1035 Exchange is the sectionof the Internal Revenue Code that allows for tax-free exchange of insurance products. For example, if you have cash value in a whole life insurance that you would like to transfer to an indexed universal life plan, you may do this tax-free under the guidelines of this section.
Specifically, a 1035 Exchange provides for the taking of the proceeds from one life insurance policy or annuity and the exchanging of these proceeds immediately in another life insurance policy or annuity of an equivalent type without being required to pay a tax on any gain. The annuities or life insurance policies are not assessed by capital gains or any other taxes, allowing a policyholder to avoid taxes that would have been applied on the first policy as long as the second is of equal or greater cost. The annuities or life insurance policies must be directly exchanged; therefore, selling one and buying another is not applicable.