An IRC Section 1035 tax-free exchange can avoid recognition of gain if a life insurance or annuity policy is replaced. However, the benefit of receiving a step-up in basis at death is lost if a 1035 exchange occurs.
The parents reduced their taxable income by $5,000 by using a tax-free exchange to avoid recognition of gain when they replaced their life insurance or annuity policy. Since the parents income was taxed at the 30% tax bracket, the income reduction may decrease their income taxes by $1,500 ($5,000 x 30%).
If you are in a combined (federal, self-employment, and state) tax bracket of 30%, you could reduce your taxes up to $300 for every $1,000 of income reduction by using a tax-free exchange to avoid recognition of gain when a life insurance or annuity policy is replaced.