Taxation✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
Which of the following exchanges is permitted tax-free under IRC §1035?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
IRC §1035 allows a tax-free exchange of a life insurance policy for another life insurance policy on the same insured, a life insurance policy for an annuity, and an annuity for another annuity. Because the rule protects the deferred build-up only while it stays in an insurance contract, exchanging an annuity for a life policy is not permitted — the direction of the rule matters. A policy on a different insured is a different contract, and a non-insurance investment is outside §1035 entirely, so both would trigger taxable gain.
Why the other options are wrong
- B) The exchange of an annuity for a life insurance policy is not a permitted §1035 exchange. The rule allows life to annuity but not annuity to life, so the transaction is taxable.
- C) §1035 requires the exchange to be on the life of the same insured. A policy on a different person is a new contract and triggers taxable gain.
- D) Only insurance contracts can be exchanged tax-free under §1035. Exchanging an annuity for a non-insurance investment is a taxable disposition of the contract.
Memory hook
§1035: life to life or life to annuity is tax-free; trading the other way is a taxable about-face.