Under IRC Section 1035, which exchange of contracts is generally tax-free?

Why A is correct

Section 1035 permits tax-free exchanges of: life insurance for life insurance, life insurance for an annuity, and annuity for annuity — provided the insured/annuitant is the same and the exchange is direct. An annuity may NOT be exchanged tax-free for a life insurance policy, and a surrender-then-repurchase is a taxable event. The exchange must be property-for-property, same owner.

Why the other options are wrong

• B) The 1035 privilege runs one way into annuities; exchanging an annuity for life insurance is a taxable event.
• C) Surrendering for cash triggers taxable gain on the excess over basis, even if a new policy is bought soon after.
• D) A Section 1035 exchange must involve the same insured/owner; changing the owner breaks the tax-free treatment.

Memory hook

1035 = the one-way escalator: life→life, life→annuity, annuity→annuity. You can climb toward annuities, never back down to life.

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.