by John Darer CLU ChFC MSSC CeFT RSP CLTC
Holders of retirement annuities may be in for a nasty surprise if they liquidate their long term tax deferred annuities for "secondary market annuities". For some it could mean hundreds of thousands in taxes!
That's because acquired structured settlement payment rights are not annuities despite the scam label that may be bestowed on them falsely suggesting they are. Whether through ignorance, negligence, commission hunger or fraud, salespeople who pitch the surrender of legitimate retirement annuities for " secondary market annuities" are not able to avail their clients of a Section 1035 Exchange that would mitigate the tax hit.
What is a 1035 Exchange?
A Section 1035 exchange replaces an annuity for a new one without tax consequences.
Section 1035(a)(3) provides that no gain or loss shall be recognized on the exchange of an annuity contract for another annuity contract. Section 1.1035-1 of the Income Tax Regulations provides "that the exchange, without recognition of gain or loss, of an annuity contract for another annuity contract under ' 1035(a)(3) is limited to cases where the same person or persons are the obligee or obligees under the contract received in the exchange as under the original contract". [Source IRS.gov }
Where is a 1035 Exchange used?
- A Section 1035 exchange replaces an annuity for a new one without tax consequences.
- This is often used to replace outdated contracts with new contracts that have better terms.
- To replace an annuity for another annuity contract with identical annuitants
- To replace a life insurance policy with another life insurance policy, endowment policy, or annuity contract
- To replace one endowment policy for an identical endowment policy or an annuity contract
- The 2006 Pension Protection Act (effective in 2010), modified the law to allow exchanges into long-term care products. All distributions from non-qualified annuities for qualified long term care expenses are tax free, regardless of cost basis whether the distributions are from your cash value component of your annuity or from your annuity's long term care extension of benefits provision.
Last updated July 21, 2023