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I have a variable annuity with one insurance company, and a friend mentioned that I should do a 1035 exchange into another product that he has through his broker. What is a 1035 exchange?


If you cash in an insurance policy, including an annuity, the proceeds are taxable unless you take out another policy. To change policies and avoid a tax bill, the transaction has to be done between the two insurers. The one that sold you your present policy has to transfer the paperwork and any money to the new company directly, not through you. Also, you must exchange your annuity for another one. You can’t trade it in for a conventional life insurance policy. If these criteria are met, it’s considered a 1035 exchange, a reference to the relevant section of the U.S. Tax Code. One other factor to bear in mind: If there’s a discrepancy in the values of the two contracts, there’s no present tax liability, but the cost basis – how much you’re deemed to have paid for the policy – changes, and that can mean paying more or less tax in the future. All of this, by the way, has nothing to do with the merits or lack of them of the annuity touted by your friend and his broker. That’s a separate issue. I would ask for a lot of details if I were you.

-Conrad de Aenlle