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What is a tax-free 1035 exchange? Why would someone need to do this?


A 1035 exchange, named for the section of the Internal Revenue Code that sets out the rules and minutiae for executing one, allows money to be transferred out of one life insurance or annuity contract and into another. A key bit of fine print is that your assets have to be sent directly from one insurance company to the next; the policyholder or annuitant can’t take possession of the proceeds when the old contract is closed. Another restriction is that a life insurance policy can be exchanged for another one or for an annuity, while an annuity must be exchanged for another annuity and not a life insurance policy. One other thing: The policyholder or annuitant has to be the same person in the old and new contracts. As for reasons for doing a 1035 exchange, a common one is that someone with a life insurance policy experiences a change in circumstances, such as the death of a spouse or children growing up and being able to fend for themselves, and realizes that an annuity is more useful than insurance. Aside from that, individuals or their financial advisers simply may discover products that have more attractive features or lower costs than the ones that they’ve been using.

-Conrad de Aenlle