new annuity contract without being subjected to taxation, it drives insurance companies to generate annuity proposals that offer the best annuity features for consumers.

Applying for a new insurance plan is also of extreme importance, especially in regard with financial concerns. This is especially true when the consumer’s health status and lifestyle have changed since the acquirement of his/her old insurance asset. To elaborate on this, let us use an example. Let us say that the consumer has a whole-life insurance policy. At the time of his/her acquirement of this policy, he was a smoker. Because he was a smoker, he had to pay a high premium. Today, however, he/she does not smoke anymore. Because he/she is already a non-smoker, he/she should pay a premium that is lower than the premium stated in the insurance contract. However, the premium stated in the contract is not subject to a change in the consumer’s lifestyle. In order to save on his/her insurance premium, he/she should apply for a new policy. By employing the 1035 Exchange provision, the consumer might not even have to pay a single penny for the transaction. His/her old insurance policy will simply be cancelled and its accrued value will be turned over to the new policy.

The 1035 Exchange and the Economy

The 1035 Exchange provision promotes economic competence. First, it pushes for a high quality insurance asset, like an annuity. Because consumers can exchange an unprofitable asset for an asset that is deemed more profitable, the 1035 Exchange heightens the economic competence between insurance companies. The resulting tight economic competence then drives each insurance company to produce high-quality annuity proposals that will attract more consumers and that would make their old clients keep their trust and confidence in the company. Second, the 1035 Exchange provision helps remove economic inefficiency by allowing consumers to exchange assets that are closely substitutable without being discouraged by taxation. This may guarantee that unproductive annuity plans available in the market will eventually be eliminated if consumers will watch their backs in the annuity game and take advantage of the 1035 Exchange provision.