≡ Menu

Customer Reviews
Advertiser Disclosure

Life Insurance 1035 Exchange

Fact Checked by Jason Herring & Barry Brooksby
Licensed Agents & Life Insurance Experts.
Insurance and Estates, a strategic life insurance provider composed of life insurance professionals, is committed to integrity in our editorial standards and transparency in how we receive compensation from our insurance partners.
Tips for Using a 1035 Exchange

Unless you peruse the IRS tax code regularly, you may not be familiar with the code sections 1035 or 1031. However, in the world of wealth building and asset protection, these little combinations of numbers get a lot of attention for good reason.

Simply put, these IRS code sections allow for the transfer of asset values without capital gains taxes.

This article will focus on tips for a 1035 exchange with life insurance to be successful, and will draw some analogies to the 1031 exchange for real estate as a way to help clarify this concept of upgrading.

You might also be interested in our article 1035 Exchange for Annuities.

1035 Exchange Life Insurance

It is sometimes helpful to draw analogies between the characteristics of real estate and life insurance as an asset. The reasoning goes something like this…

  1. Real estate often requires a fairly steep down payment
  2. Real estate is costly in the early years of ownership but can deliver big returns in the long run
  3. Real estate offers income tax advantaged cash flow
  4. Real estate offers other tax advantages
  5. Real estate builds equity that can serve as collateral for loans
  6. Real estate is a wealth builder

You may or may not be familiar with these characteristics of real estate. Yet, you should know that you can seamlessly substitute “permanent life insurance” for “real estate” in all of the above respects. The type of permanent life insurance that is most widely known is whole life and universal life, which embody many of these same characteristics found in real estate.

Another major advantage of real estate is the ability to transfer the cash value (or equity) from one similar (or “like kind”) ASSET to another, a 1031 Exchange.  In the same way, the IRS has allowed a policy owner to transfer cash value from one life insurance policy to another, a 1035 exchange.

You see, in real estate, the 1031 exchange is based on the well known IRS code section that allows one parcel of investment real estate to be sold and the proceeds used to purchase another with no tax consequences. There are parameters for this and the transaction must occur within specific timelines.

In life insurance, the 1035 exchange is based on the IRS Code section that allows a policy holder to transfer policy cash value to a new policy without tax consequences. Here, as in real estate, specific requirements must be met.

Also, there are good reasons to change to a new policy as well as not so good reasons and these must be understood and reviewed with the policy owners in detail.

However, both 1031 and 1035 exchanges require very specific steps and timelines to follow in making sure that all is compliant from a tax standpoint. Please see our companion article for more on 1035 exchange tax benefits.

Using Section 1035 to Exchange on Life Insurance Policy for Another

In the world of real estate investment, real property is typically exchanged because a larger or more suitable property is located. Rather than sell the existing real property and purchasing another, thereby incurring capital gains taxes, the 1031 exchange is allowed.

For 1031 exchanges, a qualified intermediary is used to hold the proceeds from the original property, and a suitable replacement must be located within 90 days in order to avoid capital gains.

Possible reasons that real estate investors may consider a 1031 exchange may include a) deterioration or excessive cost of current location; b) need for additional space; c) favorable economic changes; d) other changes in circumstances.

In the world of cash value life insurance, the IRS allows a similar advantage if the policy owner identifies a more advantageous life insurance product.

5 reasons that a policy owner may benefit from a 1035 exchange include:

  • 1) financial uncertainty with current company;
  • 2) new products offering more favorable options, returns, premiums, etc.;
  • 3) favorable (or unfavorable) economic changes for the policy owner;
  • 4) health changes that allow for a better rating with new policy (such as stopping smoking);
  • 5) changes in estate planning or business continuity succession planning goals.

So, a life insurance 1035 exchange may be a highly advantageous tool for moving to a better life insurance policy. Still, there are some considerations that everyone needs to know before taking next steps to make this happen.

Using 1035 Exchanges to Change Life Insurance Policies

[6 Key Concerns]

  1. Is there an outstanding loan on the current policy?
  2. Is there a need to change the owner or insured for the new policy?
  3. Is there a need for a loan from the new policy soon?
  4. Is there a need to take part of the proceeds to extinguish a loan or in cash?
  5. Is the insurance company you are currently exchanging financially sound?
  6. Is there possibility that the new policy will become a modified endowment contract (MEC)?

Outstanding Policy Loans and 1035 Exchange Issues

If there is an unpaid policy loan on your current life insurance policy, it must be paid back (if funds are available) OR the policy could be “reduced” prior to the 1035 exchange.

If you plan on reducing your policy, you should consider a few important precautions:

  • 1) the reduction can’t exceed the tax basis (the amount invested) in the original policy or a tax will follow;
  • 2) the original policy reduction should be completed well in advance of the exchange to avoid a “step transaction”;
  • 3) there may be a “forced out gain” for recent policies if within the first 15 years of the policy;
  • 4) if the new policy is denied it may be difficult to restore the original coverage.

A loan rescue may be used if a policy loan can be moved to a new policy and if this allowed, the loan could then be paid off with no recognition of taxable gain.

Changes of Policy Ownership

Ownership Changes

Changes in ownership of the policy are NOT allowed with 1035 exchanges. Attempting to change ownership with a 1035 exchange will typically result in income tax AND/OR gift tax consequences. If a change in ownership of the policy is desired, this should be accomplished prior to the exchange.

Some of the same precautions mentioned above would apply here. For example, if the new policy is denied, is the old policy adequate given the change in ownership.

Insured Changes

Changes in the insured are NOT allowed either as this would be the same as surrendering an old policy and issuing a new one to a new insured.

Second to Die Policies and 1035 Exchanges

Many people don’t know that a second to die life insurance policy converts to a single life policy for purposes of the 1035 rule upon the passing away of a spouse. Thus a surviving spouse is free to roll that policy into a new one if it is suitable and conditions are favorable to do so.

New Policy Loan Issues

If a new life insurance policy loan is needed fairly soon, this may cause an issue with a 1035 exchange because it may be deemed a “step transaction”. To be safe, it is recommended to wait a reasonable time after the completion of the 1035 exchange before taking addition policy loans.

Practice Tip:  When talking about waiting a reasonable time, a good rule of thumb is at least 6 months, however this is really a common sense test based upon the circumstances.

Taking Cash to Extinguish Loans or Other “Non-Like Kind” Issues

1035 Exchanges require a “like kind exchange”.  Going back to our analogy to real estate, the investor in a commercial property must find a similar commercial property in which to do a 1031 exchange.

For purposes of life insurance and 1035 rules, the cash value generally needs to be rolled into another policy. If proceeds are taken out of the policy, rather than transferred to the new policy, this can be considered “boot: and will most likely trigger tax consequences.

The Company You Are With is Not Financially Sound

Another problem we run into is when a company hits a rough patch and is suffering financially. Certain insurance companies make poor decisions, or other parts of the whole come under financial pressure, effecting the entire company.

For example, when AIG came under financial pressure during the housing crisis, the company’s life insurance division was sound. However, since it was connected to the whole, owners of life insurance policies were fearful of what may happen if AIG went bankrupt.

As a result, a prudent person may consider looking for another top rated life insurance company to move to.

Modified Endowment Contract (MEC) and 1035 Exchange Issues

If your current policy is NOT a Modified Endowment Contract, AKA a “MEC,” then the new policy should not have an issue provided it meets the MEC 7 pay rule requirements. However, if the original policy is a MEC, then the exchange policy will also be deemed a MEC. This issue could be especially relevant for an older “grandfathered” MEC policy.

1035 Exchanges are for More than Life Insurance Policies

Remember that 1035 exchanges may ALSO be used for endowments and non-qualified annuities AND may be made interchangeably between life insurance policies, endowments and annuities in many cases.

If you think a 1035 exchange may be advantageous, please feel free to connect with us today to speak to a member of our pro team to see what options are available for you.

13 comments… add one
  • Joan English January 15, 2018, 2:46 pm

    Is it possible to exchange a Level Benefit Term Life Policy for a Whole life policy?
    My term life policy will expire in about 2 years and I hate to see all that money that I paid into it amount to zero. Thank you.

    • Insurance&Estates January 16, 2018, 12:03 pm


      Thank you for the inquiry. We will reach out to you shortly via the contact info you provided.


  • Alma G. November 21, 2018, 7:30 am

    Can a Unisex Variable Appreciable Life Guaranteed Qualified be 1035 exchanged into another New NON-Qualified Life policy? or it should go into an Annuity, and if so, the annuity has to be Qualified or Non-Qualified??

    • Insurance&Estates November 21, 2018, 3:21 pm

      Hello Alma,

      We forwarded your request to Jason Herring, one of our Pro Client Guides, to reach out concerning your questions. Thanks for checking in.



  • Murali I. December 3, 2018, 2:05 pm

    I currently participate in our company sponsored Group Universal Life Insurance w/ AD&D rider and cash accumulation option. So far this is working out great. I am looking for additional riders like Long Term Care expense, zero sum loan, minimum guaranteed return and growth options provided similar to Indexed Universal Life. I am very familiar with 1031 exchange but didn’t know 1035 option for insurance. Will I be able to utilize 1035 exchange in my situation and more details are welcome.

    • Insurance&Estates December 3, 2018, 4:28 pm

      Hello Murali,

      Thanks for your interest and question. I can answer generally that a 1035 exchange is for any “like-kind” policy, so you should be able to utilize for other life insurance policies. That said, it’d be tough to address your questions further without some more details. I would like to connect you with Jason Herring who has an extensive background in universal life policies. Let me know if you’d like him to connect with you to answer your questions in more detail. If so , please e-mail me your best phone contact information at steve@insuranceandestates.com.

      Best to you.

      Steve Gibbs

  • alan don January 11, 2019, 9:03 am

    I currently have a whole life with about $20k in cash value. I’d like to do 1035 to a new UL which will cost about 9k/yr. When is the best time to do the 1035 exchange, and will it cause the new UL to be a MEC? thanks in advance.

  • Troy Silcox April 14, 2022, 7:10 am

    Can I combine the two (1031 & 1035) and use real estate proceeds to purchase a life insurance policy?

    • Insurance&Estates April 18, 2022, 8:47 am

      Hello Troy and thanks for commenting. I’m not aware of an ability to exchange one asset for another, though I’ll give you some creativity points here. I think asking your CPA about this is the best route to be sure.

      Best, Steve Gibbs for I&E

  • Kirk Stanley May 20, 2022, 6:04 am

    I have a universal life policy. Current cash value approx. 750k with a 2.3 million death benefit. The contact period has been fulfilled. So there are no additional surrender costs. I’d like to get out of the policy but don’t want to incur the taxes on the gains. Currently about 260k. I don’t need the high coverage or the escalating premiums that are incurring. Also the company has lowered the dividend cap. I do have a 200k loan against the policy bringing face value to approximately 950k. Can I 1035 the policy into something with a lower death benefit and premiums and a higher dividend payout without triggering a tax event or it becoming a MEC?

    • Insurance&Estates May 20, 2022, 9:28 am

      Hello Kirk and thanks for connecting. Generally speaking, a 1035 could be used for the purpose you’re describing. To see how this would work for you specifically, an expert would need to look at your existing policy and discuss solutions for an exchange. To get started, I recommend that you connect with our high cash value life expert Barry Brooksby by emailing him at barry@insuranceandestates.com.

      I will let him know to expect your email.

      Best, Steve Gibbs for I&E

  • Jerry Randall March 11, 2023, 11:12 am

    My Irrevocable life ins trust owns a $100,000 policy on my life. I have paid $30,000
    premiums in past years & filed annual guft tax returns, The cash vaue is &50,000. If I
    do a 1035 exchange within this trust to a Survivorship policy insuring my wife and me , do I need to file a gift tax return as to the $20,000 gain in cash value? Thanks

    • SJG March 11, 2023, 3:16 pm

      Hi Jerry, I’d like to help yet tax questions absolutely lend themselves to a consultation with your trusted advisor – too many ways to get it wrong relying on blog discussions.

      Best, Steve Gibbs for I&E

      Steven Gibbs is a licensed insurance agent, and the following agent
      license numbers of Steven Gibbs are provided as required by state law:

      Resident License; AZ agent #17508301,
      Non-resident Licenses: TX agent #2273189, CA agent #0K10610,
      LA agent #769583, MA agent #2049963, MN agent #40563357,
      UT agent #655544.

Leave a Comment