1035 exchanges
Moving from one life insurance policy or annuity to another without triggering income tax, and when it may or may not make sense.
About a 5-minute read
What it is
Section 1035 of the tax code lets you exchange certain life insurance and annuity contracts for new ones without paying income tax on the gain at the time of the exchange.
Allowed exchanges include life insurance to life insurance, life insurance to an annuity, annuity to annuity, and life insurance or an annuity to a qualified long-term care policy. An annuity can't be exchanged for life insurance.
Who it's often for
People with an older policy or annuity that no longer fits their needs, has high costs, or lacks features they now need, such as income guarantees or long-term care benefits.
How it works
Scene 1
The flow at a glance
How the money moves
- 1Compare the existing contract and the proposed one side by side, including guarantees, costs, surrender charges and features you'd give up.
- 2If an exchange makes sense, apply for the new contract. The owner (and generally the insured or annuitant) must stay the same.
- 3The money moves directly from the old company to the new one; you don't take possession of it.
- 4Your cost basis carries over to the new contract.
What to watch out for
- Surrender charges on the old contract may apply, and the new contract may start a new surrender period.
- A new life insurance policy means new underwriting, a new contestability period and a new suicide exclusion period.
- You may give up valuable guarantees, rates or riders in the old contract.
- Outstanding policy loans can create taxable income in an exchange.
- California requires replacement disclosures and forms, and your agent must show the exchange is suitable and in your interest.
- An exchange should clearly benefit you; if the main benefit is to the agent, it's the wrong move.
Questions to ask before moving forward
- What exactly would I gain, and what would I give up?
- What surrender charges apply now and in the new contract?
- Would I need new underwriting?
- Are there loans on my policy?
- Can I see both contracts compared side by side in writing?
Who else should be involved
Your CPA for tax questions. Consider getting a second opinion on any exchange of a large or older contract.
Related concepts and services
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Book a ConversationAdvanced concepts are described in general, simplified terms for education only. They involve legal, tax and financial considerations that depend on your situation and on current law, which can change. IAM Money Management does not provide tax or legal advice; consult your attorney and tax professional before implementing any strategy. Life insurance and annuity products are issued by insurance carriers, and features, costs and guarantees vary by carrier, product and state. Guarantees are backed by the claims-paying ability of the issuing carrier.