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A
A special endorsement rider that modifies policy terms
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B
A tax-free transfer of the cash value from one life insurance policy to another life insurance policy (or to an annuity) — the 1035 exchange allows policyholders to replace an old policy with a better one without triggering a taxable event on the accumulated gain
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C
A government programme for low-income life insurance buyers
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D
A type of accelerated death benefit
Why this is the answer
SECTION 1035 OF THE INTERNAL REVENUE CODE allows tax-free exchanges of certain insurance and annuity products. PERMITTED 1035 EXCHANGES: Life insurance → life insurance (same insured); Life insurance → annuity (tax-deferred); Annuity → annuity (same annuitant); Endowment → annuity. NOT PERMITTED: Annuity → life insurance. WHY THIS MATTERS: Without 1035 exchange treatment, any gain in a policy's cash value above the cost basis would be taxable as ordinary income when the policy is surrendered; 1035 allows the policyholder to move into a newer, better product without paying income taxes on the accumulated gain. REQUIREMENTS: Must be a direct transfer — the policyholder cannot receive the cash; the insurance company sends the funds directly to the new carrier; both policies must be on the same insured (life insurance) or annuitant (annuity); the new policy cannot have significantly different ownership; WATCH FOR: Surrender charges on the old policy that may still apply even with a 1035 exchange — the exchange doesn't eliminate surrender charges, only the income tax on gain; COMPARISON TO TAXABLE SURRENDER: If a policyholder surrenders a policy with $50,000 of gain directly (not 1035), they owe income tax on $50,000; with a 1035, the gain transfers into the new policy and is not taxed until a future surrender or distribution. AGENT RESPONSIBILITY: Explaining 1035 exchange options is part of professional service when discussing policy replacement.
Source: Life Insurance License Exam, 1035 Exchange