What is 1035 Exchange?
A 1035 Exchange refers to a tax-free transfer of funds between insurance policies, specifically related to life insurance, annuities, or endowment contracts. This provision falls under Section 1035 of the U.S. Internal Revenue Code. It allows individuals to switch from one insurance policy to another without incurring immediate tax consequences on any gains.
In the context of Indexed Universal Life Insurance, Whole Life Insurance, and Term Life Insurance, a 1035 Exchange can be a strategic move. For example, a policyholder may choose to exchange an older whole life policy for a new indexed universal life policy if they seek better potential growth. The advantage lies in the ability to make the change without recognizing taxable income from gains accumulated in the old policy.
This tax-deferred exchange can be beneficial when the policyholder’s needs have changed, or if the new policy offers better terms, improved cash value growth, or lower premiums. The new policy must be similar in nature to the old one, and only certain types of exchanges are eligible under IRS guidelines. Importantly, a 1035 Exchange can also be used to switch from a life insurance policy to an annuity, but not vice versa.
It’s important to note that while a 1035 Exchange can provide financial benefits, it requires careful consideration of surrender charges, fees, and the terms of the new policy to ensure it aligns with the policyholder’s financial goals.