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The Ins And Outs Of The '1035 Exchange'

Ben Mattlin
August 04, 2023

Under Section 1035 of the Internal Revenue Service code, certain insurance contracts can be exchanged for others without generating taxes.

Specifically, a life insurance policy can be exchanged tax-free for another life insurance policy, an annuity, or a long-term care (LTC) policy—either the traditional, standalone variety or a hybrid plan that’s linked to life insurance or an annuity. In all cases, the owner and insured person must remain the same.

In addition, a nonqualified annuity can be traded tax-free for another nonqualified annuity or for either kind of LTC plan. Again, there can be no change of ownership. Annuities cannot be exchanged for life insurance in this way.

Recent increases in interest rates have created some good reasons for considering a 1035 exchange. “Insurance companies have benefited greatly from the rising interest rate environment and can now create products with richer benefits compared to what they could do when rates were near 0%,” said Jonathan Barth, regional vice president at DPL Financial Partners in Louisville, Ky.