1035 EXCHANGES

Definition:

1035 refers to a provision in the tax code which allows for the direct transfer of accumulated funds in a life insurance policy, endowment policy or annuity policy to another life insurance policy, endowment policy or annuity policy, without creating a taxable event.

This transfer option is a like-kind exchange in which no tax is due at time of transfer. Typically, when a policy is transferred, the individual is taxed on any gain. However, if the policy is exchanged for another, Section 1035 of the tax code states that no gain or loss will be recognized. Consequently the transaction is not subject to any tax.

  • A life insurance policy for another life insurance policy, endowment policy, or annuity;
  • An endowment policy for an annuity; and
  • An annuity for another annuity

Advantages
If all the surrender proceeds from the original policy are transferred into the new policy and there are not outstanding loans on the original policy, there will be no tax on the gain in the original policy at the time of exchange. If the policy is surrendered without a 1035 Exchange, the gain from the original life insurance contract will be taxed as ordinary income (not capital gains). Please note that an annuity can NEVER be exchanged for a life insurance policy.
Business Uses of Life Insurance

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