A 1035 exchange is a tax-free policy exchange permitted by Internal Revenue Code 1035, allowing certain life insurance, endowment, and annuity contracts to be replaced without current taxation of gains. Generally, life-to-life, endowment-to-endowment, life-to-annuity, and annuity-to-annuity exchanges qualify, provided ownership and insured/annuitant rules are met and funds move directly between carriers. The transaction carries over basis and gain into the new contract. Suitability,surrender charges, new contestability periods, and state replacement regulations still apply.Annuity-to-life does not qualify. Proper documentation and carrier-to-carrier processing are essential for maintaining tax-deferred status.

Advisors deploy a 1035 exchange when an existing life policy or annuity no longer fits objectives.They document reasons-lower costs, stronger guarantees, rider needs, or underwriting changes-the complete state replacement forms and carrier disclosures. The owner signs a 1035 form authorizing direct transfer. Advisors caution about new surrender periods, contestability, and potential loss of grandfathered benefits. When properly executed, the client preserves tax deferral while obtaining a better-aligned contract. Common scenarios include moving VUL to guaranteed universal life, upgrading old whole-life dividends, or consolidating multiple annuities into a streamlined income strategy.