Utah · Long-Term Care · Annuities & Life Insurance

1035 Exchange: Old Annuity to Long-Term Care (Utah 2026)

A great many Utah retirees are sitting on an annuity they bought in their fifties and have never touched, and on no plan at all for care. Since 2010 the tax code has let you move one into the other without recognizing a dollar of gain. Here is how that works, and what it costs you.

Utah Retirement Income Data Desk

Reviewed by Brian Penner, Retirement income & long-term care planner · Published September 14, 2026

The situation is common enough that it has a shape. A couple in Bountiful bought a deferred annuity in 1998 with money from a house sale. They never annuitized it, it is worth well more than they put in, and every time they think about cashing it out they hit the same wall: the entire gain would come out first and be taxed as ordinary income in a single year. Meanwhile neither of them has any long-term care coverage, and the U.S. Administration for Community Living estimates that about 70% of people turning 65 today will need some form of long-term care. Section 1035 of the Internal Revenue Code is the bridge between those two facts. This article explains what the rule permits, what it does not, what it costs in tax benefits given up, and the order of operations in Utah.

What is a 1035 exchange, and what changed in 2010?

Section 1035(a) says that no gain or loss is recognized on certain exchanges of insurance contracts. The idea is old and simple; the legislative history from 1954 describes it as appropriate for people who have “merely exchanged one insurance policy for another better suited to their needs.” For decades, though, a long-term care policy was not on the list of things you could exchange into.

Section 844(b) of the Pension Protection Act of 2006 changed that. It expanded the categories of tax-free exchanges to include exchanges involving a qualified long-term care insurance contract, and it amended section 1035(b) so that a contract does not stop being a life insurance or annuity contract merely because a qualified long-term care contract is part of it or a rider on it. IRS Notice 2011-68, the agency's interim guidance on the whole package, is explicit about timing: the amendments generally apply to contracts issued after December 31, 1996, but only for taxable years beginning after December 31, 2009, and the exchange amendments apply to exchanges occurring after December 31, 2009. In practice, 2010 is the start date.

Two related pieces arrived at the same time and matter just as much. Section 844(a) added IRC section 72(e)(11), which provides that a charge against the cash value of an annuity or the cash surrender value of a life insurance contract, made as payment for coverage under a qualified long-term care contract that is part of or a rider on it, is not includible in income — the investment in the contract is simply reduced, but not below zero. And section 844(d) added IRC section 6050U, requiring the insurer to report those charges to you and to the IRS. That is the origin of the Form 1099-R some policyholders receive with code W in box 7, which is informational and is not income.

Which contracts can be exchanged into what?

Notice 2011-68 lists the permitted categories in a single sentence, and it is worth reading as a table, because the arrows run one way. Value flows toward long-term care coverage; it never flows back out of it.

Exchange categories under IRC section 1035(a) as amended by section 844(b) of the Pension Protection Act of 2006. The last row is not a section 1035 limitation as such — qualified retirement money is governed by the retirement-plan rules instead. Source: IRS Notice 2011-68, section 3.04 — irs.gov (PDF).

Three consequences follow. You cannot exchange an annuity into life insurance, so a retiree hoping to turn an old annuity into a death benefit has to look at a combination product rather than a bare 1035. You cannot exchange a long-term care contract into an annuity or life policy if you change your mind — only into another long-term care contract. And nothing in section 1035 reaches an IRA or a 401(k). If the annuity you are looking at was bought inside a retirement account, this article is not your route; see our guide to the long-term care medical expense deduction in Utah for the narrow retirement-plan option that opened in 2026.

Can you exchange only part of an annuity?

Usually, yes, and this is what makes the rule practical rather than theoretical. Long-term care premiums are typically paid annually over many years, not in one lump. Notice 2011-68 says that just as the direct transfer of a portion of the cash surrender value of an existing deferred annuity for a second annuity may be treated as a tax-free exchange, the direct transfer of a portion of the cash surrender value of a deferred annuity for a qualified long-term care insurance contract may also be treated as tax-free, provided the other requirements of section 1035 are met. The Notice points to Revenue Procedure 2011-38 for the conditions on partial annuity exchanges.

The Notice also flags the way people accidentally break it. Revenue Ruling 2007-24 held that receiving a check under a non-qualified annuity contract and endorsing it over to a second company as consideration for a second contract is a distribution under section 72(e), not a tax-free exchange. The money must move insurer to insurer. If a check with your name on it ever touches your hands, the exchange is gone and the gain is taxable. Use the receiving carrier's 1035 transfer paperwork and let the two companies do it directly.

What does the tax break actually save, and what does it cost?

Put the same dollar of old annuity cash value through three doors and watch what happens to it.

General federal treatment; your own result depends on facts this table cannot know. Sources: IRC sections 72, 213, 1031(d) and 1035 — 26 U.S.C. 1035, 26 U.S.C. 213; IRS Notice 2011-68 — irs.gov (PDF); Instructions for Forms 1099-R and 5498 — irs.gov. Educational only, not tax advice.

Sources: IRS Notice 2011-68 — irs.gov; IRS Rev. Proc. 2025-32, section 4.27 — irs.gov; CareScout Cost of Care Survey 2024, Utah — carescout.com.

Notice the third column. Congress did not hand out both benefits. Section 213(d) denies a medical expense deduction under section 213(a) for a payment for qualified long-term care coverage made as a charge against the cash surrender value of a life insurance contract, and the same principle runs through the 1035 route: dollars that were never taxed on the way in cannot also be deducted on the way out. For many Utah retirees the honest comparison is not deduction versus exclusion but deduction versus nothing, because the medical expense deduction requires itemizing and clearing a floor of 7.5% of adjusted gross income, which a retired couple may never reach in an ordinary year. Here is the cap you would be setting aside:

Per insured person, for premiums paid with ordinary after-tax money and claimed as an itemized medical expense subject to the 7.5%-of-AGI floor. Source: IRS Rev. Proc. 2025-32, section 4.27 — irs.gov (PDF).

What is the coverage worth against real Utah prices?

The reason any of this is worth the paperwork is the size of the bill it is aimed at. Utah is not a cheap-care state. Statewide medians from the CareScout (Genworth) Cost of Care Survey 2024 run from about $4,685 a month for assisted living to roughly $10,646 a month for a private nursing home room — and Medicare does not pay for ongoing custodial care at any of these levels, a point we cover in does Medicare pay for long-term care in Utah. All 488,797 Utahns on Medicare face the same gap.

Median annual cost of care in Utah, 2024. Source: CareScout (Genworth) Cost of Care Survey 2024 — carescout.com/cost-of-care. Survey medians, not quotes, and not a prediction of your own cost.

Against those numbers, a benefit paid as a fixed per diem rather than as reimbursement has its own ceiling. For 2026 the per diem limitation under IRC section 7702B(d)(4) is $430 a day, up from $420 in 2025. Per diem payments above that are excludable only to the extent of your actual care costs. A reimbursement-style policy that pays actual expenses is not constrained in the same way.

What do you give up besides the deduction?

Liquidity, and you should sit with that before signing anything. IRC section 7702B(b) defines a qualified long-term care insurance contract as one that provides protection only for qualified long-term care services, is guaranteed renewable, does not provide for a cash surrender value, and permits premium refunds or policyholder dividends to be applied only as a reduction in future premiums or an increase in future benefits. Section 7702B(b)(2)(C) allows a refund of premiums on a complete surrender or cancellation, capped at the aggregate premiums paid, and Notice 2011-68 adds that such a refund is includible in gross income to the extent any deduction or exclusion was allowed for those premiums.

So the trade is real: you are converting a liquid, if tax-encumbered, asset into insurance that pays only if you need care and meet the benefit trigger — generally an inability to perform at least two activities of daily living for an expected 90 days, or severe cognitive impairment, the standard Utah applies through R590-148. Alongside that, weigh the surrender charge on the old contract (our guide to annuity surrender charges and fees under Utah rules walks through the schedules) and any income rider, enhanced death benefit or grandfathered guarantee you would be walking away from. A rider you paid for over twenty years is not free to abandon.

How does this work in Utah, step by step?

1. Pull the old contract's numbers first. Ask the current insurer, in writing, for the current cash surrender value, the cost basis (investment in the contract), the remaining surrender charge, and confirmation that the contract is non-qualified. If it sits inside an IRA or an employer plan, stop here — section 1035 does not apply.
2. Apply for the new coverage before you touch anything. A 1035 exchange is a tax rule, not an approval. Long-term care coverage is medically underwritten, and health questions in your seventies are not a formality. Never surrender, lapse, or stop paying an existing policy until the new contract has actually been issued.
3. Ask whether it is a Utah Partnership policy. A qualifying Utah Long-Term Care Partnership policy earns a dollar-for-dollar Medicaid asset disregard later. See our guide to the Utah Long-Term Care Partnership program.
4. Insist on a direct, insurer-to-insurer transfer. Use the receiving carrier's 1035 exchange form and get written confirmation that it will accept and report the funds as a section 1035 exchange — and as a partial exchange if that is what you are doing. Do not accept a check.
5. Read the replacement notice. Utah Administrative Code R590-93 governs the replacement of life insurance and annuities, requires the producer and insurer to give you a replacement notice no later than the time of application, and sets a 30-day free look on a replacement. Keep your copy.
6. Use the 30-day right to return. Long-term care policies sold in Utah come with a 30-day period in which you can return the policy. Read the issued contract, not the illustration — the benefit amount, the elimination period, the inflation option, and the benefit trigger language.
7. Match the inflation option to the timeline. If care is twenty years away, a level benefit will have lost much of its purchasing power against the cost curve above. Our guide to long-term care inflation riders in Utah compares the common choices.
8. Keep the paperwork for your tax preparer. Expect a Form 1099-R, and remember that the box 7 code matters: code W reports a charge excluded under section 72(e)(11) and is informational, while a section 1035 exchange is generally reported with code 6. Hand both to whoever prepares your return, and question anything that looks like a taxable distribution.
9. Ask questions of a party with no commission. The Utah Insurance Department takes consumer questions and complaints at (801) 957-9200 or (800) 439-3805, and can confirm whether a producer and a company are licensed in Utah.

Who is this a good fit for, and who should skip it?

It tends to fit someone who holds a non-qualified annuity with substantial embedded gain that they do not intend to annuitize, who has no long-term care coverage, who is still healthy enough to be underwritten, and who has other liquid assets so that converting this particular pot into insurance does not strand them. The gain problem is the whole point: the money is trapped behind an ordinary-income tax bill, and this is one of the few doors out of it that also solves a second problem at the same time.

It tends not to fit someone who may need that cash for anything else, someone whose health makes approval unlikely, someone whose annuity carries a rich income or death-benefit guarantee that a replacement cannot match, someone still inside a steep surrender schedule, or someone whose annuity is qualified money. It is also the wrong tool if what you actually want is a death benefit rather than care coverage — an annuity cannot be exchanged into life insurance, and the alternative to look at is a combination contract, which we cover in hybrid life and long-term care insurance in Utah.

Frequently asked questions

Sources

• IRS — Notice 2011-68, Annuity and Life Insurance Contracts with a Long-Term Care Insurance Feature (Pension Protection Act section 844 amendments to IRC 72, 1035 and 7702B; permitted exchange categories at section 3.04; partial exchanges and Rev. Rul. 2007-24 at 3.05; basis carryover under IRC 1031(d) at 3.06; section 6050U reporting at 3.08; 7.7% DAC rate at 3.09; effective dates at 3.10): irs.gov — Notice 2011-68 (PDF)
• IRS — Rev. Proc. 2025-32, section 4.27 (2026 eligible long-term care premium limits by attained age; IRC 7702B(d)(4) per diem limitation of $430 for 2026): irs.gov — Rev. Proc. 2025-32 (PDF)
• 26 U.S.C. 1035 — Certain exchanges of insurance policies: law.cornell.edu — 26 U.S.C. 1035
• 26 U.S.C. 7702B — Treatment of qualified long-term care insurance (definition of a qualified contract, no cash surrender value, premium refund rule, per diem limitation): uscode.house.gov — 26 U.S.C. 7702B
• 26 U.S.C. 213 — Medical, dental, etc., expenses (the 7.5%-of-AGI floor; long-term care premium treatment; denial of a deduction for coverage charged against a life contract's cash surrender value): law.cornell.edu — 26 U.S.C. 213
• IRS — Instructions for Forms 1099-R and 5498 (box 7 distribution codes, including code W for charges excluded under section 72(e)(11) and code 6 for section 1035 exchanges): irs.gov — 1099-R instructions
• Utah Insurance Department — Long-Term Care Insurance consumer page (Utah standards, the 30-day right to return, consumer services at (801) 957-9200 or (800) 439-3805): insurance.utah.gov
• Utah Administrative Code R590-148 — Long-Term Care Insurance Rule (benefit trigger standards for qualified contracts, minimum standards, right to return): adminrules.utah.gov — R590-148
• Utah Administrative Code R590-93 — Replacement of Life Insurance and Annuities (duties of the replacing and existing insurers; replacement notice at application): law.cornell.edu — Utah Admin. Code R590-93
• U.S. Administration for Community Living — How Much Care Will You Need? (about 70% of people turning 65 will need some long-term care): acl.gov/ltc
• CareScout (Genworth) — Cost of Care Survey 2024, Utah medians: carescout.com/cost-of-care
• CMS — Medicare Monthly Enrollment, Utah, May 2026: data.cms.gov

About this article. Written by the Utah Retirement Income Data Desk and reviewed by Brian Penner, Retirement income & long-term care planner. This is educational information about published federal tax rules and Utah insurance rules — it is not tax, legal, or financial advice, not a recommendation to buy, keep, surrender, or replace any policy or annuity, and not a substitute for a licensed tax professional and a careful review of the contract you already own. Whether a particular exchange qualifies under section 1035 depends on facts we do not know, including the contract form, its ownership and annuitant, its qualified or non-qualified status, and how the two insurers process the transfer. Cost-of-care figures are 2024 statewide survey medians, not quotes and not a prediction of what your care will cost. Replacing an existing policy or annuity can result in surrender charges, a new surrender period, loss of existing guarantees or riders, and new underwriting, and it is not suitable for everyone. Insurance and annuity guarantees are subject to the claims-paying ability of the issuing company; there are no guaranteed investment returns and no promise of tax savings. Rules change — confirm current figures with the IRS and with the Utah Insurance Department at (801) 957-9200 or (800) 439-3805 before acting. Utah Retirement Income is a licensed independent insurance agency (NPN 16493717). We do not offer every product available in your area, and we are not a government agency — we are not connected with or endorsed by the IRS, the Utah Insurance Department, Utah Medicaid, the Centers for Medicare & Medicaid Services, the Social Security Administration, or the federal Medicare program. If you call or text us, you consent to be contacted about your request; message and data rates may apply, and you can opt out at any time by replying STOP.