A policyowner wants to exchange a $50,000 cash-value whole life policy for a non-qualified deferred annuity. Which statement about the tax treatment is correct?
Explanation
Under IRC §1035, a policyowner can exchange a life insurance policy for an annuity (or annuity-to-annuity, or life-to-life) without recognizing the gain at the time of exchange, provided the contracts are owned by the same person and the transfer goes directly from one insurer to another (a '1035 exchange'). Cost basis carries over to the new contract. Option A would apply only if the policyowner SURRENDERED the policy and used the proceeds to buy the annuity (a constructive receipt) — not a §1035 direct transfer. Option C is reversed — a life policy CAN exchange to an annuity (one-way only; you cannot exchange an annuity back to a life policy). Option D conflates the §72(q) 10% penalty, which applies to taxable annuity withdrawals before 59½, not to a properly executed §1035 exchange.
Law Reference: IRC §1035Practice all 315 questions free — no signup required.
Related questions on this topic
- While a non-MEC life insurance policy remains in force, how is an outstanding policy loan treated for federal income tax purposes?
- How are benefits paid from a tax-qualified long-term care insurance contract generally treated for federal income tax?
- Which statement about the federal tax treatment of a Modified Endowment Contract (MEC) is TRUE?
- A whole life policy fails the 7-pay test and is classified as a Modified Endowment Contract (MEC). Which statement BEST describes the tax consequence to the policyowner?
- A small business pays the premium on a $250,000 group term life policy on a key executive. The business is the policyowner and primary beneficiary. Which statement about premium deductibility is correct?
- Ana paid $30,000 in premiums on a non-MEC whole life policy. She surrenders the policy for $48,000 in cash. How is the surrender taxed?
Last reviewed: · editorial process