What Is a 1035 Exchange? And How Can It Benefit Your Annuity?

Thinking of upgrading your annuity or life insurance? Then, you’ve come to the right place. Here, you will learn everything you need to get yourself out of a high-fee contract and start taking advantage of a better investment option. 

To do that, you will need a 1035 exchange, a tax-friendly tool to help you switch from a policy that no longer suits your needs to one that can actually benefit you. 

In this comprehensive guide, you will learn what a 1035 exchange means, how it works for annuities, and the IRS rules you’ll need to follow.

Quick Facts

• A 1035 exchange lets you transfer from one annuity (or life insurance) to another without triggering taxes.

• The exchange must be a direct transfer between insurers — you can’t touch the funds.

• Popular reasons to do a 1035 exchange: lower fees, better benefits, stronger guarantees.

• Not all exchanges qualify — you can’t move from an annuity back to a life policy, for example.

• The main benefit of a 1035 exchange is preserving tax deferral while upgrading your retirement income strategy.

What Is a 1035 Exchange?

It’s often referred to as a “like-kind” exchange,  where you're swapping one type of contract for another similar one, such as an annuity for another, better annuity. The owner and insured mist also remain the same during the switch. 

If you’re considering a 1035 exchange annuity, this move must be done directly between insurance companies. 

🚨 If you receive the money yourself, even temporarily, the IRS considers it a distribution, and you’ll owe taxes on gains.

How a 1035 Exchange Works for Annuities

At Annuity Association, we often come across clients who’ve forgotten about annuities they purchased years ago or haven’t reviewed them in a long time. 

Let this serve as a friendly reminder to regularly review your annuities and insurance policies to ensure they still align with your financial goals and expectations.

So, what could be potential reasons to do a 1035 exchange with an annuity?

• Owning a high-fee annuity 
• Owning an annuity that lacks modern features (e.g., income riders, death benefits, inflation protection, etc.)
• Owning an annuity that no longer suits your retirement goals (e.g., a lack of lifelong income).

Real-Life Example of a 1035 Exchange

Jim invested $100,000 in a variable annuity 10 years ago. He’s now nearing retirement and wants a guaranteed lifetime income stream. By using a 1035 exchange, he transfers his current contract into a fixed indexed annuity with an income rider — all without paying taxes on the gains.

If Jim becomes unsatisfied with his upgraded annuity, he can switch to another annuity, filling out a new 1035 exchange form.

Behind the Scenes

To switch to another annuity with a 1035 exchange takes anywhere from 2 to 6 weeks. You’ll need to submit paperwork to both insurers, and the IRS will expect Form 1099-R (showing the transfer was tax-free).

1035 Exchange Rules You Need to Know

Before you print out your 1035 exchange form, you need to understand the 1035 exchange rules. Failing to meet these criteria can result in taxable gains and penalties:

• The owner and annuitant must remain the same.
• The exchange must be a direct transfer between companies.
• You can’t receive the money yourself during the process.
• Only certain types of exchanges qualify.

What can be exchanged and what is not allowed is shown below

What Is Not Allowable in a 1035 Exchange?

In a 1035 exchange, it is not allowed to:

• Move funds from an annuity into a life insurance policy 
• Take a distribution and then buy a new contract because it invalidates the tax-free treatment 
• Make any changes in ownership before or during the exchange 
• Exchanging an annuity that has a loan or lien may complicate or disqualify the exchange

Key Benefits of a 1035 Exchange for Annuity Holders

After checking the 1035 exchange rules, you may wonder why go through the hassle? Upgrading your annuity to a better one does have a lot of benefits that can directly benefit your retirement plan:

• Tax deferral stays intact: You don’t owe taxes on accumulated gains at the time of exchange.
• Access to better features: Newer contracts may offer enhanced income riders, market protection, or improved death benefits.
• Lower costs: Move from a high-fee product to a streamlined, low-cost annuity.
• Better alignment with your goals: As your needs shift (e.g. from growth to income), a new contract may serve you better.

Is a 1035 Exchange Right for You?

For many, a 1035 exchange is a strategic move, but it’s not always the right one. Ultimately, the decision will depend on your personal situation and financial goals. 

A 1035 exchange may be right for you if:

• You’ve outgrown your current contract or need better benefits.
• Market conditions have changed, and you want to lock in new rates.
• You're preparing for retirement and want guaranteed income.

⚠️ If your current annuity still carries steep surrender charges or you’re unsure about long-term trade-offs, consult with a licensed advisor to help you make the right decision.

How Annuity Association Can Help

At Annuity Association, we help people like you evaluate whether a 1035 exchange makes sense for your financial goals. We offer:

• Personalized annuity comparisons 
• Clear, unbiased advice on contract upgrades 
• Hands-on guidance through the 1035 exchange process 

Not sure if your annuity is still the right fit? Schedule a consultation today or explore annuity options on our website!

Conclusion

A 1035 exchange is one of the most powerful (yet often overlooked) tools for upgrading your retirement plan without incurring gain taxes. 

Whether you’re seeking lower fees, more guarantees, or better income features, it allows you to evolve your strategy as your needs change. Just remember to follow the IRS rules closely to preserve the benefits.

Ready to review your annuity options? Contact Annuity Association to explore how a 1035 exchange could work for you.

More Information About a 1035 Exchange

When is surrendering a policy better than doing a 1035 exchange?

If there’s no gain in the current contract, or if the policy has an outstanding loan, surrendering might be more tax-efficient. In some cases, surrendering avoids potential delays and complications, especially when market conditions or contract terms make an exchange less favorable.

Can multiple annuity contracts be combined in a 1035 exchange?

Yes, you can combine multiple contracts into a single new annuity using a 1035 exchange. However, you cannot split one annuity into multiple new contracts under this rule.

Can I keep some of the funds and transfer the rest in a 1035 exchange?

No. If you take any portion of the funds as cash during the exchange, it’s considered a taxable distribution (also called “boot”). Only full, direct transfers between like-kind contracts qualify for tax-free treatment.

Can the policy owner be changed during a 1035 exchange?

No. Ownership changes during a 1035 exchange are not permitted. Changing the owner can trigger income tax and possible gift tax liabilities. If ownership must be updated, it should be done before or after the exchange, not during.