What is a 1035 Exchange

A 1035 exchange refers to a tax-free transfer of funds from one insurance or annuity contract to another under Section 1035 of the U.S. Internal Revenue Code. This provision allows you to replace an existing life insurance policy, annuity, or endowment contract with a new one without triggering a taxable event. The goal is to enable policyholders to upgrade or switch their contracts to better suit their current financial or insurance needs.

Key Rules for a 1035 Exchange:

1. Eligible Contracts:
   • You can exchange:
     • A life insurance policy for another life insurance policy, an annuity, or an endowment contract.
     • An annuity for another annuity (but not for life insurance).
     • An endowment contract for another endowment contract or annuity.
   • You cannot exchange an annuity for life insurance.
2. Ownership Must Remain the Same:
   • The owner of the original contract must be the same as the owner of the new contract.
3. Tax-Free Treatment:
   • The exchange is tax-free, meaning you won’t owe taxes on any gains in the contract as long as the new contract is of equal or greater value.
4. Direct Transfer is Required:
   • The funds must be transferred directly between insurance companies to qualify as a 1035 exchange. If you cash out the policy or annuity and reinvest it, the tax-free status is forfeited.

When a 1035 Exchange Might Make Sense:

• Improved Policy Features: If a newer life insurance policy offers better benefits, such as lower premiums or enhanced death benefits.
• Changing Financial Needs: If your financial goals shift and an annuity might suit your retirement planning better than a life insurance policy.
• Lower Fees: Moving to a contract with lower fees or higher returns.
• Enhanced Riders: Access to more favorable riders (e.g., long-term care benefits).

Steps for a 1035 Exchange:

1. Consult a Financial Advisor: Determine if the exchange aligns with your financial goals and if there are any surrender fees or penalties.
2. Choose a Replacement Contract: Work with an insurance or annuity provider to find a new policy or contract that meets your needs.
3. Complete the Necessary Forms: Your insurance company will provide specific forms to initiate the 1035 exchange.
4. Direct Transfer: The funds are transferred directly to the new insurer.

Limitations to Keep in Mind:

• Surrender charges may apply to the old contract.
• The new policy may have a new surrender charge schedule.
• Any loans on the existing policy may complicate the exchange.

Before proceeding with a 1035 exchange, it’s important to consult with a qualified tax professional, financial advisor, or insurance agent to ensure it’s the right decision for your situation.

To see if an exchange is right for you, give us a call.