Glossary
1035 exchange, defined
A tax-free transfer of the cash value from one life policy or annuity into another, named for the section of the federal tax code that allows it. The gain inside the old contract carries over untaxed instead of being recognised as income on surrender.
In practice
The permitted directions matter: life to life, life to annuity, and annuity to annuity are allowed; annuity to life is not. The new contract must be issued to the same owner and on the same insured, and the money must move carrier to carrier, never through the owner's hands. It is the standard mechanism for replacing an underperforming permanent policy or moving an annuity out of a high-fee contract once surrender charges have run off. Watch three things: a new surrender charge schedule starts on the new contract, the suicide and contestability windows restart on a new life policy, and an old policy that is a modified endowment contract passes that status on. An outstanding policy loan complicates the transfer.
A worked example
Suppose an owner holds a universal policy with $60,000 of cash value built from $35,000 of premiums. Surrendering it would produce $25,000 of taxable gain; transferring it under this section into a new policy or annuity moves the full $60,000 with the gain deferred and the $35,000 cost basis preserved. Hypothetical figures.
Applies to: AnnuitiesLife Insurance