New Jersey Life Producer Practice Exam

What is an example of a tax-free exchange between life insurance policies?

1. Gift exchange

2. Transfer of ownership

3. 1035 Exchange

4. Partial withdrawal

The correct answer is: 1035 Exchange

A 1035 Exchange refers to Section 1035 of the Internal Revenue Code, which allows for the tax-free exchange of certain types of insurance and annuity contracts. This mechanism is specifically designed for life insurance policies, allowing policyholders to transfer the value of an existing policy into a new policy without triggering immediate tax consequences. The primary advantage of a 1035 Exchange is that policyholders can take advantage of better coverage, lower premiums, or improved benefits while preserving the tax-deferred status of their existing policy's cash value. This exchange can be beneficial for those looking to upgrade their policies or switch insurance providers without incurring tax liabilities, supporting their financial strategies effectively. In contrast, other options like gift exchanges and transfers of ownership may involve tax implications depending on specific circumstances. A partial withdrawal could also lead to taxation if it exceeds the policy's cost basis. Thus, the 1035 Exchange stands out as the only option explicitly designed to enable tax-free exchanges between life insurance policies.