FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client has a nonqualified variable annuity issued five years ago and wants to move the funds to a new variable annuity with a different insurance company. Which of the following allows for a tax-free transfer of assets between these two annuities?
- ATransfer-on-Death (TOD)
- BDirect Rollover
- CWithdrawal and Reinvestment
- DSection 1035 Exchange
Show answer & explanationAnswer & explanation
Correct answer: D. Section 1035 Exchange
A Section 1035 Exchange allows for the tax-free transfer of cash value from one annuity contract to another annuity contract, or from an annuity to a life insurance policy, or from a life insurance policy to an annuity. This is a common way to switch annuity providers without triggering a taxable event.
Why the other options are wrong
- A. Transfer-on-Death (TOD) is a beneficiary designation for transferring assets upon death, not for live exchanges.
- B. Direct rollovers typically apply to qualified retirement plans (e.g., 401(k) to IRA), not nonqualified annuities.
- C. A withdrawal would trigger ordinary income tax on any gains, and potentially a 10% penalty if the client is under 59 1/2.
Section 1035 Exchange
A Section 1035 Exchange is a provision in the U.S. tax code that allows for the tax-free transfer of funds between certain types of insurance and annuity contracts without incurring current income tax on any gains.
- Applies to life insurance, endowment, and annuity contracts.
- Must be directly transferred between insurers.
- Avoids current taxation of gains.
Memory trick: 1035 Exchange: Switch Annuities without a Tax Twitch.