Which statement best describes the tax treatment of a 1035 exchange?

Which statement best describes the tax treatment of a 1035 exchange?

• A. It allows tax-free replacement from one annuity to another.
• B. It triggers taxes on the transfer.
• C. It is only available for life insurance, not annuities.
• D. It converts the transfer into a loan.

Answer: (A)

A 1035 exchange lets you swap an existing life insurance policy or annuity for another contract without paying taxes at the time of the swap. The gains inside the old contract are carried over to the new contract, so the transaction preserves the tax deferral you already had. Taxes are not due on the transfer itself; they’ll be due later when you take distributions from the new contract, to the extent those distributions come from previously earned gains. This is why the statement describing it as a tax-free replacement from one annuity to another is the best fit: it captures the essence that the exchange avoids triggering taxes at the moment of transfer and maintains tax-deferred growth going forward.

A 1035 exchange lets you swap an existing life insurance policy or annuity for another contract without paying taxes at the time of the swap. The gains inside the old contract are carried over to the new contract, so the transaction preserves the tax deferral you already had. Taxes are not due on the transfer itself; they’ll be due later when you take distributions from the new contract, to the extent those distributions come from previously earned gains.

This is why the statement describing it as a tax-free replacement from one annuity to another is the best fit: it captures the essence that the exchange avoids triggering taxes at the moment of transfer and maintains tax-deferred growth going forward.