Can You 1035 Exchange an Annuity Into Long-Term Care? (w/Examples) + FAQs

This article reflects federal rules as of June 2026 and covers tax year 2026. State insurance and tax rules vary and are noted separately. Tax law changes — confirm current figures with the IRS or a licensed professional before you act.

Quick Answer

Yes. Since January 1, 2010, Section 1035 of the tax code lets you swap a non-qualified annuity for a tax-qualified long-term care (LTC) policy with no income tax on the gain — including hybrid annuity/LTC products. The Pension Protection Act of 2006 created this. Qualified (IRA) annuities do not qualify.

This matters because many people are holding an old, appreciated annuity they no longer need, while worrying about a future nursing-home or home-care bill they cannot cover. A 1035 exchange lets you turn that built-up gain — money you would otherwise be taxed on when you withdraw it — into long-term care coverage without triggering a tax bill, as long as you follow the rules in the right order.

The stakes are real and the timing is tight. Nearly 7 in 10 people turning 65 will need some form of long-term care, and the average annuity owner is exactly the retirement-age person facing that risk. One paperwork mistake — taking the cash yourself, or pulling money out within 180 days of a partial swap — can convert a tax-free move into a fully taxable distribution, plus a possible 10% penalty if you are under 59½.

Here’s what you’ll learn:

💡 The exact PPA rule that makes annuity-to-LTC exchanges tax-free, and the year it took effect
🧮 Worked dollar examples showing how a $150,000 annuity funds LTC coverage with zero tax
⚠️ The 180-day partial-exchange trap from Rev. Proc. 2011-38 that voids the tax break
🧭 A decision aid showing which of the three exchange paths fits your situation
📋 The step-by-step process, the forms, the deadlines, and when to call a pro

What a 1035 Exchange Actually Is

A 1035 exchange is a tax-free swap of one insurance-based contract for another “like-kind” contract, named after Section 1035 of the Internal Revenue Code. Normally, when you cash out an annuity, you owe ordinary income tax on the gain — the difference between what the contract is worth and what you paid in. A 1035 exchange lets you move that money into a new qualifying contract and carry your cost basis with it, so no gain is recognized at the time of the exchange.

The key word is exchange. The money must move directly from the old insurer to the new one. You never touch the cash. If a check is cut to you and you re-deposit it, the IRS treats that as a taxable surrender, not an exchange — and the tax break is gone. This is the single most important mechanical rule in the whole process.

Before 2010, the law was narrower. Section 1035 allowed life-for-life, life-for-annuity, and annuity-for-annuity swaps, but not annuity-for-LTC. The Pension Protection Act of 2006 (PPA) changed that, and the change became effective on January 1, 2010. Since then, you can exchange a non-qualified annuity or a life insurance policy into a tax-qualified long-term care insurance contract under Section 7702B tax-free.

The consequence of getting this right is large. A retiree sitting on a $60,000 gain inside an old annuity could otherwise owe roughly $13,000–$21,000 in federal tax on that gain at withdrawal, depending on bracket. Routed through a 1035 exchange into LTC coverage, that same gain funds care with no tax at all — and qualifying LTC benefits later come out tax-free too. The common misconception is that “tax-deferred” annuity money is somehow already tax-paid; it is not, and a plain cash-out can be a painful surprise.

The Three Exchange Paths (and the One That’s Blocked)

There is no single “annuity into long-term care” move. There are three distinct paths, and the rules differ for each. Knowing which one you’re using is the difference between a clean tax-free transfer and a taxable mess. The PPA permits the first two; the tax code blocks the third.

Path 1: Annuity → Stand-Alone Tax-Qualified LTC Insurance

Here you exchange a non-qualified annuity directly for a traditional, stand-alone LTC insurance policy that meets Section 7702B requirements. The annuity’s cash value (or a portion of it) is sent insurer-to-insurer and applied as premium. Because most stand-alone LTC policies are paid with annual premiums, this is usually done as a series of partial exchanges — a fixed amount each year — which is exactly where the 180-day rule becomes critical.

The benefit is that every dollar moved this way escapes income tax, and the gain portion is effectively “used up” tax-free as it pays premium. The consequence of mishandling it is that any cash you receive personally is taxed as ordinary income, gain-first. The common misconception is that you can take a withdrawal and “pay the premium yourself” with no difference; you cannot — that is a taxable distribution, not an exchange. What to do: instruct the carrier in writing to transfer funds directly to the LTC insurer.

Path 2: Annuity → Hybrid (Combo) Annuity/LTC Product

A hybrid or “combo” product is a single contract that is both an annuity and an LTC benefit pool under Section 7702B(e). You 1035 your old annuity into the new hybrid annuity, and the contract’s LTC rider multiplies your money into a larger pool of tax-free care benefits. This is the most popular path today because the whole value transfers at once, sidestepping the year-by-year partial-exchange problem.

The benefit is leverage: a deposit can become two to three times its value in LTC benefits, and unused money still passes to heirs as an annuity death benefit. The consequence of skipping the 7702B qualification is losing the tax-free benefit treatment. The misconception is that any annuity with an LTC feature qualifies; only contracts meeting 7702B do. What to do: confirm in writing that the new contract is “tax-qualified under IRC 7702B” before you sign.

Path 3 (Blocked): Annuity → Life Insurance or Hybrid Life/LTC

You cannot 1035 an annuity into a life insurance policy, and therefore you cannot exchange an annuity into a hybrid life insurance/LTC product. Section 1035 only allows movement “down the ladder” — life can go to annuity, but annuity cannot go to life. This blocks one of the most marketed LTC products (life/LTC combos) as a 1035 destination for annuity money.

The consequence of trying anyway is a fully taxable surrender of the annuity. The misconception is that “it’s all insurance, so it should swap” — the code is strict and one-directional here. What to do: if you want a life/LTC combo, you must surrender the annuity (and pay tax) or look at a hybrid annuity/LTC product instead, which annuity money can fund.

Which Situation Applies to You?

Your right path depends on what money you have and what you want. Use this to find your section above.

You have a non-qualified annuity (bought with after-tax money) and want stand-alone LTC coverage → Path 1.
You have a non-qualified annuity and want a single product that does it all and passes leftovers to heirs → Path 2 (hybrid annuity/LTC).
You want a life insurance/LTC combo and only have annuity money → blocked under Path 3; you’ll surrender and pay tax, or pivot to a hybrid annuity/LTC.
You have a qualified annuity inside an IRA or 401(k) → 1035 does not apply at all (see the qualified-money section below).

Qualified vs. Non-Qualified Money: The Dividing Line

This is where most readers go wrong. Section 1035 applies only to non-qualified annuities — annuities you bought with already-taxed dollars outside a retirement account. An annuity held inside an IRA, 401(k), 403(b), or other qualified plan cannot use a 1035 exchange, because that money has never been taxed and lives under different rules (Section 408 and related).

If your annuity is inside an IRA, moving it to an LTC policy means taking a taxable distribution first. You’d owe ordinary income tax on the full amount withdrawn, plus a 10% early-withdrawal penalty if you’re under 59½. The consequence is steep: a $100,000 IRA-annuity cash-out could cost $22,000–$37,000 in federal tax in a middle bracket, leaving far less to fund care.

The common misconception is that “an annuity is an annuity,” so any of them can swap into LTC. They cannot. What to do: check your contract or statement — if premiums went in pre-tax or it sits in an IRA, it’s qualified, and 1035 is off the table. Instead, look at standard medical-expense deductions for LTC premiums, or fund care from the after-tax proceeds with eyes open about the tax cost.

The 180-Day Partial-Exchange Trap

When you fund a stand-alone LTC policy from an annuity, you usually move a slice each year — a partial 1035 exchange. The IRS set strict guardrails for these in Rev. Proc. 2011-38, effective for exchanges completed on or after October 24, 2011. Break them, and the “exchange” can be recharacterized as a taxable withdrawal.

The core rule: during the 180-day period beginning on the date of the partial transfer, you may not take any amount out of either the original annuity or the new contract — unless that amount is paid as an annuity for life or for a fixed period of 10 years or more. If you pull cash inside that window, the IRS applies “general tax principles” and can treat the move as a taxable distribution under Section 72(e), gain first.

The consequence is harsh: the gain portion of what you withdrew becomes ordinary income, and a 10% penalty applies if you’re under 59½. The misconception is that the 180 days only restricts the new contract; in fact it restricts both contracts. What to do: map out your withdrawal needs before starting a partial-exchange schedule, and keep a calendar of each transfer date so no withdrawal lands inside a 180-day window.

What you do with a partial exchange	What the IRS does about it
Move a slice of annuity value directly to the LTC insurer, take nothing for 180 days	Treats it as a clean tax-free 1035 exchange — no income, no penalty
Take cash from either contract within 180 days (not as a 10-year-plus annuity)	May recharacterize using general tax principles; gain taxed as ordinary income, 10% penalty if under 59½
Receive payments as a lifetime annuity or a 10-year-plus fixed annuity	Exception applies — withdrawal does not blow up the exchange

Worked Examples With Real Dollars

Numbers make this concrete. These examples use federal tax year 2026 figures and the 2026 age-based LTC deduction limits where relevant. They are illustrations, not quotes.

Example A — Margaret, 68: Hybrid Annuity/LTC (Path 2)

Margaret owns a non-qualified deferred annuity worth $150,000, with a $90,000 basis and a $60,000 gain. She rarely touches it and worries about home care. She does a full 1035 exchange into a hybrid annuity/LTC contract. Because it’s a like-kind exchange into a 7702B-qualified product, none of the $60,000 gain is taxed now. The hybrid leverages her $150,000 into roughly $450,000 of total LTC benefits (a 3x pool, typical for combo products). If she’d instead surrendered the annuity in a 22% bracket, she’d have owed about $13,200 in federal tax on the gain — money she keeps by exchanging instead.

Example B — Robert, 72: Partial Exchanges Into Stand-Alone LTC (Path 1)

Robert has a $200,000 non-qualified annuity ($120,000 basis, $80,000 gain) and a stand-alone LTC policy costing $6,000 a year. Each year his insurer sends $6,000 directly to the LTC carrier as a partial 1035 exchange. Each transfer is tax-free, and he takes nothing else from either contract for 180 days after each one. Over time, premiums are paid with pre-tax gain dollars he never had to report. Had he withdrawn $6,000 himself each year, the IRS would treat the gain portion as ordinary income — roughly $1,320 a year in tax at 22% — defeating the purpose.

Example C — Linda, 64: The Blocked Path (Path 3)

Linda likes a life insurance/LTC combo product and wants to fund it with her $100,000 non-qualified annuity ($40,000 gain). Her agent has to stop her: annuity money cannot 1035 into a life-based contract. To buy that product, she’d surrender the annuity, report the $40,000 gain as ordinary income (about $8,800 at 22%), and fund the policy with what’s left. Her better move is a hybrid annuity/LTC product, which her annuity can fund tax-free.

Step-by-Step: How to Do the Exchange

This is the standard process for a clean, tax-free annuity-to-LTC exchange. Most carriers complete it in two to six weeks; partial-exchange schedules run for years.

Confirm your annuity is non-qualified. Check the statement or contract. If it’s in an IRA or 401(k), stop — 1035 doesn’t apply.
Choose the destination — a stand-alone 7702B LTC policy (Path 1) or a hybrid annuity/LTC product (Path 2). Get written confirmation it is “tax-qualified under IRC 7702B.”
Apply and qualify for the LTC coverage. Stand-alone and hybrid products require health underwriting; approval is not guaranteed.
Sign a 1035 exchange form with the receiving carrier authorizing a direct insurer-to-insurer transfer. Never accept a check made out to you.
For partial exchanges, schedule each annual transfer and log the date. Take no withdrawals from either contract for 180 days after each transfer.
Keep records. The old insurer reports the exchange on Form 1099-R with a code “6” (1035 exchange). Match it to your records so you don’t get taxed by mistake.

The deadline reality: there’s no IRS filing deadline for the exchange itself, but the 180-day clock on partial exchanges is hard and runs from each transfer date. The cost is usually $0 in exchange fees, though surrender charges on the old annuity may apply if it’s still in its surrender period — check before you move.

Mistakes to Avoid

Taking a check yourself. Receiving the cash converts a tax-free exchange into a taxable surrender — the entire gain becomes ordinary income.
Withdrawing inside the 180-day window. Under Rev. Proc. 2011-38, this can recharacterize a partial exchange as a taxable distribution, gain first, plus a 10% penalty under 59½.
Trying to exchange a qualified (IRA) annuity. 1035 doesn’t apply; you’d owe full income tax and possibly a penalty.
Aiming an annuity at a life/LTC combo. The code blocks annuity-to-life exchanges, so the move is a taxable surrender, not an exchange.
Assuming the new product is 7702B-qualified. If it isn’t, the LTC benefits may not be tax-free; get it in writing.
Ignoring surrender charges on the old annuity. Moving during the surrender period can cost thousands in fees that no tax break recovers.
Forgetting to reconcile the 1099-R. A misread code “6” can trigger an IRS notice if you don’t match it to the exchange in your records.
Skipping health underwriting reality. If you can’t qualify medically for the LTC policy, the exchange can’t happen — and surrendering “to be ready” triggers tax.

Do’s and Don’ts

Do confirm the annuity is non-qualified before anything else — it decides whether 1035 is even possible.
Do insist on a direct insurer-to-insurer transfer — touching the cash kills the tax break.
Do get written confirmation the LTC contract is 7702B-qualified — that’s what makes benefits tax-free.
Do track every partial-exchange date — the 180-day clock is unforgiving.
Do check surrender charges first — fees can outweigh the tax savings if timing is wrong.
Don’t withdraw from either contract inside 180 days — it can void the exchange.
Don’t try to route IRA-annuity money through 1035 — it isn’t allowed and triggers full tax.
Don’t target a life/LTC product with annuity money — the exchange is blocked.
Don’t assume tax-deferred means tax-paid — the gain is still taxable on a plain cash-out.
Don’t go it alone on a partial-exchange schedule — one mistimed withdrawal undoes years of planning.

Pros and Cons

Pro — No tax on the gain. The annuity’s built-up gain funds LTC coverage with zero income tax, unlike a cash-out.
Pro — Leverage in hybrids. A combo product can turn a deposit into two to three times its value in tax-free LTC benefits.
Pro — Tax-free benefits. Qualifying LTC benefits paid later are generally income-tax-free under 7702B.
Pro — Repurposes idle money. It converts an annuity you don’t need into protection you likely will.
Pro — Heirs aren’t left out. Hybrid annuity/LTC products often return unused value as a death benefit.
Con — Health underwriting. You must medically qualify; poor health can block the move.
Con — Liquidity loss. Money committed to LTC coverage is far less accessible than in a plain annuity.
Con — The 180-day trap. Partial-exchange timing rules are strict and easy to violate.
Con — Qualified money excluded. IRA and 401(k) annuities can’t use this at all.
Con — Surrender charges. Exiting an old annuity early can cost real money.

What to Do Next

Pull your annuity statement and confirm in writing whether it’s qualified or non-qualified.
Decide your goal — stand-alone LTC (Path 1) or a hybrid annuity/LTC (Path 2).
Shop and apply for a 7702B-qualified product, and complete health underwriting.
Sign the 1035 form with the receiving carrier for a direct transfer — never a check to you.
Calendar every transfer date and avoid withdrawals for 180 days after each.
Call a professional if your annuity has a large gain, sits near a surrender deadline, or you’re funding via partial exchanges. A CPA confirms the tax treatment, and an insurance-licensed advisor structures the exchange. This article is educational and not a substitute for advice for your specific situation.

State Rules and Programs

Start federal, then check your state. The 1035 tax-free treatment is a federal rule, and most states with an income tax conform to it for the exchange itself. But states differ on whether they allow a deduction or credit for LTC premiums and on how they regulate LTC and hybrid products through their state insurance department. Never assume your state follows federal LTC tax rules — confirm with your state Department of Revenue.

Some states also have public LTC programs that change the calculus. Washington’s WA Cares Fund imposes a payroll tax to fund a limited state LTC benefit, and residents who own qualifying private LTC coverage could exempt out during set windows. The consequence of ignoring state rules is missing a deduction you’ve earned or buying coverage that doesn’t fit a state mandate. What to do: check your state’s LTC premium deduction and any state program before you finalize the exchange.

2026 Figures You Should Know

Two federal numbers frame LTC tax treatment for tax year 2026. First, the HIPAA per diem limit — the daily indemnity LTC benefit you can receive tax-free — is $430 per day for 2026, per the IRS inflation adjustments. Benefits above that (and above your actual care costs) become taxable.

Second, the age-based deduction limits for LTC premiums under Section 213(d), counted toward medical expenses above the 7.5% AGI floor, for 2026 are: $500 (age 40 or under), $930 (41–50), $1,860 (51–60), $4,960 (61–70), and $6,200 (71 and over). These caps matter mainly for premiums paid with out-of-pocket dollars; premiums funded through a 1035 exchange aren’t deducted because that money was never taxed in the first place.

Frequently Asked Questions

Can I 1035 exchange my annuity into long-term care insurance? Yes. Since January 1, 2010, the Pension Protection Act lets you exchange a non-qualified annuity tax-free into a tax-qualified LTC policy or a hybrid annuity/LTC product under Sections 1035 and 7702B.

Can I 1035 an IRA annuity into long-term care? No. Section 1035 covers only non-qualified annuities. An IRA or 401(k) annuity must be withdrawn as a taxable distribution, with a possible 10% penalty if you’re under 59½.

Can I exchange an annuity into a life insurance/LTC combo? No. The code only allows life-to-annuity, not annuity-to-life. Annuity money can fund a hybrid annuity/LTC product, but not a life-based one.

What is the 180-day rule? It’s a partial-exchange guardrail. Under Rev. Proc. 2011-38, you can’t take cash from either contract for 180 days after a partial transfer, unless paid as a 10-year-plus or lifetime annuity, or the exchange may be taxed.

Will I owe tax on the exchange? No, if done correctly. A direct insurer-to-insurer 1035 exchange into a 7702B contract recognizes no gain. Touching the cash yourself makes it a taxable surrender instead.

Are the long-term care benefits taxable later? Generally no. Benefits from a tax-qualified LTC contract are income-tax-free up to actual care costs, or up to the 2026 HIPAA per-diem limit of $430 per day for indemnity policies.

Do I need to be in good health? Yes, usually. Both stand-alone and hybrid LTC products require health underwriting. If you can’t qualify medically, the exchange can’t be completed.

What form reports a 1035 exchange? Form 1099-R. The old insurer issues it with distribution code “6,” signaling a tax-free 1035 exchange. Match it to your records so you aren’t taxed by error.

Can I do a partial exchange to pay annual premiums? Yes. Sending a fixed annual amount directly to a stand-alone LTC insurer is a partial 1035 exchange — just respect the 180-day no-withdrawal rule after each transfer.

How much can I deduct for LTC premiums in 2026? Up to $6,200. For tax year 2026, the age-based Section 213(d) cap ranges from $500 (under 40) to $6,200 (over 70), subject to the 7.5% AGI medical floor.

Does my state follow the federal 1035 rule? Usually for the exchange. Most income-tax states conform to the tax-free exchange, but state LTC premium deductions and programs vary. Confirm with your state Department of Revenue.

Can I reverse the exchange if I change my mind? No simple undo. Once funds move and the LTC contract is issued, reversing it can trigger surrender charges and tax. Use any free-look period to cancel early if needed.

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