An investor, age 57, exchanges a non-qualified variable annuity contract purchased five years ago for a new variable annuity contract offering enhanced rider options. The surrendered contract is subject to a seven-year surrender charge schedule. Which of the following statements correctly describes the tax and financial implications of executing this transaction under Section 1035 of the Internal Revenue Code?
- The transaction avoids immediate federal income tax on accumulated growth, but the investor remains liable for any contractual surrender fees imposed by the surrendering insurer.Cevap
- BThe transaction triggers ordinary income tax and a 10% IRS tax penalty on accumulated growth because the contract holder is under age .
- CThe insurer's surrender charges are automatically waived by federal law whenever an exchange qualifies for Section 1035 tax treatment.
- DThe transaction qualifies for tax deferral and surrender fee exemption only if the liquidation proceeds are deposited directly into an Individual Retirement Account (IRA) within 60 days.
Cevap
The transaction avoids immediate federal income tax on accumulated growth, but the investor remains liable for any contractual surrender fees imposed by the surrendering insurer.
Under Section 1035 of the Internal Revenue Code, exchanging one non-qualified annuity contract for another allows the owner to defer federal income tax and avoid the 10% IRS early withdrawal penalty on built-in gain. However, IRS tax-deferral privileges do not affect the terms of the private insurance contract; therefore, any applicable surrender charges (contingent deferred sales charges) from the original insurer still apply.
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Section 1035 Tax-Free Exchanges and Surrender Charge Mechanics