Life Insurance✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
A policyowner exchanges an existing life insurance policy for a new life insurance policy with different coverage. Which statement about a Section 1035 exchange is correct?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
IRC §1035 permits the tax-free exchange of a life insurance policy for another life insurance policy, a life policy for an annuity, or an annuity for another annuity, provided the exchange meets the statutory requirements, such as the same policyowner and a direct exchange of contracts. The policyowner's cost basis carries over to the new policy, so the taxable gain is deferred, not eliminated. The exchange need not be with the same insurer. Surrender charges may apply but are not deductible; if the exchange fails §1035 rules, gain becomes taxable.
Why the other options are wrong
- B) A qualifying §1035 exchange defers gain rather than taxing it in the current year.
- C) §1035 exchanges may be made between different insurers; same-insurer is not required.
- D) Surrender charges from the old policy are not deductible; they reduce cash value but create no tax deduction.
Memory hook
1035 = swap life for life or annuity, tax deferred. Basis rides along, tax waits.