FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client owns a nonqualified variable annuity issued five years ago and wants to move the contract value into a new annuity from a different insurance company offering lower fees, without triggering current income taxation. Which provision allows this transfer?
- AA tax-free exchange under Section 1035
- BA stepped-up basis transfer under Section 1014
- CA qualified charitable distribution under Section 408
- DA rollover under Section 401(k)
Show answer & explanationAnswer & explanation
Correct answer: A. A tax-free exchange under Section 1035
IRC Section 1035 permits a tax-free exchange of one annuity contract for another (or a life insurance policy for an annuity) without recognizing gain, as long as the owner and annuitant remain the same. The cost basis and any deferred gain carry over to the new contract, deferring taxation until eventual withdrawal.
Why the other options are wrong
- B. Incorrect — stepped-up basis applies to inherited property, not lifetime exchanges.
- C. Incorrect — qualified charitable distributions apply to IRA gifts to charity, not annuity exchanges.
- D. Incorrect — 401(k) rollovers apply to qualified retirement plans, not nonqualified annuities.
Section 1035 Exchange
A tax-free exchange allowing an annuity or life insurance contract to be swapped for another similar contract without recognizing taxable gain, with cost basis carried over.
- Applies to annuity-to-annuity, life-to-life, or life-to-annuity exchanges (not annuity-to-life)
- Owner and annuitant must remain the same
- Deferred gain and cost basis transfer to the new contract
Memory trick: '10-35' lets you swap and stay tax-free — no gain recognized.