What Is a 1035 Exchange?

According to the most recent information available, Americans have individual life insurance with a total face value of $14 trillion. 

Due to a variety of factors, these individuals may find themselves in circumstances where the specific life insurance policy or annuity contract they own does not suit their needs. They may want to exchange products without incurring a taxable event.

That’s where Section 1035 of the Internal Revenue Code comes in. A 1035 exchange provides a means for exchanging an annuity contract or life insurance policy without being treated as if it had been surrendered or sold. Keep in mind that a 1035 exchange can be used only when it involves the same contract or policyholder and the same type of product.

Trading In an Older Policy

A 1035 exchange, provided certain requirements are met, gives policy or contract holders the flexibility to “trade-in” an older contract or policy for a newer contract or policy. A newer policy or contract may have lower costs, a higher death benefit, or more investment choices.

1035 exchanges involve a complex set of tax rules and regulations. Before moving forward with a 1035 exchange, consider working with a tax professional who is familiar with the rules and regulations.

Partial Exchanges

Also, individuals can do a partial 1035 exchange for a portion of the total contract. A tax professional should be consulted for a partial exchange because any gain may be subject to ordinary income tax when withdrawn.

Key Considerations

Several factors will affect the cost and availability of life insurance, including age, health, and the type and amount of insurance purchased. Life insurance policies have expenses, including mortality and other charges. If a policy is surrendered prematurely, the policyholder may also pay surrender charges and have income tax implications. You should consider determining whether you are insurable before implementing a strategy involving life insurance. Any guarantees associated with a policy are dependent on the ability of the issuing insurance company to continue making claim payments.