An investor exchanges an existing deferred variable annuity contract for a new deferred variable annuity contract issued by a different insurance carrier under Section 1035 of the Internal Revenue Code. Which of the following statements correctly describes the tax treatment and contract fee consequences of this transaction?
- The transaction is non-taxable for federal income tax purposes, but the surrendered contract may still be subject to insurance company surrender charges.Answer
- BThe exchange triggers an immediate 10% IRS early withdrawal penalty on accumulated growth if the contract owner is under age , regardless of how the funds are transferred.
- CThe 1035 exchange provision automatically waives all insurer surrender fees and resets the cost basis of the contract to current market value.
- DThe exchange is fully taxable as ordinary income on all earnings, but the issuing company waives the prospective mortality and expense risk fees for the first contract year.
Answer
A Section 1035 exchange allows an annuity owner to exchange one contract for another without recognizing immediate gain or loss for federal income tax purposes. However, the transaction remains subject to any contingent deferred surrender charges imposed by the surrendering insurance company.
Under Section 1035 of the Internal Revenue Code, an investor can exchange one annuity for another on a tax-deferred basis without triggering immediate tax liability or the 10% IRS early withdrawal penalty. However, IRS rules do not override contract terms with the insurance company, meaning surrender charges may still apply if the existing contract is within its surrender period.
Step-by-Step Solution
Key Concept
Section 1035 Exchange Mechanics and Surrender Charge Distinction
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