Named for Section 1035 of the Internal Revenue Code, a 1035 exchange lets you replace an existing life insurance or annuity contract with a new one without recognizing a taxable gain on the transfer.
Why use one
You might exchange an older, underperforming policy for one with better features, lower costs, or a structure that fits your current goals — for example, moving from an outdated universal life policy into a modern IUL or a fixed indexed annuity.
The rules
The exchange must be between "like-kind" contracts (e.g., life-to-life, life-to-annuity, annuity-to-annuity — but not annuity-to-life), the owner and insured generally must stay the same, and the transfer should go directly between insurers. Outstanding policy loans can complicate it.
Proceed carefully
A new policy may have a fresh surrender period and new underwriting. A suitability review ensures the exchange actually benefits you — not just generates a new sale.
Is a 1035 exchange taxable? +
No — that's the point. A properly executed 1035 exchange transfers value between like-kind policies without triggering income tax on the gain.
What can I exchange under Section 1035? +
Life-to-life, life-to-annuity, and annuity-to-annuity are allowed. You cannot exchange an annuity into a life insurance policy tax-free.
Are there downsides to a 1035 exchange? +
Possibly — a new surrender period, new underwriting, or fees. It should only be done when the new policy clearly serves your goals better.