Section 1035 Exchange

What Does Section 1035 Exchange Mean?

A Section 1035 exchange refers to the process of exchanging an existing annuity contract, life insurance contract, or endowment contract for a new one without incurring any tax consequences, provided that it involves the same policyholder or annuitant and the same type of contract or policy.

This type of exchange is also known as a tax-free 1035 exchange.

Insuranceopedia Explains Section 1035 Exchange

A Section 1035 exchange typically occurs when annuitants or policyholders wish to swap their existing policy or contract for a new one that offers enhanced benefits, lower fees, or different investment options. Universal life insurance policies are common targets for these exchanges because of their flexible premiums and adjustable death benefits, both of which give owners more room to adapt as their finances change. As long as it adheres to the strict guidelines set by the Internal Revenue Service, the exchange is free of any taxation.

To qualify for tax-free treatment, the owner, annuitant, or policyholder of the old contract must be the same on the new contract. Additionally, the exchange must be conducted directly between insurance companies to ensure the policy remains free from tax implications. Owners of annuities use Section 1035 frequently, often to move from older contracts with weaker income riders or higher mortality and expense charges. Anyone considering an exchange should compare quotes from several life insurance companies first, since the new contract has to be a meaningful improvement to make the move worthwhile.