Exchange of Annuity Contracts Under Section 1035

The taxpayer, proposing to make the exchange, is an individual entitled to receive an annuity which currently is owned by a section 401(a) profit-sharing trust created by his former employer. The taxpayer wishes to arrange to receive the annuity, and then, in connection with that transaction, to enter into a binding annuity agreement with an insurance company offering a like annuity (except for a substantially higher annuity purchase rate) with annuitization to begin immediately.

Section 1035(a)(3) provides that no gain or loss is recognized on the exchange of an annuity contract for an annuity contract.

Rev. Rul. 73-124, 1973-1 C.B. 200, discussed in * * *, G.C.M. 34969, I-4424 (August 1, 1972), had considered whether a taxable event occurred when the proceeds of an individual section 403(b) annuity contract received by an employee were immediately surrendered to the employer for reinvestment in another annuity contract for the same employee, but with a different insurer. The ruling concluded that the total transaction constituted an exchange within the meaning of section 1035(a)(3) provided the proceeds received upon surrender were applied immediately to the purchase of a second annuity contract for the same employee.This conclusion was not precluded by the fact that section 401(g) required the employee to first surrender the original annuity contract to the first insurer.

We can find no basis for distinguishing this case from the one in Rev. Rul. 73-124 in respect of its section 1035 analysis. Similarly we believe that the exchange here qualifies for nonrecognition under section 1035(a)(3) provided the proceeds from the first contract are immediately applied to the purchase of the second contract. However, in order that the trust will continue to qualify under section 401(a), the second annuity must be payable over a period allowable for distributions from plans qualified under section 401(a).

We note that section 401(g) provides that the first annuity contract here, i.e., the one distributed from a section 401(a) qualified plan, is nontransferable. Consequently, as in Rev. Rul. 73-124, the taxpayer must surrender the first annuity to its issuer before he can exchange the contract for one issued by a different insurance company. Rev. Rul. 73-124 stated that this required surrender did not prevent the transaction from coming within section 1035, and we believe the same applies here. Also, we do not believe that the fact that the legally binding agreement in respect of the second annuity was with the insurance company issuing the new contract rather than with the employer (as in Rev. Rul. 73-124) should have any impact upon our conclusions.

We have coordinated this case with the Employee Plans and Exempt Organizations Division (CC:EE). They are in agreement with the above discussion.

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Administrative File