This is actually a non-IRA question, but any guidance will be very much appreciated. I’m asking for interpretation of Revenue Procedure 2011-38 in how it relates to this specific situation.

Susan, age 85, owns a $200,000 NQ fixed annuity that has reached its 5 year schedule for renewal. She has been withdrawing 100% of interest payments since inception, so currently the annuity value is equal to the cost basis. She plans to 1035 exchange only 1/2 of the annuity to a higher interest rate annuity for another 5 years and start withdrawing the interest payments immediately. She plans to withdraw the remaining 1/2 of the original annuity and open a CD at the bank to keep it more liquid, but also withdraw the interest off the CD immediately.

Under 2011-38, my understanding is this would “disqualify” the 1035 exchange; however, because she is over 59.5 and there is currently no gain in the original contract, then there would be no additional taxes or penalty other than the taxes she will naturally owe on the interest withdrawals from the new annuity. Does anyone see an issue with this transaction?

Thank you.