1035 Exchange - variable annuity

[shERPA]

Individual currently owns a non-qualified VA, he is the owner and annuitant, contract had a ratchet and guaranteed minimum withdrawal benefit.  The ratchet has expired so he is looking at exchanging into a new 
VA contract.  

The current contract has the owner as the annuitant and his spouse as designated beneficiary.  He is looking at exchanging into a VA where he will be the owner and he and his spouse will be joint annuitants.  Does this qualify for a 1035 exchange?   Best I've found in trying to research is that the Service has not directly addressed this.  The wording in the code and regs is vague at best, saying: 

The exchange, without recognition of gain or loss, of an annuity contract for another annuity contract under section 1035(a)(3) is limited to cases where the same person or persons are the obligee or obligees under the contract received in exchange as under the original contract.

Clearly the current owner/annuitant would be the same obligee.  But is the spouse, who is currently the designated beneficiary in the existing contract an "obligee", as she would be under the new joint contract?

Thanks.

[Bird]

I'll admit I'm not sure but I don't think it matters.  Having said that...does it really matter who is/are the annuitant(s)?  I'd be inclined to match up the old and new exactly just to be safe.  

[shERPA]

Thanks.  Well it's apparently important to IRS that the contract have the same "obligees" to qualify for the 1035 exchange.   Going from the same two people as annuitant/beneficiary to joint annuitants just doesn't appear to be specifically addressed.  But it doesn't seem like much of a stretch.  Either way if the primary annuitant dies the contract is "obligated" to pay the spouse, it's just a matter of what is paid to the spouse, either the remaining account balance, or a continuing annuity for life. 

Spouse has family history of relatives living well into their 90s, they have savings, 401(k), etc. but no other guaranteed income that cannot be outlived except social security.  So setting up the new annuity as a JSA seems like a good idea.

This is not really my area, but the question came up, I did some quick research, didn't find anything conclusive, hence the posting here. 

[Michael Devault]

Can you determine how the existing company will report it to the IRS?  If they code the 1099-R as a 1035 exchange, you're good to go.  Most likely, they will because transfers among spouses are not taxable events.  Plus, companies tend to view the "obligee" as the contract owner, since the owner is the one that controls the contract.

If they decide not to code it as desired, a potential work-around will be to have the new contract issued with the same annuitant and owner designations.  Then, once issued, have the new company re-issue the contract with joint annuitants.

HTH

[shERPA]

Thanks, I will suggest they check on this.

I guess this does raise a related question.  Forget about the exchange, suppose an existing policy is changed to add a joint annuitant spouse - does this need to be treated as an exchange or is it as simple as updating a beneficiary designation, which has no tax ramifications.  

[Michael Devault]

I would argue that it's not an exchange because ownership has not changed.  The joint annuitant has no control over the terms of the contract.

Adding a joint annuitant simply changes the measuring period for income payments when the annuity contract reaches its maturity date.  It would be similar in concept to changing the payout  period from, for example, a lifetime payout to one that is made over a fixed period. 

And, when payments begin, the fact that a joint annuitant has been added will impact the exclusion allowance calculation.  But aside from that, the joint annuitant shouldn't have any effect on income taxation.

 

[FPGuy]

Couple of thoughts:

Exchanging a single life insurance policy for a survivorship policy (insuring H & W) does not qualify as a 1035 exchange regardless of consistency of ownership;

If only the owner is considered an obligee, exchanging a life insurance policy or annuity on H as insured/annuitant to one with W as insured/annuitant would qualify as a 1035 exchange as long as the owner was the same in both cases. I don't believe it does.