Distribution Planning After a Partial 1035 Exchange

May 24, 2013

Are your clients considering executing a partial 1035 exchange from one annuity to another annuity?

If so, the good news is that the current tax law permits partial exchanges. However, if your client wishes to take a distribution after the partial 1035 exchange, there are issues of which you should be aware. This blog can provide you with accurate directions designed to assist your clients as they seek to avoid any unwanted results.

Have you ever driven to a place expecting to get there through streets you remembered from the past, however, due to new construction, the road no longer led you to where you wanted to go? If only you had a dependable GPS navigational system, which would have provided accurate directions to get you to your destination.  

For some advisors and clients, the quirky rules associated with partial 1035 exchanges are similar to driving these types of streets without a functioning GPS navigational system. Fortunately, Revenue Procedure 2011-38, which became effective on October 24, 2011, provides clear guidance your clients can follow to take a compliant distribution after executing a partial 1035 exchange.   

You may have a client who owns 2 non-qualified deferred annuity contracts. The first annuity was purchased a while ago and the value has grown significantly, while the second annuity was purchased more recently and is relatively small in value. The client is now ready to begin taking income from their first annuity, however they do not need income based on the entire contract value. What to do? You may suggest executing a partial 1035 exchange from annuity 1 to annuity 2. This sounds like a great idea, however there are a couple things you and your client need to be aware of in order to avoid adverse tax consequences – there is typically a waiting period before a distribution can be taken from either annuity after executing a partial 1035 exchange.

Revenue Procedure 2011-38 outlines 2 options for taxpayers who are looking to take distributions after executing a partial 1035 exchange.

  1. The taxpayer must wait at least 180 days after a partial 1035 exchange before they can take a distribution from either contract.
  2. The taxpayer can annuitize one or both of the contracts for a period certain of 10 years or more, or for one or more lives.

If the taxpayer does not comply with either of these options, the IRS will apply general tax principles to determine the treatment of the transfer.

So, like the GPS navigational system, Revenue Ruling 2011-38 provides accurate directions to assist you and your clients regarding when to take a compliant distribution after executing a partial 1035 exchange.

You can also pull over and ask for directions by contacting the Retirement Strategies Group at (800) 722-2333, ext. 3939  or RSG@pacificlife.com for more information regarding these rules.

Picture of Steve Chmelka

Steve is a Senior Retirement Strategies Consultant with the Retirement Solutions Division at Pacific Life. He brings more than 25 years of industry experience in financial planning and wealth management, including detailed knowledge of both employer-sponsored retirement plans and retirement-planning strategies.

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