Section 1035 exchange rules are the tax provisions that allow policyowners to exchange one life insurance, endowment, or nonqualified annuity contract for another without recognizing current gain, as long as specific like-kind and ownership requirements are met. The insured or annuitant generally must remain the same, and exchanges cannot move from an annuity back into life insurance. Partial 1035 exchanges and exchanges into hybrid LTC products have special guidance. While Section 1035 preserves tax deferral, it does not erase prior gain or guarantee that the new contract is more suitable or efficient.

Advisors use Section 1035 exchanges to reposition underperforming policies into newer products with better guarantees, features, or costs, while deferring tax on embedded gains. They coordinate with carriers to complete 1035 paperwork, confirming that ownership, insureds, and tax reporting are handled correctly. Compliance and tax advisors review reasons for the exchange and potential impacts on MEC status, surrender charges, or new contestability periods. Understanding Section 1035 exchange rules helps advisors balance tax efficiency with suitability, ensuring that clients are trading up economically rather than simply moving problems to a new contract.