Many individuals and families own life insurance or related products like variable annuities, which have accumulated a significant cash value in the investment portion of the policy. Due to a variety of factors, these individuals may find themselves in circumstances where the specific life insurance policy or annuity contract they own no longer suits their needs, or perhaps there is a newer type of insurance product that may be better for their situation. They may want to exchange products without incurring a taxable event.

That’s where Section 1035 of the Internal Revenue Code comes into play. A 1035 exchange provides a means for exchanging an annuity contract or life insurance policy without being treated as if it had been surrendered or sold. Keep in mind that a 1035 exchange can be used only when it involves the same contract or policy holder.

A 1035 exchange, provided certain requirements are met, gives policy or contract holders the flexibility to “trade-in” an older contract or policy for a newer contract or policy. A newer policy or contract may have lower costs, a higher death benefit or more investment choices. A 1035 exchange involves a complex set of tax rules and regulation so make sure to seek guidance from your tax or investment professional.

Several factors will affect the cost and availability of life insurance, including age, health and the type and amount of insurance purchased. If a policy is surrendered prematurely, the policy holder also may pay surrender charges and have income tax implications. You should consider determining whether you are insurable for a new policy before implementing a strategy involving life insurance.

Annuities have contract limitations, fees and potential surrender charges, which should be considered before making any exchanges. Surrender fees are usually highest if you take out the money in the initial years of the annuity contact.

Section 1035 allows for the following types of exchanges:

• Life insurance contract for an annuity contract, endowment contract or another life insurance contract;

• An endowment insurance contract for an annuity contract or another endowment contract;

• An annuity contract for another annuity contract;

Any other exchanges will trigger taxation of any gain in the original contract.

Why would someone want to do a 1035 exchange? As stated above, perhaps the individual or family situation has changed. Perhaps life insurance was important at one time, but now the policy holder may not need life insurance and is more concerned about long-term care insurance. Today there are some newer life insurance policies which have built in long-term care benefits. Or perhaps the individual desires to move a low yielding cash balance from an old life insurance policy into a more productive growth investment like a variable annuity for the benefit of his or her heirs.

Another possibility is the owner of an older variable annuity, which desires the features and benefits available in a newer product now available. Many possible scenarios exist, and a 1035 exchange allows cash value insurance based products to be swapped without any tax ramifications.

Again, since this is a somewhat complex financial transaction, it is best to obtain tax and investment guidance from your tax preparer and financial advisor.

Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.