A Section 1035 Exchange refers to the replacement of an annuity or life insurance policy for a new one without incurring any tax consequence for the exchange. The IRS allows holders of these types of contracts to do this in order to replace outdated contracts with new contracts with improved benefits, lower fees/cost of insurance and different investment options.
The following exchanges of insurance contracts are considered tax-free by the IRS:
• replacing one annuity contract for another annuity contract with identical annuitants
• replacing one life insurance policy for another life insurance policy, endowment policy or annuity contract
• replacing one endowment policy for an identical endowment policy or an annuity contract
If you have heard of 1031 exchanges with real estate – this will be something much easier to understand.