What the rule says
- Contract for contract. Section 1035(a)(3) provides that no gain or loss is recognized on the exchange of one annuity contract for another, when the same person or persons are the obligee under the new contract as under the old one.
- Cash you receive is taxed. If you also receive money or other property, gain is recognized up to that amount.
- Do not take the check. The IRS cites a ruling treating a check you receive and then endorse to a second company as a distribution, not a tax-free exchange.
- Basis carries over. In a partial exchange, the cost basis of the original contract is allocated ratably between the original and the new contract.
Source: IRS Rev. Proc. 2011-38 (partial annuity exchanges), which covers exchanges of annuity contracts. It does not address exchanges involving life insurance or annuities held inside IRAs, so ask the carriers which rules apply to your contract.
The 180-day rule for partial exchanges
For transfers completed on or after October 24, 2011, a direct transfer of part of an annuity’s cash value to a second annuity is treated as a tax-free exchange if no amount, other than annuity payments over 10 years or more or over one or more lives, is received under either contract during the 180 days starting on the transfer date. The revenue procedure replaced an earlier 12-month period, and it removed the earlier requirement to show a qualifying life event. If a transfer fails the test, the IRS looks at the facts and circumstances.
The traps
- A new surrender period. A new contract can start a new surrender schedule. Ask for it in writing.
- What you give up. Ask which benefits, riders or crediting terms in the old contract will not carry over.
- Withdrawing too soon. In a partial exchange, taking a withdrawal in the first 180 days can change the tax treatment.
- Replacement rules. State insurance departments regulate replacing one policy or annuity with another. Ask for any disclosure forms, and compare the old and new contracts side by side.
Where it fits with rollovers
A 1035 exchange and a rollover solve different problems. A rollover moves money between retirement accounts. A 1035 exchange swaps one annuity for another. See every rollover account at a glance and how annuities are taxed. Annuity guarantees depend on the issuing company’s claims-paying ability, so check the new carrier as well.
Thinking about replacing an annuity? Compare before you sign.
Request a no-obligation Retirement Income Review. We explain your options in plain English, with no pressure and no promises of returns.
Request my Retirement Income ReviewQuestions to ask
- Is this a full or a partial exchange?
- What surrender charge applies to the old contract, and what new schedule starts on the new one?
- Which features, riders or rates do I lose?
- Will I need to withdraw anything in the next 180 days?
- Is the transfer going directly between the two insurers?
Related reading
See fixed indexed annuities, single-premium annuities and what to ask before you move money.
Where to check these rules
Every rule on this page comes from the IRS. Read the source for your situation:
Availability and rules vary by state
Life insurance and annuity products, rates, riders and consumer protections differ by state, and a given product may not be available in every state. Honorbrook is licensed in the 11 states below; which products we can offer you depends on what carriers sell in your state. Each state’s insurance regulator can verify an agent’s license and answer consumer questions.
- Virginia: Virginia Bureau of Insurance
- Maryland: Maryland Insurance Administration
- North Carolina: North Carolina Department of Insurance
- South Carolina: South Carolina Department of Insurance
- Georgia: Georgia Office of Insurance and Safety Fire Commissioner
- Alabama: Alabama Department of Insurance
- Louisiana: Louisiana Department of Insurance
- Texas: Texas Department of Insurance
- Michigan: Michigan Department of Insurance and Financial Services
- Indiana: Indiana Department of Insurance
- West Virginia: West Virginia Offices of the Insurance Commissioner
This article is general information and is not tax, legal, investment or financial advice. Annuity guarantees depend on the issuing company’s claims-paying ability, and surrender charges and fees may apply. A licensed agent can help with your situation.