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Retirement Planning > Retirement Investing > Annuity Investing

Ask the expert: What about taxes on annuity exchanges?

By Tax Facts

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The question was: Does tax liability arise when a policyholder exchanges one annuity contract for another?

The answer is: The Internal Revenue Code provides that the following are nontaxable exchanges [IRC Sec. 1035(a)]:

(1) the exchange of a life insurance policy for another life insurance policy or for an endowment or annuity contract;

(2) the exchange of an endowment contract for an annuity contract, or for an endowment contract under which payments will begin no later than payments would have begun under the contracts exchanges;

(3) the exchange of an annuity contract for another annuity contract.

These rules do not apply to any exchange having the effect of transferring property to any non-United States person. [IRC Sec. 1035(c)]

For exchanges after 2009, an annuity contract may be exchanged for a qualified long term care insurance contract. [IRC Sec. 1035(a)(c)]

If an annuity is exchanged for another annuity, the contracts must be payable to the same person or persons. Otherwise, the exchange does not qualify as a tax-free exchange under IRC Section 1035(a). [Treas. Reg. ?1.1035-1]

The Code defines an annuity for this purpose as a contract with an insurance company that may be payable during the life of the annuity only in installments. [IRC Sec. 1035(b)(2)]

Despite the singular reference in IRC Section 1035(a)(3) to “an annuity contract for an annuity contract,” the service concluded that one annuity could properly be exchanged under IRC Section 1035 for two annuities, issued by either the same or a different insurance company. [Let. Rul. 199937042]

Further, the exchange of two life insurance policies for a single annuity contract has also been considered a proper IRC section 1035 exchange. [Let. Rul. 9708016]

The exchange of one annuity for a second annuity with term life insurance rider attached was afforded income tax-free treatment under IRC section 1035. [Let. Rul. 200022003]

A proper IRC Section 1035 Exchange also occurred where an annuity holder transferred directly a portion of the funds in one annuity to a second newly-issued annuity. [Conway v. Comm., 111 TC 350 (1998), acq. 1999-2 CB xvi.]

An assignment of an annuity contract for consolidation with a pre-existing annuity contract is a tax-free exchange under Section 1035, even though the two annuities were issued by different insurance companies. [Let. Rul. 2002-75, 2002-2 CB 812]

For more discussion, see the resource.

Source: This is an excerpt from Tax Facts on Insurance and Employee Benefits, 2009 Ed., published in 2009 by The National Underwriter Company, Cincinnati, Ohio. See pp. 29-30. Learn about Tax Facts here

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