Is It a Rollover or 1035 Exchange?

You may have been tempted to answer A due to the fact that the transaction was from one annuity to another. After all, isn’t this always a 1035 exchange? You may have been tempted to answer B due to the fact that any transaction where your client doesn’t “touch” the money would logically be a transfer. You may have been tempted to answer D because anytime you move money to an IRA, it’s considered a rollover. And, you may have been tempted to answer E because any question related to tax codes is a trick question and any logical answer is certainly wrong. All of these are certainly reasonable temptations, but look at the rules.

If money is coming from an employer-sponsored qualified plan and then going to an IRA annuity, this transaction will be either a rollover or a direct rollover. The differentiation is based on whether or not your client has “constructive receipt” of the funds during the transaction.

As a practical matter, if the distribution check is made out to the receiving insurer, deposited accordingly, then your client has no constructive receipt. In this case, the transaction would be a direct rollover. Direct rollovers suffer no tax consequences.

If constructive receipt does occur, then the employer plan is required to withhold 20 percent for income tax purposes. If your client then proceeds to place the remaining 80 percent of the monies, or makes up the 20 percent from other funds and places 100 percent of the monies into an IRA annuity (within 60 days), then this would be a rollover. An example of constructive receipt would be when the employer makes the distribution check out to the employee (your client) and then your client deposits those funds into her account.

If the money is in an IRA annuity now and you wish to move that money from that IRA annuity (A) to another IRA annuity (B) then this transaction will either be a transfer or a rollover. Again it depends on the constructive receipt doctrine. If no constructive receipt occurs and the monies are subsequently (within 60 days) moved to IRA annuity (B), then this would be a rollover.

Last, but certainly not least, is a 1035 exchange. Contrary to popular belief, a 1035 exchange involves only non-qualified monies. Qualified plan and IRA rules apply for qualified monies. A 1035 exchange occurs whenever your client moves from annuity (A) to annuity (B). Constructive receipt cannot occur for a valid 1035 exchange to exist.

One final word on 1035 exchanges. Much has been written lately about a recent IRS Private Letter Ruling that allowed for multiple exchanges i.e., an exchange of one annuity for two annuities, all within one company. Unfortunately for most of you, this ruling isn’t directly on point. Specifically, most often you would have a client with annuity A with company A and annuity B with company B wishing to exchange both to annuity C with company C. The IRS has never ruled specifically on this point. Some carriers believe this to be allowed and have done it for years. Some others who have a more conservative position have never allowed it. Yet others have viewed the recent Private Letter Ruling as indicating IRS flexibility on the issue and have started to allow multiple exchanges.

This continues to show the complexity of what should be a simple issue. Make certain when you’re dealing in these areas that you get competent tax and legal advice.

Reproduced from National Underwriter Life & Health/Financial Services Edition, May 5, 1997. Copyright (C) 1997 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.