Section 1035 Exchange

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Section 1035 Exchange

The tax-exempt exchange of two annuities or life insurance policies. The annuities exchanged are not assessed capital gains or any other taxes. Section 1035 exchanges allow a policyholder to avoid taxes that would have been levied on the first annuity or policy as long as the second is of equal or greater cost. The IRS only recognizes a Section 1035 exchange as such if the annuities or policies are directly exchanged. Selling one and buying another, for example, does not count.
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The Association recently made available a free guide for consumers detailing how Section 1035 exchanges work and how they can benefit consumers.
While Section 1035 exchanges can benefit some investors, "some financial professionals try to generate sales by persuading investors to engage in these exchanges, even when the exchange is not advisable because of surrender charges or other features that offset the benefits," Fleming said.
While Section 1035 exchanges do not make sense in all situations and the protection and coverage provided by the current contract should be carefully weighed and considered, you and I know that clients' situations do change.
It also clearly demonstrates that there may be other more flexible and economic options for existing life insurance policies than simply moving cash value from an old insurance contract to a new policy via a section 1035 exchange. This doesn't mean that section 1035 exchanges are of no value; however, it does mean that a thorough analysis is essential in order to find the right solution.
An exchange where both contracts or policies are issued by the same insurer (i.e., an "in-house" exchange) is not subject to the reporting requirements for IRC Section 1035 exchanges (3) provided that the exchange does not result in a designated distribution and the insurer's records are sufficient to determine the policyholder's basis.
Life insurance and annuity contracts can also benefit from the provisions for tax-free exchanges, which are often referred to as "Section 1035 exchanges" (after the governing Code provision).
Sales opportunities lie with prospects for Section 1035 exchanges, middle-aged consumers, and women, who constitute up to two-thirds of life/LTCI combination product purchasers.
Ron Bachrach, J.D., CLU provided valuable assistance and information in the appendix chapter on Section 1035 exchanges.
Effective after 2009, the law specifically includes qualified LTC contracts or life or annuity contracts containing qualified LTC insurance riders (or provisions) as being contracts to which, or from which, (income tax free) Section 1035 exchanges can be made.
So-called section 1035 exchanges are useful, but often overlooked, financial planning tools.
These transactions could include annuitized settlement options, IRC Section 1035 exchanges, changes of ownership, payment to a beneficiary upon the death of the annuitant/owner, lifetime withdrawals from the annuity contract etc.
The following is a checklist of the major tax traps incurred in Section 1035 exchanges: