--- title: "1035 Exchange From Life Insurance to Annuity: The Rules" canonical: "https://www.simplyinsurance.com/1035-exchange/" description: "1035 exchange explained - how to swap a life insurance policy or annuity without a tax bill, which exchanges are allowed, and the rules you must follow." silo: "annuities" published: "2026-07-24" author: "sa-el" source: "Simply Insurance" --- **A 1035 exchange lets you swap one life insurance policy or annuity contract for a new one without triggering a tax bill on the gains you've built up.** The IRS permits this tax-deferred transfer under Internal Revenue Code Section 1035, but you have to play by strict rules — the right type of product, the same owner, and a direct carrier-to-carrier transfer. Get it right and you keep your tax deferral intact. --- ## What Is a 1035 Exchange? A 1035 exchange lets you roll an old life insurance policy or annuity into a new contract, so the gain isn't taxed yet. A 1035 exchange is a provision in the U.S. tax code that lets you move money from one insurance or annuity contract to another without recognizing — and paying taxes on — the gain in the original contract. Think of it as a tax-free upgrade path. Instead of cashing out an old whole life policy or annuity (which triggers ordinary income tax on any growth), you roll it directly into a new contract and keep the tax clock paused. ### IRC Section 1035 Explained Internal Revenue Code Section 1035 is the specific rule that makes this possible. It covers four types of approved exchanges: - Life insurance policy → life insurance policy - Life insurance policy → endowment contract - Life insurance policy → annuity contract - Annuity contract → annuity contract Congress created this provision because it didn't make sense to penalize people for simply upgrading to a better contract — one with lower fees, better investment options, or improved benefits. ### How a 1035 Exchange Works Step by Step The process is simpler than it sounds: 1. You identify a new policy or annuity you want to move into. 2. You complete a 1035 exchange form (usually the ACORD form) with your new carrier. 3. The new carrier contacts the old carrier directly. 4. The funds transfer carrier-to-carrier — you never touch the money. 5. The old carrier issues a 1099-R showing the distribution code for a tax-free exchange. That fourth step is non-negotiable. If the money touches your hands at any point, the IRS treats it as a taxable distribution — full stop. ### 1035 Exchange vs. Surrender: Why It Matters When you surrender a policy, you cash it out. Any gain above your cost basis (what you paid in premiums) becomes ordinary income in that tax year, potentially pushing you into a higher bracket. A 1035 exchange preserves your original cost basis and carries it into the new contract, so you only owe taxes when you eventually withdraw money or surrender the new contract. --- ## 1035 Exchange Rules To qualify for tax-free treatment, transfers have to meet specific requirements set by the IRS. Not every swap between insurance products automatically qualifies. ### Eligible Policy-to-Policy Transfers The IRS has a clear hierarchy. Here's what's allowed and what isn't: | From | To | Allowed? | |---|---|---| | Life insurance | Life insurance | ✅ Yes | | Life insurance | Endowment | ✅ Yes | | Life insurance | Annuity | ✅ Yes | | Life insurance | Long-term care | ✅ Yes (post-2010) | | Annuity | Annuity | ✅ Yes | | Endowment | Annuity | ✅ Yes | | Annuity | Life insurance | ❌ No | | Annuity | Endowment | ❌ No | ### Owner and Insured Requirements The owner of the original contract and the new contract must be the same person. If you change ownership as part of the transfer — say, moving a policy from your name to a trust — the IRS will treat the exchange as a taxable event. The insured person also has to remain the same in life insurance swaps. ### 1035 Exchange Rules for Annuities When [exchanging one annuity for another](https://www.simplyinsurance.com/compare-annuity-quotes-online/), the contract must be non-qualified (meaning it's held outside an IRA or 401(k)) or both contracts must be within the same qualified plan structure. The annuitant — the person whose life the contract is based on — must remain the same. Partial exchanges of [annuities](/annuities/) are allowed, but they come with a 36-month lookback rule (more on that below). ### 1035 Exchange Rules for Life Insurance For life insurance swaps, the insured person must be identical on both the old and new policy. You can move from term life to whole life, whole life to universal life, or any permanent life policy to an annuity. You cannot move from a group policy to an individual policy under 1035 rules — group contracts don't qualify. --- ## What Is Not Allowable in a 1035 Exchange? Knowing what disqualifies an exchange is just as important as knowing what qualifies. One wrong move and your transfer becomes a fully taxable distribution. ### Prohibited Transfer Directions The biggest prohibited exchange is moving an **annuity to a life insurance policy**. The IRS only lets you go "down" the hierarchy from life insurance toward annuities — never back up. Other blocked transfers include: - Annuity to an endowment contract - Any exchange where the product type doesn't appear in the approved list ### Changes in Ownership That Disqualify the Exchange If the policy owner changes during the transfer — even temporarily — the exchange loses its tax-free status. This includes transfers to a spouse, a business entity, or a trust. If you need to change ownership, do it before or after the exchange, not during it (and consult a tax advisor on the timing). ### Common Mistakes That Trigger a Taxable Event - **Taking a check:** If the old carrier sends a check payable to you rather than the new carrier, you've triggered a taxable distribution. - **Loans on the old policy:** Outstanding policy loans reduce your cost basis and can create a taxable gain even in an otherwise valid exchange. - **Exchanging into a modified endowment contract (MEC):** If the new life policy becomes a MEC due to premium structuring, gains withdrawn later are taxed differently. - **Changing the insured:** On life insurance swaps, the insured person can't change — even if ownership stays the same. --- ## 1035 Exchange Time Limit and the 36-Month Rule If you're doing a partial exchange out of an annuity, time matters more than most people realize. ### Why the 36-Month Window Matters The IRS's 36-month rule (Revenue Procedure 2011-38) says that if you take a withdrawal from the new contract within 36 months of a partial 1035 exchange, the IRS can recharacterize the original exchange as a taxable distribution. The rule exists to prevent people from using partial exchanges as a workaround to take tax-free distributions. ### 1035 Exchange 36-Month Rule Example Say you partially exchange $50,000 from Annuity A into a new Annuity B in January 2024. If you take a withdrawal from Annuity B in October 2025 — only 22 months later — the IRS may treat the $50,000 partial exchange as a taxable distribution, not a 1035 exchange. Wait until at least January 2027 to take withdrawals from the new contract to stay clean. ### State-Specific Variations Most states follow federal rules, but a few add their own wrinkles. California, for example, requires that insurers provide specific disclosure language on 1035 exchanges, and the state insurance department has its own suitability review process for annuity replacements. Always check your state's requirements before finalizing a transfer. ### How Often Can You Do a 1035 Exchange? The IRS doesn't cap how many times you can use a 1035 exchange. Technically, you could exchange into a new contract every few years if you had a compelling reason. In practice, doing it too frequently raises suitability concerns — many states require insurers to document why a replacement is in the client's best interest — and surrender charges can pile up quickly if you're leaving contracts before they mature. --- ## 1035 Exchange Life Insurance Life insurance is where 1035 exchanges come up most often in the real world. ### Life Insurance to Annuity: The Most Common Transfer Swapping a whole life or universal life policy for an annuity is the most popular use of a 1035 exchange. People who no longer need the death benefit — maybe the kids are grown and the mortgage is paid — can convert years of cash value into guaranteed retirement income without paying taxes on decades of growth in that moment. ### Life Insurance to Long-Term Care Insurance Since 2010, the Pension Protection Act has allowed life insurance policies to exchange into qualified long-term care insurance (LTCI) policies on a tax-free basis under Section 1035. This is a powerful planning option for people who realize they need LTC coverage more than a death benefit. Premiums paid from a 1035-exchanged LTCI policy may even be income-tax-free if used to pay for qualifying long-term care expenses. ### Partial 1035 Exchange on a Life Insurance Policy You don't have to exchange the entire policy. You can do a partial 1035 exchange, moving a portion of your cash value into a new contract while keeping the original policy in force. This is often used to fund a small annuity or LTC rider while preserving some death benefit. The cost basis is split proportionally between the two contracts. ### At What Age Should You Stop Paying Term Life Insurance? Term life generally makes sense while you have dependents, debt, or income that others rely on. By the time you're in your mid-60s to early 70s, most people have paid off major debts and have retirement savings covering their spouse. That's often the age when term renewal premiums spike sharply — and when converting cash-value life insurance via a 1035 exchange into annuity income starts to make more financial sense than continuing to pay premiums. --- ## 1035 Exchange Form: How to Complete the Transfer The paperwork is straightforward once you know what to expect. ### What the ACORD 1035 Exchange Form Includes Most carriers use the ACORD 1035 Exchange Form (or their own proprietary version). It typically collects: - Policy owner's name and contact information - Existing policy/contract number and carrier name - New policy/contract number and carrier name - Type of exchange (full or partial) - Amount to transfer (for partial exchanges) - Owner and insured signatures - Authorization for the direct carrier-to-carrier transfer You submit this form to the **new** carrier, not the old one. The new carrier handles the request to the old carrier on your behalf. ### Fidelity and Allianz 1035 Exchange Form Examples Major carriers like Fidelity and Allianz have their own branded versions of the 1035 exchange form, but they collect the same core information. Fidelity's form, for example, requires a Medallion Signature Guarantee for transfers above a certain dollar threshold. Allianz's form walks through suitability questions required by state regulators. Always download the current form directly from the carrier's website — versions can change. ### How to Report a 1035 Exchange on Your Tax Return The old carrier will send you a **Form 1099-R** at tax time. For a valid 1035 exchange, the distribution code in Box 7 should be **"6"** — which tells the IRS this was a tax-free exchange. You still have to report it on your return (it goes on Form 1040 via Schedule 1 in some cases), but no tax is owed if the exchange was done correctly. Keep the 1099-R and any exchange confirmation paperwork in your records. --- ## 1035 Exchange Real Estate: What You Need to Know People sometimes mix up "1035 exchange" with "1031 exchange" when talking about real estate. They're completely different animals. ### Can You Use a 1035 Exchange for Real Estate? No. A 1035 exchange applies only to insurance and annuity contracts. It has nothing to do with real estate. If someone mentions a "1035 real estate exchange," they're either confused or they're talking about the 1031 exchange — the tax code provision that lets real estate investors defer capital gains by rolling proceeds from a property sale into a like-kind property. ### 1031 Exchange vs. 1035 Exchange: Key Differences | Feature | 1031 Exchange | 1035 Exchange | |---|---|---| | Asset type | Real property | Insurance / annuity contracts | | Tax treatment | Capital gains deferred | Ordinary income tax deferred | | Replacement timeline | 45-day ID / 180-day close | No hard IRS deadline (carrier-driven) | | Intermediary required | Yes — qualified intermediary | No — carrier-to-carrier | | Like-kind requirement | Like-kind property | Specific product hierarchy | The confusion is understandable — both "exchanges" defer taxes — but the rules, timelines, and assets involved are completely separate. If you're shopping for annuity coverage, the 1035 exchange is your tool. If you're selling an investment property, that's a 1031. --- ## Pros and Cons of a 1035 Exchange A 1035 exchange isn't automatically the right move. Here's an honest look at both sides. ### Tax-Deferral Benefits of Exchanging - You keep your accumulated tax deferral intact — no immediate tax bill on gains - Your cost basis transfers to the new contract - You can upgrade to better investment options, lower fees, or stronger guarantees without a tax penalty - Life insurance cash value can convert to guaranteed retirement income tax-efficiently ### Surrender Charges and Costs to Watch Out For - **Surrender charges:** If your current contract is still in its surrender charge period, leaving early can cost 5–10% of the contract value - **New surrender period:** The new contract starts its own surrender charge clock — typically 5–10 years - **Loss of benefits:** Some older contracts have guaranteed rates or living benefits that won't carry over to the new contract - **Sales costs:** The new contract may have higher internal fees that offset the benefits of switching ### When a 1035 Exchange Makes Sense (and When It Doesn't) It makes sense when: - Your current contract has high fees and your surrender period has ended - You no longer need a death benefit and want guaranteed income - You want to add long-term care benefits - Better annuity rates are available and the spread more than covers any costs It doesn't make sense when: - You're still in a surrender charge period on the old contract - The new contract's fees are higher and negate the savings - You need the money within the next few years (annuities are long-term vehicles) - You'd trigger state suitability red flags without a clear benefit If you're weighing your options, comparing today's top annuity rates from leading carriers can help you see whether a 1035 exchange into a new contract actually pencils out. --- ## Frequently Asked Questions ## What qualifies as a 1035 exchange? A carrier to carrier transfer between eligible contracts qualifies if the owner and insured stay the same and you never touch the money. A 1035 exchange qualifies when you transfer directly between eligible contracts: life insurance to life insurance, life insurance to an annuity, life insurance to an endowment, annuity to annuity, or life insurance to qualified long-term care insurance. The policy owner and insured must remain the same, the transfer must be carrier-to-carrier, and you cannot take constructive receipt of the funds at any point during the transfer. ## What are the disadvantages of a 1035 exchange? You could pay surrender charges, restart a surrender period, lose guaranteed riders or rates, and face higher fees that eat into the tax savings. The main downsides are surrender charges on the outgoing contract, a fresh surrender period on the new one, and the potential loss of valuable guaranteed riders or interest rates on the old contract. You also start the 36-month clock for partial annuity exchanges, restricting withdrawals. If fees on the new contract are higher, the tax savings may be offset by the added costs over time. ## What is the difference between a 1031 exchange and a 1035 exchange? A 1035 exchange defers ordinary income tax on insurance and annuity contracts, while a 1031 exchange defers capital gains on real estate. A 1031 exchange applies to real estate, allowing investors to defer capital gains by reinvesting proceeds into a like-kind property within a 180-day window. A 1035 exchange applies to insurance and annuity contracts, deferring ordinary income tax on contract gains. They share the concept of tax deferral but cover completely different asset classes, with different timelines, intermediary requirements, and IRS rules. ## How do I report a 1035 exchange on my tax return? You report the 1099-R your old carrier sends on your federal return, and if the exchange was done right, you owe no tax. Your old carrier will send a Form 1099-R with distribution code "6" in Box 7, indicating a tax-free 1035 exchange. You report the 1099-R on your federal tax return but owe no tax as long as the exchange was completed correctly. Keep all exchange confirmation documents alongside your 1099-R in case the IRS has questions. ## Which 1035 exchange is not allowed? You can't move an annuity back into life insurance: the IRS only lets you go from life insurance toward an annuity, never the reverse. An annuity-to-life-insurance exchange is not allowed. The IRS only permits movement "down" the hierarchy — from life insurance toward annuities — not back up. You also cannot exchange an annuity into an endowment contract, transfer between group and individual contracts, or complete any exchange where the owner changes during the process. ## What is not allowed in a 1035 exchange? You can't go from an annuity to life insurance, change the owner midway, touch the money yourself, or start from a group policy. Beyond the prohibited product directions (annuity to life insurance), you cannot change the policy owner during the transfer, take constructive receipt of the funds, or use a group policy as the source contract. Outstanding loans on the old policy can create partial taxable events even in an otherwise valid exchange. Any of these missteps can convert a tax-free exchange into a fully taxable distribution. ## At what age should you stop paying term life insurance? For most people, it's the mid 60s to early 70s, once the kids are independent, the mortgage is paid, and retirement savings are solid. There's no universal age, but most people find term life less necessary once their children are financially independent, their mortgage is paid, and they've built adequate retirement savings — typically somewhere between the mid-60s and early 70s. At that point, the death benefit may matter less than converting any accumulated cash value (in a permanent policy) into retirement income through a 1035 exchange.