What is a "1035 exchange"?

A 1035 exchange allows you to exchange "like accounts" without any tax penalty under the current tax rules. Transferring "like accounts" means transferring from an annuity to another annuity, from a life insurance policy to another life insurance policy, or from a life insurance policy to an annuity. However, you can't transfer, tax-free, from an annuity to a life insurance policy.

You do not pay income taxes on any gain in the policy if you do a 1035 exchange of a policy for one that is of equal value. If you did a 1035 exchange and ended up keeping $5,000 worth of the cash value you had in your original policy, that money would be subject to taxes.

If you transfer your money into a plan that is not permitted uner a 1035 exchange, all the money is subject to taxes. Exactly how much tax is a question to ask your financial advisor or accountant.

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