You can move an annuity to another insurance company without triggering a tax bill by using what the tax code calls a 1035 exchange, named for Section 1035 of the Internal Revenue Code.1Office of the Law Revision Counsel. 26 USC 1035 – Certain Exchanges of Insurance Policies If your annuity sits inside an IRA or 401(k), a different route applies: a custodian-to-custodian transfer under the retirement account rules. Either way, the money has to move directly from one carrier to the other, and the owner has to stay the same. Slip up on either point and the IRS treats the whole balance as a taxable withdrawal.
How a 1035 Exchange Keeps the Move Tax-Free
Section 1035 lets you swap one non-qualified annuity for another without recognizing gain or loss on the transaction.1Office of the Law Revision Counsel. 26 USC 1035 – Certain Exchanges of Insurance Policies Your original cost basis — the total premiums you paid into the old contract — carries over to the new annuity, so future withdrawals will be taxed the same way they would have been under the old contract.2IRS. 2025 Instructions for Forms 1099-R and 5498
A properly completed exchange also avoids the 10% early withdrawal penalty that would otherwise apply if you pulled the money out before age 59½.3Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts One direction is closed off: you cannot exchange an annuity into a life insurance policy. That combination is not allowed under Section 1035 and produces a taxable event.1Office of the Law Revision Counsel. 26 USC 1035 – Certain Exchanges of Insurance Policies
The Same-Owner Requirement
Federal regulations require that the same person or persons remain entitled to payments under both the old and the new contract.4eCFR. 26 CFR 1.1035-1 – Certain Exchanges of Insurance Policies The contract owner and the annuitant have to be identical on both sides of the exchange. If you try to change ownership during the transfer, for example by moving your annuity into a contract owned by your child, the IRS treats the whole transaction as a taxable distribution rather than a qualified exchange.
If Your Annuity Is Inside an IRA or 401(k)
The 1035 exchange rules apply only to non-qualified annuities, meaning contracts bought with after-tax dollars outside a retirement account. If your annuity is held inside a traditional IRA or a 401(k), you don’t use a 1035 form at all. The funds move through a custodian-to-custodian (or trustee-to-trustee) transfer under the retirement account rules, going directly from one IRA custodian to another. As long as you never take personal possession of the money, the transfer is not taxable.
You cannot cross the line between the two categories. A qualified annuity can only move to another qualified account, and a non-qualified annuity can only move to another non-qualified annuity (or, in limited cases, to a qualified long-term care contract). Ask the receiving company for its IRA transfer paperwork rather than a 1035 exchange form. Using the wrong process can cause the IRS to treat the transaction as a distribution, creating a tax bill and, if you’re under 59½, the 10% early withdrawal penalty.3Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
Costs That Can Shrink the Amount Transferred
A 1035 exchange is tax-free, but it isn’t necessarily cost-free. Several charges from your current carrier, and some features of the new contract, can reduce what actually arrives at the receiving company.
Surrender Charges
Most annuities carry a surrender period of roughly five to seven years, during which withdrawing or transferring funds triggers a surrender charge. The charge typically starts around 7% of the contract value in the first year and drops by about one percentage point per year until it reaches zero.5Investor.gov. Surrender Charge Each new premium payment you make can start its own separate surrender clock, so a contract you’ve held for years may still have charges on more recent contributions.
Market Value Adjustments
Some fixed and fixed-indexed annuities include a market value adjustment. If interest rates have risen since you bought the contract, the MVA reduces your surrender value; if rates have fallen, it increases it. The adjustment applies only to amounts withdrawn during the surrender period that exceed any free withdrawal allowance in your contract.
A New Surrender Clock and New Fees
The new annuity comes with its own surrender schedule, which restarts. If the new contract runs a seven-year surrender period, you’re looking at another seven years of potential charges. Some new contracts also carry higher mortality and expense fees, advisory fees, or rider costs. A “bonus” credit from the new carrier of 1% to 5% of the transferred amount can be appealing, but bonus-credit annuities often carry higher ongoing fees that offset the bonus over time.6FINRA. Should You Exchange Your Variable Annuity?
How the Money Actually Moves
Once the receiving company has your completed application and exchange form, the transfer follows a carrier-to-carrier protocol designed to keep the funds out of your hands. The new carrier sends a formal request for funds to your current insurance company. The original carrier verifies the request, liquidates the underlying assets, calculates the final value after any surrender charges or market value adjustments, and sends the money (by check or wire) directly to the receiving carrier. A statement of your cost basis travels with it so the new carrier can track future taxable withdrawals. The receiving company deposits the funds, issues the new contract, and sends you a confirmation statement.
That direct carrier-to-carrier flow is what preserves the tax-free treatment. If the money passes through your hands even briefly, the IRS treats you as having taken “constructive receipt,” and the transaction becomes a taxable distribution.
Most transfers take four to six weeks, though electronic processing through standardized industry forms can be faster.7ACORD. ACORD 951e – 1035 Exchange/Rollover/Transfer Some companies require a verbal confirmation call before releasing large balances. When your confirmation arrives, compare the amount received against the final surrender value your original carrier quoted, and raise any discrepancy with both companies right away.
Partial Exchanges and the 180-Day Rule
You don’t have to move the whole contract. A partial 1035 exchange lets you shift a portion of one annuity into a new contract while keeping the original in place. The catch is a 180-day holding period: you cannot take a distribution from either the original or the new contract during the 180 days following the transfer, or the IRS may recharacterize the exchange as taxable.8Internal Revenue Service. Revenue Procedure 2011-38 – Section 1035
If you violate the rule, the IRS looks at the substance of the transaction and may treat the amount as taxable boot (an extra payment alongside an otherwise tax-free exchange) or as a regular distribution under the standard annuity withdrawal rules.8Internal Revenue Service. Revenue Procedure 2011-38 – Section 1035 The safest approach is to leave both contracts untouched for at least six months after a partial exchange.
Your Free Look Period on the New Contract
Once the new annuity is issued, most states give you a free look period during which you can cancel for a full refund with no surrender charge. The minimum is typically 10 days, though many states stretch it to 20 or 30 days for replacement contracts (which is what a 1035 exchange produces) or for buyers over a certain age. The clock starts on the day you receive the contract, so read the free look terms printed on the first pages as soon as it arrives.
Tax Reporting After the Exchange
Even a tax-free exchange gets reported. Your original carrier will issue a Form 1099-R for the year of the transfer. Box 1 shows the full contract value, Box 2a (taxable amount) shows zero, and Box 7 carries Code 6, which tells the IRS the transaction was a Section 1035 exchange. Keep the form with your tax records. If the exchange involved a canceled contract loan or other property distributed alongside the transfer, that piece may be taxable and reported on a separate 1099-R.2IRS. 2025 Instructions for Forms 1099-R and 5498 Talk to a tax professional first if you have an outstanding loan against the annuity.
When the Recommendation Itself Deserves a Second Look
An agent or advisor recommending that you exchange annuities has to determine the move is in your best interest. The NAIC’s Suitability in Annuity Transactions Model Regulation, adopted in most states, requires recommendations to be made with reasonable diligence and prohibits agents from putting their own financial interest ahead of yours.9NAIC. Annuity Suitability and Best Interest Standard
For variable annuities sold through broker-dealers, FINRA Rule 2330 adds specific checkpoints. Before recommending an exchange, the representative must consider whether you would lose existing death or living benefit riders, face a new surrender period, incur higher fees, or have already exchanged a variable annuity within the past 36 months.10FINRA. FINRA Rule 2330 – Members’ Responsibilities Regarding Deferred Variable Annuities A pattern of frequent exchanges without a clear benefit to you may violate these rules and is worth reporting to your state insurance department or FINRA.