Whole Life Income

1035 Exchange Rules: Replacing a Policy Without a Tax Bill

A 1035 exchange moves cash value from one contract to another without triggering tax — if you follow the direction rules and handle loans correctly.

6 min read · Updated June 12, 2026

Key takeaways

  • Life to life, life to annuity, and annuity to annuity are permitted; annuity to life is not.
  • Basis carries over, which matters most in a loss position.
  • Outstanding loans carried into an exchange can create taxable boot.
  • A new contract restarts surrender charges and the two-year contestability period.

What is allowed

FromTo life insuranceTo annuityTo long-term care
Life insuranceYesYesYes
AnnuityNoYesYes
EndowmentLimitedYesYes

How basis works

Your cost basis carries over to the new contract. If you paid $180,000 into a policy now worth $120,000, exchanging preserves the $180,000 basis in the new contract, which shelters future gains. Surrendering instead would waste that basis, since a loss on a personal life insurance contract is generally not deductible.

Loans and boot

If the old policy has an outstanding loan that is extinguished in the exchange, the IRS can treat the relieved debt as boot — taxable to the extent of gain. The usual fixes are repaying the loan before the exchange, or carrying the loan to the new contract where the carrier permits it. Coordinate this with the carriers in writing before signing anything.

When not to exchange

  • The existing policy is past its surrender period and the new one restarts a 10-year schedule.
  • The old contract has a guaranteed rate or rider unavailable today — legacy contracts from the 1980s and 1990s often do.
  • Your health has declined and the new policy requires underwriting.
  • The primary motivation came from a producer who earns a new commission on the transfer.

Frequently asked questions

Do I have to do a full exchange?
No. Partial 1035 exchanges from annuities are permitted, though the IRS applies a 180-day look-back rule that can recharacterize the transaction if you take withdrawals shortly after.
Does a 1035 exchange require new underwriting?
Exchanging into a new life insurance policy generally does. Annuity-to-annuity exchanges typically do not.
How long does a 1035 exchange take?
Typically three to eight weeks, depending on how quickly the surrendering carrier releases funds. The money must move directly between carriers — if it passes through your hands, the tax deferral is lost.

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