Tax Rules on Partial 1035 Exchanges 2011

New Nonqualified Annuity Partial Exchange and Annuitization Rules

IRS Rev. Proc. 2011-38 addresses partial 1035 exchanges and partial annuitizations of nonqualified annuities that occur Oct. 24, 2011 and later as follows:
  1. IRS Rev. Proc. 2008-24 established a 12-month period during which withdrawals could not be taken from a nonqualified annuity contract involved in a partial 1035 exchange without resulting in the exchange being treated as a taxable distribution, rather than as a nontaxable 1035 exchange.

    Rev. Proc. 2011-38 reduces this time period to 180 days.

  2. Previously, exemption from treatment as a taxable distribution required meeting qualifying exceptions, such as an owner attaining age 59, death, disability or a life event (i.e., divorce or job loss) occurring between the date of the partial 1035 exchange transfer and the date of the withdrawal or surrender of a contract involved in a partial 1035 exchange.

    Meeting an exception is no longer required.

  3. Limitations on withdrawals from an annuity involved in a partial 1035 exchange within 180 days of its funding do not apply to
    • amounts received as an annuity paid for a period of 10+ years.
    • annuity payments based on one or more lives.

  4. Automatic treatment of a transfer as either a tax-free 1035 exchange or a taxable distribution followed by payment for a second contract is eliminated. Now, if a portion of a nonqualified annuity is transferred from its issuing company to a nonqualified annuity issued by the same or another insurance company, and a withdrawal is taken from either contract within 180 days, the IRS will determine how to treat this annuity distribution for income tax purposes on a case-by-case basis by applying general tax principles.
Partial Exchanges and Transfers

This communication is to reiterate our business rules concerning the use of a contract's free amount to fund 1035 exchanges or qualified transfers:


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