Advanced Underwriting Consultants

Ask the Experts – December 10

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers.  Here’s the question of the day.

Question: I have a client who inherited a nonqualified annuity from his father. Can he exchange this contract for another nonqualified annuity without recognizing gain under Section 1035, or is he stuck with the current annuity contract?

Answer: It appears so, but the beneficiary must still take required distributions.

The IRS recently issued Private Letter Ruling 201330016 addressing this issue. There, the owner of several fixed and variable nonqualified inherited annuities wanted to exchange these contracts for another variable annuity contract. The IRS allowed the tax-free exchange because:

  • The technical requirements for the 1035 exchange were honored; and
  • The beneficiary ensured that distributions from the new annuity would be at least as rapidly as required under the old, inherited contract.

The IRS essentially wants to make sure that the exchange is not simply used to avoid the Section 72(s) post-death required distribution rules. The exchange must only provide a means of changing the contract and investments.

As long as these requirements are met, a beneficiary should be able to make a tax-free exchange of his current inherited annuity contract for a new one.

If the IRS did not allow this tax-free transfer, the beneficiary would recognize gain on the distribution from her inherited annuity, and then reinvest whatever remains in a separate contract.

As always, keep in mind that Private Letter Rulings are not binding on the IRS, but they can serve as guidance on the IRS’s interpretation of the Code.


Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.