1035 Exchange

A 1035 Exchange is a provision in the US tax code that allows one to directly transfer funds from a life insurance policy, endowment policy or annuity policy to another life insurance policy, endowment policy or annuity policy, without creating a taxable event. In other words, If a person could have surrendered his policy and received an amount greater than his cost basis (usually cumulative premiums paid in), a surrender would produce taxable ordinary income for that gain. Moving the funds into a new policy via a 1035 exchange will at least postpone any taxable gain. Under certain circumstances, funds may also be transferred to a long term care policy.

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. But 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 taxed.

The practical result allows insureds to take advantage of newer types of coverage without suffering a tax penalty for changing from the old. Of course, the insured will still incur start-up costs of the new policy, so care should be taken to determine whether or not such a change is likely to benefit the policy owner in the long run. (Back to IUL Table of Contents)