Photo: Nenad Stojkovic / Wikimedia Commons, CC BY 2.0.
Picture a 71-year-old who has paid into a whole life policy for decades. The kids are grown, the mortgage is gone, and nobody really needs the death benefit anymore. Stopping the premiums and cashing the thing out feels like the obvious move.
It may not be. A scenario laid out by 24/7 Wall St. on Oct. 29, 2026 walks through why. Cash out, and part of that money can count as ordinary income on your tax return. Move the same money directly into qualified long-term care coverage, and federal tax law lets you skip the bill.
Why cashing out can cost more than you expect
When you surrender a policy, the insurer compares what you get back with your “investment in the contract,” which is roughly the premiums you paid minus any tax-free money you already took out. Anything above that line is taxed as ordinary income, and the insurer reports it on a Form 1099-R.
Policy loans make this worse. As 24/7 Wall St. explains, you pay off an outstanding loan from the cash value at surrender. You might get a small check in the mail while the 1099-R shows a much larger taxable amount.
There’s a second bill that retirees often miss. Medicare Part B premiums rise once your income crosses certain lines. For 2026, CMS says the standard premium is $202.90 a month for people with modified adjusted gross income up to $109,000 (single) or $218,000 (married filing jointly). Just above that, single filers pay $284.10. Medicare looks back two years, so 2026 premiums are based on 2024 tax returns. A large taxable surrender this year could raise your premiums two years from now. The dollar thresholds for that year haven’t been set yet.
What a 1035 exchange actually does
Section 1035 of the tax code says no gain or loss is recognized on the exchange of “a contract of life insurance for another contract of life insurance or for an endowment or annuity contract or for a qualified long-term care insurance contract.” The Pension Protection Act of 2006 added that last option, and it applies to exchanges made after Dec. 31, 2009, according to the statute and its notes.
The gain inside your old policy moves into the new long-term care contract without being taxed. Your cost basis carries over. Under Section 7702B, benefits paid by a qualified long-term care contract are generally treated as reimbursement for medical care, so they’re usually tax-free. Policies that pay a flat daily amount are subject to a per-day cap that’s adjusted for inflation.
The rules are strict, though. Per 24/7 Wall St., the money has to go directly from one insurer to the other. If a check passes through your hands, or if you take any cash out as part of the swap, that cash is taxable. The insured person generally has to stay the same, and usually the owner does too.
The catches
- Underwriting. Long-term care coverage usually requires medical approval. At 71, a health history can mean a higher price or a flat no. Get approved before you touch the old policy.
- Surrender charges. Some older policies still carry them. Ask.
- Premium increases. Traditional long-term care policies can raise premiums later. 24/7 Wall St. notes that hybrid products can be funded with a single lump sum instead.
- The death benefit goes away. Once the old policy is exchanged, there’s no payout to heirs from it. If someone still depends on that money, this isn’t your move.
Where DFN stands
We’ve said it many times: for most families, buying term insurance and investing the difference beats whole life. So if you’re holding a whole life policy you no longer need, getting out is a reasonable goal. The question is how to get out without handing a chunk to the IRS.
Be careful, though, that the exit doesn’t lead you into another expensive product. Some “hybrid” long-term care products are built on a life insurance or annuity chassis with their own fees. Ask for every cost in writing and compare them side by side with a standalone qualified long-term care policy.
A 1035 exchange isn’t the only option, either. 24/7 Wall St. lists two others. You can convert to a reduced paid-up policy, which stops premiums but keeps a smaller death benefit. Or you can sell the policy in a life settlement, which the article notes is taxed like a sale of property. And if your gain is small, a plain surrender may be fine.
What to ask your insurer, in writing
Before deciding anything, get three numbers from the company, in writing:
- Your investment in the contract (your cost basis)
- The current cash surrender value
- Any outstanding loan balance, including accrued interest
Those three numbers tell you roughly how much of a surrender would be taxable. Bring them to a tax preparer, and ask a long-term care carrier whether you’d qualify before you start an exchange.
The Bottom Line
If you’re ready to quit a whole life policy, don’t cash it out on autopilot. A 1035 exchange into qualified long-term care coverage can move the gain tax-free and may help you avoid a Medicare premium bump down the road. Get the numbers, get approved for the new coverage first, and make sure the money moves insurer to insurer.
Sources and Further Reading
- 24/7 Wall St., “At 71, He’ll Stop Paying on a Whole Life Policy He No Longer Needs” (Oct. 29, 2026)
- 26 U.S. Code § 1035, Certain exchanges of insurance policies (Cornell LII)
- 26 U.S. Code § 7702B, Treatment of qualified long-term care insurance (Cornell LII)
- IRS Notice 2011-68
- CMS, 2026 Medicare Parts A and B Premiums and Deductibles
- Medicare.gov, Medicare Costs (2026)
- Photo: Nenad Stojkovic, Wikimedia Commons, CC BY 2.0