What Is the Section 1035 Exchange and What Are Its Rules?
A Section 1035 Exchange is an IRS code that permits a tax-free swap of an existing annuity or life insurance policy for a new one. The IRS only grants tax-free exchanges if the owner, annuitant and insured individual are identical on both the old and new policies.
For an exchange to qualify as tax-free under the IRC Section 1035, the individual named on the annuity contract or life insurance policy must replace the old contract with an equivalent new contract. This rule effectively disqualifies the holder from a tax-free swap if an annuity contract was exchanged for a life insurance policy or vice versa.
The IRS also forbids any individual named in the old contract to assume a different role in the new contract. Moreover, the new contract must be swapped directly between the two participating insurance providers to secure the tax-free status.
The IRS reviews 1035 exchanges on a case-by-case basis to ensure that each swap satisfies the agency's stringent rules. The IRS routinely taxes exchanges made from the proceeds of an expiring life insurance or annuity contract. Before executing an insurance or annuity swap, be sure to consult a tax professional to ensure proper compliance with IRC Code 1035.