Section 1035 Tax-Free Exchanges: Permissible Transfers and 36-Month Rule
Under Internal Revenue Code Section 1035 and FINRA Rule 2330, an investor executes a tax-free exchange of an existing variable annuity for a new variable annuity. What regulatory supervision and tax consequences apply?
Section 1035 allows tax-free annuity-to-annuity exchanges. FINRA Rule 2330 requires registered principals to review whether the customer executed an exchange within the prior 36 months.
Complete Analysis & Legal Rationale
IRC Section 1035 permits tax-free exchanges between like-kind insurance products: Life Insurance to Life Insurance, Life Insurance to Annuity, Annuity to Annuity. (Crucially: An Annuity CANNOT be exchanged tax-free for Life Insurance). Under FINRA Rule 2330, because deferred variable annuities carry surrender charges and new surrender periods, representatives and principals must review whether the customer had another 1035 exchange within the preceding 36 months to prevent abusive churning of insurance contracts.
Distractor Autopsy (Why Other Options Are Traps)
FINRA exam writers design incorrect distractors using specific calculation mistakes and regulatory misconceptions. Review why each option succeeds or fails:
Section 1035 allows tax-free annuity-to-annuity exchanges. FINRA Rule 2330 requires registered principals to review whether the customer executed an exchange within the prior 36 months.
Fails to adhere to packaged product rules for B.
Fails to adhere to packaged product rules for C.
Fails to adhere to packaged product rules for D.
Official Standard: IRC Section 1035 permits tax-free exchanges between like-kind insurance products: Life Insurance to Life Insurance, Life Insurance to Annuity, Annuity