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1035 exchange: roll over your annuity tax-free.

A 1035 exchange is the IRS-blessed way to move money from one annuity to another without owing a dime in income tax on accumulated gains. Used correctly, it lets you upgrade to a better rate, lower fees, or richer income features — without losing the tax-deferred treatment you've built up.

How a 1035 exchange works

  1. You apply with the new annuity carrier and request a 1035 exchange from your existing contract.
  2. The new carrier sends paperwork to your current carrier authorizing the transfer.
  3. Your current carrier liquidates the contract and wires the cash value directly to the new carrier.
  4. The new annuity is funded. Your cost basis carries over; any deferred gain remains untaxed.

Critically, the money cannot pass through your bank account. If you take a check payable to yourself and re-deposit it, the IRS treats the original distribution as fully taxable.

What qualifies as a 1035 exchange

  • Annuity → Annuity ✓
  • Life insurance → Life insurance ✓
  • Life insurance → Annuity ✓
  • Annuity → Life insurance ✗ (not allowed)
  • Annuity or life → qualified Long-Term Care contract ✓ (Pension Protection Act provision)

When a 1035 exchange makes sense

The most common — and usually the best — scenarios are:

  • Your MYGA is maturing. Roll the principal plus gains into a new MYGA at today's higher rate. See current MYGA rates.
  • Your variable annuity has high fees. Exchange into a lower-cost or fixed product to stop the fee drag without owing tax on the gain.
  • You want a better income rider. Newer FIA income riders may offer higher guaranteed lifetime withdrawal rates than older contracts.
  • Carrier downgrade. If your carrier's AM Best rating drops materially, moving to a stronger carrier is reasonable.

When a 1035 exchange does NOT make sense

  • Your current contract still has meaningful surrender charges and the rate pickup doesn't recover them within 2–3 years.
  • You'd lose a valuable bonus or guaranteed minimum that no new contract can replicate.
  • You're being pitched by an agent whose only argument is "this new product is better" without showing math.

The break-even calculation

Before any 1035 exchange, calculate: (annual rate increase × years remaining) − total surrender charge. If the answer is positive and large enough to offset the inconvenience, the exchange likely pays off. If it's close to zero or negative, stay put.

Frequently asked questions

What is a 1035 exchange?
A 1035 exchange is a provision in Section 1035 of the Internal Revenue Code that allows you to transfer the cash value of one annuity or life insurance contract into another similar contract without triggering a taxable event. It's the annuity world's equivalent of an IRA rollover.
What contracts qualify for a 1035 exchange?
Annuity to annuity is allowed. Life insurance to life insurance is allowed. Life insurance to annuity is allowed. Annuity to life insurance is NOT allowed. Long-term care contracts can be involved in certain qualifying exchanges. The owner of both contracts must be the same person.
Are there fees or taxes for a 1035 exchange?
There is no federal tax on a properly executed 1035 exchange. However, the old contract may impose surrender charges if it's still within its surrender period. Always compare the surrender charge cost against the benefit (typically a higher rate or better features) before exchanging.
How long does a 1035 exchange take?
Typically 3 to 6 weeks. The new carrier sends paperwork to the old carrier, who liquidates the contract and wires the proceeds directly. Funds never pass through your hands — if they do, the exchange is invalidated and the full amount becomes taxable.
When does a 1035 exchange make sense?
Common scenarios: (1) your current MYGA matures and you want to lock in a new higher rate without paying tax on gains, (2) your variable annuity has high fees and you want to move to a lower-cost or fixed product, (3) you want different income rider features. It rarely makes sense if your current contract has meaningful surrender charges remaining.
Can you do a partial 1035 exchange?
Yes. A partial 1035 exchange moves only a portion of the contract value to a new annuity, tax-free. The IRS imposes a 180-day rule: withdrawals from either contract within 180 days of a partial exchange can re-characterize the transaction as taxable.

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