(b)lines Ask the Experts – What Is a 1035 Exchange?

Michael A. Webb, vice president, Cammack Retirement Group, answers

If the Experts could transfer you back in a time machine to the 1980’s, you would be well versed in the phrase “1035 exchange,” though it is rarely referenced in the 403(b) world today. Back then, 1035 exchanges, where a contract with one annuity provider was exchanged for another annuity contract of the same, or different, annuity provider, were a primary mechanism for moving money between 403(b) providers.

However, the 1035 exchange rules were somewhat restrictive and confusing and, in 1990, the Internal Revenue Service (IRS) essentially revoked the basis for such transfers by issuing Revenue Ruling 90-24, and subsequent transfers under these rules were referred to as “90-24 transfers.” The rules under Revenue Ruling 90-24 were much more flexible, as custodial accounts (mutual fund contracts) could be transferred in addition to annuity contracts, and partial transfers were permitted as well.

This new regime lasted until the issuance of the final 403(b) regulations in 2007, which eliminated 90-24 transfers and replaced them with two alternatives: contract exchanges, where assets can be moved between providers in a 403(b) plan (the use of the term “exchange” brings back memories of 1035 exchanges, but the two transactions are quite different), and plan-to-plan transfers, which are used to transfer assets between 403(b) plans, under certain conditions. Along with rollovers, which require a distributable event (see our prior Rollovers vs. Transfers Ask the Experts column for an explanation of the differences between rollovers and transfers), these are the primary methods of moving funds between investment providers today in a 403(b) plan.

So why is a term that essentially disappeared 25 years ago resurfacing for you? The answer lies in the forms used by several providers for 403(b) related exchanges/transfers. In some cases, the forms are generic and are also used for exchanges between nonqualified annuities (e.g. retail fixed/variable annuities purchased by individuals outside of a retirement plan), where the 1035 exchange regime still exists.  Furthermore, the forms are often confusing and inappropriately titled, so it is easy to see how a participant may erroneously complete such a form to request a 1035 exchange in a 403(b) plan, where such an exchange is not possible.

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NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.