Life Insurance

1035 Exchange

A 1035 exchange, named after IRC Section 1035, allows the tax-deferred rollover of cash value from an existing life insurance policy to a new life insurance policy or annuity—or from an annuity to another annuity—without triggering a taxable event on the transferred gain.

Last reviewed: May 2026 · Editorial methodology

Definition

Under Internal Revenue Code Section 1035, a policyholder can surrender an existing life insurance or annuity contract and directly transfer the proceeds to a new contract without recognizing the accumulated gain as taxable income in the year of transfer. Eligible exchanges include: life insurance to life insurance, life insurance to an annuity or long-term care policy, and annuity to annuity. The original cost basis of the old policy carries over to the new contract, preserving the tax deferral. For example, if a policyholder has a whole life policy with $120,000 in cash value and a $40,000 cost basis, a direct 1035 exchange to a new universal life policy defers the $80,000 gain; a direct cash surrender followed by a new purchase would trigger $80,000 of ordinary income. The exchange must be a direct transfer—the policyholder cannot receive a check—and must be handled between carriers using IRS-approved documentation. A 1035 exchange does not restart the contestability period on the new policy in most circumstances. Partial 1035 exchanges are permitted but subject to complex basis allocation rules and should be handled by a qualified tax advisor.

Where this term matters

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Tip

Glossary definitions are educational. Always check your own policy language — insurers can define common terms differently from one another. When in doubt, request a written explanation from your agent.

Related terms

Surrender ValueSurrender value is the actual dollar amount paid to the policyholder when a permanent life insurance contract is voluntarily terminated, equal to the accumulated cash value minus any outstanding loans and applicable surrender charges.Cash ValueThe savings component inside permanent life insurance policies that can be borrowed against or withdrawn.Modified Endowment Contract (MEC)A modified endowment contract (MEC) is a life insurance policy that has been funded too rapidly—violating the IRS 7-pay test—causing it to lose the tax-preferred treatment that normally applies to policy loans and withdrawals, subjecting them instead to LIFO taxation and a 10% penalty.Universal Life InsuranceUniversal life insurance is a type of permanent coverage that lets policyholders adjust their premium payments and death benefit amounts within certain limits, with a cash value component that earns interest.Whole Life InsurancePermanent life insurance with lifelong coverage, fixed premiums, and a cash value component.

Related guides

Source: Cover Forge USA editorial team|Last verified: May 2026|Methodology
Definitions are educational and may be simplified. Always refer to your policy contract and consult a licensed agent for terms that affect coverage decisions.
CF

Cover Forge USA Editorial Team

Editorial Lead

This article was researched and written by the Cover Forge USA editorial team against federal sources (NAIC, CMS, FEMA, DOL, SSA, state DOIs) and standard policy forms. Bylines organize content by topic — they do not assert individual licensure. See our editorial-policy for details.

Reviewed June 2026

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