A 1035 exchange is a tax-free transfer of a life insurance policy, annuity contract, endowment, or long-term care insurance policy to another policy of like kind under Section 1035 of the Internal Revenue Code.
What qualifies for a 1035 exchange?
To qualify for a 1035 exchange, you must exchange one insurance-related policy for another of like kind—such as a life insurance policy for another life insurance policy, an annuity for another annuity, or a life insurance policy for an annuity.
According to the IRS, the exchange must involve the same insured person and the same policy owner. You can’t swap an annuity for a life insurance policy, and you can’t use the proceeds for anything other than buying a new qualifying contract.
What is a 1035 exchange annuity?
A 1035 exchange annuity is the tax-free swap of an existing annuity contract for a new annuity contract that better aligns with your financial goals.
This move falls under Section 1035 of the Internal Revenue Code. It lets you dodge taxes on gains in your current annuity. People use it to lock in better interest rates, cut fees, or add riders without creating a taxable event.
What is the cost basis on a 1035 exchange?
In a 1035 exchange, the cost basis from the old policy carries over to the new one, adjusted for any taxable gain recognized or “boot” (such as cash received) during the exchange.
The IRS sees this as a continuation, not a sale. Any taxable gain you recognize lowers the cost basis, and any “boot” (cash or value you take out) reduces it further. That keeps your previously untaxed gains tax-deferred.
Should I do a 1035 exchange?
You should consider a 1035 exchange if you want to avoid taxes on gains in an annuity or cash-value life insurance policy and upgrade to a better-performing or lower-cost contract.
It’s especially handy if your current contract has sky-high fees, terrible investment performance, or missing riders. That said, run the numbers on surrender charges, new contract terms, and potential tax hits with a financial advisor first.
What is the difference between a 1035 exchange and a rollover?
The key difference is control of funds: a 1035 exchange transfers policy ownership directly between insurers, while a rollover has you receive the funds and then plop them into a new IRA-annuity within 60 days.
A 1035 exchange skips “constructive receipt” of funds, so you keep tax-deferred status without risking the 60-day deadline or penalties.
How often can I do a 1035 exchange?
There is no IRS limit on how often you can do a 1035 exchange, but insurers may slap surrender charge periods (usually 5–15 years) on the new contract.
You can chain multiple exchanges together, but each one may restart surrender periods and fees. Always eyeball the new contract’s terms and surrender schedule before jumping in.
How is a 1035 exchange reported?
A 1035 exchange is reported on IRS Form 1099-R with distribution code “6,” indicating a tax-free exchange to another insurance company.
The IRS demands this paperwork even though no tax is owed. The receiving insurer also files Form 5498 to confirm the new contract’s cost basis matches the transferred amount.
Why would someone 1035 exchange their existing policy?
Policyholders exchange outdated, underperforming, or high-fee contracts for modern alternatives with better terms, lower costs, or improved living benefits—without triggering a taxable event.
Common moves include switching from a variable annuity to a fixed index annuity for principal protection, consolidating multiple policies, or adding long-term care riders to a life insurance policy.
Can a beneficiary 1035 exchange an annuity?
No. Only the policy owner can initiate a 1035 exchange; beneficiaries can’t perform one after the owner’s death.
That said, if the annuity stays active after death and the beneficiary inherits it, they can receive payments based on the original contract’s terms. They can’t exchange it tax-free unless they become the owner and the contract isn’t annuitized.
What is not allowable in a 1035 exchange?
Single Premium Immediate Annuities (SPIAs), Deferred Income Annuities (DIAs), and Qualified Longevity Annuity Contracts (QLACs) are not allowable in a 1035 exchange.
These contracts start income payments right away and can’t be replaced tax-free. Exchanges from annuities to life insurance policies are also off the table.
Which of the following is an example of a 1035 exchange of contracts?
An example is exchanging a whole life insurance policy for a universal life policy, or a fixed annuity for a fixed index annuity, with the same insured and owner.
Imagine swapping a 20-year-old term life policy with built-up cash value for a new universal life policy to tap into cash value growth—that’s a legit 1035 exchange.
Can you 1035 an endowment contract?
Yes. You can perform a 1035 exchange on an endowment contract to another life insurance policy, annuity, or long-term care policy of like kind.
This lets you pivot from an endowment that’s run its course or no longer fits your needs into a better-suited financial product while deferring taxes on gains.
Can you lose your money in an annuity?
Yes. You can lose money in variable annuities, indexed annuities with caps/floors, or market-linked products if the underlying investments tank.
Fixed annuities and fixed index annuities with principal protection shield you from market risk. Still, inflation, fees, and surrender charges can nibble away at your balance over time.
Can I transfer a lifetime annuity?
Yes. You can transfer a lifetime annuity from one insurance company to another, but the transfer must meet IRS “like-kind” rules to avoid being treated as a taxable distribution.
Mess this up and you could face unauthorized payment penalties. Always route the transfer through a 1035 exchange to keep tax-deferred status intact.
Can a non spouse beneficiary do a 1035 exchange?
No. Only the policy owner can perform a 1035 exchange; a non-spouse beneficiary can’t initiate one on an inherited annuity or life insurance policy.
Non-spouse beneficiaries do have options, though. They may do a direct transfer into an inherited IRA or use other payout choices—just check with a tax pro first.
Edited and fact-checked by the TechFactsHub editorial team.
